Red Lobster 2011 Annual Report Download - page 33

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
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2011 Annual Report 31
The judgments we make related to the expected useful lives of long-lived
assets and our ability to realize undiscounted cash flows in excess of the carrying
amounts of these assets are affected by factors such as the ongoing maintenance
and improvements of the assets, changes in economic conditions, changes in
usage or operating performance, desirability of the restaurant sites and other
factors, such as our ability to sell our assets held for sale. As we assess the
ongoing expected cash flows and carrying amounts of our long-lived assets,
significant adverse changes in these factors could cause us to realize a material
impairment loss. During fiscal 2011, we recognized asset impairment losses of
$4.7 million ($2.9 million after tax), primarily related to the permanent closure
of two Red Lobsters and the write-down of another Red Lobster based on an
evaluation of expected cash flows, and the write-down of assets held for
disposition based on updated valuations. During fiscal 2010, we recognized asset
impairment losses of $6.2 million ($3.8 million after tax), primarily related to
the write-down of assets held for disposition based on updated valuations, the
permanent closure of three Red Lobsters and three LongHorn Steakhouses and
the write-down of two LongHorn Steakhouses and one Olive Garden based on
an evaluation of expected cash flows. During fiscal 2009, we recognized asset
impairment losses of $12.0 million ($7.4 million after tax), primarily related to
the write-down of assets held for disposition, the permanent closure of one
LongHorn Steakhouse and the write-down of another LongHorn Steakhouse
based on an evaluation of expected cash flows. Asset impairment losses are
included in asset impairment, net, on our consolidated statements of earnings.
Valuation and Recoverability of Goodwill
and Trademarks
We review our goodwill and trademarks for impairment annually, as of the first
day of our fiscal fourth quarter, or more frequently if indicators of impairment
exist. Goodwill and trademarks are not subject to amortization and have been
assigned to reporting units for purposes of impairment testing. The reporting
units are our restaurant brands. At May 29, 2011 and May 30, 2010, we had
goodwill of $517.1 million and $517.3 million, respectively. At May 29, 2011 and
May 30, 2010, we had trademarks of $454.0 million.
A significant amount of judgment is involved in determining if an indicator
of impairment has occurred. Such indicators may include, among others:
a฀significant฀decline฀in฀our฀expected฀future฀cash฀flows;฀a฀sustained,฀significant฀
decline฀in฀our฀stock฀price฀and฀market฀capitalization;฀a฀significant฀adverse฀change฀
in฀legal฀factors฀or฀in฀the฀business฀climate;฀unanticipated฀competition;฀the฀testing฀
for฀recoverability฀of฀a฀significant฀asset฀group฀within฀a฀reporting฀unit;฀and฀slower฀
growth rates. Any adverse change in these factors could have a significant impact
on the recoverability of these assets and could have a material impact on our
consolidated financial statements.
The goodwill impairment test involves a two-step process. The first step is
a comparison of each reporting unit’s fair value to its carrying value. We estimate
fair value using the best information available, including market information and
discounted cash flow projections (also referred to as the income approach).
The income approach uses a reporting unit’s projection of estimated operating
results and cash flows that is discounted using a weighted-average cost of capital
that reflects current market conditions. The projection uses management’s best
estimates of economic and market conditions over the projected period including
growth rates in sales, costs and number of units, estimates of future expected
changes in operating margins and cash expenditures. Other significant estimates
and assumptions include terminal value growth rates, future estimates of capital
expenditures and changes in future working capital requirements. We validate
our estimates of fair value under the income approach by comparing the values to
fair value estimates using a market approach. A market approach estimates fair
value by applying cash flow and sales multiples to the reporting unit’s operating
performance. The multiples are derived from comparable publicly traded companies
with similar operating and investment characteristics of the reporting units.
If the fair value of the reporting unit is higher than its carrying value,
goodwill is deemed not to be impaired, and no further testing is required. If the
carrying value of the reporting unit is higher than its fair value, there is an indication
that impairment may exist and the second step must be performed to measure
the amount of impairment loss. The amount of impairment is determined by
comparing the implied fair value of reporting unit goodwill to the carrying value
of the goodwill in the same manner as if the reporting unit was being acquired in
a business combination. Specifically, we would allocate the fair value to all of the
assets and liabilities of the reporting unit, including any unrecognized intangible
assets, in a hypothetical analysis that would calculate the implied fair value of
goodwill. If the implied fair value of goodwill is less than the recorded goodwill,
we would record an impairment loss for the difference.
Consistent with our accounting policy for goodwill and trademarks, we
performed our annual impairment test of our goodwill and trademarks as of
the first day of our fiscal fourth quarter. As of the beginning of our fiscal fourth
quarter,฀we฀had฀six฀reporting฀units;฀Red฀Lobster,฀Olive฀Garden,฀LongHorn฀
Steakhouse, The Capital Grille, Bahama Breeze and Seasons 52. Two of these
reporting units, LongHorn Steakhouse and The Capital Grille, have a significant
amount of goodwill. As part of our process for performing the step one impair-
ment test of goodwill, we estimated the fair value of our reporting units utilizing
the income and market approaches described above to derive an enterprise value
of the Company. We reconciled the enterprise value to our overall estimated
market capitalization. The estimated market capitalization considers recent
trends in our market capitalization and an expected control premium, based
on comparable recent and historical transactions. Based on the results of the
step one impairment test, no impairment of goodwill was indicated.
Given the significance of goodwill related to these reporting units, we also
performed sensitivity analyses on our estimated fair value of LongHorn Steakhouse
and The Capital Grille using the income approach. A key assumption in our fair
value estimate is the weighted-average cost of capital utilized for discounting
our cash flow estimates in our income approach. We selected a weighted-average
cost of capital for LongHorn Steakhouse and The Capital Grille of 12.0 percent.
An increase in the weighted-average cost of capital of approximately 620 basis
points and approximately 90 basis points would result in an impairment of a portion
of the goodwill of LongHorn Steakhouse and The Capital Grille, respectively. The
estimated fair value of LongHorn Steakhouse and The Capital Grille exceeded
their carrying value by approximately 116 percent and 7 percent, respectively.