Pizza Hut 2005 Annual Report Download - page 44

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฀19฀for฀a฀further฀discussion฀of฀our฀income฀taxes.
Stock฀Option฀Expense฀ Compensation฀expense฀for฀stock฀
options฀is฀estimated฀on฀the฀grant฀date฀using฀a฀Black-Scholes฀
option฀pricing฀model.฀Our฀specific฀weighted-average฀assump-
tions฀for฀the฀risk-free฀interest฀rate,฀expected฀term,฀expected฀
volatility฀ and฀ expected฀ dividend฀ yield฀ are฀ documented฀ in฀
Note฀15.฀Additionally,฀under฀SFAS฀123R฀we฀are฀required฀to฀
estimate฀pre-vesting฀forfeitures฀for฀purposes฀of฀determining฀
compensation฀expense฀to฀ be฀recognized.฀ Future฀ expense฀
amounts฀for฀any฀particular฀quarterly฀or฀annual฀period฀could฀
be฀affected฀by฀changes฀in฀our฀assumptions฀or฀changes฀in฀
market฀conditions.
In฀connection฀with฀our฀adoption฀of฀SFAS฀123R,฀we฀deter-
mined฀that฀it฀was฀appropriate฀to฀group฀our฀stock฀option฀grants฀
into฀two฀homogeneous฀groups฀when฀estimating฀expected฀life฀
and฀pre-vesting฀forfeitures.฀These฀groups฀consist฀of฀grants฀
made฀ primarily฀ to฀ restaurant-level฀ employees฀ under฀ our฀
Restaurant฀General฀Manager฀Stock฀Option฀Plan฀(the฀“RGM฀
Plan”)฀and฀grants฀made฀to฀executives฀under฀our฀other฀stock฀
option฀plans.฀Historically,฀approximately฀20%฀of฀total฀options฀
granted฀have฀been฀made฀under฀the฀RGM฀Plan.
We฀have฀traditionally฀used฀six฀years฀as฀the฀expected฀term฀
of฀all฀stock฀option฀grants.฀In฀connection฀with฀our฀adoption฀of฀
SFAS฀123R฀and฀the฀increasing฀amount฀of฀historical฀data฀we฀
now฀possess฀with฀regard฀to฀stock฀option฀exercise฀activity,฀
we฀revaluated฀our฀expected฀term฀assumptions.฀Based฀on฀
historical฀exercise฀and฀post-vesting฀employment฀termination฀
behavior,฀we฀determined฀that฀the฀expected฀life฀for฀options฀
granted฀ under฀ the฀ RGM฀ Plan฀ was฀ five฀ years.฀ For฀ options฀
granted฀to฀our฀above-store฀executives,฀we฀determined฀that฀
an฀expected฀life฀of฀six฀years฀was฀appropriate.
Prior฀to฀the฀adoption฀of฀SFAS฀123R฀we฀have฀tradition-
ally฀based฀expected฀volatility฀on฀Company฀specific฀historical฀
stock฀data฀ over฀ the฀ expected฀ term฀of฀the฀option.฀We฀are฀
in฀the฀process฀of฀revaluating฀expected฀volatility,฀including฀
consideration฀ of฀ both฀ historical฀ volatility฀ of฀ our฀ stock฀ as฀
well฀as฀implied฀volatility฀associated฀with฀our฀traded฀options.฀
Options฀granted฀subsequent฀to฀the฀adoption฀of฀SFAS฀123R฀
in฀the฀fourth฀quarter฀of฀2005฀were฀not฀significant.
Prior฀to฀our฀adoption฀of฀SFAS฀123R฀we฀recorded฀reduc-
tions฀ in฀ expense฀ due฀ to฀ pre-vesting฀ forfeitures฀ as฀ they฀
occurred.฀In฀connection฀with฀the฀adoption฀of฀SFAS฀123R฀we฀
have฀estimated฀forfeitures฀based฀on฀historical฀data.฀Based฀
on฀ such฀ data,฀ we฀ believe฀ that฀ approximately฀ 45%฀ of฀ all฀
options฀granted฀under฀the฀RGM฀Plan,฀which฀typically฀vest฀on฀
a฀cliff-basis฀after฀four฀years,฀will฀be฀forfeited฀while฀approxi-
mately฀19%฀of฀options฀granted฀to฀above-store฀executives,฀
which฀typically฀vest฀25%฀per฀year฀ over฀four฀years,฀will฀be฀
forfeited.฀An฀insignificant฀transition฀adjustment฀was฀recorded฀
upon฀the฀adoption฀of฀SFAS฀123R฀for฀the฀difference฀between฀
actual฀and฀estimated฀forfeitures฀for฀the฀first฀three฀quarters฀
of฀2005฀which฀we฀restated฀under฀the฀modified฀retrospective฀
transition฀method.
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฀instruments฀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฀31,฀ 2005฀ and฀ December฀25,฀ 2004,฀ a฀
hypothetical฀100฀basis฀point฀increase฀in฀short-term฀interest฀
rates฀would฀result,฀over฀the฀following฀twelve-month฀period,฀
in฀a฀reduction฀of฀approximately฀$7฀million฀and฀$6฀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฀instru-
ments฀ at฀ December฀31,฀ 2005฀ and฀ December฀25,฀ 2004฀
would฀decrease฀approximately฀$39฀million฀and฀$51฀million,฀
respectively.฀The฀fair฀value฀of฀our฀Senior฀Unsecured฀Notes฀
at฀ December฀31,฀ 2005฀ and฀ December฀25,฀ 2004฀ would฀
decrease฀approximately฀$59฀million฀and฀$76฀million,฀respec-
tively.฀Fair฀value฀was฀determined฀by฀discounting฀the฀projected฀
cash฀flows.
Foreign฀ Currency฀ Exchange฀ Rate฀ Risk฀ The฀ combined฀
International฀Division฀and฀China฀Division฀operating฀profits฀
constitute฀approximately฀43%฀of฀our฀operating฀profit฀in฀2005,฀
excluding฀unallocated฀income฀(expenses).฀In฀addition,฀the฀
Company’s฀net฀asset฀exposure฀(defined฀as฀foreign฀currency฀
assets฀ less฀ foreign฀ currency฀ liabilities)฀ totaled฀ approxi-
mately฀$1.3฀billion฀as฀of฀December฀31,฀2005.฀Operating฀in฀
48.฀ ฀ ฀ |฀ ฀ ฀ Yum!฀Brands,฀Inc.