Sonic 2014 Annual Report Download - page 25

Management’s Discussion and Analysis of Financial Condition
and Results of Operations
We assess the recoverability of goodwill at least annually and more frequently if events or changes in circumstances occur
indicating that the carrying amount of goodwill may not be recoverable or as a result of allocating goodwill to Company Drive-Ins
that are sold. Since the Company is one reporting unit, we identify potential goodwill impairment by comparing the fair value of the
Company to its carrying value. The fair value of the Company is determined using a market approach. If the carrying value of the
Company exceeds fair value, a comparison of the fair value of goodwill against the carrying value of goodwill is made to determine
whether goodwill has been impaired.
During the fourth quarter of fiscal year 2014, we performed our annual assessment of recoverability of goodwill and determined
that no impairment was indicated. As of the impairment testing date, the fair value of the Company significantly exceeded the
carrying value. As of August 31, 2014, the Company had $77.1 million 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 until
they are resolved 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. 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.
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.
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