Pizza Hut 2004 Annual Report Download - page 47

Income฀ Tax฀ Valuation฀ Allowances฀ and฀ Tax฀ Reserves฀ At฀
December฀25,฀ 2004,฀ we฀ have฀ a฀ valuation฀ allowance฀ of฀
$351฀million฀ primarily฀ to฀ reduce฀ our฀ net฀ operating฀ loss฀
and฀tax฀credit฀carryforwards฀of฀$231฀million฀and฀our฀other฀
deferred฀ tax฀ assets฀to฀ amounts฀that฀ will฀more฀ likely฀than฀
not฀be฀realized.฀The฀net฀operating฀loss฀and฀tax฀credit฀carry-
forwards฀exist฀in฀many฀state฀and฀foreign฀jurisdictions฀and฀
have฀varying฀carryforward฀periods฀and฀restrictions฀on฀usage.฀
The฀estimation฀of฀future฀taxable฀income฀in฀these฀state฀and฀
foreign฀jurisdictions฀and฀our฀resulting฀ability฀ to฀ utilize฀net฀
operating฀loss฀and฀tax฀credit฀carryforwards฀can฀significantly฀
change฀based฀on฀future฀events,฀including฀our฀determinations฀
as฀to฀the฀feasibility฀of฀certain฀tax฀planning฀strategies.฀Thus,฀
recorded฀valuation฀allowances฀may฀be฀subject฀to฀material฀
future฀changes.
As฀ a฀ matter฀ of฀ course,฀ we฀ are฀ regularly฀ audited฀ by฀
federal,฀state฀and฀foreign฀tax฀authorities.฀We฀provide฀reserves฀
for฀potential฀exposures฀when฀we฀consider฀it฀probable฀that฀
a฀ taxing฀ authority฀ may฀ take฀ a฀ sustainable฀ position฀ on฀ a฀
matter฀contrary฀to฀our฀position.฀We฀evaluate฀these฀reserves,฀
including฀interest฀thereon,฀on฀a฀quarterly฀basis฀to฀insure฀that฀
they฀have฀been฀appropriately฀adjusted฀for฀events,฀including฀
audit฀settlements,฀that฀may฀impact฀our฀ultimate฀payment฀for฀
such฀exposures.
See฀Note฀22฀for฀a฀further฀discussion฀of฀our฀income฀taxes.
QUANTITATIVE฀AND฀QUALITATIVE฀฀
DISCLOSURES฀ABOUT฀MARKET฀RISK
The฀Company฀is฀exposed฀ to฀financial฀market฀risks฀associ-
ated฀with฀interest฀rates,฀foreign฀currency฀exchange฀rates฀and฀
commodity฀prices.฀In฀the฀normal฀course฀of฀business฀and฀in฀
accordance฀with฀our฀policies,฀we฀manage฀these฀risks฀through฀
a฀variety฀of฀strategies,฀which฀may฀include฀the฀use฀of฀derivative฀
financial฀and฀commodity฀instruments฀to฀hedge฀our฀underlying฀
exposures.฀Our฀policies฀prohibit฀the฀use฀of฀derivative฀instru-
ments฀for฀trading฀purposes,฀and฀we฀have฀procedures฀in฀place฀
to฀monitor฀and฀control฀their฀use.
Interest฀ Rate฀ Risk฀ We฀ have฀ a฀ market฀ risk฀ exposure฀ to฀
changes฀in฀interest฀rates,฀principally฀in฀the฀United฀States.฀
We฀ attempt฀ to฀ minimize฀ this฀ risk฀ and฀ lower฀ our฀ overall฀
borrowing฀costs฀through฀the฀utilization฀of฀derivative฀financial฀
instruments,฀primarily฀interest฀rate฀swaps.฀These฀swaps฀are฀
entered฀into฀with฀financial฀institutions฀and฀have฀reset฀dates฀
and฀critical฀terms฀that฀match฀those฀of฀the฀underlying฀debt.฀
Accordingly,฀ any฀ change฀ in฀ market฀ value฀ associated฀ with฀
interest฀rate฀swaps฀is฀offset฀by฀the฀opposite฀market฀impact฀
on฀the฀related฀debt.
At฀ December฀25,฀ 2004฀ and฀ December฀27,฀ 2003,฀ a฀
hypothetical฀100฀basis฀point฀increase฀in฀short-term฀interest฀
rates฀would฀result,฀over฀the฀following฀twelve-month฀period,฀
in฀a฀ reduction฀of฀approximately฀$6฀million฀and฀ $3฀million,฀
respectively,฀in฀income฀before฀income฀taxes.฀The฀estimated฀
reductions฀are฀based฀upon฀the฀level฀ of฀ variable฀ rate฀debt฀
and฀assume฀ no฀ changes฀in฀the฀volume฀ or฀ composition฀of฀
debt.฀In฀addition,฀the฀fair฀value฀of฀our฀derivative฀financial฀
instruments฀at฀December฀25,฀2004฀and฀December฀27,฀2003฀
would฀decrease฀approximately฀$51฀million฀and฀$5฀million,฀
respectively.฀The฀fair฀value฀of฀our฀Senior฀Unsecured฀Notes฀
at฀ December฀25,฀ 2004฀ and฀ December฀27,฀ 2003฀ would฀
decrease฀approximately฀$76฀million฀and฀$87฀million,฀respec-
tively.฀Fair฀value฀was฀determined฀by฀discounting฀the฀projected฀
cash฀flows.
Foreign฀Currency฀Exchange฀Rate฀Risk฀ International฀oper-
ating฀profit฀constitutes฀approximately฀41%฀of฀our฀operating฀
profit฀in฀2004,฀excluding฀unallocated฀income฀(expenses).฀
In฀ addition,฀ the฀ Company’s฀ net฀ asset฀ exposure฀ (defined฀
as฀foreign฀currency฀assets฀less฀foreign฀currency฀liabilities)฀
totaled฀approximately฀$1.5฀billion฀as฀of฀December฀25,฀2004.฀
Operating฀in฀international฀ markets฀exposes฀the฀Company฀
to฀ movements฀ in฀ foreign฀ currency฀ exchange฀ rates.฀ The฀
Company’s฀primary฀exposures฀result฀from฀our฀operations฀in฀
Asia-Pacific,฀the฀Americas฀ and฀Europe.฀Changes฀in฀foreign฀
currency฀exchange฀rates฀would฀impact฀the฀translation฀of฀our฀
investments฀in฀foreign฀operations,฀the฀fair฀value฀of฀our฀foreign฀
currency฀denominated฀financial฀instruments฀and฀our฀reported฀
foreign฀currency฀denominated฀earnings฀and฀cash฀flows.฀For฀
the฀fiscal฀year฀ended฀December฀25,฀2004,฀operating฀profit฀
would฀have฀decreased฀$59฀million฀if฀all฀foreign฀currencies฀had฀
uniformly฀weakened฀10%฀relative฀to฀the฀U.S.฀dollar.฀The฀esti-
mated฀reduction฀assumes฀no฀changes฀in฀sales฀volumes฀or฀
local฀currency฀sales฀or฀input฀prices.
We฀attempt฀to฀minimize฀the฀exposure฀related฀to฀our฀
investments฀in฀foreign฀operations฀by฀financing฀those฀invest-
ments฀with฀local฀currency฀debt฀when฀practical฀and฀holding฀
cash฀ in฀ local฀ currencies฀ when฀ possible.฀ In฀ addition,฀ we฀
attempt฀to฀minimize฀the฀exposure฀related฀to฀foreign฀currency฀
denominated฀financial฀instruments฀by฀purchasing฀goods฀and฀
services฀ from฀third฀parties฀in฀local฀ currencies฀when฀ prac-
tical.฀Consequently,฀foreign฀currency฀denominated฀financial฀
instruments฀ consist฀ primarily฀ of฀ intercompany฀ short-term฀
receivables฀ and฀ payables.฀ At฀ times,฀ we฀ utilize฀ forward฀
contracts฀ to฀ reduce฀ our฀ exposure฀ related฀ to฀ these฀ inter-
company฀short-term฀receivables฀and฀payables.฀The฀notional฀
amount฀and฀maturity฀dates฀of฀these฀contracts฀match฀those฀
of฀ the฀ underlying฀ receivables฀ or฀ payables฀ such฀ that฀ our฀
foreign฀currency฀exchange฀risk฀related฀to฀these฀instruments฀
is฀eliminated.
Commodity฀Price฀Risk฀ We฀are฀subject฀to฀volatility฀in฀food฀
costs฀as฀a฀result฀of฀market฀risk฀associated฀with฀commodity฀
prices.฀Our฀ability฀to฀recover฀increased฀costs฀through฀higher฀
pricing฀is,฀at฀times,฀limited฀by฀the฀competitive฀environment฀
in฀which฀we฀operate.฀We฀manage฀our฀exposure฀to฀this฀risk฀
primarily฀through฀pricing฀agreements฀as฀well฀as,฀on฀a฀limited฀
basis,฀commodity฀future฀and฀ option฀ contracts.฀ Commodity฀
future฀and฀option฀contracts฀entered฀into฀for฀the฀fiscal฀years฀
ended฀December฀25,฀2004,฀and฀December฀27,฀2003,฀did฀not฀
significantly฀impact฀our฀financial฀position,฀results฀of฀opera-
tions฀or฀cash฀flows.
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Yum!฀Brands,฀Inc.