Sonic 2013 Annual Report Download - page 30

Management's Discussion and Analysis of Financial Condition and Results of Operations
Our estimates are based on the best available information at the time that we prepare the provision, including
legislative and judicial developments. We generally file our annual income tax returns several months after our
fiscal year end. Income tax returns are subject to audit by federal, state and local governments, typically several
years after the returns are filed. These returns could be subject to material adjustments or differing interpretations
of the tax laws. Adjustments to these estimates or returns can result in significant variability in the tax rate from
period to period.
Leases. We lease the land and buildings for certain Company Drive-Ins from third parties. Rent expense for
operating leases is recognized on a straight-line basis over the expected lease term, including cancelable option
periods when it is deemed to be reasonably assured that we would incur an economic penalty for not exercising the
options. Judgment is required to determine options expected to be exercised. Within the terms of some of our
leases, there are rent holidays and/or escalations in payments over the base lease term, as well as renewal periods.
The effects of the rent holidays and escalations are reflected in rent expense on a straight-line basis over the
expected lease term, including cancelable option periods when appropriate. The lease term commences on the date
when we have the right to control the use of lease property, which can occur before rent payments are due under
the terms of the lease. Contingent rent is generally based on sales levels and is accrued at the point in time we
determine that it is probable that such sales levels will be achieved.
Accounts and Notes Receivable. We charge interest on past due accounts receivable and recognize income as
it is collected. Interest accrues on notes receivable based on the contractual terms of the respective notes. We
monitor all accounts and notes receivable for delinquency and provide for estimated losses for specific receivables
that are not likely to be collected. We assess credit risk for accounts and notes receivable of specific franchisees
based on payment history, current payment patterns, the health of the franchisee’s business, and an assessment of
the franchisee’s ability to pay outstanding balances. In addition to allowances for bad debt for specific franchisee
receivables, a general provision for bad debt is estimated for accounts receivable based on historical trends. Account
balances generally are charged against the allowance when we believe it is probable that the receivable will not be
recovered and legal remedies have been exhausted. We continually review our allowance for doubtful accounts.
Quantitative and Qualitative Disclosures About Market Risk
Sonic’s use of debt directly exposes the Company to interest rate risk. Fixed rate debt, where the interest rate
is fixed over the life of the instrument, exposes the Company to changes in market interest rates reflected in the
fair value of the debt and to the risk that the Company may need to refinance maturing debt with new debt at a higher
rate. Sonic is also exposed to market risk from changes in commodity prices. The Company does not utilize financial
instruments for trading purposes. Sonic manages its debt portfolio to achieve an overall desired position of fixed
and floating rates.
Interest Rate Risk. Our exposure to interest rate risk at August 31, 2013, was primarily based on the 2011
Fixed Rate Notes and 2013 Fixed Rate Notes with an effective rate of 5.4% and 3.75%, respectively, before
amortization of debt-related costs. At August 31, 2013, the fair value of the 2011 Fixed Rate Notes and 2013 Fixed
Rate Notes approximated their carrying value of $447.6 million, including accrued interest. To derive the fair value,
management used market information available for public debt transactions for companies with ratings that are
similar to our ratings and information gathered from brokers who trade in our notes. Management believes this fair
value is a reasonable estimate. Should interest rates and/or credit spreads increase or decrease by one percentage
point, the estimated fair value of the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes would decrease or increase
by approximately $19 million, respectively. The fair value estimate required significant assumptions by management.
Commodity Price Risk. 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 generally do not make any long-term commitments to purchase any minimum
quantities under these arrangements other than as disclosed under “Contractual Obligations and Commitments.”
We also do not use financial instruments to hedge commodity prices because these purchase arrangements help
control the ultimate cost.
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.
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