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YUM BRANDS INC 10-Q 2009
___________
FORM
10-Q
(Mark
One)
For
the transition period from ____________ to _________________
Commission file number
1-13163>
________________________
YUM!
BRANDS, INC.
(Exact
name of registrant as specified in its charter)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [Ö] No
[ ]
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes [Ö] No
[ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one): Large accelerated filer: [Ö] Accelerated
filer: [ ] Non-accelerated
filer: [ ] Smaller reporting
company: [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes [ ] No [Ö]
The
number of shares outstanding of the Registrant’s Common Stock as of October 5,
2009 was 467,702,275 shares.
YUM!
BRANDS, INC.
INDEX
PART
I - FINANCIAL INFORMATION
CONDENSED
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
YUM!
BRANDS, INC. AND
SUBSIDIARIES
(in
millions, except per share data)
3
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
YUM!
BRANDS, INC. AND SUBSIDIARIES
(in
millions)
4
CONDENSED
CONSOLIDATED BALANCE SHEETS
YUM!
BRANDS, INC. AND SUBSIDIARIES
(in
millions)
5
(Tabular
amounts in millions, except per share data)
We have
prepared our accompanying unaudited Condensed Consolidated Financial Statements
(“Financial Statements”) in accordance with the rules and regulations of the
Securities and Exchange Commission (“SEC”) for interim financial
information. Accordingly, they do not include all of the information
and footnotes required by United States (“U.S.”) generally accepted accounting
principles for complete financial statements. Therefore, we suggest
that the accompanying Financial Statements be read in conjunction with the
Consolidated Financial Statements and Notes thereto included in our annual
report on Form 10-K for the fiscal year ended December 27, 2008 (“2008 Form
10-K”). Except as disclosed herein, there has been no material change
in the information disclosed in the Notes to our Consolidated Financial
Statements included in the 2008 Form 10-K.
YUM!
Brands, Inc. and Subsidiaries (collectively referred to as “YUM” or the
“Company”) comprise the worldwide operations of KFC, Pizza Hut, Taco Bell, Long
John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”)
(collectively the “Concepts”). References to YUM throughout these
Notes to our Financial Statements are made using the first person notations of
“we,” “us” or “our.”
YUM’s
business consists of three reporting segments: United States, YUM
Restaurants International (“YRI” or “International Division”) and YUM
Restaurants China (“China Division”). The China Division includes
mainland China (“China”), Thailand, and KFC Taiwan, and YRI includes the
remainder of our international operations.
Our
fiscal year ends on the last Saturday in December and, as a result, a 53rd week
is added every five or six years. The first three quarters of each
fiscal year consist 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 subsidiaries operate on similar fiscal calendars except
that certain international subsidiaries operate on a monthly calendar, with two
months in the first quarter, three months in the second and third quarters and
four months in the fourth quarter. All of our international
businesses except China close one period or one month earlier to facilitate
consolidated reporting.
In 2008,
we began consolidating an entity in which we have a majority ownership interest
and that operates the KFCs in Beijing, China. Additionally, as
discussed in Note 4, in the quarter ended June 13, 2009 we began consolidating
the entity that operates the KFCs in Shanghai, China. The increases
in cash related to the consolidation of these entities’ cash balances ($17
million in both instances) are presented as a single line item on our Condensed
Consolidated Statement of Cash Flows.
Our
preparation of the accompanying Financial Statements in conformity with
generally accepted accounting principles in the United States of America
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 Financial Statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from the estimates.
In our
opinion, the accompanying Financial Statements include all normal and recurring
adjustments considered necessary to present fairly, when read in conjunction
with our 2008 Form 10-K, our financial position as of September 5, 2009, and the
results of our operations for the quarters and years to date ended September 5,
2009 and September 6, 2008 and cash flows for the years to date ended September
5, 2009 and September 6, 2008. Our results of operations for these
interim periods are not necessarily indicative of the results to be expected for
the full year.
Our
significant interim accounting policies include the recognition of certain
advertising and marketing costs, generally in proportion to revenue, and the
recognition of income taxes using an estimated annual effective tax rate.
Our quarter and year to date tax rates for both 2009 and 2008 are lower
than the expected U.S. federal statutory rate of 35% primarily due to the
majority of our income being earned outside of the U.S. where tax rates are
generally lower than the U.S. rate.
6
We have
reclassified certain items in the accompanying Financial Statements and Notes to
the Financial Statements for the prior periods in order to be comparable with
the current classifications. As discussed in our 2008 Form 10-K, we
have begun reporting capital spending on our Condensed Consolidated Statements
of Cash Flows excluding the impact of purchases that have been accrued but not
yet paid. For the year to date ended September 6, 2008 this resulted
in increased Capital spending of $12 million with an offsetting impact to
Changes in accounts payable and other current liabilities. Also, as
rental income from franchisees has increased over time and is anticipated to
continue to increase, we believe it is more appropriate to report such income as
Franchise and license fees and income as opposed to a reduction in Franchise and
license expenses, as it has historically been reported. For the
quarter and year to date ended September 6, 2008 this resulted in an increase of
$7 million and $18 million, respectively, in both Franchise and license expenses
and Franchise and license fees and income in our Condensed Consolidated
Statement of Income. A similar amount of rental income was reported
in Franchise and license fees and income in the quarter and year to date ended
September 5, 2009. These reclassifications had no effect on
previously reported Net Income.
Under the
authority of our Board of Directors, we repurchased shares of our Common Stock
during the year to date ended September 6, 2008, as indicated
below. All amounts exclude applicable transaction fees. We
had no share repurchases in the year to date ended September 5,
2009.
On
September 30, 2009, our Board of Directors authorized share repurchases through
September 30, 2010 of up to $300 million (excluding applicable transaction fees)
of our outstanding Common Stock.
7
Comprehensive
income was as follows:
U.S. Business
Transformation
As part
of our plan to transform our U.S. business we took several measures in 2008 and
are taking similar measures in 2009 (“the U.S. business transformation
measures”). These measures include: expansion of our U.S.
refranchising; charges relating to General and Administrative (“G&A”)
productivity initiatives and realignment of resources (primarily severance and
early retirement costs); and investments in our U.S. Brands made on behalf of
our franchisees such as equipment purchases.
In the
quarter and year to date ended September 5, 2009, we recorded pre-tax gains of
$8 million and $23 million, respectively, from refranchising in the
U.S. In the quarter and year to date ended September 6, 2008, we
recorded a pre-tax gain of $3 million and a pre-tax loss of $22 million,
respectively, from refranchising in the U.S. The refranchising losses
recorded for the year to date ended September 6, 2008 were primarily due to our
refranchising of stores or groups of stores, principally at Long John Silver’s,
for prices less than their recorded carrying value.
In
connection with our G&A productivity initiatives and realignment of
resources we recorded no charges in the quarter ended September 5, 2009 and a
pre-tax charge of $1 million in the quarter ended September 6, 2008, and pre-tax
charges of $9 million and $8 million in the years to date ended September 5,
2009 and September 6, 2008, respectively. The unpaid current
liability for the severance portion of these charges was $8 million as of
September 5, 2009. Severance payments in the quarter and year to date
ended September 5, 2009 totaled approximately $6 million and $22 million,
respectively.
Additionally,
the Company recognized a reduction to Franchise and license fees and income of
$1 million and $32 million, pre-tax, in the quarter and year to date ended
September 5, 2009, respectively, related to investments in our U.S.
Brands. These investments reflect our reimbursements to KFC
franchisees for installation costs of ovens for the national launch of Kentucky
Grilled Chicken. This reduction to Franchise and license fees and
income was recorded in accordance with Emerging Issues Task Force (“EITF”) Issue
No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor’s Products)”. In the quarter and
year to date ended September 6, 2008, the Company recognized pre-tax expense of
$2 million and $5 million, respectively, related to investments in our U.S.
Brands.
We are
not including the impacts of these U.S. business transformation measures in our
U.S. segment for performance reporting purposes as we do not believe they are
indicative of our ongoing operations.
8
Acquisition of Interest in
Little Sheep
On March
24, 2009, our China Division paid approximately $44 million to purchase 14% of
the outstanding common shares of Little Sheep Group Limited (“Little
Sheep”). On June 2, 2009, we purchased an additional 6% of Little
Sheep for $19 million and obtained Board of Directors
representation. Accordingly, in the quarter ended September 5, 2009
we began reporting our investment in Little Sheep using the equity method of
accounting and this investment is now included in Investments in unconsolidated
affiliates on our Condensed Consolidated Balance Sheet. Equity income
recognized from our investment in Little Sheep was not significant in the
quarter ended September 5, 2009.
Little
Sheep is the leading brand in China’s “Hot Pot” restaurant category with
approximately 375 restaurants, primarily in China as well as Hong Kong, Japan,
Canada and the U.S.
Consolidation of a Former
Unconsolidated Affiliate in China
On May 4,
2009 we acquired an additional 7% ownership in the entity that operates more
than 200 KFCs in Shanghai, China for $12 million, increasing our ownership to
58%. The acquisition was driven by our desire to increase our
management control over the entity and further integrate the business with the
remainder of our KFC operations in China. This entity has
historically been accounted for as an unconsolidated affiliate under the equity
method of accounting due to the effective participation of our partners in the
significant decisions of the entity that were made in the ordinary course of
business as addressed in EITF Issue No. 96-16, “Investor's Accounting for an
Investee When the Investor Has a Majority of the Voting Interest but the
Minority Shareholder or Shareholders Have Certain Approval or Veto
Rights”. Concurrent with the acquisition we received additional
rights in the governance of the entity, and thus we began consolidating the
entity upon acquisition. As required by Statement of Financial
Accounting Standards (“SFAS”) No. 141(R), “Business Combinations” (“SFAS 141R”),
we remeasured our previously held 51% ownership in the entity, which had a
recorded value of $17 million at the date of acquisition, at fair value and
recognized a gain of $68 million accordingly. This gain, which
resulted in no related income tax expense, was recorded in Other (income)
expense on our Condensed Consolidated Statements of Income during the quarter
ended June 13, 2009 and was not allocated to any segment for performance
reporting purposes.
Our
preliminary estimate of the identifiable assets acquired and liabilities assumed
upon acquisition for the consolidated entity is as follows:
Additionally,
$70 million was recorded as Noncontrolling interest in our Condensed
Consolidated Balance Sheet, representing the fair value of our partner’s
interest in the entity’s net assets upon acquisition. Intangible
assets primarily comprise reacquired franchise rights which are being amortized
over the franchise contract period of ten years.
Goodwill,
which will be allocated to the China Division, is not expected to be deductible
for income tax purposes.
9
Under the
equity method of accounting, we previously reported our 51% share of the net
income of the unconsolidated affiliate (after interest expense and income taxes)
as Other (income) expense in the Condensed Consolidated Statements of
Income. We also recorded a franchise fee for the royalty received
from the stores owned by the unconsolidated affiliate. From the date of the
acquisition through August 31, 2009 (our China Division’s third quarter end), we
reported the results of operations for the entity in the appropriate line items
of our Condensed Consolidated Statement of Income. We no longer
recorded franchise fee income for these restaurants nor did we report Other
(income) expense as we did under the equity method of accounting. For
the quarter and year to date ended September 5, 2009 the consolidation of this
entity increased Company sales by $82 million and $105 million, respectively,
and decreased Franchise and license fees and income by $5 million and $6
million, respectively. The consolidation of this entity positively
impacted Operating Profit by $4 million and $5 million for the quarter and year
to date ended September 5, 2009, respectively. The impact on Net
Income – YUM! Brands, Inc. was not significant to either the quarter or the year
to date ended September 5, 2009.
The pro
forma impact on our results of operations if the acquisition had been completed
as of the beginning of both 2009 and 2008 would not have been
significant.
Cash Tender Offer to
Purchase Senior Unsecured Notes
During
the quarter ended June 13, 2009 we completed a cash tender offer to repurchase
certain of our Senior Unsecured Notes due July 1, 2012 with an aggregate
principal amount of $137 million. In conjunction with this
transaction, we settled interest rate swaps with a notional amount of $150
million that were hedging these Senior Unsecured Notes, receiving $14 million in
cash. The net impact of the repurchase of Senior Unsecured Notes and
related interest rate swap settlement had no significant impact on Interest
expense.
Issuance of Senior Unsecured
Notes
On August
20, 2009, we issued $250 million aggregate principal amount of 4.25% Senior
Unsecured Notes that are due on September 15, 2015 and $250 million aggregate
principal amount of 5.30% Senior Unsecured Notes that are due on September 15,
2019 (together the “2009 Notes”). We used a portion of the proceeds
to repay our variable rate senior unsecured term loan with an aggregate
principal amount of $375 million that was scheduled to mature in 2011 and the
remainder of the proceeds will be used to make discretionary payments to our
pension plans during the fourth quarter of 2009.
In the
quarter ended September 5, 2009, in anticipation of issuing the Senior Unsecured
Notes due in 2019, we entered into treasury locks with aggregate notional
amounts of $188 million to hedge a portion of the interest rate risk
attributable to changes in United States Treasury Rates. As the
treasury locks were designated and highly effective in offsetting the
variability in cash flows associated with the future interest payments, a
resulting $3 million loss from settlement of these instruments is being
amortized over ten years as an increase in interest expense.
In
connection with the issuance of the $250 million Senior Unsecured Notes due in
2015, we entered into pay-variable interest rate swaps with an aggregate
notional amount of $150 million with the objective of reducing our exposure to
interest rate risk and lowering interest expenses for a portion of our
debt. These swaps have been designated as fair value hedges of a
portion of our fixed rate debt.
10
Facility
Actions
Refranchising
(gain) loss, Store closure (income) costs and Store impairment charges by
reportable segment are as follows:
11
Assets
held for sale at September 5, 2009 and December 27, 2008 total $35 million and
$31 million, respectively, of U.S. property, plant and equipment and are
included in Prepaid expenses and other current assets on our Condensed
Consolidated Balance Sheets.
12
In
February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position (“FSP”) No. 157-2, “Effective Date of FASB Statement No. 157”
which permitted a one-year deferral for the implementation of SFAS No. 157,
“Fair Value Measurements” (“SFAS 157”) with regard to non-financial assets and
liabilities that are not recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). We adopted SFAS
157 at the beginning of 2009 for such non-financial assets and liabilities,
which, for the Company, primarily includes long-lived assets, goodwill and
intangibles. The fair values of such non-financial assets and
liabilities measured at fair value during 2009 and remaining on our
Condensed Consolidated Balance Sheet at September 5, 2009 are included in the
required disclosures in Note 12. The full adoption of SFAS 157 did
not materially impact the measurement of these disclosed amounts.
In
December 2007, the FASB issued SFAS 141R. SFAS 141R, which is broader
in scope than SFAS 141, applies to all transactions or other events in which an
entity obtains control of one or more businesses, and requires that the
acquisition method be used for such transactions or events. SFAS
141R, with limited exceptions, will require an acquirer to recognize the assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree at the acquisition date, measured at their fair values as of that
date. This will result in acquisition related costs and anticipated
restructuring costs related to the acquisition being recognized separately from
the business combination. The Company adopted SFAS 141R on December
28, 2008. Adoption of SFAS 141R did not significantly impact the
accounting for the Company’s acquisitions of franchise restaurants in the
quarter or year to date ended September 5, 2009. SFAS 141R did
require that our existing equity interest in the entity that operates the KFCs
in Shanghai, China be remeasured at its fair value upon our acquisition of
additional ownership in and consolidation of the entity (See Note
4).
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (“SFAS 160”). SFAS 160 amends
Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and
changed the accounting and reporting for noncontrolling interests, which are the
portion of equity in a subsidiary not attributable, directly or indirectly, to a
parent. SFAS 160 was effective for the quarter ended March 21, 2009
for the Company and requires retroactive adoption of its presentation and
disclosure requirements. SFAS 160 requires us to report net income
attributable to the noncontrolling interests separately on the face of our
Condensed Consolidated Statements of Income. Additionally, SFAS 160
requires that the portion of equity in the entity not attributable to the
Company be reported within equity, separately from the Company’s equity on the
Condensed Consolidated Balance Sheets.
In 2008,
the Company consolidated one entity for which a third party owned a
noncontrolling interest. This entity operates the KFCs in Beijing,
China. Prior to the adoption of SFAS 160, we reported Operating
Profit attributable to the noncontrolling interest in the Beijing entity in
Other (income) expense and the related tax impact as a reduction to our Income
tax provision. Additionally, we reported the equity attributable to
the noncontrolling interest in the Beijing entity within Other liabilities and
deferred credits. As required, the presentation requirements of SFAS
160 were applied retroactively to the quarter and year to date ended September
6, 2008 for this noncontrolling interest.
During
second quarter 2009, we began consolidating the entity that operates the KFCs in
Shanghai, China in which a third party owns a noncontrolling interest (See Note
4). We are accounting for the noncontrolling interest in this entity
in accordance with SFAS 160.
A
reconciliation of the beginning and ending carrying amount of the equity
attributable to noncontrolling interests is as follows:
13
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”). SFAS 161 amends and expands the
disclosure requirements in SFAS 133, “Accounting for Derivative Instruments and
Hedging Activities”. SFAS 161 was effective for the quarter ended
March 21, 2009 for the Company, and we have included the required disclosures in
Note 11.
In April
2009, the FASB issued FSP No. FAS 157-4 (“FSP FAS 157-4”), “Determining Fair
Value When the Volume and Level of Activity for the Asset or Liability has
Significantly Decreased and Identifying Transactions That Are Not Orderly” and
FSP No. FAS 115-2 and FAS 124-2 (“FSP FAS 115-2”), “Recognition and Presentation
of Other-Than-Temporary Impairments”. These two FSPs were issued to
provide additional guidance about (1) measuring the fair value of financial
instruments when the markets become inactive and quoted prices may reflect
distressed transactions, and (2) recording impairment charges on investments in
debt instruments. Additionally, the FASB issued FSP No. FAS 107-1 and
APB 28-1 (“FSP FAS 107-1”), “Interim Disclosures about Fair Value of Financial
Instruments,” to require disclosures of fair value of certain financial
instruments in interim financial statements. These FSPs were
effective for the quarter ended September 5, 2009 for the
Company. The adoption of these FSPs did not significantly impact the
Company’s results of operations. We have expanded our fair value
disclosures in accordance with these FSPs.
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS
165”). SFAS 165 establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. SFAS
165 was effective for the quarter ended September 5, 2009 for the
Company. The Company evaluated subsequent events through the date the
financial statements were issued and filed with the Securities and Exchange
Commission.
In
December 2008, the FASB issued FSP No. FAS 132(R)-1 (“FSP FAS 132(R)-1”),
“Employers’ Disclosures about Postretirement Benefit Plan Assets,” which expands
the disclosure requirements about plan assets for defined benefit pension plans
and postretirement plans. FSP FAS 132(R)-1 is effective for financial
statements issued for fiscal years ending after December 15, 2009, the year
ending December 26, 2009 for the Company.
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets – an amendment of FASB Statement No. 140” (“SFAS 166”) and SFAS No. 167,
“Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 166
will require more information about transfers of financial assets, eliminates
the qualifying special purpose entity (QSPE) concept, changes the requirements
for derecognizing financial assets and requires additional
disclosures. SFAS 167 amends FASB Interpretation No. 46(R),
“Consolidation of Variable Interest Entities” regarding certain guidance for
determining whether an entity is a variable interest entity and modifies the
methods allowed for determining the primary beneficiary of a variable interest
entity. In addition, SFAS 167 requires ongoing reassessments of
whether an enterprise is the primary beneficiary of a variable interest entity
and enhanced disclosures related to an enterprise’s involvement in a variable
interest entity. We are evaluating whether the adoption of SFAS 166
and SFAS 167 will require the Company to consolidate an entity that provides
loans used primarily to assist franchisees in the development of new restaurants
and, to a lesser extent, in connection with the Company’s historical
refranchising programs. If required, the consolidation of this entity
would increase the Company’s long-term debt by approximately $52 million with a
corresponding increase to receivables. See Note 13 for additional
information regarding this franchisee loan program. SFAS 166 and SFAS
167 are effective for the first annual reporting period that begins after
November 15, 2009, our fiscal 2010.
In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards
CodificationTM and
the Hierarchy of Generally Accepted Accounting Principles – a replacement of
FASB Statement No. 162” (“SFAS 168”). SFAS 168 provides for the FASB
Accounting Standards CodificationTM (the
“Codification”) to become the single official source of authoritative,
nongovernmental U.S. generally accepted accounting principles
(“GAAP”). The Codification did not change GAAP but reorganizes the
literature. SFAS 168 is effective for interim and annual periods
ending after September 15, 2009, the year ending December 26, 2009 for the
Company.
14
In
connection with our U.S. business transformation measures our reported segment
results began reflecting increased allocations of certain expenses in 2009 that
were previously reported in Unallocated and corporate expenses. While
our consolidated results were not impacted, we believe the revised allocation
better aligns costs with accountability of our segment
managers. These revised allocations are being used by our Chairman
and Chief Executive Officer, in his role as chief operating decision maker, in
his assessment of operating performance. We have restated segment
information for the quarter and year to date ended September 6, 2008 to be
consistent with the current period presentation. This resulted in a
$13 million decrease in Unallocated and corporate expense and increases in U.S.
and YRI G&A expense of $12 million and $1 million, respectively, for the
quarter ended September 6, 2008, and a $40 million decrease in Unallocated and
corporate G&A expense and increases in U.S. and YRI G&A expense of $36
million and $4 million, respectively, for the year to date ended September 6,
2008.
The
following tables summarize revenue and operating profit for each of our
reportable operating segments:
15
16
We
sponsor noncontributory defined benefit pension plans covering certain full-time
salaried and hourly U.S. employees. The most significant of these
plans, the YUM Retirement Plan (the “Plan”), is funded while benefits from the
other U.S. plan are paid by the Company as incurred. During 2001, the
plans covering our U.S. salaried employees were amended such that any salaried
employee hired or rehired by YUM after September 30, 2001 is not eligible to
participate in those plans. We also sponsor various defined benefit
pension plans covering certain of our non-U.S. employees, the most significant
of which are in the United Kingdom (“U.K.”). Our plans in the U.K.
have previously been amended such that new employees are not eligible to
participate in these plans.
The
components of net periodic benefit cost associated with our U.S. pension plans
and significant International pension plans are as follows:
We made
contributions of $84 million and $8 million to the Plan and our U.K. plans,
respectively, during the year to date ended September 5, 2009. We
anticipate making additional discretionary contributions of $150 to $200 million
to our pension plans during the fourth quarter of 2009.
17
The
Company is exposed to certain market risks relating to its ongoing business
operations. The primary market risks managed by using derivative
instruments are interest rate risk and cash flow volatility arising from foreign
currency fluctuations.
We enter
into interest rate swaps with the objective of reducing our exposure to interest
rate risk and lowering interest expense for a portion of our fixed-rate
debt. At September 5, 2009, our interest rate derivative instruments
outstanding had notional amounts of $775 million. These swaps have
reset dates and floating rate indices which match those of our underlying
fixed-rate debt and have been designated as fair value hedges of a portion of
that debt. As the swaps qualify for the short-cut method under SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities”, no
ineffectiveness has been recorded.
We enter
into foreign currency forward contracts with the objective of reducing our
exposure to cash flow volatility arising from foreign currency fluctuations
associated with certain foreign currency denominated intercompany short-term
receivables and payables. The notional amount, maturity date, and
currency of these contracts match those of the underlying receivables or
payables. For those foreign currency exchange forward contracts that
we have designated as cash flow hedges, we measure ineffectiveness by comparing
the cumulative change in the forward contract with the cumulative change in the
hedged item. At September 5, 2009, foreign currency forward contracts
outstanding had a total notional amount of $505 million.
The
unrealized gains associated with our interest rate swaps that hedge the interest
rate risk for a portion of our debt have been reported as an addition of $41
million to long-term debt at September 5, 2009. During the quarter
and year to date ended September 5, 2009, Interest expense, net was reduced by
$5 million and $23 million, respectively, for recognized gains on these interest
rate swaps, including $13 million in the year to date ended September 5, 2009
related to the settlement of interest rate swaps that were hedging the 2012
Senior Unsecured Notes that were extinguished (See Note 4).
For our
foreign currency forward contracts the following effective portions of gains and
losses were recognized into Other Comprehensive Income (“OCI”) and reclassified
into income from OCI in the quarter and year to date ended September 5,
2009.
The
gains/losses reclassified from Accumulated OCI into income were recognized as
Other income (expense) in our Condensed Consolidated Statement of Income,
largely offsetting foreign currency transaction losses/gains recorded when the
related intercompany receivables and payables were adjusted for foreign currency
fluctuations. Changes in fair values of the foreign currency forwards
recognized directly in our results of operations either from ineffectiveness or
exclusion from effectiveness testing were insignificant in the quarter and year
to date ended September 5, 2009.
18
Additionally,
we had a net deferred loss of $12 million, net of tax, as of September 5, 2009
within Accumulated OCI due to treasury locks and forward starting interest rate
swaps that have been cash settled, including $2 million, net of tax, for
treasury locks settled during the quarter ended September 5, 2009 associated
with the 2009 Notes. In the quarter and year to date ended September
5, 2009, an insignificant amount was reclassified from Accumulated OCI to
Interest expense, net as a result of these previously settled cash flow
hedges.
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 September 5, 2009, all of the
counterparties to our interest rate swaps and foreign currency forwards had
investment grade ratings. To date, all counterparties have performed
in accordance with their contractual obligations.
The
following table presents the fair values for those assets and liabilities
measured at fair value on a recurring basis as of September 5,
2009:
The
following table presents the fair values for those assets and liabilities
measured at fair value during 2009 on a non-recurring basis, and remaining on
our Condensed Consolidated Balance Sheet as of September 5, 2009. Total
losses include losses recognized from all non-recurring fair value
measurements during the quarter and year to date ended September 5,
2009:
Long-lived
assets (primarily property, plant and equipment and allocated intangible assets
subject to amortization) of restaurants or groups of restaurants that
are currently operating and have not been offered for refranchise are reviewed
for impairment semi-annually or whenever events or changes in circumstances
indicate that the carrying amount of the restaurants’ assets may not be
recoverable.
19
Additionally,
we test for impairment when we have offered to refranchise a restaurant or
groups of restaurants for a price less than their carrying value but do not
believe the restaurants have met the criteria to be classified as held for
sale. Any such impairment is recorded at the offer date and is
classified as refranchising loss. Our impairment of long-lived assets
policy is fully described in our 2008 Form 10-K.
Long-lived
assets held for use presented in the table above include restaurants or groups
of restaurants that were impaired as a result of our semi-annual impairment
review or restaurants not meeting held for sale criteria that have been offered
for sale at a price less than their carrying value during the quarter and year
to date ended September 5, 2009. All $10 million in impairment
charges shown in the table above for the quarter ended September 5, 2009 was
included in Refranchising (gain) loss in the Condensed Consolidated Statements
of Income. For the $34 million of impairment charges shown in the
table above for the year to date ended September 5, 2009, $17 million was
included in both Closures and impairment (income) expenses and Refranchising
(gain) loss.
At
September 5, 2009 the carrying values of cash and cash equivalents, accounts
receivable 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 Company’s debt obligations,
excluding capital leases, were estimated to have a fair value of $3.3 billion,
compared to their carrying value of $3.0 billion. We estimated the
fair value of debt using market quotes and calculations based on market
rates.
Lease
Guarantees
As a
result of (a) assigning our interest in obligations under real estate leases as
a condition to the refranchising of certain Company restaurants; (b)
contributing certain Company restaurants to unconsolidated affiliates; and (c)
guaranteeing certain other leases, we are frequently contingently liable on
lease agreements. These leases have varying terms, the latest of
which expires in 2031. As of September 5, 2009, the potential amount
of undiscounted payments we could be required to make in the event of
non-payment by the primary lessee was approximately $450 million. The
present value of these potential payments discounted at our pre-tax cost of debt
at September 5, 2009 was approximately $375 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 September 5, 2009 was not material.
Franchise Loan Pool and
Equipment Guarantees
We have
provided a partial guarantee of approximately $15 million of a franchisee loan
program used primarily to assist franchisees in the development of new
restaurants and, to a lesser extent, in connection with the Company’s historical
refranchising programs at September 5, 2009. We have also provided
two letters of credit totaling approximately $23 million in support of the
franchisee loan program. One such letter of credit could be used if
we fail to meet our obligations under our guarantee. The other letter
of credit could be used, in certain circumstances, to fund our participation in
the funding of the franchisee loan program. The total loans
outstanding under the loan pool were approximately $52 million at September 5,
2009.
20
In
addition to the guarantee described above, YUM has provided guarantees of
approximately $42 million on behalf of franchisees for several equipment
financing programs related to specific initiatives, the most significant of
which was the purchase of ovens by KFC franchisees for the launch of Kentucky
Grilled Chicken. The total loans outstanding under these equipment
financing programs were approximately $56 million at September 5,
2009.
Insurance
Programs
We are
self-insured for a substantial portion of our current and prior years’ coverage
including workers’ compensation, employment practices liability, general
liability, automobile liability and property losses (collectively, “property and
casualty losses”). To mitigate the cost of our exposures for certain
property and casualty losses, we make annual decisions to self-insure the risks
of loss up to defined maximum per occurrence retentions on a line by line basis
or to combine certain lines of coverage into one loss pool with a single
self-insured aggregate retention. The Company then purchases
insurance coverage, up to a certain limit, for losses that exceed the
self-insurance per occurrence or aggregate 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. As of September
5, 2009, we had approximately $180 million of liabilities recorded for property
and casualty losses.
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.
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.
21
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