Sonic 2006 Annual Report Download - page 32

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 royalties to Sonic 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.
Accounting for Stock-Based Compensation. As discussed further in Note 1 and Note 12 of Notes to the
Consolidated Financial Statements, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
“Share-Based Payment” (“SFAS 123R”) effective September 1, 2005 using the modified retrospective application
method. As a result,financial statement amounts for prior periods presented have been adjusted to reflect the fair
value method of expensing prescribed by SFAS 123R.
We estimate the fair value of options granted using the Black-Scholes option pricing model along with the
assumptions shown in Note 12 to the financial statements. The assumptions used in computing the fair value of share-
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 for the first nine months of 2006 could have been materially different.
Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be
materially impacted in the future.
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.
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.Certain Partner Drive-Ins lease land and buildings 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 provisions of certain 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 leased 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.
Sonic Corp. 2006 Annual Report
30
Management’s Discussion and
Analysis of Financial Condition
and Results of Operations