NOTES FOR CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in millions, except share data)
Note 1 Description of Business
TRICON Global Restaurants, Inc. and
Subsidiaries (collectively referred to as "TRICON" or the "Company")
is the world's largest quick service restaurant company based on the number of system
units, with more than 29,000 restaurants in 103 countries and territories. References to
TRICON throughout these Consolidated Financial Statements are made using the first person
notations of "we" or "our." The worldwide business of our core
concepts, KFC, Pizza Hut and Taco Bell, include the operations, development, franchising,
and licensing of a system of both traditional and non-traditional quick service restaurant
units featuring dine-in, carryout, and in some instances drive-thru or delivery service.
Each concept has proprietary menu items and emphasizes the preparation
of food with high quality ingredients as well as unique recipes and special seasonings to provide appealing, tasty, and attractive food at competitive prices. We also previously operated other non-core concepts disposed of in 1997, which included California Pizza Kitchen ("CPK"), Chevys Mexican Restaurant ("Chevys"), D'Angelo Sandwich Shop ("D'Angelo"), East Side Mario's ("ESM") and Hot 'n Now ("HNN") (collectively, the "Non-core Businesses"). As of year-end 1997,38% of total worldwide units were operated by us or international joint ventures in which we participate and 62% by our franchisees and licensees. Approximately 31% of our system units are located outside the United States. Three years ago, we determined that the system should be rebalanced toward franchising and that underperforming units should be closed and, to that end, over 2,300 units have been refranchised and 1,300 units have been closed through December27, 1997. We expect to continue to develop new Company and franchised units both domestically and internationally and to continue to refranchise existing Company restaurants.
On October 6, 1997 (the "Spin-off Date"), we became a publicly owned company via a tax-free distribution of our Common Stock (the "Distribution" or "Spin-off") to the shareholders of our former parent, PepsiCo, Inc. ("PepsiCo"). A description of the Spin-off and certain transactions with PepsiCo is included in Note 3..
Note 2 - Summary of Significant Accounting Policies
Preparation of the accompanying Consolidated Financial Statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts of assets and liabilities and 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 our estimates.
Principles of Consolidation and Basis of Preparation. The accompanying Consolidated Financial Statements present our financial position, results of operations and cash flows as if we had been an independent, publicly owned company for all periods presented. Certain allocations of previously unallocated PepsiCo interest and general and administrative expenses, as well as computations of separate tax provisions, have been made to facilitate such presentation. See Note 3. The Consolidated Financial Statements prior to October 6, 1997 represent the former combined worldwide operations of KFC, Pizza Hut and Taco Bell and the Non-core Businesses disposed of in 1997.Intercompany accounts and transactions have been eliminated. Investments in unconsolidated affiliates in which we exercise significant influence but do not control are accounted for by the equity method, and our share of the net income or loss of our unconsolidated affiliates and foreign exchange losses is included in general, administrative and other expenses.
Fiscal Year. Our fiscal year ends on the last Saturday in December and, as a result, a fifty-third week is added every five or six years. Fiscal years 1997, 1996 and 1995 comprise 52 weeks. The first, second and third quarters of each year include 12 weeks each, while the fourth quarter includes 16 weeks.
Direct Marketing Costs. Direct marketing costs are reported in occupancy and other operating expenses in the Consolidated Statement of Operations and include costs of advertising and other marketing activities. Direct marketing costs are charged to expense ratably in relation to revenues over the year in which incurred. Advertising expenses were $544 million, $571 million and $570 million in 1997, 1996 and 1995, respectively.
Research and Development Expenses. Research and development expenses, which are expensed as incurred, were $21 million, $20 million and $17 million in 1997, 1996 and 1995, respectively.
Stock-Based Employee Compensation. As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), we measure stock-based employee compensation cost for financial statement purposes in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and its related interpretations ("APB Opinion No. 25") and include pro forma information in Note 13. Accordingly, compensation cost for the stock option grants to our employees is measured as the excess of the quoted market price of our common stock at the grant date over the amount the employee must pay for the stock. Our policy is to generally grant stock options at the fair market value of the underlying common stock at the date of the grant.
Loss per Common Share. Historical loss per share has been omitted since we were not an independent, publicly owned company with a capital structure of our own for any of the fiscal years presented in the accompanying Consolidated Statement of Operations.
Net loss per share for the fourth quarter of 1997, included in Note 18, is computed by dividing the net loss by the weighted average number of shares outstanding. In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options. Additionally, the dilutive effects of options are not included when losses from continuing operations exist.
Derivative Instruments. From time to time, we utilize interest rate swaps to hedge our exposure to fluctuations in variable interest rates. The interest differential to be paid or received on an interest rate swap is recognized as an adjustment to interest expense as the differential occurs. The interest differential not yet settled in cash is reflected in the accompanying Consolidated Balance Sheet as a receivable or payable under the appropriate current asset or liability caption.If an interest rate swap position was to be terminated, the gain or loss realized upon termination would be deferred and amortized to interest expense over the remaining term of the underlying debt instrument it was intended to modify or would be recognized immediately if the underlying debt instrument was settled prior to maturity.
Gains and losses on futures contracts that are designated and effective as hedges of future commodity purchases are deferred and included in the cost of the related raw materials when purchased. Changes in the value of futures contracts that we use to hedge commodity purchases are highly correlated to the changes in the value of the purchased commodity. If the degree of correlation between the futures contracts and the purchase contracts were to diminish such that the two were no longer considered highly correlated, subsequent changes in the value of the futures contracts would be recognized in income.
Cash and Cash Equivalents. Cash equivalents represent funds temporarily invested (with original maturities not exceeding three months) as part of managing day-to-day operating cash receipts and disbursements.
Inventories. Inventories are valued at the lower of cost (computed on the first-in, first-out method) or net realizable value.
Property, Plant and Equipment. Property, plant and equipment ("PP&E") are stated at cost less accumulated depreciation and amortization, except for PP&E that have been impaired, for which the carrying amount is reduced to estimated fair market value which becomes the new cost basis. Depreciation and amortization is calculated on a straight-line basis over the estimated useful lives of the assets as follows: 5 to 25 years for buildings and improvements and 3 to 20 years for machinery and equipment. Depreciation and amortization expense was $460 million, $521 million and $555 million in 1997, 1996 and 1995, respectively.
Intangible Assets. Intangible assets include both identifiable intangibles and goodwill arising from the allocation of purchase prices of businesses acquired. Amounts assigned to identifiable intangibles are based on independent appraisals or internal estimates. Goodwill represents the residual purchase price after allocation to all identifiable net assets. Intangible assets are stated at historical allocated cost less accumulated amortization, except for intangibles that have been impaired, for which the carrying amount is reduced to estimated fair market value which becomes the new cost basis. Intangible assets are amortized on a straight-line basis as follows: 20 years for reacquired franchise rights, 3 to 34 years for trademarks and other identifiable intangibles and 20 years for goodwill. Amortization expense was $70 million, $95 million and $109 million in 1997, 1996 and 1995, respectively.
Impairment of Long-Lived Assets to be Held and Used in the Business. We review our long-lived assets related to each restaurant to be held and used in the business semi-annually for impairment, or whenever events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable. We evaluate restaurants using a "two-year history of operating losses" as our primary indicator of potential impairment. An impaired restaurant is written down to its estimated fair market value based on the best information available. We generally measure estimated fair market value by discounting estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates.
Impairment of Investments in Unconsolidated Affiliates and EnterpriseLevel Goodwill. Our methodology for determining and measuring impairment of our investments in unconsolidated affiliates and enterprise-level goodwill was changed in 1996 to conform with the methodology we use for our restaurants except (a) the recognition test for an investment in an unconsolidated affiliate compares the carrying amount of the investment to a forecast of our share of the unconsolidated affiliate's undiscounted cash flows including interest and taxes, compared to undiscounted cash flows before interest and taxes used for restaurants and (b) enterprise-level goodwill is evaluated at a country level instead of by individual restaurant. The change in methodology had no impact in 1996. Also, impairment charges related to investments in unconsolidated affiliates are recorded when other circumstances indicate that a decrease in value of the investment has occurred which is other than temporary.
Pre-opening Costs. Costs associated with opening a new restaurant are expensed as incurred.
Refranchising Gains (Losses). Refranchising gains (losses) include gains or losses on sales of Company restaurants to new and existing franchisees and the related initial franchise fees. Direct administrative costs of refranchising are included in the gain or loss calculation. Gains on restaurant refranchisings are recognized when the sale transaction closes, the franchisee has a minimum amount of the purchase price in at-risk equity and we are satisfied that the franchisee can meet its financial obligations. Otherwise, refranchising gains are deferred until those criteria have been met. Losses on restaurant refranchisings are recognized when a decision is made to refranchise a store within the next twelve months and the estimated fair value less costs to sell is less than the carrying amount of the store.
Store Closure Costs. Store closure costs are recognized when a decision is made to close a restaurant within the next twelve months. Store closure costs include the cost of writing-down (impairing) the carrying amount of a restaurant's assets to estimated fair market value less costs of disposal and the net present value of any remaining operating lease payments after the expected closure date, net of estimated sub-lease income.
Franchise and License Fees. Franchise or license agreements are executed for each point of distribution and provide the terms of the arrangement with the franchisee/licensee. The franchise and certain license agreements require the franchisee/licensee to pay an initial, non-refundable fee. The agreements also require continuing fees based upon a percentage of sales. Subject to franchiser approval and payment of a renewal fee, a franchise agreement may generally be renewed upon expiration.
Initial fees are recognized as revenue when we have substantially performed all initial services required by the franchising/licensing agreement, which is generally upon the opening of a store. Continuing fees are recognized as earned with an appropriate provision for estimated uncollectible amounts. Renewal fees are recognized in earnings when a renewal agreement becomes effective.
Direct costs incurred to secure and perform the required services under the franchise and license agreements, which are not material, are charged to expense as incurred.
Reclassifications. Certain items have been reclassified in the accompanying Consolidated Financial Statements for prior periods in order to be comparable with the classification adopted for the fiscal year ended December 27, 1997.Such reclassifications had no effect on previously reported net income
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