Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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. and its subsidiaries (collectively referred to herein as the “Company”, “YUM”, “we”, “us” or “our”) franchise or operate a system of over 58,000 restaurants in more than 155 countries and territories, primarily under the concepts of KFC, Taco Bell, Pizza Hut and The Habit Burger Grill (collectively, the “Concepts”). The Company’s KFC, Taco Bell and Pizza Hut brands are global leaders of the chicken, Mexican-style food and pizza categories, respectively. The Habit Burger Grill is a fast-casual restaurant concept specializing in made-to-order chargrilled burgers, sandwiches and more. Of the over 58,000 restaurants, 98% are operated by franchisees.
As of December 31, 2023, YUM consists of four operating segments:
• The KFC Division which includes our worldwide operations of the KFC concept
• The Taco Bell Division which includes our worldwide operations of the Taco Bell concept
• The Pizza Hut Division which includes our worldwide operations of the Pizza Hut concept
• The Habit Burger Grill Division which includes our worldwide operations of the Habit Burger Grill concept
Through our Recipe for Good Growth 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 unit economics and higher rates of growth. Key enablers include accelerated use of digital and technology and better leverage of our systemwide scale.
Our global citizenship and sustainability strategy is reflected in our Good agenda, which includes our priorities for social responsibility, risk management and sustainable stewardship of our people, food and planet.
Our Growth agenda 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 unit expansion with strong economics and value
We intend to drive long-term growth and shareholder returns primarily through consistent same-store sales growth and new unit development across all of our Concepts. We intend to support this growth and development through a capital and operating structure that:
• Invests capital in a manner consistent with an asset light, franchisor model;
• Allocates G&A in an efficient manner that provides leverage to operating profit growth while at the same time opportunistically investing in strategic growth initiatives;
• Maximize shareholder return through a combination of paying a competitive dividend and returning excess free cash flow through debt paydowns and share repurchases; and
• Targets a consolidated net leverage ratio that balances shareholder returns, cost of capital and flexibility against various risk factors.
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:
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• Same-store sales growth is the estimated percentage change in system sales of all restaurants that have been open and in the YUM system for one year or more (except as noted below), 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. The system sales of restaurants we deem temporarily closed remain in our base for purposes of determining same-store sales growth and the restaurants remain in our unit count (see below). 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 2021, when calculating respective same-store sales growth we also included in our prior year base the sales of stores that were added as a result of our acquisition of The Habit Restaurants, Inc. on March 18, 2020, and that were open for one year or more.
• Gross unit openings reflects new openings by us and our franchisees. Net new unit growth reflects gross unit openings offset by permanent store closures, by us and our franchisees. To determine whether a restaurant meets the definition of a unit we consider factors such as 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 gross unit openings and net new unit growth are useful to investors because we depend on new units for a significant portion of our growth. Additionally, gross unit openings and net new unit growth are generally reflective of the economic returns to us and our franchisees from opening and operating our Concept restaurants.
• System sales and System sales excluding the impacts of foreign currency translation (“FX”) reflect 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. Increasingly, customers are paying a fee to a third party to deliver or facilitate the ordering of our Concepts’ products. We also include in System sales any portion of the amount customers pay these third parties for which the third party is obligated to pay us a license fee as a percentage of such amount. Franchise restaurant sales and fees paid by customers to third parties to deliver or facilitate the ordering of our Concepts’ products are not included in Company sales on the Consolidated Statements of Income; however, any resulting franchise and license fees we receive 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 our primary revenue drivers, Company and franchise same-store sales as well as net unit growth.
As of the beginning of the second quarter of 2022, as a result of our progress towards exiting Russia and our decision to reclass future net profits attributable to Russia subsequent to the date of invasion of Ukraine from the Division segments in which those profits were earned to Unallocated Other income (see Notes 3 and 19), we elected to remove all Russia units from our unit count as well as to begin excluding those units’ associated sales from our system sales totals. We removed 1,112 units and 53 units in Russia from our global KFC and Pizza Hut unit counts, respectively. These units were treated similar to permanent store closures for purposes of our same-store sales calculations and thus they were removed from our same-store sales calculations beginning April 1, 2022.
In addition to the results provided in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”), the Company provides the following non-GAAP measurements.
• Diluted Earnings Per Share excluding Special Items (as defined below);
• Effective Tax Rate excluding Special Items;
• Core Operating Profit. Core Operating Profit excludes Special Items and FX and we use Core Operating Profit for the purposes of evaluating performance internally;
• Company restaurant profit and Company restaurant margin as a percentage of sales (as defined below).
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.
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.
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Company restaurant profit is defined as Company sales less Company restaurant expenses, both of which appear on the face of our Consolidated Statements of Income. Company restaurant expenses include those expenses incurred directly by our Company-owned restaurants in generating Company sales, including cost of food and paper, cost of restaurant-level labor, rent, depreciation and amortization of restaurant-level assets and advertising expenses incurred by and on behalf of that Company restaurant. Company restaurant margin as a percentage of sales (“Company restaurant margin %”) is defined as Company restaurant profit divided by Company sales. We use Company restaurant profit for the purposes of internally evaluating the performance of our Company-owned restaurants and we believe Company restaurant profit provides useful information to investors as to the profitability of our Company-owned restaurants. In calculating Company restaurant profit, the Company excludes revenues and expenses directly associated with our franchise operations as well as non-restaurant-level costs included in General and administrative expenses, some of which may support Company-owned restaurant operations. The Company also excludes restaurant-level asset impairment and closures expenses, which have historically not been significant, from the determination of Company restaurant profit as such expenses are not believed to be indicative of ongoing operations. Company restaurant profit and Company restaurant margin % as presented may not be comparable to other similarly titled measures of other companies in the industry.
Certain performance metrics and 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.
Results of Operations
Summary
All comparisons within this summary are versus the same period a year ago. For discussion of our results of operations for 2022 compared to 2021, 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, 2022, filed with the SEC on February 27, 2023.
2023 financial highlights:
% Change
System Sales,
ex FX Same-Store Sales Units GAAP Operating Profit Core Operating Profit
KFC Division +12 +7 +8 +9 +12
Taco Bell Division +9 +5 +4 +11 +11
Pizza Hut Division +5 +2 +4 +1 +3
Worldwide +10 +6 +6 +6 +12
Additionally:
• Foreign currency translation unfavorably impacted Divisional Operating Profit by $49 million for the year ended December 31, 2023. This included a negative impact to our KFC Division Operating Profit of $41 million for the year ended December 31, 2023.
2023 2022
% Change
GAAP EPS $5.59 $4.57 +23
Special Items EPS
$0.42 $0.04 NM
EPS Excluding Special Items $5.17 $4.53 +14
• Gross unit openings for the year were 4,754 units resulting in 3,349 net new units.
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Worldwide
GAAP Results
Amount % B/(W)
2023 2022 2021 2023 2022
Company sales $ 2,142 $ 2,072 $ 2,106 3 (2)
Franchise and property revenues 3,247 3,096 2,900 5 7
Franchise contributions for advertising and other services 1,687 1,674 1,578 1 6
Total revenues 7,076 6,842 6,584 3 4
Company restaurant expenses $ 1,774 $ 1,745 $ 1,725 (2) (1)
G&A expenses 1,193 1,140 1,060 (5) (8)
Franchise and property expenses 123 123 117 (1) (4)
Franchise advertising and other services expense 1,683 1,667 1,576 (1) (6)
Refranchising (gain) loss (29) (27) (35) NM NM
Other (income) expense 14 7 2 NM NM
Total costs and expenses, net 4,758 4,655 4,445 (2) (5)
Operating Profit 2,318 2,187 2,139 6 2
Investment (income) expense, net (7) (11) (86) NM NM
Other pension (income) expense (6) 9 7 NM NM
Interest expense, net 513 527 544 3 3
Income before income taxes 1,818 1,662 1,674 9 (1)
Income tax provision 221 337 99 35 (242)
Net Income $ 1,597 $ 1,325 $ 1,575 21 (16)
Diluted EPS (a)
$ 5.59 $ 4.57 $ 5.21 23 (12)
Effective tax rate 12.1 % 20.3 % 5.9 % 8.2 ppts. (14.4) ppts.
(a) See Note 4 for the number of shares used in this calculation.
Performance Metrics
% Increase (Decrease)
Unit Count 2023 2022 2021 2023 2022
Franchise 57,691 54,371 52,373 6 4
Company-owned 1,017 990 1,051 3 (6)
Total 58,708 55,361 53,424 6 4
2023 2022 2021
Same-Store Sales Growth (Decline) % 6 4 10
System Sales Growth (Decline) %, reported 8 2 16
System Sales Growth (Decline) %, excluding FX 10 6 13
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Our system sales breakdown by Company and franchise sales was as follows:
Year
2023 2022 2021
Consolidated
Company sales (a)
$ 2,142 $ 2,072 $ 2,106
Franchise sales 61,647 57,211 56,082
System sales 63,789 59,283 58,188
Negative (Positive) Foreign Currency Impact (b)
1,169 2,653 N/A
System sales, excluding FX $ 64,958 $ 61,936 $ 58,188
KFC Division
Company sales (a)
$ 484 $ 491 $ 596
Franchise sales 33,379 30,625 30,769
System sales 33,863 31,116 31,365
Negative (Positive) Foreign Currency Impact (b)
965 2,102 N/A
System sales, excluding FX $ 34,828 $ 33,218 $ 31,365
Taco Bell Division
Company sales (a)
$ 1,069 $ 1,002 $ 944
Franchise sales 14,846 13,651 12,336
System sales 15,915 14,653 13,280
Negative (Positive) Foreign Currency Impact (b)
(3) 52 N/A
System sales, excluding FX $ 15,912 $ 14,705 $ 13,280
Pizza Hut Division
Company sales (a)
$ 14 $ 21 $ 46
Franchise sales 13,301 12,832 12,909
System sales 13,315 12,853 12,955
Negative (Positive) Foreign Currency Impact (b)
207 499 N/A
System sales, excluding FX $ 13,522 $ 13,352 $ 12,955
Habit Burger Grill Division
Company sales (a)
$ 575 $ 558 $ 520
Franchise sales 121 103 68
System sales 696 661 588
Negative (Positive) Foreign Currency Impact (b)
— — N/A
System sales, excluding FX $ 696 $ 661 $ 588
(a) Company sales represents sales from our Company-operated stores as presented on our Consolidated Statements of Income.
(b) 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.
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Non-GAAP Items
Non-GAAP Items, along with the reconciliation to the most comparable GAAP financial measure, are presented below.
2023 2022 2021
Core Operating Profit Growth % 12 5 18
Diluted EPS Growth %, excluding Special Items 14 1 23
Effective Tax Rate excluding Special Items 20.6 % 20.9 % 21.4 %
2023 2022 2021
Company restaurant profit $ 368 $ 327 $ 381
Company restaurant margin % 17.2 % 15.8 % 18.1 %
Year
2023 2022 2021
Reconciliation of GAAP Operating Profit to Core Operating Profit
Consolidated
GAAP Operating Profit $ 2,318 $ 2,187 $ 2,139
Detail of Special Items:
(Gain) loss associated with market-wide refranchisings (a)
5 — 4
Operating (profit) loss impact from decision to exit Russia (b)
11 (44) —
Charges associated with resource optimization (c)
21 11 9
Other Special Items (Income) Expense
2 — 3
Special Items (Income) Expense - Operating Profit
39 (33) 16
Negative (Positive) Foreign Currency Impact on Operating Profit
49 118 N/A
Core Operating Profit $ 2,406 $ 2,272 $ 2,155
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Special Items as shown above were recorded to the financial statement line items identified below:
Year
2023 2022 2021
Consolidated Statement of Income Line Item
General and administrative expenses
$ 28 $ 19 $ 7
Franchise and property expenses
1 6 (1)
Refranchising (gain) loss
5 — 4
Other (income) expense
5 (58) 6
Special Items (Income) Expense - Operating Profit
$ 39 $ (33) $ 16
KFC Division
GAAP Operating Profit $ 1,304 $ 1,198 $ 1,230
Negative (Positive) Foreign Currency Impact
41 98 N/A
Core Operating Profit $ 1,345 $ 1,296 $ 1,230
Taco Bell Division
GAAP Operating Profit $ 944 $ 850 $ 758
Negative (Positive) Foreign Currency Impact
— 2 N/A
Core Operating Profit $ 944 $ 852 $ 758
Pizza Hut Division
GAAP Operating Profit $ 391 $ 387 $ 387
Negative (Positive) Foreign Currency Impact
8 18 N/A
Core Operating Profit $ 399 $ 405 $ 387
Habit Burger Grill Division
GAAP Operating Profit (Loss) $ (14) $ (24) $ 2
Negative (Positive) Foreign Currency Impact
— — N/A
Core Operating Profit (Loss) $ (14) $ (24) $ 2
Reconciliation of GAAP Net Income to Net Income excluding Special Items
GAAP Net Income
$ 1,597 $ 1,325 $ 1,575
Special Items (Income) Expense - Operating Profit
39 (33) 16
Special Items (Income) Expense - Interest Expense, net (d)
— 28 34
Special Items (Income) Expense - Other Pension Income
— — (1)
Special Items Tax (Benefit) Expense (e)
(161) (8) (270)
Net Income excluding Special Items
$ 1,475 $ 1,312 $ 1,354
Reconciliation of Diluted EPS to Diluted EPS excluding Special Items
Diluted EPS $ 5.59 $ 4.57 $ 5.21
Less Special Items Diluted EPS
0.42 0.04 0.73
Diluted EPS excluding Special Items $ 5.17 $ 4.53 $ 4.48
Reconciliation of GAAP Effective Tax Rate to Effective Tax Rate, excluding Special Items
GAAP Effective Tax Rate 12.1 % 20.3 % 5.9 %
Impact on Tax Rate as a result of Special Items (8.5) % (0.6) % (15.5) %
Effective Tax Rate excluding Special Items 20.6 % 20.9 % 21.4 %
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(a) Due to their size and volatility, we have reflected as Special Items those refranchising gains and losses that were recorded in connection with market-wide refranchisings. During the years ended December 31, 2023 and 2021, we recorded net refranchising losses of $5 million and $4 million, respectively, that have been reflected as Special Items.
Additionally, during the years ended December 31, 2023, 2022 and 2021, we recorded net refranchising gains of $34 million, $27 million and $39 million, respectively, that have not been reflected as Special Items. These net refranchising gains relate to refranchising of restaurants unrelated to market-wide refranchisings that we believe are indicative of our expected ongoing refranchising activity.
(b) In the first quarter of 2022, as a result of the Russian invasion of Ukraine, we suspended all investment and restaurant development in Russia. We also suspended all operations of our 70 company-owned KFC restaurants in Russia and began finalizing an agreement to suspend all Pizza Hut operations in Russia, in partnership with our master franchisee. Further, we pledged to redirect any future net profits attributable to Russia subsequent to the date of invasion to humanitarian efforts. During the second quarter of 2022, we completed the transfer of ownership of the Pizza Hut Russia business to a local operator. In the second quarter of 2023, we completed our exit from the Russia market by selling the KFC business in Russia.
Our GAAP operating results presented herein reflect revenues from and expenses to support the Russian operations for KFC and Pizza Hut prior to the dates of sale or transfer, within their historical financial statement line items and operating segments. However, given our decision to exit Russia and our pledge to direct any future net profits attributable to Russia subsequent to the date of invasion to humanitarian efforts, we reclassed such net operating profits or losses from the Division segment results in which they were earned to Unallocated Other income (expense). Additionally, we incurred certain expenses related to the dispositions of the businesses and other one-time costs related to our exit from Russia which we recorded within Corporate and unallocated G&A and Unallocated Franchise and property expenses. Also recorded in Unallocated Other income (expense) were foreign exchange impacts attributable to fluctuations in the value of the Russian ruble and a charge of $3 million recorded during the year ended December 31, 2023, as a result of the completion of the sale of the KFC Russia business. The resulting net Operating Loss of $11 million for the year ended December 31, 2023, and net Operating Profit of $44 million for the year ended December 31, 2022, have been reflected as Special Items.
(c) Charges related to a resource optimization program initiated in the third quarter of 2020. See Note 5. Due to their scope and size, the charges over the life of the program, which have primarily resulted from severance associated with positions that have been eliminated or relocated and consultant fees, are being recorded as Special Items.
(d) Amounts recorded in connection with redemptions of long-term debt. See Note 5. Due to their size and the fact that they are not indicative of our ongoing interest expense, these amounts have been reflected as Special Items.
(e) The below table includes the detail of Special Items Tax (Benefit) Expense:
Year
2023 2022 2021
Tax (Benefit) Expense on Special Items Operating Profit and Interest Expense $ (8) $ 2 $ (11)
Tax (Benefit) Expense - Other Income tax impacts from decision to exit Russia
(7) 72 —
Tax (Benefit) - Intra-entity transfers and valuations of intellectual property
(183) (82) (251)
Tax Expense - Other Income tax impacts recorded as Special
37 — (8)
Special Items Tax (Benefit) Expense $ (161) $ (8) $ (270)
Tax (Benefit) Expense on Special Items Operating Profit and Interest Expense was determined by assessing the tax impact of each individual component within Special Items based upon the nature of the item and jurisdictional tax law.
In addition to the corresponding Tax (Benefit) Expense on the Operating (Profit) Loss impact from our decision to exit Russia as included above, Special Items Tax (Benefit) Expense also includes $72 million of incremental net tax expense recorded in the year ended December 31, 2022 from the remeasurement and reassessment of the need for a valuation allowance on deferred tax assets in Switzerland due to the expected reduction in the tax basis of intellectual property rights ("IP") associated with the loss of the Russian royalty income. In addition, we reassessed certain deferred tax liabilities associated with the Russia business given the expectation that the existing basis difference would reverse by way of sale.
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Special Items Tax (Benefit) Expense includes $183 million, $82 million and $251 million of tax benefit recorded in the years ended December 31, 2023, 2022 and 2021 respectively, associated with intra-entity transfers and valuations of certain IP rights.
• The benefit recorded in the year ended December 31, 2023, resulted primarily from $99 million of deferred tax benefit arising from the remeasurement of deferred tax assets associated with previously transferred IP rights in Switzerland as a result of an increase in our jurisdictional tax rate, as well as a $29 million deferred tax benefit associated with credits granted by local Swiss tax authorities. The benefit recorded in the year ended December 31, 2023, also includes $30 million of deferred tax benefit associated with the intra-entity transfer of certain Asia region IP rights to Singapore or the U.S.
• The benefit recorded in the year ended December 31, 2022, resulted from the remeasurement of deferred tax assets associated with IP rights held in Switzerland in connection with an annual valuation under Swiss law, as well as the reassessment of the need for a valuation allowance on those deferred tax assets based on forecasted future taxable income. The annual valuation supported an increase to tax basis of Swiss IP rights associated with parts of our business that continue to use these IP rights due to expected royalty growth assumptions in those parts of the business that largely offset the loss of Russia royalty income associated with such IP rights as a result of our decision to exit the Russia market.
• The benefit recorded in the year ended December 31, 2021, resulted primarily from $187 million of tax benefit as a result of concentration of management responsibility for European (excluding the UK) KFC franchise development, support operations and management oversight in Switzerland. Concurrent with this change in management responsibility, we completed intra-entity transfers of certain KFC IP rights from subsidiaries in the UK to subsidiaries in Switzerland, and later, additional European IP rights from subsidiaries in the U.S. to subsidiaries in Switzerland. With the transfers of these rights, we received a step-up in amortizable basis of those IP rights to current fair value under Swiss law. The benefit recorded in the year ended December 31, 2021, also includes $64 million of benefit resulting from the remeasurement of deferred tax assets associated with previously transferred IP rights in the UK as a result of an increase in our jurisdictional tax rate.
Other Income Tax impacts recorded as Special in the year ended December 31, 2023 include $41 million of expense associated with a correction in the timing of capital loss utilization related to refranchising gains previously recorded as Special Items to tax years with a lower statutory tax rate.
Reconciliation of GAAP Operating Profit to Company Restaurant Profit
2023
KFC Division Taco Bell Division Pizza Hut Division Habit Burger Grill Division Corporate and Unallocated Consolidated
GAAP Operating Profit (Loss) $ 1,304 $ 944 $ 391 $ (14) $ (307) $ 2,318
Less:
Franchise and property revenues 1,698 918 622 9 — 3,247
Franchise contributions for advertising and other services 648 654 383 2 — 1,687
Add:
General and administrative expenses 383 204 221 59 326 1,193
Franchise and property expenses 72 32 15 3 1 123
Franchise advertising and other services expense 648 644 389 2 — 1,683
Refranchising (gain) loss — — — — (29) (29)
Other (income) expense 6 — (11) 10 9 14
Company restaurant profit $ 67 $ 252 $ — $ 49 — $ 368
Company sales $ 484 $ 1,069 $ 14 $ 575 — $ 2,142
Company restaurant margin % 13.7 % 23.7 % 0.1 % 8.5 % N/A 17.2 %
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2022
KFC Division Taco Bell Division Pizza Hut Division Habit Burger Grill Division Corporate and Unallocated Consolidated
GAAP Operating Profit (Loss) $ 1,198 $ 850 $ 387 $ (24) $ (224) $ 2,187
Less:
Franchise and property revenues 1,645 837 607 7 — 3,096
Franchise contributions for advertising and other services 698 598 376 2 — 1,674
Add:
General and administrative expenses 390 191 211 51 297 1,140
Franchise and property expenses 69 33 13 2 6 123
Franchise advertising and other services expense 684 599 382 2 — 1,667
Refranchising (gain) loss — — — — (27) (27)
Other (income) expense 67 (2) (10) 4 (52) 7
Company restaurant profit $ 65 $ 236 $ — $ 26 $ — $ 327
Company sales $ 491 $ 1,002 $ 21 $ 558 $ — $ 2,072
Company restaurant margin % 13.2 % 23.6 % (2.2) % 4.7 % N/A 15.8 %
2021
KFC Division Taco Bell Division Pizza Hut Division Habit Burger Grill Division Corporate and Unallocated Consolidated
GAAP Operating Profit (Loss) $ 1,230 $ 758 $ 387 $ 2 $ (238) $ 2,139
Less:
Franchise and property revenues 1,557 742 597 4 — 2,900
Franchise contributions for advertising and other services 640 552 385 1 — 1,578
Add:
General and administrative expenses 377 174 201 48 260 1,060
Franchise and property expenses 74 33 11 — (1) 117
Franchise advertising and other services expense 627 553 395 1 — 1,576
Refranchising (gain) loss — — — — (35) (35)
Other (income) expense (5) 1 (9) 1 14 2
Company restaurant profit $ 106 $ 225 $ 3 $ 47 $ — $ 381
Company sales $ 596 $ 944 $ 46 $ 520 $ — $ 2,106
Company restaurant margin % 17.7 % 23.9 % 6.8 % 9.0 % N/A 18.1 %
Items Impacting Reported Results and/or Reasonably Likely to Impact Future Results
The following items impacted reported results in 2023 and/or 2022 and/or are reasonably likely to impact future results. See also the Detail of Special Items section of this MD&A for other items similarly impacting results.
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Middle East Conflict
During the fourth quarter of 2023, certain of our markets, principally in our KFC and Pizza Hut Divisions, began being impacted by a military conflict in the Middle East region. As a result, our sales were impacted to varying degrees in markets across the Middle East, Malaysia and Indonesia. This represented a low single-digit headwind to fourth-quarter same-store sales growth. This trend has continued into the first quarter of 2024, and we expect the sales impact to decrease over the course of 2024.
Impact of Foreign Currency Translation on Operating Profit
Changes in foreign currency exchange rates negatively impacted the translation of our foreign currency denominated Divisional Operating Profit by $49 million for the year ended December 31, 2023. This included a negative impact to our KFC Division Operating Profit of $41 million for the year ended December 31, 2023. For 2024, we currently expect changes in foreign currency to negatively impact Divisional Operating Profit by approximately $10 to $30 million, primarily in the first half of the year.
Investment in Devyani
In 2020, we received an approximate 5% minority interest in Devyani International Limited (“Devyani”), an entity that owns our KFC India and Pizza Hut India master franchisee rights. The minority interest was received in lieu of cash proceeds upon the refranchising of approximately 60 KFC restaurants in India. On August 16, 2021, Devyani executed an initial public offering and subsequently the fair value of this investment became readily determinable. As a result, concurrent with the initial public offering we began recording changes in fair value in Investment (income) expense, net in our Consolidated Statements of Income and recognized pre-tax investment income of $8 million and $11 million in the years ended December 31, 2023 and 2022, respectively.
KFC Division
The KFC Division has 29,900 units, 87% of which are located outside the U.S. Additionally, 99% of the KFC Division units were operated by franchisees as of the end of 2023.
% B/(W) % B/(W)
2023 2022
2023 2022 2021 Reported Ex FX Reported Ex FX
System Sales $ 33,863 $ 31,116 $ 31,365 9 12 (1) 6
Same-Store Sales Growth (Decline) % 7 % 4 % 11 % N/A N/A N/A N/A
Company sales $ 484 $ 491 $ 596 (2) 2 (18) (11)
Franchise and property revenues 1,698 1,645 1,557 3 6 6 12
Franchise contributions for advertising and other services 648 698 640 (7) (6) 9 16
Total revenues $ 2,830 $ 2,834 $ 2,793 — 2 1 8
Company restaurant profit $ 67 $ 65 $ 106 2 7 (39) (33)
Company restaurant margin % 13.7 % 13.2 % 17.7 % 0.5 ppts. 0.6 ppts. (4.5) ppts. (4.4) ppts.
G&A expenses $ 383 $ 390 $ 377 2 2 (3) (6)
Franchise and property expenses 72 69 74 (5) (6) 7 (3)
Franchise advertising and other services expense 648 684 627 5 4 (9) (15)
Operating Profit $ 1,304 $ 1,198 $ 1,230 9 12 (3) 5
40
% Increase (Decrease)
Unit Count 2023 2022 2021 2023 2022
Franchise 29,680 27,541 26,643 8 3
Company-owned 220 219 291 — (25)
Total 29,900 27,760 26,934 8 3
Company sales and Company restaurant margin %
In 2023, the increase in Company sales, excluding the impact of foreign currency translation, was driven by Company same-store sales growth of 5%, partially offset by the suspension of operations of our 70 company owned KFC restaurants in Russia.
In 2023, the increase in Company restaurant margin percentage was driven by Company same-store sales growth, partially offset by commodity inflation.
Franchise and property revenues
In 2023, the increase in Franchise and property revenues, excluding the impact of foreign currency translation, was driven by franchise same-store sales growth of 7% and unit growth, partially offset by a 5% negative impact from the sale of our KFC Russia business.
G&A
In 2023, the decrease in G&A, excluding the impact of foreign currency translation, was driven by the impact of the sale of our KFC Russia business, partially offset by higher headcount and salaries, and higher expenses related to our annual incentive compensation programs.
Operating Profit
In 2023, the increase in Operating Profit, excluding the impact of foreign currency translation, was driven by same-store sales growth and unit growth, partially offset by higher restaurant operating costs and the negative impact of 1 percentage point on operating profit growth as a result of lower profits in Russia.
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Taco Bell Division
The Taco Bell Division has 8,564 units, 86% of which are in the U.S. The Company owned 7% of the Taco Bell units in the U.S. as of the end of 2023.
% B/(W) % B/(W)
2023 2022
2023 2022 2021 Reported Ex FX Reported Ex FX
System Sales $ 15,915 $ 14,653 $ 13,280 9 9 10 11
Same-Store Sales Growth (Decline) % 5 % 8 % 11 % N/A N/A N/A N/A
Company sales $ 1,069 $ 1,002 $ 944 7 7 6 6
Franchise and property revenues 918 837 742 10 10 13 13
Franchise contributions for advertising and other services 654 598 552 9 9 8 8
Total revenues $ 2,641 $ 2,437 $ 2,238 8 8 9 9
Company restaurant profit $ 252 $ 236 $ 225 7 7 5 5
Company restaurant margin % 23.7 % 23.6 % 23.9 % 0.1 ppts. 0.1 ppts. (0.3) ppts. (0.3) ppts.
G&A expenses $ 204 $ 191 $ 174 (7) (7) (9) (10)
Franchise and property expenses 32 33 33 4 4 1 —
Franchise advertising and other services expense 644 599 553 (7) (7) (8) (8)
Operating Profit $ 944 $ 850 $ 758 11 11 12 12
% Increase (Decrease)
Unit Count 2023 2022 2021 2023 2022
Franchise 8,081 7,754 7,329 4 6
Company-owned 483 464 462 4 —
Total 8,564 8,218 7,791 4 5
Company sales and Company restaurant margin %
In 2023, the increase in Company sales was driven by company same-store sales growth of 5% and unit growth partially offset by refranchising.
In 2023, the increase in Company restaurant margin percentage was driven by same-store sales growth partially offset by higher labor costs, commodity inflation and increases in other restaurant operating costs.
Franchise and property revenues
In 2023, the increase in Franchise and property revenues was driven by franchise same-store sales growth of 6% and unit growth.
G&A
In 2023, the increase in G&A was driven by higher digital and technology expenses and higher headcount and salaries, partially offset by lower expenses related to our annual incentive compensation programs.
Operating Profit
In 2023, the increase in Operating Profit was driven by same-store sales growth and unit growth partially offset by higher restaurant operating costs and higher G&A.
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Pizza Hut Division
The Pizza Hut Division has 19,866 units, 67% of which are located outside the U.S. Over 99% of the Pizza Hut Division units were operated by franchisees as of the end of 2023. The Pizza Hut Division uses multiple distribution channels including delivery, dine-in and express (e.g. airports) and includes units operating under both the Pizza Hut and Telepizza brands.
% B/(W) % B/(W)
2023 2022
2023 2022 2021 Reported Ex FX Reported Ex FX
System Sales $ 13,315 $ 12,853 $ 12,955 4 5 (1) 3
Same-Store Sales Growth (Decline) % 2 Even 7 % N/A N/A N/A N/A
Company sales $ 14 $ 21 $ 46 (33) (33) (55) (55)
Franchise and property revenues 622 607 597 3 4 2 5
Franchise contributions for advertising and other services 383 376 385 2 2 (2) (1)
Total revenues $ 1,019 $ 1,004 $ 1,028 1 2 (2) —
Company restaurant profit $ — $ — $ 3 NM NM NM NM
Company restaurant margin % 0.1 % (2.2) % 6.8 % 2.3 ppts. 2.3 ppts. (9.0) ppts. (9.0) ppts.
G&A expenses $ 221 $ 211 $ 201 (5) (5) (5) (7)
Franchise and property expenses 15 13 11 (16) (15) (23) (25)
Franchise advertising and other services expense 389 382 395 (2) (2) 3 2
Operating Profit $ 391 $ 387 $ 387 1 3 Even 4
% Increase (Decrease)
Unit Count 2023 2022 2021 2023 2022
Franchise 19,859 19,013 18,359 4 4
Company-owned 7 21 22 (67) (5)
Total 19,866 19,034 18,381 4 4
Franchise and property revenues
In 2023, the increase in Franchise and property revenues, excluding the impacts of foreign currency translation, was driven by unit growth and franchise same-store sales growth of 2%, partially offset by lapping the prior year recognition of franchise fees related to unexercised development rights arising from a master franchise agreement.
G&A
In 2023, the increase in G&A, excluding the impacts of foreign currency translation, was driven by higher headcount and salaries, higher professional fees and higher travel related expenses.
Operating Profit
In 2023, the increase in Operating Profit, excluding the impacts of foreign currency translation, was driven by unit growth and same-store sales growth, partially offset by higher G&A and lapping the prior year recognition of franchise fees related to unexercised development rights arising from a master franchise agreement.
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Habit Burger Grill Division
The Habit Burger Grill Division has 378 units, the vast majority of which are in the U.S. The Company owned 84% of the Habit Burger Grill units in the U.S. as of December 31, 2023.
% B/(W) % B/(W)
2023 2022
2023
2022
2021 Reported Ex FX Reported Ex FX
System Sales $ 696 $ 661 $ 588 6 6 12 12
Same-Store Sales Growth (Decline) % (3) % (1) % 16 % N/A N/A N/A N/A
Total revenues $ 586 $ 567 $ 525 3 3 8 8
Operating Profit (Loss) $ (14) $ (24) $ 2 42 42 NM NM
% Increase (Decrease)
Unit Count 2023
2022
2021 2023
2022
Franchise 71 63 42 13 50
Company-owned 307 286 276 7 4
Total 378 349 318 8 10
Corporate & Unallocated
% B/(W)
(Expense)/Income 2023 2022 2021 2023 2022
Corporate and unallocated G&A $ (326) $ (297) $ (260) (10) (14)
Unallocated Franchise and property income (expense)
(1) (6) 1 NM
NM
Unallocated Refranchising gain (loss) (See Note 5)
29 27 35 NM NM
Unallocated Other income (expense) (9) 52 (14) NM NM
Investment income (expense), net (See Note 5)
7 11 86 NM NM
Other pension income (expense) (See Note 15)
6 (9) (7) NM NM
Interest expense, net (513) (527) (544) 3 3
Income tax provision (See Note 18)
(221) (337) (99) 35 (242)
Effective tax rate (See Note 18)
12.1 % 20.3 % 5.9 % 8.2 ppts. (14.4) ppts.
Corporate and unallocated G&A
In 2023, the increase in Corporate and Unallocated G&A expenses was driven by higher costs associated with our resource optimization program, higher current year expenses related to our annual incentive compensation programs and costs associated with the previously disclosed January 2023 ransomware attack.
Unallocated Other income (expense)
Unallocated Other income (expense) for the year ended December 31, 2022, includes Russia net operating profits of $44 million reclassed from KFC and Pizza Hut Division Other income due to our decision to exit Russia (see Note 19).
Interest expense, net
The decrease in Interest expense, net for 2023 was primarily driven by lapping $28 million of expense in the prior year relating to the call premium and unamortized debt issuance costs written-off associated with the redemption of the 2025 Notes (as discussed in our 2022 Form 10-K) and higher interest income. This was partially offset by a higher weighted average interest rate.
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Consolidated Cash Flows
Net cash provided by operating activities was $1,603 million in 2023 versus $1,427 million in 2022. The increase was largely driven by an increase in Operating profit and a decrease in incentive compensation payments, partially offset by higher tax payments.
Net cash used in investing activities was $107 million in 2023 versus $202 million in 2022. The change was primarily driven by proceeds from the current year sale of KFC Russia, partially offset by lower refranchising proceeds.
Net cash used in financing activities was $1,429 million in 2023 versus $1,323 million in 2022. The change was primarily driven by lower net borrowings, partially offset by lower current year share repurchases.
Liquidity and Capital Resources
We have historically generated substantial cash flows from our extensive franchise operations, which require a limited YUM investment, and from the operations of our Company-owned stores. Our annual operating cash flows have been in excess of $1.3 billion in each of the past five years and we expect that to continue to be the case in 2024. It is our intent to use these operating cash flows to continue to invest in growing our business and pay a competitive dividend, with any remaining excess then returned to shareholders through debt paydowns and share repurchases. To the extent operating cash flows plus other sources of cash do not cover our anticipated cash needs, we maintain a $1.25 billion Revolving Facility under our Credit Agreement (see Note 11) that was undrawn as of December 31, 2023. We believe that our ongoing cash from operations, cash on hand, which was approximately $500 million at December 31, 2023, and availability under our Revolving Facility will be sufficient to fund our cash requirements over the next twelve months.
Our material cash requirements include the following contractual and other obligations.
Debt Obligations and Interest Payments
As of December 31, 2023, approximately 94%, including the impact of interest rate swaps, of our $11.2 billion of total debt outstanding, excluding finance leases and debt issuance costs and discounts, is fixed with an effective overall interest rate of approximately 4.6%. We ended 2023 with a consolidated net leverage ratio of 4.2x EBITDA . We continually reassess our optimal leverage ratio to maximize shareholder returns. We target a capital structure 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 currently have credit ratings of BB (Standard & Poor’s)/Ba2 (Moody’s).
The following table summarizes the future maturities of our outstanding long-term debt, excluding finance leases and debt issuance costs and discounts, as of December 31, 2023.
2024 2025 2026 2027 2028 2029 2030 2031 2032 2037 2043 Total
Securitization Notes $ 938 $ 884 $ 595 $ 589 $ 737 $ 3,743
Credit Agreement $ 48 $ 53 661 15 1,399 2,176
Subsidiary Senior Unsecured Notes 750 750
YUM Senior Unsecured Notes $ 800 1,050 $ 2,100 $ 325 $ 275 4,550
Total $ 48 $ 53 $ 1,599 $ 1,649 $ 1,994 $ 589 $ 800 $ 1,787 $ 2,100 $ 325 $ 275 $ 11,219
Interest payments on the outstanding long-term debt in the table above total approximately $3.1 billion, with approximately $500 million due within the next twelve months on the outstanding amounts on a nominal basis. The estimated interest payments related to the variable rate portion of our debt, net of our interest rate swaps, are based on current Secured Overnight Financing Rate (“SOFR”) interest rates.
See Note 11 for details on the Securitization Notes, the Credit Agreement, Subsidiary Senior Unsecured Notes and YUM Senior Unsecured Notes.
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Operating and Finance Leases
Payments required under our operating and finance leases total $1,163 million, of which $128 million is payable within the next 12 months. These amounts are on a nominal basis and include payments related to lease renewal options we are reasonably certain to exercise. These leases relate primarily to approximately 700 Company-owned restaurants and approximately 250 leased restaurants for which we sublease land, building or both to our franchisees. See Note 12.
Investing Activities
We remain committed to maintaining our asset light, franchisor model that includes at least a 98% franchise mix. Our allocation strategy for investing activities includes:
• Run-rate capital expenditures consisting of company restaurant repairs, maintenance and remodels, support of our digital and technology initiatives and project-specific capital expenditures,
• Targeted new company unit development to spur additional growth that is largely funded through refranchising a comparable number of existing company units, and
• Strategic investments that create incremental value for shareholders and franchisees.
In 2024, we expect that company store investments will exceed refranchising proceeds by $85 to $95 million, primarily driven by our strategy to accelerate growth of Habit Burger Grill company units and continued investments in Taco Bell company restaurants. This will result in net capital expenditures of approximately $275 million, reflecting up to $315 million of gross capital expenditures and $40 million of refranchising proceeds.
Additionally, on December 6th, 2023, the Company announced that it had entered into a definitive agreement to acquire 218 KFC restaurants in the U.K. and Ireland from a franchisee. The transaction will be funded from the Company’s cash on hand and is expected to close early in 2024.
Purchase Obligations
Our 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. Our purchase obligations relate primarily to marketing, information technology and supply agreements. We have purchase obligations of approximately $425 million at December 31, 2023, with approximately $250 million due within the next 12 months.
In addition to our contractual and other obligations, we seek to pay a competitive dividend and return excess cash to shareholders through share repurchases. As discussed in Note 20, we are also subject to claims and contingencies related to certain tax and legal matters that may require future cash outlays.
Dividends and Share Repurchases
In January 2024, our Board of Directors declared a dividend of $0.67 per share of Common Stock, a 11% increase from the quarterly dividend of $0.605 per share of Common Stock paid in 2023. This quarterly dividend will be distributed March 8, 2024, to shareholders of record at the close of business on February 21, 2024, and will total approximately $190 million.
In September 2022, our Board of Directors authorized share repurchases of up to $2 billion (excluding applicable transaction fees) of our outstanding Common Stock through June 30, 2024. This authorization took effect during the fourth quarter of 2022 upon the exhaustion of a prior authorization approved in May 2021. As of December 31, 2023, we have remaining capacity to repurchase up to $1.7 billion of Common Stock under the September 2022 authorization. This authorization does not obligate the Company to acquire any specific number of shares.
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Contingencies
As discussed in Note 20, as a result of an audit by the Internal Revenue Service (“IRS”) for fiscal years 2013 through 2015, in August 2022, we received a Revenue Agent’s Report (“RAR”) from the IRS asserting an underpayment of tax of $2.1 billion plus $418 million in penalties for the 2014 fiscal year. Additionally, interest on the underpayment is estimated to be approximately $1.1 billion through December 31, 2023. The proposed underpayment relates primarily to a series of reorganizations we undertook during that year in connection with the business realignment of our corporate and management reporting structure along brand lines. The IRS asserts that these transactions resulted in taxable distributions of approximately $6.0 billion.
We disagree with the IRS’s position as asserted in the RAR and intend to contest that position vigorously. In September 2022, we filed a Protest with the IRS Examination Division disputing on multiple grounds the proposed underpayment of tax and penalties. We have received the IRS Examination Division’s Rebuttal to our Protest and the case has been accepted by the IRS Office of Appeals.
Also, as discussed in Note 20, on January 29, 2020, we received an order from the Special Director of the Directorate of Enforcement (“DOE”) in India imposing a penalty on Yum! Restaurants India Private Limited (“YRIPL”) of approximately Indian Rupee 11 billion, or approximately $135 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 have filed a writ petition with the Delhi High Court, which granted an interim stay of the penalty order on March 5, 2020. In November 2022, YRIPL was notified that an administrative tribunal bench had been constituted to hear an appeal by DOE of certain findings of the January 2020 order, including claims that certain charges had been wrongly dropped and that an insufficient amount of penalty had been imposed. A hearing with the administrative tribunal that had been scheduled for December 4, 2023 has been rescheduled to March 4, 2024. The stay order remains in effect, and the next hearing in the Delhi High Court that had been scheduled for December 14, 2023 has been rescheduled to March 21, 2024. We deny liability and intend to continue vigorously defending this matter.
See the Lease Guarantees section of Note 20 for discussion of our off-balance sheet arrangements.
New Accounting Pronouncements Not Yet Adopted
In November 2023, the Financial Accounting Standards Board ("FASB") issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which updates reportable segment disclosure requirements through enhanced disclosures about significant segment expenses. The standard is effective for the Company's Annual Report on Form 10-K for fiscal 2024, and subsequent interim periods, with early adoption permitted. The amendments should be applied retrospectively to all prior periods presented in the financial statements. We are currently evaluating the impact of the standard on our disclosures.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which updates income tax disclosure requirements related to the income tax rate reconciliation and requires disclosure of income taxes paid by jurisdiction. The standard is effective for the Company's Annual Report on Form 10-K for fiscal 2025 with early adoption permitted. The amendments should be applied prospectively; however, retrospective application is permitted. We are currently evaluating the impact of the standard on our disclosures.
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 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 use two consecutive years of operating losses as our primary indicator of potential impairment for our annual impairment testing of these restaurant
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assets. 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.
Fair value is an estimate of the price a franchisee would pay for the restaurant and its related assets, including any right-of-use assets, and is determined by discounting the estimated future after-tax cash flows of the restaurant, which include a deduction for royalties we would receive under a franchise agreement with terms substantially at market. The after-tax cash flows incorporate reasonable sales growth and margin improvement assumptions as well as expectations as to the useful lives of the restaurant assets that would be used by a franchisee in the determination of a purchase price for the restaurant.
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 similar assumptions to those of a restaurant level assessment.
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.
Estimates of future cash flows are highly subjective judgments and can be significantly impacted by changes in the business or economic conditions. We formulate these estimates in consideration of historical experience, recent economic and industry trends, and competitive conditions. If our estimates or underlying assumptions, including the discount rate, change, we may experience higher impairment charges in the future.
We evaluate indefinite-lived intangible assets 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. Fair value is an estimate of the price a willing buyer would pay for the intangible asset and is generally estimated by discounting the expected future after-tax cash flows associated with the intangible asset. Our most significant indefinite-lived intangible asset is our Habit Burger Grill brand asset with a book value of $96 million at December 31, 2023. As of our fourth quarter 2023 annual impairment testing date, the fair values of all of our indefinite-lived intangible assets were in excess of their respective carrying values and no impairment was recorded.
Impairment of Goodwill
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 our KFC, Taco Bell, Pizza Hut and Habit Burger Grill 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-store 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 in excess of their respective carrying values as of our fourth quarter 2023 goodwill testing date, with all but the Habit Burger Grill reporting unit having fair values that were substantially in excess of their respective carrying values. As it relates to our Habit Burger Grill reporting unit, which includes a goodwill balance of $66 million as of the end of 2023, the assumptions that are most impactful to our fair value estimate include margin improvement, sales growth from net new units and same-store sales growth. Significant changes in the
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assumptions used in our analysis could result in a future goodwill impairment charge. Circumstances that could result in changes to our assumptions and related fair value estimate include, but are not limited to, expectations of lower than originally estimated margin improvement, which can be caused by a variety of factors including changes in expected labor costs and commodity inflation.
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. The fair value of the reporting unit retained is based on the price a willing buyer would pay for the reporting unit retained and includes the value of franchise agreements. Appropriate adjustments are made to the fair value determinations if such franchise agreement is determined to not be at prevailing market rates. As such, the fair value of the reporting unit retained can include expected future cash flows from royalties from those restaurants currently being refranchised, royalties from existing franchise businesses and retained company restaurant operations. As a result, the percentage of a reporting unit’s goodwill that will be written off in a refranchising transaction will be less than the percentage of the reporting unit’s Company-owned restaurants that are refranchised in that transaction and goodwill can be allocated to a reporting unit with only franchise restaurants. 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 2023, refranchising activity completed by the Company was limited and the write-off of goodwill associated with these transactions was less than $1 million.
Pension Plans
Certain of our employees are covered under defined benefit pension plans. Our two most significant plans are in the U.S. and combined had a projected benefit obligation (“PBO”) of $778 million and a fair value of plan assets of $680 million at December 31, 2023.
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 our U.S. plans, we measured our PBOs using a discount rate of 5.60% at December 31, 2023. 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 or Standard & 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 these U.S. plans’ PBOs by approximately $40 million at our measurement date. Conversely, a 50 basis-point decrease in this discount rate would have increased our U.S. plans’ PBOs by approximately $45 million at our measurement date.
The net periodic benefit cost we will record in 2024 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 income for our U.S. plans of $3 million in 2024 compared to $4 million of periodic benefit income in 2023, which represents a decrease in
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benefit of $1 million year-over-year. A 50 basis-point change in our discount rate assumption at our 2023 measurement date would impact our 2024 U.S. net periodic benefit cost by approximately $5 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 on U.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 on U.S. plan assets, for purposes of determining 2024 pension expense, at December 31, 2023, was 6.35%, 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 2024 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 6.35% will impact our unrecognized pre-tax actuarial net loss by approximately $8 million.
We have an unrecognized pre-tax actuarial net loss of $84 million included in Accumulated other comprehensive income for these U.S. plans at December 31, 2023. We will recognize approximately $1 million of loss in net periodic benefit cost in 2024 versus $1 million of gain recognized in 2023.
Income Taxes
At December 31, 2023, we had valuation allowances of $386 million to reduce our $1,758 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 profitable U.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, carryforward periods, restrictions on usage and prudent and feasible tax planning strategies. 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. At December 31, 2023, we had $151 million of unrecognized tax benefits, $102 million of which would impact the effective income tax rate if recognized. 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.
Repatriation of earnings generated after December 31, 2017, will generally be eligible for the 100% dividends received deduction or considered a distribution of previously taxed income and, therefore, exempt from U.S. federal tax. Undistributed foreign earnings may still be subject to certain state and foreign income and withholding taxes upon repatriation. Subject to limited exceptions, we do not intend to indefinitely reinvest our unremitted earnings outside the U.S. Thus, we have provided taxes, including any U.S. federal and state income, foreign income, or foreign withholding taxes on the majority of our unremitted earnings. In jurisdictions where we do intend to indefinitely reinvest our unremitted earnings, we would be required to accrue and pay applicable income taxes (if any) and foreign withholding taxes if the funds were repatriated in taxable transactions. We believe any such taxes would be immaterial.