filings.toolsItem 8. Financial Statements and Supplementary Data.
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Item 8. Financial Statements and Supplementary Data.
INDEX TO FINANCIAL INFORMATION
| Page Reference | ||
| Consolidated Financial Statements | ||
| Report of Independent Registered Public Accounting Firm | 49 | |
| Consolidated Statements of Income | 52 | |
| Consolidated Statements of Comprehensive Income | 53 | |
| Consolidated Statements of Cash Flows | 54 | |
| Consolidated Balance Sheets | 55 | |
| Consolidated Statements of Shareholders’ Deficit | 56 | |
| Notes to Consolidated Financial Statements | 57 |
Financial Statement Schedules
No schedules are required because either the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the above-listed financial statements or notes thereto.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Yum! Brands, Inc.:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Yum! Brands, Inc. and Subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, cash flows, and shareholders’ deficit for each of the fiscal years in the three-year period ended December 31, 2019, and the related notes (collectively, the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Changes in Accounting Principle
As discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for leases in fiscal year 2019 due to the adoption of Topic 842, Leases, and for revenue from contracts with customers in fiscal year 2018 due to the adoption of Topic 606, Revenue from Contracts with Customers.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting in the accompanying Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Evaluation of unrecognized tax benefits
As discussed in Note 17 to the consolidated financial statements, the Company has recorded unrecognized tax benefits, excluding associated interest, of $188 million. Tax laws are complex and often subject to different interpretations by tax payers and the respective taxing authorities.
We identified the evaluation of unrecognized tax benefits as a critical audit matter. Subjective and complex auditor judgment was required to evaluate tax law and regulations, court rulings and audit settlements in various taxing jurisdictions to assess the population of significant uncertain tax positions identified by the Company arising from tax planning strategies.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s process of identification of uncertain tax positions, including controls to (1) identify tax planning strategies that create significant uncertain tax positions, (2) evaluate interpretations of tax laws and court rulings, and (3) assess which tax positions may not be sustained upon examination by a taxing authority. We involved tax professionals with specialized skills and knowledge who assisted in:
| • | Obtaining an understanding of the Company’s implementation of tax planning strategies; |
| • | Identifying new tax positions created by tax planning strategies and comparing the results to the Company’s identification of uncertain tax positions; |
| • | Evaluating the Company’s interpretation of tax laws and court rulings by developing an independent assessment; and |
| • | Performing an independent assessment to identify tax positions that may not be sustained upon examination by the respective taxing authority and comparing the results to the Company’s assessment. |
Evaluation of intercompany transfer of certain intellectual property rights
As discussed in Note 17 to the consolidated financial statements, the Company completed an intercompany restructuring and transfer of certain intellectual property rights primarily to subsidiaries in the United States and United Kingdom (UK). The Company recorded a deferred tax asset of $586 million for the step-up in the tax basis to current fair value of the intellectual property rights transferred to the UK and determined the portion that is amortizable under the applicable tax law. A valuation allowance of $366 million was established for the portion of the deferred tax asset that is not expected to be realized, resulting in a net deferred tax asset of $221 million, which is expected to be amortized and recovered over a 20-year period.
We identified the evaluation of the intercompany transfer of certain intellectual property rights as a critical audit matter. Specifically, subjective and complex auditor judgment was required to evaluate management’s interpretation of UK tax law and regulations in determining the step-up in tax basis of the intellectual property rights and the portion that is amortizable under UK tax law.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s evaluation of the intercompany transfer, including controls related to evaluating UK tax laws and regulations, measurement of the tax basis resulting from the intercompany transfer and determining the amortizable portion. We involved tax professionals with specialized skills and knowledge who assisted in:
| • | Evaluating the Company’s interpretation of UK tax laws and regulations applicable to the intercompany transfer; and |
| • | Assessing the Company’s measurement of the tax basis of the intellectual property rights transferred to the UK, including the portion of the tax basis that is amortizable under UK tax law. |
/s/ KPMG LLP
We have served as the Company’s auditor since 1997.
Louisville, Kentucky
February 19, 2020
| Consolidated Statements of Income | ||||||||||||
| Yum! Brands, Inc. and Subsidiaries | ||||||||||||
| Fiscal years ended December 31, 2019, 2018 and 2017 | ||||||||||||
| (in millions, except per share data) | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Revenues | ||||||||||||
| Company sales | $ | 1,546 | $ | 2,000 | $ | 3,572 | ||||||
| Franchise and property revenues | 2,660 | 2,482 | 2,306 | |||||||||
| Franchise contributions for advertising and other services | 1,391 | 1,206 | — | |||||||||
| Total revenues | 5,597 | 5,688 | 5,878 | |||||||||
| Costs and Expenses, Net | ||||||||||||
| Company restaurant expenses | 1,235 | 1,634 | 2,954 | |||||||||
| General and administrative expenses | 917 | 895 | 999 | |||||||||
| Franchise and property expenses | 180 | 188 | 237 | |||||||||
| Franchise advertising and other services expense | 1,368 | 1,208 | — | |||||||||
| Refranchising (gain) loss | (37 | ) | (540 | ) | (1,083 | ) | ||||||
| Other (income) expense | 4 | 7 | 10 | |||||||||
| Total costs and expenses, net | 3,667 | 3,392 | 3,117 | |||||||||
| Operating Profit | 1,930 | 2,296 | 2,761 | |||||||||
| Investment (income) expense, net | 67 | (9 | ) | (5 | ) | |||||||
| Other pension (income) expense | 4 | 14 | 47 | |||||||||
| Interest expense, net | 486 | 452 | 445 | |||||||||
| Income before income taxes | 1,373 | 1,839 | 2,274 | |||||||||
| Income tax provision | 79 | 297 | 934 | |||||||||
| Net Income | $ | 1,294 | $ | 1,542 | $ | 1,340 | ||||||
| Basic Earnings Per Common Share | $ | 4.23 | $ | 4.80 | $ | 3.86 | ||||||
| Diluted Earnings Per Common Share | $ | 4.14 | $ | 4.69 | $ | 3.77 | ||||||
| Dividends Declared Per Common Share | $ | 1.68 | $ | 1.44 | $ | 0.90 | ||||||
| See accompanying Notes to Consolidated Financial Statements. |
| Consolidated Statements of Comprehensive Income | ||||||||||||
| Yum! Brands, Inc. and Subsidiaries | ||||||||||||
| Fiscal years ended December 31, 2019, 2018 and 2017 | ||||||||||||
| (in millions) | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Net Income | $ | 1,294 | $ | 1,542 | $ | 1,340 | ||||||
| Other comprehensive income (loss), net of tax: | ||||||||||||
| Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature | ||||||||||||
| Adjustments and gains (losses) arising during the year | 28 | (94 | ) | 115 | ||||||||
| Reclassifications of adjustments and (gains) losses into Net Income | — | (4 | ) | 55 | ||||||||
| 28 | (98 | ) | 170 | |||||||||
| Tax (expense) benefit | (4 | ) | 6 | (8 | ) | |||||||
| 24 | (92 | ) | 162 | |||||||||
| Changes in pension and post-retirement benefits | ||||||||||||
| Unrealized gains (losses) arising during the year | (39 | ) | 32 | (17 | ) | |||||||
| Reclassification of (gains) losses into Net Income | 10 | 22 | 52 | |||||||||
| (29 | ) | 54 | 35 | |||||||||
| Tax (expense) benefit | 7 | (13 | ) | (14 | ) | |||||||
| (22 | ) | 41 | 21 | |||||||||
| Changes in derivative instruments | ||||||||||||
| Unrealized gains (losses) arising during the year | (51 | ) | 19 | (52 | ) | |||||||
| Reclassification of (gains) losses into Net Income | (25 | ) | (39 | ) | 58 | |||||||
| (76 | ) | (20 | ) | 6 | ||||||||
| Tax (expense) benefit | 20 | 6 | (2 | ) | ||||||||
| (56 | ) | (14 | ) | 4 | ||||||||
| Other comprehensive income (loss), net of tax | (54 | ) | (65 | ) | 187 | |||||||
| Comprehensive Income | $ | 1,240 | $ | 1,477 | $ | 1,527 | ||||||
| See accompanying Notes to Consolidated Financial Statements. |
| Consolidated Statements of Cash Flows | ||||||||||||
| Yum! Brands, Inc. and Subsidiaries | ||||||||||||
| Fiscal years ended December 31, 2019, 2018 and 2017 | ||||||||||||
| (in millions) | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Cash Flows – Operating Activities | ||||||||||||
| Net Income | $ | 1,294 | $ | 1,542 | $ | 1,340 | ||||||
| Depreciation and amortization | 112 | 137 | 253 | |||||||||
| Refranchising (gain) loss | (37 | ) | (540 | ) | (1,083 | ) | ||||||
| Investment (income) expense, net | 67 | (9 | ) | (5 | ) | |||||||
| Contributions to defined benefit pension plans | (15 | ) | (16 | ) | (55 | ) | ||||||
| Deferred income taxes | (232 | ) | (11 | ) | 634 | |||||||
| Share-based compensation expense | 59 | 50 | 65 | |||||||||
| Changes in accounts and notes receivable | (56 | ) | (66 | ) | (19 | ) | ||||||
| Changes in prepaid expenses and other current assets | (8 | ) | — | (10 | ) | |||||||
| Changes in accounts payable and other current liabilities | (36 | ) | (68 | ) | (173 | ) | ||||||
| Changes in income taxes payable | 23 | 65 | (55 | ) | ||||||||
| Other, net | 144 | 92 | 138 | |||||||||
| Net Cash Provided by Operating Activities | 1,315 | 1,176 | 1,030 | |||||||||
| Cash Flows – Investing Activities | ||||||||||||
| Capital spending | (196 | ) | (234 | ) | (318 | ) | ||||||
| QuikOrder acquisition, net of cash acquired | — | (66 | ) | — | ||||||||
| Investment in Grubhub Inc. common stock | — | (200 | ) | — | ||||||||
| Proceeds from refranchising of restaurants | 110 | 825 | 1,773 | |||||||||
| Other, net | (2 | ) | (12 | ) | 17 | |||||||
| Net Cash Provided by (Used in) Investing Activities | (88 | ) | 313 | 1,472 | ||||||||
| Cash Flows – Financing Activities | ||||||||||||
| Proceeds from long-term debt | 800 | 1,556 | 1,088 | |||||||||
| Repayments of long-term debt | (331 | ) | (1,264 | ) | (385 | ) | ||||||
| Revolving credit facilities, three months or less, net | — | — | — | |||||||||
| Short-term borrowings, by original maturity | ||||||||||||
| More than three months – proceeds | 130 | 59 | — | |||||||||
| More than three months – payments | (126 | ) | (59 | ) | — | |||||||
| Three months or less, net | — | — | — | |||||||||
| Repurchase shares of Common Stock | (815 | ) | (2,390 | ) | (1,960 | ) | ||||||
| Dividends paid on Common Stock | (511 | ) | (462 | ) | (416 | ) | ||||||
| Debt issuance costs | (10 | ) | (13 | ) | (32 | ) | ||||||
| Other, net | (75 | ) | (47 | ) | (90 | ) | ||||||
| Net Cash Used in Financing Activities | (938 | ) | (2,620 | ) | (1,795 | ) | ||||||
| Effect of Exchange Rate on Cash and Cash Equivalents | 5 | (63 | ) | 61 | ||||||||
| Net Increase (Decrease) in Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents | 294 | (1,194 | ) | 768 | ||||||||
| Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents – Beginning of Year | 474 | 1,668 | 831 | |||||||||
| Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents – End of Year | $ | 768 | $ | 474 | $ | 1,599 | ||||||
| See accompanying Notes to Consolidated Financial Statements. |
| Consolidated Balance Sheets | ||||||||
| Yum! Brands, Inc. and Subsidiaries | ||||||||
| December 31, 2019 and 2018 | ||||||||
| (in millions) | ||||||||
| 2019 | 2018 | |||||||
| ASSETS | ||||||||
| Current Assets | ||||||||
| Cash and cash equivalents | $ | 605 | $ | 292 | ||||
| Accounts and notes receivable, net | 584 | 561 | ||||||
| Prepaid expenses and other current assets | 338 | 354 | ||||||
| Total Current Assets | 1,527 | 1,207 | ||||||
| Property, plant and equipment, net | 1,170 | 1,237 | ||||||
| Goodwill | 530 | 525 | ||||||
| Intangible assets, net | 244 | 242 | ||||||
| Other assets | 1,313 | 724 | ||||||
| Deferred income taxes | 447 | 195 | ||||||
| Total Assets | $ | 5,231 | $ | 4,130 | ||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | ||||||||
| Current Liabilities | ||||||||
| Accounts payable and other current liabilities | $ | 960 | $ | 911 | ||||
| Income taxes payable | 150 | 69 | ||||||
| Short-term borrowings | 431 | 321 | ||||||
| Total Current Liabilities | 1,541 | 1,301 | ||||||
| Long-term debt | 10,131 | 9,751 | ||||||
| Other liabilities and deferred credits | 1,575 | 1,004 | ||||||
| Total Liabilities | 13,247 | 12,056 | ||||||
| Shareholders’ Deficit | ||||||||
| Common Stock, no par value, 750 shares authorized; 300 shares and 306 shares issued in 2019 and 2018, respectively | — | — | ||||||
| Accumulated deficit | (7,628 | ) | (7,592 | ) | ||||
| Accumulated other comprehensive loss | (388 | ) | (334 | ) | ||||
| Total Shareholders’ Deficit | (8,016 | ) | (7,926 | ) | ||||
| Total Liabilities and Shareholders’ Deficit | $ | 5,231 | $ | 4,130 | ||||
| See accompanying Notes to Consolidated Financial Statements. |
| Consolidated Statements of Shareholders’ Deficit | ||||||||||||||||||||
| Yum! Brands, Inc. and Subsidiaries | ||||||||||||||||||||
| Fiscal years ended December 31, 2019, 2018 and 2017 | ||||||||||||||||||||
| (in millions) | ||||||||||||||||||||
| Issued Common Stock | Accumulated Deficit | Accumulated Other Comprehensive Income(Loss) | Total Shareholders' Deficit | |||||||||||||||||
| Shares | Amount | |||||||||||||||||||
| Balance at December 31, 2016 (As Restated) | 355 | $ | — | $ | (5,157 | ) | $ | (458 | ) | $ | (5,615 | ) | ||||||||
| Net Income | 1,340 | 1,340 | ||||||||||||||||||
| Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature (net of tax impact of $8 million) | 107 | 107 | ||||||||||||||||||
| Reclassification of translation adjustments into income | 55 | 55 | ||||||||||||||||||
| Pension and post-retirement benefit plans (net of tax impact of $14 million) | 21 | 21 | ||||||||||||||||||
| Net gain on derivative instruments (net of tax impact of $2 million) | 4 | 4 | ||||||||||||||||||
| Comprehensive Income | 1,527 | |||||||||||||||||||
| Dividends declared | (311 | ) | (311 | ) | ||||||||||||||||
| Repurchase of shares of Common Stock | (27 | ) | — | (1,915 | ) | (1,915 | ) | |||||||||||||
| Employee share-based award exercises | 4 | (58 | ) | (20 | ) | (78 | ) | |||||||||||||
| Share-based compensation events | — | 58 | — | 58 | ||||||||||||||||
| Balance at December 31, 2017 | 332 | $ | — | $ | (6,063 | ) | $ | (271 | ) | $ | (6,334 | ) | ||||||||
| Net Income | 1,542 | 1,542 | ||||||||||||||||||
| Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature (net of tax impact of $6 million) | (88 | ) | (88 | ) | ||||||||||||||||
| Reclassification of translation adjustments into income | (4 | ) | (4 | ) | ||||||||||||||||
| Pension and post-retirement benefit plans (net of tax impact of $13 million) | 41 | 41 | ||||||||||||||||||
| Net loss on derivative instruments (net of tax impact of $6 million) | (14 | ) | (14 | ) | ||||||||||||||||
| Comprehensive Income | 1,477 | |||||||||||||||||||
| Dividends declared | (464 | ) | (464 | ) | ||||||||||||||||
| Repurchase of shares of Common Stock | (28 | ) | (38 | ) | (2,356 | ) | (2,394 | ) | ||||||||||||
| Employee share-based award exercises | 2 | (41 | ) | (41 | ) | |||||||||||||||
| Share-based compensation events | 79 | 79 | ||||||||||||||||||
| Adoption of accounting standards | (251 | ) | 2 | (249 | ) | |||||||||||||||
| Balance at December 31, 2018 | 306 | $ | — | $ | (7,592 | ) | $ | (334 | ) | $ | (7,926 | ) | ||||||||
| Net Income | 1,294 | 1,294 | ||||||||||||||||||
| Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature (net of tax impact of $4 million) | 24 | 24 | ||||||||||||||||||
| Pension and post-retirement benefit plans (net of tax impact of $7 million) | (22 | ) | (22 | ) | ||||||||||||||||
| Net loss on derivative instruments (net of tax impact of $20 million) | (56 | ) | (56 | ) | ||||||||||||||||
| Comprehensive Income | 1,240 | |||||||||||||||||||
| Dividends declared | (514 | ) | (514 | ) | ||||||||||||||||
| Repurchase of shares of Common Stock | (8 | ) | (14 | ) | (796 | ) | (810 | ) | ||||||||||||
| Employee share-based award exercises | 2 | (57 | ) | (18 | ) | (75 | ) | |||||||||||||
| Share-based compensation events | 71 | 71 | ||||||||||||||||||
| Adoption of accounting standards | (2 | ) | (2 | ) | ||||||||||||||||
| Balance at December 31, 2019 | 300 | $ | — | $ | (7,628 | ) | $ | (388 | ) | $ | (8,016 | ) | ||||||||
| See accompanying Notes to Consolidated Financial Statements. |
Notes to Consolidated Financial Statements
(Tabular amounts in millions, except share data)
Note 1 – Description of Business
Yum! Brands, Inc. and its Subsidiaries (collectively referred to herein as the “Company,” “YUM,” “we,” “us” or “our”) franchises or operates a system of over 50,000 quick service restaurants in more than 150 countries and territories. At December 31, 2019, 98% of these restaurants were owned and operated by franchisees. The Company’s KFC, Pizza Hut and Taco Bell brands (collectively the “Concepts”) are global leaders of the chicken, pizza and Mexican-style food categories.
Through our widely-recognized Concepts, we develop, operate or franchise a system of both traditional and non-traditional quick service restaurants. The terms "franchise" or "franchisee" within these Consolidated Financial Statements are meant to describe third parties that operate units under either franchise or license agreements. Our traditional restaurants feature dine-in, carryout and, in some instances, drive-thru or delivery service. Non-traditional units include express units and kiosks which have a more limited menu and operate in non-traditional locations like malls, airports, gasoline service stations, train stations, subways, convenience stores, stadiums, amusement parks and colleges, where a full-scale traditional outlet would not be practical or efficient. We also operate or franchise multibrand units, where two or more of our Concepts are operated in a single unit.
As of December 31, 2019, YUM consisted of three operating segments:
| • | The KFC Division which includes our worldwide operations of the KFC concept |
| • | The Pizza Hut Division which includes our worldwide operations of the Pizza Hut concept |
| • | The Taco Bell Division which includes our worldwide operations of the Taco Bell concept |
Note 2 – Summary of Significant Accounting Policies
Our preparation of the accompanying Consolidated Financial Statements in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Principles of Consolidation and Basis of Preparation. Intercompany accounts and transactions have been eliminated in consolidation. We consolidate entities in which we have a controlling financial interest, the usual condition of which is ownership of a majority voting interest. We also consider for consolidation an entity, in which we have certain interests, where the controlling financial interest may be achieved through arrangements that do not involve voting interests. Such an entity, known as a variable interest entity (“VIE”), is required to be consolidated by its primary beneficiary. The primary beneficiary is the entity that possesses the power to direct the activities of the VIE that most significantly impact its economic performance and has the obligation to absorb losses or the right to receive benefits from the VIE that are significant to it.
Our most significant variable interests are in entities that operate restaurants under our Concepts’ franchise and license arrangements. We do not have an equity interest in any of our franchisee businesses except for a minority interest in an entity that owns our KFC Brazil and Pizza Hut Brazil master franchisee rights. This minority interest does not give us the ability to significantly influence the franchisee. Additionally, we do not typically provide significant financial support such as loans or guarantees to our franchisees. However, we do have variable interests in certain franchisees through real estate lease arrangements to which we are a party. At the end of 2019, YUM has future lease payments due from franchisees, on a nominal basis, of approximately $1 billion, and we are secondarily liable on certain other lease agreements that have been assigned to franchisees. See the Lease Guarantees section in Note 19. As our franchise arrangements provide our franchisee entities the power to direct the activities that most significantly impact their economic performance, we do not consider ourselves the primary beneficiary of any such entity that might otherwise be considered a VIE.
We participate in various advertising cooperatives with our franchisees, typically within a country where we have both Company-owned restaurants and franchise restaurants, established to collect and administer funds contributed for use in advertising and promotional programs designed to increase sales and enhance the reputation of the Company and our Concepts. Contributions to the advertising cooperatives are required for both Company-owned and franchise restaurants and are generally based on a percentage of restaurant sales. We maintain certain variable interests in these cooperatives. As the cooperatives are required to spend all funds collected on advertising and promotional programs, total equity at risk is not sufficient to permit the cooperatives to finance their activities without additional subordinated financial support. Therefore, these cooperatives are VIEs. As a result of our voting rights, we consolidate certain of these cooperatives for which we are the primary beneficiary.
Fiscal Year. YUM's fiscal year begins on January 1 and ends December 31 of each year, with each quarter comprised of three months. Our U.S. subsidiaries and certain international subsidiaries operate on a weekly periodic calendar where the first three quarters of each fiscal year consists of 12 weeks and the fourth quarter consists of 16 weeks in fiscal years with 52 weeks and 17 weeks in fiscal years with 53 weeks. Our remaining international subsidiaries operate on a monthly calendar similar to that on which YUM operates.
Fiscal year 2019 included 53 weeks for our U.S. businesses and for our international subsidiaries that reported on a period calendar. The 53rd week added $66 million to Total revenues, $24 million to Operating Profit and $17 million to Net Income in our 2019 Consolidated Statement of Income.
On January 27, 2017, YUM’s Board of Directors approved a change in the Company's fiscal year from a year ending on the last Saturday of December to a year beginning on January 1 and ending December 31 of each year, commencing with the year ending December 31, 2017. In connection with this change, the Company moved from a 52-week periodic fiscal calendar with three 12-week interim quarters and a 16-week fourth quarter to a monthly reporting calendar with each quarter comprised of three months. Our U.S. subsidiaries continue to report on a period calendar as described above.
Concurrent with the change in the Company's fiscal year, we also eliminated the one month or one period reporting lags of our international subsidiaries. As a result of removing these reporting lags, each international subsidiary operates either on a monthly calendar consistent with the Company’s new calendar or on a periodic calendar consistent with our U.S. subsidiaries. We believe this change in our international subsidiary reporting calendars and the resulting elimination of reporting lags is preferable because a more current reporting calendar allows the Consolidated Financial Statements to more consistently and more timely reflect the impact of current events, economic conditions and global trends.
The change to the Company’s fiscal year and removal of the international reporting lags became effective beginning in 2017. We applied this change in accounting principle retrospectively to financial periods presented prior to 2017.
Our next fiscal year scheduled to include a 53rd week is 2024.
Foreign Currency. The functional currency of our foreign entities is the currency of the primary economic environment in which the entity operates. Functional currency determinations are made based upon a number of economic factors, including but not limited to cash flows and financing transactions. The operations, assets and liabilities of our entities outside the U.S. are initially measured using the functional currency of that entity. Income and expense accounts for our operations of these foreign entities are then translated into U.S. dollars at the average exchange rates prevailing during the period. Assets and liabilities of these foreign entities are then translated into U.S. dollars at exchange rates in effect at the balance sheet date. As of December 31, 2019, net cumulative translation adjustment losses of $221 million are recorded in Accumulated other comprehensive loss ("AOCI") in the Consolidated Balance Sheet.
The majority of our foreign currency net asset exposure is in countries where we have Company-owned restaurants. As we manage and share resources at the individual brand level within a country, cumulative translation adjustments are recorded and tracked at the foreign-entity level that represents the operations of our individual brands within that country. Translation adjustments recorded in AOCI are subsequently recognized as income or expense generally only upon sale of the related investment in a foreign entity, or upon a sale of assets and liabilities within a foreign entity that represents a complete or substantially complete liquidation of that foreign entity. For purposes of determining whether a sale or complete or substantially complete liquidation of an investment in a foreign entity has occurred, we consider those same foreign entities for which we record and track cumulative translation adjustments.
Gains and losses arising from the impact of foreign currency exchange rate fluctuations on transactions in foreign currency are included in Other (income) expense in our Consolidated Statements of Income.
Reclassifications. We have reclassified certain items in the Consolidated Financial Statements for prior periods to be comparable with the classification for the fiscal year ended December 31, 2019. These reclassifications had no effect on previously reported Net Income.
Revenue Recognition. From 2014 through 2017, the Financial Accounting Standards Board ("FASB") issued standards to provide principles within a single framework for revenue recognition of transactions involving contracts with customers across all industries ("Topic 606"). We adopted Topic 606 at the beginning of the year ended December 31, 2018. Below is a discussion of how our revenues are earned, our accounting policies pertaining to revenue recognition prior to the adoption of Topic 606 ("Legacy Revenue GAAP"), our accounting policies pertaining to revenue recognition subsequent to the adoption of Topic 606 and other required disclosures. Refer to Note 4 for information regarding the cumulative effect adjustment recorded to Accumulated deficit as of the
beginning of the year ended December 31, 2018 to reflect the adoption of Topic 606. Also included in Note 4 is disclosure of the amount by which each balance sheet and income statement line item was impacted in 2018 as compared to Legacy Revenue GAAP.
Company Sales
Revenues from the sale of food items by Company-owned restaurants are recognized as Company sales when a customer purchases the food, which is when our obligation to perform is satisfied. The timing and amount of revenue recognized related to Company sales was not impacted by the adoption of Topic 606.
Franchise and Property Revenues
Franchise Revenues
Our most significant source of revenues arises from the operation of our Concepts' stores by our franchisees. Franchise rights may be granted through a store-level franchise agreement or through a master franchise agreement that sets out the terms of our arrangement with the franchisee. Our franchise agreements require that the franchisee remit continuing fees to us as a percentage of the applicable restaurant’s sales in exchange for the license of the intellectual property associated with our Concepts' brands (the “franchise right”). Our franchise agreements also typically require certain, less significant, upfront franchise fees such as initial fees paid upon opening of a store, fees paid to renew the term of the franchise right and fees paid in the event the franchise agreement is transferred to another franchisee.
Continuing fees represent the substantial majority of the consideration we receive under our franchise agreements. Continuing fees are typically billed and paid monthly and are usually 4%-6% for store-level franchise agreements. Master franchise agreements allow master franchisees to operate restaurants as well as sub-franchise restaurants within certain geographic territories. The percentage of sales that we receive for restaurants owned or sub-franchised by our master franchisees as a continuing fee is typically less than the percentage we receive for restaurants operating under a store-level franchise agreement. Upfront franchise fees are typically billed and paid when a new franchise or sub-franchise agreement becomes effective or when an existing agreement is transferred to another franchisee or sub-franchisee.
Under Legacy Revenue GAAP, continuing fees were recognized as the related restaurant sales occurred. The timing and amount of revenue recognized related to continuing fees was not impacted by the adoption of Topic 606 based on the application of the sales-based royalty exception within Topic 606. Under Legacy Revenue GAAP, revenue related to initial fees was recognized upon store opening and renewal and transfer fees were recognized when the related agreement became effective. Upon the adoption of Topic 606, we have determined that the services we provide in exchange for these upfront franchise fees, which primarily relate to pre-opening support, are highly interrelated with the franchise right and are not individually distinct from the ongoing services we provide to our franchisees. As a result, upon the adoption of Topic 606, upfront franchise fees are recognized as revenue over the term of each respective franchise or sub-franchise agreement. Revenues for these upfront franchise fees are recognized on a straight-line basis, which is consistent with the franchisee’s or sub-franchisee's right to use and benefit from the intellectual property. Revenues from continuing fees and upfront franchise fees are presented within Franchise and property revenues in our Consolidated Statements of Income.
Additionally, from time-to-time we provide non-refundable consideration to franchisees in the form of cash or other incentives (e.g. cash payments to incent new unit openings, free or subsidized equipment, etc.). The Company’s intent in providing such consideration is to drive new unit development or same-store sales growth that will result in higher future revenues for the Company. Under Legacy Revenue GAAP, this consideration was recognized when we were obligated to provide the incentive and was presented as either a reduction to Franchise and property revenues, if cash was provided directly to the franchisee, or as Franchise and property expenses, if cash was not provided directly to the franchisee. Due to the adoption of Topic 606, such payments are capitalized and presented within Prepaid expense and other current assets or Other assets. These assets are being amortized as a reduction in Franchise and property revenues over the period of expected cash flows from the franchise agreements to which the payment relates.
Property Revenues
From time to time, we enter into rental agreements with franchisees for the lease or sublease of restaurant locations. These rental agreements typically originate from refranchising transactions and revenues related to the agreements are recognized as they are earned. Amounts owed under the rental agreements are typically billed and paid on a monthly basis. Revenues from rental agreements with franchisees are presented within Franchise and property revenues within our Consolidated Statements of Income. Related expenses are presented as Franchise and property expenses within our Consolidated Statements of Income and primarily
include depreciation or, in the case of a sublease, rental expense. The timing and amount of revenue and expenses recognized related to the rental of restaurants we lease or sublease was not impacted by the adoption of Topic 606.
Franchise Contributions for Advertising and Other Services
Advertising Cooperatives
Under Legacy Revenue GAAP, receipts and expenditures related to advertising cooperatives we were required to consolidate were presented on a net basis in our Consolidated Statements of Income and Consolidated Statements of Cash Flows. Additionally, assets and liabilities of the advertising cooperatives we were required to consolidate were presented within Advertising cooperative assets, restricted and Advertising cooperative liabilities, respectively, within our Consolidated Balance Sheets. In accordance with the provisions of Topic 606, we have determined we act as a principal in the transactions entered into by the advertising cooperatives we are required to consolidate based on our responsibility to define the nature of the goods or services provided and/or our responsibility to define which franchisees receive the benefit of the goods or services. Additionally, we have determined the advertising services provided to franchisees are highly interrelated with the franchise right and therefore not distinct. Franchisees remit to these consolidated advertising cooperatives a percentage of restaurant sales as consideration for providing the advertising services. As a result, revenues for advertising services are recognized when the related restaurant sales occur based on the application of the sales-based royalty exception within Topic 606. Revenues for these services are typically billed and received on a monthly basis. These revenues are presented as Franchise contributions for advertising and other services. Expenses incurred to provide these services are presented as Franchise advertising and other services expense. When revenues of an advertising cooperative exceed the related advertising expenses, advertising costs are accrued up to the amount of revenues on an annual basis. Lastly, upon adoption of Topic 606 we have reclassified assets and liabilities of advertising cooperatives we are required to consolidate to the respective balance sheet caption to which the assets and liabilities relate.
Other Services
On a much more limited basis, we provide goods or services to certain franchisees that are individually distinct from the franchise right because they do not require integration with other goods or services we provide. Such arrangements typically relate to supply chain, quality assurance and information technology services. In instances where we rely on third parties to provide goods or services to franchisees at our direction, we have determined we act as a principal in these transactions. The extent to which we provide such goods or services varies by brand, geographic region and, in some instances, franchisee. Similar to advertising services, receipts and expenditures related to these other services were presented on a net basis under Legacy Revenue GAAP. Upon adoption of Topic 606, revenues from the goods or services described above are presented as Franchise contributions for advertising and other services within our Consolidated Statements of Income. Expenses related to the provisioning of these goods and services are recorded in Franchise advertising and other services expense. These revenues are recognized as the goods or services are transferred to the franchisee and related expenses are recognized as incurred.
Franchise Support Costs
The internal costs we incur to provide support services to our franchisees for which we do not receive a direct reimbursement are charged to General and administrative expenses (“G&A”) as incurred. Certain direct costs of our franchise operations are charged to Franchise and property expenses. These costs include provisions for estimated uncollectible upfront and continuing fees, rent or depreciation expense associated with restaurants we lease or sublease to franchisees, franchise marketing funding, amortization expense for franchise-related intangible assets, value added taxes on royalties and certain other direct incremental franchise support costs.
Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue transaction and collected from a customer are excluded from revenue under both Legacy Revenue GAAP and Topic 606.
Direct Marketing Costs. To the extent we participate in advertising cooperatives, we expense our contributions as incurred, which are based on a percentage of sales of our Company restaurants. We charge direct marketing costs incurred outside of a cooperative to expense ratably in relation to revenues over the year in which incurred and, in the case of advertising production costs, in the year the advertisement is first shown. Deferred direct marketing costs, which are classified as prepaid expenses, consist of media and related advertising production costs that will generally be used for the first time in the next fiscal year and have historically not been significant. Advertising expenses incurred by our Company-owned restaurants are recorded within Company restaurant expenses and totaled $73 million, $96 million and $179 million in 2019, 2018 and 2017, respectively. Advertising expenses incurred on behalf of franchised restaurants by the Company are recorded within Franchise and property expenses and totaled $10 million, $35 million and $66 million in 2019, 2018 and 2017, respectively. The amounts recorded within Franchise and property expenses include $12.5 million and $25 million related to the Pizza Hut U.S. Transformation Agreement
in 2018 and 2017, respectively, and $10 million and $20 million related to the KFC U.S. Acceleration Agreement in 2018 and 2017, respectively. See Note 4 for further discussion of these agreements. In 2019 and 2018 we incurred an additional $1,133 million and $1,035 million, respectively, in spending attributable to franchise contributions to advertising cooperatives that we consolidate and are now reporting on a gross basis within our Consolidated Statements of Income subsequent to the adoption Topic 606.
Share-Based Employee Compensation. We recognize ongoing share-based payments to employees, including grants of employee stock options and stock appreciation rights (“SARs”), in the Consolidated Financial Statements as compensation cost over the service period based on their fair value on the date of grant. This compensation cost is recognized over the service period on a straight-line basis, net of an assumed forfeiture rate, for awards that actually vest. Forfeiture rates are estimated at grant date based on historical experience and compensation cost is adjusted in subsequent periods for differences in actual forfeitures from the previous estimates. We present this compensation cost consistent with the other compensation costs for the employee recipient in either Company restaurant expenses or G&A. See Note 15 for further discussion of our share-based compensation plans.
Legal Costs. Settlement costs are accrued when they are deemed probable and reasonably estimable. Anticipated legal fees related to self-insured workers' compensation, employment practices liability, general liability, automobile liability, product liability and property losses (collectively, "property and casualty losses") are accrued when deemed probable and reasonably estimable. Legal fees not related to self-insured property and casualty losses are recognized as incurred. See Note 19 for further discussion of our legal proceedings.
Impairment or Disposal of Long-Lived Assets. Long-lived assets, including Property, plant and equipment (“PP&E”) as well as right-of-use operating lease assets are tested for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The assets are not recoverable if their carrying value is less than the undiscounted cash flows we expect to generate from such assets. If the assets are not deemed to be recoverable, impairment is measured based on the excess of their carrying value over their fair value.
For purposes of impairment testing for our restaurants, we have concluded that an individual restaurant is the lowest level of independent cash flows unless it is more likely than not that we will refranchise restaurants as a group. We review our long-lived assets of such individual restaurants (primarily PP&E, right-of-use operating lease assets and allocated intangible assets subject to amortization) that we intend to continue operating as Company restaurants annually for impairment, or whenever events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable. We use two consecutive years of operating losses as our primary indicator of potential impairment for our annual impairment testing of these restaurant assets. We evaluate the recoverability of these restaurant assets by comparing the estimated undiscounted future cash flows, which are based on our entity-specific assumptions, to the carrying value of such assets. For restaurant assets that are not deemed to be recoverable, we write-down an impaired restaurant to its estimated fair value, which becomes its new cost basis. Fair value is an estimate of the price a franchisee would pay for the restaurant and its related assets and is determined by discounting the estimated future after-tax cash flows of the restaurant, which include a deduction for royalties we would receive under a franchise agreement with terms substantially at market. The after-tax cash flows incorporate reasonable assumptions we believe a franchisee would make such as sales growth and margin improvement. The discount rate used in the fair value calculation is our estimate of the required rate of return that a franchisee would expect to receive when purchasing a similar restaurant and the related long-lived assets. The discount rate incorporates rates of returns for historical refranchising market transactions and is commensurate with the risks and uncertainty inherent in the forecasted cash flows. Individual restaurant-level impairment is recorded within Other (income) expense.
In executing our refranchising initiatives, we most often offer groups of restaurants for sale. When we believe it is more likely than not a restaurant or groups of restaurants will be refranchised for a price less than their carrying value, but do not believe the restaurant(s) have met the criteria to be classified as held for sale, we review the restaurants for impairment. We evaluate the recoverability of these restaurant assets by comparing estimated sales proceeds plus holding period cash flows, if any, to the carrying value of the restaurant or group of restaurants. For restaurant assets that are not deemed to be recoverable, we recognize impairment for any excess of carrying value over the fair value of the restaurants, which is based on the expected net sales proceeds. To the extent ongoing agreements to be entered into with the franchisee simultaneous with the refranchising are expected to contain terms, such as royalty rates, not at prevailing market rates, we consider the off-market terms in our impairment evaluation. We recognize any such impairment charges in Refranchising (gain) loss. Refranchising (gain) loss includes the gains or losses from the sales of our restaurants to new and existing franchisees, including any impairment charges discussed above, and associated termination, relocation or retention costs associated with store-level employees of refranchised stores or employees of restaurant-support centers which we have closed due to refranchising. We recognize gains on restaurant refranchisings when the sale transaction closes and control of the restaurant operations have transferred to the franchisee.
When we decide to close a restaurant, it is reviewed for impairment, which includes an estimate of sublease income that could be reasonably obtained, if any, in relation to the right-of-use operating lease asset. Additionally, depreciable lives are adjusted based on the expected disposal date. Other costs incurred when closing a restaurant such as costs of disposing of the assets as well as other facility-related expenses from previously closed stores are generally expensed as incurred. Any costs recorded upon store closure as well as any subsequent adjustments to liabilities for remaining lease obligations as a result of lease termination or changes in estimates of sublease income are recorded in Other (income) expense. To the extent we sell assets, primarily land, associated with a closed store, any gain or loss upon that sale is also recorded in Other (income) expense.
Considerable management judgment is necessary to estimate future cash flows, including cash flows from continuing use, terminal value, sublease income and refranchising proceeds. Accordingly, actual results could vary significantly from our estimates.
Guarantees. We recognize, at inception of a guarantee, a liability for the fair value of certain obligations undertaken. The majority of our guarantees are issued as a result of assigning our interest in obligations under operating leases as a condition to the refranchising of certain Company restaurants. We recognize a liability for the fair value of such lease guarantees upon refranchising and upon subsequent renewals of such leases when we remain secondarily liable. The related expense and any subsequent changes are included in Refranchising (gain) loss. Any expense and subsequent changes in the guarantees for other franchise support guarantees not associated with a refranchising transaction are included in Franchise and property expenses.
Income Taxes. We record deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as operating loss, capital loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those differences or carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in our Income tax provision in the period that includes the enactment date. Additionally, in determining the need for recording a valuation allowance against the carrying amount of deferred tax assets, we consider the amount of taxable income and periods over which it must be earned, actual levels of past taxable income and known trends and events or transactions that are expected to affect future levels of taxable income. Where we determine that it is more likely than not that all or a portion of an asset will not be realized, we record a valuation allowance.
We recognize the benefit of positions taken or expected to be taken in our tax returns in our Income tax provision when it is more likely than not (i.e., a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement with the taxing authorities. We evaluate these amounts on a quarterly basis to ensure that they have been appropriately adjusted for audit settlements and other events we believe may impact the outcome. Changes in judgment that result in subsequent recognition, derecognition or a change in measurement of a tax position taken in a prior annual period (including any related interest and penalties) are recognized as a discrete item in the interim period in which the change occurs. We recognize accrued interest and penalties related to unrecognized tax benefits as components of our Income tax provision.
We do not record a deferred tax liability for unremitted earnings of our foreign subsidiaries to the extent that the earnings meet the indefinite reversal criteria. This criteria is met if the foreign subsidiary has invested, or will invest, the earnings indefinitely. The decision as to the amount of unremitted earnings that we intend to maintain in non-U.S. subsidiaries considers items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans and expected cash requirements in the U.S.
See Note 17 for a further discussion of our income taxes.
Fair Value Measurements. Fair value is the price we would receive to sell an asset or pay to transfer a liability (exit price) in an orderly transaction between market participants. For those assets and liabilities we record or disclose at fair value, we determine fair value based upon the quoted market price, if available. If a quoted market price is not available for identical assets, we determine fair value based upon the quoted market price of similar assets or the present value of expected future cash flows considering the risks involved, including counterparty performance risk if appropriate, and using discount rates appropriate for the duration. The fair values are assigned a level within the fair value hierarchy, depending on the source of the inputs into the calculation.
| Level 1 | Inputs based upon quoted prices in active markets for identical assets. |
| Level 2 | Inputs other than quoted prices included within Level 1 that are observable for the asset, either directly or indirectly. |
| Level 3 | Inputs that are unobservable for the asset. |
Cash and Cash Equivalents. Cash equivalents represent funds we have temporarily invested (with original maturities not exceeding three months), including short-term, highly liquid debt securities. Cash and overdraft balances that meet the criteria for right of setoff are presented net on our Consolidated Balance Sheet.
Receivables. The Company’s receivables are primarily generated from ongoing business relationships with our franchisees as a result of franchise agreements, as well as contributions due to consolidated advertising cooperatives. These receivables from franchisees are generally due within 30 days of the period in which the corresponding sales occur and are classified as Accounts and notes receivable, net on our Consolidated Balance Sheet. Our provision for uncollectible franchisee receivable balances is based upon pre-defined aging criteria or upon the occurrence of other events that indicate that we may not collect the balance due. Additionally, we monitor the financial condition of our franchisees and record provisions for estimated losses on receivables when we believe it probable that our franchisees will be unable to make their required payments. While we use the best information available in making our determination, the ultimate recovery of recorded receivables is also dependent upon future economic events and other conditions that may be beyond our control. Receivables that are ultimately deemed to be uncollectible, and for which collection efforts have been exhausted, are written off against the allowance for doubtful accounts.
We recorded $24 million, $11 million and $5 million in net provisions within Franchise and property expenses in 2019, 2018 and 2017, respectively, related to uncollectible continuing fees, initial fees and rent receivables from our franchisees. Additionally, in 2019 we recorded $19 million in net provisions within Franchise advertising and other services expense related to uncollectible franchisee receivables of advertising cooperatives we are required to consolidate. Our consolidated advertising cooperatives are required to spend contributions from franchisees and us on advertising. To the extent these cooperatives were unable to collect the approximately $1.1 billion in contributions due from participating franchisees in 2019 we recorded the aforementioned bad debt provision. At the same time, we reduced advertising spending to the extent of these uncollectible franchise receivables. Thus, recorded advertising expense was reduced by the same amount as the bad debt provision within these consolidated advertising cooperatives and there was no net, direct impact to our Operating Profit in 2019.
Accounts and notes receivable as well as the Allowance for doubtful accounts, including balances attributable to our consolidated advertising cooperatives, as of December 31, 2019 and 2018, respectively, are as follows:
| 2019 | 2018 | |||||||
| Accounts and notes receivable | $ | 656 | $ | 592 | ||||
| Allowance for doubtful accounts | (72 | ) | (31 | ) | ||||
| Accounts and notes receivable, net | $ | 584 | $ | 561 |
Our financing receivables primarily consist of notes receivables and direct financing leases with franchisees which we enter into from time-to-time. As these receivables primarily relate to our ongoing business agreements with franchisees, we consider such receivables to have similar risk characteristics and evaluate them as one collective portfolio segment and class for determining the allowance for doubtful accounts. We monitor the financial condition of our franchisees and record provisions for estimated losses on receivables when we believe it is probable that our franchisees will be unable to make their required payments. Balances of notes receivable and direct financing leases due within one year are included in Accounts and notes receivable, net while amounts due beyond one year are included in Other assets. Amounts included in Other assets totaled $68 million (net of an allowance of less than $1 million) and $62 million (net of an allowance of $1 million) at December 31, 2019 and December 31, 2018, respectively. Financing receivables that are ultimately deemed to be uncollectible, and for which collection efforts have been exhausted, are written off against the allowance for doubtful accounts. Interest income recorded on financing receivables has historically been insignificant.
Property, Plant and Equipment. We state PP&E at cost less accumulated depreciation and amortization. We calculate depreciation and amortization on a straight-line basis over the estimated useful lives of the assets as follows: 5 to 25 years for buildings and leasehold improvements and 3 to 20 years for machinery and equipment. We suspend depreciation and amortization on assets that are held for sale.
Leases and Leasehold Improvements. Starting in February 2016 and continuing into 2019, the FASB issued standards on the recognition and measurement of leases ("Topic 842"). We adopted these standards at the beginning of the year ended December 31, 2019, using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of 2019 and have not recast the comparative periods presented in the Consolidated Financial Statements. The standards provide a number of optional practical expedients and policy elections in transition. We elected the ‘package of practical expedients’ under which we did not reassess under the standards our prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements. Refer to Note 4 for information regarding the adjustments recorded to our Consolidated Balance Sheet as of the beginning of the year ended December 31, 2019 to reflect the adoption of Topic 842. Below is information about the nature of our leases, accounting policies and assumptions subsequent to adopting Topic 842.
In certain instances, we lease or sublease certain restaurants to franchisees. Our lessor and sublease portfolio primarily consists of stores that have been leased to franchisees subsequent to refranchising transactions. Our most significant leases with lease and non-lease components are leases with our franchisees that include both the right to use a restaurant as well as a license of the intellectual property associated with our Concepts’ brands. For these leases, which are primarily classified as operating leases, we account for the lease and non-lease components separately. Revenues from rental agreements with franchisees are presented within Franchise and property revenues in our Consolidated Statements of Income and related expenses (e.g. depreciation and rent expense) are presented within Franchise and property expenses. The impact of adopting Topic 842 on the accounting for our lessor and sublease portfolio was not significant.
We lease land, buildings or both for certain of our Company-operated restaurants and restaurant support centers worldwide. Rental expense for leased Company-operated restaurants is presented in our Consolidated Statements of Income as Company restaurant expenses and rental expense for restaurant support centers is presented as G&A. The length of our lease terms, which vary by country and often include renewal options, are an important factor in determining the appropriate accounting for leases including the initial classification of the lease as finance (referred to as “capital” leases prior to the adoption of Topic 842) or operating as well as the timing of recognition of rent expense over the duration of the lease. We include renewal option periods in determining the term of our leases when failure to renew the lease would impose a penalty on the Company in such an amount that a renewal appears to be reasonably certain at the commencement of the lease. The primary penalty to which we are subject is the economic detriment associated with the existence of leasehold improvements that might be impaired if we choose not to continue the use of the leased property. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term. We generally do not receive leasehold improvement incentives upon opening a store that is subject to a lease. We expense rent associated with leased land or buildings while a restaurant is being constructed whether rent is paid or we are subject to a rent holiday. Our leasing activity for other assets, including equipment, is not significant.
Prior to the adoption of Topic 842 (“Legacy Lease GAAP”) liabilities for future rental payments under operating leases were not recognized on the balance sheet of the Company except when recognizing a liability was necessary to reflect the impact of recognizing rent expense on a straight-line basis. Upon the adoption of Topic 842, right-of-use assets and liabilities are recognized upon lease commencement for operating leases based on the present value of lease payments over the lease term. Similar assets and liabilities have historically always been recorded for finance leases. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Subsequent amortization of the right-of-use asset and accretion of the lease liability for an operating lease is recognized as a single lease cost, on a straight-line basis, over the lease term. For finance leases, the right-of-use asset is depreciated on a straight-line basis over the lesser of the useful life of the leased asset or lease term. Interest on each finance lease liability is determined as the amount that results in a constant periodic discount rate on the remaining balance of the liability. As most of our leases do not provide an implicit discount rate, we use our incremental secured borrowing rate based on the information available at commencement date, including the lease term and currency, in determining the present value of lease payments for both operating and finance leases. Leases with an initial term of 12 months or less are not recorded in the Consolidated Balance Sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Right-of-use assets are assessed for impairment in accordance with our long-lived asset impairment policy, which is performed annually for restaurant-level assets or whenever events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable. We reassess lease classification and remeasure right-of-use assets and lease liabilities when a lease is modified and that modification is not accounted for as a separate new lease or upon certain other events that require reassessment in accordance with Topic 842. The difference between operating lease rental expense recognized in our Consolidated Statements of Income and cash payments for operating leases is recognized within Other, net within Net Cash Provided by Operating Activities in our Consolidated Statements of Cash Flows.
Goodwill and Intangible Assets. From time-to-time, the Company acquires restaurants from one of our Concept’s franchisees or acquires another business. Goodwill from these acquisitions represents the excess of the cost of a business acquired over the
net of the amounts assigned to assets acquired, including identifiable intangible assets and liabilities assumed. Goodwill is not amortized and has been assigned to reporting units for purposes of impairment testing. Our reporting units are our business units (which are aligned based on geography) in our KFC, Pizza Hut and Taco Bell Divisions.
We evaluate goodwill for impairment on an annual basis or more often if an event occurs or circumstances change that indicate impairment might exist. We have selected the beginning of our fourth quarter as the date on which to perform our ongoing annual impairment test for goodwill. We may elect to perform a qualitative assessment for our reporting units to determine whether it is more likely than not that the fair value of the reporting unit is greater than its carrying value. If a qualitative assessment is not performed, or if as a result of a qualitative assessment it is not more likely than not that the fair value of a reporting unit exceeds its carrying value, then the reporting unit’s fair value is compared to its carrying value. Fair value is the price a willing buyer would pay for a reporting unit, and is generally estimated using discounted expected future after-tax cash flows from Company-owned restaurant operations, if any, and franchise royalties. The discount rate is our estimate of the required rate of return that a third-party buyer would expect to receive when purchasing a business from us that constitutes a reporting unit. We believe the discount rate is commensurate with the risks and uncertainty inherent in the forecasted cash flows. If the carrying value of a reporting unit exceeds its fair value, goodwill is written down to its implied fair value.
If we record goodwill upon acquisition of a restaurant(s) from a franchisee and such restaurant(s) is then sold within two years of acquisition, the goodwill associated with the acquired restaurant(s) is written off in its entirety. If the restaurant is refranchised two years or more subsequent to its acquisition, we include goodwill in the carrying amount of the restaurants disposed of based on the relative fair values of the portion of the reporting unit disposed of in the refranchising and the portion of the reporting unit that will be retained. The fair value of the portion of the reporting unit disposed of in a refranchising is determined by reference to the discounted value of the future cash flows expected to be generated by the restaurant and retained by the franchisee, which includes a deduction for the anticipated, future royalties the franchisee will pay us associated with the franchise agreement entered into simultaneously with the refranchising transition. The fair value of the reporting unit retained is based on the price a willing buyer would pay for the reporting unit and includes the value of franchise agreements. Appropriate adjustments are made if a franchise agreement includes terms that are determined to not be at prevailing market rates. As such, the fair value of the reporting unit retained can include expected cash flows from future royalties from those restaurants currently being refranchised, future royalties from existing franchise businesses and company restaurant operations. As a result, the percentage of a reporting unit’s goodwill that will be written off in a refranchising transaction will be less than the percentage of the reporting unit’s Company-owned restaurants that are refranchised in that transaction and goodwill can be allocated to a reporting unit with only franchise restaurants.
Our definite-lived intangible assets that are not allocated to an individual restaurant are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of the intangible asset may not be recoverable. An intangible asset that is deemed not recoverable on an undiscounted basis is written down to its estimated fair value, which is our estimate of the price a willing buyer would pay for the intangible asset based on discounted expected future after-tax cash flows. For purposes of our impairment analysis, we update the cash flows that were initially used to value the definite-lived intangible asset to reflect our current estimates and assumptions over the asset’s future remaining life.
Capitalized Software. We state capitalized software at cost less accumulated amortization within Intangible assets, net on our Consolidated Balance Sheets. We calculate amortization on a straight line basis over the estimated useful life of the software which ranges from 3 to 7 years.
Derivative Financial Instruments. We use derivative instruments primarily to hedge interest rate and foreign currency risks. These derivative contracts are entered into with financial institutions. We do not use derivative instruments for trading purposes and we have procedures in place to monitor and control their use.
We record all derivative instruments on our Consolidated Balance Sheet at fair value. For derivative instruments that are designated and qualify as a cash flow hedge, gain or loss on the derivative instrument is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the results of operations immediately.
As a result of the use of derivative instruments, the Company is exposed to risk that the counterparties will fail to meet their contractual obligations. To mitigate the counterparty credit risk, we only enter into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and continually assess the creditworthiness of counterparties. At December 31, 2019 and December 31, 2018, all of the counterparties to our interest rate swaps and foreign currency forwards had investment grade ratings according to the three major ratings agencies. To date, all counterparties have performed in accordance with their contractual obligations.
Common Stock Share Repurchases. From time-to-time, we repurchase shares of our Common Stock under share repurchase programs authorized by our Board of Directors. Shares repurchased constitute authorized, but unissued shares under the North Carolina laws under which we are incorporated. Additionally, our Common Stock has no par or stated value. Accordingly, we record the full value of share repurchases, or other deductions to Common Stock such as shares cancelled upon employee share-based award exercises, upon the trade date, against Common Stock on our Consolidated Balance Sheet except when to do so would result in a negative balance in such Common Stock account. In such instances, on a period basis, we record the cost of any further share repurchases, or other deductions to Common Stock as an addition to Accumulated deficit. Due to the large number of share repurchases of our stock over the past several years, our Common Stock balance is frequently zero at the end of any period. Accordingly, $796 million, $2,356 million and $1,915 million in share repurchases in 2019, 2018 and 2017, respectively, were recorded as an addition to Accumulated deficit. Additionally $18 million and $20 million related to shares cancelled upon employee share-based award exercises in 2019 and 2017 were recorded as an addition to Accumulated deficit, respectively. See Note 16 for additional information on our share repurchases.
Pension and Post-retirement Medical Benefits. We measure and recognize the overfunded or underfunded status of our pension and post-retirement plans as an asset or liability in our Consolidated Balance Sheet as of our fiscal year end. The funded status represents the difference between the projected benefit obligations and the fair value of plan assets, which is calculated on a plan-by-plan basis. The projected benefit obligation and related funded status are determined using assumptions as of the end of each year. The projected benefit obligation is the present value of benefits earned to date by plan participants, including the effect of future salary increases, as applicable. The difference between the projected benefit obligations and the fair value of plan assets that has not previously been recognized in our Consolidated Statement of Income is recorded as a component of AOCI.
The net periodic benefit costs associated with the Company's defined benefit pension and post-retirement medical plans are determined using assumptions regarding the projected benefit obligation and, for funded plans, the market-related value of plan assets as of the beginning of each year, or remeasurement period, if applicable. We record the service cost component of net periodic benefit costs in G&A. Non-service cost components are recorded in Other pension (income) expense. We have elected to use a market-related value of plan assets to calculate the expected return on assets, net of administrative and investment fees paid from plan assets, in net periodic benefit costs. For each individual plan we amortize into pension expense the net amounts in AOCI, as adjusted for the difference between the fair value and market-related value of plan assets, to the extent that such amounts exceed 10% of the greater of a plan’s projected benefit obligation or market-related value of assets, over the remaining service period of active participants in the plan or, for plans with no active participants, over the expected average life expectancy of the inactive participants in the plan. The market-related value of plan assets is the fair value of plan assets as of the beginning of each year adjusted for variances between actual returns and expected returns. We attribute such variances to the market-related value of plan assets evenly over five years. We record a curtailment when an event occurs that significantly reduces the expected years of future service or eliminates the accrual of defined benefits for the future services of a significant number of employees. We record a curtailment gain when the employees who are entitled to the benefits terminate their employment; we record a curtailment loss when it becomes probable a loss will occur.
We recognize settlement gains or losses only when we have determined that the cost of all settlements in a year will exceed the sum of the service and interest costs within an individual plan.
Recent Accounting Pronouncements. In June 2016, the FASB issued a standard that requires measurement and recognition of expected versus incurred credit losses for financial assets held. The standard is effective for the Company in our first quarter of fiscal 2020 and any impact upon adoption will be reflected through a cumulative-effect adjustment to Accumulated deficit as of the beginning of 2020. We do not anticipate the impact of adopting this standard will be material to our Consolidated Financial Statements.
Note 3 – Earnings Per Common Share (“EPS”)
| 2019 | 2018 | 2017 | ||||||||||
| Net Income | $ | 1,294 | $ | 1,542 | $ | 1,340 | ||||||
| Weighted-average common shares outstanding (for basic calculation) | 306 | 322 | 347 | |||||||||
| Effect of dilutive share-based employee compensation | 7 | 7 | 8 | |||||||||
| Weighted-average common and dilutive potential common shares outstanding (for diluted calculation) | 313 | 329 | 355 | |||||||||
| Basic EPS | $ | 4.23 | $ | 4.80 | $ | 3.86 | ||||||
| Diluted EPS | $ | 4.14 | $ | 4.69 | $ | 3.77 | ||||||
| Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a) | 2.0 | 2.0 | 2.3 |
| (a) | These unexercised employee stock options and stock appreciation rights were not included in the computation of diluted EPS because to do so would have been antidilutive for the periods presented. |
Note 4 – Items Affecting Comparability of Net Income and Cash Flows
Refranchising (Gain) Loss
The Refranchising (gain) loss by our Divisional reportable segments is presented below. Given the size and volatility of refranchising initiatives, our chief operating decision maker ("CODM") does not consider the impact of Refranchising (gain) loss when assessing Divisional segment performance. As such, we do not allocate such gains and losses to our Divisional segments for performance reporting purposes.
During the years ended December 31, 2019, 2018 and 2017, we refranchised 25, 660 and 1,470 restaurants, respectively. Additionally, during the year ended December 31, 2019, we sold certain restaurant assets associated with existing franchise restaurants to the franchisee. We received $110 million, $825 million and $1,773 million in pre-tax refranchising proceeds in 2019, 2018 and 2017, respectively.
A summary of Refranchising (gain) loss is as follows:
| Refranchising (gain) loss | |||||||||||||||||
| 2019 | 2018 | 2017 | |||||||||||||||
| KFC Division | $ | (6 | ) | $ | (240 | ) | $ | (581 | ) | ||||||||
| Pizza Hut Division | — | 13 | (16 | ) | |||||||||||||
| Taco Bell Division | (31 | ) | (313 | ) | (486 | ) | |||||||||||
| Worldwide | $ | (37 | ) | $ | (540 | ) | $ | (1,083 | ) |
As a result of classifying restaurant and related assets as held for sale and ceasing depreciation expense, depreciation expense was reduced versus what would have otherwise been recorded by less than $1 million, $3 million and $10 million during the years ended December 31, 2019, 2018 and 2017, respectively. Our CODM does not consider the impact of these depreciation reductions, which were recorded within Company restaurant expenses, when assessing Divisional segment performance. These depreciation reductions were recorded as an unallocated benefit and were not allocated to the Division segments resulting in depreciation expense continuing to be recorded within our Divisional results at the rate at which it was prior to the held for sale classification.
Pizza Hut U.S. Transformation Agreement
In May 2017, we reached an agreement with Pizza Hut U.S. franchisees that will improve brand marketing alignment, accelerate enhancements in operations and technology and that included a permanent commitment to incremental advertising as well as digital and technology contributions by franchisees (the “Transformation Agreement”). In connection with the Transformation Agreement we anticipate investing approximately $90 million from 2017 to 2020 to upgrade restaurant equipment to improve operations,
fund improvements in restaurant technology and enhance digital and e-commerce capabilities. As of December 31, 2019, we have invested $89 million since the inception of the agreement.
We have invested $25 million, $25 million and $39 million for the years ended December 31, 2019, 2018 and 2017, respectively, related to the Transformation Agreement. These amounts consisted of capital investments and franchisee incentive payments that were capitalized. Also included are operating investments of $13 million, $6 million and $31 million in the years ended December 31, 2019, 2018 and 2017, respectively.
Due to their unique and long-term brand-building nature as well as their non-recurring impact on Pizza Hut’s Division results, the financial impact of operating investments that are part of the Transformation Agreement are not being considered by our CODM when assessing segment performance. As such, these operating investments are not being allocated to the Pizza Hut Division operating segment results for performance reporting purposes.
Depreciation on capital investments made as part of the Transformation Agreement is being allocated to Pizza Hut segment results as the expense is recurring and is not expected to significantly impact the comparability of results in any given period. For the same reasons, the amortization related to capitalized franchisee incentive payments is being allocated to Pizza Hut Division operating segment results.
In addition to the investments above, we funded $37.5 million of incremental system advertising from the second half of 2017 through 2018, including $12.5 million and $25 million we incurred during the years ended December 31, 2018 and 2017, respectively. These advertising amounts were recorded primarily in Franchise and property expenses and were included in the Pizza Hut Division segment operating results.
KFC U.S. Acceleration Agreement
During 2015, we reached an agreement with our KFC U.S. franchisees that gave us control of brand marketing execution as well as an accelerated path to expanded menu offerings, improved assets and enhanced customer experience. In connection with this agreement we invested approximately $130 million from 2015 through 2019. These investments, which primarily related to new back-of-house equipment for franchisees and incentives to accelerate franchisee store remodels, totaled $6 million, $6 million and $17 million in the years ended December 31, 2019, 2018 and 2017, respectively. To the extent these investments were not capitalized ($2 million in 2018 and $17 million in 2017) the financial impacts of the investments were not considered by our CODM when assessing segment performance. As such, these investments are not being allocated to the KFC Division operating segment results for performance reporting purposes. As of December 31, 2019 the initiatives related to this program are substantially complete.
In addition to the investments above, we funded $60 million of incremental system advertising from 2015 through 2018, including $10 million and $20 million incurred during the years ended December 31, 2018 and 2017, respectively. These advertising amounts were recorded primarily in Franchise and property expenses and were included in the KFC Division segment operating results.
Turkey Acquisition Contingent Consideration
During the second quarter of 2019 we recorded charges of $8 million and $2 million to Other (income) expense and Interest expense, net, respectively, related to cash payments in excess of our recorded liability to settle contingent consideration associated with our 2013 acquisition of the KFC Turkey and Pizza Hut Turkey businesses. Consistent with prior adjustments to the recorded contingent consideration, our CODM does not consider this charge when assessing segment performance due to the nature of these costs. As such, these costs were not allocated to any of our segment operating results for performance reporting purposes.
Investment in Grubhub, Inc. ("Grubhub")
On February 7, 2018, certain of our subsidiaries entered into a master services agreement with a subsidiary of Grubhub, an online and mobile takeout food-ordering company in the U.S., which is intended to provide dedicated support for the KFC and Taco Bell branded online delivery channels in the U.S. through Grubhub’s online ordering platform, logistics and last-mile support for delivery orders, as well as point-of-sale integration to streamline operations. Concurrently with the master services agreement, one of our subsidiaries entered into an investment agreement with Grubhub to invest $200 million in exchange for approximately 2.8 million shares of Grubhub common stock, subject to customary closing conditions. In April 2018, all necessary regulatory approvals were obtained and the purchase of Grubhub shares was consummated. Shares acquired as part of this purchase are restricted from being transferred until the earlier of the two-year anniversary of closing the investment agreement or 30 days following the termination of our master services agreement with Grubhub. In the years ended December 31, 2019 and 2018 we recognized pre-tax expense of $77 million and pre-tax income of $14 million, respectively, related to the mark-to-market of these
shares, which includes the respective depreciation and appreciation in the market price of Grubhub common stock. Changes in the fair value of our investment in Grubhub common stock are presented as Investment (income) expense, net within our Consolidated Statements of Income.
Income Tax Matters
During the year ended December 31, 2019 we completed intercompany transfers of certain intellectual property rights. As a result of the transfer of certain of these rights, largely to subsidiaries in the United Kingdom, we received a step-up in tax basis to current fair value under applicable tax law. To the extent this step-up in basis will be amortizable against future taxable income, we recognized a one-time deferred tax benefit of $226 million in the year ended December 31, 2019.
We recognized $434 million in our Income tax provision for the year ended December 31, 2017 as a result of the December 22, 2017 enactment of the Tax Cuts and Jobs Act of 2017 ("Tax Act"). During the year ended December 31, 2018, we recorded a $35 million decrease related to our provisional tax expense recorded in the fourth quarter of 2017 associated with the Tax Act.
See Note 17.
YUM's Strategic Transformation Initiatives
In October 2016, we announced our strategic transformation plans to drive global expansion of the KFC, Pizza Hut and Taco Bell brands ("YUM's Strategic Transformation Initiatives") following the then anticipated spin-off of our China business (the "Separation") on October 31, 2016 into an independent, publicly-traded company under the name of Yum China Holdings, Inc. ("Yum China"). Major features of the Company’s strategic transformation plans involved being more focused on the development of our three brands, increasing our franchise ownership and creating a leaner, more efficient cost structure. We incurred pre-tax costs of $8 million and $23 million related to our Strategic Transformation Initiatives in 2018 and 2017, respectively, primarily recorded in G&A. In 2018 and 2017, these costs included contract termination costs and relocation and severance costs for restaurant-support center employees. Due to the scope of the initiatives as well as their significance, our CODM did not consider the associated cost when assessing segment performance. As such, these costs were not allocated to any of our segment operating results for performance reporting purposes.
Modifications of Share-based Compensation Awards
In connection with the Separation, we modified certain share-based compensation awards held as part of our Executive Income Deferral ("EID") Plan in phantom shares of YUM Common Stock to provide one phantom Yum China share-based award for each outstanding phantom YUM share-based award. Through October 31, 2018, these Yum China awards could be settled in cash, as opposed to stock, which required recognition of the fair value of these awards within G&A in our Consolidated Income Statement. During 2018 and 2017, we recorded pre-tax credits of $3 million and charges of $18 million, respectively, related to these awards due to changes in the market price of Yum China's common stock. Given these adjustments were a direct result of the separation of our China business, our CODM did not consider their impact when assessing segment performance. As such, these amounts were not allocated to any of our segment operating results.
Beginning October 31, 2018, deferrals in phantom shares of Yum China common stock were no longer an investment option within our EID Plan and any balances relating to these phantom shares were moved to another available EID Plan investment option as selected by the participants. Amounts directed into cash or phantom shares of a Stock Index Fund or a Bond Index Fund remained classified as a liability and any appreciation or depreciation in these investments from the transfer date forward is being recognized as compensation expense and included in our segment operating results consistent with existing investments in these funds. Any balances directed into phantom shares of YUM Common Stock were reclassified to Common Stock on our Consolidated Balance Sheet. We do not recognize compensation expense for the appreciation or depreciation, if any, of investments in phantom shares of our Common Stock. See Note 15 for further description of our EID Plan.
Impact of Adopting New Lease Standards
As discussed in Note 2, we adopted Topic 842 at the beginning of the year ended December 31, 2019, using a modified retrospective method. Topic 842 was applied to all leases existing at, or entered into after, the beginning of 2019. As a result of adopting Topic 842, the following adjustments were made to the Consolidated Balance Sheet as of the beginning of the year ended December 31, 2019:
| CONSOLIDATED BALANCE SHEET | |||||||||||
| As Reported 12/31/2018 | Adjustments | Balances with Adoption of Topic 842 1/1/2019 | |||||||||
| ASSETS | |||||||||||
| Current Assets | |||||||||||
| Cash and cash equivalents | $ | 292 | $ | — | $ | 292 | |||||
| Accounts and notes receivable, net | 561 | — | 561 | ||||||||
| Prepaid expenses and other current assets | 354 | (10 | ) | 344 | |||||||
| Total Current Assets | 1,207 | (10 | ) | 1,197 | |||||||
| Property, plant and equipment, net | 1,237 | — | 1,237 | ||||||||
| Goodwill | 525 | — | 525 | ||||||||
| Intangible assets, net | 242 | — | 242 | ||||||||
| Other assets | 724 | 689 | 1,413 | ||||||||
| Deferred income taxes | 195 | — | 195 | ||||||||
| Total Assets | $ | 4,130 | $ | 679 | $ | 4,809 | |||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | |||||||||||
| Current Liabilities | |||||||||||
| Accounts payable and other current liabilities | $ | 911 | $ | 76 | $ | 987 | |||||
| Income taxes payable | 69 | — | 69 | ||||||||
| Short-term borrowings | 321 | — | 321 | ||||||||
| Total Current Liabilities | 1,301 | 76 | 1,377 | ||||||||
| Long-term debt | 9,751 | — | 9,751 | ||||||||
| Other liabilities and deferred credits | 1,004 | 605 | 1,609 | ||||||||
| Total Liabilities | 12,056 | 681 | 12,737 | ||||||||
| Shareholders’ Deficit | |||||||||||
| Accumulated deficit | (7,592 | ) | (2 | ) | (7,594 | ) | |||||
| Accumulated other comprehensive loss | (334 | ) | — | (334 | ) | ||||||
| Total Shareholders’ Deficit | (7,926 | ) | (2 | ) | (7,928 | ) | |||||
| Total Liabilities and Shareholders’ Deficit | $ | 4,130 | $ | 679 | $ | 4,809 |
We recorded lease liabilities within Accounts payable and other current liabilities and Other liabilities and deferred credits of $83 million and $661 million, respectively, related to the present value of the remaining operating lease payments. These adjustments were partially offset by reductions to Accounts payable and other current liabilities and Other liabilities and deferred credits of $7 million and $56 million, respectively, primarily related to the write offs of liabilities previously recorded to reflect the impact of recognizing rent expense on a straight-line basis when lease payments were escalating under Legacy Lease GAAP. Additionally, lease liabilities recognized upon adoption were offset by the write-off of prepaid rent of $11 million that was recorded under Legacy Lease GAAP resulting in a decrease within Prepaid expenses and other current assets and Other assets of $10 million and $1 million, respectively.
We recorded a corresponding right-of-use asset within Other Assets of $690 million. This right-of-use asset reflected a $2 million impairment charge that would have been recorded before adoption of Topic 842 had the right-of-use asset been recognized under Legacy Lease GAAP. A related increase was recorded in Accumulated deficit.
Impact of Adopting New Revenue Recognition Standards
As discussed in Note 2, we adopted Topic 606 at the beginning of the year ended December 31, 2018, using the modified retrospective method. Topic 606 was applied to all contracts with customers as of January 1, 2018 and the cumulative effective of this transition was recorded as an adjustment to Accumulated deficit as of this date. As a result, the following adjustments were made to the Consolidated Balance Sheet as of January 1, 2018:
| CONSOLIDATED BALANCE SHEET | ||||||||||||
| As Reported 12/31/2017 | Adjustments | Balances with Adoption of Topic 606 1/1/2018 | ||||||||||
| ASSETS | ||||||||||||
| Current Assets | ||||||||||||
| Cash and cash equivalents | $ | 1,522 | $ | 11 | $ | 1,533 | ||||||
| Accounts and notes receivable, net | 400 | 112 | 512 | |||||||||
| Prepaid expenses and other current assets | 384 | 76 | (a) | 460 | ||||||||
| Advertising cooperative assets, restricted | 201 | (201 | ) | — | ||||||||
| Total Current Assets | 2,507 | (2 | ) | 2,505 | ||||||||
| Property, plant and equipment, net | 1,594 | 2 | 1,596 | |||||||||
| Goodwill | 512 | — | 512 | |||||||||
| Intangible assets, net | 214 | 9 | 223 | |||||||||
| Other assets | 345 | 118 | 463 | |||||||||
| Deferred income taxes | 139 | 26 | 165 | |||||||||
| Total Assets | $ | 5,311 | $ | 153 | $ | 5,464 | ||||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | ||||||||||||
| Current Liabilities | ||||||||||||
| Accounts payable and other current liabilities | $ | 813 | $ | 220 | $ | 1,033 | ||||||
| Income taxes payable | 123 | — | 123 | |||||||||
| Short-term borrowings | 375 | — | 375 | |||||||||
| Advertising cooperative liabilities | 201 | (201 | ) | — | ||||||||
| Total Current Liabilities | 1,512 | 19 | 1,531 | |||||||||
| Long-term debt | 9,429 | — | 9,429 | |||||||||
| Other liabilities and deferred credits | 704 | 353 | 1,057 | |||||||||
| Total Liabilities | 11,645 | 372 | 12,017 | |||||||||
| Shareholders’ Deficit | ||||||||||||
| Accumulated deficit | (6,063 | ) | (240 | ) | (6,303 | ) | ||||||
| Accumulated other comprehensive loss | (271 | ) | 21 | (250 | ) | |||||||
| Total Shareholders’ Deficit | (6,334 | ) | (219 | ) | (6,553 | ) | ||||||
| Total Liabilities and Shareholders’ Deficit | $ | 5,311 | $ | 153 | $ | 5,464 |
| (a) | Includes $58 million of restricted cash related to advertising cooperatives. These balances can only be used to settle obligations of the respective cooperatives. |
We recorded an increase in Accounts payable and other current liabilities and Other liabilities and deferred credits of $57 million and $335 million, respectively, as part of our cumulative adjustment related to unamortized upfront franchise fees, with a corresponding $392 million increase in Accumulated deficit. We recorded increases in Prepaid expenses and other current assets and Other assets of $18 million and $118 million, respectively, as part of our cumulative adjustment related to unamortized franchise incentives, with a corresponding $136 million decrease in Accumulated deficit.
Deferred income taxes increased $26 million as a result of recording the tax effects of the two adjustments noted above, with a corresponding decrease to Accumulated deficit. Accumulated other comprehensive loss decreased $21 million as a result of recognizing the impact of foreign currency translation related to the three adjustments noted above, with a corresponding increase in Accumulated deficit.
The remaining adjustments to our December 31, 2017 Consolidated Balance Sheet are primarily a result of reclassifying the assets and liabilities of our consolidated advertising cooperative from Advertising cooperative assets, restricted and Advertising cooperative liabilities to the respective balance sheet caption to which the assets and liabilities relate.
The following tables reflect the impact of the adoption of Topic 606 on our Consolidated Statement of Income for the year ended December 31, 2018 and our Consolidated Balance Sheet as of December 31, 2018.
| CONSOLIDATED STATEMENT OF INCOME | ||||||||||||
| Year ended 12/31/2018 | ||||||||||||
| Revenues | As Reported | Impact | Balances under Legacy Revenue GAAP | |||||||||
| Company sales | $ | 2,000 | $ | — | $ | 2,000 | ||||||
| Franchise and property revenues | 2,482 | 43 | 2,525 | |||||||||
| Franchise contributions for advertising and other services | 1,206 | (1,206 | ) | — | ||||||||
| Total revenues | 5,688 | (1,163 | ) | 4,525 | ||||||||
| Costs and Expenses, Net | ||||||||||||
| Company restaurant expenses | 1,634 | — | 1,634 | |||||||||
| General and administrative expenses | 895 | — | 895 | |||||||||
| Franchise and property expenses | 188 | 27 | 215 | |||||||||
| Franchise advertising and other services expense | 1,208 | (1,208 | ) | — | ||||||||
| Refranchising (gain) loss | (540 | ) | 4 | (536 | ) | |||||||
| Other (income) expense | 7 | — | 7 | |||||||||
| Total costs and expenses, net | 3,392 | (1,177 | ) | 2,215 | ||||||||
| Operating Profit | 2,296 | 14 | (a) | 2,310 | ||||||||
| Investment (income) expense, net | (9 | ) | — | (9 | ) | |||||||
| Other pension (income) expense | 14 | — | 14 | |||||||||
| Interest expense, net | 452 | — | 452 | |||||||||
| Income before income taxes | 1,839 | 14 | 1,853 | |||||||||
| Income tax provision (benefit) | 297 | 3 | 300 | |||||||||
| Net Income | $ | 1,542 | $ | 11 | $ | 1,553 | ||||||
| Basic Earnings Per Common Share | $ | 4.80 | $ | 0.03 | $ | 4.83 | ||||||
| Diluted Earnings Per Common Share | $ | 4.69 | $ | 0.03 | $ | 4.72 | ||||||
| (a) | Includes $23 million of franchise incentive payments made to or on behalf of franchisees during 2018 that under Legacy Revenue GAAP would have been recognized as expense in full in 2018. Due to the size and nature of such payments, we historically would not have allocated their impact to our Divisional results. Upon the adoption of Topic 606, these payments have been capitalized as assets. |
Upon the adoption of Topic 606, the timing and amount of revenue recognized for upfront franchise fees and franchise incentives changed from upfront recognition under Legacy Revenue GAAP to recognition over the term of the franchise agreement to which the fees and incentives relate. Also, under Legacy Revenue GAAP, amounts reported as Franchise contributions for advertising and other services and Franchise advertising and other services expense were presented on a net basis. Upon the adoption of Topic
606, these amounts require gross presentation in our Consolidated Statements of Income. Lastly, Legacy Revenue GAAP required that certain value-added taxes withheld and remitted on our behalf by our franchisees be reported as revenue and corresponding expense in our Consolidated Statements of Income. Upon adoption of Topic 606, these taxes are reported on a net basis as a reduction in Franchise and property revenues.
| CONSOLIDATED BALANCE SHEET | |||||||||||
| As Reported 12/31/2018 | Impact | Balances under Legacy Revenue GAAP 12/31/2018 | |||||||||
| ASSETS | |||||||||||
| Current Assets | |||||||||||
| Cash and cash equivalents | $ | 292 | $ | (13 | ) | $ | 279 | ||||
| Accounts and notes receivable, net | 561 | (120 | ) | 441 | |||||||
| Prepaid expenses and other current assets | 354 | (107 | ) | 247 | |||||||
| Advertising cooperative assets, restricted | — | 241 | 241 | ||||||||
| Total Current Assets | 1,207 | 1 | 1,208 | ||||||||
| Property, plant and equipment, net | 1,237 | (2 | ) | 1,235 | |||||||
| Goodwill | 525 | — | 525 | ||||||||
| Intangible assets, net | 242 | (16 | ) | 226 | |||||||
| Other assets | 724 | (127 | ) | 597 | |||||||
| Deferred income taxes | 195 | (25 | ) | 170 | |||||||
| Total Assets | $ | 4,130 | $ | (169 | ) | $ | 3,961 | ||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | |||||||||||
| Current Liabilities | |||||||||||
| Accounts payable and other current liabilities | $ | 911 | $ | (287 | ) | $ | 624 | ||||
| Income taxes payable | 69 | — | 69 | ||||||||
| Short-term borrowings | 321 | — | 321 | ||||||||
| Advertising cooperative liabilities | — | 241 | 241 | ||||||||
| Total Current Liabilities | 1,301 | (46 | ) | 1,255 | |||||||
| Long-term debt | 9,751 | — | 9,751 | ||||||||
| Other liabilities and deferred credits | 1,004 | (354 | ) | 650 | |||||||
| Total Liabilities | 12,056 | (400 | ) | 11,656 | |||||||
| Shareholders’ Deficit | |||||||||||
| Accumulated deficit | (7,592 | ) | 251 | (7,341 | ) | ||||||
| Accumulated other comprehensive loss | (334 | ) | (20 | ) | (354 | ) | |||||
| Total Shareholders’ Deficit | (7,926 | ) | 231 | (7,695 | ) | ||||||
| Total Liabilities and Shareholders’ Deficit | $ | 4,130 | $ | (169 | ) | $ | 3,961 |
The significant impacts resulting from the adoption of Topic 606 on our Consolidated Balance Sheet as of December 31, 2018, are consistent with those recorded as of January 1, 2018 as described previously.
Under Legacy Revenue GAAP, Cash, Cash Equivalents, Restricted Cash, and Restricted Cash Equivalents pertaining to advertising cooperatives that we were required to consolidate were classified within Advertising cooperative assets, restricted. Upon adoption of Topic 606, these amounts are reflected on our Consolidated Balance Sheet and changes in these balances are reported within our Consolidated Statement of Cash Flows.
Items Impacting Other Pension (Income) Expense
During the first quarter of 2017, as a result of the completion of a pension data review and reconciliation, we recorded a non-cash, out-of-year charge of $22 million to Other pension (income) expense to adjust our historical U.S. pension liability related to our deferred vested participants. Our CODM did not consider the impact of this charge when assessing segment performance given the number of years over which it accumulated. As such, this cost was not allocated to any of our segment operating results for performance reporting purposes. See Note 14 for further discussion of our pension plans.
Note 5 – Revenue Recognition
Disaggregation of Total Revenues
The following table disaggregates revenue by Concept, for our two most significant markets based on Operating Profit and for all other markets. We believe this disaggregation best reflects the extent to which the nature, amount, timing and uncertainty of our revenues and cash flows are impacted by economic factors.
| 2019 | ||||||||||||||||
| KFC Division | Pizza Hut Division | Taco Bell Division | Total | |||||||||||||
| U.S. | ||||||||||||||||
| Company sales | $ | 74 | $ | 21 | $ | 919 | $ | 1,014 | ||||||||
| Franchise revenues | 175 | 282 | 602 | 1,059 | ||||||||||||
| Property revenues | 20 | 6 | 44 | 70 | ||||||||||||
| Franchise contributions for advertising and other services | 10 | 318 | 483 | 811 | ||||||||||||
| China | ||||||||||||||||
| Franchise revenues | 214 | 60 | — | 274 | ||||||||||||
| Other | ||||||||||||||||
| Company sales | 497 | 33 | 2 | 532 | ||||||||||||
| Franchise revenues | 912 | 246 | 27 | 1,185 | ||||||||||||
| Property revenues | 69 | 3 | — | 72 | ||||||||||||
| Franchise contributions for advertising and other services | 520 | 58 | 2 | 580 | ||||||||||||
| $ | 2,491 | $ | 1,027 | $ | 2,079 | $ | 5,597 |
| 2018 | ||||||||||||||||
| KFC Division | Pizza Hut Division | Taco Bell Division | Total | |||||||||||||
| U.S. | ||||||||||||||||
| Company sales | $ | 72 | $ | 37 | $ | 1,034 | $ | 1,143 | ||||||||
| Franchise revenues | 171 | 284 | 539 | 994 | ||||||||||||
| Property revenues | 23 | 4 | 27 | 54 | ||||||||||||
| Franchise contributions for advertising and other services | 9 | 269 | 428 | 706 | ||||||||||||
| China | ||||||||||||||||
| Franchise revenues | 201 | 59 | — | 260 | ||||||||||||
| Other | ||||||||||||||||
| Company sales | 822 | 32 | 3 | 857 | ||||||||||||
| Franchise revenues | 825 | 248 | 24 | 1,097 | ||||||||||||
| Property revenues | 74 | 3 | — | 77 | ||||||||||||
| Franchise contributions for advertising and other services | 447 | 52 | 1 | 500 | ||||||||||||
| $ | 2,644 | $ | 988 | $ | 2,056 | $ | 5,688 |
Property revenues for the year ended December 31, 2017 were $86 million.
Contract Liabilities
Our contract liabilities are comprised of unamortized upfront fees received from franchisees. A summary of significant changes to the contract liability balance during 2019 and 2018 is presented below.
| Deferred Franchise Fees | ||||
| Balance at January 1, 2018 | $ | 392 | ||
| Revenue recognized that was included in unamortized upfront fees received from franchisees at the beginning of the period | (66 | ) | ||
| Increase for upfront fees associated with contracts that became effective during the period, net of amounts recognized as revenue during the period | 102 | |||
| Other(a) | (14 | ) | ||
| Balance at December 31, 2018 | $ | 414 | ||
| Revenue recognized that was included in unamortized upfront fees received from franchisees at the beginning of the period | (70 | ) | ||
| Increase for upfront fees associated with contracts that became effective during the period, net of amounts recognized as revenue during the period | 93 | |||
| Other(a) | 4 | |||
| Balance at December 31, 2019 | $ | 441 |
| (a) | Includes impact of foreign currency translation as well as, in 2018, the recognition of deferred franchise fees into Refranchising (gain) loss upon the modification of existing franchise agreements when entering into master franchise agreements. |
We expect to recognize contract liabilities as revenue over the remaining term of the associated franchise agreement as follows:
| Less than 1 year | $ | 65 | ||
| 1 - 2 years | 60 | |||
| 2 - 3 years | 56 | |||
| 3 - 4 years | 51 | |||
| 4 - 5 years | 46 | |||
| Thereafter | 163 | |||
| Total | $ | 441 |
We have applied the optional exemption, as provided for under Topic 606, which allows us to not disclose the transaction price allocated to unsatisfied performance obligations when the transaction price is a sales-based royalty.
Note 6 – Supplemental Cash Flow Data
| 2019 | 2018 | 2017 | ||||||||||
| Cash Paid For: | ||||||||||||
| Interest | $ | 497 | $ | 455 | $ | 442 | ||||||
| Income taxes | 283 | 279 | 346 | |||||||||
| Significant Non-Cash Investing and Financing Activities: | ||||||||||||
| Finance lease obligations incurred | $ | 14 | $ | 4 | $ | 8 | ||||||
| Finance lease and other debt obligations transferred through refranchising | (1 | ) | (24 | ) | (35 | ) | ||||||
| Reconciliation of Cash and cash equivalents to Consolidated Statements of Cash Flows: | ||||||||||||
| Cash and cash equivalents as presented in Consolidated Balance Sheets | $ | 605 | $ | 292 | $ | 1,522 | ||||||
| Restricted cash included in Prepaid expenses and other current assets(a) | 138 | 151 | 60 | |||||||||
| Restricted cash and restricted cash equivalents included in Other assets(b) | 25 | 31 | 17 | |||||||||
| Cash, Cash Equivalents and Restricted Cash as presented in Consolidated Statements of Cash Flows(c) | $ | 768 | $ | 474 | $ | 1,599 |
| (a) | Restricted cash within Prepaid expenses and other current assets reflects Taco Bell Securitization interest reserves (See Note 10) and the cash related to advertising cooperatives that we consolidate that can only be used to settle obligations of the respective cooperatives. |
| (b) | Primarily trust accounts related to our self-insurance program. |
| (c) | Upon adoption of Topic 606 we reclassified cash of $11 million and restricted cash of $58 million, respectively, from Advertising cooperative assets, restricted to Cash and cash equivalents and Prepaid expenses and other current assets. These amounts are included in the Beginning of Year balance of Cash, Cash Equivalents, Restricted Cash and Restricted Cash equivalents in our Consolidated Statement of Cash Flows for the year ended December 31, 2018. |
Note 7 – Other (Income) Expense
| 2019 | 2018 | 2017 | ||||||||||
| Foreign exchange net (gain) loss and other(a) | $ | (1 | ) | $ | 1 | $ | 7 | |||||
| Closure and impairment expense | 5 | 6 | 3 | |||||||||
| Other (income) expense | $ | 4 | $ | 7 | $ | 10 |
| (a) | 2019 includes settlement of contingent consideration associated with our 2013 acquisition of the KFC Turkey and Pizza Hut Turkey businesses (See Note 4). |
Note 8 – Supplemental Balance Sheet Information
| Prepaid Expenses and Other Current Assets | 2019 | 2018 | ||||||
| Income tax receivable | $ | 39 | $ | 36 | ||||
| Restricted cash | 138 | 151 | ||||||
| Assets held for sale(a) | 25 | 24 | ||||||
| Other prepaid expenses and current assets | 136 | 143 | ||||||
| Prepaid expenses and other current assets | $ | 338 | $ | 354 |
| Property, Plant and Equipment | 2019 | 2018 | ||||||
| Land | $ | 408 | $ | 422 | ||||
| Buildings and improvements | 1,325 | 1,349 | ||||||
| Finance leases, primarily buildings | 68 | 59 | ||||||
| Machinery, equipment and other | 505 | 523 | ||||||
| Property, plant and equipment, gross | 2,306 | 2,353 | ||||||
| Accumulated depreciation and amortization | (1,136 | ) | (1,116 | ) | ||||
| Property, plant and equipment, net | $ | 1,170 | $ | 1,237 |
Depreciation and amortization expense related to PP&E was $114 million, $146 million and $215 million in 2019, 2018 and 2017, respectively.
| Other Assets | 2019 | 2018 | ||||||
| Operating lease right-of-use assets(b) | $ | 642 | $ | — | ||||
| Investment in Grubhub common stock(c) | 137 | 214 | ||||||
| Franchise incentives | 174 | 141 | ||||||
| Other | 360 | 369 | ||||||
| Other assets | $ | 1,313 | $ | 724 |
| Accounts Payable and Other Current Liabilities | 2019 | 2018 | ||||||
| Accounts payable | $ | 173 | $ | 202 | ||||
| Accrued compensation and benefits | 223 | 206 | ||||||
| Accrued advertising | 96 | 108 | ||||||
| Operating lease liabilities(b) | 67 | — | ||||||
| Accrued taxes, other than income taxes | 52 | 48 | ||||||
| Other current liabilities | 349 | 347 | ||||||
| Accounts payable and other current liabilities | $ | 960 | $ | 911 |
| (a) | Reflects the carrying value of restaurants we have offered for sale to franchisees and excess properties that we do not intend to use for restaurant operations in the future. |
| (b) | Increase from 2018 primarily due to the adoption of Topic 842 beginning with the year ended December 31, 2019. See Notes 2 and 4 for further discussion. |
| (c) | Refer to Note 4 for additional discussion regarding our investment in Grubhub. |
Note 9 – Goodwill and Intangible Assets
The changes in the carrying amount of goodwill are as follows:
| KFC | Pizza Hut | Taco Bell | Worldwide | |||||||||||||
| Goodwill, net as of December 31, 2017(a) | $ | 247 | $ | 162 | $ | 103 | $ | 512 | ||||||||
| Disposal and other, net(b) | (17 | ) | (5 | ) | (4 | ) | (26 | ) | ||||||||
| QuikOrder acquisition(c) | — | 39 | — | 39 | ||||||||||||
| Goodwill, net as of December 31, 2018(a) | $ | 230 | $ | 196 | $ | 99 | $ | 525 | ||||||||
| Disposal and other, net(b) | 3 | 3 | (1 | ) | 5 | |||||||||||
| Goodwill, net as of December 31, 2019(a) | $ | 233 | $ | 199 | $ | 98 | $ | 530 |
| (a) | Goodwill, net includes $17 million of accumulated impairment losses for each year presented related to our Pizza Hut segment. |
| (b) | Disposals and other, net includes the impact of foreign currency translation on existing balances and goodwill write-offs associated with refranchising. |
| (c) | In December 2018, we completed the acquisition of QuikOrder, LLC, an online ordering software and service provider for the restaurant industry (“QuikOrder”), who was a provider of services to Company and franchise restaurants of our Pizza Hut U.S. business for nearly two decades. The purchase price allocated for accounting purposes of $77 million consisted of cash, net of cash acquired, in the amount of $66 million, settlement of a prepaid asset of $6 million related to our preexisting contractual relationship with QuikOrder and contingent consideration of $5 million. The contingent consideration was paid in the year ended December 31, 2019. The acquisition was part of our strategy to deliver an easy and personalized online ordering experience and accelerate digital innovation. Subsequent to the acquisition, fees paid by franchisees for use of the QuikOrder software are being presented within Franchise contributions for advertising and other services. Associated costs we incur are being presented within Franchise advertising and other services expense and G&A. |
The primary assets recorded as a result of the purchase price allocation were goodwill of $39 million and amortizable intangible assets (primarily software) of $33 million. The goodwill recorded resulted from increased synergies expected to be achieved through leveraging our scale and resources to enhance the services previously offered by QuikOrder. The goodwill amortization is deductible for tax purposes and has been allocated to the Pizza Hut U.S. reporting unit.
The pro forma impact on our results of operations if the acquisition had been completed as of the beginning of 2017 would not have been significant. The direct transaction costs associated with the acquisition were also not material and were expensed as incurred.
Intangible assets, net for the years ended 2019 and 2018 are as follows:
| 2019 | 2018 | |||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | |||||||||||||
| Definite-lived intangible assets | ||||||||||||||||
| Capitalized software costs | $ | 306 | $ | (130 | ) | $ | 319 | $ | (156 | ) | ||||||
| Reacquired franchise rights | 38 | (32 | ) | 37 | (30 | ) | ||||||||||
| Franchise contract rights | 100 | (83 | ) | 99 | (79 | ) | ||||||||||
| Lease tenancy rights | 5 | (1 | ) | 11 | (1 | ) | ||||||||||
| Other | 38 | (28 | ) | 38 | (27 | ) | ||||||||||
| $ | 487 | $ | (274 | ) | $ | 504 | $ | (293 | ) | |||||||
| Indefinite-lived intangible assets | ||||||||||||||||
| KFC trademark | $ | 31 | $ | 31 | ||||||||||||
Amortization expense for all definite-lived intangible assets was $52 million in 2019, $37 million in 2018 and $33 million in 2017. Amortization expense for definite-lived intangible assets is expected to approximate $53 million in 2020, $42 million in 2021, $25 million in 2022, $19 million in 2023 and $14 million in 2024.
Note 10 – Short-term Borrowings and Long-term Debt
| 2019 | 2018 | |||||||
| Short-term Borrowings | ||||||||
| Current maturities of long-term debt | $ | 437 | $ | 331 | ||||
| Other | 4 | — | ||||||
| 441 | 331 | |||||||
| Less current portion of debt issuance costs and discounts | (10 | ) | (10 | ) | ||||
| Short-term borrowings | $ | 431 | $ | 321 | ||||
| Long-term Debt | ||||||||
| Securitization Notes | $ | 2,898 | $ | 2,928 | ||||
| Subsidiary Senior Unsecured Notes | 2,850 | 2,850 | ||||||
| Term Loan A Facility | 463 | 488 | ||||||
| Term Loan B Facility | 1,935 | 1,955 | ||||||
| YUM Senior Unsecured Notes | 2,425 | 1,875 | ||||||
| Finance lease obligations (See Note 11) | 77 | 71 | ||||||
| $ | 10,648 | $ | 10,167 | |||||
| Less debt issuance costs and discounts | (80 | ) | (85 | ) | ||||
| Less current maturities of long-term debt | (437 | ) | (331 | ) | ||||
| Long-term debt | $ | 10,131 | $ | 9,751 |
Securitization Notes
Taco Bell Funding, LLC (the “Issuer”), a special purpose limited liability company and a direct, wholly-owned subsidiary of Taco Bell Corp. (“TBC”) through a series of securitization transactions has issued fixed rate senior secured notes collectively referred to as the “Securitization Notes”. The following table summarizes Securitization Notes outstanding at December 31, 2019:
| Interest Rate | ||||||||||||
| Issuance Date | Anticipated Repayment Date(a) | Outstanding Principal (in millions) | Stated | Effective(b) | ||||||||
| May 2016 | May 2023 | $ | 488 | 4.377 | % | 4.59 | % | |||||
| May 2016 | May 2026 | $ | 975 | 4.970 | % | 5.14 | % | |||||
| November 2018 | November 2023 | $ | 816 | 4.318 | % | 4.53 | % | |||||
| November 2018 | November 2028 | $ | 619 | 4.940 | % | 5.06 | % |
| (a) | The legal final maturity dates of the Securitization Notes issued in 2016 and 2018 are May 2046 and November 2048, respectively. If the Issuer has not repaid or refinanced a series of Securitization Notes prior to its respective Anticipated Repayment Dates, rapid amortization of principal on all Securitization Notes will occur and additional interest will accrue on the Securitization Notes. |
| (b) | Includes the effects of the amortization of any discount and debt issuance costs. |
The Securitization Notes were issued in transactions pursuant to which certain of TBC’s domestic assets, consisting principally of franchise-related agreements and domestic intellectual property, were contributed to the Issuer and the Issuer’s special purpose, wholly-owned subsidiaries (the “Guarantors”, and collectively with the Issuer, the "Securitization Entities") to secure the Securitization Notes. The Securitization Notes are secured by substantially all of the assets of the Securitization Entities, and include a lien on all existing and future U.S. Taco Bell franchise and license agreements and the royalties payable thereunder, existing and future U.S. Taco Bell intellectual property, certain transaction accounts and a pledge of the equity interests in asset owning Securitization Entities. The remaining U.S. Taco Bell assets that were excluded from the transfers to the Securitization Entities continue to be held by Taco Bell of America, LLC ("TBA") and TBC. The Securitization Notes are not guaranteed by the remaining U.S. Taco Bell assets, the Company, or any other subsidiary of the Company.
Payments of interest and principal on the Securitization Notes are made from the continuing fees paid pursuant to the franchise and license agreements with all U.S. Taco Bell restaurants, including both company and franchise operated restaurants. Interest on and principal payments of the Securitization Notes are due on a quarterly basis. In general, no amortization of principal of the Securitization Notes is required prior to their anticipated repayment dates unless as of any quarterly measurement date the consolidated leverage ratio (the ratio of total debt to Net Cash Flow (as defined in the related indenture)) for the preceding four fiscal quarters of either the Company and its subsidiaries or the Issuer and its subsidiaries exceeds 5.0:1, in which case amortization payments of 1% per year of the outstanding principal as of the closing of the Securitization Notes are required. As of the most recent quarterly measurement date the consolidated leverage ratio exceeded 5.0:1 and, as a result, amortization payments are required.
The Securitization Notes are subject to a series of covenants and restrictions customary for transactions of this type, including (i) that the Issuer maintains specified reserve accounts to be available to make required interest payments in respect of the Securitization Notes, (ii) provisions relating to optional and mandatory prepayments and the related payment of specified amounts, including specified make-whole payments in the case of the Securitization Notes under certain circumstances, (iii) certain indemnification payments relating to taxes, enforcement costs and other customary items and (iv) covenants relating to recordkeeping, access to information and similar matters. The Securitization Notes are also subject to rapid amortization events provided for in the indenture, including events tied to failure to maintain a stated debt service coverage ratio (as defined in the related indenture) of at least 1.1:1, gross domestic sales for branded restaurants being below certain levels on certain measurement dates, a manager termination event, an event of default and the failure to repay or refinance the Securitization Notes on the Anticipated Repayment Date (subject to limited cure rights). The Securitization Notes are also subject to certain customary events of default, including events relating to non-payment of required interest or principal due on the Securitization Notes, failure to comply with covenants within certain time frames, certain bankruptcy events, breaches of specified representations and warranties, failure of security interests to be effective, certain judgments and failure of the Securitization Entities to maintain a stated debt service coverage ratio. As of December 31, 2019, we were in compliance with all of our debt covenant requirements and were not subject to any rapid amortization events.
In accordance with the indenture, certain cash accounts have been established with the indenture trustee for the benefit of the note holders, and are restricted in their use. The indenture requires a certain amount of securitization cash flow collections to be allocated on a weekly basis and maintained in a cash reserve account. As of December 31, 2019, the Company had restricted cash of $81 million primarily related to required interest reserves included in Prepaid expenses and other current assets on the Consolidated Balance Sheets. Once the required obligations are satisfied, there are no further restrictions, including payment of dividends, on the cash flows of the Securitization Entities.
Additional cash reserves are required if any of the rapid amortization events occur, as noted above, or in the event that as of any quarterly measurement date the Securitization Entities fail to maintain a debt service coverage ratio (or the ratio of Net Cash Flow to all debt service payments for the preceding four fiscal quarters) of at least 1.75:1. The amount of weekly securitization cash flow collections that exceed the required weekly allocations is generally remitted to the Company. During the most recent quarter ended December 31, 2019, the Securitization Entities maintained a debt service coverage ratio significantly in excess of the 1.75:1 requirement.
Term Loan Facilities, Revolving Facility and Subsidiary Senior Unsecured Notes
KFC Holding Co., Pizza Hut Holdings, LLC, and TBA, each of which is a wholly-owned subsidiary of the Company, as co-borrowers (the "Borrowers") have entered into a credit agreement providing for senior secured credit facilities and a $1.0 billion revolving facility (the Revolving Facility"). The senior secured credit facilities, which include a Term Loan A Facility and a Term Loan B Facility, and the Revolving Facility are collectively referred to as the "Credit Agreement". Additionally, the Borrowers through a series of transactions have issued the Subsidiary Senior Unsecured Notes due 2024, 2026 and 2027 (collectively referred to as the “Subsidiary Senior Unsecured Notes”). The following table summarizes borrowings outstanding under the Credit Agreement as well as our Subsidiary Senior Unsecured Notes as of December 31, 2019. There are no outstanding borrowings under the Revolving Facility and $1.3 million of letters of credit outstanding as of December 31, 2019.
| Interest Rate | ||||||||||||||
| Issuance Date | Maturity Date | Outstanding Principal (in millions) | Stated | Effective(b) | ||||||||||
| Term Loan A Facility | June 2016 | June 2022 | $ | 463 | (a) | 3.46 | % | |||||||
| Term Loan B Facility | June 2016 | April 2025 | $ | 1,935 | (a) | 3.65 | % | |||||||
| Senior Note Due 2024 | June 2016 | June 2024 | $ | 1,050 | 5.00 | % | 5.16 | % | ||||||
| Senior Note Due 2026 | June 2016 | June 2026 | $ | 1,050 | 5.25 | % | 5.39 | % | ||||||
| Senior Note Due 2027 | June 2017 | June 2027 | $ | 750 | 4.75 | % | 4.90 | % |
| (a) | The interest rates applicable to the Term Loan A Facility as well as the Revolving Facility range from 1.25% to 1.75% plus LIBOR or from 0.25% to 0.75% plus the Base Rate (as defined in the Credit Agreement), at the Borrowers’ election, based upon the total leverage ratio of the Borrowers and the Specified Guarantors (as defined in the Credit Agreement). As of December 31, 2019 the interest rate spreads on the LIBOR and Base Rate applicable to our Term Loan A Facility were 1.50% and 0.50%, respectively. |
The interest rates applicable to the Term Loan B Facility are 1.75% plus LIBOR or 0.75% plus the Base Rate, at the Borrowers’ election.
| (b) | Includes the effects of the amortization of any discount and debt issuance costs as well as the impact of the interest rate swaps on the Term Loan B Facility (See Note 12). The effective rates related to our Term Loan A and B Facilities are based on current LIBOR-based interest rates at December 31, 2019. |
The Term Loan A Facility is subject to quarterly amortization payments currently in an amount equal to 1.25% of the initial principal amount of the facility. These amortization payments will increase to an amount equal to 1.875% of the initial principal amount of the facility on the fourth anniversary of the closing date and to an amount equal to 3.75% of the initial principal amount of the facility on the fifth anniversary of the closing date, with the balance payable at maturity on June 7, 2022.
The Term Loan B Facility is subject to quarterly amortization payments in an amount equal to 0.25% of the initial principal amount of the facility, with the balance payable at maturity on April 3, 2025.
The Credit Agreement is unconditionally guaranteed by the Company and certain of the Borrowers’ principal domestic subsidiaries and excludes Taco Bell Funding LLC and its special purpose, wholly-owned subsidiaries (see above). The Credit Agreement is also secured by first priority liens on substantially all assets of the Borrowers and each subsidiary guarantor, excluding the stock of certain subsidiaries and certain real property, and subject to other customary exceptions.
The Credit Agreement is subject to certain mandatory prepayments, including an amount equal to 50% of excess cash flow (as defined in the Credit Agreement) on an annual basis and the proceeds of certain asset sales, casualty events and issuances of indebtedness, subject to customary exceptions and reinvestment rights.
The Credit Agreement includes two financial maintenance covenants which require the Borrowers to maintain a total leverage ratio (defined as the ratio of Consolidated Total Debt to Consolidated EBITDA (as these terms are defined in the Credit Agreement)) of 5.0:1 or less and a fixed charge coverage ratio (defined as the ratio of EBITDA minus capital expenditures to fixed charges (inclusive of rental expense and scheduled amortization)) of at least 1.5:1, each as of the last day of each fiscal quarter. The Credit Agreement includes other affirmative and negative covenants and events of default that are customary for facilities of this type. The Credit Agreement contains, among other things, limitations on certain additional indebtedness and liens, and certain other transactions specified in the agreement. We were in compliance with all debt covenants as of December 31, 2019.
The Subsidiary Senior Unsecured Notes are guaranteed on a senior unsecured basis by (i) the Company, (ii) the Specified Guarantors and (iii) by each of the Borrower's and the Specified Guarantors’ domestic subsidiaries that guarantees the Borrower's obligations under the Credit Agreement, except for any of the Company’s foreign subsidiaries. The indenture governing the Subsidiary Senior Unsecured Notes contains covenants and events of default that are customary for debt securities of this type. We were in compliance with all debt covenants as of December 31, 2019.
YUM Senior Unsecured Notes
The majority of our remaining long-term debt primarily comprises YUM Senior Unsecured Notes. The following table summarizes all YUM Senior Unsecured Notes issued that remain outstanding at December 31, 2019:
| Interest Rate | ||||||||||||
| Issuance Date | Maturity Date | Principal Amount (in millions) | Stated | Effective(a) | ||||||||
| October 2007 | November 2037 | $ | 325 | 6.88 | % | 7.45 | % | |||||
| August 2010 | November 2020 | $ | 350 | 3.88 | % | 4.01 | % | |||||
| August 2011 | November 2021 | $ | 350 | 3.75 | % | 3.88 | % | |||||
| October 2013 | November 2023 | $ | 325 | 3.88 | % | 4.01 | % | |||||
| October 2013 | November 2043 | $ | 275 | 5.35 | % | 5.42 | % | |||||
| September 2019 | January 2030 | $ | 800 | 4.75 | % | 4.90 | % |
| (a) | Includes the effects of the amortization of any (1) premium or discount; (2) debt issuance costs; and (3) gain or loss upon settlement of related treasury locks and forward starting interest rate swaps utilized to hedge the interest rate risk prior to debt issuance. |
As included in the table above, on September 11, 2019, Yum! Brands, Inc. issued $800 million aggregate principal amount of 4.75% YUM Senior Unsecured Notes due January 15, 2030 (the “2030 Notes”). The net proceeds from the issuance were used to repay in full $250 million aggregate principal amount of YUM Senior Unsecured Notes that matured in September 2019, to repay the then outstanding borrowings under our $1 billion revolving facility and for general corporate purposes. Interest on the 2030 Notes is payable semiannually in arrears on January 15 and July 15 of each year. The Company incurred debt issuance costs of $10 million in connection with the issuance of the 2030 Notes. These issuance costs are recorded as a reduction in Long-term debt on our Consolidated Balance Sheet.
The YUM Senior Unsecured Notes represent senior, unsecured obligations and rank equally in right of payment with all of our existing and future unsecured unsubordinated indebtedness. Our YUM Senior Unsecured Notes contain cross-default provisions whereby the acceleration of the maturity of any of our indebtedness in a principal amount in excess of $50 million will constitute a default under the YUM Senior Unsecured Notes unless such indebtedness is discharged, or the acceleration of the maturity of that indebtedness is annulled, within 30 days after notice.
The annual maturities of all Short-term borrowings and Long-term debt as of December 31, 2019, excluding finance lease obligations of $77 million are as follows:
| Year ended: | |||
| 2020 | $ | 434 | |
| 2021 | 455 | ||
| 2022 | 424 | ||
| 2023 | 1,626 | ||
| 2024 | 1,086 | ||
| Thereafter | 6,550 | ||
| Total | $ | 10,575 |
Interest expense on Short-term borrowings and Long-term debt was $519 million, $496 million and $473 million in 2019, 2018 and 2017, respectively.
Note 11 – Lease Accounting
Components of Lease Expense
| 2019 | ||||||
| Operating lease cost | $ | 115 | ||||
| Finance lease cost | ||||||
| Amortization of right-of-use assets | 3 | |||||
| Interest on lease liabilities | 3 | |||||
| Total finance lease cost | 6 | |||||
| Sublease income | (69 | ) |
Rental expense related to operating leases was $151 million and $214 million for the years ended December 31, 2018 and 2017, respectively.
Supplemental Cash Flow Information
| 2019 | ||||
| Cash paid for amounts included in the measurement of lease liabilities | ||||
| Operating cash flows from operating leases | $ | 104 | ||
| Operating cash flows from finance leases | 3 | |||
| Financing cash flows from finance leases | 4 | |||
| Right-of-use assets obtained in exchange for lease obligations | ||||
| Operating leases | 79 | |||
| Finance leases | 14 |
Supplemental Balance Sheet Information
| 2019 | Consolidated Balance Sheet | |||||
| Assets | ||||||
| Operating lease right-of-use assets | $ | 642 | Other assets | |||
| Finance lease right-of-use assets | 42 | Property, plant and equipment, net | ||||
| Total right-of-use assets(a) | $ | 684 | ||||
| Liabilities | ||||||
| Current | ||||||
| Operating | $ | 67 | Accounts payable and other current liabilities | |||
| Finance | 7 | Short-term borrowings | ||||
| Non-current | ||||||
| Operating | 640 | Other liabilities and deferred credits | ||||
| Finance | 70 | Long-term debt | ||||
| Total lease liabilities(a) | $ | 784 | ||||
| Weighted-average Remaining Lease Term (in years) | ||||||
| Operating leases | 12.3 | |||||
| Finance leases | 12.7 | |||||
| Weighted-average Discount Rate | ||||||
| Operating leases | 5.6 | % | ||||
| Finance leases | 6.6 | % |
| (a) | U.S. operating lease right-of-use assets and liabilities totaled $283 million and $337 million, respectively, as of December 31, 2019. These amounts primarily related to Taco Bell U.S. including leases related to Company-operated restaurants, leases related to franchise-operated restaurants we sublease and the Taco Bell restaurant support center. |
Maturity of Lease Payments and Receivables
Future minimum lease payments, including rental payments for lease renewal options we are reasonably certain to exercise, and amounts to be received as lessor or sublessor as of December 31, 2019 were as follows:
| Commitments | Lease Receivables | |||||||||||||||
| Finance | Operating | Direct Financing | Operating | |||||||||||||
| 2020 | $ | 11 | $ | 105 | $ | 5 | $ | 81 | ||||||||
| 2021 | 11 | 100 | 4 | 76 | ||||||||||||
| 2022 | 9 | 92 | 4 | 72 | ||||||||||||
| 2023 | 9 | 83 | 4 | 69 | ||||||||||||
| 2024 | 8 | 76 | 3 | 65 | ||||||||||||
| Thereafter | 62 | 531 | 28 | 601 | ||||||||||||
| Total lease payments/receipts | 110 | 987 | 48 | $ | 964 | |||||||||||
| Less imputed interest/unearned income | (33 | ) | (280 | ) | (18 | ) | ||||||||||
| Total lease liabilities/receivables | $ | 77 | $ | 707 | $ | 30 |
As of December 31, 2019, we have executed real estate leases that have not yet commenced with estimated future lease payments of approximately $46 million, which are not included in the tables above. These leases are expected to commence in 2020 with lease terms of up to 20 years.
Future minimum lease payments and amounts to be received as lessor or sublessor under the non-cancellable term of leases as of December 31, 2018 as required to be disclosed under Legacy Lease GAAP were as follows:
| Commitments | Lease Receivables | |||||||||||||||
| Capital | Operating | Direct Financing | Operating | |||||||||||||
| 2019 | $ | 10 | $ | 103 | $ | 6 | $ | 89 | ||||||||
| 2020 | 10 | 89 | 5 | 79 | ||||||||||||
| 2021 | 9 | 78 | 4 | 74 | ||||||||||||
| 2022 | 8 | 71 | 4 | 69 | ||||||||||||
| 2023 | 8 | 61 | 3 | 67 | ||||||||||||
| Thereafter | 58 | 384 | 30 | 638 | ||||||||||||
| $ | 103 | $ | 786 | $ | 52 | $ | 1,016 |
At December 31, 2018 and 2017, the present value of minimum payments under capital leases was $71 million and $105 million, respectively. At December 31, 2018, unearned income associated with direct financing lease receivables was $19 million.
Note 12 - Derivative Instruments
We use derivative instruments to manage certain of our market risks related to fluctuations in interest rates and foreign currency exchange rates.
Interest Rate Swaps
We have entered into interest rate swaps with the objective of reducing our exposure to interest rate risk for a portion of our variable-rate debt interest payments. On July 25, 2016, we agreed with multiple counterparties to swap the variable LIBOR-based component of the interest payments related to $1.55 billion of borrowings under our Term Loan B Facility. These interest rate swaps will expire in July 2021. Further, on May 14, 2018 we entered into forward-starting interest rate swaps to fix the interest rate on $1.5 billion of borrowings under our Term Loan B Facility from the date the July 2016 swaps expire through March 2025. The interest rate swaps executed in May 2018 will result in a fixed rate of 4.81% on the swapped portion of the Term Loan B Facility from July 2021 through March 2025. These interest rate swaps are designated cash flow hedges as the changes in the
future cash flows of the swaps are expected to offset changes in expected future interest payments on the related variable-rate debt. There were no other interest rate swaps outstanding as of December 31, 2019.
Gains or losses on the interest rate swaps are reported as a component of AOCI and reclassified into Interest expense, net in our Consolidated Statements of Income in the same period or periods during which the related hedged interest payments affect earnings. Through December 31, 2019, the swaps were highly effective cash flow hedges.
Foreign Currency Contracts
We have entered into foreign currency forward and swap contracts with the objective of reducing our exposure to earnings volatility arising from foreign currency fluctuations associated with certain foreign currency denominated intercompany receivables and payables. The notional amount, maturity date, and currency of these contracts match those of the underlying intercompany receivables or payables. Our foreign currency contracts are designated cash flow hedges as the future cash flows of the contracts are expected to offset changes in intercompany receivables and payables due to foreign currency exchange rate fluctuations.
Gains or losses on the foreign currency contracts are reported as a component of AOCI. Amounts are reclassified from AOCI each quarter to offset foreign currency transaction gains or losses recorded within Other (income) expense when the related intercompany receivables and payables affect earnings due to their functional currency remeasurements. Through December 31, 2019, all foreign currency contracts related to intercompany receivables and payables were highly effective cash flow hedges.
As of December 31, 2019 and December 31, 2018, foreign currency contracts outstanding related to intercompany receivables and payables had total notional amounts of $20 million and $459 million, respectively. During the third quarter of 2019 we terminated foreign currency contracts with notional amounts of $430 million and settled the related intercompany receivable and payable. As a result of this termination and settlement, we reclassified $4 million of unrealized loss from AOCI to Interest expense, net in our Consolidated Statements of Income. We received $3 million in cash from the counterparty upon termination, which represented the fair value of the contracts at the time of termination. Our remaining foreign currency forward contracts all have durations that expire in 2020.
As a result of the use of interest rate swaps and foreign currency contracts, the Company is exposed to risk that the counterparties will fail to meet their contractual obligations. To mitigate the counterparty credit risk, we only enter into contracts with major financial institutions carefully selected based upon their credit ratings and other factors, and continually assess the creditworthiness of counterparties. At December 31, 2019, all of the counterparties to our interest rate swaps and foreign currency contracts had investment grade ratings according to the three major ratings agencies. To date, all counterparties have performed in accordance with their contractual obligations.
Gains and losses on derivative instruments designated as cash flow hedges recognized in OCI and reclassifications from AOCI into Net Income:
| Gains/(Losses) Recognized in OCI | (Gains)/Losses Reclassified from AOCI into Net Income | ||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | ||||||||||||||||||
| Interest rate swaps | $ | (71 | ) | $ | (3 | ) | $ | 4 | $ | (17 | ) | $ | (19 | ) | $ | 2 | |||||||
| Foreign currency contracts | 20 | 22 | (56 | ) | (8 | ) | (20 | ) | 56 | ||||||||||||||
| Income tax benefit/(expense) | 16 | 1 | 1 | 4 | 5 | (3 | ) |
As of December 31, 2019, the estimated net gain included in AOCI related to our cash flow hedges that will be reclassified into earnings in the next 12 months is $6 million, based on current LIBOR interest rates.
See Note 13 for the fair value of our derivative assets and liabilities.
Note 13 – Fair Value Disclosures
As of December 31, 2019 the carrying values of cash and cash equivalents, restricted cash, short-term investments, accounts receivable, short-term borrowings and accounts payable approximated their fair values because of the short-term nature of these instruments. The fair value of notes receivable net of allowances and lease guarantees less subsequent amortization approximates their carrying value. The following table presents the carrying value and estimated fair value of the Company’s debt obligations:
| 2019 | 2018 | ||||||||||||||
| Carrying Value | Fair Value (Level 2) | Carrying Value | Fair Value (Level 2) | ||||||||||||
| Securitization Notes(a) | $ | 2,898 | $ | 3,040 | $ | 2,928 | $ | 2,967 | |||||||
| Subsidiary Senior Unsecured Notes(b) | 2,850 | 3,004 | 2,850 | 2,733 | |||||||||||
| Term Loan A Facility(b) | 463 | 464 | 488 | 479 | |||||||||||
| Term Loan B Facility(b) | 1,935 | 1,949 | 1,955 | 1,915 | |||||||||||
| YUM Senior Unsecured Notes(b) | 2,425 | 2,572 | 1,875 | 1,798 | |||||||||||
| (a) | We estimated the fair value of the Securitization Notes by obtaining broker quotes from two separate brokerage firms that are knowledgeable about the Company’s Securitization Notes and, at times, trade these notes. The markets in which the Securitization Notes trade are not considered active markets. |
| (b) | We estimated the fair value of the YUM and Subsidiary Senior Unsecured Notes, Term Loan A Facility, and Term Loan B Facility using market quotes and calculations based on market rates. |
Recurring Fair Value Measurements
The Company has interest rate swaps, foreign currency contracts, an investment in Grubhub common stock and other investments, all of which are required to be measured at fair value on a recurring basis (See Note 12 for discussion regarding derivative instruments and Note 4 for discussion regarding our investment in Grubhub common stock). The following table presents fair values for those assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the measurements fall.
| Fair Value | |||||||||||||
| Consolidated Balance Sheet | Level | 2019 | 2018 | ||||||||||
| Assets | |||||||||||||
| Interest Rate Swaps | Prepaid expenses and other current assets | 2 | $ | 6 | $ | 21 | |||||||
| Foreign Currency Contracts | Prepaid expenses and other current assets | 2 | — | 5 | |||||||||
| Interest Rate Swaps | Other assets | 2 | 3 | 29 | |||||||||
| Investment in Grubhub Common Stock | Other assets | 1 | 137 | 214 | |||||||||
| Other Investments | Other assets | 1 | 43 | 27 | |||||||||
| Liabilities | |||||||||||||
| Interest Rate Swaps | Other liabilities and deferred credits | 2 | 71 | 23 | |||||||||
| Foreign Currency Contracts | Other liabilities and deferred credits | 2 | — | 24 |
The fair value of the Company’s foreign currency contracts and interest rate swaps were determined based on the present value of expected future cash flows considering the risks involved, including nonperformance risk, and using discount rates appropriate for the duration based on observable inputs. The fair value of the investment in Grubhub common stock was determined primarily based on closing market prices for the shares. The other investments primarily include investments in mutual funds, which are used to offset fluctuations for a portion of our deferred compensation liabilities and whose fair values were determined based on the closing market prices of the respective mutual funds as of December 31, 2019 and December 31, 2018.
Non-Recurring Fair Value Measurements
During the year ended December 31, 2019, we recognized non-recurring fair value measurements of $7 million related to refranchising related impairment. Refranchising related impairment results from writing down the assets of restaurants or restaurant groups offered for refranchising, including certain instances where a decision has been made to refranchise restaurants that are deemed to be impaired. The fair value measurements used in our impairment evaluation were based on actual bids received from potential buyers (Level 2). The remaining net book value of these restaurants at December 31, 2019 is insignificant.
During the years ended December 31, 2019 and December 31, 2018, we recognized non-recurring fair value measurements of $4 million and $1 million, respectively, related to restaurant-level impairment. Restaurant-level impairment charges are recorded in Other (income) expense and resulted primarily from our impairment evaluation of long-lived assets of individual restaurants that
were being operated at the time of impairment and had not been offered for refranchising. The fair value measurements used in these impairment evaluations were based on discounted cash flow estimates using unobservable inputs (Level 3). These amounts exclude fair value measurements made for assets that were subsequently disposed of prior to those respective year end dates. The remaining net book value of restaurant assets measured at fair value during the years ended December 31, 2019 and December 31, 2018 is insignificant.
Note 14 – Pension, Retiree Medical and Retiree Savings Plans
U.S. Pension Plans
We sponsor qualified and supplemental (non-qualified) noncontributory defined benefit plans covering certain full-time salaried and hourly U.S. employees. The qualified plan meets the requirements of certain sections of the Internal Revenue Code and provides benefits to a broad group of employees with restrictions on discriminating in favor of highly compensated employees with regard to coverage, benefits and contributions. The supplemental plans provide additional benefits to certain employees. We fund our supplemental plans as benefits are paid.
The most significant of our U.S. plans is the YUM Retirement Plan (the “Plan”), which is a qualified plan. Our funding policy with respect to the Plan is to contribute amounts necessary to satisfy minimum pension funding requirements, including requirements of the Pension Protection Act of 2006, plus additional amounts from time-to-time as are determined to be necessary to improve the Plan’s funded status. We do not expect to make any significant contributions to the Plan in 2020. Our two significant U.S. plans were previously amended such that any salaried employee hired or rehired by YUM after September 30, 2001 is not eligible to participate in those plans.
We do not anticipate any plan assets being returned to the Company during 2020 for any U.S. plans.
Obligation and Funded Status at Measurement Date:
The following chart summarizes the balance sheet impact, as well as benefit obligations, assets, and funded status associated with our two significant U.S. pension plans. The actuarial valuations for all plans reflect measurement dates coinciding with our fiscal year end.
| 2019 | 2018 | |||||||
| Change in benefit obligation: | ||||||||
| Benefit obligation at beginning of year | $ | 873 | $ | 1,007 | ||||
| Service cost | 6 | 8 | ||||||
| Interest cost | 39 | 38 | ||||||
| Plan amendments | 2 | 1 | ||||||
| Special termination benefits | — | 1 | ||||||
| Benefits paid | (57 | ) | (73 | ) | ||||
| Settlement payments | (1 | ) | — | |||||
| Actuarial (gain) loss | 153 | (109 | ) | |||||
| Benefit obligation at end of year | $ | 1,015 | $ | 873 | ||||
A significant component of the overall increase in the Company's benefit obligation for the year ended December 31, 2019 was due to an actuarial loss, which was primarily due to a decrease in the discount rate used to measure our benefit obligation from 4.60% at December 31, 2018 to 3.50% at December 31, 2019. A significant component of the overall decrease in the Company's benefit obligation for the year ended December 31, 2018 was due to an actuarial gain, which was primarily due to an increase in the discount rate used to measure our benefit obligation from 3.90% at December 31, 2017 to 4.60% at December 31, 2018.
| Change in plan assets: | ||||||||
| Fair value of plan assets at beginning of year | $ | 755 | $ | 864 | ||||
| Actual return on plan assets | 176 | (49 | ) | |||||
| Employer contributions | 12 | 13 | ||||||
| Benefits paid | (57 | ) | (73 | ) | ||||
| Fair value of plan assets at end of year | $ | 886 | $ | 755 | ||||
| Funded status at end of year | $ | (129 | ) | $ | (118 | ) |
| Amounts recognized in the Consolidated Balance Sheet: | ||||||||
| 2019 | 2018 | |||||||
| Accrued benefit liability - current | $ | (4 | ) | $ | (5 | ) | ||
| Accrued benefit liability - non-current | (125 | ) | (113 | ) | ||||
| $ | (129 | ) | $ | (118 | ) |
The accumulated benefit obligation was $984 million and $849 million at December 31, 2019 and December 31, 2018, respectively.
| Information for pension plans with an accumulated benefit obligation in excess of plan assets: | ||||||||
| 2019 | 2018 | |||||||
| Projected benefit obligation | $ | 1,015 | $ | 873 | ||||
| Accumulated benefit obligation | 984 | 849 | ||||||
| Fair value of plan assets | 886 | 755 |
| Information for pension plans with a projected benefit obligation in excess of plan assets: | ||||||||
| 2019 | 2018 | |||||||
| Projected benefit obligation | $ | 1,015 | $ | 873 | ||||
| Accumulated benefit obligation | 984 | 849 | ||||||
| Fair value of plan assets | 886 | 755 |
Components of net periodic benefit cost:
| 2019 | 2018 | 2017 | ||||||||||
| Service cost | $ | 6 | $ | 8 | $ | 10 | ||||||
| Interest cost | 39 | 38 | 41 | |||||||||
| Amortization of prior service cost(a) | 6 | 5 | 6 | |||||||||
| Expected return on plan assets | (44 | ) | (44 | ) | (45 | ) | ||||||
| Amortization of net loss | 1 | 16 | 5 | |||||||||
| Net periodic benefit cost | $ | 8 | $ | 23 | $ | 17 | ||||||
| Additional (gain) loss recognized due to: Settlement charges(b) | $ | 3 | $ | — | $ | 19 | ||||||
| Special termination benefits | $ | — | $ | 1 | $ | 2 | ||||||
| Pension data adjustment(c) | $ | — | $ | — | $ | 22 |
| (a) | Prior service costs are amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits. |
| (b) | Settlement losses result when benefit payments exceed the sum of the service cost and interest cost within a plan during the year. These losses were recorded in Other pension (income) expense. |
| (c) | Reflects a non-cash, out-of-year charge related to the adjustment of certain historical deferred vested liability balances in the Plan during the first quarter of 2017 recorded in Other pension (income) expense. See Note 4. |
| Pension gains (losses) in AOCI: | ||||||||
| 2019 | 2018 | |||||||
| Beginning of year | $ | (123 | ) | $ | (160 | ) | ||
| Net actuarial gain (loss) | (22 | ) | 17 | |||||
| Curtailments | — | — | ||||||
| Amortization of net loss | 1 | 16 | ||||||
| Amortization of prior service cost | 6 | 5 | ||||||
| Prior service cost | (2 | ) | (1 | ) | ||||
| Settlement charges | 4 | — | ||||||
| End of year | $ | (136 | ) | $ | (123 | ) |
| Accumulated pre-tax losses recognized within AOCI: | ||||||||
| 2019 | 2018 | |||||||
| Actuarial net loss | $ | (118 | ) | $ | (101 | ) | ||
| Prior service cost | (18 | ) | (22 | ) | ||||
| $ | (136 | ) | $ | (123 | ) |
| Weighted-average assumptions used to determine benefit obligations at the measurement dates: | ||||||
| 2019 | 2018 | |||||
| Discount rate | 3.50 | % | 4.60 | % | ||
| Rate of compensation increase | 3.00 | % | 3.00 | % |
| Weighted-average assumptions used to determine the net periodic benefit cost for fiscal years: | |||||||||
| 2019 | 2018 | 2017(a) | |||||||
| Discount rate | 4.60 | % | 3.90 | % | 4.53 | % | |||
| Long-term rate of return on plan assets | 5.75 | % | 5.65 | % | 6.06 | % | |||
| Rate of compensation increase | 3.00 | % | 3.75 | % | 3.75 | % |
(a) Reflects a weighted average due to interim re-measurements in 2017.
Our estimated long-term rate of return on plan assets represents the weighted-average of expected future returns on the asset categories included in our target investment allocation based primarily on the historical returns for each asset category and future growth expectations.
Plan Assets
The fair values of our pension plan assets at December 31, 2019 and December 31, 2018 by asset category and level within the fair value hierarchy are as follows:
| 2019 | 2018 | |||||||
| Level 1: | ||||||||
| Cash | $ | 5 | $ | 3 | ||||
| Cash Equivalents(a) | 13 | 10 | ||||||
| Fixed Income Securities - U.S. Corporate(b) | 161 | 140 | ||||||
| Equity Securities – U.S. Large cap(b) | 268 | 215 | ||||||
| Equity Securities – U.S. Mid cap(b) | 44 | 35 | ||||||
| Equity Securities – U.S. Small cap(b) | 43 | 34 | ||||||
| Equity Securities – Non-U.S.(b) | 88 | 74 | ||||||
| Level 2: | ||||||||
| Fixed Income Securities – U.S. Corporate(c) | 120 | 106 | ||||||
| Fixed Income Securities – U.S. Government and Government Agencies(d) | 274 | 161 | ||||||
| Fixed Income Securities – Other(d) | 39 | 18 | ||||||
| Total fair value of plan assets(e) | $ | 1,055 | $ | 796 |
| (a) | Short-term investments in money market funds. |
| (b) | Securities held in common trusts. |
| (c) | Investments held directly by the Plan. |
| (d) | Includes securities held in common trusts and investments held directly by the Plan. |
| (e) | 2019 and 2018 exclude net unsettled trade payables of $169 million and $41 million, respectively. |
Our primary objectives regarding the investment strategy for the Plan’s assets are to reduce interest rate and market risk and to provide adequate liquidity to meet immediate and future payment requirements. To achieve these objectives, we are using a combination of active and passive investment strategies. The Plan's equity securities, currently targeted to be 50% of our investment mix, consist primarily of low-cost index funds focused on achieving long-term capital appreciation. The Plan diversifies its equity risk by investing in several different U.S. and foreign market index funds. Investing in these index funds provides the Plan with the adequate liquidity required to fund benefit payments and plan expenses. The fixed income asset allocation, currently targeted to be 50% of our mix, is actively managed and consists of long-duration fixed income securities that help to reduce exposure to interest rate variation and to better correlate asset maturities with obligations. The fair values of all pension plan assets are determined based on closing market prices or net asset values.
A mutual fund held as an investment by the Plan includes shares of Common Stock valued at $0.3 million at both December 31, 2019 and December 31, 2018 (less than 1% of total plan assets in each instance).
Benefit Payments
The benefits expected to be paid in each of the next five years and in the aggregate for the five years thereafter are set forth below:
| Year ended: | ||||
| 2020 | $ | 43 | ||
| 2021 | 47 | |||
| 2022 | 49 | |||
| 2023 | 52 | |||
| 2024 | 53 | |||
| 2025 - 2029 | 287 |
Expected benefit payments are estimated based on the same assumptions used to measure our benefit obligation on the measurement date and include benefits attributable to estimated future employee service.
International Pension Plans
We also sponsor various defined benefit plans covering certain of our non-U.S. employees, the most significant of which are in the UK. Both of our UK plans have previously been frozen such that they are closed to new participants and existing participants can no longer earn future service credits.
At the end of 2019 and 2018, the projected benefit obligations of these UK plans totaled $290 million and $233 million, respectively and plan assets totaled $372 million and $319 million, respectively. These plans were both in a net overfunded position at the end of 2019 and 2018 and related expense amounts recorded in each of 2019, 2018 and 2017 were not significant.
The funding rules for our pension plans outside of the U.S. vary from country to country and depend on many factors including discount rates, performance of plan assets, local laws and regulations. We do not plan to make significant contributions to either of our UK plans in 2020.
Retiree Medical Benefits
Our post-retirement plan provides health care benefits, principally to U.S. salaried retirees and their dependents, and includes retiree cost-sharing provisions and a cap on our liability. This plan was previously amended such that any salaried employee hired or rehired by YUM after September 30, 2001 is not eligible to participate in this plan. Employees hired prior to September 30, 2001 are eligible for benefits if they meet age and service requirements and qualify for retirement benefits. We fund our post-retirement plan as benefits are paid.
At the end of 2019 and 2018, the accumulated post-retirement benefit obligation was $44 million and $45 million, respectively. Actuarial pre-tax gains of $9 million and $13 million were recognized in AOCI at the end of 2019 and 2018, respectively. The net periodic benefit cost recorded was $1 million in 2019, $2 million in 2018 and $2 million in 2017, the majority of which is interest cost on the accumulated post-retirement benefit obligation. The weighted-average assumptions used to determine benefit obligations and net periodic benefit cost for the post-retirement medical plan are identical to those as shown for the U.S. pension plans.
The benefits expected to be paid in each of the next five years are approximately $4 million and in aggregate for the five years thereafter are $14 million.
U.S. Retiree Savings Plan
We sponsor a contributory plan to provide retirement benefits under the provisions of Section 401(k) of the Internal Revenue Code (the “401(k) Plan”) for eligible U.S. salaried and hourly employees. Participants are able to elect to contribute up to 75% of eligible compensation on a pre-tax basis. Participants may allocate their contributions to one or any combination of multiple investment options or a self-managed account within the 401(k) Plan. We match 100% of the participant’s contribution to the 401(k) Plan up to 6% of eligible compensation. We recognized as compensation expense our total matching contribution of $11 million in 2019, $12 million in 2018 and $13 million in 2017.
Note 15 – Share-based and Deferred Compensation Plans
Overview
At year end 2019, we had one stock award plan in effect: the Yum! Brands, Inc. Long-Term Incentive Plan (the “LTIP”). Under the LTIP, the exercise price of stock options and SARs granted must be equal to or greater than the average market price or the ending market price of the Company’s stock on the date of grant.
Potential awards to employees and non-employee directors under the LTIP include stock options, incentive stock options, SARs, restricted stock, restricted stock units (“RSUs”), performance restricted stock units, performance share units (“PSUs”) and performance units. We have issued only stock options, SARs, RSUs and PSUs under the LTIP. While awards under the LTIP can have varying vesting provisions and exercise periods, outstanding awards under the LTIP vest in periods ranging from immediate to five years. Stock options and SARs generally expire ten years after grant.
At year end 2019, approximately 26 million shares were available for future share-based compensation grants under the LTIP.
Our EID Plan allows participants to defer receipt of a portion of their annual salary and all or a portion of their incentive compensation. As defined by the EID Plan, we credit the amounts deferred with earnings based on the investment options selected
by the participants. These investment options are limited to cash, phantom shares of our Common Stock, phantom shares of a Stock Index Fund and phantom shares of a Bond Index Fund. Investments in cash and phantom shares of both index funds will be distributed in cash at a date as elected by the employee and therefore are classified as a liability on our Consolidated Balance Sheets. We recognize compensation expense for the appreciation or the depreciation, if any, of investments in cash and both of the index funds. Deferrals into the phantom shares of our Common Stock will be distributed in shares of our Common Stock, under the LTIP, at a date as elected by the employee and therefore are classified in Common Stock on our Consolidated Balance Sheets. We do not recognize compensation expense for the appreciation or the depreciation, if any, of investments in phantom shares of our Common Stock. Our EID plan also allows certain participants to defer incentive compensation to purchase phantom shares of our Common Stock and receive a 33% Company match on the amount deferred. Deferrals receiving a match are similar to an RSU award in that participants will generally forfeit both the match and incentive compensation amounts deferred if they voluntarily separate from employment during a vesting period that is two years from the date of deferral. We expense the intrinsic value of the match and the incentive compensation amount over the requisite service period which includes the vesting period.
Historically, the Company has repurchased shares on the open market in excess of the amount necessary to satisfy award exercises and expects to continue to do so in 2020.
In connection with the Separation of our China business, under the provisions of our LTIP, employee stock options, SARs, RSUs and PSUs were adjusted to maintain the pre-spin intrinsic value of the awards. Depending on the tax laws of the country of employment, awards were modified using either the shareholder method or the employer method. Share-based compensation as recorded in Net Income is based on the amortization of the fair value for both YUM and Yum China awards held by YUM employees. Share issuances for Yum China awards held by YUM employees will be satisfied by Yum China. Share issuances for YUM awards held by Yum China employees are being satisfied by YUM.
Under the shareholder method, investments in phantom shares of our Common Stock held within our EID Plan were partially converted into phantom investments in Yum China. Through October 31, 2018, distributions of investments in phantom shares of Yum China could be settled in cash, as opposed to stock, at a date as elected by the employee and, therefore, were classified as a liability and remeasured to fair value at each reporting period in our Consolidated Balance Sheet. During 2018 and 2017, we recorded a $3 million credit and a $18 million charge, respectively, within G&A related to these awards (See Note 4).
As of October 31, 2018, deferrals in phantom shares of Yum China common stock were no longer an investment option within our EID Plan and any balances relating to these shares were moved to another available EID Plan investment option as selected by the participants. Amounts directed into cash or phantom shares of a Stock Index Fund or a Bond Index Fund remained classified as a liability and appreciation or depreciation in these investments from the transfer date forward are recognized as compensation expense. Any amounts directed into phantom shares of YUM Common Stock were reclassified to Common Stock on our Consolidated Balance Sheet. We do not recognize compensation expense for the appreciation or depreciation, if any, of investments in phantom shares of our Common Stock.
Award Valuation
We estimated the fair value of each stock option and SAR award as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
| 2019 | 2018 | 2017 | |||||||
| Risk-free interest rate | 2.5 | % | 2.5 | % | 1.9 | % | |||
| Expected term | 6.5 years | 6.5 years | 6.4 years | ||||||
| Expected volatility | 22.0 | % | 22.0 | % | 22.9 | % | |||
| Expected dividend yield | 1.8 | % | 1.8 | % | 1.8 | % |
We believe it is appropriate to group our stock option and SAR awards into two homogeneous groups when estimating expected term. These groups consist of grants made primarily to restaurant-level employees, which cliff-vest after 4 years and expire 10 years after grant, and grants made to executives, which typically have a graded vesting schedule of 25% per year over 4 years and expire 10 years after grant. We use a single weighted-average term for our awards that have a graded vesting schedule. Based on analysis of our historical exercise and post-vesting termination behavior, we have determined that our restaurant-level employees and our executives exercised the awards on average after 5 years and 6.5 years, respectively.
When determining expected volatility, we consider both historical volatility of our stock as well as implied volatility associated with our publicly-traded options. The expected dividend yield is based on the annual dividend yield at the time of grant.
The fair values of PSU awards without market-based conditions and RSU awards are based on the closing price of our Common Stock on the date of grant. The fair values of PSU awards with market-based conditions have been valued based on the outcome of a Monte Carlo simulation.
Award Activity
Stock Options and SARs
| Shares (in thousands) | Weighted-Average Exercise Price | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value (in millions) | |||||||||||||
| Outstanding at the beginning of the year | 16,191 | $ | 51.84 | |||||||||||||
| Granted | 2,332 | 93.52 | ||||||||||||||
| Exercised | (3,210 | ) | 38.16 | |||||||||||||
| Forfeited or expired | (449 | ) | 75.29 | |||||||||||||
| Outstanding at the end of the year | 14,864 | (a) | 60.76 | 5.62 | $ | 594 | ||||||||||
| Exercisable at the end of the year | 9,283 | $ | 49.38 | 4.10 | $ | 477 |
| (a) | Outstanding awards include 782 options and 14,082 SARs with weighted average exercise prices of $45.03 and $61.64, respectively. Outstanding awards represent YUM awards held by employees of both YUM and Yum China. |
The weighted-average grant-date fair value of stock options and SARs granted during 2019, 2018 and 2017 was $19.82, $16.45 and $14.08, respectively. The total intrinsic value of stock options and SARs exercised during the years ended December 31, 2019, December 31, 2018 and December 31, 2017, was $204 million, $195 million and $154 million, respectively.
As of December 31, 2019, $49 million of unrecognized compensation cost related to unvested stock options and SARs, which will be reduced by any forfeitures that occur, is expected to be recognized over a remaining weighted-average period of approximately 1.7 years. This reflects unrecognized cost for both YUM and Yum China awards held by YUM employees. The total fair value at grant date of awards for both YUM and Yum China awards held by YUM employees that vested during 2019, 2018 and 2017 was $31 million, $28 million and $33 million, respectively.
RSUs and PSUs
As of December 31, 2019, there was $30 million of unrecognized compensation cost related to 1.1 million unvested RSUs and PSUs, none of which related to Yum China common stock. The total fair value at grant date of awards that vested during 2019, 2018 and 2017 was $14 million, $16 million and $10 million, respectively.
Impact on Net Income
The components of share-based compensation expense and the related income tax benefits are shown in the following table:
| 2019 | 2018 | 2017 | |||||||||||
| Options and SARs | $ | 39 | $ | 37 | $ | 30 | |||||||
| Restricted Stock Units | 12 | 6 | 26 | ||||||||||
| Performance Share Units | 8 | 7 | 9 | ||||||||||
| Total Share-based Compensation Expense | $ | 59 | $ | 50 | (a) | $ | 65 | (a) | |||||
| Deferred Tax Benefit recognized | $ | 9 | $ | 9 | $ | 22 | (b) | ||||||
| EID compensation expense not share-based | $ | 17 | $ | (2 | ) | $ | 12 |
| (a) | Includes $3 million of appreciation and $18 million of depreciation in the market price of Yum China's stock in 2018 and 2017, respectively. See Note 4. |
(b) Deferred tax benefit recognized does not reflect the impact of the Tax Act. See Note 17.
Cash received from stock option exercises for 2019, 2018 and 2017 was $1 million, $5.5 million and $12 million, respectively. Tax benefits realized on our tax returns from tax deductions associated with share-based compensation for 2019, 2018 and 2017 totaled $66 million, $60 million and $153 million, respectively.
Note 16 – Shareholders’ Deficit
Under the authority of our Board of Directors, we repurchased shares of our Common Stock during 2019, 2018 and 2017. All amounts exclude applicable transaction fees.
| Shares Repurchased (thousands) | Dollar Value of Shares Repurchased | ||||||||||||||||||||||||||
| Authorization Date | 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | |||||||||||||||||||||
| August 2018 | 7,788 | 10,003 | — | 810 | 894 | — | |||||||||||||||||||||
| November 2017 | — | 18,240 | — | — | 1,500 | — | |||||||||||||||||||||
| November 2016 | — | — | 26,561 | — | — | 1,915 | |||||||||||||||||||||
| Total | 7,788 | (a) | 28,243 | (a) | 26,561 | (b) | $ | 810 | (a) | $ | 2,394 | (a) | $ | 1,915 | (b) |
| (a) | 2019 amount excludes and 2018 amount includes the effect of $5 million in share repurchases (0.1 million shares) with trade dates on, or prior to, December 31, 2018 but settlement dates subsequent to December 31, 2018. |
| (b) | 2017 amount excludes the effect of $45 million in share repurchases (0.7 million shares) with trade dates prior to December 31, 2016 but settlement dates subsequent to December 31, 2016. |
On November 21, 2019, our Board of Directors authorized share repurchases through June 2021 of up to $2 billion (excluding applicable transaction fees) of our outstanding Common Stock. As of December 31, 2019, we have remaining capacity to repurchase up to $2 billion of Common Stock under this authorization. Unutilized share repurchase capacity of $296 million under the August 2018 authorization expired on December 31, 2019.
Changes in AOCI are presented below.
| Translation Adjustments and Gains (Losses) From Intra-Entity Transactions of a Long-Term Nature(a) | Pension and Post-Retirement Benefits(b) | Derivative Instruments(c) | Total | |||||||||||||
| Balance at December 31, 2017, net of tax | $ | (174 | ) | $ | (106 | ) | $ | 9 | $ | (271 | ) | |||||
| Adoption of accounting standards | 21 | (d) | (17 | ) | (e) | (2 | ) | (e) | 2 | |||||||
| OCI, net of tax | ||||||||||||||||
| Gains (losses) arising during the year classified into AOCI, net of tax | (88 | ) | 24 | 20 | (44 | ) | ||||||||||
| (Gains) losses reclassified from AOCI, net of tax | (4 | ) | 17 | (34 | ) | (21 | ) | |||||||||
| (92 | ) | 41 | (14 | ) | (65 | ) | ||||||||||
| Balance at December 31, 2018, net of tax | $ | (245 | ) | $ | (82 | ) | $ | (7 | ) | $ | (334 | ) | ||||
| OCI, net of tax | ||||||||||||||||
| Gains (losses) arising during the year classified into AOCI, net of tax | 24 | (30 | ) | (35 | ) | (41 | ) | |||||||||
| (Gains) losses reclassified from AOCI, net of tax | — | 8 | (21 | ) | (13 | ) | ||||||||||
| 24 | (22 | ) | (56 | ) | (54 | ) | ||||||||||
| Balance at December 31, 2019, net of tax | $ | (221 | ) | $ | (104 | ) | $ | (63 | ) | $ | (388 | ) | ||||
| (a) | Amounts reclassified from AOCI are due to substantially complete liquidations of foreign entities related to the KFC and Pizza Hut Brazil refranchising transactions during 2018. |
| (b) | Amounts reclassified from AOCI for pension and post-retirement benefit plans losses during 2019 include amortization of net losses of $2 million, amortization of prior service cost of $5 million, settlement charges of $3 million and related income tax benefit of $2 million. Amounts reclassified from AOCI for pension and post-retirement benefit plan losses during 2018 include amortization of net losses of $17 million, amortization of prior service cost of $5 million and related income tax benefit of $5 million. See Note 14. |
| (c) | See Note 12 for details on amounts reclassified from AOCI. |
| (d) | Represents the impact of foreign currency translation from the adoption of Topic 606. See Notes 2 and 4. |
| (e) | During the quarter ended March 31, 2018, we adopted a standard that allowed for the reclassification from AOCI to Accumulated deficit for stranded tax effects resulting from the Tax Act. |
Note 17 – Income Taxes
U.S. and foreign income before taxes are set forth below:
| 2019 | 2018 | 2017 | ||||||||||
| U.S. | $ | 466 | $ | 726 | $ | 662 | ||||||
| Foreign | 907 | 1,113 | 1,612 | |||||||||
| $ | 1,373 | $ | 1,839 | $ | 2,274 |
The details of our income tax provision (benefit) are set forth below:
| 2019 | 2018 | 2017 | ||||||||||||
| Current: | Federal | $ | 129 | $ | 102 | $ | (2 | ) | ||||||
| Foreign | 166 | 181 | 290 | |||||||||||
| State | 16 | 25 | 12 | |||||||||||
| $ | 311 | $ | 308 | $ | 300 | |||||||||
| Deferred: | Federal | $ | (16 | ) | $ | (24 | ) | $ | 603 | |||||
| Foreign | (213 | ) | 5 | 19 | ||||||||||
| State | (3 | ) | 8 | 12 | ||||||||||
| $ | (232 | ) | $ | (11 | ) | $ | 634 | |||||||
| $ | 79 | $ | 297 | $ | 934 |
The reconciliation of income taxes calculated at the U.S. federal statutory rate to our effective tax rate is set forth below:
| 2019 | 2018 | 2017 | |||||||
| U.S. federal statutory rate | 21.0 | % | 21.0 | % | 35.0 | % | |||
| State income tax, net of federal tax | 0.8 | 1.0 | 0.5 | ||||||
| Statutory rate differential attributable to foreign operations | 1.6 | (12.3 | ) | (9.3 | ) | ||||
| Adjustments to reserves and prior years | 4.2 | 2.8 | 0.5 | ||||||
| Share-based compensation | (4.0 | ) | (2.5 | ) | (5.1 | ) | |||
| Change in valuation allowances | (2.6 | ) | 8.5 | 1.5 | |||||
| Intercompany restructuring | (16.1 | ) | — | — | |||||
| Tax Act Enactment | — | (1.9 | ) | 19.1 | |||||
| Other, net | 0.8 | (0.4 | ) | (1.1 | ) | ||||
| Effective income tax rate | 5.7 | % | 16.2 | % | 41.1 | % |
Statutory rate differential attributable to foreign operations. This item includes local country taxes, withholding taxes, and shareholder-level taxes, net of foreign tax credits. In 2019, this expense included the full year impact of the global intangible low-taxed income (GILTI) provisions of the Tax Cuts and Jobs Act of 2017. In 2018, this benefit was positively impacted by approximately 8 percentage points due to a transaction resulting in the recognition of excess foreign tax credits that were fully offset by expense included in 'Change in valuation allowances'. 2017 is favorably impacted by a majority of our income being earned outside of the U.S. where tax rates were generally lower than the U.S. rate.
Adjustments to reserves and prior years. This item includes: (1) changes in tax reserves, including interest thereon, established for potential exposure we may incur if a taxing authority takes a position on a matter contrary to our position; and (2) the effects of reconciling income tax amounts recorded in our Consolidated Statements of Income to amounts reflected on our tax returns, including any adjustments to the Consolidated Balance Sheets. In 2019, this item was unfavorably impacted by $31 million in reserves related to the inclusion of stock based compensation in cost sharing arrangements that was largely offset by the benefit from the utilization of foreign tax credits included in 'Change in valuation allowances' as well as $34 million in reserves related
to taxes recorded associated with a prior year divestiture. This unfavorable impact was partially offset by the reversal of a $20 million reserve established in 2018 due to the favorable resolution of an income tax rate dispute in a foreign market. In 2018, this item was unfavorably impacted by the aforementioned $20 million reserve and a $19 million charge for the correction of an error associated with the tax recorded on a prior year divestiture.
Share-based compensation. 2019, 2018 and 2017 includes $55 million, $47 million and $117 million, respectively, of excess tax benefit related to share-based compensation. The 2017 excess tax benefits were largely associated with deferred compensation payouts to recently retired employees.
Change in valuation allowances. This item relates to changes for deferred tax assets generated or utilized during the current year and changes in our judgment regarding the likelihood of using deferred tax assets that existed at the beginning of the year. The impact of certain changes may offset items reflected in the 'Statutory rate differential attributable to foreign operations' line and the 'Adjustments to reserves and prior years' line*.* In 2019, $35 million of net tax benefit was driven by a $45 million tax benefit attributable to changes in judgment regarding deferred tax assets that existed at the beginning of the year largely resulting from the utilization of foreign tax credits as discussed in 'Adjustments to reserves and prior years' sections above. This benefit was partially offset by $9 million of expense for valuation allowances recorded against deferred tax assets generated in the current year. This amount excludes a valuation allowance of $373 million which is included in the 'Intercompany Restructuring' line. In 2018, $156 million of net tax expense was driven by valuation allowances recorded against deferred tax assets generated in the current year. This expense was largely offset by a benefit related to a transaction resulting in the recognition of excess foreign tax credits in 'Statutory rate differential attributable to foreign operations'. This amount also excludes a valuation allowance release of $78 million, which is included in the 'Tax Act Enactment' line. In 2017, $34 million of net tax expense was driven by valuation allowances recorded against deferred tax assets generated in the current year. This amount excludes a valuation allowance of $189 million, which is included in the 'Tax Act Enactment' line.
Intercompany Restructuring. In December 2019, we completed an intercompany restructuring that resulted in the transfer of certain intellectual property rights held by wholly owned foreign subsidiaries primarily to the U.S. and the United Kingdom (UK). The intellectual property rights transferred to the UK resulted in a step up in the tax basis for UK tax purposes resulting in a deferred tax asset of $586 million. The deferred tax asset was analyzed for realizability and a valuation allowance of $366 million was established representing the portion of the deferred tax asset not likely to be realized. The recognized tax benefit of $220 million is amortizable for UK tax purposes over a twenty year period. The transfer of certain intellectual property rights to other non-UK jurisdictions resulted in the recording of deferred tax assets of $13 million and related valuation allowances of $7 million for deferred tax assets that are not likely to be realized, for a net tax benefit of $6 million.
Tax Act Enactment. On December 22, 2017, the U.S. government enacted comprehensive Federal tax legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). The Tax Act significantly modifies the U.S. corporate income tax system by, among other things, reducing the federal income tax rate from 35% to 21%, limiting certain deductions, including limiting the deductibility of interest expense to 30% of U.S. Earnings Before Interest, Taxes, Depreciation and Amortization, imposing a mandatory one-time deemed repatriation tax on accumulated foreign earnings and creating a territorial tax system that changes the manner in which foreign earnings are subject to U.S. tax.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin 118 which allowed us to record provisional amounts related to the impacts of the Tax Act during a measurement period not to extend beyond one year of the enactment date. As a result, we recorded a $434 million provisional estimate of the effect of the Tax Act in 2017. This expense was comprised of an estimate of our deemed repatriation tax, the remeasurement of net deferred tax assets resulting from the permanent reduction in the U.S. tax rate to 21%, and establishment of a valuation allowance on foreign tax credit carryforwards which are unlikely to be realized under the U.S. territorial tax system.
In 2018, we completed the accounting for the tax effects of the enactment of the Tax Act. As a result of the Tax Act, we recorded cumulative net tax expense of $399 million ($35 million benefit in 2018 and $434 million expense in 2017). This net expense was comprised of $241 million for our deemed repatriation tax liability, $47 million related to the remeasurement of our net deferred tax assets to the 21% U.S. tax rate and $111 million to establish a valuation allowance on foreign tax credits that are unlikely to be realized under the U.S. territorial tax system.
Other. This item primarily includes the net impact of permanent differences related to current year earnings as well as U.S. tax credits. In 2018 and 2017, this item was primarily driven by the favorable impact of certain international refranchising gains.
Companies subject to the Global Intangible Low-Taxed Income provision (GILTI) have the option to account for the GILTI tax as a period cost if and when incurred, or to recognize deferred taxes for outside basis temporary differences expected to reverse as GILTI. The Company has elected to account for GILTI as a period cost.
The details of 2019 and 2018 deferred tax assets (liabilities) are set forth below:
| 2019 | 2018 | |||||||
| Operating losses | $ | 176 | $ | 180 | ||||
| Capital losses | 3 | 3 | ||||||
| Tax credit carryforwards | 230 | 266 | ||||||
| Employee benefits | 85 | 72 | ||||||
| Share-based compensation | 55 | 62 | ||||||
| Self-insured casualty claims | 6 | 7 | ||||||
| Lease-related liabilities | 199 | 43 | ||||||
| Various liabilities | 43 | 43 | ||||||
| Intangible assets | 602 | 8 | ||||||
| Property, plant and equipment | 21 | 19 | ||||||
| Deferred income and other | 85 | 45 | ||||||
| Gross deferred tax assets | 1,505 | 748 | ||||||
| Deferred tax asset valuation allowances | (787 | ) | (454 | ) | ||||
| Net deferred tax assets | $ | 718 | $ | 294 | ||||
| Intangible assets, including goodwill | $ | (40 | ) | $ | (42 | ) | ||
| Property, plant and equipment | (44 | ) | (33 | ) | ||||
| Operating lease right-of-use assets | (156 | ) | — | |||||
| Other | (31 | ) | (31 | ) | ||||
| Gross deferred tax liabilities | $ | (271 | ) | $ | (106 | ) | ||
| Net deferred tax assets (liabilities) | $ | 447 | $ | 188 |
| Reported in Consolidated Balance Sheets as: | ||||||||
| Deferred income taxes | $ | 447 | $ | 195 | ||||
| Other liabilities and deferred credits | — | (7 | ) | |||||
| $ | 447 | $ | 188 |
As of December 31, 2019, we had approximately $2.9 billion of unremitted foreign retained earnings. The Tax Act imposed U.S. federal tax on all post-1986 foreign Earnings and Profits accumulated through December 31, 2017. Repatriation of earnings generated after December 31, 2017, will generally be eligible for the 100% dividends received deduction or considered a distribution of previously taxed income and, therefore, exempt from U.S. tax. Undistributed foreign earnings may still be subject to certain foreign income and withholding taxes upon repatriation. Subject to limited exceptions, our intent is to indefinitely reinvest our unremitted earnings outside the U.S., and our current plans do not demonstrate a need to repatriate these amounts to fund our U.S. operations. Thus, we have not provided taxes, including U.S. federal and state income, foreign income, or foreign withholding taxes, for the unremitted earnings that we believe are permanently invested. However, if these funds were repatriated in taxable transactions, we would be required to accrue and pay applicable income taxes (if any) and foreign withholding taxes. A determination of the deferred tax liability on this amount is not practicable due to the complexities, variables and assumptions inherent in the hypothetical calculations.
At December 31, 2019, the Company has foreign operating and capital loss carryforwards of $0.4 billion, U.S. state operating loss and tax credit carryforwards of $1.1 billion, and U.S. federal tax credit carryforwards of $0.2 billion. The tax losses are being carried forward in jurisdictions where we are permitted to use losses from prior periods to reduce future taxable income. The losses and tax credits will expire as follows:
| Year of Expiration | ||||||||||||||||||||
| 2020 | 2021-2024 | 2025-2038 | Indefinitely | Total | ||||||||||||||||
| Foreign | $ | 10 | $ | 26 | $ | 36 | $ | 336 | $ | 408 | ||||||||||
| U.S. state | 2 | 111 | 1,021 | — | 1,134 | |||||||||||||||
| U.S. federal | — | 36 | 178 | — | 214 | |||||||||||||||
| $ | 12 | $ | 173 | $ | 1,235 | $ | 336 | $ | 1,756 |
Valuation allowances of $0.1 billion, $0.1 billion and $0.2 billion have been recorded against the deferred tax assets established for foreign operating loss and capital loss carryforwards, the U.S. state operating loss and tax credit carryforwards, and the U.S. federal tax credit carryforwards, respectively, that are not likely to be realized.
We recognize the benefit of positions taken or expected to be taken in tax returns in the Consolidated Financial Statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement.
The Company had $188 million and $113 million of unrecognized tax benefits at December 31, 2019 and December 31, 2018, respectively, $8 million and $10 million of which are temporary in nature and if recognized, would not impact the effective income tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits follows:
| 2019 | 2018 | |||||||
| Beginning of Year | $ | 113 | $ | 100 | ||||
| Additions on tax positions - current year | 84 | 19 | ||||||
| Additions for tax positions - prior years | 54 | — | ||||||
| Reductions for tax positions - prior years | (30 | ) | (5 | ) | ||||
| Reductions for settlements | (31 | ) | — | |||||
| Reductions due to statute expiration | (2 | ) | (1 | ) | ||||
| Foreign currency translation adjustment | — | — | ||||||
| End of Year | $ | 188 | $ | 113 |
The Company believes it is reasonably possible that its unrecognized tax benefits as of December 31, 2019 may decrease by approximately $26 million in the next 12 months due to settlements or statute of limitations expirations.
The Company’s income tax returns are subject to examination in the U.S. federal jurisdiction and numerous U.S. state and foreign jurisdictions.
The Company has settled audits with the IRS through fiscal year 2010 and is currently under IRS examination for 2011-2015. Our operations in certain foreign jurisdictions remain subject to examination for tax years as far back as 2006, some of which years are currently under audit by local tax authorities.
The accrued interest and penalties related to income taxes at December 31, 2019 and December 31, 2018 were $26 million and $12 million, respectively.
During 2019, 2018 and 2017, the company recognized a net expense of $13 million, a net benefit of $2 million and a net expense of $5 million, respectively, for interest and penalties in our Consolidated Statements of Income as components of its Income tax provision.
Note 18 – Reportable Operating Segments
See Note 1 for a description of our operating segments.
| Revenues | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| KFC Division(a) | $ | 2,491 | $ | 2,644 | $ | 3,110 | ||||||
| Pizza Hut Division(a) | 1,027 | 988 | 893 | |||||||||
| Taco Bell Division(a) | 2,079 | 2,056 | 1,880 | |||||||||
| Unallocated(b)(f) | — | — | (5 | ) | ||||||||
| $ | 5,597 | $ | 5,688 | $ | 5,878 |
| Operating Profit | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| KFC Division | $ | 1,052 | $ | 959 | $ | 981 | ||||||
| Pizza Hut Division | 369 | 348 | 341 | |||||||||
| Taco Bell Division | 683 | 633 | 619 | |||||||||
| Corporate and unallocated G&A expenses(b)(g) | (188 | ) | (171 | ) | (230 | ) | ||||||
| Unallocated Company restaurant expenses(b)(h) | — | 3 | 10 | |||||||||
| Unallocated Franchise and property revenues(b)(f) | — | — | (5 | ) | ||||||||
| Unallocated Franchise and property expenses(b)(f) | (14 | ) | (8 | ) | (30 | ) | ||||||
| Unallocated Refranchising gain (loss)(b) | 37 | 540 | 1,083 | |||||||||
| Unallocated Other income (expense)(b) | (9 | ) | (8 | ) | (8 | ) | ||||||
| Operating Profit | 1,930 | 2,296 | 2,761 | |||||||||
| Investment income (expense), net(b) | (67 | ) | 9 | 5 | ||||||||
| Other pension income (expense)(b)(i) | (4 | ) | (14 | ) | (47 | ) | ||||||
| Interest expense, net(b) | (486 | ) | (452 | ) | (445 | ) | ||||||
| Income before income taxes | $ | 1,373 | $ | 1,839 | $ | 2,274 |
| Depreciation and Amortization | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| KFC Division | $ | 30 | $ | 58 | $ | 138 | ||||||
| Pizza Hut Division | 15 | 10 | 26 | |||||||||
| Taco Bell Division | 59 | 61 | 82 | |||||||||
| Corporate | 8 | 8 | 7 | |||||||||
| $ | 112 | $ | 137 | $ | 253 |
| Capital Spending | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| KFC Division | $ | 81 | $ | 105 | $ | 176 | ||||||
| Pizza Hut Division | 33 | 38 | 42 | |||||||||
| Taco Bell Division | 76 | 85 | 95 | |||||||||
| Corporate | 6 | 6 | 5 | |||||||||
| $ | 196 | $ | 234 | $ | 318 |
| Identifiable Assets(d) | ||||||||
| 2019 | 2018 | |||||||
| KFC Division | $ | 2,042 | $ | 1,481 | ||||
| Pizza Hut Division | 801 | 701 | ||||||
| Taco Bell Division | 1,330 | 1,074 | ||||||
| Corporate(c) | 1,058 | 874 | ||||||
| $ | 5,231 | $ | 4,130 |
| Long-Lived Assets(e) | ||||||||
| 2019 | 2018 | |||||||
| KFC Division | $ | 1,179 | $ | 868 | ||||
| Pizza Hut Division | 427 | 384 | ||||||
| Taco Bell Division | 938 | 720 | ||||||
| Corporate | 42 | 32 | ||||||
| $ | 2,586 | $ | 2,004 |
| (a) | U.S. revenues included in the combined KFC, Pizza Hut and Taco Bell Divisions totaled $3.0 billion in 2019, $2.9 billion in 2018 and $2.8 billion in 2017. |
(b) Amounts have not been allocated to any segment for performance reporting purposes.
(c) Primarily includes cash, our Grubhub investment and deferred tax assets.
| (d) | U.S. identifiable assets included in the combined Corporate and KFC, Pizza Hut and Taco Bell Divisions totaled $2.7 billion and $2.0 billion in 2019 and 2018, respectively. |
| (e) | Includes PP&E, goodwill, intangible assets, net and in 2019, Operating lease right-of-use assets. |
| (f) | Represents costs associated with the KFC U.S. Acceleration Agreement and Pizza Hut U.S. Transformation Agreement. See Note 4. |
| (g) | Amounts in 2018 include costs related to YUM's Strategic Transformation Initiatives of $8 million, partially offset by non-cash credits associated with modifications of share-based compensation awards of $3 million. Amounts in 2017 include costs related to YUM’s Strategic Transformation Initiatives of $21 million, non-cash charges associated with modifications of share-based compensation awards of $18 million and costs associated with the Pizza Hut U.S. Transformation Agreement of $13 million. See Note 4. |
| (h) | Represents depreciation reductions arising primarily from KFC restaurants that were held for sale. See Note 4. |
| (i) | Amounts in 2017 include a non-cash charge of $22 million related to the adjustment of certain historical deferred vested liability balances in our qualified U.S. plan. See Note 4. |
Note 19 – Contingencies
Lease Guarantees
As a result of having assigned our interest in obligations under real estate leases as a condition to the refranchising of certain Company-owned restaurants, and guaranteeing certain other leases, we are frequently secondarily liable on lease agreements. These leases have varying terms, the latest of which expires in 2065. As of December 31, 2019, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessee was approximately $475 million. The present value of these potential payments discounted at our pre-tax cost of debt at December 31, 2019 was approximately $400 million. Our franchisees are the primary lessees under the vast majority of these leases. We generally have cross-default provisions with these franchisees that would put them in default of their franchise agreement in the event of non-payment under the lease. We believe these cross-default provisions significantly reduce the risk that we will be required to make payments under these leases. Accordingly, the liability recorded for our probable exposure under such leases at December 31, 2019 and December 31, 2018 was not material.
Insurance Programs
We are self-insured for a substantial portion of our current and prior years’ coverage including property and casualty losses. To mitigate the cost of our exposures for certain property and casualty losses, we self-insure the risks of loss up to defined maximum per occurrence retentions on a line-by-line basis. The Company then purchases insurance coverage, up to a certain limit, for losses that exceed the self-insurance per occurrence retention. The insurers’ maximum aggregate loss limits are significantly above our actuarially determined probable losses; therefore, we believe the likelihood of losses exceeding the insurers’ maximum aggregate loss limits is remote.
The following table summarizes the 2019 and 2018 activity related to our net self-insured property and casualty reserves as of December 31, 2019.
| Beginning Balance | Expense | Payments | Ending Balance | |||||||||||
| 2019 Activity | $ | 66 | 9 | (21 | ) | $ | 54 | |||||||
| 2018 Activity | $ | 84 | 11 | (29 | ) | $ | 66 |
Due to the inherent volatility of actuarially determined property and casualty loss estimates, it is reasonably possible that we could experience changes in estimated losses which could be material to our growth in quarterly and annual Net Income. We believe that we have recorded reserves for property and casualty losses at a level which has substantially mitigated the potential negative impact of adverse developments and/or volatility.
In the U.S. and in certain other countries, we are also self-insured for healthcare claims and long-term disability for eligible participating employees subject to certain deductibles and limitations. We have accounted for our retained liabilities for property and casualty losses, healthcare and long-term disability claims, including reported and incurred but not reported claims, based on information provided by independent actuaries.
Legal Proceedings
We are subject to various claims and contingencies related to lawsuits, real estate, environmental and other matters arising in the normal course of business. An accrual is recorded with respect to claims or contingencies for which a loss is determined to be probable and reasonably estimable.
Yum! Restaurants India Private Limited (“YRIPL”), a Yum subsidiary in India, is the subject of a regulatory enforcement action in India (the “Action”). The Action alleges, among other things, that KFC International Holdings, Inc. and Pizza Hut International failed to satisfy certain conditions imposed by the Secretariat for Industrial Approval in 1993 and 1994 when those companies were granted permission for foreign investment and operation in India. The conditions at issue include an alleged minimum investment commitment and store build requirements as well as limitations on the remittance of fees outside of India.
The Action originated with a complaint and show cause notice filed in 2009 against YRIPL by the Deputy Director of the Directorate of Enforcement (“DOE”) of the Indian Ministry of Finance following an income tax audit for the years 2002 and 2003. The matter was argued at hearing in 2015, but no order was issued. Following a change in the incumbent official holding the position of Special Director of DOE (the “Special Director”), the matter resumed in 2018 and several additional hearings were conducted.
On January 29, 2020, the Special Director issued an order imposing a penalty on YRIPL and certain former directors of approximately Indian Rupee 11 billion, or approximately $156 million. Of this amount, approximately $150 million relates to the alleged failure to invest a total of $80 million in India within an initial seven year period. We have been advised by external counsel that the order is flawed and that several options for appeal exist. We deny liability and intend to continue vigorously defending this matter. We do not consider the risk of any significant loss arising from this order to be probable.
We are currently engaged in various other legal proceedings and have certain unresolved claims pending, the ultimate liability for which, if any, cannot be determined at this time. However, based upon consultation with legal counsel, we are of the opinion that such proceedings and claims are not expected to have a material adverse effect, individually or in the aggregate, on our Consolidated Financial Statements.
Note 20 – Selected Quarterly Financial Data (Unaudited)
| 2019 | ||||||||||||||||||||
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | ||||||||||||||||
| Revenues: | ||||||||||||||||||||
| Company sales | $ | 333 | $ | 359 | $ | 364 | $ | 490 | $ | 1,546 | ||||||||||
| Franchise and property revenues | 612 | 633 | 645 | 770 | 2,660 | |||||||||||||||
| Franchise contributions for advertising and other services | 309 | 318 | 330 | 434 | 1,391 | |||||||||||||||
| Total revenues | 1,254 | 1,310 | 1,339 | 1,694 | 5,597 | |||||||||||||||
| Restaurant profit | 61 | 73 | 72 | 105 | 311 | |||||||||||||||
| Operating Profit(a) | 433 | 471 | 480 | 546 | 1,930 | |||||||||||||||
| Net Income | 262 | 289 | 255 | 488 | 1,294 | |||||||||||||||
| Basic earnings per common share | 0.85 | 0.94 | 0.83 | 1.61 | 4.23 | |||||||||||||||
| Diluted earnings per common share | 0.83 | 0.92 | 0.81 | 1.58 | 4.14 | |||||||||||||||
| Dividends declared per common share | 0.42 | 0.42 | 0.42 | 0.42 | 1.68 |
| 2018 | ||||||||||||||||||||
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | ||||||||||||||||
| Revenues: | ||||||||||||||||||||
| Company sales | $ | 512 | $ | 512 | $ | 499 | $ | 477 | $ | 2,000 | ||||||||||
| Franchise and property revenues | 584 | 584 | 605 | 709 | 2,482 | |||||||||||||||
| Franchise contributions for advertising and other services | 275 | 272 | 287 | 372 | 1,206 | |||||||||||||||
| Total revenues | 1,371 | 1,368 | 1,391 | 1,558 | 5,688 | |||||||||||||||
| Restaurant profit | 74 | 91 | 100 | 101 | 366 | |||||||||||||||
| Operating Profit(b) | 553 | 449 | 553 | 741 | 2,296 | |||||||||||||||
| Net Income | 433 | 321 | 454 | 334 | 1,542 | |||||||||||||||
| Basic earnings per common share | 1.30 | 0.99 | 1.43 | 1.07 | 4.80 | |||||||||||||||
| Diluted earnings per common share | 1.27 | 0.97 | 1.40 | 1.04 | 4.69 | |||||||||||||||
| Dividends declared per common share | 0.36 | 0.36 | 0.36 | 0.36 | 1.44 |
| (a) | Includes net gains from refranchising initiatives of $6 million, $4 million, $8 million and $19 million in the first, second, third and fourth quarters, respectively. |
| (b) | Includes net gains from refranchising initiatives of $156 million, $29 million, $100 million and $255 million in the first, second, third and fourth quarters, respectively. |
Note 21 – Subsequent Event
On January 6, 2020, we announced our definitive agreement pursuant to which the Company will acquire all of the issued and outstanding common shares of The Habit Restaurants, Inc. (“Habit”) for $14 per share in cash or a total of approximately $375 million. The transaction is subject to approval by Habit’s stockholders and other customary closing conditions. The transaction is expected to be completed by the end of the first-quarter of 2020.
Additionally, if the transaction is consummated, Habit will make payment to certain of its former shareholders pursuant to an existing Tax Receivable Agreement in the aggregate amount of approximately $53 million. The amount of this payment in excess of Habit’s cash necessary at closing for normal working capital purposes, in addition to customary transaction fees and expenses, will be liabilities funded by the Company.
We intend to fund all amounts for the acquisition of Habit using cash on hand and available borrowing capacity under our Revolving Facility.
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