Sonic 2003 Annual Report Download - page 27

p.25
Management’s Discussion and Analysis
which purchases advertising on national cable and broadcast networks and other national media and sponsorship
opportunities.
As stated in the terms of existing license agreements, these funds do not constitute assets of the company and the
company acts with limited agency in the administration of these funds. Accordingly, neither the revenues and expenses nor
the assets and liabilities of the advertising cooperatives, the Sonic Advertising Fund, or the System Marketing Fund are
included in the company’s consolidated financial statements. However, all advertising contributions by company-owned
restaurants are recorded as an expense in the company’s financial statements.
Revenue Recognition Related to Franchise Fees and Royalties. Initial franchise fees are nonrefundable and are recognized in
income when all material services or conditions relating to the sale of the franchise have been substantially performed or
satisfied by the company. Area development fees are nonrefundable and are recognized in income on a pro-rata basis
when the conditions for revenue recognition under the individual development agreements are met. Both initial franchise
fees and area development fees are generally recognized upon the opening of a franchise drive-in or upon termination of
the agreement between the company and the franchisee.
Our franchisees are required under the provisions of the license agreements to pay the company royalties each month
based on a percentage of actual net royalty sales. However, the royalty payments and supporting financial statements are
not due until the 20th of the following month. As a result, we accrue royalty revenue in the month earned based on
estimates of franchise store sales. These estimates are based on actual sales at company-owned stores and projections of
average unit volume growth at franchise stores.
Income Taxes. We provide for income taxes based on our estimate of federal and state tax liability. In making this
estimate, we consider the impact of legislative and judicial developments. As these developments evolve, we will update
our estimate which could result in an adjustment to the tax rate.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from changes in interest rates on debt and notes receivable, as well as changes in
commodity prices.
Our exposure to interest rate risk currently consists of our Senior Notes, outstanding line of credit, and notes
receivable. The Senior Notes bear interest at fixed rates which average 6.8%. The aggregate balance outstanding under
the Senior Notes as of August 31, 2003 was $60.0 million. Should interest rates increase or decrease, the estimated fair
value of these notes would decrease or increase, respectively. As of August 31, 2003, the estimated fair value of the Senior
Notes exceeded the carrying amount by approximately $2.8 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 $79.3
million as of August 31, 2003. We have made certain loans to our store operating partners and franchisees totaling $13.3
million as of August 31, 2003. The interest rates on these notes are generally between 8.5% and 10.5%. We believe the
fair market value of these notes approximates their carrying amount. The impact on our results of operations of a one
percent interest rate change on the outstanding balances under the line of credit as of the end of fiscal year 2003 would
be approximately $0.6 million.
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, we
have not made any long-term commitments to purchase any minimum quantities under these arrangements. We do not
use financial instruments to hedge commodity prices because these purchase agreements help control the ultimate cost
and any commodity price fluctuations 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.