Sonic 2013 Annual Report Download - page 29

Management's Discussion and Analysis of Financial Condition and Results of Operations
We assess the recoverability of goodwill and other intangible assets related to our brand and drive-ins at least
annually and more frequently if events or changes in circumstances occur indicating that the carrying amount of
the asset may not be recoverable or as a result of allocating goodwill to Company Drive-Ins that are sold. Goodwill
impairment testing first requires a comparison of the fair value of each reporting unit to the carrying value. We
estimate fair value based on a comparison of two approaches: an income approach, using the discounted cash flow
method, and a market approach, using the guideline public company method. The discounted estimates of future
cash flows include significant management assumptions such as revenue growth rates, operating margins, capital
expenditures, weighted average cost of capital, and future economic and market conditions. In addition, the market
approach includes significant assumptions such as the use of projected cash flow and revenue multiples derived from
a comparable set of public companies as well as a control premium based on recent market transactions. These
assumptions are significant factors in calculating the value of the reporting units and can be affected by changes
in consumer demand, commodity pricing, labor and other operating costs, our cost of capital and changes in
guideline public company market multiples. If the carrying value of the reporting unit exceeds fair value, goodwill
is considered impaired. The amount of the impairment is the difference between the carrying value of the goodwill
and the “implied” fair value, which is calculated as if the reporting unit had just been acquired and accounted for
as a business combination.
During the fourth quarter of fiscal year 2013, we performed our annual assessment of recoverability of goodwill
and other intangible assets and determined that no impairment was indicated. As of the impairment testing date,
the fair value for both reporting units significantly exceeded the carrying value. As of August 31, 2013, the Company
had $77.1 million of goodwill, of which $71.1 million was attributable to the Company Drive-Ins segment and $6.0
million was attributable to the Franchise Operations segment. If cash flows generated by our Company Drive-Ins
were to decline significantly in the future or there were negative revisions to key assumptions, we may be required
to record impairment charges to reduce the carrying amount of goodwill.
Revenue Recognition Related to Franchise Fees and Royalties. Franchise fees are recognized in income when
we have substantially performed or satisfied all material services or conditions relating to the sale of the franchise
and the fees are nonrefundable. 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
franchise fees and development fees are generally recognized upon the opening of a Franchise Drive-In or upon
termination of the agreement between Sonic and the franchisee.
Our franchisees pay royalties based on a percentage of sales. Royalties are recognized as revenue when they
are earned.
Accounting for Stock-Based Compensation. We estimate the fair value of options granted using the Black-
Scholes option pricing model along with the assumptions shown in note 13 – Stockholders’ Equity in the Notes to
the Consolidated Financial Statements in this Annual Report. The assumptions used in computing the fair value of
stock-based payments reflect our best estimates, but involve uncertainties relating to market and other conditions,
many of which are outside of our control. We estimate expected volatility based on historical daily price changes
of the Company’s stock for a period equal to the current expected term of the options. The expected option term
is the number of years the Company estimates that options will be outstanding prior to exercise considering vesting
schedules and our historical exercise patterns. If other assumptions or estimates had been used, the stock-based
compensation expense that was recorded could have been materially different. Furthermore, if different
assumptions are used in future periods, stock-based compensation expense could be materially impacted.
Income Taxes. We estimate certain components of our provision for income taxes. These estimates include,
among other items, depreciation and amortization expense allowable for tax purposes, allowable tax credits for
items such as wages paid to certain employees, effective rates for state and local income taxes and the tax
deductibility of certain other items.
Although we believe we have adequately accounted for our uncertain tax positions, from time to time, audits
result in proposed assessments where the ultimate resolution may give rise to us owing additional taxes. We adjust
our uncertain tax positions in light of changing facts and circumstances, such as the completion of a tax audit,
expiration of a statute of limitations, the refinement of an estimate, and penalty and interest accruals associated
with uncertain tax positions until they are resolved. We believe that our tax positions comply with applicable tax
law and that we have adequately provided for these matters. However, to the extent that the final tax outcome of
these matters is different from the amounts recorded, such differences will impact the provision for income taxes
in the period in which such determination is made.
27