Red Lobster 2014 Annual Report Download - page 13

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
2014 Annual Report 11
of a location) as continuing cash flows and evaluate the significance of
expected guest transfer when evaluating a restaurant for discontinued
operations reporting. To the extent we dispose of enough assets where
classification between continuing operations and discontinued operations
would be material to our consolidated financial statements, we utilize the
reporting provisions for discontinued operations. Assets whose disposal is
not probable within one year remain in land, buildings and equipment until
their disposal within one year is probable.
We account for exit or disposal activities, including restaurant closures,
in accordance with Financial Accounting Standards Board (FASB) Accounting
Standards Codification (ASC) Topic 420, Exit or Disposal Cost Obligations.
Such costs include the cost of disposing of the assets as well as other facility-
related expenses from previously closed restaurants. These costs are
generally expensed as incurred. Additionally, at the date we cease using a
property under an operating lease, we record a liability for the net present
value of any remaining lease obligations, net of estimated sublease income.
Any subsequent adjustments to that liability as a result of lease termination
or changes in estimates of sublease income are recorded in the period
incurred. Upon disposal of the assets, primarily land, associated with a
closed restaurant, any gain or loss is recorded in the same caption within
our consolidated statements of earnings as the original impairment.
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 2014, 2013 and
2012 we recognized long-lived asset impairment charges of $18.3 million
($11.3 million net of tax), $0.7 million ($0.4 million net of tax) and $0.2 million
($0.1 million net of tax), respectively. Impairment charges resulted primarily
from the carrying value of restaurant assets exceeding the estimated fair
market value, which is based on projected cash flows. These costs are
included in asset impairments, net as a component of earnings from con-
tinuing operations in the accompanying consolidated statements of earnings
for fiscal 2014, 2013 and 2012. Impairment charges were measured based
on the amount by which the carrying amount of these assets exceeded their
fair value. Fair value is generally determined based on appraisals or sales
prices of comparable assets and estimates of future cash flows.
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 25, 2014 and
May 26, 2013, we had goodwill of $872.5 million and $908.3 million,
respectively. At May 25, 2014 and May 26, 2013, we had trademarks of
$574.6 million and $573.8 million, respectively.
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 esti-
mates 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, fair value
is allocated 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 eight reporting units, six of which had goodwill:
Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille,
Eddie V’s, and Yard House. As part of our process for performing the step one
impairment 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 relative to the size of the LongHorn
Steakhouse ($49.4 million), The Capital Grille ($401.7 million), Eddie V’s
($22.0 million) and Yard House ($369.2 million) reporting units, we also
performed sensitivity analyses on our estimated fair value of these reporting
units 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 of 10.0 percent for LongHorn Steakhouse and The Capital Grille,
15.0 percent for Eddie V’s and 13.0 percent for Yard House. An increase
in the weighted-average cost of capital of approximately 518 basis points,