YUM! BRANDS, INC. Introduction and Overview
The following Management's Discussion and Analysis ("MD&A"), should be read in
conjunction with the Consolidated Financial Statements ("Financial Statements")
in Item 8 and the Forward-Looking Statements and the Risk Factors set forth in
Item 1A. All Note references herein refer to the Notes to the Financial
Statements. Tabular amounts are displayed in millions of U.S. dollars except per
share and unit count amounts, or as otherwise specifically identified.
Percentages may not recompute due to rounding.
Yum! Brands, Inc. ("Company", "YUM", "we", "us" or "our") franchises or operates
a worldwide system of over 50,000 restaurants in more than 150 countries and
territories, primarily under the concepts of KFC , Pizza Hut and Taco Bell
(collectively, the "Concepts"). These three Concepts are global leaders of the
chicken, pizza and Mexican-style food categories, respectively. Of the over
50,000 restaurants, 98% are operated by franchisees.
As of
• The KFC Division which includes our worldwide operations of the
• 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
Through our Recipe for Growth and Good we intend to unlock the growth potential
of our Concepts and YUM, drive increased collaboration across our Concepts and
geographies and consistently deliver better customer experiences, improved
economics and higher rates of growth. Key enablers include accelerated use of
technology and better leverage of our systemwide scale.
Our Recipe for Growth is based on four key drivers:
• Unrivaled Culture and Talent: Leverage our culture and people capability
to fuel brand performance and franchise success
• Unmatched Operating Capability: Recruit and equip the best restaurant
operators in the world to deliver great customer experiences
• Relevant, Easy and Distinctive Brands: Innovate and elevate iconic
restaurant brands people trust and champion
• Bold Restaurant Development : Drive market and franchise expansion with
strong economics and value
Our Recipe for Good reflects our global citizenship and sustainability strategy
and practices, while reinforcing our public commitment to drive socially
responsible growth, risk management and sustainable stewardship of our food,
planet and people.
On October 11, 2016 YUM announced our transformation plans to drive global
expansion of our KFC , Pizza Hut and Taco Bell brands ("YUM's Strategic
Transformation Initiatives") following the spin-off of our China business into
an independent publicly-traded company under the name of Yum China Holdings,
Inc. ("Yum China"). At this time, we established transformation goals that were
met by the end of 2019 including becoming:
• More Focused. By focusing on four growth drivers similar to those that
make up our Recipe for Growth above we accelerated system sales growth to
8% in 2019 (excluding the impacts of the 53rd week and foreign currency
translation).
• More Franchised. The Company successfully increased franchise restaurant
ownership to 98% as of the end of 2018.
• More Efficient. The Company revamped its financial profile, improving the
efficiency of its organization and cost structure globally, by:
• Reducing annual capital expenditures associated with
Company-operated restaurant maintenance and other projects and
funded additional capital for new Company units through the
refranchising of existing Company units. Capital spending in 2019
net of refranchising proceeds was $86 million .
• Lowering General and administrative expenses ("G&A") to 1.7% of
system sales in 2019; and
• Maintaining an optimized capital structure of ~5.0x Earnings Before
Interest, Taxes, Depreciation and Amortization ("EBITDA") leverage.
From 2017 through 2019, we returned $6.5 billion to shareholders through share
repurchases and cash dividends. We funded these shareholder returns through a
combination of refranchising proceeds, free cash flow generation and maintenance
of our ~5.0x EBITDA leverage. We generated pre-tax proceeds of $2.8 billion
through our refranchising initiatives to achieve targeted franchise ownership of
98%. Refer to the Liquidity and Capital Resources section of this MD&A for
additional details.
26
--------------------------------------------------------------------------------Going forward, we expect to:
• Maintain a capital structure of ~5.0x EBITDA leverage;
• Invest capital in a manner consistent with an asset light, franchisor model;
and
• Allocate G&A in an efficient manner that provides leverage to operating
profit growth while at the same time opportunistically investing in strategic
growth initiatives.
We intend for this MD&A to provide the reader with information that will assist
in understanding our results of operations, including performance metrics that
management uses to assess the Company's performance. Throughout this MD&A, we
commonly discuss the following performance metrics:
• Same-store sales growth is the estimated percentage change in sales of all
restaurants that have been open and in the YUM system for one year or more,
including those temporarily closed. From time-to-time restaurants may be
temporarily closed due to remodeling or image enhancement, rebuilding,
natural disasters, health epidemic or pandemic, landlord disputes or other
issues. We believe same-store sales growth is useful to investors because our
results are heavily dependent on the results of our Concepts' existing store
base. Additionally, same-store sales growth is reflective of the strength of
our Brands, the effectiveness of our operational and advertising initiatives
and local economic and consumer trends. In 2019, when calculating same-store
sales growth we also included in our prior year base the sales of stores that
were added as a result of the Telepizza strategic alliance in
and that were open for one year or more. See description of the Telepizza
strategic alliance within this MD&A.
• Net new unit growth reflects new unit openings offset by store closures, by
us and our franchisees. To determine whether a restaurant meets the
definition of a unit we consider whether the restaurant has operations that
are ongoing and independent from another YUM unit, serves the primary product
of one of our Concepts, operates under a separate franchise agreement (if
operated by a franchisee) and has substantial and sustainable sales. We
believe net new unit growth is useful to investors because we depend on net
new units for a significant portion of our growth. Additionally, net new unit
growth is generally reflective of the economic returns to us and our
franchisees from opening and operating our Concept restaurants.
• Company restaurant profit ("Restaurant profit") is defined as Company sales
less expenses incurred directly by our Company-owned restaurants in
generating Company sales. Company restaurant margin as a percentage of sales
is defined as Restaurant profit divided by Company sales. Restaurant profit
is useful to investors as it provides a measure of profitability for our
Company-owned stores.
In addition to the results provided in accordance with Generally Accepted
Accounting Principles in
• System sales, System sales excluding the impacts of foreign currency
translation ("FX"), and, in 2019, System sales excluding FX and the impact of
the 53rd week for our
subsidiaries that operate on a weekly periodic calendar. System sales include
the results of all restaurants regardless of ownership, including
Company-owned and franchise restaurants. Sales at franchise restaurants
typically generate ongoing franchise and license fees for the Company at a
rate of 3% to 6% of sales. Franchise restaurant sales are not included in
Company sales on the Consolidated Statements of Income; however, the
franchise and license fees derived from franchise restaurants are included in
the Company's revenues. We believe System sales growth is useful to investors
as a significant indicator of the overall strength of our business as it
incorporates all of our significant revenue drivers, Company and franchise
same-store sales as well as net unit growth.
• Diluted Earnings Per Share excluding Special Items (as defined below);
• Effective Tax Rate excluding Special Items;
• Core Operating Profit and, in 2019, Core Operating Profit excluding the
impact of the 53rd week. Core Operating Profit excludes Special Items and FX
and we use Core Operating Profit for the purposes of evaluating performance
internally.
These non-GAAP measurements are not intended to replace the presentation of our
financial results in accordance with GAAP. Rather, the Company believes that the
presentation of these non-GAAP measurements provide additional information to
investors to facilitate the comparison of past and present operations.
27
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Special Items are not included in any of our Division segment results as the
Company does not believe they are indicative of our ongoing operations due to
their size and/or nature. Our chief operating decision maker does not consider
the impact of Special Items when assessing segment performance.
Certain non-GAAP measurements are presented excluding the impact of FX. These
amounts are derived by translating current year results at prior year average
exchange rates. We believe the elimination of the FX impact provides better
year-to-year comparability without the distortion of foreign currency
fluctuations.
For 2019 we provided Core Operating Profit excluding the impact of the 53rd week
and System sales excluding the impact of the 53rd week to further enhance the
comparability given the 53rd week that was part of our fiscal calendar in 2019.
Results of Operations
Summary
All comparisons within this summary are versus the same period a year ago and
unless otherwise stated include the impact of a 53rd week in 2019. For
discussion of our results of operations for 2018 compared to 2017, refer to the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Part II, Item 7 of our Form 10-K for the fiscal year
ended December 31, 2018 , filed with the SEC on February 21, 2019 .
For 2019, GAAP diluted EPS decreased 12% to
2019 financial highlights:
% Change
GAAP Core
System Sales, Operating Operating
ex FX Same-Store Sales Net New Units Profit Profit
KFC Division +10 +4 +7 +10 +14
Pizza Hut Division +8 Even +1 +6 +8
Taco Bell Division +9 +5 +4 +8 +8
Worldwide +9 +3 +4 (16) +12
Results Excluding 53rd Week in 2019
(% Change)
System Sales, ex FX Core Operating Profit
KFC Division +9 +13
Pizza Hut Division +7 +7
Taco Bell Division +8 +6
Worldwide +8 +11
Additionally:
• Adjusting the prior year base to include units added as a result of our
fourth quarter 2018 strategic alliance with Telepizza, system sales
growth, excluding the impacts of foreign currency translation and 53rd
week, would have been 7% and 2% for Worldwide and the Pizza Hut Division,
respectively.
• During the year, we opened 2,040 net new units for 4% net new unit growth.
• During the year, we refranchised 25 restaurants and sold certain
restaurant assets associated with existing franchise restaurants to the
franchisee for total pre-tax proceeds of $110 million . We recorded net
refranchising gains of $37 million related to these transactions.
• During the year, we repurchased 7.8 million shares totaling
at an average price of $104 .
28--------------------------------------------------------------------------------
• During the year, we recognized pre-tax expense of
the change in fair value of our investment in Grubhub, which resulted in a
negative ($0.19 ) impact to diluted EPS on the year.
• Foreign currency translation impacted Divisional Operating Profit
unfavorably for the year by $46 million .
• Our effective tax rate for the year was 5.7% and our effective tax rate,
excluding Special Items, was 19.8%.
Worldwide
GAAP Results
Amount % B/(W)
2019 2018 2017 2019 2018
Company sales $ 1,546 $ 2,000 $ 3,572 (23 ) (44 )
Franchise and property revenues 2,660 2,482 2,306 7
8
Franchise contributions for
advertising and other services 1,391 1,206 - 15 N/A
Total revenues $ 5,597 $ 5,688 $ 5,878 (2 ) (3 )
Restaurant profit $ 311 $ 366 $ 618 (15 ) (41 )
Restaurant margin % 20.1 % 18.3 % 17.3 % 1.8 ppts. 1.0 ppts.
G&A expenses $ 917 $ 895 $ 999 (2 ) 10Franchise and property expenses 180 188 237 4
21
Franchise advertising and other
services expense 1,368 1,208 - (13 ) N/A
Refranchising (gain) loss (37 ) (540 ) (1,083 ) (93 ) (50 )
Other (income) expense 4 7 10 NM NM
Operating Profit $ 1,930 $ 2,296 $ 2,761 (16 ) (17 )
Investment (income) expense, net 67 (9 ) (5 ) NM
88
Other pension (income) expense 4 14 47 71 70
Interest expense, net 486 452 445 (8 ) (1 )
Income tax provision 79 297 934 74 68
Net Income $ 1,294 $ 1,542 $ 1,340 (16 ) 15
Diluted EPS(a) $ 4.14 $ 4.69 $ 3.77 (12 ) 24
Effective tax rate 5.7 % 16.2 % 41.1 % 10.5 ppts. 24.9 ppts.
(a) See Note 3 for the number of shares used in this calculation.
Performance Metrics
% Increase (Decrease)
Unit Count 2019 2018 2017 2019 2018(a)
Franchise 49,257 47,268 43,603 4 8
Company-owned 913 856 1,481 7 (42 )
Total 50,170 48,124 45,084 4 7
(a) 2018 unit growth includes units added as a result of our fourth quarter 2018
strategic alliance with Telepizza.
2019 2018 2017
Same-Store Sales Growth % 3 2 2
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Non-GAAP Items
Non-GAAP Items, along with the reconciliation to the most comparable GAAP financial measure,
are presented below.
2019 2018 2017
System Sales Growth %, reported 7 5 4
System Sales Growth %, excluding FX 9 5 4
System Sales Growth %, excluding FX and 53rd week 8 N/A 5
Core Operating Profit Growth % 12 Even 7
Core Operating Profit Growth %, excluding 53rd week 11 N/A 9
Diluted EPS Growth %, excluding Special Items 12 7 20
Effective Tax Rate excluding Special Items 19.8 % 20.4 % 18.8 %
Year
Detail of Special Items 2019 2018 2017
Refranchising gain (loss)(a) $ 12 $ 540 $ 1,083
YUM's Strategic Transformation Initiatives (See
Note 4) - (8 ) (23 )
Costs associated with Pizza Hut U.S.
Transformation Agreement (See Note 4) (13 ) (6 ) (31 )
Costs associated with KFC U.S. Acceleration
Agreement (See Note 4) - (2 ) (17 )
Non-cash credits (charges) associated with
share-based compensation (See Note 4) - 3 (18 )
Other Special Items Income (Expense)(b) (10 ) 3 7
Special Items Income (Expense) - Operating Profit (11 ) 530
1,001
Special Items - Other Pension Income (Expense) (See Note 4) - - (23 ) Interest expense, net(b) (2 ) - - Special Items Income (Expense) before Income Taxes (13 ) 530
978
Tax Expense on Special Items(c) (30 ) (96 ) (256 ) Tax Benefit - Intercompany transfer of intellectual property(d) 226 - - Tax Benefit (Expense) - U.S. Tax Act(e) - 66 (434 ) Special Items Income, net of tax$ 183 $ 500 $ 288 Average diluted shares outstanding 313 329 355 Special Items diluted EPS$ 0.59 $ 1.52 $ 0.81 30
-------------------------------------------------------------------------------- Reconciliation of GAAP Operating Profit to Core Operating Profit and Core Operating Profit, excluding 53rd Week Consolidated GAAP Operating Profit$ 1,930 $ 2,296 $ 2,761 Special Items Income (Expense) - Operating Profit (11 ) 530 1,001 Foreign Currency Impact on Divisional Operating Profit(f) (46 ) 1 N/A Core Operating Profit 1,987 1,765 1,760 Impact of 53rd Week 24 N/A N/A Core Operating Profit, excluding 53rd Week$ 1,963 $ 1,765 $ 1,760 KFC Division GAAP Operating Profit$ 1,052 $ 959 $ 981 Foreign Currency Impact on Divisional Operating Profit(f) (39 ) - N/A Core Operating Profit 1,091 959 981 Impact of 53rd Week 8 N/A N/A Core Operating Profit, excluding 53rd Week$ 1,083 $ 959 $ 981 Pizza Hut Division GAAP Operating Profit$ 369 $ 348 $ 341 Foreign Currency Impact on Divisional Operating Profit(f) (7 ) 1 N/A Core Operating Profit 376 347 341 Impact of 53rd Week 3 N/A N/A Core Operating Profit, excluding 53rd Week$ 373 $ 347 $ 341 Taco Bell Division GAAP Operating Profit$ 683 $ 633 $ 619 Foreign Currency Impact on Divisional Operating Profit(f) - - N/A Core Operating Profit 683 633 619 Impact of 53rd Week 13 N/A N/A
Core Operating Profit, excluding 53rd Week
Reconciliation of Diluted EPS to Diluted EPS excluding Special Items Diluted EPS$ 4.14 $ 4.69 $ 3.77 Special Items Diluted EPS 0.59 1.52 0.81 Diluted EPS excluding Special Items$ 3.55 $
3.17
Reconciliation of GAAP Effective Tax Rate to
Effective Tax Rate, excluding Special Items
GAAP Effective Tax Rate 5.7 % 16.2 % 41.1 %
Impact on Tax Rate as a result of Special
Items(c)(d)(e) (14.1 )% (4.2 )% 22.3 %
Effective Tax Rate excluding Special Items 19.8 % 20.4 % 18.8 %
31-------------------------------------------------------------------------------- Reconciliation ofGAAP Company sales to System sales, System sales, excluding FX and System sales, excluding FX and 53rd week Consolidated GAAP Company sales(g)$ 1,546 $ 2,000 $ 3,572 Franchise sales 51,038 47,237 43,122 System sales 52,584 49,237 46,694 Foreign Currency Impact on System sales(h) (1,169 ) 186 N/A System sales, excluding FX 53,753 49,051 46,694 Impact of 53rd week 454 N/A N/A System sales, excluding FX and 53rd Week$ 53,299 $ 49,051 $ 46,694 KFC Division GAAP Company sales(g)$ 571 $ 894 $ 1,928 Franchise sales 27,329 25,345 22,587 System sales 27,900 26,239 24,515 Foreign Currency Impact on System sales(h) (898 ) 142 N/A System sales, excluding FX 28,798 26,097 24,515 Impact of 53rd week 167 N/A N/A System sales, excluding FX and 53rd Week$ 28,631 $ 26,097 $ 24,515 Pizza Hut Division GAAP Company sales(g)$ 54 $ 69 $ 285 Franchise sales 12,846 12,143 11,749 System sales 12,900 12,212 12,034 Foreign Currency Impact on System sales(h) (259 ) 47 N/A System sales, excluding FX 13,159 12,165 12,034 Impact of 53rd week 103 N/A N/A System sales, excluding FX and 53rd Week$ 13,056 $ 12,165 $ 12,034 Taco Bell Division GAAP Company sales(g)$ 921 $ 1,037 $ 1,359 Franchise sales 10,863 9,749 8,786 System sales 11,784 10,786 10,145 Foreign Currency Impact on System sales(h) (12 ) (3 ) N/A System sales, excluding FX 11,796 10,789 10,145 Impact of 53rd week 184 N/A N/A System sales, excluding FX and 53rd Week$ 11,612 $ 10,789 $ 10,145
(a) We have reflected as Special Items those refranchising gains and losses
that were recorded in connection with or prior to our previously announced
plans to have at least 98% franchise restaurant ownership by the end of
2018. As such, refranchising gains and losses recorded during 2019 asSpecial Items primarily include gains or losses associated with sales of
underlying real estate associated with stores that were franchised as of
prior to
During the years ended
(b) In the second quarter of 2019 we recorded charges of
million to Other (income) expense and Interest expense, net, respectively,
related to cash payments in excess of our recorded liability to settle
contingent consideration
32--------------------------------------------------------------------------------
associated with our 2013 acquisition of the KFC Turkey and Pizza Hut Turkey businesses. Consistent with prior adjustments to the recorded contingent consideration we have reflected this as a Special Item.
(c) Tax Expense on Special Items was determined based upon the impact of the
nature, as well as the jurisdiction of the respective individual
components within Special Items. Additionally, we increased our Income tax
provision by
against and by
error related to the tax recorded on a prior year divestiture, the effects
of which were previously recorded as a Special Item.
(d) During the year ended December 31, 2019 we completed intercompany
transfers of certain intellectual property rights. As a result of thetransfer 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
December 31, 2019 . See Note 17 for further discussion.
(e) In 2018, we recorded a
expense recorded in the fourth quarter of 2017 associated with the Tax
Cuts and Jobs Act of 2017 ("Tax Act") that was reported as a Special
Item. We also recorded a Special Items tax benefit of
related to 2018 U.S. foreign tax credits that became realizable directly
as a result of the impact of deemed repatriation tax expense associated
with the Tax Act. We recognized
provision that was reported as a Special Item as a result of the December
22, 2017 enactment of the Tax Act.
(f) The foreign currency impact on reported Operating Profit is presented in
relation only to the immediately preceding year presented. When
determining applicable Core Operating Profit Growth percentages, the Core
Operating Profit for the current year should be compared to the prior year
Operating Profit, prior to adjustment for the prior year FX impact.
(g) Company sales represents sales from our Company-operated stores as
presented on our Consolidated Statements of Income.
(h) The foreign currency impact on System sales is presented in relation only
to the immediately preceding year presented. When determining applicable
System sales growth percentages, the System sales excluding FX for the
current year should be compared to the prior year System sales prior to
adjustment for the prior year FX impact.
Items Impacting Reported Results and/or Expected to Impact Future Results
The following items impacted reported results in 2019 and/or 2018 and/or are expected to impact future results. See also the Detail of Special Items section of this M&DA for other items similarly impacting results.
Fiscal 2019 included a 53rd week for all of ourU.S. and certain international subsidiaries that operate on a period calendar. See Note 2 for additional details related to our fiscal calendar. The following table summarizes the estimated impact of the 53rd week on Revenues and Operating Profit for the year endedDecember 31, 2019 . The 53rd week in 2019 favorably impacted Diluted EPS by$0.05 per share. 33 -------------------------------------------------------------------------------- KFC Division Pizza Hut Division Taco Bell Division Total Revenues Company sales $ 8 $ 1 $ 15$ 24 Franchise and property revenues 9 5 10 24 Franchise contributions for advertising and other services 5 5 8 18 Total revenues $ 22 $ 11 $ 33$ 66 Operating Profit Franchise and property revenues $ 9 $ 5 $ 10$ 24 Franchise contributions for advertising and other services 5 5 8 18 Restaurant profit 1 - 5 6 Franchise and property expenses - (1 ) - (1 ) Franchise for advertising and other services expenses (5 ) (5 ) (8 ) (18 ) G&A expenses (2 ) (1 ) (2 ) (5 ) Operating Profit $ 8 $ 3 $ 13$ 24
Impact of Coronavirus Outbreak
Since the beginning of 2020, the novel coronavirus outbreak in mainlandChina has significantly impacted the operations of our largest master franchisee, Yum China, who pays us a continuing fee of 3% on system sales of our Concepts in mainlandChina . These continuing fees represented approximately 20% of theKFC Division and 16% of the PH Division operating profits in the year endedDecember 31, 2019 . Through the date of the filing of this Form 10-K, Yum China has experienced widespread store closures and significant sales declines as a result of the coronavirus. Additionally, other nearby franchisees, such as those inHong Kong andTaiwan , have experienced significant sales declines as well. While our Concepts outside ofChina have not experienced the same levels of same-store sales declines or store closures to date that Yum China has experienced, there can be no assurance that the impacts of the coronavirus will not have a material, adverse impact on our and our franchisees' results on a more widespread basis. The coronavirus situation is ongoing and its dynamic nature makes it difficult to forecast any impacts on the Company's 2020 results with any certainty. However, as of the date of this filing we expect our results for the quarter endingMarch 31, 2020 to be significantly impacted with potential continuing, adverse impacts beyondMarch 31, 2020 .
Pizza Hut
During the year endedDecember 31, 2019 the Pizza Hut Division recorded$22 million in bad debt expense primarily associated with the nearly$600 million in continuing and initial fees earned in 2019 from franchisees. This represented an increase of$12 million versus the bad debt provision within the Division for the year endedDecember 31, 2018 . The increased bad debt was largely attributable to a small number ofU.S. franchisees who are facing financial challenges due to unit-level economics that have been pressured by wage increases and recentU.S. same-store sales declines of 1% in 2019, including a decline of 4% in the fourth quarter of 2019. Additionally, certainPizza Hut U.S. franchisees are burdened by high debt service levels. We continue to believe that the move of the Pizza HutU.S. system to a more delivery-focused and modern estate will optimize our ability to grow the Pizza HutU.S. system going forward. However, we could see impacts to our near-term results as we work through transitions of the estate and of certain franchise stores to new franchisees. These impacts could include expense related to further bad debts and payments we may be required to make with regard to franchisee lease obligations for which we remain secondarily liable. Additionally, Pizza HutU.S. system sales could be negatively impacted by decreased system advertising spend due to lower franchisee contributions and closures of underperforming units, including certain units that are largely dine-in focused. Given the fluid nature of issues surrounding our Pizza HutU.S. franchisees, in particular surrounding our largest Pizza HutU.S. franchisee who owns approximately 1,225 units or 17% of the Pizza HutU.S. system as ofDecember 31, 2019 , the potential impact to the Company's 2020 results is difficult to forecast.
Refranchising Initiatives
During the years endedDecember 31, 2019 , 2018 and 2017, we recorded net refranchising gains of$37 million ,$540 million and$1,083 million , respectively. We have reflected those refranchising gains and losses that were recorded in connection with or prior to our previously announced plans to have at least 98% franchise restaurant ownership by the end of 2018 as Special Items. In 34 -------------------------------------------------------------------------------- 2019 net refranchising gains reflected as Special Items included$12 million associated with sales of underlying real estate associated with stores that were franchised as ofDecember 31, 2018 or true-ups to refranchising gains and losses recorded prior toDecember 31, 2018 . All net refranchising gains recorded in 2018 and 2017 were reflected as Special Items. Additionally, during the year endedDecember 31, 2019 we recorded net refranchising gains of$25 million that have not been reflected as Special Items. These net gains relate to the refranchising of restaurants in 2019 that were not part of and arose subsequent to our aforementioned plans to achieve 98% franchise ownership. Investment in Grubhub For the years endedDecember 31, 2019 and 2018 we recognized pre-tax expense of$77 million and pre-tax income of$14 million , respectively, related to changes in fair value in our investment in Grubhub, Inc. ("Grubhub"). See Note 4 for further discussion of our investment in Grubhub.
OnDecember 30, 2018 , the Company consummated a strategic alliance withTelepizza Group S.A. ("Telepizza"), the largest nonU.S. -based pizza delivery company in the world, to be the master franchisee ofPizza Hut inLatin America and portions ofEurope . The key terms of the alliance are set forth below:
• In
brand and will oversee franchisees operating
• In Latin America (excluding
Telepizza will progressively convert its existing restaurants to the Pizza
Hut brand and oversee franchisees operating
• Telepizza will manage supply chain logistics for the entire master
franchise territory and will become an authorized supplier of Pizza Hut
branded restaurants
• Across the regions covered by the master franchise agreement, Telepizza
will target opening at least 1,300 new units over the next ten years and
2,550 units in total over 20 years
As a result of the alliance we added approximately 1,300 Telepizza units to our
Pizza Hut Division unit count on December 30, 2018 . In total approximately 2,300
Pizza Hut and Telepizza units are subject to the master franchise agreement as
of December 31, 2019 .
Based upon our ongoing and active maintenance of the Pizza Hut intellectual
property as well as Telepizza's active involvement in supply chain management
and their role as a master franchisee, both parties are exposed to significant
risks and rewards depending on the commercial success of the alliance. As a
result, the alliance has been identified as a collaborative arrangement and upon
consummation of the alliance no amounts were recorded in our Consolidated
Financial Statements (other than insignificant success fees that were paid to
third-party advisors). Subsequent to consummation of the deal, for all Pizza Hut
restaurants that are part of the alliance, we are receiving a continuing fee of
3.5% of restaurant sales. Likewise, for most Telepizza restaurants that are part
of the alliance we are receiving an alliance fee of 3.5% of restaurant sales.
These fees are being recorded as Franchise and property revenues within our
Consolidated Statement of Income when the related sales occur, consistent with
our recognition of continuing fees for all other restaurants subject to our
franchise agreements. These fees are reduced by a sales-based credit that
decreases over time and, potentially, certain incentive payments if development
or conversion targets are met. Previously, the existing Pizza Hut restaurants
that are now subject to the master franchise agreement with Telepizza generally
paid a continuing fee of 6% of restaurant sales consistent with our standard
International franchise agreement terms. The impact to Operating Profit for the
year ended December 31, 2019 as a result of the strategic alliance was not
significant. System Sales growth in 2019, excluding foreign currency and 53rd
week, was approximately 1 and 5 percentage points higher for Worldwide and the
Pizza Hut Division, respectively as a result of the strategic alliance.
Additionally, net new unit growth in 2018 was approximately 3 and 8 percentage
points higher for Worldwide and the Pizza Hut Division, respectively, as a
result of the strategic alliance.
KFC United Kingdom ("UK") Supply Availability Issues
OnFebruary 14, 2018 , we and our franchisees transitioned to a new distributor for the products supplied to our approximately 900 KFCs in theUnited Kingdom andIreland (those restaurants accounted for approximately 3% of YUM's global system sales in the year endedDecember 31, 2018 ). In connection with this transition, certain of the restaurants experienced supply availability issues which resulted in store closures or stores operating under a limited menu. Beginningmid-May 2018 , all restaurants opened for business, offering their full menus, with advertising beginning at the end of May. On a full-year basis in 2018, we estimated the negative impact to Core Operating Profit growth was 2 percentage points for KFC Division and 1 percentage point for YUM, 35 -------------------------------------------------------------------------------- respectively, and the negative impact to same-store sales growth was 50 basis points for KFC Division and 25 basis points for YUM, respectively, as a result of these supply availability issues.
KFC Division
The KFC Division has 24,104 units, 83% of which are located outside theU.S. Additionally, 99% of the KFC Division units were operated by franchisees as of the end of 2019. % B/(W) % B/(W) 2019 2018 Ex FX and 53rd Week in 2019 2018 2017 Reported Ex FX 2019 Reported Ex FX System Sales$ 27,900 $ 26,239 $ 24,515 6 10 9 7 6 Same-Store Sales Growth % 4 N/A N/A 2 N/A Company sales$ 571 $ 894 $ 1,928 (36 ) (33 ) (34 ) (54 ) (53 ) Franchise and property revenues 1,390 1,294 1,182 7 11 10 10 9 Franchise contributions for advertising and other services 530 456 - 16 21 20 N/A N/A Total revenues$ 2,491 $ 2,644 $ 3,110 (6 ) (2 ) (3 ) (15 ) (15 ) Restaurant profit$ 87 $ 119 $ 289 (26 ) (23 ) (24 ) (59 ) (58 ) Restaurant margin % 15.3 % 13.3 % 15.0 % 2.0 ppts.
2.0 ppts. 2.0 ppts. (1.7) ppts. (1.5) ppts.
G&A expenses$ 346 $ 350 $ 370 1 (1 ) (1 ) 5 5 Franchise and property expenses 89 107 117 17 13 13 8 9 Franchise advertising and other services expense 520 452 - (15 ) (20 ) (19 ) N/A N/A Operating Profit$ 1,052 $ 959 $ 981 10 14 13 (2 ) (2 ) % Increase (Decrease) Unit Count 2019 2018 2017 2019 2018 Franchise 23,759 22,297 20,819 7 7 Company-owned 345 324 668 6 (51 ) Total 24,104 22,621 21,487 7 5
Company sales and Restaurant margin percentage
In 2019, the decrease in Company sales, excluding the impacts of foreign
currency translation and 53rd week, was primarily driven by refranchising offset
by company same-store sales growth of 5%, including lapping the prior year
impact of supply interruptions in our KFC
The 2019 increase in Restaurant margin percentage was driven by same-store sales growth, including lapping the prior year impact of supply interruptions in our KFCUK business, and refranchising.
Franchise and property revenues
In 2019, the increase in Franchise and property revenues, excluding the impacts of foreign currency translation and 53rd week, was driven by international net new unit growth, franchise same-store sales growth of 4%, including lapping the prior year impact of supply interruptions in our KFCUK business, and refranchising. 36 --------------------------------------------------------------------------------
G&A
In 2019, the increase in G&A, excluding the impacts of foreign currency translation and 53rd week, was driven by higher expenses related to our deferred and incentive compensation programs, partially offset by the positive impact of YUM's Strategic Transformation Initiatives, including reductions in G&A directly attributable to refranchising.
Operating Profit
In 2019, the increase in Operating Profit, excluding the impacts of foreign
currency translation and 53rd week, was driven by net new unit growth,
same-store sales growth and lapping the prior year impact of supply
interruptions in our KFC
Pizza Hut Division
The Pizza Hut Division has 18,703 units, 61% of which are located outside theU.S. The Pizza Hut Division uses multiple distribution channels including delivery, dine-in and express (e.g. airports) and includes units operating under both thePizza Hut and Telepizza brands. Additionally, over 99% of thePizza Hut Division units were operated by franchisees as of the end of 2019. % B/(W) % B/(W) 2019 2018 Ex FX and 53rd Week in 2019 2018 2017 Reported Ex FX 2019 Reported Ex FX System Sales$ 12,900 $ 12,212 $ 12,034 6 8 7 1 1 Same-Store Sales Growth (Decline) % Even N/A N/A Even N/A Company sales$ 54 $ 69 $ 285 (23 ) (21 ) (21 ) (76 ) (76 ) Franchise and property revenues 597 598 608 Even 1 1 (2 ) (2 ) Franchise contributions for advertising and other services 376 321 - 17 18 16 N/A N/A Total revenues$ 1,027 $ 988 $ 893 4 5 4 11 10 Restaurant profit$ 3 $ -$ 14 NM NM NM NM NM Restaurant margin % 4.2 % (0.1 )% 5.3 % 4.3 ppts. 4.2 ppts. 4.1 ppts. (5.4) ppts. (5.3) ppts. G&A expenses$ 202 $ 197 $ 211 (2 ) (3 ) (2 ) 7 7 Franchise and property expenses 39 45 68 12 11 13 35 36 Franchise advertising and other services expense 367 328 - (12 ) (12 ) (11 ) N/A N/A Operating Profit$ 369 $ 348 $ 341 6 8 7 2 2 % Increase (Decrease) Unit Count 2019 2018 2017 2019 2018(a) Franchise 18,603 18,369 16,588 1 11 Company-owned 100 62 160 61 (61 ) Total 18,703 18,431 16,748 1 10
(a) 2018 unit growth includes units added as a result of our fourth quarter 2018 strategic alliance with Telepizza.
37
--------------------------------------------------------------------------------Company sales
In 2019, the decrease in Company sales, excluding the impacts of foreign currency translation and 53rd week, was driven by refranchising. Company same-store sales growth was 2%.
Franchise and property revenues
In 2019, the increase in Franchise and property revenues, excluding the impacts of foreign currency translation and 53rd week, was driven by net new unit growth. Franchise same-store sales were flat.
G&A
In 2019, the increase in G&A, excluding the impacts of foreign currency translation and 53rd week, was driven by higher expenses related to our deferred compensation program, partially offset the positive impact of YUM's Strategic Transformation Initiatives, including reductions in G&A directly attributable to refranchising. Operating Profit In 2019, the increase in Operating Profit, excluding the impacts of foreign currency translation and 53rd week, was driven by lapping advertising costs in the prior year associated with the Pizza Hut Transformation Agreement (See Note 4), higher profit associated with providing incremental technology-related services, net new unit growth and refranchising, partially offset by higher provisions for past due receivables and higher G&A.
Taco Bell Division
The Taco Bell Division has 7,363 units, 92% of which are in the
% B/(W) % B/(W)
2019 2018
Ex FX and
53rd Week in
2019 2018 2017 Reported
Ex FX 2019 Reported Ex FX
System Sales
9 8 6 6 Same-Store Sales Growth % 5 N/A N/A 4 N/A Company sales$ 921 $ 1,037 $ 1,359 (11 ) (11 ) (13 ) (24 ) (24 ) Franchise and property revenues 673 590 521 14 14 12 13 13 Franchise contributions for advertising and other services 485 429 - 13 13 11 N/A N/A Total revenues$ 2,079 $ 2,056 $ 1,880 1 1 - 9 9
Restaurant profit
(20 ) (20 )
Restaurant margin
% 24.0 % 23.5 % 22.4 % 0.5 ppts. 0.5 ppts. 0.4 ppts. 1.1 ppts. 1.1 ppts.
G&A expenses$ 181 $ 177 $ 188 (2 ) (3 ) (2 ) 6 6 Franchise and property expenses 38 28 22 (33 ) (33 ) (32 ) (31 ) (31 ) Franchise advertising and other services expense 481 428 - (12 ) (12 ) (11 ) N/A N/A Operating Profit$ 683 $ 633 $ 619 8 8 6 2 2 38
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% Increase (Decrease)
Unit Count 2019 2018 2017 2019 2018
Franchise 6,895 6,602 6,196 4 7
Company-owned 468 470 653 - (28 )
Total 7,363 7,072 6,849 4 3
Company sales and Restaurant margin percentage
In 2019, the decrease in Company Sales, excluding the impact of 53rd week, was driven by refranchising partially offset by company same-store sales growth of 4% and net new unit growth.
In 2019, the increase in restaurant margin percentage was driven by same-store sales growth partially offset by higher labor and commodity costs.
Franchise and property revenues
In 2019, the increase in Franchise and property revenues, excluding the impact of 53rd week, was driven by franchise same-store sales growth of 5%, refranchising and net new unit growth.
G&A
In 2019, the increase in G&A, excluding the impact of 53rd week, was driven by
higher expenses related to our deferred and incentive compensation programs and
the unfavorable impact of lapping prior year forfeitures related to share based
compensation awards, partially offset by the positive impact of YUM's Strategic
Transformation Initiatives.
Operating Profit
In 2019, the increase in Operating Profit, excluding the impacts of foreign
currency translation and 53rd week, was driven by same-store sales growth and
net new unit growth, partially offset by refranchising and higher restaurant
operating costs.
Corporate & Unallocated
% B/(W)
(Expense)/Income 2019 2018 2017 2019 2018
Corporate and unallocated G&A
(10 ) 26 Unallocated restaurant costs - 3 10 (95 ) (69 ) Unallocated Franchise and property revenues - - (5 ) NM NM Unallocated Franchise and property expenses (14 ) (8 ) (30 ) (72 ) 73 Refranchising gain (loss) (See Note 4) 37 540 1,083 (93 ) (50 ) Unallocated Other income (expense) (See Note 4) (9 ) (8 ) (8 ) NM NM Investment income (expense), net (See Note 4) (67 ) 9 5 NM 88 Other pension income (expense) (See Note 14) (4 ) (14 ) (47 ) 71 70 Interest expense, net (486 ) (452 ) (445 ) (8 ) (1 )
Income tax provision (See Note 17) (79 ) (297 ) (934 )
74 68
Effective tax rate (See Note 17) 5.7 % 16.2 % 41.1 % 10.5 ppts. 24.9 ppts.
Corporate and unallocated G&A
In 2019, the increase in Corporate and unallocated G&A expenses was driven by
higher expenses related to our deferred and incentive compensation programs and
higher professional fees related to strategic projects, the largest of which was
related to global tax reforms, partially offset by lapping costs associated with
YUM's Strategic Transformation Initiatives (See Note 4) and current year G&A
reductions due to the impact of YUM's Strategic Transformation Initiatives.
39
--------------------------------------------------------------------------------Unallocated restaurant costs
Unallocated restaurant costs represents the cessation of depreciation on held for sale assets that were not allocated to the Division segments.
Unallocated Franchise and property expenses
Unallocated Franchise and property expenses reflect charges related to the Pizza HutU.S. Transformation Agreement and/or the KFCU.S. Acceleration Agreement. See Note 4. Interest expense, net
The increase in Interest expense, net for 2019 was driven by increased outstanding borrowings. See Note 10.
Consolidated Cash Flows
Net cash provided by operating activities was$1,315 million in 2019 compared to$1,176 million in 2018. The increase was largely driven by an increase in Operating profit before Special Items and lower compensation payments, partially offset by an increase in interest payments. Net cash used in investing activities was$88 million in 2019 compared to net cash provided by investing activities of$313 million in 2018. The change was primarily driven by lower refranchising proceeds in the current year, partially offset by the lapping of our prior year investment in Grubhub common stock and the acquisition ofQuikOrder, LLC , an online ordering software and service provider for the restaurant industry ("QuikOrder") (See Note 9).
Net cash used in financing activities was
Consolidated Financial Condition
Our Consolidated Balance Sheet was impacted by the adoption of Topic 842 (See Note 2) and deferred tax assets recorded related to the intercompany transfers of certain intellectual property rights (See Note 17).
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash generated by operations and availability under our revolving facilities. As ofDecember 31, 2019 , we had Cash and cash equivalents of$605 million . Cash and cash equivalents increased from$292 million atDecember 31, 2018 due to the issuance of$800 million aggregate principal amount of YUM Senior Unsecured Notes inSeptember 2019 . We have historically generated substantial cash flows from the operations of our Company-owned stores and from our extensive franchise operations, which require a limited YUM investment. Our annual operating cash flows have historically been in excess of$1 billion . Decreases in operating cash flows from the operation of fewer Company-owned stores due to refranchising in recent years have been offset, and are expected to continue to be offset, with savings generated from decreased capital investment and G&A required to support company operations. To the extent operating cash flows plus other sources of cash such as refranchising proceeds do not cover our anticipated cash needs, we maintain a$1 billion Revolving Facility under our existing Credit Agreement that was undrawn as of year end 2019. We believe that our existing cash on hand, cash from operations and availability under our Revolving Facility, will be sufficient to fund our operations, anticipated capital expenditures and debt repayment obligations over the next twelve months. From 2017 through 2019, we returned a cumulative$6.5 billion to shareholders through share repurchases and cash dividends. We funded these shareholder returns through a combination of refranchising proceeds, free cash flow generation and maintenance of our ~5.0x EBITDA leverage. From the fourth quarter of 2016 to the end of 2018, we generated total gross refranchising proceeds of$2.8 billion in connection with our initiative to increase franchise ownership to 98%. Going forward, we anticipate refranchising proceeds to be much more limited and any shareholder returns we choose to make to be funded through cash flows from operations and leverage maintenance. OnJanuary 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. 40 -------------------------------------------------------------------------------- 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.
Our balance sheet often reflects a working capital deficit, which is not uncommon in our industry and is also historically common for YUM. Our royalty receivables from franchisees are generally due within 30 days of the period in which the related sales occur and Company sales are paid in cash or by credit card (which is quickly converted into cash). Substantial amounts of cash received have historically been either returned to shareholders or invested in new restaurant assets which are non-current in nature. As part of our working capital strategy, we negotiate favorable credit terms with vendors and, as a result, our on-hand inventory turns faster than the related short-term liabilities. Accordingly, it is not unusual for current liabilities to exceed current assets. We believe such a deficit has no significant impact on our liquidity or operations.
Debt Instruments
As ofDecember 31, 2019 , approximately 92%, including the impact of interest rate swaps, of our$10.6 billion of total debt outstanding, excluding finance leases, is fixed with an effective overall interest rate of approximately 4.7%. We are managing a capital structure which is levered in-line with our target of ~5.0x EBITDA, and which we believe provides an attractive balance between optimized interest rates, duration and flexibility with diversified sources of liquidity and maturities spread over multiple years. We have credit ratings of BB (Standard & Poor's )/Ba2 (Moody's) with a balance sheet consistent with highly-levered peer restaurant franchise companies.
The following table summarizes the future maturities of our outstanding
long-term debt, excluding finance leases and debt issuance costs and discounts,
as of
2020 2021 2022 2023 2024 2025 2026 2027 2028 2030 2037 2043 Total
Securitization Notes $ 29 $ 29 $ 29 $ 1,281 $ 16 $ 16 $ 921 $ 6 $ 571 $ 2,898
Credit Agreement 51 76 395 20 20 1,836 2,398
Subsidiary Senior
Unsecured Notes 1,050 1,050 750 2,850
YUM Senior Unsecured
Notes 350 350 325 800 325 275 2,425
Total $ 430 $ 455 $ 424 $ 1,626 $ 1,086 $ 1,852 $ 1,971 $ 756 $ 571 $ 800 $ 325 $ 275 $ 10,571
Securitization Notes include four senior secured notes issued by Taco Bell
Funding, LLC (the "Issuer") totaling $2.9 billion with fixed interest rates
ranging from 4.318% to 4.970%. The Securitization Notes are secured by
substantially all of the assets of the Issuer and the Issuer's special purpose,
wholly-owned subsidiaries (collectively with the Issuer, 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 Securitization Notes contain cross-default provisions whereby the failure to
pay principal on any outstanding Securitization Notes will constitute an event
of default under any other Securitization Notes.
Credit Agreement includes senior secured credit facilities consisting of a $463
million Term Loan A facility (the "Term Loan A Facility"), a $1.9 billion Term
Loan B facility (the "Term Loan B Facility") and a $1.0 billion revolving
facility (the "Revolving Facility") issued by KFC Holding Co. , Pizza Hut
Holdings, LLC and Taco Bell of America, LLC , each of which is a wholly-owned
subsidiary of the Company, as co-borrowers (the "Borrowers"). Our Revolving
Facility was undrawn as of December 31, 2019 . The interest rates applicable to
the Credit Agreement range from 1.25% to 1.75% plus LIBOR or from 0.25% to 0.75%
plus the Base Rate, at the Borrowers' election, based upon the total net
leverage ratio of the Borrowers and the Specified Guarantors (as defined in the
Credit Agreement). Our Term Loan A Facility and Term Loan B Facility contain
cross-default provisions whereby the failure to pay principal of or otherwise
perform any agreement or condition under indebtedness of certain subsidiaries
with a principal amount in excess of $100 million will constitute an event of
default under the Credit Agreement.
Subsidiary Senior Unsecured Notes include three senior unsecured notes issued by
the Borrowers totaling $2.9 billion with fixed interest rates ranging from 4.75%
to 5.25%. Our Subsidiary Senior Unsecured Notes contain cross-default
provisions whereby
41
--------------------------------------------------------------------------------
the acceleration of the maturity of the indebtedness of certain subsidiaries
with a principal amount in excess of $100 million or the failure to pay
principal of such indebtedness will constitute an event of default under the
Subsidiary Senior Unsecured Notes.
YUM Senior Unsecured Notes include six senior unsecured notes issued by Yum!
Brands, Inc. totaling $2.4 billion with fixed interest rates ranging from 3.75%
to 6.88% including $800 million aggregate principal amount of 4.75% notes due
January 15, 2030 that we issued on September 11, 2019 . See Note 10 for
additional details. Our YUM Senior Unsecured Notes contain cross-default
provisions whereby the acceleration of the maturity of any of our indebtedness
or the failure to pay principal of such indebtedness will constitute an event of
default under the YUM Senior Unsecured Notes unless such indebtedness is
discharged, or the acceleration of the maturity of that indebtedness is
annulled, within 30 days after notice.
See Note 10 for details on the Securitization Notes, the Credit Agreement, Subsidiary Senior Unsecured Notes and YUM Senior Unsecured Notes.
Contractual Obligations
Our significant contractual obligations and payments as ofDecember 31, 2019 included: Less than 1 More than 5 Total Year 1-3 Years 3-5 Years Years Long-term debt obligations(a)$ 13,911 $ 895 $ 1,804 $ 3,505 $ 7,707 Finance leases(b) 110 11 20 17 62 Operating leases(b) 987 105 192 159 531 Purchase obligations(c) 297 159 124 13 1 Benefit plans and other(d) 290 155 32 30 73 Total contractual obligations$ 15,595 $ 1,325 $ 2,172 $ 3,724 $ 8,374
(a) Amounts include maturities of debt outstanding as of
expected interest payments on those outstanding amounts on a nominal
basis. The estimated interest payments related to the variable rate
portion of our debt is based on current LIBOR interest rates. See Note 10.
(b) These obligations, which are shown on a nominal basis and represent the
non-cancellable term of the lease, relate primarily to approximately 600Company-owned restaurants and 400 units that we sublease land, building or
both to our franchisees. See Note 11.
(c) Purchase obligations include agreements to purchase goods or services that
are enforceable and legally binding on us and that specify all significant
terms, including: fixed or minimum quantities to be purchased; fixed,
minimum or variable price provisions; and the approximate timing of the
transaction. We have excluded agreements that are cancellable without
penalty. Purchase obligations relate primarily to marketing, information
technology and supply agreements.
(d) Includes actuarially-determined timing of payments from our most
significant unfunded pension plan as well as scheduled payments from ourdeferred compensation plan and other unfunded benefit plans where payment
dates are determinable. This table excludes
payments for deferred compensation and other unfunded benefit plans to be
paid upon separation of employee's service or retirement from the company,
as we cannot reasonably estimate the dates of these future cash payments.
Other amounts include a cash tax obligation related to an income tax audit
expected to conclude in 2020 and anticipated investments related to the
Pizza Hut U.S. Transformation Agreement (See Note 4).
We sponsor noncontributory defined benefit pension plans covering certain
salaried and hourly employees, the most significant of which are in the U.S. and
UK . The most significant of the U.S. plans, the YUM Retirement Plan (the
"Plan"), is funded while benefits from our other significant U.S. plan are paid
by the Company as incurred (see footnote (d) above). Our funding policy for the
Plan is to contribute annually amounts that will at least equal the minimum
amounts required to comply with the Pension Protection Act of 2006. However,
additional voluntary contributions are made from time-to-time to improve the
Plan's funded status. At December 31, 2019 the Plan was in a net underfunded
position of $44 million . The UK pension plans were in a net overfunded position
of $82 million at our 2019 measurement date.
We do not anticipate making any significant contributions to the Plan in 2020.
Investment performance and corporate bond rates have a significant effect on our
net funding position as they drive our asset balances and discount rate
assumptions. Future changes
42
--------------------------------------------------------------------------------in investment performance and corporate bond rates could impact our funded status and the timing and amounts of required contributions in 2020 and beyond.
Our post-retirement health care plan in theU.S. is not required to be funded in advance, but is pay as you go. We made post-retirement benefit payments of$5 million in 2019 and no future funding amounts are included in the contractual obligations table. See Note 14. We have excluded from the contractual obligations table payments we may make for exposures for which we are self-insured, including workers' compensation, employment practices liability, general liability, automobile liability, product liability and property losses (collectively "property and casualty losses") and employee healthcare and long-term disability claims. The majority of our recorded liability for self-insured property and casualty losses and employee healthcare and long-term disability claims represents estimated reserves for incurred claims that have yet to be filed or settled. We have not included in the contractual obligations table$56 million of liabilities for unrecognized tax benefits relating to various tax positions we have taken. These liabilities may increase or decrease over time as a result of tax examinations, and given the status of the examinations, we cannot reliably estimate the period of any cash settlement with the respective taxing authorities. As discussed further in Note 19, onJanuary 29, 2020 we received an order from the Special Director of theDirectorate of Enforcement inIndia imposing a penalty on Yum!Restaurants India Private Limited of approximatelyIndian Rupee 11 billion , or approximately$156 million , primarily relating to alleged violations of operating conditions imposed in 1993 and 1994. 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 and thus have not recorded any reserve atDecember 31, 2019 . It is possible that we could be required to post a deposit for some or all portion of the penalty amount as we pursue appeal options. We have not included any potential deposit amount in the contractual obligations table as we cannot reliably estimate the timing or amount of any such deposit that may be required.
Off-Balance Sheet Arrangements
See the Lease Guarantees section of Note 19 for discussion of our off-balance sheet arrangements.
New Accounting Pronouncements Not Yet Adopted
InJune 2016 , theFinancial Accounting Standards Board ("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 prospectively 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.
Critical Accounting Policies and Estimates
Our reported results are impacted by the application of certain accounting policies that require us to make subjective or complex judgments. These judgments involve estimations of the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations or financial condition. Changes in the estimates and judgments could significantly affect our results of operations and financial condition and cash flows in future years. A description of what we consider to be our most significant critical accounting policies follows.
Impairment or Disposal of Long-Lived Assets
We review long-lived assets of restaurants we intend to continue operating as
Company restaurants (primarily PP&E, right-of-use operating lease assets and
allocated intangible assets subject to amortization) annually for impairment, or
whenever events or changes in circumstances indicate that the carrying amount of
a restaurant may not be recoverable. We evaluate recoverability based on the
restaurant's forecasted undiscounted cash flows, which incorporate our best
estimate of sales growth and margin improvement based upon our plans for the
unit and actual results at comparable restaurants. For restaurant assets that
are deemed to not be recoverable, we write-down the impaired restaurant to its
estimated fair value. Key assumptions in the determination of fair value are the
future after-tax cash flows of the restaurant, which are reduced by future
royalties a franchisee would pay and a discount rate. The after-tax cash flows
incorporate reasonable sales growth and margin improvement assumptions that
would be used by a franchisee in the determination of a purchase price for the
restaurant. Estimates of future cash flows are highly subjective judgments and
can be significantly impacted by changes in the business or economic conditions.
43
--------------------------------------------------------------------------------
We perform an impairment evaluation at a restaurant group level when it is more
likely than not that we will refranchise restaurants as a group. Expected net
sales proceeds are generally based on actual bids from the buyer, if available,
or anticipated bids given the discounted projected after-tax cash flows for the
group of restaurants. Historically, these anticipated bids have been reasonably
accurate estimations of the proceeds ultimately received. The after-tax cash
flows used in determining the anticipated bids incorporate reasonable
assumptions we believe a franchisee would make such as sales growth and margin
improvement as well as expectations as to the useful lives of the restaurant
assets. These after-tax cash flows also include a deduction for the anticipated,
future royalties we would receive under a franchise agreement with terms
substantially at market entered into simultaneously with the refranchising
transaction.
The discount rate used in the fair value calculations is our estimate of the
required rate of return that a franchisee would expect to receive when
purchasing a similar restaurant or groups of restaurants 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.
Impairment of
We evaluate goodwill for impairment on an annual basis as of the beginning of our fourth quarter or more often if an event occurs or circumstances change that indicates impairment might exist.Goodwill is evaluated for impairment by determining whether the fair value of our reporting units exceed their carrying values. Our reporting units are our business units (which are aligned based on geography) in ourKFC ,Pizza Hut and Taco Bell Divisions. Fair value is the price a willing buyer would pay for the reporting unit, and is generally estimated using discounted expected future after-tax cash flows from franchise royalties and Company-owned restaurant operations, if any. Future cash flow estimates and the discount rate are the key assumptions when estimating the fair value of a reporting unit. Future cash flows are based on growth expectations relative to recent historical performance and incorporate sales growth (from net new units or same-sales growth) and margin improvement (for those reporting units which include Company-owned restaurant operations) assumptions that we believe a third-party buyer would assume when determining a purchase price for the reporting unit. Any margin improvement assumptions that factor into the discounted cash flows are highly correlated with sales growth as cash flow growth can be achieved through various interrelated strategies such as product pricing and restaurant productivity initiatives. 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.
The fair values of all our reporting units with goodwill balances were substantially in excess of their respective carrying values as of the 2019 goodwill testing date.
When we refranchise restaurants, 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 versus 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 include a deduction for the anticipated, future royalties the franchisee will pay us associated with the franchise agreement entered into simultaneously with the refranchising transaction. Appropriate adjustments are made to the fair value determinations if such franchise agreement is determined to not be at prevailing market rates. When determining whether such franchise agreement is at prevailing market rates our primary consideration is consistency with the terms of our current franchise agreements both within the country that the restaurants are being refranchised in and around the world. The Company believes consistency in royalty rates as a percentage of sales is appropriate as the Company and franchisee share in the impact of near-term fluctuations in sales results with the acknowledgment that over the long-term the royalty rate represents an appropriate rate for both parties. The discounted value of the future cash flows expected to be generated by the restaurant and retained by the franchisee is reduced by future royalties the franchisee will pay the Company. The Company thus considers the fair value of future royalties to be received under the franchise agreement as fair value retained in its determination of the goodwill to be written off when refranchising. Others may consider the fair value of these future royalties as fair value disposed of and thus would conclude that a larger percentage of a reporting unit's fair value is disposed of in a refranchising transaction.
During 2019, refranchising activity completed by the Company was limited and the
write-off of goodwill associated with these transactions was less than
See Note 2 for a further discussion of our policies regarding goodwill.
44
--------------------------------------------------------------------------------Pension Plans
Certain of our employees are covered under defined benefit pension plans. Our two most significant plans are in theU.S. and combined had a projected benefit obligation ("PBO") of$1,015 million and a fair value of plan assets of$886 million atDecember 31, 2019 . The PBO reflects the actuarial present value of all benefits earned to date by employees and incorporates assumptions as to future compensation levels. Due to the relatively long time frame over which benefits earned to date are expected to be paid, our PBOs are highly sensitive to changes in discount rates. For ourU.S. plans, we measured our PBOs using a discount rate of 3.50% atDecember 31, 2019 . The primary basis for this discount rate determination is a model that consists of a hypothetical portfolio of ten or more corporate debt instruments rated Aa or higher by Moody's orStandard & Poor's ("S&P") with cash flows that mirror our expected benefit payment cash flows under the plans. We exclude from the model those corporate debt instruments flagged by Moody's or S&P for a potential downgrade (if the potential downgrade would result in a rating below Aa by both Moody's and S&P) and bonds with yields that were two standard deviations or more above the mean. In considering possible bond portfolios, the model allows the bond cash flows for a particular year to exceed the expected benefit payment cash flows for that year. Such excesses are assumed to be reinvested at appropriate one-year forward rates and used to meet the benefit payment cash flows in a future year. The weighted-average yield of this hypothetical portfolio was used to arrive at an appropriate discount rate. We also ensure that changes in the discount rate as compared to the prior year are consistent with the overall change in prevailing market rates and make adjustments as necessary. A 50 basis-point increase in this discount rate would have decreased theseU.S. plans' PBOs by approximately$64 million at our measurement date. Conversely, a 50 basis-point decrease in this discount rate would have increased ourU.S. plans' PBOs by approximately$71 million at our measurement date. The net periodic benefit cost we will record in 2020 is also impacted by the discount rate, as well as the long-term rates of return on plan assets and mortality assumptions we selected at our measurement date. We expect net periodic benefit cost plus expected pension settlement charges for ourU.S. plans to increase approximately$10 million in 2020. A 50 basis-point change in our discount rate assumption at our 2019 measurement date would impact our 2020U.S. net periodic benefit cost by approximately$6 million . The impacts of changes in net periodic benefit costs are reflected primarily in Other pension (income) expense. Our estimated long-term rate of return onU.S. plan assets is based upon the weighted-average of historical and expected future returns for each asset category. Our expected long-term rate of return onU.S. plan assets, for purposes of determining 2020 pension expense, atDecember 31, 2019 was 5.50%, net of administrative and investment fees paid from plan assets. We believe this rate is appropriate given the composition of our plan assets and historical market returns thereon. A 100 basis point change in our expected long-term rate of return on plan assets assumption would impact our 2020 U.S. net periodic benefit cost by approximately$8 million . Additionally, every 100 basis point variation in actual return on plan assets versus our expected return of 5.50% will impact our unrecognized pre-tax actuarial net loss by approximately$8 million .
A decrease in discount rates over time has largely contributed to an
unrecognized pre-tax actuarial net loss of
Income Taxes
AtDecember 31, 2019 , we had valuation allowances of approximately$787 million to reduce our$1,517 million of deferred tax assets to amounts that are more likely than not to be realized. The net deferred tax assets primarily relate to temporary differences in profitableU.S. federal, state and foreign jurisdictions and net operating losses in certain foreign jurisdictions, the majority of which do not expire. In evaluating our ability to recover our deferred tax assets, we consider future taxable income in the various jurisdictions as well as carryforward periods and restrictions on usage. The estimation of future taxable income in these jurisdictions and our resulting ability to utilize deferred tax assets can significantly change based on future events, including our determinations as to feasibility of certain tax planning strategies and refranchising plans. Thus, recorded valuation allowances may be subject to material future changes. As a matter of course, we are regularly audited by federal, state and foreign tax authorities. 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 that the position would be sustained upon examination by these 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. AtDecember 31, 2019 , we had$188 million of unrecognized tax benefits,$8 million of which are temporary in nature and, if recognized, would not impact the effective tax rate. We evaluate unrecognized tax benefits, including interest thereon, on a quarterly basis to ensure that they have been appropriately adjusted for events, including audit settlements, which may impact our ultimate payment for such exposures. 45
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The 2017 Tax Cuts and Jobs Act included a mandatory deemed repatriation tax on accumulated earnings of foreign subsidiaries, and as a result, previously unremitted earnings for which noU.S. deferred tax liability had been provided have now been subject toU.S. tax. Our cash currently held overseas is primarily limited to that necessary to fund working capital requirements. Thus, we have not provided taxes on our foreign unremitted earnings, includingU.S. state income and foreign withholding taxes, as we believe they are indefinitely reinvested. See Note 17 for a further discussion of our Income taxes.
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