What characterizes Level 3 unobservable inputs that Carls uses to determine the fair value of assets or liabilities?
Carls Franchise · 2024 FDDAnswer from 2024 FDD Document
- Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Our impairment analyses rely upon a number of estimates, assumptions and measurements with significant Level 2 and Level 3 unobservable inputs (see Note 13), including estimates of future cash flows, assumptions of future same-store sales and projected operating expenses for each of our restaurants over their estimated remaining useful lives in order to evaluate recoverability and estimate fair value. Future cash flows are estimated based upon experience gained, current intentions about refranchising or closing restaurants, recent and expected sales trends, internal plans, the period of time since the restaurant was opened or remodeled, the maturity of the related market and other relevant information. We generally estimate the useful life of restaurants on owned property to be 20 to 40 years and estimate the useful life of restaurants subject to leases to range from the end of the lease term then in effect to the end of such lease term including option periods. If our future cash flows or same-store sales do not meet or exceed our forecasted levels, or if restaurant operating cost increases exceed our forecast and we are unable to recover such costs through price increases, the carrying value of certain of our restaurants may prove to be unrecoverable, and we may incur additional impairment charges in the future.
Source: Item 21 — FINANCIAL STATEMENTS (FDD pages 79–80)
What This Means (2024 FDD)
According to Carls's 2024 Franchise Disclosure Document, Level 3 inputs are unobservable inputs that have little to no support from market activity but are significant when determining the fair value of assets or liabilities. These inputs are used in impairment analyses, which rely on estimates, assumptions, and measurements. These include estimates of future cash flows, assumptions regarding future same-store sales, and projected operating expenses for each restaurant over their estimated remaining useful lives to evaluate recoverability and estimate fair value.
Carls estimates future cash flows based on experience, intentions regarding refranchising or closing restaurants, recent and expected sales trends, internal plans, the time since a restaurant was opened or remodeled, the maturity of the market, and other relevant information. The company generally estimates the useful life of restaurants on owned property to be 20 to 40 years and estimates the useful life of restaurants subject to leases to range from the end of the lease term then in effect to the end of such lease term including option periods.
For a prospective franchisee, this means that Carls relies on internal projections and assumptions, rather than concrete market data, when assessing the value of its assets. If these projections are overly optimistic, it could lead to an overvaluation of assets and potential future impairment charges. Franchisees should be aware of the subjective nature of these Level 3 inputs and how they could impact Carls's financial performance.