Sonic 2004 Annual Report Download - page 20

Ownership Program/Allowance for Uncollectible Notes and Accounts Receivable.Our
drive-in philosophy stresses an ownership relationship with supervisors and drive-in
managers. Most supervisors and managers of Partner Drive-Ins own an equity interest in
the drive-in, which was previously financed by the Company. We outsourced the
financing of partner notes to a third party in the fourth fiscal quarter of 2004. Supervisors
and managers are not employees of Sonic or of the drive-in in which they have an
ownership interest.
The investments made by managers and supervisors in each partnership or limited
liability company are accounted for as minority interests in the financial statements. The
ownership agreements contain provisions, which give Sonic the right, but not the
obligation, to purchase the minority interest of the supervisor or manager in a drive-in.
The amount of the investment made by a partner and the amount of the buy-out are
based on a number of factors, primarily upon the drive-in’s financial performance for the
preceding 12 months, and are intended to approximate the fair value of a minority
interest in the drive-in.
The net book value of a minority interest acquired by the Company in a Partner
Drive-In is recorded as an investment in partnership, which results in a reduction in the
minority interest liability on the Consolidated Balance Sheet. If the purchase price
exceeds the net book value of the assets underlying the partnership interest, the excess
is recorded as goodwill. The acquisition of a minority interest for less than book value
results in a decrease in purchased goodwill. Any subsequent sale of the minority interest
to another minority partner is recorded as a pro-rata reduction of goodwill and
investment, and no gain or loss is recognized on the sale of the minority ownership
interest. Goodwill created as a result of the acquisition of minority interests in Partner
Drive-Ins is not amortized but is tested annually for impairment under the provisions of
FAS 142,“Goodwill and Other Intangible Assets.”
We collect royalties from franchisees and provide for estimated losses for receivables
that are not likely to be collected. General allowances for uncollectible receivables are
estimated based on historical trends. Although we have a good relationship with our
franchisees and collection rates are currently high, if average sales or the financial health
of franchisees were to deteriorate, we may have to increase reserves against collection of
franchise revenues.
Contingency Reserves.From time to time, we are involved in various legal
proceedings and have certain unresolved claims pending involving taxing authorities,
franchisees, suppliers, employees, competitors and others. We are required to assess the
likelihood of any adverse judgments or outcomes to these matters as well as estimate
potential ranges of probable losses. A determination of the amount of reserves required,
if any, for these contingencies is made after careful analysis of each issue. In addition, our
estimate of probable losses may change in the future due to new developments or
changes in approach such as a change in settlement strategy in dealing with these
matters. Based on the information currently available, we believe that all claims currently
pending are either covered by insurance or would not have a material adverse effect on
our business or financial condition.
Advertising.Under our license agreements, both Partner Drive-Ins and Franchise
Drive-Ins must contribute a minimum percentage of revenues to a national media
production fund (Sonic Advertising Fund) and spend an additional minimum percentage
of gross revenues on local advertising, either directly or through Company-required
participation in advertising cooperatives. A portion of the local advertising contributions
is redistributed to the System Marketing Fund, 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 our consolidated financial statements. However, all
advertising contributions by Partner Drive-Ins 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 we have substantially performed or
satisfied all material services or conditions relating to the sale of the franchise. 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 Sonic and the franchisee.
Our franchisees are required under the provisions of the license agreements to pay
Sonic royalties each month based on a percentage of actual net 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 Drive-Ins sales. These estimates are based on actual sales at
Partner Drive-Ins and projections of average unit volume growth at Franchise Drive-Ins.
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.
Management's Discussion and Analysis of Financial Condition and Results of Operations
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