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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

OR

For the Fiscal Year Ended August 31, 1999

Commission File Number 0-18859

SONIC CORP.

(Exact Name of Registrant as Specified in Its Charter)

Registrant's Telephone Number, Including Area Code: (405) 280-7654

Securities Registered Pursuant to Section 12(b) of the Exchange Act:

None

Securities Registered Pursuant to Section 12(g) of the Exchange Act:

Common Stock, Par Value $.01

Rights to Purchase Series A Junior Preferred Stock, Par Value $.01

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

    Indicate by check mark if this Form 10-K does not contain and, to the best of the Registrant's knowledge, the Registrant's definitive proxy statement or information statement incorporated by reference in Part III of this Form 10-K will not contain a disclosure of delinquent filers pursuant to Item 405 of Regulation S-K. YES /x/  No / /

    As of November 10, 1999, the aggregate market value of the 17,006,966 shares of common stock of the Company held by non-affiliates of the Company equaled approximately $440 million, based on the closing sales price for the common stock as reported for that date. As of November 10, 1999, the Registrant had 18,337,586 shares of common stock issued and outstanding (excluding 2,408,876 shares of common stock held as treasury stock).

(Facing Sheet Continued)

Documents Incorporated by Reference

    Part III of this report incorporates by reference certain portions of the definitive proxy statement which the Registrant will file with the Securities and Exchange Commission in connection with the Company's annual meeting of stockholders following the fiscal year ended August 31, 1999.

FORM 10-K OF SONIC CORP.

TABLE OF CONTENTS

FORM 10-K

SONIC CORP.

PART I

Item 1. Business

General

    Sonic Corp. (the "Company") operates and franchises the largest chain of drive-in restaurants in the United States. As of August 31, 1999, the Company had 2,011 restaurants in operation, consisting of 296 Company-owned restaurants and 1,715 franchised restaurants, principally in the south central and southeastern United States. Sonic restaurants offer made-to-order hamburgers and other sandwiches and feature Sonic signature items, such as extra-long cheese coneys, hand-battered onion rings, tater tots, specialty soft drinks, including cherry limeades and slushes, and frozen desserts. At a typical Sonic restaurant, a customer drives into one of 24 to 36 covered drive-in spaces, orders through an intercom speaker system, and has the food delivered by a carhop within an average of four minutes.

    In September of 1995, the Company reorganized its operating subsidiaries into two, directly-held subsidiaries consisting of Sonic Industries Inc. and Sonic Restaurants, Inc. Sonic Industries Inc. serves as the franchisor of the Sonic restaurant chain, as well as the administrative services center for the Company. Sonic Restaurants, Inc. develops and operates the Company's Company-owned restaurants. In February of 1996, the Company sold its equipment sales division to N. Wasserstrom & Sons, Inc. of Columbus, Ohio, and discontinued that line of business.

    The Company's objective is to maintain its position as, or to become, a leading operator in terms of the number of quick-service restaurants within each of its core and developing markets. The Company has developed and is implementing a strategy designed to build the Sonic brand and to continue to achieve high levels of customer satisfaction and repeat business. The key elements of that strategy are (1) a unique drive-in concept focusing on a menu of quality made-to-order and signature food items; (2) a commitment to customer service featuring the quick delivery of food by carhops; (3) the expansion of Company-owned and franchised restaurants within the Company's core and developing markets; (4) an owner/operator philosophy, in which managers have an equity interest in their restaurant, thereby providing an incentive for managers to operate Company-owned restaurants profitably and efficiently; and (5) a commitment to support the Sonic system.

    The Company has its principal executive offices at 101 Park Avenue, Oklahoma City, Oklahoma 73102. Its telephone number is (405) 280-7654. As used in this report, the word "Company" means Sonic Corp. and each of its subsidiaries and predecessors, unless the context indicates otherwise.

Restaurant Locations

    As of August 31, 1999, the Company owned or franchised 2,011 drive-in restaurants, principally in the south central and southeastern United States. The Company's core markets, consisting of the nine contiguous states of Texas, Oklahoma, Tennessee, Missouri, Arkansas, Kansas, Louisiana, Mississippi, and New Mexico, contained approximately 79% of all Sonic restaurants as of August 31, 1999. Developing markets primarily are located in Alabama, Arizona, Colorado, Florida, Georgia, Kentucky, North Carolina, South Carolina, and Virginia. The following table sets forth the number of Company-owned and franchised restaurants by core and developing markets as of August 31, 1999:

Expansion

    During fiscal 1999, the Company opened 37 Company-owned restaurants and its franchisees opened 139 restaurants. During fiscal 2000, the Company plans to open approximately 35 Company-owned restaurants and anticipates that its franchisees will open at least 140 restaurants. That expansion plan involves the opening of new restaurants by franchisees under existing area development agreements, single-store development by existing franchisees, and development by new franchisees. The Company believes that its existing core and developing markets offer a significant growth opportunity for both Company-owned and franchised restaurant expansion. However, the ability of the Company and its franchisees to open the anticipated number of Sonic drive-in restaurants during fiscal 2000 necessarily will depend on various factors. Those factors include (among others) the availability of suitable sites, the negotiation of acceptable lease or purchase terms for new locations, local permitting and regulatory compliance, the financial resources of the Company and the Company's franchisees, and the general economic and business conditions to be faced in fiscal 2000.

    The Company's expansion strategy for Company-owned restaurants involves two principal components: (1) the building-out of existing core markets and (2) the further penetration of developing markets. In addition, the Company may consider the acquisition of other similar concepts for conversion to Sonic restaurants.

Restaurant Design and Construction

    General.  The typical Sonic drive-in restaurant consists of a kitchen housed in a one-story building flanked by two canopy-covered rows of 24 to 36 parking spaces, with each space having its own intercom speaker system and menu board. In addition, since the first half of fiscal 1995, the Company has incorporated a drive-through service and patio seating area in most new restaurants. A few Sonic restaurants provide an indoor seating area.

    Retrofit Program.  In fiscal 1997, the Company began implementing a remodeling program to retrofit all Sonic drive-in restaurants. The retrofit includes new signage, new menu and speaker housings, and significant trade dress modifications to the exterior of each restaurant's building. The Company currently estimates the cost to make a standard retrofit at approximately $58,000 to $70,000 per restaurant. The Company implemented the program on a market-by-market basis, and anticipates 100% completion of the retrofit program for Company-owned restaurants, and 90% completion for franchised restaurants by August 31, 2000. In addition, all new restaurants being built in all markets now feature the new retrofit signage and trade dress style. As of August 31, 1999, there were 287 retrofitted Company-owned restaurants and 1,091 retrofitted franchised restaurants, which together total more than two-thirds of all Sonic restaurants.

Marketing

    The Company has designed its marketing program to differentiate Sonic drive-in restaurants from the Company's competitors by emphasizing five key areas of customer satisfaction: (1) the personal manner of service by carhops, (2) made-to-order menu items, (3) speed of service, (4) quality, and (5) value. The marketing plan includes monthly promotions for use throughout the Sonic chain. The Company supports those promotions with television and radio commercials and point-of-sale materials. Those promotions center on a "meal deal" which highlights signature menu items of Sonic drive-in restaurants.

    Each year the Company and its advertising agency (with involvement of the Sonic Franchise Advisory Council) develop a marketing plan. The Company requires the formation of advertising cooperatives among restaurant owners to pool and direct advertising expenditures in local markets. Under each of the Company's license agreements, the franchisee must contribute a minimum percentage of the franchisee's gross revenues to a national media production fund and spend an additional minimum percentage of gross revenues on local advertising, either directly or through the Company-required participation in advertising cooperatives. Depending on the type of license agreement, the minimum percentages of gross revenues contributed by franchisees for local advertising cooperative funds range from 1.125% to 3.25% and, for the Sonic Advertising Fund (the national fund directed by the Company), the franchisees contribute a range of 0.375% to 0.75% of gross revenues. Franchisees may elect and frequently do elect to contribute more than the minimum percentage of gross revenues to their local advertising cooperative funds. In 1999, Sonic restaurant owners approved the establishment of a System Marketing Fund to be effective as of January 1, 2000. The purpose of this fund is to complement local advertising efforts in attracting customers to Sonic restaurants by exposing the message of the Sonic brand to a new audience. The primary focus of the fund will be to purchase advertising on national cable networks such as USA, TBS, TNT, ESPN, ESPN 2 and CMT. The System Marketing Fund will be funded by 0.5% of each franchisee's gross revenues, which amount will be redistributed to the fund from the franchisee's local advertising fund contribution.

    For fiscal 1999, franchisees participating in cooperatives contributed an average of 3.32% of gross revenues to Sonic advertising cooperatives, exceeding the required 2.375% under most license agreements in effect during that period. As of August 31, 1999, 2,009 Sonic restaurants (99.9% of the chain) participated in advertising cooperatives. The Company estimates that the total amount spent on media (principally television) exceeded $54 million for fiscal 1999 and is expected to exceed $64 million for fiscal 2000.

Purchasing

    The Company negotiates with suppliers for its primary food products (hamburger patties, dairy products, hot dogs, french fries, tater tots, cooking oil, fountain syrup, and other products) and packaging supplies to ensure adequate quantities of food and supplies and to obtain competitive prices. The Company seeks competitive bids from suppliers on many of its food products. The Company approves suppliers of those products and requires them to adhere to product specifications established by the Company. Suppliers manufacture several key products for the Company under private label and sell them to authorized distributors for resale to Company-owned and franchised restaurants. The Company and its franchisees purchase a majority of their food and beverage products from authorized local or national distributors.

    The Company requires its Company-owned and franchised restaurants to participate in purchasing cooperatives. Those cooperatives have achieved cost savings, improved food quality and consistency, and helped decrease the volatility of food and supply costs for Sonic restaurants. For fiscal 1999, the average cost of food and packaging for a Sonic restaurant, as reported to the Company by its franchisees, equaled approximately 28% of revenues. The Company believes that food purchasing cooperatives have allowed Sonic restaurants to avoid menu price increases that otherwise might have occurred. The reduction in the number of food and paper product distributors to the Sonic chain over the past few years has improved the ability of the Company to negotiate more advantageous purchasing terms and to maintain more uniform products.

Company Operations

    Ownership Program.  The Sonic restaurant philosophy stresses an ownership relationship with supervisors and managers. Most supervisors and managers of Company-owned and franchised restaurants own an equity interest in the restaurant. The Company believes that its ownership structure provides a substantial incentive for restaurant managers and supervisors to operate their restaurants profitably and efficiently.

    Under the ownership program, a separate limited liability company or general partnership owns and operates each Company-owned restaurant. As members of the limited liability company or partners of the general partnership, the Company owns a majority interest and the managers and supervisors own a minority interest in the restaurant. Ownership equity of a typical established Company-owned restaurant generally is distributed 60% to the Company, up to 20% to the manager, and up to 20% to the supervisor. The Company records other members' or partners' interests as a minority interest in earnings of restaurants on its financial statements. Under the standard operating agreement or partnership agreement, the Company has the right to purchase the interest of any other manager or supervisor on short notice. Each supervisor and manager contributes his or her pro rata portion of all start-up costs, which include the required franchise fee, opening inventory, advertising and promotion costs, initial training and insurance costs, and some amounts for working capital. The amount of capital contribution by a supervisor and manager for a restaurant typically equals approximately $10,000 for a 20% interest. Each restaurant usually purchases equipment with funds borrowed from the Company at competitive rates. In most cases, the Company alone guarantees any third-party lease entered into for the site. The restaurants distribute available cash flow to the supervisors or partners on a monthly basis pursuant to the terms of the operating agreements or partnership agreements.

    Restaurant Personnel. A typical Sonic restaurant is operated by a manager, two assistant managers, and approximately 25 hourly employees, many of whom work part-time. The manager has responsibility for the day-to-day operations of the restaurant.

    Each supervisor has the responsibility of overseeing an average of four to six Company-owned restaurants. Those supervisors derive their income out of their share of the available cash flow of the restaurants they supervise.

    The Company also employs nine Directors of Operations who oversee supervisors within their respective regions and three Regional Vice Presidents who oversee the Directors of Operations. The Company employs a Vice President of Operations based in Oklahoma City who oversees the operations of all Company-owned restaurants.

    Point-of-Sale Systems.  The Company is currently in the final installation phase of a planned software enhancement for the point-of-sale systems in Company-owned restaurants. The software enhancement includes added store management tools as well as expanded polling capabilities. The polling features allow the Company to integrate centrally maintained product and promotion information and also support the collection of store-level sales information.

    Hours of Operation.  Sonic restaurants operate seven days a week, typically from 10:30 a.m. to 11:00 p.m.

    Company-owned Restaurant Data.  The following table provides certain financial information relating to Company-owned restaurants and the number of Company-owned restaurants opened and closed during the past five fiscal years.

Franchise Program

    General.  During its more than 40 years in operation, the Sonic system has produced a large number of successful multi-unit franchisee groups. Those franchisees continue to develop new restaurants in their franchise territories either through area development agreements or single site development. The Company considers its franchisees a vital part of the Company's continued growth and believes its relationship with its franchisees is good.

    As of August 31, 1999, the Company had 1,715 franchised restaurants operating in 27 states and the Company had entered into area development agreements which contemplate the opening of 86 additional restaurants during fiscal 2000. However, the Company cannot give any assurance that the Company's franchisees will achieve that number of new restaurants for fiscal 2000. During fiscal 1999, the Company's franchisees opened 74 Sonic drive-in restaurants pursuant to existing area development agreements.

    Franchise Agreements.  Each Sonic restaurant, including each Company-owned restaurant, operates under a franchise agreement that provides for payments to the Company of an initial franchise fee and a royalty fee based on a graduated percentage of the gross revenues of the restaurant. In September of 1994, the Company began offering a Number 6 License Agreement, which provides for a franchise fee of $30,000 and an ascending royalty rate beginning at 1.0% of gross revenues and increasing to 5.0% as the level of gross revenues increases. In September of 1998, the Company began offering a Number 6A License Agreement, which provides for the same fees and other general terms of the Number 6 License Agreement, but also provides for mutual rights and obligations between the Company and the franchisees in the event the Company acquires operating restaurants or development sites within a franchisee's protected territory or desires to develop non-traditional restaurant locations within a protected territory. The Number 6A License Agreement requires the Company to offer the franchisee a right of first refusal to acquire the restaurant or site from the Company at its cost with the requirement to convert the restaurant or develop the site into a Sonic restaurant pursuant to the terms of the then current license agreement. Approximately 60% of all Sonic restaurants opening in fiscal year 2000 are expected to open under the Number 6 or Number 6A License Agreement. Pursuant to the terms of existing area development agreements and the outstanding license option agreements described below, approximately 40% of all Sonic restaurants opening in fiscal 2000 will open under either the Number 5 License Agreement or the Number 5.1 License Agreement. Those agreements each provide for a franchisee fee of $15,000 and an ascending royalty rate beginning at 1.0% of gross revenues and increasing to 4.0% as the level of gross revenues increases. For fiscal 1999, the Company's average royalty rate equaled 2.96%. The Number 5 License Agreement provides for a term of 15 years, with an option to renew pursuant to the terms of the then current license agreement. The Number 5.1 License Agreement, the Number 6 License Agreement and the Number 6A License Agreement provide for a term of 20 years, with one 10-year renewal option. The Company has the right to terminate any franchise agreement for a variety of reasons, including a franchisee's failure to make payments when due or failure to adhere to the Company's policies and standards. Many state franchise laws limit the ability of the Company to terminate or refuse to renew a franchise.

    Because of the graduated percentage royalty rates set forth in the license agreements, in fiscal year 1999, six franchised restaurants formerly operating under the Number 4.2 License Agreement had their royalty rates increase to the same rate as the Number 5 License Agreement rate. Beginning in fiscal year 2000 and continuing through fiscal year 2010, a total of 654 additional franchised restaurants currently operating under the Number 4.2 License Agreement will have their royalty rates increase to the same rate as the Number 5 License Agreement rate. Also, beginning in fiscal year 2000 and continuing through fiscal year 2010, the terms of the remaining Number 4 License Agreements will expire and the licensed restaurants either will cease operations or renew their licenses pursuant to the terms of the then current license agreement (currently the Number 6A License Agreement). The Company expects that the automatic conversion of the Number 4.2 License Agreements and the renewals of the expiring Number 4 License Agreements will result in an incremental increase in the Company's royalty revenues attributable to the change in royalty rate. For the five-year period beginning in fiscal year 2000, the Company expects that process to generate in excess of $10 million in incremental royalty revenue, which will build in a stair-stepped fashion. The actual amount of revenue will depend on a number of factors, including (among others) the average unit volumes of the affected restaurants and the extent to which the expiring Number 4 License Agreements in fact renew and convert to the Number 6A License Agreement.

    In July of 1998, the Company gave franchisees operating under a Number 1, 4, 4.1 or 5 License Agreement an opportunity to convert the franchisee's agreement to a Number 5.2 License Agreement, effective as of January 1, 1999. The Number 5.2 License Agreement allowed the franchisee with an expiring license agreement the opportunity to elect to renew prior to the actual expiration date and accept the terms of the then current Number 6 License Agreement. The franchisee paid a $1,000 conversion franchisee fee and a higher royalty rate from the time of conversion through the expiration date of the franchisee's original license agreement. Upon the expiration of the original term of the franchisee's license agreement, the Number 5.2 License Agreement will shift the royalty rate to the Number 6 License Agreement royalty schedule. Approximately 137 Number 1, 4, 4.1 and 5 License Agreements were converted to the Number 5.2 License Agreement.

    Area Development Agreements.  The Company uses area development agreements to facilitate the planned expansion of the Sonic drive-in restaurant chain through multiple unit development. While existing franchisees continue to expand on a single restaurant basis, approximately 54.6% of the new franchised restaurants opened during fiscal 1999 occurred as a result of then-existing area development agreements. Each area development agreement gives a developer the exclusive right to construct, own and operate Sonic restaurants within a defined area. In exchange, each developer agrees to open a minimum number of Sonic restaurants in the area within a prescribed time period. If the developer does not meet the minimum opening requirements, the Company has the right to terminate the area development agreement and grant a new area development agreement to other franchisees for the area previously covered by the terminated area development agreement.

    During fiscal 1999, the Company entered into 25 new area development agreements calling for the opening of 144 Sonic drive-in restaurants during the next five years. As of August 31, 1999, the Company had a total of 80 area development agreements in effect, calling for the development of 365 additional Sonic drive-in restaurants during the next six years. Of the 78 restaurants scheduled to open during fiscal 1999 under area development agreements in place at the beginning of that fiscal year, 66 (or 84.6%) opened during the period.

    Realization by the Company of the expected benefits under various existing and future area development agreements currently depends and will continue to depend upon the ability of franchisees to open the minimum number of restaurants within the time periods required by the agreements. The financial resources of the developers, as well as their experience in managing quick-service restaurant franchises, represent critical factors in the success of area development agreements. Although the Company grants area development agreements only to those developers whom the Company believes possess those qualities, the Company cannot give any assurances that the future performance by developers will result in the opening of the minimum number of restaurants contemplated by the area development agreements or reach the compliance rate previously experienced by the Company.

    Option Agreements.  In connection with the Company's introduction of a new Number 6 License Agreement in fiscal 1995, the Company offered its existing franchisees the opportunity to acquire options to purchase the Number 5.1 License Agreement for new Sonic drive-in restaurants developed by the franchisee (the "Number 5.1 Options"). The Number 5.1 License Agreement has a lower initial franchise fee and royalty rate than the Number 6 License Agreement. All outstanding Number 5.1 Options have terms ending on December 31, 1999, with the right to renew for one additional year upon the payment of $1,000 by December 31, 1999. Unlike the area development agreements described above, the options do not cover any specific location. The Company currently is not offering additional option agreements to its franchisees and, as the options expire or the franchisees exercise them, the number of outstanding options will decrease over time. As of August 31, 1999, the Company had 74 Number 5.1 Options outstanding.

    Franchised Restaurant Development.  The Company furnishes each franchisee with assistance in selecting sites and developing restaurants. Each franchisee has responsibility for selecting the franchisee's restaurant locations but must obtain Company approval of each restaurant design and each location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age, and traffic. The Company provides its franchisees with the physical specifications for the typical Sonic drive-in restaurants.

    Franchisee Financing.  The Company has entered into an agreement with Franchise Finance Company of America ("FFCA"), pursuant to which FFCA may make loans to Sonic franchisees who meet certain underwriting criteria set by FFCA. Under the terms of the agreement with FFCA, the Company may provide a guaranty of 10% of the outstanding balance of a loan from FFCA to a Sonic franchisee. The Company retains the absolute right to determine which loans it will guarantee and to impose any conditions the Company may deem appropriate.

    The Company also has entered into agreements with Federated Capital Corporation Company ("FCC"), Bank of America, N.A. ("Bank of America"), and STI Credit Corporation ("Sun Trust"), pursuant to which each of those lenders may provide financing for the Company's franchisees to implement the retrofit of their existing restaurants. Under the terms of those agreements, the Company has given FCC a limited guaranty of up to $750,000 and Bank of America and Sun Trust limited guaranties of up to $250,000 with regard to all loans made pursuant to the terms of each agreement with the lenders.

    Franchisee Training.  Each franchisee must have at least one individual working full time at the Sonic drive-in restaurant who has completed the Sonic Management Development Program before opening or operating the Sonic drive-in restaurant. The program consists of 12 weeks of on-the-job training and one week of classroom development. The program emphasizes food safety, quality food preparation, quick service, cleanliness of restaurants, management techniques and consistency of service.

    Franchisee Support.  In addition to training, advertising and food purchasing cooperatives, and marketing programs, the Company provides various other services to its franchisees. Those services include (1) assistance with quality control through area field representatives, to ensure that each franchisee consistently delivers high quality food and service; (2) assistance in selecting sites for new restaurants using demographic data and studies of traffic patterns; (3) financing through third party sources to qualified franchisees for purchasing restaurant equipment; and (4) one-stop shopping for all equipment needed to open a new restaurant through N. Wasserstrom & Sons, Inc. in Columbus, Ohio. The Company's field services organization consists of 17 field service representatives, 12 field marketing representatives, five real estate directors and managers, and 10 other field representatives, all with responsibility for defined geographic areas. The field service representatives provide operational services and support for the Company's franchisees, while the field marketing representatives assist the franchisees with point-of-sale and local marketing programs. The real estate directors and managers assist the franchisees with the identification of trade areas for new restaurants, the franchisees' selection of sites for their restaurants, and the approval of those sites by the Company. The other field representatives provide a variety of other services to franchisees.

    Franchise Operations.  All franchisees must operate their Sonic drive-in restaurants in compliance with the Company's policies, standards, and specifications, including matters such as menu items, materials, supplies, services, fixtures, furnishings, decor, and signs. Each franchisee has full discretion to determine the prices charged to its customers. All restaurants must display a Sonic drive-in restaurant sign manufactured in accordance with Company specifications. In most cases, the Company owns the sign and leases it to the franchisee and, if the franchisee breaches its franchise agreement, the Company may remove the sign.

    Franchise Advisory Council.  The Company has established a Franchise Advisory Council which provides advice, counsel, and input to the Company on important issues impacting the business, such as marketing and promotions, operations, purchasing, building design, human resources, and new products. The Franchise Advisory Council currently consists of 16 members selected by the Company. Seven executive committee members are selected at large. The remaining nine members are regional members who represent three defined regions of the country and serve two-year terms. The Franchise Advisory Council serves in an advisory capacity only and does not have decision-making power. As the franchisor of the Sonic drive-in restaurant chain, the Company has and reserves the power to change or dissolve the Franchise Advisory Council as it may deem in its best interest.

    Reporting.  The Company collects weekly and monthly sales and other operating information from its franchisees. The Company has agreements with 106 or 6% of its franchisees permitting the Company to debit electronically the franchisees' bank accounts for the payment of royalties and advertising fund contributions. That system significantly reduces the resources needed to process receivables, improves cash flow, and reduces past-due accounts receivable.

    Franchised Restaurant Data.  The following table provides certain financial information relating to franchised restaurants and the number of franchised restaurants opened, purchased from or sold to the Company, and closed during the Company's last five fiscal years.

Equipment Sales

    In fiscal 1996, the Company sold its restaurant equipment division and discontinued that operation. As a result, the Company had no revenues from equipment sales during fiscal years 1999, 1998 and 1997, compared to approximately $3.7 million during fiscal 1996 (an amount equal to 2.5% of the Company's total consolidated revenues).

Competition

    The Company competes in the quick-service restaurant industry, a highly competitive industry in terms of price, service, restaurant location, and food quality, and an industry often affected by changes in consumer trends, economic conditions, demographics, traffic patterns, and concerns about the nutritional content of quick-service foods. The Company competes on the basis of speed and quality of service, method of food preparation (made-to-order), food quality, signature food items, and monthly promotions. The quality of service, featuring Sonic carhops, constitutes one of the Company's primary marketable points of difference with the competition. Several major chains, many of which have substantially greater financial resources than the Company, dominate the quick-service restaurant industry. A significant change in pricing or other marketing strategies by one or more of those competitors could have an adverse impact on the Company's sales, earnings, and growth. In selling franchises, the Company also competes with many franchisors of fast-food and other restaurants and other business opportunities.

Employees

    As of August 31, 1999, the Company had 227 full-time employees. No collective bargaining agreement covers any of its employees. Company-owned restaurants (operated as separate partnerships or limited liability companies) employed approximately 1,200 full-time and 4,800 part-time employees as of August 31, 1999, none of whom constitute employees of the Company. The Company believes that it has good labor relations with its employees.

Trademarks and Service Marks

    The Company, through a wholly-owned subsidiary, owns numerous trademarks and service marks. The Company has registered many of those marks, including the "Sonic" logo and trademark, with the United States Patent and Trademark Office. The Company believes that its trademarks and service marks have significant value and play an important role in its marketing efforts.

Government Regulation

    The Company must comply with regulations adopted by the Federal Trade Commission (the "FTC") and with several state laws that regulate the offer and sale of franchises. The Company also must comply with a number of state laws that regulate certain substantive aspects of the franchisor-franchisee relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") requires that the Company furnish prospective franchisees with a franchise offering circular containing information prescribed by the FTC Rule.

    State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states. Those laws regulate the franchise relationship, for example, by requiring the franchisor to deal with its franchisees in good faith, by prohibiting interference with the right of free association among franchisees, by regulating discrimination among franchisees with regard to charges, royalties or fees, and by restricting the development of other restaurants within certain proscribed distances from existing franchised restaurants. Those laws also restrict a franchisor's rights with regard to the termination of a franchise agreement (for example, by requiring "good cause" to exist as a basis for the termination), by requiring the franchisor to give advance notice and the opportunity to cure the default to the franchisee, and by requiring the franchisor to repurchase the franchisee's inventory or provide other compensation upon termination. To date, those laws have not precluded the Company from seeking franchisees in any given area and have not had a significant effect on the Company's operations.

    Each Sonic restaurant must comply with regulations adopted by federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire, and other departments. Difficulties or failures in obtaining the required licenses or approvals can delay and sometimes prevent the opening of a new restaurant.

    Sonic restaurants must comply with federal and state environmental regulations, but those regulations have not had a material effect on their operations. More stringent and varied requirements of local governmental bodies with respect to zoning, land use, and environmental factors can delay and sometimes prevent development of new restaurants in particular locations.

    The owners of Sonic restaurants must comply with the Fair Labor Standards Act and various state laws governing various matters, such as minimum wages, overtime, and other working conditions. Significant numbers of the food service personnel in Sonic restaurants receive compensation at rates related to the federal minimum wage and, accordingly, increases in the minimum wage will increase labor costs at those locations.

    The owners of Sonic restaurants also must comply with the provisions of the Americans with Disabilities Act (the "ADA"), which requires the owners to provide reasonable accommodation for employees with disabilities and to make their restaurants accessible to customers with disabilities. The Company has made certain modifications to the design and construction of its restaurants in order to comply with the ADA. However, the ADA has not had a material impact on the Company, primarily because of a drive-in restaurant's inherent accessibility to all customers through their motor vehicles.

    Many owners of Sonic restaurants also must comply with the Family Medical Leave Act (the "Family Leave Act"), which covers employers of 50 or more persons at locations within any 75-mile radius. The Family Leave Act requires covered employers to grant eligible employees up to 12 weeks of unpaid leave for family and medical reasons and to reinstate the employee to the same or an equivalent position at the end of the leave. An employee may take leave for the birth, adoption, or foster care of a child; for any serious health condition of a spouse, sibling, child or parent; or for an employee's own serious health condition.

Item 2. Properties

    Of the 296 Company-owned restaurants operating as of August 31, 1999, the Company operated 106 of them on property leased from third parties and 190 of them on property owned by the Company. The leases expire on dates ranging from 1999 to 2019, with the majority of the leases providing for renewal options. All leases provide for specified monthly rental payments, and some of the leases call for additional rentals based on sales volume. All leases require the Company to maintain the property and pay the cost of insurance and taxes.

    The Company has its principal office located in approximately 64,000 square feet of leased office space in Oklahoma City, Oklahoma, at an effective annual rental rate of $9.15 per square foot and approximately 500 square feet at an effective annual rental rate of $10.50 per square feet. The lease for that property expires in November of 2002. The Company also leases approximately 10,000 square feet of warehouse space in Oklahoma City, Oklahoma, at an annual rental rate of $3.75 per square foot. The lease for the warehouse space expires in December of 2001. The Company believes that its leased office and warehouse space provides an adequate amount of space and will meet the Company's needs for the foreseeable future.

Item 3. Legal Proceedings

    The Company does not have any material legal proceedings pending against the Company, any of its subsidiaries, or any of their properties.

Item 4. Submission of Matters to a Vote of Security Holders

    The Company did not submit any matter during the fourth quarter of the Company's last fiscal year to a vote of the Company's stockholders, through the solicitation of proxies or otherwise.

Item 4A. Executive Officers of the Company

Identification of Executive Officers

    The following table identifies the executive officers of the Company.

Business Experience

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

    J. Clifford Hudson has served as President and Chief Executive Officer of the Company since April of 1995 and has served as a director of the Company since August of 1993. He served as President and Chief Operating Officer of the Company from August of 1994 until April of 1995, and he served as Executive Vice President and Chief Operating Officer from August of 1993 until August of 1994. From August of 1992 until August of 1993, Mr. Hudson served as Senior Vice President and Chief Financial Officer of the Company. Since October of 1994, Mr. Hudson has served as Chairman of the Board of Securities Investor Protection Corporation, the federally-chartered organization which serves as the insurer of customer accounts with brokerage firms.

    Kenneth L. Keymer has served as the Executive Vice President and Chief Operating Officer of the Company since January of 1998, and has served as a director of the Company since January of 1999. He has served as the President and a director of Sonic Industries Inc., the Company's franchise operations subsidiary, since August of 1996. From June of 1994 to August of 1996, Mr. Keymer served as Executive Vice President of Operations for the Memphis, Tennessee region of Perkins Family Restaurants, a subsidiary of Tennessee Restaurant Corporation of Itasca, Illinois. From March of 1993 to June of 1994, Mr. Keymer served as Senior Vice President of Operations for the then Chicago-based Boston Chicken, Inc.

    Pattye L. Moore has served as Senior Vice President of Marketing and Brand Development of the Company since August of 1996. From August of 1995 until August of 1996, Ms. Moore served as Senior Vice President of Marketing and Brand Development for Sonic Industries Inc. and served as Vice President of Marketing of Sonic Industries Inc. from June of 1992 to August of 1995.

    Ronald L. Matlock has served as Vice President, General Counsel and Secretary of the Company since April of 1996. Mr. Matlock has also served as a director of Sonic Restaurants, Inc. and as a director of Sonic Industries Inc. since April of 1996. Prior to joining the Company, Mr. Matlock practiced law from January of 1995 to April of 1996 with the Matlock Law Firm in Oklahoma City, Oklahoma, concentrating in corporate, securities and franchise law. From November of 1987 to December of 1994, Mr. Matlock was a shareholder and director of the law firm of Hastie & Kirschner in Oklahoma City, Oklahoma.

    W. Scott McLain has served as Vice President of Finance and Chief Financial Officer of the Company since August of 1997. From August of 1997 until August of 1999 he also served as Treasurer of the Company. From April of 1996 to August of 1997, he served as Vice President of Finance and Treasurer of the Company. From August of 1993 until joining the Company, Mr. McLain served as Treasurer of Stevens International, Inc. in Fort Worth, Texas.

    Donald E. Foringer has served as Vice President of Information Technology since August of 1997. From January of 1993 to August of 1997, Mr. Foringer served as the Director of Information Services for Del Taco, Inc. of Laguna Hills, California.

    G. Michael Gent has served as Vice President of Corporate Development of Sonic Restaurants, Inc. since November of 1997. From May of 1996 until joining the Company, Mr. Gent served as Vice President of Business Development of Calido Chile Traders Systems, Inc. in Merriam, Kansas. A petition under the Federal bankruptcy laws was filed by Calido Chile Traders Systems, Inc. in October of 1997. From September of 1995 until May of 1996, Mr. Gent provided consulting services for multiple unit franchisors and franchisees. From March of 1992 until September of 1995, he served as Vice President for Franchise Development of Taco John's International, Inc., in Cheyenne, Wyoming.

    Mitchell W. Gregory has served as Vice President of Brand Development for Sonic Industries Inc. since August of 1999. Mr. Gregory served as an Area Vice President of Brand Development for Sonic Industries Inc. from September of 1998 until August of 1999. From June of 1995 until September of 1998, Mr. Gregory was Director of Market Research and was also Director of Field Marketing from September of 1997 until September of 1998 for Sonic Industries Inc. From June of 1994 until joining Sonic Industries Inc., Mr. Gregory was a Market Development Representative for Pepsico, Inc. in Oklahoma City, Oklahoma.

    Terry D. Harryman has served as Controller of the Company since January of 1999. From October of 1996 until January of 1999, Mr. Harryman served as Director of Tax of the Company. From January of 1998 until January of 1999, Mr. Harryman also served as Assistant Treasurer of the Company. Mr. Harryman has served as Assistant Treasurer of Sonic Industries Inc. and Sonic Restaurants, Inc. since October of 1996. From May of 1988 until October of 1996, he was with Kerr-McGee Corporation, and served as Senior Research Tax Accountant just prior to joining Sonic.

    Jill M. Hudson has served as Vice President of Human Resources and Corporate Administration of the Company since November of 1998. From June of 1996 until joining the Company, Ms. Hudson served as a Regional Human Resources Manager of McDonald's Corporation. From June of 1993 until June of 1996, she served as a Regional Human Resources Supervisor of McDonald's.

    Stanley S. Jeska has served as Vice President of Franchise Development of Sonic Industries Inc. since July of 1996 and also served in that capacity from September of 1993 until August of 1994. Mr. Jeska served as Vice President of Corporate Development for Sonic Restaurants, Inc. from August of 1994 until July of 1996.

    Keith O. Jossell has served as Treasurer of the Company since August of 1999. From June of 1997 until August of 1999, Mr. Jossell served as Assistant Treasurer of the Company. From January of 1996 until May of 1997, Mr. Jossell was employed by the Company in the positions of Financial Analyst, Treasury Analyst, then Treasury Manager. From August of 1993 until October of 1995, Mr. Jossell was the Senior Treasury Analyst for Brinker International, in Dallas, Texas.

    Norman R. Kaufman has served as Vice President of Operations Services for Sonic Restaurants, Inc. since September of 1998. From July of 1997 to September of 1998, Mr. Kaufman served as a Regional Vice President of Sonic Industries, Inc. From June of 1993 until joining the Company, he served as the President, Chief Operating Officer, and Director of Sobik's Subs, Inc. in Orlando, Florida.

    Kris J. Miotke has served as Vice President of Advertising and Sales of Sonic Industries Inc. since February of 1998. From November of 1996 until joining the Company, Mr. Miotke served as Vice President, General Manager of Kragie/Newell, an advertising agency in St. Louis, Missouri. From November of 1993 until February of 1996, Mr. Miotke served as Director of Advertising and Promotions for Popeye's Chicken & Biscuits in Atlanta, Georgia.

    Michael A. Perry has served as Vice President of Franchise Services of Sonic Industries Inc. since September 1, 1998. Mr. Perry served as the Vice President of Operations Services of Sonic Restaurants, Inc. from March of 1998 until August of 1998. From October of 1994 until joining the Company, Mr. Perry was a Region Vice President for Au Bon Pain Co., Inc. in Chicago, Illinois. From February of 1993 until October of 1994, Mr. Perry served as the Senior Director of Operations for Taco Bell Corp., Division of Pepsico, in Elmhurst, Illinois.

    Andrew G. Ritger, Jr. has served as Vice President of Purchasing of Sonic Industries Inc. since January of 1996. From May of 1993 until joining the Company, Mr. Ritger served as Vice President of Purchasing of Fast Food Merchandisers, Inc., a subsidiary of Hardees, Inc. of Rocky Mount, North Carolina.

    Nancy L. Robertson has served as Vice President of Corporate Communications of the Company since April of 1999. Ms. Robertson served as Senior Director of Corporate Communications of the Company from September of 1997 until April of 1999. From September of 1994 until August of 1997, Ms. Robertson was Director of Corporate Communications of the Company. Ms. Robertson joined the Company as Manager of Corporate Communications in August of 1993.

    Stephen C. Vaughan has served as Vice President of Planning and Analysis of the Company since January of 1999 and as a Vice President of the Company since August of 1997. Mr. Vaughan was Controller of the Company from January of 1996 to January of 1999. Mr. Vaughan joined the Company in March of 1992 as an internal auditor and became Assistant Controller of the Company in March of 1993.

    David A.Vernon has served as Vice President of Franchise Sales for Sonic Industries Inc. since September of 1998. Mr. Vernon served as the Director of Franchise Sales for Sonic Industries from December of 1996 until August of 1998. From January of 1996 until December of 1996, Mr. Vernon was the Franchise Development Manager for Brinker International, Inc., Dallas, Texas. From February of 1990 until January of 1996, Mr. Vernon was the Director of Franchise Sales for Pizza Inn, Inc., Dallas, Texas.

    Frank B. Young, Jr. has served as Vice President of Operations of Sonic Restaurants, Inc. since October of 1994. From April of 1989 until joining the Company, Mr. Young served as the President and sole shareholder of Wendco, Inc. of Madison, Wisconsin, a business consulting firm.

PART II

Item 5. Market for the Company's Common Stock and Related Stockholder Matters

Market Information

    The Company's common stock trades on the Nasdaq National Market ("Nasdaq") under the symbol "SONC." The following table sets forth the high and low closing bids for the Company's common stock during each fiscal quarter within the two most recent fiscal years as reported on Nasdaq.

Stockholders

    As of November 10, 1999, the Company had 343 record holders of its common stock. As of that date, the Company had approximately 2,600 stockholders, including beneficial owners holding shares in street or nominee names.

Dividends

    The Company did not pay any dividends on its common stock during its two most recent fiscal years and does not intend to pay any dividends in the foreseeable future.

Item 6. Selected Financial Data

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

Selected Financial Data
(In thousands, except per share data)

(1)

Adjusted for a 3-for-2 stock split in 1998 and 1995.

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

    This Form 10-K contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements represent the Company's expectations or belief concerning future events, including the following: any statements regarding future sales or expenses, any statements regarding the continuation of historical trends, and any statements regarding the sufficiency of the Company's working capital and cash generated from operating and financing activities for the Company's future liquidity and capital resources needs. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. The Company cautions that those statements are further qualified by important economic and competitive factors that could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, risks of the restaurant industry, including a highly competitive industry and the impact of changes in consumer tastes, local, regional and national economic conditions, weather, demographic trends, traffic patterns, employee availability and cost increases. In addition, the opening and success of new restaurants will depend on various factors, including the availability of suitable sites for new restaurants, the negotiation of acceptable lease or purchase terms for new locations, permitting and regulatory compliance, the ability of the Company to manage the anticipated expansion and hire and train personnel, the financial viability of the Company's franchisees, particularly multi-unit operators, and general economic and business conditions. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and may not be realized.

Results of Operations

    The Company derives its revenues primarily from Company-owned restaurant sales and royalty fees from franchisees. The Company also receives revenues from initial franchise fees, area development fees, the selling and leasing of signs and real estate, and from minority ownership positions in certain franchised restaurants. Costs of Company-owned restaurant sales and minority interest in earnings of restaurants relate directly to Company-owned restaurant sales. Other expenses, such as depreciation, amortization, and general and administrative expenses, relate to both Company-owned restaurant operations, as well as the Company's franchising operations. The Company's revenues and expenses are directly affected by the number and sales volumes of Company-owned restaurants. The Company's revenues and, to a lesser extent, expenses are also affected by the number and sales volumes of franchised restaurants. Initial franchise fees are directly affected by the number of franchised restaurant openings.

    The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of certain items included in the Company's statements of income. The table also sets forth certain restaurant data for the periods indicated.

Percentage Results of Operations and Restaurant Data
($ in thousands)

(1)

As a percentage of Company-owned restaurant sales.

(2)

Number of restaurants open at end of year (the allocation of Company-owned restaurants by core and developing markets differs from the table on page two because that table sets forth the numbers by state rather than by television market.)

(3)

Represents percentage increase from the comparable period in the prior year.

(4)

Represents percentage increase for restaurants open in both the reported and prior years.

    Comparison of Fiscal 1999 to Fiscal 1998.  Total revenues increased 17.6% to $257.6 million during fiscal year 1999 from $219.1 million in fiscal year 1998. Company-owned restaurant sales increased 15.6% to $210.4 million in fiscal year 1999 from $182.0 million in fiscal year 1998. Of the $28.4 million increase in Company-owned restaurant sales, $18.3 million was due to the net addition of 40 Company-owned restaurants since the beginning of fiscal 1998. Average sales increases of approximately 6.9% by stores open throughout the full reporting periods of fiscal 1999 and 1998 accounted for $10.1 million of the increase. One hundred thirty-nine franchise drive-ins opened in fiscal 1999 compared to 120 in fiscal 1998, with the contribution of franchise fee revenues increasing 35.3%. In addition to the larger store count, this increase resulted from a higher proportion of drive-ins opening under the current form of license agreement which requires a $30,000 franchise fee. Franchise royalties increased 26.1% to $40.9 million in fiscal 1999, compared to $32.4 million in fiscal 1998. Of the $8.5 million increase, approximately $4.5 million resulted from the franchise same-store sales growth of 8.3% in fiscal 1999. Approximately $0.6 million was due to the conversion of certain stores to new license agreements which became effective on January 1, 1999. The balance of the increase was attributable to additional franchise restaurants in operation.

    Restaurant cost of operations, as a percentage of Company-owned restaurant sales, was 73.9% in fiscal 1999, compared to 74.6% in fiscal 1998. Food and packaging costs decreased 100 basis points as a percentage of Company-owned restaurant sales, as a result of reduced discounting from standard menu pricing as well as overall lower unit costs, particularly lower ice cream mix costs. Payroll and other employee benefits, as a percentage of Company-owned restaurant sales, were down 40 basis points from fiscal 1998 due to lower pre-opening costs as a result of fewer company store openings and worker's compensation refunds received during the year. Margin improvements resulting from the leverage of operating at higher volumes were offset by an increase in the average wage rate resulting from unfavorable conditions in the labor market and an increase in the labor hours per store. The increase in labor hours resulted from the Company's continued efforts to provide superior customer service.

    The increase in other operating expenses resulted from higher marketing expenditures, increased landscaping and repair costs associated with the Sonic 2000 retrofit, and higher repair and maintenance costs resulting from the outsourcing of point-of-sale support which was handled internally during fiscal 1998. The increase in marketing expenditures reflects the Company's commitment to increased media efficiency through its system of advertising cooperatives. As a result of the increase in restaurant operating margins, minority interest in earnings of restaurants increased 9.1% to $8.6 million in fiscal year 1999, compared to $7.9 million in fiscal 1998. Many of the managers and supervisors of Company-owned restaurants own a minority interest in the restaurants, and their compensation flows through the minority interest in earnings of restaurants.

    Selling, general and administrative expenses, as a percentage of total revenues, decreased to 9.9% in fiscal 1999, compared with 10.2% in fiscal 1998. Management expects selling, general and administrative expenses, as a percentage of revenues, to continue to decline in future periods because of a declining rate of increase in the number of corporate employees and because the Company expects a significant portion of future revenue growth to be attributable to Company-owned restaurants. Company-owned restaurants require a lower level of selling, general and administrative expenses, as a percentage of revenues, than the Company's franchising operations since most of these expenses are reflected in restaurant cost of operations and minority interest in restaurant operations. Depreciation and amortization expense increased 24.8% or $3.7 million in fiscal 1999 resulting primarily from new drive-in development and retrofits of existing restaurants. Management expects this trend to decrease reflecting the slower rate of growth in company stores as well as the impact of sold stores.

    During fiscal year 1999, four drive-ins became impaired under the guidelines of FAS 121—"Accounting for the Impairment of Long-Lived Assets." Two additional drive-ins were written down due to accessibility and expiring lease issues. As a result, a provision for impairment of long-lived assets of $1.5 million was recorded for the drive-ins' carrying cost in excess of the present value of estimated future cash flows.

    Income from operations increased 25.9% to $47.9 million in fiscal year 1999 from $38.1 million in fiscal year 1998 (excluding a $2.7 million special provision for litigation settlement recorded in fiscal 1998).

    Net interest expense in fiscal 1999 increased to $4.3 million from $2.7 million in fiscal 1998. This increase was the result of additional borrowings to fund share repurchases of $13.0 million and capital expenditures of $46.0 million. The Company expects interest expense to increase in the 8% to 10% range during fiscal year 2000 depending on the level of future share repurchases.

    Provision for income taxes reflects an effective federal and state tax rate of 37.25% for fiscal 1999 and 1998. Net income increased 23.6% to $27.4 million in fiscal 1999 compared to $22.2 million in fiscal 1998, excluding the special provision for litigation settlement and before the cumulative effect of accounting change. Diluted earnings per share increased to $1.41 per share in fiscal 1999, compared to $1.12 per share before cumulative effect of accounting change and the special provision for litigation settlement in fiscal 1998, for an increase of 25.9%.

    Comparison of Fiscal 1998 to Fiscal 1997.  Total revenues increased 19.1% to $219.1 million in fiscal 1998 from $184.0 million in fiscal 1997. Company-owned restaurant sales increased 19.2% to $182.0 million in fiscal 1998 from $152.7 million in fiscal 1997. Of the $29.3 million increase in Company-owned restaurant sales, $24.2 million was due to the net addition of 61 Company-owned restaurants since the beginning of fiscal 1997. Average sales increases of approximately 4.0% by stores open the full reporting periods of fiscal 1998 and fiscal 1997 accounted for $5.1 million of the increase. Franchise fee revenues increased to $2.6 million during fiscal 1998 as compared to $1.7 million during fiscal 1997, primarily resulting from the opening of 120 new franchise restaurants in fiscal 1998 compared to 92 in fiscal 1997. Franchise royalties increased 21.0% to $32.4 million in fiscal 1998 compared to $26.8 million in fiscal 1997. Increased sales by comparable franchised restaurants resulted in an increase in royalties of approximately $3.1 million and resulted from the franchise same store sales growth of 6.9% over fiscal 1997. Additional franchise restaurants in operation resulted in an increase in royalties of $2.5 million. The decrease in other revenues of approximately $0.7 million resulted primarily from the fiscal year 1997 gain on the sale of the Company's minority interest in 10 restaurants.

    Restaurant cost of operations, as a percentage of Company-owned restaurant sales, was 74.6% in fiscal 1998, compared to 73.7% in fiscal 1997. The reported decline in operating margins resulted primarily from the Company's adoption of a new accounting standard, SOP 98-5, which requires that pre-opening and other start-up costs be expensed as incurred. The Company previously capitalized such costs and amortized them over 12 months. Implementation of the standard resulted in the reclassification of expenses from depreciation and amortization into restaurant cost of operations. The following table sets out the pro forma operating margins for fiscal 1998 and 1997 as if the Company had adopted the new standard as of the beginning of fiscal 1997.

    The following discussion is based on the pro forma margin analysis. Management believes the decrease in food and packaging costs resulted from the negotiation of more favorable contracts with suppliers, a reduction in promotional discounting from standard menu prices and a continued shift in product mix toward higher margin items such as drinks and ice cream. The increase in payroll and other employee benefit costs resulted primarily from an increase in the hourly wage rate related to a minimum wage increase which was effective September 1, 1997 without a corresponding increase in pricing. The increase in other operating expenses resulted primarily from increased marketing expenditures, which reflects the Company's commitment to increased media penetration through its system of advertising cooperatives. Minority interest in earnings of restaurants decreased, as a percentage of Company-owned restaurant sales, to 4.3% in fiscal 1998 versus 4.9% in fiscal 1997. This decrease reflected the minority partners' share of depreciation expense associated with the roll-out of a point-of-sale system.

    Selling, general and administrative expenses, as a percentage of total revenues, decreased to 10.2% in fiscal 1998 compared with 10.5% in fiscal 1997. Management expects selling, general and administrative expenses to decline in future periods, as a percentage of total revenues, because the Company plans to add fewer corporate employees, as a percentage of the existing corporate employee base, than in previous periods. This strategy is expected to result in revenues growing at a higher rate than selling, general and administrative expenses. Depreciation and amortization expense increased approximately $2.5 million due to the purchase of buildings and equipment for new restaurants, retrofit expenditures for existing restaurants and information systems upgrades.

    The Company recorded a $2.7 million special provision for litigation settlement in the third fiscal quarter of 1998 as a result of the denial by the Supreme Court of the State of Texas of the Company's appeal of a decision by the Texas Court of Appeals in a real estate related lawsuit. See Note 16 of the Notes to Consolidated Financial Statements.

    Income from operations increased to $35.4 million from $32.0 million in fiscal 1997. Excluding the special provision for litigation settlement discussed above, income from operations increased 19.1% to $38.1 million.

    Net interest expense increased to $2.8 million in fiscal 1998 from $1.6 million in fiscal 1997. This increase was the result of additional borrowings to partially fund the Company's capital additions of $67.0 million and share repurchases of $10.0 million. The Company expects interest expense to continue to increase in fiscal 1999.

    Provision for income taxes reflects an effective federal and state tax rate of 37.25% for fiscal 1998 and 1997. Net income, excluding the special provision for litigation settlement and before the cumulative effect of the change in accounting for pre-opening costs, increased 16.2%. Net income per diluted share increased 17.9% over fiscal 1997, excluding the cumulative effect of the accounting change and the special provision for litigation settlement.

Liquidity and Sources of Capital

    During fiscal 1999, the Company opened 37 newly-constructed restaurants and sold a net of 32 restaurants to franchisees. The Company funded the total capital additions for fiscal 1999 of $46.0 million, which included the cost of newly-opened restaurants, retrofits of existing restaurants, restaurants under construction, new equipment for existing restaurants, and other capital expenditures, from cash generated by operating activities and through borrowings under the Company's line of credit. During fiscal 1999, the Company purchased the real estate for 35 of the 37 newly-constructed restaurants. The Company expects to own the land and building for most of its future newly-constructed restaurants. The Company's board of directors expanded the share repurchase program during fiscal 1999, increasing the funds authorized for the repurchase of the Company's common stock from $10 million to $32 million. The Company repurchased approximately 472 thousand shares of common stock at an aggregate cost of $13.0 million during the year. As of August 31, 1999, the Company's total cash balance of $1.6 million reflected the impact of the cash generated from operating activities, borrowing activity, and capital expenditures mentioned above.

    The Company has an agreement with a group of banks which provides the Company with a $60 million line of credit expiring in July of 2001. The Company will use the line of credit to finance the opening of newly-constructed restaurants, retrofit of existing restaurants, acquisitions of existing restaurants, purchases of the Company's common stock and for other general corporate purposes. As of August 31, 1999, the Company's outstanding borrowings under the line of credit were $22.0 million, as well as $0.3 million in outstanding letters of credit. The available line of credit as of August 31, 1999, was $37.7 million.

    The Company plans capital expenditures of $50 to $55 million in fiscal 2000, excluding potential acquisitions and share repurchases. These capital expenditures primarily relate to the development of additional Company-owned restaurants, retrofit and remodeling of Company-owned restaurants, and enhancements to existing financial and operating information systems, including refinement of a point-of-sale system. The Company expects to fund these capital expenditures through borrowings under its existing unsecured revolving credit facility and cash flow from operations. As of August 31, 1999, the Company had several restaurants under construction. The estimated cost to complete construction of these restaurants was $4.2 million. The Company believes that existing cash and funds generated from internal operations, as well as borrowings under the line of credit, will meet the Company's needs for the foreseeable future.

Year 2000

    Description.  The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded computer chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations which could disrupt the Company's normal business activities.

    To date, the Company has established a plan to prepare its systems for the Year 2000 issue as well as to reasonably assure that its critical business partners are prepared. The phases of the Company's plan to resolve the Year 2000 issue involve awareness, assessment, remediation, testing and implementation. To date, the Company has completed its assessment of all internal systems that could be significantly affected by the Year 2000 issue. Based upon its assessment, the Company has determined that it will be required to modify or replace portions of its software primarily related to customized interfaces between its financial systems and other applications. The Company believes that with modifications or replacements of the identified software programs, the Year 2000 issue can be mitigated. However, if all additional phases of the Year 2000 plan are not completed timely, the Year 2000 issue could have a material impact on the operations of the Company as set forth under Risks and Contingency Plans.

    Status.  The Company's internal information technology exposures are primarily related to financial and management information systems. As of August 31, 1999, the Company had completed the remediation of existing custom developed software and had completed the necessary replacement of certain package software with Year 2000 compliant versions. As of August 31, 1999, the Company had completed its testing and had implemented all necessary remediated applications.

    The Company's non-information technology systems consist primarily of restaurant operating equipment including its point-of-sale systems. While the Company believes the primary functionality of its point-of-sale systems is not impacted by the Year 2000 issue, the assessment of these systems has indicated that an upgrade to a Windows NT operating system will be necessary to address certain ancillary reporting functions. As of November 15, 1999, the Company had substantially completed the upgrade to the Windows NT operating system in the Company-owned stores. The remainder of the point-of-sale systems in the Company-owned stores will be upgraded by November 30, 1999.

    Significant Third Parties.  The Company's significant third party business partners consist of suppliers, banks, and its franchisees. The Company does not have any significant system interfaces with third parties. An inventory of significant suppliers and distributors has been completed and letters mailed requesting information regarding each party's Year 2000 compliance status. Additionally, the Company has met with approximately 15 key suppliers and distributors to discuss their Year 2000 readiness. The Company's process of developing contingency plans with each of its key suppliers was completed September 30, 1999.

    Letters were sent to all relationship banks before January 1, 1999 requesting an update on their Year 2000 compliance status. Review and evaluation of responses is complete. Based on the banks' information provided to Sonic, management of Sonic believes all relationship banks have adequately addressed Year 2000 concerns.

    A Year 2000 information manual and certain other correspondence has been sent to all franchisees explaining the Year 2000 issue and associated business risks. The Company will continue its efforts to raise awareness and inform franchisees of the risks posed by the Year 2000 through its regional meeting processes and continued correspondence.

    Costs.  The Company's Year 2000 plan encompasses the use of both internal and external resources to identify, remediate, test and implement systems for Year 2000 readiness. External resources include contract resources which will be used to supplement available internal resources. The total cost of the Year 2000 project, excluding non-incremental internal personnel costs, is estimated at $500 thousand and is being funded by operating cash flows. As of August 31, 1999, the Company had incurred costs of approximately $413 thousand, of which $342 thousand has been expensed and $71 thousand has been capitalized.

    Risks and Contingency Plans.  Management of the Company believes it has an effective plan in place to address the Year 2000 issue in a timely manner. However, due to the forward-looking nature and lack of historical experience with Year 2000 issues, it is difficult to predict with certainty what will happen after December 31, 1999. Despite the Year 2000 remediation efforts being made, it is likely that there will be disruptions and unexpected business problems during the early months of 2000. The Company has made diligent efforts to assess the Year 2000 readiness of its significant business partners and has developed contingency plans for critical areas where it believes its exposure to Year 2000 risk is the greatest. However, despite the Company's efforts, it may encounter unanticipated third party failures, more general public infrastructure failures or a failure to successfully conclude its remediation efforts as planned. If the Company's efforts to mitigate Year 2000 exposures are not successful, in addition to the implications noted above, the Company may be required to utilize manual processing of certain otherwise automated processes primarily related to partner compensation and cash management. Any one of these unforeseen events could have a material adverse impact on the Company's results of operations, financial condition or cash flows in 1999 and beyond. Additionally, the inability of franchisees to remit royalty payments on a timely basis could have a material adverse effect on the Company. The amount of potential loss cannot be reasonably estimated at this time.

Impact of Inflation

    Though increases in labor, food or other operating costs could adversely affect the Company's operations, management does not believe that inflation has had a material effect on income during the past several years.

Seasonality

    The Company does not expect seasonality to affect its operations in a materially adverse manner. The Company's results during its second fiscal quarter (the months of December, January and February) generally are lower than other quarters because of the climate of the locations of a number of Company-owned and franchised restaurants.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    The Company is exposed to market risk from changes in interest rates on debt and notes receivable, as well as changes in commodity prices.

    The Company's exposure to interest rate risk currently consists of its Senior Notes, outstanding line of credit and notes receivable. The Senior Notes bear interest at fixed rates which average 6.7%. The aggregate balance outstanding under the Senior Notes as of August 31, 1999 was $50.0 million. Should interest rates increase or decrease, the estimated fair value of these notes would decrease or increase, respectively. As of August 31, 1999, the carrying amount of the Senior Notes exceeded the estimated fair value by approximately $1.5 million. The line of credit bears interest at a rate benchmarked to U.S. and European short-term interest rates. The balance outstanding under the line of credit was $22 million as of August 31, 1999. The Company has made certain loans to its store operating partners and franchisees totaling $7.6 million as of August 31, 1999. The interest rates on these notes are generally between ten and eleven percent. The Company believes the fair market value of these notes approximates their carrying amount. The impact on the Company's results of operations of a one-point interest rate change on the outstanding balances under the Senior Notes, line of credit and notes receivable as of August 31, 1999, would be immaterial.

    The Company and its franchisees purchase certain commodities such as beef, potatoes, chicken and dairy products. These commodities are generally purchased based upon market prices established with vendors. These purchase arrangements may contain contractual features that limit the price paid by establishing price floors or caps; however, the Company has not committed to purchase any minimum quantities under these arrangements. The Company does not use financial instruments to hedge commodity prices because these purchase arrangements help control the ultimate cost and any commodity price aberrations are generally short term in nature.

    This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in financial markets.

Item 8. Financial Statements and Supplementary Data

    The Company has included the financial statements and supplementary financial information required by this item immediately following Part IV of this report and hereby incorporates by reference the relevant portions of those statements and information into this Item 8.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    No disagreements between the Company and its accountants have occurred within the 24-month period prior to the date of the Company's most recent financial statements.

PART III

    Except for the information on the Company's executive officers set forth under Item 4A of Part I of this report, the Company hereby incorporates by reference the information required by Part III of this report from the definitive proxy statement which the Company must file with the Securities and Exchange Commission in connection with the Company's annual meeting of stockholders following the fiscal year ended August 31, 1999.

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

Financial Statements

    The following consolidated financial statements of the Company appear immediately following this Item 14:

Financial Statement Schedules

    The Company has included the following schedule immediately following this Item 14:

    The Company has omitted all other schedules because the conditions requiring their filing do not exist or because the required information appears in the Company's Consolidated Financial Statements, including the notes to those statements.

Exhibits

    The Company has filed the exhibits listed below with this report. The Company has marked all employment contracts and compensatory plans or arrangements with an asterisk (*).

Reports on Form 8-K

    The Company did not file any reports on Form 8-K during its last fiscal quarter ended August 31, 1999.

Report of Independent Auditors

The Board of Directors and Stockholders
Sonic Corp.

    We have audited the accompanying consolidated balance sheets of Sonic Corp. as of August 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended August 31, 1999. Our audits also included the financial statement schedule listed in Item 14. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

    We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sonic Corp. at August 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

    As discussed in Note 1 to the accompanying consolidated financial statements, in fiscal year 1998 Sonic Corp. changed its method of accounting for pre-opening and other start-up costs by adopting Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities."

ERNST & YOUNG LLP

Oklahoma City, Oklahoma
October 15, 1999

Sonic Corp.

Consolidated Balance Sheets

Sonic Corp.

Consolidated Balance Sheets (continued)

See accompanying notes.

Sonic Corp.

Consolidated Statements of Income

See accompanying notes.

Sonic Corp.

Consolidated Statements of Stockholders' Equity