In the impairment analysis for Carls restaurants, what are some of the Level 2 and Level 3 unobservable inputs used to estimate fair value?
Carls Franchise · 2024 FDDAnswer from 2024 FDD Document
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 re franchising 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, the impairment analysis for restaurant-level long-lived assets relies on several estimates, assumptions, and measurements that include Level 2 and Level 3 unobservable inputs. These inputs are used to estimate the fair value of the restaurants. Specifically, the unobservable inputs include estimates of future cash flows, assumptions of future same-store sales, and projected operating expenses for each restaurant over their estimated remaining useful lives.
Carls estimates future cash flows based on experience, intentions regarding refranchising or closing restaurants, recent and expected sales trends, internal plans, the period since the restaurant was opened or remodeled, the maturity of the related market, and other relevant information. The company generally estimates the useful life of restaurants on owned property to be 20 to 40 years. For restaurants subject to leases, the useful life is estimated to range from the end of the current lease term to the end of such lease term including option periods.
For a prospective Carls franchisee, this means that the company's financial performance and asset valuation are subject to considerable estimation and judgment, particularly regarding future revenues and expenses. If actual cash flows or same-store sales fall short of forecasted levels, or if operating cost increases exceed forecasts, Carls may incur additional impairment charges. This could affect the financial stability of the company and, by extension, the support and resources available to franchisees. Therefore, it is important for potential franchisees to carefully review Carls's financial statements and understand the assumptions underlying these estimates.