Pizza Hut 2011 Annual Report Download - page 148

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Impairment of Goodwill
We evaluate goodwill for impairment on an annual basis or more often if an event occurs or circumstances change that indicates
impairment might exist. Goodwill is evaluated for impairment through the comparison of fair value of our reporting units to their
carrying values. Our reporting units are our operating segments in the U.S., our YRI business units (typically individual countries)
and our China Division brands. Fair value is the price a willing buyer would pay for the reporting unit, and is generally estimated
using discounted expected future after-tax cash flows from company operations and franchise royalties.
Future cash flow estimates and the discount rate are the key assumptions when estimating the fair value of a reporting unit. Future
cash flows are based on growth expectations relative to recent historical performance and incorporate sales growth and margin
improvement assumptions that we believe a buyer would assume when determining a purchase price for the reporting unit. The
sales growth and margin improvement assumptions that factor into the discounted cash flows are highly correlated as cash flow
growth can be achieved through various interrelated strategies such as product pricing and restaurant productivity initiatives. The
discount rate is our estimate of the required rate of return that a third-party buyer would expect to receive when purchasing a
business from us that constitutes a reporting unit. We believe the discount rate is commensurate with the risks and uncertainty
inherent in the forecasted cash flows.
The fair values of each of our reporting units were substantially in excess of their respective carrying values as of the 2011 goodwill
impairment test that was performed at the beginning of the fourth quarter.
When we refranchise restaurants, we include goodwill in the carrying amount of the restaurants disposed of based on the relative
fair values of the portion of the reporting unit disposed of in the refranchising versus the portion of the reporting unit that will be
retained. The fair value of the portion of the reporting unit disposed of in a refranchising is determined by reference to the
discounted value of the future cash flows expected to be generated by the restaurant and retained by the franchisee, which include
a deduction for the anticipated, future royalties the franchisee will pay us associated with the franchise agreement entered into
simultaneously with the refranchising transaction. Appropriate adjustments are made to the fair value amount being disposed if
such franchise agreement is determined to not be at prevailing market rates. When determining whether such franchise agreement
is at prevailing market rates our primary consideration is consistency with the terms of our current franchise agreements both
within the country that the restaurants are being refranchised in and around the world. The Company believes consistency in
royalty rates as a percentage of sales is appropriate as the Company and franchisee share in the impact of near-term fluctuations
in sales results with the acknowledgment that over the long-term the royalty rate represents an appropriate rate for both parties.
The discounted value of the future cash flows expected to be generated by the restaurant and retained by the franchisee is reduced
by future royalties the franchisee will pay the Company. The Company thus considers the fair value of future royalties to be
received under the franchise agreement as fair value retained in its determination of the goodwill to be written off when
refranchising. Others may consider the fair value of these future royalties as fair value disposed of and thus would conclude that
a larger percentage of a reporting unit’s fair value is disposed of in a refranchising transaction.
During 2011, the Company's reporting units with the most significant refranchising activity and recorded goodwill were our KFC
U.S. operating segment and our Pizza Hut United Kingdom (“U.K.”) business unit. Within our KFC U.S. operating segment, 264
restaurants were refranchised (representing 34% of beginning-of-year company units) and $8 million in goodwill was written off
(representing 7% of beginning-of-year goodwill). Within our Pizza Hut U.K. business unit, 47 delivery restaurants were
refranchised (representing 10% of beginning-of-year company units) and $4 million in goodwill was written off (representing 4%
of beginning-of-year goodwill).
See Note 2 for a further discussion of our policies regarding goodwill.
Allowances for Franchise and License Receivables/Guarantees
Franchise and license receivable balances include royalties, initial fees and other ancillary receivables such as rent and fees for
support services. Our reserve for franchisee or licensee receivable balances is based upon pre-defined aging criteria or upon the
occurrence of other events that indicate that we may not collect the balance due. This methodology results in an immaterial amount
of unreserved past due receivable balances at December 31, 2011. As such, we believe our allowance for franchise and license
receivables is adequate to cover potential exposure from uncollectible receivable balances at December 31, 2011.
We issue certain guarantees on behalf of franchisees primarily as a result of 1) assigning our interest in obligations under operating
leases, primarily as a condition to the refranchising of certain Company restaurants, 2) facilitating franchisee development and 3)
equipment financing arrangements to facilitate the launch of new sales layers by franchisees. We recognize a liability for the fair
value of such guarantees upon inception of the guarantee and upon any subsequent modification, such as franchise lease renewals,
Form 10-K