Pizza Hut 2013 Annual Report Download - page 145

YUM! BRANDS, INC.-2013 Form10-K 49
Form 10-K
PART II
ITEM 8Financial Statements andSupplementaryData
NOTE4 Items Affecting Comparability of Net Income and Cash Flows
Little Sheep Acquisition and Subsequent
Impairment
On February 1, 2012 we acquired an additional 66% interest in Little Sheep
Group Limited (“Little Sheep”) for $540 million, net of cash acquired of $44
million, increasing our ownership to 93%. The acquisition was driven by our
strategy to build leading brands across China in every significant category.
Prior to our acquisition of this additional interest, our 27% interest in Little
Sheep was accounted for under the equity method of accounting. As a
result of the acquisition we obtained voting control of Little Sheep, and
thus we began consolidating Little Sheep upon acquisition. As required by
GAAP, we remeasured our previously held 27% ownership in Little Sheep,
which had a recorded value of $107 million at the date of acquisition, at
fair value based on Little Sheep’s traded share price immediately prior to
our offer to purchase the business and recognized a non-cash gain of
$74 million. This gain, which resulted in no related income tax expense,
was recorded in Other (income) expense on our Consolidated Statement
of Income in 2012 and was not allocated to any segment for performance
reporting purposes.
We recorded the following assets acquired and liabilities assumed upon
acquisition of Little Sheep as a result of our purchase price allocation:
Current assets, including cash of $44 $ 109
Property, plant and equipment 64
Goodwill 376
Intangible assets, including indefinite-lived
trademark of $404 421
Other assets 35
Total assets acquired 1,005
Deferred taxes 105
Other liabilities 60
Total liabilities assumed 165
Redeemable noncontrolling interest 59
Other noncontrolling interests 16
NET ASSETS ACQUIRED $ 765
The fair values of intangible assets were determined using an income
approach based on expected cash flows� The goodwill recorded resulted
from the value expected to be generated from applying YUM’s processes
and knowledge in China, including YUM’s development capabilities, to
the Little Sheep business� The goodwill is not expected to be deductible
for income tax purposes and has been allocated to the China operating
segment�
As part of the acquisition, YUM granted an option to the shareholder that
holds the remaining 7% ownership interest in Little Sheep that would require
us to purchase their remaining shares owned upon exercise, which may occur
any time after the third anniversary of the acquisition� This noncontrolling
interest has been recorded as a Redeemable noncontrolling interest in the
Consolidated Balance Sheet� The Redeemable noncontrolling interest was
reported at its fair value of $59 million at the date of acquisition, which was
based on the Little Sheep traded share price immediately subsequent to
our offer to purchase the additional interest�
Under the equity method of accounting, we previously reported our 27%
share of the net income of Little Sheep as Other (income) expense in
the Consolidated Statements of Income� Since the acquisition, we have
reported Little Sheep’s results of operations in the appropriate line items
of our Consolidated Statement of Income� We no longer report Other
(income) expense as we did under the equity method of accounting� Net
income attributable to our partner’s ownership percentage is recorded
in Net Income (loss) – noncontrolling interests� Little Sheep reports on a
one month lag, and as a result, their consolidated results were included
in the China Division starting the second quarter of 2012� In 2012, the
consolidation of Little Sheep increased China Division Revenues by 4%
and did not have a significant impact on China Division Operating Profit
versus 2011.
The purchase price paid for the additional 66% interest and the resulting
purchase price allocation assumed same-store sales growth and new
unit development for the brand. Little Sheep’s sales were negatively
impacted by a longer than expected purchase approval and ownership
transition phase. Our efforts to regain sales momentum were significantly
compromised in May 2013 due to negative publicity regarding quality
issues with unrelated hot pot concepts in China, even though there was
not an issue with the quality of Little Sheep products.
The sustained declines in sales and profits that began in May 2013 and
continued through the third quarter, coupled with the anticipated time it will
now take for the business to recover, resulted in a determination during the
quarter ended September 7, 2013 that it is not more likely than not that
the Little Sheep trademark and reporting unit fair values are in excess of
their carrying values. Therefore, our Little Sheep trademark and goodwill
were tested for impairment in the quarter ended September 7, 2013, prior
to the annual impairment reviews performed at the beginning of the fourth
quarter of each year in accordance with our accounting policy.
As a result of comparing the trademark’s fair value of $345 million to its
carrying value of $414 million, an impairment charge of $69 million was
recorded in the quarter ended September 7, 2013. Additionally, after
determining the fair value of the Little Sheep reporting unit was less than
its carrying value, goodwill was written down to $162 million, resulting in
an impairment charge of $222 million. The Company also evaluated other
Little Sheep long-lived assets for impairment and recorded a $4 million
impairment charge related to restaurant-level PP&E.
These non-cash impairment charges totalling $295 million were recorded in
Closures and impairment (income) expense on our Consolidated Statement
of Income and were not allocated to any segment for performance
reporting purposes, consistent with the classification of the $74 million
gain that was recorded upon acquisition. We recorded an $18 million tax
benefit associated with these impairments and allocated $19 million of
the net impairment charges to Net Income (loss) - noncontrolling interests,
which resulted in a net impairment charge of $258 million allocated to Net
Income – YUM! Brands, Inc.
The fair values of the Little Sheep trademark and reporting unit were based
on the estimated prices a willing buyer would pay. The fair value of the
trademark was determined using a relief from royalty valuation approach
that included future estimated sales as a significant input. The reporting
unit fair value was determined using an income approach with future cash
flow estimates generated by the business as a significant input. Future
cash flow estimates are impacted by new unit development, sales growth
and margin improvement. Both fair values incorporated a discount rate of
13% as our estimate of the required rate of return that a third-party buyer
would expect to receive when purchasing the Little Sheep trademark or
reporting unit.
The inputs used in determining the fair values of the Little Sheep trademark
and reporting unit assumed that the business will recover to pre-acquisition
average-unit sales volumes and profit levels over the next three years. At
such pre-acquisition sales and profit levels, we believe that the Little Sheep
restaurant-level unit economics will support the new unit development we
assumed in the fair value estimations of the trademark and reporting unit.
Long-term average growth assumptions subsequent to this assumed
recovery include same-store-sales growth of 4% and average annual net
unit growth of approximately 75 units.