Sonic 2014 Annual Report Download - page 26

Management’s Discussion and Analysis of Financial Condition
and Results of Operations
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, 2014, 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, 2014, the fair value of the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes approximated their carrying value
of $437.8 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 $15 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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