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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
___________

FORM 10-Q

(Mark One)
[Ÿ]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2018
 
 
 
OR
 
 
 
[  ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ____________ to _________________
 
 Commission file number 1-13163
________________________
YUM! BRANDS, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
 
13-3951308
 
(State or other jurisdiction of
 
(I.R.S. Employer
 
incorporation or organization)
 
Identification No.)
 
 
 
 
 
1441 Gardiner Lane, Louisville, Kentucky
 
40213
 
(Address of principal executive offices)
 
(Zip Code)
 
 
 
 
Registrant’s telephone number, including area code:  (502) 874-8300

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 [ü]  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 [ü] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer:
[ü]
 
Accelerated filer:
[  ]
 
 
 
 
 
Non-accelerated filer: 
[  ]
(Do not check if a smaller reporting company)
Smaller reporting company: 
[  ]
 
 
 
 
 
Emerging growth company: 
[  ]
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [  ] No [ü]

The number of shares outstanding of the Registrant’s Common Stock as of July 31, 2018 was 317,355,684 shares.
 




YUM! BRANDS, INC.

INDEX
 
 
 
Page
 
 
No.
Part I.
Financial Information
 
 
 
 
 
Item 1 - Financial Statements
 
 
 
 
 
Condensed Consolidated Statements of Income
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income
 
 
 
 
Condensed Consolidated Statements of Cash Flows
 
 
 
 
Condensed Consolidated Balance Sheets
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
 
Item 2 - Management’s Discussion and Analysis of Financial Condition
              and Results of Operations
 
 
 
 
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
Item 4 – Controls and Procedures
 
 
 
 
Report of Independent Registered Public Accounting Firm
 
 
 
Part II.
Other Information and Signatures
 
 
 
 
 
Item 1 – Legal Proceedings
 
 
 
 
Item 1A – Risk Factors
 
 
 
 
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
Item 6 – Exhibits
 
 
 
 
Signatures


2



PART I - FINANCIAL INFORMATION

Item 1.
Financial Statements
 

3



CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
(in millions, except per share data)
 
 
 
 
 
 
 
 
Quarter ended
 
Year to date
Revenues
6/30/2018
 
6/30/2017
 
6/30/2018
 
6/30/2017
Company sales
$
512


$
909


$
1,024


$
1,811

Franchise and property revenues
584


539


1,168


1,054

Franchise contributions for advertising and other services
272

 

 
547

 

Total revenues
1,368

 
1,448


2,739


2,865

Costs and Expenses, Net
 
 
 
 
 
 
 
Company restaurant expenses
421

 
748


859


1,506

General and administrative expenses
208


247


427


484

Franchise and property expenses
40


54


87


100

Franchise advertising and other services expense
274

 

 
546

 

Refranchising (gain) loss
(29
)

(19
)

(185
)

(130
)
Other (income) expense
5


(1
)

3


2

Total costs and expenses, net
919


1,029


1,737


1,962

Operating Profit
449


419


1,002


903

Investment (income) expense, net
(23
)
 
(1
)
 
(89
)
 
(2
)
Other pension (income) expense
3

 
4

 
6

 
32

Interest expense, net
112


105


219


215

Income before income taxes
357

 
311


866


658

Income tax provision
36


105


112


172

Net Income
$
321

 
$
206


$
754


$
486

 
 
 
 
 
 
 
 
Basic Earnings Per Common Share
$
0.99


$
0.59


$
2.30


$
1.37

 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share
$
0.97


$
0.58


$
2.25


$
1.34

 
 
 
 
 
 
 
 
Dividends Declared Per Common Share
$
0.36

 
$
0.30

 
$
0.72

 
$
0.60

 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 
 
 
 


4



CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
 
 
 
 
(in millions)
 
 
 
 
 
 
 
 
Quarter ended
 
Year to date
 
6/30/2018
 
6/30/2017
 
6/30/2018
 
6/30/2017
 
 
 
 
 
 
 
 
Net Income
$
321

 
$
206

 
$
754

 
$
486

Other comprehensive income (loss), net of tax
 
 
 
 

 

Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature
 
 
 
 
 
 
 
Adjustments and gains (losses) arising during the period
(76
)
 
7

 
(30
)
 
57

Reclassification of adjustments and (gains) losses into Net Income

 
(5
)
 

 
(5
)
 
(76
)
 
2

 
(30
)
 
52

Tax (expense) benefit
6

 
(3
)
 

 
(4
)
 
(70
)
 
(1
)
 
(30
)
 
48

Changes in pension and post-retirement benefits
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period

 
(18
)
 

 
(13
)
Reclassification of (gains) losses into Net Income
5

 
6

 
11

 
36

 
5

 
(12
)
 
11

 
23

Tax (expense) benefit
(2
)
 
4

 
(3
)
 
(8
)
 
3

 
(8
)
 
8

 
15

Changes in derivative instruments
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period
25

 
(37
)
 
27

 
(40
)
Reclassification of (gains) losses into Net Income
(26
)
 
30

 
(15
)
 
37

 
(1
)
 
(7
)
 
12

 
(3
)
Tax (expense) benefit
1

 
3

 
(3
)
 
2

 

 
(4
)
 
9

 
(1
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
(67
)
 
(13
)
 
(13
)
 
62

Comprehensive Income
$
254

 
$
193

 
$
741

 
$
548

 
 
 
 
 
 
 
 
  See accompanying Notes to Condensed Consolidated Financial Statements.
 
 


5



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
(in millions)
 
 
 
 
Year to date
 
6/30/2018
 
6/30/2017
Cash Flows – Operating Activities
 
 
 
Net Income
$
754

 
$
486

Depreciation and amortization
71

 
135

Refranchising (gain) loss
(185
)

(130
)
Investment (income) expense, net
(89
)
 
(2
)
Contributions to defined benefit pension plans
(5
)
 
(12
)
Deferred income taxes
(23
)
 
10

Share-based compensation expense
27

 
43

Changes in accounts and notes receivable
(15
)
 
30

Changes in prepaid expenses and other current assets
4

 
3

Changes in accounts payable and other current liabilities
(160
)
 
(137
)
Changes in income taxes payable
(15
)
 
(83
)
Other, net
17

 
96

Net Cash Provided by Operating Activities
381

 
439

 
 
 
 
Cash Flows – Investing Activities
 
 
 
Capital spending
(85
)
 
(150
)
Investment in Grubhub Inc. common stock
(200
)
 

Proceeds from refranchising of restaurants
252

 
321

Other, net
(9
)
 
2

Net Cash Provided by (Used in) Investing Activities
(42
)
 
173

 
 
 
 
Cash Flows – Financing Activities
 
 
 
Proceeds from long-term debt
106

 
1,088

Repayments of long-term debt
(449
)
 
(360
)
Revolving credit facilities, three months or less, net
202

 

Short-term borrowings by original maturity
 
 
 
More than three months - proceeds
51

 

More than three months - payments
(43
)
 

Three months or less, net

 

Repurchase shares of Common Stock
(1,168
)
 
(856
)
Dividends paid on Common Stock
(236
)
 
(211
)
Debt issuance costs

 
(32
)
Other, net
(42
)
 
(39
)
Net Cash Used in Financing Activities
(1,579
)
 
(410
)
Effect of Exchange Rates on Cash and Cash Equivalents
(19
)
 
23

Net Increase (Decrease) in Cash and Cash Equivalents, Restricted Cash and Restricted Cash Equivalents
(1,259
)
 
225

Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents - Beginning of Period
1,668

 
831

Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents - End of Period
$
409

 
$
1,056

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 


6



CONDENSED CONSOLIDATED BALANCE SHEETS
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
(in millions)
 
 
 
 
(Unaudited) 6/30/2018
 
12/31/2017
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
313


$
1,522

Accounts and notes receivable, net
527

 
400

Prepaid expenses and other current assets
363

 
384

Advertising cooperative assets, restricted

 
201

Total Current Assets
1,203

 
2,507

 
 
 
 
Property, plant and equipment, net
1,533


1,697

Goodwill
502

 
512

Intangible assets, net
90

 
110

Other assets
787

 
346

Deferred income taxes
211

 
139

Total Assets
$
4,326

 
$
5,311

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current Liabilities
 
 
 
Accounts payable and other current liabilities
$
822

 
$
813

Income taxes payable
48

 
123

Short-term borrowings
54

 
375

Advertising cooperative liabilities

 
201

Total Current Liabilities
924

 
1,512

 
 
 
 
Long-term debt
9,612

 
9,429

Other liabilities and deferred credits
1,037

 
704

Total Liabilities
11,573

 
11,645

 
 
 
 
Shareholders’ Deficit
 
 
 
Common Stock, no par value, 750 shares authorized; 319 and 332 shares issued in 2018 and 2017, respectively

 

Accumulated deficit
(6,965
)
 
(6,063
)
Accumulated other comprehensive loss
(282
)

(271
)
Total Shareholders’ Deficit
(7,247
)
 
(6,334
)
Total Liabilities and Shareholders’ Deficit
$
4,326

 
$
5,311

 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 

7



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(Tabular amounts in millions, except per share data)

Note 1 - Financial Statement Presentation

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 Generally Accepted Accounting Principles in the United States (“GAAP”) for complete financial statements.  Therefore, we suggest that the accompanying Financial Statements be read in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (“2017 Form 10-K”).  

YUM! Brands, Inc. and its Subsidiaries (collectively referred to herein as “YUM” or the “Company”) comprise the worldwide operations of KFC, Pizza Hut and Taco Bell (collectively the “Concepts”).  YUM has over 45,000 units in more than 140 countries and territories, of which 60% are located outside the U.S.  YUM was created as an independent, publicly-owned company on October 6, 1997 via a tax-free distribution by our former parent, PepsiCo, Inc., of our Common Stock to its shareholders.  References to YUM throughout these Financial Statements are made using the first person notations of “we,” “us” or “our.”

As of June 30, 2018, YUM consisted of three operating segments:  

The KFC Division which includes our worldwide operations of the KFC concept
The Pizza Hut Division which includes our worldwide operations of the Pizza Hut concept
The Taco Bell Division which includes our worldwide operations of the Taco Bell concept

YUM's fiscal year begins on January 1 and ends December 31 of each year, with each quarter comprised of three months. Our U.S. subsidiaries and certain international subsidiaries operate on a weekly periodic calendar where the first three quarters of each fiscal year consists of 12 weeks and the fourth quarter consists of 16 weeks in fiscal years with 52 weeks and 17 weeks in fiscal years with 53 weeks. Our remaining international subsidiaries operate on a monthly calendar similar to that on which YUM operates.

Our preparation of the accompanying Financial Statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Financial Statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

The accompanying Financial Statements include all normal and recurring adjustments considered necessary to present fairly, when read in conjunction with our 2017 Form 10-K, our financial position as of June 30, 2018, our cash flows for the years to date ended June 30, 2018 and 2017 and the results of our operations and comprehensive income for the quarters and years to date ended June 30, 2018 and 2017. Our results of operations, comprehensive income and cash flows 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 advertising and marketing costs, generally in proportion to revenue, and the recognition of income taxes using an estimated annual effective tax rate.

In January 2016, the Financial Accounting Standards Board ("FASB") issued a standard that updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments. We adopted this standard beginning with the quarter ended March 31, 2018. While the adoption of this standard did not have a material impact on our Financial Statements the standard requires our investment in Grubhub Inc. ("Grubhub") common stock, which was consummated in April 2018 (see Note 5), to be remeasured to fair value in each future reporting period with corresponding changes recorded in our Condensed Consolidated Statement of Income.

In October 2016, the FASB issued a standard that requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. As required, we adopted this standard in the quarter ended March 31, 2018 and have recorded a cumulative adjustment to beginning retained earnings. As a result, we recognized a reduction in Other assets of $30 million to write-off the unamortized tax consequences of certain historical intra-entity transfers of assets with an offsetting increase to our Accumulated deficit.


8



In August 2017, the FASB issued a standard that refines and expands existing hedge accounting guidance. We adopted this standard beginning with the quarter ended March 31, 2018. The adoption of this standard did not have a material impact on the Financial Statements.

In February 2018, the FASB issued a standard that allows a reclassification to retained earnings for stranded tax effects within accumulated other comprehensive (income) loss ("AOCI") subsequent to the accounting in the fourth quarter of 2017 necessary as a result of the enactment of the Tax Cuts and Jobs Act of 2017. We adopted this standard during the quarter ended March 31, 2018 and reclassified stranded tax effects of $19 million from AOCI with a corresponding decrease to Accumulated deficit at the beginning of our first quarter 2018. These stranded tax effects primarily related to the remeasurement of deferred tax assets associated with pension losses within AOCI. The Company's policy is to follow the specific identification approach for releasing stranded tax effects from AOCI.

From 2014 through 2017 the FASB issued standards to provide principles within a single framework for revenue recognition of transactions involving contracts with customers across all industries ("Topic 606"). We adopted these standards beginning with the quarter ended March 31, 2018, using the modified retrospective method. See Notes 2 and 5.

We have reclassified certain other items in the Financial Statements for the prior periods to be comparable with the classification for the quarter and year to date ended June 30, 2018. These reclassifications had no effect on previously reported Net Income.


Note 2 - Revenue Recognition Accounting Policy

We adopted Topic 606 at the beginning of the quarter ended March 31, 2018. Below is a discussion of how our revenues are earned, our accounting policies pertaining to revenue recognition prior to the adoption of Topic 606 ("Legacy GAAP"), our accounting policies pertaining to revenue recognition subsequent to the adoption of Topic 606 and other required disclosures. Refer to Note 5 for information regarding the cumulative effect adjustment recorded to Accumulated deficit as of the beginning of the quarter ended March 31, 2018 to reflect the adoption of Topic 606. Also included in Note 5 is disclosure of the amount by which each balance sheet and income statement line item was impacted in the current reporting periods as compared to Legacy GAAP.

Company Sales

Revenues from the sale of food items by Company-owned restaurants are recognized as Company sales when a customer purchases the food, which is when our obligation to perform is satisfied. The timing and amount of revenue recognized related to Company sales was not impacted by the adoption of Topic 606.

Franchise and Property Revenues

Franchise Revenues

Our most significant source of revenues arises from the operation of our Concept stores by our franchisees. Franchise rights may be granted through a store-level franchise agreement or through a master franchise agreement. Our franchise agreements require that the franchisee remit continuing fees to us as a percentage of the applicable restaurant’s sales in exchange for the license of the intellectual property associated with our Concepts' brands (the “franchise right”). Our franchise agreements also typically require certain, less significant, upfront franchise fees such as fees paid upon opening of a store, fees paid to renew the term of the franchise right and fees paid in the event the franchise agreement is transferred to another franchisee.

Continuing fees represent the substantial majority of the consideration we receive under our franchise agreements. Continuing fees are typically billed and paid monthly and are usually 4%-6% for store-level franchise agreements. Master franchise agreements transfer exclusive master franchise rights and administrative obligations, including control of advertising contributions, to master franchisees in certain regions who in turn grant sub-franchising rights to sub-franchisees. As a result of transferring administrative obligations to a master franchisee the percentage of a master franchisee’s restaurants’ sales that we receive as a continuing fee (typically 3%) is less than the percentage we receive for restaurants operating under a store-level franchise agreement. Upfront franchise fees are typically billed and paid when a new franchise or sub-franchise agreement becomes effective or when an existing agreement is transferred to another franchisee or sub-franchisee.

Under Legacy GAAP, continuing fees were recognized as the related sales occurred. The timing and amount of revenue recognized related to continuing fees was not impacted by the adoption of Topic 606 based on the application of the sales-based royalty exception within Topic 606. Under Legacy GAAP, revenue related to initial fees was recognized upon store opening and renewal and transfer fees were recognized when the related agreement became effective. Upon the adoption of Topic 606, we have determined

9



that the services we provide in exchange for these upfront franchise fees are highly interrelated with the franchise right and are not individually distinct from the ongoing services we provide to our franchisees. As a result, upon the adoption of Topic 606, upfront franchise fees are recognized as revenue over the term of each respective franchise or sub-franchise agreement. Revenues for these upfront franchise fees are recognized on a straight-line basis, which is consistent with the franchisee’s or sub-franchisee's right to use and benefit from the intellectual property. Revenues from continuing fees and upfront franchise fees is presented within Franchise and property revenues in our Condensed Consolidated Statements of Income.

Additionally, from time-to-time we provide non-refundable consideration to franchisees in the form of cash or other incentives (e.g. cash payments to incent new unit openings and free or subsidized equipment). The Company’s intent in providing such consideration is to drive new unit development or same-store sales growth that will result in higher future revenues for the Company. Under Legacy GAAP, these payments were recognized when we were obligated to make the payment and were presented as either a reduction to Franchise and property revenues, if cash was provided directly to the franchisee, or as Franchise and property expenses, if cash was not provided directly to the franchisee. Due to the adoption of Topic 606, such payments are capitalized and presented within Prepaid expense and other current assets and Other assets. These capitalized balances are being amortized as a reduction in Franchise and property revenues over the period of expected cash flows from the franchise agreements to which the payment relates.

Property Revenues

From time to time, we enter into rental agreements with franchisees for the lease or sublease of restaurant locations. These rental agreements typically originate from refranchising transactions and revenues related to the agreements are recognized as they are earned. Amounts owed under the rental agreements are typically billed and paid on a monthly basis. Revenues from rental agreements with franchisees are presented within Franchise and property revenues within our Condensed Consolidated Statements of Income. Related expenses are presented as Franchise and property expenses within our Condensed Consolidated Statements of Income and include depreciation or, in the case of a sublease, rental expense. The timing and amount of revenue and expenses recognized related to the rental of restaurants we lease or sublease was not impacted by the adoption of Topic 606.

Franchise Contributions for Advertising and Other Services

Advertising Cooperatives

We participate in various advertising cooperatives with our franchisees, typically within a country where we have both Company-owned restaurants and franchise restaurants. These advertising cooperatives are established to collect and administer funds contributed for use in advertising and promotional programs designed to increase sales and enhance the reputation of the Company and its franchise owners. Contributions to the advertising cooperatives are required for both Company-owned and franchise restaurants and are generally based on a percentage of restaurant sales. Revenues for these services are typically billed and paid on a monthly basis. We are required to spend all funds collected by advertising cooperatives we consolidate on advertising and promotional programs. Under Legacy GAAP, receipts and expenditures related to advertising cooperatives we were required to consolidate were presented on a net basis in our Condensed Consolidated Statements of Income. In accordance with the provisions of Topic 606, we have determined we act as a principal in the transactions entered into by the advertising cooperatives we are required to consolidate based on our responsibility to define the nature of the goods or services provided and/or our responsibility to define which franchisees receive the benefit of the goods or services. Additionally, we have determined the advertising services provided to franchisees are highly interrelated with the franchise right and therefore not distinct. Franchisees remit to us a percentage of restaurant sales as consideration for providing the advertising services. As a result, revenues for advertising services are recognized when the related sales occur based on the application of the sales-based royalty exception within Topic 606. These revenues are presented as Franchise contributions for advertising and other services. Expenses incurred to provide these services are presented as Franchise advertising and other services expense.

Other Services

On a much more limited basis, we provide goods or services to certain franchisees that are individually distinct from the franchise right. Such arrangements typically relate to supply chain, quality assurance and information technology services that are provided by a third party at our direction and that do not require integration with other goods or services we provide. The extent to which we provide such goods or services varies by brand, geographic region and, in some instances, franchisee. Similar to advertising services, receipts and expenditures related to these other services were presented on a net basis under Legacy GAAP. Upon adoption of Topic 606, revenues from the goods or services described above are presented as Franchise contributions for advertising and other services within our Condensed Consolidated Statements of Income. Expenses related to the provisioning of these goods and services are recorded in Franchise advertising and other services expense. These revenues are recognized as the goods or services are transferred to the franchisee and related expenses are recognized as incurred.

10




Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue transaction and collected from a customer are excluded from revenue under both Legacy GAAP and Topic 606.

Disaggregation of Total Revenues

The following table disaggregates revenue by Concept and our most significant markets based on Operating Profit. We believe this disaggregation best reflects the extent to which the nature, amount, timing and uncertainty of our revenues and cash flows are impacted by economic factors.
 
Quarter ended 6/30/2018
 
 
KFC Division
 
Pizza Hut Division
 
Taco Bell Division
 
Total
U.S.
 
 
 
 
 
 
 
 
Company sales
 
$
16

 
$
11

 
$
252

 
$
279

Franchise and property revenues
 
45

 
64

 
129

 
238

Franchise contributions for advertising and other services
 
2

 
60

 
97

 
159

 
 
 
 
 
 
 
 
 
China
 
 
 
 
 
 
 
 
Franchise and property revenues
 
49

 
15

 

 
64

 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
Company sales
 
225

 
7

 
1

 
233

Franchise and property revenues
 
216

 
61

 
5

 
282

Franchise contributions for advertising and other services
 
98

 
15

 

 
113

 
 
$
651

 
$
233

 
$
484

 
$
1,368



 
Year to date ended 6/30/2018
 
 
KFC Division
 
Pizza Hut Division
 
Taco Bell Division
 
Total
U.S.
 
 
 
 
 
 
 
 
Company sales
 
$
33

 
$
25

 
$
494

 
$
552

Franchise and property revenues
 
89

 
134

 
251

 
474

Franchise contributions for advertising and other services
 
4

 
125

 
188

 
317

 
 
 
 
 
 
 
 
 
China
 
 
 
 
 
 
 
 
Franchise and property revenues
 
103

 
31

 

 
134

 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
Company sales
 
453

 
17

 
2

 
472

Franchise and property revenues
 
425

 
124

 
11

 
560

Franchise contributions for advertising and other services
 
202

 
28

 

 
230

 
 
$
1,309

 
$
484

 
946

 
$
2,739



Contract Liabilities

Our contract liabilities are comprised of unamortized upfront fees received from franchisees. A summary of significant changes to the contract liability balance during 2018 is presented below.


11



 
 
Deferred Franchise Fees
Balance at January 1, 2018
 
$
392

Revenue recognized that was included in unamortized upfront fees received from franchisees at the beginning of the period
 
(31
)
Increase for upfront fees associated with contracts that became effective during the period, net of amounts recognized as revenue during the period
 
40

Other(a)
 
(7
)
Balance at June 30, 2018
 
$
394



(a)
Includes impact of foreign currency translation as well as the recognition of deferred franchise fees upon the modification of existing franchise agreements when entering into master franchise agreements.

We expect to recognize contract liabilities as revenue over the remaining term of the associated franchise agreement as follows:

Less than 1 year
$
58

 
1 - 2 years
53

 
2 - 3 years
49

 
3 - 4 years
45

 
4 - 5 years
40

 
Thereafter
149

 
Total
$
394

 


We have applied the optional exemption, as provided for under Topic 606, which allows us to not disclose the transaction price allocated to unsatisfied performance obligations when the transaction price is a sales-based royalty.

Note 3 - Earnings Per Common Share (“EPS”)
 
 
Quarter ended
 
Year to date
 
 
2018
 
2017
 
2018
 
2017
Net Income
 
$
321

 
$
206

 
$
754

 
$
486

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (for basic calculation)
 
324


350

 
328

 
354

Effect of dilutive share-based employee compensation
 
7

 
8

 
8

 
7

Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)
 
331


358

 
336


361

 
 
 
 
 
 
 
 
 
Basic EPS
 
$
0.99

 
$
0.59

 
$
2.30

 
$
1.37

 
 
 
 
 
 
 
 
 
Diluted EPS
 
$
0.97

 
$
0.58

 
$
2.25

 
$
1.34

Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a)
 
2.3

 
2.7

 
1.8

 
2.3


(a)
These unexercised employee stock options and stock appreciation rights were not included in the computation of diluted EPS because to do so would have been antidilutive for the periods presented.


Note 4 - Shareholders’ Deficit

Under the authority of our Board of Directors, we repurchased shares of our Common Stock during the years to date ended June 30, 2018 and 2017 as indicated below.  All amounts exclude applicable transaction fees.


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Shares Repurchased (thousands)
 
Dollar Value of Shares Repurchased
 
Remaining Dollar Value of Shares that may be Repurchased
 
 
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
 
November 2016 Authorization
 

 
 
12,462

 
 
$

 
 
$
826

 
 
$

 
 
 
November 2017 Authorization
 
14,147

 
 

 
 
1,171

 
 

 
 
329

 
 
 
Total
 
14,147

(a) 
 
12,462

(b) 
 
$
1,171

(a) 
 
$
826

(b) 
 
$
329

 
 
 
 
 
 
 

(a)
Includes the effect of $3 million in share repurchases (0.03 million shares) with trade dates prior to June 30, 2018, but cash settlement dates subsequent to June 30, 2018.

(b)
Includes the effect of $15 million in share repurchases (0.2 million shares) with trade dates on, or prior to, June 30, 2017, but cash settlement dates subsequent to June 30, 2017 and excludes the effect of $45 million in share purchases (0.7 million shares) with trades dates prior to December 31, 2016, but cash settlement dates subsequent to December 31, 2016.

Changes in AOCI are presented below.
 
 
Translation Adjustments and Gains (Losses) From Intra-Entity Transactions of a Long-Term Nature
 
Pension and Post-Retirement Benefits
 
Derivative Instruments
 
Total
Balance at December 31, 2017, net of tax
 
$
(174
)
 
$
(106
)
 
$
9

 
$
(271
)
 
 
 
 
 
 
 
 
 
Adoption of accounting standards
 
21

(a) 
(17
)
(b) 
(2
)
(b) 
2

 
 
 
 
 
 
 
 
 
OCI, net of tax
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) arising during the period classified into AOCI, net of tax
 
(30
)
 

 
22

 
(8
)
 
 
 
 
 
 
 
 
 
(Gains) losses reclassified from AOCI, net of tax
 

 
8

 
(13
)
 
(5
)
 
 
 
 
 
 
 
 
 
 
 
(30
)
 
8

 
9

 
(13
)
 
 
 
 
 
 
 
 
 
Balance at June 30, 2018, net of tax
$
(183
)
 
$
(115
)
 
$
16

 
$
(282
)


(a)
Represents the impact of foreign currency translation from the adoption of Topic 606. See Notes 2 and 5.

(b)
During the quarter ended March 31, 2018, we adopted a standard that allows for the reclassification from AOCI to Accumulated deficit for stranded tax effects resulting from the Tax Act. See Note 1.

Note 5 - Items Affecting Comparability of Net Income, Financial Position and Cash Flows

Refranchising (Gain) Loss

The Refranchising (gain) loss by reportable segment is presented below. Given the size and volatility of refranchising initiatives, our chief operating decision maker ("CODM") does not consider the impact of Refranchising (gain) loss when assessing segment performance. As such, we do not allocate such gains and losses to our segments for performance reporting purposes.

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During the quarter and year to date ended June 30, 2018, we refranchised 51 restaurants and 195 restaurants, respectively, and received $47 million and $252 million, respectively, in pre-tax proceeds. During the quarter and year to date ended June 30, 2017, we refranchised 244 restaurants and 365 restaurants, respectively, and received $136 million and $321 million, respectively, in pre-tax proceeds.

A summary of Refranchising (gain) loss is as follows:

 
 
Quarter ended
 
Year to date
 
 
2018
 
2017
 
2018
 
2017
KFC Division
 
$
(42
)
 
$
41

 
$
(99
)
 
$
42

Pizza Hut Division
 
13

 
11

 
11

 
13

Taco Bell Division
 

 
(71
)
 
(97
)
 
(185
)
Worldwide
 
$
(29
)
 
$
(19
)
 
$
(185
)
 
$
(130
)


KFC U.S. Acceleration Agreement

During 2015, we reached an agreement with our KFC U.S. franchisees that gave us brand marketing control as well as an accelerated path to expanded menu offerings, improved assets and enhanced customer experience. In connection with this agreement we are investing approximately $130 million from 2015 through 2019 primarily to fund new back-of-house equipment for franchisees and to provide incentives to accelerate franchisee store remodels. Under Legacy GAAP these amounts were expensed as incurred including $5 million and $8 million during the quarter and year to date ended June 30, 2017, respectively. We recorded total pre-tax charges of $115 million, primarily as Franchise and property expenses, during the three year period ended December 31, 2017. Due to their size and unique and long-term brand building nature, as well as their non-recurring impact on KFC Division's results when expensed upfront, our CODM did not consider the impact of these investments when assessing segment performance from 2015 through 2017. As such, prior to 2018 the investments were not allocated to the KFC Division segment operating results for performance reporting purposes.

Upon adoption of Topic 606 in 2018, approximately $100 million of these incentives paid to franchisees from 2015 through 2017 were capitalized, net of amortization of $19 million. These capitalized amounts are being amortized as a reduction to Franchise and property revenues over the period of expected cash flows from the franchise agreements to which the payment relates. Amortization related to both franchise incentive payments that were capitalized upon the adoption of Topic 606 and franchise incentive payments that will be capitalized going forward will be allocated to KFC segment operating results as the expense is recurring and is not expected to significantly impact the comparability of results in any given period. During the quarter and year to date ended June 30, 2018, we recorded a reduction to KFC Division Franchise and property revenues related to the amortization of these franchise incentive payments of $3 million and $5 million, respectively.

In addition to the investments above, we agreed to fund $60 million of incremental system advertising from 2015 through 2018. During the quarters ended June 30, 2018 and 2017, we incurred $3 million and $5 million, respectively, in incremental system advertising expense. During the years to date ended June 30, 2018 and 2017, we incurred $5 million and $9 million, respectively, in incremental system advertising expense. We funded approximately $50 million of such advertising during the three year period ended December 31, 2017, which included $20 million during 2017. We currently expect to fund approximately $10 million in 2018. All of these advertising amounts were recorded primarily in Franchise and property expenses and have been and will continue to be included in the KFC Division segment operating results.

YUM's Strategic Transformation Initiatives

In October 2016, we announced our strategic transformation plans to drive global expansion of the KFC, Pizza Hut and Taco Bell brands ("YUM's Strategic Transformation Initiatives") following the then anticipated separation of our China business on October 31, 2016. Major features of the Company’s strategic transformation plans involve being more focused on the development of our three brands, increasing our franchise ownership and creating a leaner, more efficient cost structure. During the quarters ended June 30, 2018 and 2017, we recognized pre-tax charges of less than $1 million and $4 million, respectively, primarily within G&A, related to these initiatives. During the years to date ended June 30, 2018 and 2017, we recognized pre-tax charges of $1 million and $11 million, respectively, primarily within G&A. These costs primarily related to severance and relocation costs. Due to the scope of the initiatives as well as their significance, our CODM does not consider the impact of these initiatives when assessing

14



segment performance. As such, costs associated with the initiatives are not being allocated to any segment for performance reporting purposes.

Pizza Hut U.S. Transformation Agreement

In May 2017, we reached an agreement with Pizza Hut U.S. franchisees that will improve brand marketing alignment, accelerate enhancements in operations and technology and that includes a permanent commitment to incremental advertising as well as digital and technology contributions by franchisees (the “Transformation Agreement”). In connection with the Transformation Agreement we anticipate investing approximately $90 million to upgrade restaurant equipment to improve operations, fund improvements in restaurant technology and enhance digital and ecommerce capabilities. We currently expect the majority of this investment, which will be a mix of both capital and operating investments, to be split between 2017 and 2018.

We invested $39 million related to the Transformation Agreement in 2017, which included $8 million of investments that we capitalized and $31 million that was expensed primarily as Franchise and property expenses or G&A. The $31 million expense amount included $5 million of franchisee incentive payments that under Legacy GAAP were expensed as incurred. Due to the adoption of Topic 606 in 2018, franchise incentive payments related to the Transformation Agreement are now being capitalized, including the $5 million from 2017 that was capitalized as part of the Topic 606 transition adjustment recorded as of January 1, 2018. These capitalized amounts are being amortized as a reduction to Franchise and property revenues over the period of expected cash flows from the franchise agreements to which the payment relates.

We invested $4 million and $11 million in the quarter and year to date ended June 30, 2018, respectively, related to the Transformation Agreement, primarily consisting of investments that were capitalized.

Due to their unique and long-term brand-building nature as well as their non-recurring impact on Pizza Hut’s Division results, the financial impact of operating investments that are part of the Transformation Agreement are not considered by our CODM when assessing segment performance. As a result, these operating investments are not being allocated to the Pizza Hut Division operating segment results for performance reporting purposes. Depreciation on capital investments is being allocated to Pizza Hut segment results as the expense is recurring and is not expected to significantly impact the comparability of results in any given period. For the same reasons, the amortization related to franchise incentive payments that were capitalized upon the adoption of Topic 606 and amortization related to franchise incentive payments that will be capitalized going forward will be allocated to Pizza Hut segment operating results.

In addition to the investments above, we agreed to fund $37.5 million of incremental system advertising dollars from the second half of 2017 through 2018. During the quarter and year to date ended June 30, 2018, we incurred $2 million and $5 million, respectively, in related incremental system advertising expense. We funded approximately $25 million of such advertising during 2017, which was expensed in the third and fourth quarters of 2017. We currently expect to fund approximately $12.5 million in 2018. These advertising amounts have been and will continue to be recorded primarily in Franchise and property expenses and are included in Pizza Hut's segment operating results.

Modifications of Share-based Compensation Awards

In connection with the separation of our business in China, we modified certain share-based compensation awards held as part of our Executive Income Deferral ("EID") Plan in phantom shares of YUM Common Stock to provide one phantom Yum China share-based award for each outstanding phantom YUM share-based award. These Yum China awards may now be settled in cash, as opposed to stock, which requires recognition of the fair value of these awards within G&A in our Condensed Consolidated Income Statement. During the quarter and year to date ended June 30, 2018 we recorded pre-tax credits related to these awards of $2 million and $1 million, respectively, due to depreciation in the market price of Yum China's stock. During the quarter and year to date ended June 30, 2017, we recorded pre-tax charges related to these awards of $16 million and $18 million, respectively. Given these adjustments were a direct result of the separation, our CODM does not consider their impact when assessing segment performance. As such, these amounts are not being allocated to any of our segment operating results.

Impact of Adopting New Revenue Recognition Standards

As discussed in Note 1, we adopted Topic 606 beginning with the quarter ended March 31, 2018, using the modified retrospective method. Topic 606 was applied to all contracts with customers as of January 1, 2018 and the cumulative effective of this transition was recorded as an adjustment to Accumulated deficit as of this date. As a result, the following adjustments were made to the Condensed Consolidated Balance Sheet as of January 1, 2018:


15



CONDENSED CONSOLIDATED BALANCE SHEET
 
As Reported 12/31/2017
 
Adjustments
 
 
Balances with Adoption of Topic 606 1/1/2018
ASSETS
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
Cash and cash equivalents
$
1,522

 
$
11

 
 
$
1,533

Accounts and notes receivable, net
400

 
112

 
 
512

Prepaid expenses and other current assets
384

 
76

(a) 
 
460

Advertising cooperative assets, restricted
201

 
(201
)
 
 

Total Current Assets
2,507

 
(2
)
 
 
2,505

 
 
 
 
 
 
 
Property, plant and equipment, net
1,697

 
11

 
 
1,708

Goodwill
512

 

 
 
512

Intangible assets, net
110

 

 
 
110

Other assets
346

 
118

 
 
464

Deferred income taxes
139

 
26

 
 
165

Total Assets
$
5,311

 
$
153

 
 
$
5,464

 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
 
 
 
Current Liabilities
 
 
 
 
 
 
Accounts payable and other current liabilities
$
813

 
$
220

 
 
$
1,033

Income taxes payable
123

 

 
 
123

Short-term borrowings
375

 

 
 
375

Advertising cooperative liabilities
201

 
(201
)
 
 

Total Current Liabilities
1,512

 
19

 
 
1,531