Sonic 2006 Annual Report Download - page 33

Quantitative and Qualitative Disclosures About Market Risk
Sonic’s use of debt directly exposes the company to interest rate risk. Floating rate debt, where the interest rate
fluctuates periodically, exposes the company to short-term changes in market interest rates. 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. Sonic does not utilize financial
instruments for trading purposes.
Sonic manages its debt portfolio to achieve an overall desired position of fixed and floating rates and may
employ interest rate swaps as a tool to achieve that goal.The major risks from interest rate derivatives include changes
in the interest rates affecting the fair value of the instruments, potential increases in interest expense due to market
increases in floating rates and the creditworthiness of the counterparties in such transactions.
Interest Rate Risk. Our exposure to interest rate risk at August 31, 2006 consisted of our senior notes, outstanding
line of credit, and notes receivable.The senior notes and line of credit were subsequently repaid with the proceeds
under the term loan facility of the new senior secured credit facility. The term loan facility bears interest at a floating
rate benchmarked to U.S. and European short-term interest rates. The collective balances outstanding as of August 31,
2006 that were repaid by the term loan facility totaled $121.0 million.The impact on our results of operations of a one-
point interest rate change on the average combined balance that was outstanding under the line of credit and senior
notes during fiscal year 2006 would have been approximately $0.8 million. Looking forward, the impact on our results
of operations of a one-point interest rate change on the balances subsequently outstanding under the new senior
credit facility would be approximately $4.6 million. We have made certain loans to our franchisees totaling $5.9 million
as of August 31, 2006. The interest rates on these notes are generally between 6.0% and 10.5%. We believe the fair
market value of these notes approximates their carrying amount.
The company entered into an interest rate swap in February 2006, which was designated as a cash flow hedge to
modify a portion of the variable rate line of credit to a fixed rate obligation, thereby reducing the exposure to market
rate fluctuations. Subsequent to repayment of the line of credit, this interest rate swap was terminated, resulting in an
immaterial gain being recognized immediately to income in the first quarter of fiscal year 2007.
In August 2006, the company entered into a forward starting swap agreement, which was designated as a cash
flow hedge of the variability in the cash outflows of interest payments on the securitized financing that is anticipated
to be completed by December 31, 2006. The swap has a notional principal amount of $400 million.The gross fair value
of the forward starting swap as of August 31, 2006 was a liability of $0.8 million. A 1% increase or decrease in the
benchmark rate is estimated to result in approximately a $.2 million increase or decrease, respectively, in the gross fair
value of the forward starting swap.
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 have not made any long-term commitments to purchase any minimum quantities under
these arrangements.We do not use financial instruments to hedge commodity prices because these purchase
agreements help control the ultimate cost and any commodity price aberrations are generally short term in nature.
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.
Sonic Corp. 2006 Annual Report
31
Management’s Discussion and
Analysis of Financial Condition
and Results of Operations