Sonic 2009 Annual Report Download - page 24

Management's Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies and Estimates
The Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this document contain
information that is pertinent to management's discussion and analysis. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to use its judgment to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. These assumptions and estimates could
have a material effect on our financial statements. We evaluate our assumptions and estimates on an ongoing basis using historical
experience and various other factors that are believed to be relevant under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions.
We annually review our financial reporting and disclosure practices and accounting policies to ensure that our financial reporting
and disclosures provide accurate and transparent information relative to the current economic and business environment. We believe
that of our significant accounting policies (see Note 1 of Notes to Consolidated Financial Statements), the following policies involve a
higher degree of risk, judgment and/or complexity.
Impairment of Long-Lived Assets. We review Partner Drive-In assets for impairment when events or circumstances indicate they
might be impaired. We test for impairment using historical cash flows and other relevant facts and circumstances as the primary basis
for our estimates of future cash flows. This process requires the use of estimates and assumptions, which are subject to a high degree
of judgment.These impairment tests require us to estimate fair values of our drive-ins by making assumptions regarding future cash flows
and other factors. During fiscal year 2009, we reviewed Partner Drive-Ins and other long-lived assets with combined carrying amounts
of $52 million in property, equipment and capital leases for possible impairment, and our cash flow assumptions resulted in impairment
charges totaling $11.2 million to write down certain assets to their estimated fair value.
We assess the recoverability of goodwill and other intangible assets related to our brand and drive-ins at least annually and more
frequently if events or changes in circumstances occur indicating that the carrying amount of the asset may not be recoverable. Goodwill
impairment testing first requires a comparison of the fair value of each reporting unit to the carrying value. We estimate fair value based
on a comparison of two approaches: discounted cash flow analyses and a market multiple approach. The discounted estimates of future
cash flows include significant management assumptions such as revenue growth rates, operating margins, weighted average cost of
capital, and future economic and market conditions. In addition, the market multiple approach includes significant assumptions such as
the use of recent historical market multiples to estimate future market pricing. These assumptions are significant factors in calculating
the value of the reporting units and can be affected by changes in consumer demand, commodity pricing, labor and other operating costs,
our cost of capital and our ability to identify buyers in the market. If the carrying value of the reporting unit exceeds fair value, goodwill
is considered impaired. The amount of the impairment is the difference between the carrying value of the goodwill and the “implied”
fair value, which is calculated as if the reporting unit had just been acquired and accounted for as a business combination.
During the fourth quarter of fiscal year 2009, we performed our annual assessment of recoverability of goodwill and other intangible
assets and determined that no impairment was indicated. As of the 2009 impairment testing date, the fair value of the Partner Drive-In
reporting unit exceeded the carrying value by approximately 15%. The carrying value of goodwill as of August 31, 2009, was $76.3
million, all of which was allocated to the Partner Drive-In reporting unit. If cash flows generated by our Partner Drive-Ins were to decline
significantly in the future or there were negative revisions to key assumptions, we may be required to record impairment charges to reduce
the carrying amount of goodwill.
Ownership Program. 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 is financed by third parties. Supervisors and
managers are neither employees of Sonic nor of the drive-in in which they have an ownership interest.
The minority ownership interests in Partner Drive-Ins of the managers and supervisors are recorded as a minority interest liability
on the Consolidated Balance Sheets, and their share of the drive-in earnings is reflected as minority interest in earnings of Partner Drive-
Ins in the costs and expenses section of the Consolidated Statements of Income. The ownership agreements contain provisions that 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, including primarily 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 company acquires and sells minority interests in Partner Drive-Ins from time to time as managers and supervisors buy out and
buy in to the partnerships or limited liability companies. If the purchase price of a minority interest that we acquire 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 is recorded as a reduction in purchased goodwill. When the company sells a minority interest, the sales price is typically
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