For the quarterly period ended November 30, 2016February 28, 2017

For the transition period from _______________ to ________________

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(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of January 3,March 30, 2017, approximately 43,934.66042,431,664 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

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PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission ("SEC").  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of Sonic Corp. (the “Company”).  In the opinion of management, these financial statements reflect all adjustments of a normal recurring nature, including recurring accruals, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented in conformity with GAAP.  In certain situations, recurring accruals, including franchise royalties, are based on more limited information at interim reporting dates than at the Company’s fiscal year end due to the abbreviated reporting period.  Actual results may differ from these estimates.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended August 31, 2016, included in the Company’s Annual Report on Form 10-K.  Interim results are not necessarily indicative of the results that may be expected for a full year or any other interim period. The second fiscal quarter is typically the most volatile for the company due to seasonality and weather.

The accompanying financial statements include the accounts of the Company, its wholly owned subsidiaries and a number of Company Drive-Ins in which a subsidiary has a controlling ownership interest.  All intercompany accounts and transactions have been eliminated.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize revenue in an amount that reflects the consideration to which the entity expects to be entitled for the transfer of promised goods or services to customers.  The standard also requires additional disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  The ASU will replace most of the existing revenue recognition requirements in U.S. GAAP when it becomes effective.  Further, in March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” which clarifies the guidance in ASU No. 2014-09 for evaluating when another party, along with the entity, is involved in providing a good or service to a customer.  In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing,” which clarifies the guidance in ASU No. 2014-09 regarding assessing whether promises to transfer goods or services are distinct, and whether an entity's promise to grant a license provides a customer with a right to use or right to access the entity's intellectual property. In December 2016, the FASB issued ASU No. 2016-20, "Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers," which provides corrections or improvements to issues that affect narrow aspects of the guidance issued in ASU No. 2014-09.

The Company plans to adopt the standard in the first quarter of fiscal year 2019, which aligns with the required adoption date. The standards are to be applied retrospectively or using a cumulative effect transition method, with early application not permitted; however, we have not yet decided on a method of transition upon adoption.permitted. The Company does not believe the new revenue recognition standard will impact the recognition of sales from Company Drive-Ins or the recognition of royalty fees from franchisees.  The Company expects the pronouncement will impact the recognition of the initial franchise fee, which is currently recognized upon the opening of a Franchise Drive-In. The impact on these fees has not yet been estimated, and no transition method has been selected. The Company is currently evaluating the effect that this pronouncement will have on the recognition of other transactions, the financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, “Leases.”  The new standard, which replaces existing lease guidance, requires lessees to recognize on the balance sheet a liability to make lease payments and a corresponding right-of-use asset. The guidance also requires certain qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. Accounting guidance for lessors is largely unchanged. The standard is effective for fiscal years beginning after December 15, 2018, which will require the Company to adopt the provisions in the first quarter

In March 2016, the FASB issued ASU No. 2016-04, “Liabilities – Extinguishment of Liabilities: Recognition of Breakage for Certain Prepaid Stored-Value Products,” which is intended to eliminate current and future diversity in practice related to derecognition of prepaid stored-value product liability in a way that aligns with the new revenue recognition guidance.  The update is effective for fiscal years beginning after December 15, 2017;year 2019; however, early applicationadoption is permitted.  The adoption of the update is not expected to have a material impact on the Company’s financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses.” The update was issued to provide more decision-useful information about the expected credit losses on financial instruments. The update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The update is effective for fiscal years beginning after December 15, 2019,year 2021, with early adoption permitted for fiscal years beginning after December 15, 2018. The update should be adopted using a modified-retrospective approach. The Company is currently evaluating the effect that this update will have on its financial statements and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments.” The update is intended to reduce diversity in practice in how certain transactions are classified and will make eight targeted changes to how cash receipts and cash payments are presented in the statement of cash flows. The update is effective for fiscal years beginning after December 15, 2017.year 2019. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case the amendments will apply prospectively as of the earliest date practicable. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.

In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory" as part of its simplification initiatives. The update requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than deferring the recognition until the asset has been sold to an outside party as is required under current GAAP. The update is effective for fiscal years beginning after December 15, 2017.year 2019. The new standard will require adoption on a modified retrospective basis through a cumulative-effect adjustment to retained earnings, and early adoption is permitted. The Company is currently evaluating the effect that this update will have on its financial statements and related disclosures.

The Company has reviewed all other recently issued accounting pronouncements and concluded they are not applicable or not expected to be significant to our operations.

In April 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs.”  This update requires debt issuance costs to be presented in the balance sheet as a reduction of the related liability rather than as an asset.  The recognition and measurement guidance for debt issuance costs are not affected by this update. This update is effective for fiscal years beginning after December 15, 2015, including interim periods within that reporting period, and is to be applied retrospectively; early adoption is permitted.  In August 2015, the FASB issued ASU 2015-15, which addresses the SEC’s comments related to the absence of authoritative guidance within ASU 2015-03 related to line-of-credit arrangements.  The SEC would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company retrospectively adopted this guidance in the first quarter of fiscal year 2017, which resulted in a reclassification of unamortized debt issuance costs of $11.3 million related to the Company's fixed rate notes from non-current assets to long-term debt, net, within the Company's consolidated balance sheet, resulting in a corresponding reduction in total assets and total long-term liabilities as of August 31, 2016. Other than this reclassificat

In April 2015, the FASB issued ASU No. 2015-05, “Customer's Accounting for Fees Paid in a Cloud Computing Arrangement.”  The update provides clarification on whether a cloud computing arrangement includes a software license.  If a software license is included, the customer should account for the license consistent with its accounting of other software licenses.  If a software license is not included, the arrangement should be accounted for as a service contract.  The update is effective for fiscal years beginning after December 15, 2015.  The Company adopted this standard in the first quarter of fiscal year 2017 on a prospective basis. The adoption did not have a material impact on the Company’s consolidated financial statements.

During the first quarter of fiscal 2017, the Company early adopted ASU No. 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of accounting for share-based payment transactions, including excess tax benefits, an accounting policy election for forfeitures, statutory tax withholding requirements and classification in the statements of cash flows. As required by the update, on a prospective basis, the Company recognized excess tax benefits related to share-based payments in ourthe provision for income taxes in the condensed consolidated statements of income. These items were historically recorded in additional paid-in capital.  As allowed by the update, on a prospective basis, cash flows related to excess tax benefits recognized on stock-based compensation expense are classified as an operating activity in the Company's condensed consolidated statements of cash flows. These prospective changes did not have a material impact on the Company's financial statements for the first quarterhalf of fiscal year 2017. Cash paid on employees’ behalf related to shares withheld for tax purposes continues to be classified as a financing activity. OurThe stock compensation expense continues to reflect estimated forfeitures.

The following table sets forth the computation of basic and diluted earnings per share:

In August 2015, the Company’s Board of Directors extended the Company’s share repurchase program, authorizing the Company to purchase up to $145.0 million of its outstanding shares of common stock to be repurchased through August 31, 2016.  The Board of Directors further extended the share repurchase program effective May 2016, authorizing the purchase of up to an additional $155.0 million of our outstanding shares of common stock through August 31, 2017.  During fiscal year 2016, approximately 5.2 million shares were repurchased for a total cost of $148.3 million, resulting in an average price per share of $28.48.

In October 2016, the Company's Board of Directors increased the authorization under the share repurchase program by $40.0 million. During the first threesix months of fiscal year 2017, approximately 2.03.7 million shares were repurchased for a total cost of $50.6$97.5 million, resulting in an average price per share of $25.87.$26.21.  The total remaining amount authorized under the share repurchase program as of November 30, 2016February 28, 2017 was $122.4$75.4 million.

Share repurchases may be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions.  The share repurchase program may be extended, modified, suspended or discontinued at any time.

The higherlower effective income tax rate during the second quarter of fiscal year 2017 and for the first six months of fiscal year 2017 was due primarily to the recognition of excess tax benefits related to stock option exercises due to the early adoption of ASU No. 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting,” in the first quarter of 2017. Excess tax benefits recognized in the condensed consolidated statements of income were negligible in the first quarter of fiscal year 20162017 and $0.7 million in the second quarter of fiscal year 2017 as a component of the provision for income taxes. The early adoption of ASU No. 2016-09 resulted in a favorable effective tax rate impact of 4.7% in the second quarter of fiscal year 2017. Please refer to "Recently Adopted Accounting Pronouncements" section of note 1 - Summary of Significant Accounting Policies for details regarding the adoption of this standard. This decrease was primarily attributable to a decreasepartially offset by the favorable impact of the retroactive reinstatement of the Work Opportunity Tax Credit in employment tax credits due to expired credit provisions.the second quarter of fiscal year 2016.

Accounts and notes receivable consist of the following:

The Company’s receivables are primarily due from franchisees, all of whom are in the restaurant business.  Substantially all of the notes receivable from franchisees are collateralized by real estate or equipment. The receivables from system funds represent transactions in the normal course of business. Royalties and other trade receivables have decreased primarily as a result of the seasonality of the business.  The decrease in current notes receivable from franchisees is due to short-term financing for refranchised drive-ins and newly constructed drive-ins sold to franchisees that were established in fiscal year 2016 and were repaid in the first quarter of fiscal year 2017. The increase in other current accounts and notes receivable is due to the timing of various receipts and disbursements. The decrease in noncurrent receivables from system funds is due to payment on notes extended in fiscal year 2016 related to the establishment of the Brand Technology Fund.

The Company is involved in various legal proceedings and has certain unresolved claims pending.  Based on the information currently available, management believes that all claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business, operating results or financial condition.

On December 20, 2013, the Company extended a note purchase agreement to a bank that serves to guarantee the repayment of a franchisee loan, with a term through 2018.  In the event of default by the franchisee, the Company would purchase the franchisee loan from the bank, thereby becoming the note holder and providing an avenue of recourse with the franchisee.  The Company recorded a liability for this guarantee which was based on the Company’s estimate of fair value.  As of November 30, 2016,February 28, 2017, the balance of the franchisee’s loan was $5.7 million.

The Company has obligations under various operating lease agreements with third-party lessors related to the real estate for certain Company Drive-In operations that were sold to franchisees.  Under these agreements, which expire through 2029, the Company remains secondarily liable for the lease payments for which it was responsible as the original lessee.  As of November 30, 2016,February 28, 2017, the amount remaining under these guaranteed lease obligations totaled $6.9$6.8 million.  At this time, the Company does not anticipate any material defaults under the foregoing leases; therefore, zero liability has been provided.

The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties.  The Company has no financial liabilities that are required to be measured at fair value on a recurring basis.

The Company categorizes its assets and liabilities recorded at fair value based on the following fair value hierarchy established by the FASB:

The Company’s cash equivalents, some of which are included in restricted cash, are carried at cost which approximates fair value and totaled $28.1$27.3 million at November 30, 2016February 28, 2017 and $59.2 million at August 31, 2016.  This fair value is estimated using Level 1 inputs.

At November 30, 2016February 28, 2017 and August 31, 2016, the fair value of the Company’s Series 2016-1 Senior Secured Fixed Rate Notes, Class A-2 (the "2016“2016 Fixed Rate Notes"Notes”) and Series 2013-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2013 Fixed Rate Notes” and, together with the 2016 Fixed Rate Notes, the “Fixed Rate Notes”) approximated the carrying

During the first quarter of fiscal year 2017, the Company recorded a gain of $3.8 million on the sale of minority investments in franchise operations retained as part of a refranchising transaction that occurred in fiscal year 2009. The gain is reflected in other operating income, net on the condensed consolidated statement of income.

In June 2016, the Company announced plans to refranchise Company Drive-Ins as part of a refranchising initiative to move toward an approximately 95%-franchised system. During the first quarter of fiscal year 2017, the Company completed two transactions to refranchise the operations of 56 Company Drive-Ins and retained a non-controlling minority investment in the franchise operations. In the second quarter of fiscal year 2017, the Company completed additional transactions to refranchise the operations of 54 Company Drive-Ins and retained a non-controlling minority investment in 50 of these refranchised drive-ins.

During fiscal year 2016, the Company refranchised the operations of 38 Company Drive-Ins. Of the Company Drive-Ins refranchised in fiscal year 2016, 29 were completed as part of the refranchising initiative announced in June 2016. The Company retained a non-controlling minority investment in the franchise operations of 25 of these refranchised drive-ins.

Income from minority investments is included in other revenue on the condensed consolidated statements of income. Gains and losses associated with refranchised drive-ins are recorded in other operating income, net on the condensed consolidated statement of income. The following is a summary of the pretax activity recorded as a result of the refranchising initiative:initiative ($ in thousands):

As part of the refranchising initiative, the Company entered into direct franchising leases ("DFLs") in fiscal year 2016 and the first half of fiscal year 2017. During the second quarter of fiscal year 2017, the Company reclassified a portion of the balance from noncurrent to current investment in direct financing lease, related to the option included in the 53 drive-in refranchising transaction in the first quarter of fiscal year 2017. In March 2017, the franchisee initiated exercise of the option by purchasing a portion of the real estate, and the Company expects the remainder of the real estate to be purchased within the next 12 months.

Components of net investment in direct financing leases as of February 28, 2017 are as follows at November 30:follows:

    

Future minimum rental payments receivable as of November 30, 2016February 28, 2017 are as follows:

Initial direct costs incurred in the negotiationsnegotiation and consummationsconsummation of direct financing lease transactions have not been material. Accordingly, no portion of unearned income has been recognized to offset those costs.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

In the Quarterly Report on Form 10-Q, unless the context otherwise requires, the terms “Sonic Corp.,” “the Company,” “we,” “us” and “our” refer to Sonic Corp. and its subsidiaries.

Overview

System-wideSystemwide same-store sales decreased 2.0%7.4% during the second quarter and decreased 4.6% for the first quartersix months of fiscal year 2017 as compared to an increase of 5.3%6.5% and 5.9%, respectively, for the same periodperiods last year. Same-store sales at Company Drive-Ins decreased 2.4%8.9% during the second quarter and 5.5% for the first quartersix months of fiscal year 2017 as compared to an increase of 4.4%6.3% and 5.3%, respectively, for the same periodperiods last year.  Approximately one percentage point of the decrease in sales for the second quarter and approximately one-half percentage point of the decrease for the first six months of fiscal year 2017 are attributable to one additional day of operations in February 2016 versus February 2017, due to leap year. The same-store sales decrease reflects a decline in traffic, driven by lower consumer spending in the restaurant industry, as well as aggressive competitive activity.activity and strong performance in the prior-year periods. We continue to execute on our long-term strategies, including new technology, people initiatives, product innovation, a greater emphasis on personalized service, targeted value promotions and our fully integrated media strategy.  All of these initiatives drive Sonic’s multi-layered growth strategy, which incorporates same-store sales growth, operating leverage, deployment of cash, an ascending royalty rate and new drive-in development.  Same-store sales growth is the most important layer and drives operating leverage and increased operating cash flows.

Revenues decreased to $129.6$100.2 million for the second quarter and $229.7 million for the first quartersix months of fiscal year 2017 from $145.8$133.2 million and $279.0 million, respectively, for the same periodperiods last year, primarily due to a decrease in Company Drive-In sales. The decrease in Company Drive-In sales was a result of refranchising certain Company Drive-Ins induring the fourth quarter of fiscal year 2016 and the first quarterhalf of fiscal year 2017, as part of our initiative to move toward an approximately 95%-franchised system, as well as decreased same-store sales. Restaurant margins at Company Drive-Ins were unfavorable by 150330 basis points during the second quarter of fiscal year 2017 and 220 basis points for the first quartersix months of fiscal year 2017, reflecting the de-leveraging impact of same-stores sales decreases increased investments in employees’ compensation and benefits to attract and retain employees at the drive-in level and the impact of fees paid to the Brand Technology Fund (“BTF”) that was established in the third quarter of fiscal year 2016.

FirstSecond quarter results for fiscal year 2017 reflected net income of $13.1$11.0 million or $0.28$0.25 per diluted share as compared to net income of $12.5$10.8 million or $0.24$0.22 per diluted share for the same periods last year.  Net income and diluted earnings per share for the first six months of fiscal year 2017 were $24.1 million and $0.53, respectively, as compared to net income of $23.3 million or $0.46 per diluted share for the same period last year. Excluding the non-GAAP adjustments further described below,Adjustments to net income for the first quarterare detailed below in Results of fiscal year 2017 decreased 9.4% and diluted earnings per share was flat.   

In June 2016, we announced plans to refranchise Company Drive-Ins as part of a refranchising initiative to move toward an approximately 95%-franchised system. During the first quarter of fiscal year 2017, we completed two transactions to refranchise the operations of 56 Company Drive-Ins and retained a non-controlling minority investment in the franchise operations. In the second quarter of fiscal year 2017, the Company completed additional transactions to refranchise the operations of 54 Company Drive-Ins and retained a non-controlling minority investment in 50 of these refranchised drive-ins.

During fiscal year 2016, we refranchised the operations of 38 Company Drive-Ins. Of the Company Drive-Ins refranchised in fiscal year 2016, 29 were completed as part of the refranchising initiative announced in June 2016. We retained a non-controlling minority investment in the franchise operations of 25 refranchised drive-ins.

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Income from minority investments is included in other revenue on the condensed consolidated statements of income. Gains and losses associated with refranchised drive-ins are recorded in other operating income, net on the condensed consolidated statement of income. The following is a summary of the pretax activity recorded as a result of the refranchising initiative:initiative ($ in thousands):

The following table provides information regarding the number of Company Drive-Ins and Franchise Drive-Ins operating as of the end of the periods indicated as well as the system-widesystemwide change in sales and average unit volume.  System-wideSystemwide information includes both Company Drive-In and Franchise Drive-In information, which we believe is useful in analyzing the growth of the brand as well as the Company’s revenues since franchisees pay royalties based on a percentage of sales.

Results of Operations

Same-store sales for Company Drive-Ins decreased 2.4%8.9% for the second quarter and 5.5% for the first quartersix months of fiscal year 2017, as compared to an increase of 4.4%6.3% and 5.3% for the same periodperiods last year, reflecting a decrease in traffic due to lower consumer spending in the restaurant industry, as well as aggressive competitive activity.activity and strong performance in the prior-year periods.  We continue to focus on our innovative product pipeline, multi-day-part promotions and increased media effectiveness.  Company Drive-In sales decreased $16.7$31.0 million during the second quarter and $47.8 million during the first quartersix months of fiscal year 2017 as compared to the same periodperiods last year. The decrease in the second quarter and first six months of fiscal year mainly2017 is primarily due to decreaseda decrease in sales of $13.2 million related tofrom stores sold to franchisees of $23.8 million and $36.9 million, respectively, and a decrease in same-store sales of $2.2$6.4 million and a decrease of $1.7$8.6 million, related to stores that were permanently or temporarily closed during the period.respectively.

The following table reflects the change in franchise sales, the number of Franchise Drive-Ins, average unit volumes and franchising revenues.  While we do not record Franchise Drive-In sales as revenues, we believe this information is important in understanding our financial performance since these sales are the basis on which we calculate and record franchise royalties.  This information is also indicative of the financial health of our franchisees.

Same-store sales for Franchise Drive-Ins decreased 2.0%7.3% for the second quarter and 4.5% for the first quartersix months of fiscal year 2017 as compared to an increase of 5.4%6.5% and 5.9%, respectively, for the same periodperiods last year, reflecting a decrease in traffic due to lower consumer spending in the restaurant industry, as well as aggressive competitive activity.activity and strong performance in the prior-year periods.  We continue to focus on our innovative product pipeline, multi-day-part promotions and increased media effectiveness. Franchising revenues were flatdecreased $1.4 million, or 3.9%, for the second quarter and decreased $1.4 million, or 1.8%, for the first quartersix months of fiscal year 2017, compared to the same periodperiods last year.  Franchise royalties were negatively impacted by the decrease in same-store sales butand were partially offset by an increase in royalties related to net new unit growth and franchisee acquisitions of Company Drive-ins.Drive-ins and net new unit growth.