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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

OR

For the transition period from                  to                 

Commission file number 1-13163

YUM! BRANDS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (502) 874-8300

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

     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   X   No     

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   [X]

     The aggregate market value of the voting stock (which consists solely of shares of Common Stock) held by non-affiliates of the registrant as of June 15, 2002 computed by reference to the closing price of the registrant’s Common Stock on the New York Stock Exchange Composite Tape on such date was $9,335,860,595.

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes   X   No     

     The number of shares outstanding of the registrant’s Common Stock as of February 28, 2003 was 293,337,872 shares.

Documents Incorporated by Reference

     Portions of the definitive proxy statement furnished to shareholders of the registrant in connection with the annual meeting of shareholders to be held on May 15, 2003 are incorporated by reference into Part III.

PART I

YUM! Brands, Inc. (referred to herein as “YUM” or the “Company”), formerly known as TRICON Global Restaurants, Inc., was incorporated under the laws of the state of North Carolina in 1997. The principal executive offices of YUM are located at 1441 Gardiner Lane, Louisville, Kentucky 40213, and its telephone number at that location is (502) 874-8300.

YUM, the registrant, together with its restaurant operating companies and other subsidiaries, is referred to in this Form 10-K annual report (“Form 10-K”) as the Company. Prior to October 6, 1997, the business of the Company was conducted by PepsiCo, Inc. (“PepsiCo”) through various subsidiaries and divisions.

This Form 10-K should be read in conjunction with the Cautionary Statements on pages 39 and 40.

In January 1997, PepsiCo announced its decision to spin-off its restaurant businesses to shareholders as an independent public company (the “Spin-off”). Effective October 6, 1997, PepsiCo disposed of its restaurant businesses by distributing all of the outstanding shares of common stock of YUM to its shareholders. YUM’s Common Stock began trading on the New York Stock Exchange on October 7, 1997 under the symbol “YUM.” Prior to that date, from September 17, 1997 through October 6, 1997, YUM’s Common Stock was traded on the New York Stock Exchange on a “when-issued” basis.

On May 7, 2002, YUM completed the acquisition of Yorkshire Global Restaurants, Inc. (“YGR”), the parent company and operator of Long John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”). Additionally, on May 16, 2002, following receipt of shareholder approval, the Company changed its name from TRICON Global Restaurants, Inc. to YUM! Brands, Inc.

As used in this Form 10-K, references to YUM or the Company include the historical operating results of the businesses and operations transferred to the Company in the Spin-off and since May 7, 2002, acquired from YGR. Additionally, throughout this Form 10-K, the terms “restaurants,” “stores” and “units” are used interchangeably.

YUM consists of five operating segments: KFC, Pizza Hut, Taco Bell, LJS/A&W and YUM Restaurants International (“YRI” or “International”). For financial reporting purposes, management considers the four U.S. operating segments to be similar and, therefore, has aggregated them into a single reportable operating segment. Operating segment information for the years ended December 28, 2002, December 29, 2001 and December 30, 2000 for the Company is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in Part II, Item 7, pages 17 through 39 and in the related Consolidated Financial Statements and footnotes in Part II, Item 8, pages 41 through 79.

General

YUM is the world’s largest quick service restaurant (“QSR”) company based on number of system units, with nearly 33,000 units in over 100 countries and territories. The YUM organization is currently made up of six operating companies organized around five restaurant concepts including its three original concepts, KFC, Pizza Hut and Taco Bell, and two acquired concepts, LJS and A&W (the “Concepts”). The six operating companies are KFC, Pizza Hut, Taco Bell, LJS, A&W and YRI.

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Restaurant Concepts

Through its five Concepts, the Company develops, operates, franchises and licenses a worldwide system of restaurants which prepare, package and sell a menu of competitively priced food items. These restaurants are operated by the Company or, under the terms of franchise or license agreements, by franchisees or licensees who are independent third parties, or by affiliates in which we own a non-controlling equity interest (“Unconsolidated Affiliates”).

In each Concept, consumers can dine in and/or carry out food. In addition, Taco Bell, KFC, LJS and A&W offer a drive-thru option in many stores. Pizza Hut offers a drive-thru option on a much more limited basis. Pizza Hut and, on a much more limited basis, KFC offer 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.

The franchise program of the Company is designed to assure consistency and quality, and the Company is selective in granting franchises. Under the standard franchise agreement, franchisees supply capital – initially by paying a franchise fee to YUM, purchasing or leasing the land and building and purchasing equipment, signs, seating, inventories and supplies and, over the longer term, by reinvesting in the business. Franchisees then contribute to the Company’s revenues through the payment of royalties based on a percentage of sales.

The Company believes that it is important to maintain strong and open relationships with its franchisees and their representatives. To this end, the Company invests a significant amount of time working with the franchisee community and their representative organizations on all aspects of the business, including new products, equipment and management techniques.

The Company is actively pursuing the strategy of multibranding, where two or more of its Concepts are operated in a single unit. In addition, the Company is testing multibranding options involving one of its Concepts and a restaurant concept not owned by or affiliated with YUM. By combining two or more restaurant concepts, particularly those that have complementary daypart strengths in one location, the Company believes it can generate higher sales volumes from such units, significantly improve returns on per unit investment, and enhance its ability to penetrate a greater number of trade areas throughout the U.S. and internationally. Through the consolidation of market planning initiatives across all of its Concepts, the Company has established, or is in the process of establishing in the case of LJS and A&W, multi-year development plans by trade area to optimize franchise and company penetration of its Concepts and to improve returns on its existing asset base. The development of multibranded units may be limited, in some instances, by prior development and/or territory rights granted to franchisees.

At year-end 2002, there were 1,975 multibranded units in the worldwide system. These units were comprised of 1,918 units offering food products from two of the Concepts (a “2n1”), 51 units offering food products from three of the Concepts (a “3n1”) and 6 units offering food products from one of the Concepts and a restaurant concept not owned by or affiliated with YUM.

Restaurant Operations

Through its Concepts, YUM develops, operates, franchises and licenses a system of both traditional and non-traditional QSR restaurants. Traditional units feature dine-in, carryout and, in some instances, drive-thru or delivery services. Non-traditional units, which are typically licensed outlets, include express units and kiosks which have a more limited menu and operate in non-traditional locations like malls, airports, gasoline service stations, convenience stores, stadiums, amusement parks and colleges, where a full-scale traditional outlet would not be practical or efficient.

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The Company’s restaurant management structure varies by concept and unit size. Generally, each Company restaurant is led by a restaurant general manager (“RGM”), together with one or more assistant managers, depending on the operating complexity and sales volume of the restaurant. Each restaurant usually has between 10 and 35 hourly employees, most of whom work part-time. The Company’s six operating companies each issue detailed manuals covering all aspects of their respective operations, including food handling and product preparation procedures, safety and quality issues, equipment maintenance, facility standards and accounting control procedures. The restaurant management teams are responsible for the day-to-day operation of each unit and for ensuring compliance with operating standards. CHAMPS – which stands for Cleanliness, Hospitality, Accuracy, Maintenance, Product Quality and Speed of Service – is our core systemwide program for training, measuring and rewarding employee performance against key customer measures. CHAMPS is intended to align the operating processes of our entire system around one set of standards. RGMs’ efforts, including CHAMPS performance measures, are monitored by area managers or market coaches. Market coaches typically work with approximately six to twelve restaurants. The Company’s restaurants are visited from time to time by various senior operators to help ensure adherence to system standards and mentor restaurant team members.

RGMs attend and complete their respective operating company’s required training programs. These programs consist of initial training, as well as additional continuing development and training programs that may be offered or required from time to time. Initial manager training programs generally last at least six weeks and emphasize leadership, business management, supervisory skills (including training, coaching, and recruiting), product preparation and production, safety, quality control, customer service, labor management, and equipment maintenance.

Following is a brief description of each Concept:

KFC

• KFC was founded in Corbin, Kentucky by Colonel Harland D. Sanders, an early developer of the quick service food business and a pioneer of the restaurant franchise concept. The Colonel perfected his secret blend of 11 herbs and spices for Kentucky Fried Chicken in 1939 and signed up his first franchisee in 1952. KFC is based in Louisville, Kentucky.
  
  
• As of year-end 2002, KFC was the leader in the U.S. chicken QSR segment among companies featuring chicken as their primary product offering, with a 46 percent market share in that segment which is nearly four times that of its closest national competitor.
  
  
• KFC operates in 88 countries and territories throughout the world. As of year-end 2002, KFC had 5,472 units in the U.S., and 6,890 units outside the U.S. Approximately 23 percent of the U.S. units and 22 percent of the non-U.S. units are operated by the Company.
  
  
• While product offerings vary throughout the worldwide system, traditional KFC restaurants offer fried chicken-on-the-bone products, primarily marketed under the names Original Recipe and Extra Tasty Crispy. Other principal entree items include chicken sandwiches (including the Twister), Colonel’s Crispy Strips, Popcorn Chicken and, seasonally, Chunky Chicken Pot Pies. KFC restaurants also offer a variety of side items, such as biscuits, mashed potatoes and gravy, coleslaw, corn, Potato Wedges (in the U.S.) and french fries (outside of the U.S.), as well as desserts. Restaurant decor is characterized by the image of the Colonel, and KFC’s distinctive packaging includes the “Bucket” of chicken.

Pizza Hut

• The first Pizza Hut restaurant was opened in 1958 in Wichita, Kansas, and within a year, the first franchise unit was opened. Today, Pizza Hut is the largest restaurant chain in the world specializing in the sale of ready-to-eat pizza products. Pizza Hut is based in Dallas, Texas.
  
  
  

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• As of year-end 2002, Pizza Hut was the leader in the U.S. pizza QSR segment, with a 15 percent market share in that segment.
  
  
• Pizza Hut operates in 85 countries and territories throughout the world. As of year-end 2002, Pizza Hut had 7,599 units in the U.S., and 4,431 units outside of the U.S. Approximately 23 percent of the U.S. units and 18 percent of the non-U.S. units are operated by the Company.
  
  
• Pizza Hut features a variety of pizzas, which may include Pan Pizza, Thin ‘n Crispy, Hand Tossed, Sicilian, Stuffed Crust, Twisted Crust, The Big New Yorker, The Insider and The Chicago Dish. Each of these pizzas is offered with a variety of different toppings. In some restaurants, Pizza Hut also offers breadsticks, pasta, salads and sandwiches. The distinctive Pizza Hut image typically features a bright red roof.

Taco Bell

• The first Taco Bell restaurant was opened in 1962 by Glen Bell in Downey, California, and in 1964, the first Taco Bell franchise was sold. Taco Bell is based in Irvine, California.
  
  
• As of year-end 2002, Taco Bell was the leader in the U.S. Mexican QSR segment, with a 65 percent market share in that segment.
  
  
• Taco Bell operates in 12 countries and territories throughout the world. As of year-end 2002, there were 6,165 Taco Bell units in the U.S., and 267 units outside of the U.S. Approximately 21 percent of the U.S. units and 14 percent of the non-U.S. units are operated by the Company.
  
  
• Taco Bell specializes in Mexican-style food products, including various types of tacos, burritos, gorditas, chalupas, quesadillas, salads, nachos and other related items. Additionally, proprietary entreè items include Grilled Stuft Burritos and Border Bowls. Taco Bell units feature a distinctive bell logo on their signage.

LJS

• The first LJS restaurant opened in 1969 and the first LJS franchise unit opened later the same year. LJS is presently based in Lexington, Kentucky; however, the Company has announced its intention to move the LJS headquarters to Louisville, Kentucky in 2003.
  
  
• As of year-end 2002, LJS was the leader in the U.S. seafood QSR segment, with a 33 percent market share in that segment.
  
  
• LJS operates in 5 countries and territories throughout the world. As of year-end 2002, there were 1,221 LJS units in the U.S., and 28 units outside the U.S. Approximately 61 percent of the U.S. units are operated by the Company. All non-U.S. units are operated by franchisees.
  
  
• LJS features a variety of seafood items, including meals featuring batter-dipped fish, chicken, shrimp and hushpuppies. LJS units typically feature a distinctive seaside/nautical theme.

A&W

• A&W was founded in Lodi, California by Roy Allen in 1919 and the first A&W franchise unit opened in 1925. A&W is presently based in Lexington, Kentucky; however, the Company has announced its intention to move the A&W headquarters to Louisville, Kentucky in 2003.
  
  

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• A&W operates in 17 countries and territories throughout the world. As of year-end 2002, there were 665 A&W units in the U.S., and 182 units outside the U.S. Approximately 19 percent of the U.S. units are operated by the Company. All non-U.S. units are operated by franchisees.
  
  
• A&W serves A&W draft Root Beer and a signature A&W Root Beer float, as well as all-American pure-beef hamburgers and hot dogs.

International

The international operations of the five Concepts are consolidated into a separate operating company (YRI), which has directed its focus toward franchise system growth and concentration of Company development in those markets in which the Company believes sufficient scale is achievable. YRI has developed global systems and tools designed to improve marketing, operations consistency, product delivery, market planning and development and franchise support capability. YRI is based in Dallas, Texas.

As of year-end 2002, YRI had 11,798 units. Approximately 20 percent of these units are operated by the Company. In 2002, YRI accounted for 35 percent of the Company’s total system sales and 31 percent of the Company’s revenues.

Operating Structure

In all five of its Concepts, the Company either operates units or they are operated by independent franchisees or licensees. Franchisees can range in size from individuals owning just a few units to large publicly traded companies. In addition, the Company owns non-controlling interests in Unconsolidated Affiliates who operate similar to franchisees. As of year-end 2002, approximately 23 percent of YUM’s worldwide units were operated by the Company, approximately 63 percent by franchisees, approximately 8 percent by licensees and approximately 6 percent by Unconsolidated Affiliates.

Supply and Distribution

The Company is a substantial purchaser of a number of food and paper products, equipment and other restaurant supplies. The principal items purchased include beef, cheese, chicken products, seafood, cooking oils, corn, flour, lettuce, paper and packaging materials, pinto beans, pork, seasonings, certain beverage products and tomato products.

Effective as of March 1, 1999, the Company, along with the KFC National Purchasing Cooperative, Inc. and representatives of the Company’s KFC, Pizza Hut and Taco Bell franchisee groups, formed the Unified FoodService Purchasing Co-op, LLC (the “Unified Co-op”) for the purpose of purchasing certain restaurant products and equipment in the U.S. The Company has also substantially integrated the purchasing activities for LJS and A&W into the Unified Co-op. The core mission of the Unified Co-op is to provide the lowest possible sustainable store-delivered prices for restaurant products and equipment. This arrangement combines the purchasing power of the Company and franchisee restaurants in the U.S. which the Company believes will further leverage the system’s scale to drive cost savings and effectiveness in the purchasing function. The Company also believes that the Unified Co-op has resulted, and should continue to result, in closer alignment of interests and a stronger relationship with its franchisee community.

To ensure the wholesomeness of food products, suppliers are required to meet or exceed strict quality control standards. Long-term contracts and long-term vendor relationships are used to ensure availability of products. The Company has not experienced any significant continuous shortages of supplies, and alternative sources for most of these products are generally available. Prices paid for these supplies may be subject to fluctuation. When prices increase, the Company may be able to pass on such increases to its customers, although there is no assurance this can be done in the future.

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Most food products, paper and packaging supplies, and equipment used in the operation of the Company’s restaurants are distributed to individual restaurant units by third party distribution companies. Since November 30, 2000, McLane Company, Inc. (“McLane”), a subsidiary of Wal-Mart, has been the exclusive distributor for Company-operated KFCs, Pizza Huts and Taco Bells in the U.S. and for a substantial number of franchisee and licensee stores. McLane became the distributor when it assumed all supply and distribution responsibilities under an existing agreement between AmeriServe Food Distribution, Inc. (“AmeriServe”) and the Company (the “AmeriServe Agreement”). McLane assumed the AmeriServe Agreement, as amended, as well as distribution agreements covering a substantial portion of the Pizza Hut and Taco Bell franchise system, and, to a lesser extent, the KFC franchise system simultaneously with its acquisition of the AmeriServe business. The AmeriServe business was acquired by McLane after AmeriServe filed for protection under Chapter 11 of the U.S. Bankruptcy Code and a plan of reorganization for AmeriServe (the “POR”) was approved by the U.S. Bankruptcy Court on November 28, 2000. A discussion of the impact of the AmeriServe bankruptcy reorganization process on the Company is contained in Note 25 to the Consolidated Financial Statements on page 78. In connection with McLane’s acquisition and assumption of the AmeriServe Agreement, the Company agreed to certain amendments, including an extension of the AmeriServe Agreement through October 31, 2010. Under the terms of the Agreement with McLane, Company-operated KFC, Pizza Hut and Taco Bell restaurants in the U.S. generally cannot use alternative distributors. The Company stores within the LJS system are covered under a separate agreement with McLane. A&W units are not currently serviced by McLane.

YRI and its franchisees use decentralized sourcing and distribution systems involving many different global, regional, and local suppliers and distributors. In certain countries, including China, YRI may own all or a portion of the distribution system.

Trademarks and Patents

The Company and its Concepts own numerous registered trademarks and service marks. The Company believes that many of these marks, including its Kentucky Fried Chicken®, KFC®, Pizza Hut®, Taco Bell® and Long John Silver’s® marks, have significant value and are materially important to its business. The Company’s policy is to pursue registration of its important marks whenever feasible and to oppose vigorously any infringement of its marks. The Company also licenses certain trademarks and service marks, including certain of the A&W trademarks and service marks (the “A&W Marks”), which are owned by A&W Concentrate Company (formerly A&W Brands, Inc.). A&W Concentrate Company, which is not affiliated with the Company, has granted the Company an exclusive, worldwide (excluding Canada), perpetual, royalty-free license (with right to sublicense) to use the A&W Marks for restaurant services.

The use of these marks by franchisees and licensees has been authorized in KFC, Pizza Hut, Taco Bell, LJS and A&W franchise and license agreements. Under current law and with proper use, the Company’s rights in its marks can generally last indefinitely. The Company also has certain patents on restaurant equipment which, while valuable, are not material to its business.

Working Capital

Information about the Company’s working capital is included in MD&A in Part II, Item 7, pages 17 through 39 and the Consolidated Statements of Cash Flows in Part II, Item 8, pages 41 through 79.

Customers

The Company’s business is not dependent upon a single customer or small group of customers.

Seasonal Operations

The Company does not consider its operations to be seasonal to any material degree.

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Backlog Orders

Company restaurants have no backlog orders.

Government Contracts

No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. government.

Competition

The overall food service industry and the QSR segment are intensely competitive with respect to food quality, price, service, convenience, restaurant location and concept. The restaurant business is often affected by changes in consumer tastes; national, regional or local economic conditions; currency fluctuations; demographic trends; traffic patterns; the type, number and location of competing restaurants; and disposable purchasing power. Each of the Concepts compete with national and regional chains as well as locally-owned restaurants, not only for customers, but also for management and hourly personnel, suitable real estate sites and qualified franchisees.

Research and Development (“R&D”)

The Company operates R&D facilities in Louisville, Kentucky; Dallas, Texas; Irvine, California; and Lexington, Kentucky. The Company expensed $23 million in 2002, $23 million in 2001 and $24 million in 2000 for R&D activities. From time to time, independent suppliers also conduct research and development activities for the benefit of the YUM system. The Company has announced its intention to move the Lexington facility to Louisville in 2003.

Environmental Matters

The Company is not aware of any federal, state or local environmental laws or regulations that will materially affect its earnings or competitive position, or result in material capital expenditures. However, the Company cannot predict the effect on its operations of possible future environmental legislation or regulations. During 2002, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.

Government Regulation

U.S. The Company is subject to various federal, state and local laws affecting its business. Each of the Company’s restaurants must comply with licensing and regulation by a number of governmental authorities, which include health, sanitation, safety and fire agencies in the state or municipality in which the restaurant is located. In addition, each of the YUM operating companies must comply with various state laws that regulate the franchisor/franchisee relationship. To date, the Company has not been significantly affected by any difficulty, delay or failure to obtain required licenses or approvals.

A small portion of Pizza Hut’s net sales is attributable to the sale of beer and wine. A license is required in most cases for each site that sells alcoholic beverages (in most cases, on an annual basis) and licenses may be revoked or suspended for cause at any time. Regulations governing the sale of alcoholic beverages relate to many aspects of restaurant operations, including the minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, storage and dispensing of alcoholic beverages.

The Company is also subject to federal and state laws governing such matters as employment and pay practices, overtime, tip credits and working conditions. The bulk of the Company’s employees are paid on an hourly basis at rates related to the federal minimum wage.

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The Company is also subject to federal and state child labor laws which, among other things, prohibit the use of certain “hazardous equipment” by employees 18 years of age or younger. The Company has not to date been materially adversely affected by such laws.

The Company continues to monitor its facilities for compliance with the Americans with Disabilities Act (“ADA”) in order to conform to its requirements. Under the ADA, the Company could be required to expend funds to modify its restaurants to better provide service to, or make reasonable accommodation for the employment of disabled persons. We believe that expenditures, if required, would not have a material adverse effect on the Company’s operations.

International. Internationally, the Company’s restaurants are subject to national and local laws and regulations which are similar to those affecting the Company’s U.S. restaurants, including laws and regulations concerning labor, health, sanitation and safety. The international restaurants are also subject to tariffs and regulations on imported commodities and equipment and laws regulating foreign investment. International compliance with environmental requirements has not had a material adverse effect on the Company’s results of operations, capital expenditures or competitive position.

Employees

As of year-end 2002, the Company employed approximately 244,000 persons, approximately 68 percent of whom were part-time employees. Approximately 55 percent of the Company’s employees are employed in the U.S. The Company believes that it provides working conditions and compensation that compare favorably with those of its principal competitors. Most Company employees are paid on an hourly basis. The Company’s non-U.S. employees are subject to numerous labor council relationships that vary due to the diverse cultures in which the Company operates. The Company considers its employee relations to be good.

Financial information about International and U.S. markets is incorporated herein by reference from Selected Financial Data in Part II, Item 6, page 16; Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in Part II, Item 7, pages 17 through 39; and in the related Consolidated Financial Statements and footnotes in Part II, Item 8, pages 41 through 79.

The Company makes available through its internet website www.yum.com its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission. The reference to the Company’s website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this document.

As of year-end 2002, YUM Concepts owned over 1,600 units and leased almost 3,600 units in the U.S.; and YRI owned over 300 units and leased over 2,000 units outside the U.S. Company restaurants in the U.S. which are not owned are generally leased for initial terms of 15 or 20 years and generally have renewal options; however, Pizza Hut delivery/carryout units in the U.S. generally are leased for significantly shorter initial terms with short renewal options. Pizza Hut leases its and YRI’s corporate headquarters and research facility in Dallas, Texas. Taco Bell leases its corporate headquarters and research facility in Irvine, California and KFC owns its and YUM’s corporate headquarters and a research facility in Louisville, Kentucky. LJS and A&W presently lease a corporate headquarters and research facility in Lexington, Kentucky; however, YUM has announced its intention to move the LJS and A&W headquarters and research facility to Louisville, Kentucky in 2003. In addition, YUM leases office facilities for certain support groups in

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Louisville, Kentucky, and Albuquerque, New Mexico. Additional information about the Company’s properties is included in the Consolidated Financial Statements and footnotes in Part II, Item 8, pages 41 through 79.

The Company believes that its properties are generally in good operating condition and are suitable for the purposes for which they are being used.

The Company is subject to various claims and contingencies related to lawsuits, taxes, real estate, environmental and other matters arising in the normal course of business. The following is a brief description of the more significant of these categories of lawsuits and other matters. Except as stated below, the Company believes that the ultimate liability, if any, in excess of amounts already provided for these matters in the Consolidated Financial Statements, is not likely to have a material adverse effect on the Company’s annual results of operations, financial condition or cash flows.

Franchising

A substantial number of the restaurants of each of the Concepts are franchised to independent businesses operating under arrangements with the Concepts. In the course of the franchise relationship, occasional disputes arise between the Company and its franchisees relating to a broad range of subjects, including, without limitation, quality, service, and cleanliness issues, contentions regarding grants, transfers or terminations of franchises, territorial disputes and delinquent payments.

Suppliers

The Company, through approved distributors, purchases food, paper, equipment and other restaurant supplies from numerous independent suppliers throughout the world. These suppliers are required to meet and maintain compliance with the Company’s standards and specifications. On occasion, disputes arise between the Company and its suppliers on a number of issues, including, but not limited to, compliance with product specifications and terms of procurement and service requirements.

Employees

At any given time, the Company employs hundreds of thousands of persons, primarily in its restaurants. In addition, each year thousands of persons seek employment with the Company and its restaurants. From time to time, disputes arise regarding employee hiring, compensation, termination and promotion practices.

Like some other retail employers, the Company has been faced in a few states with allegations of purported class-wide wage and hour violations.

On August 29, 1997, a class action lawsuit against Taco Bell Corp., entitled Bravo, et al. v. Taco Bell Corp. (“Bravo”), was filed in the Circuit Court of the State of Oregon of the County of Multnomah. The lawsuit was filed by two former Taco Bell shift managers purporting to represent approximately 17,000 current and former hourly employees statewide. The lawsuit alleges violations of state wage and hour laws, principally involving unpaid wages including overtime, and rest and meal period violations, and seeks an unspecified amount in damages. Under Oregon class action procedures, Taco Bell was allowed an opportunity to “cure” the unpaid wage and hour allegations by opening a claims process to all putative class members prior to certification of the class. In this cure process, Taco Bell paid out less than $1 million. On January 26, 1999, the Court certified a class of all current and former shift managers and crew members who claim one or more of the alleged violations. A Court-approved notice and claim form was mailed to approximately 14,500 class members on January 31, 2000. Trial began on January 4, 2001. On March 9, 2001, the jury reached verdicts on the substantive issues in this matter. A number of these verdicts were in favor of the Taco Bell position; however, certain issues were decided in favor of the plaintiffs. In April 2002, a jury trial to determine the damages of 93 of those claimants found that Taco Bell failed to pay for certain meal breaks and/or off-the-clock work for 86 of the 93 claimants.

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However, the total amount of hours awarded by the jury was substantially less than that sought by the claimants. In July and September 2002, the court ruled on several post-trial motions, including fixing the total number of potential claimants at 1,031 (including the 93 claimants for which damages have already been determined) and holding that claimants who prevail are entitled to prejudgment interest and penalty wages. The court has indicated that it will likely schedule a damages trial for the remaining 938 claimants sometime in 2003. Taco Bell intends to appeal the April 2002 damages verdict as well as the March 2001 liability verdict.

We have provided for the estimated costs of the Bravo litigation, based on a projection of eligible claims (including claims filed to date, where applicable), the amount of each eligible claim, the estimated legal fees incurred by the plaintiffs and the results of settlement negotiations in this and other wage and hour litigation matters. Although the outcome of this case cannot be determined at this time, we believe the ultimate cost of this case in excess of amounts already provided will not be material to our annual results of operations, financial condition or cash flows. Any provisions have been recorded as unusual items.

Customers

The Company’s restaurants serve a large and diverse cross-section of the public and in the course of serving so many people, disputes arise regarding products, service, accidents and other matters typical of large restaurant systems such as those of the Company.

Intellectual Property

The Company has registered trademarks and service marks, many of which are of material importance to the Company’s business. From time to time, the Company may become involved in litigation to defend and protect its use of its registered marks.

Other Litigation

On January 16, 1998, a lawsuit against Taco Bell Corp., entitled Wrench LLC, Joseph Shields and Thomas Rinks v. Taco Bell Corp. (“Wrench”) was filed in the United States District Court for the Western District of Michigan. The lawsuit alleges that Taco Bell Corp. misappropriated certain ideas and concepts used in its advertising featuring a Chihuahua. Plaintiffs seek to recover damages under several theories, including breach of implied-in-fact contract, idea misappropriation, conversion and unfair competition. On June 10, 1999, the District Court granted summary judgment in favor of Taco Bell Corp. Plaintiffs filed an appeal with the U.S. Court of Appeals for the Sixth Circuit (the “Court of Appeals”), and oral arguments were held on September 20, 2000. On July 6, 2001, the Court of Appeals reversed the District Court’s judgment in favor of Taco Bell and remanded the case to the District Court. Taco Bell Corp. unsuccessfully petitioned the Court of Appeals for rehearing en banc, and its petition for writ of certiorari to the United States Supreme Court was denied on January 21, 2002. The case has now officially been returned to the District Court, where the Wrench plaintiffs will be allowed to bring their claims to trial. It is expected that the trial will commence in May, 2003.

We believe that the Wrench plaintiffs’ claims are without merit and are vigorously defending the case. However, in view of the inherent uncertainties of litigation, the outcome of the case cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.

None.

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Executive Officers of the Registrant

The executive officers of the Company as of February 28, 2003, and their ages and current positions as of that date are as follows:

David C. Novak is Chairman of the Board, Chief Executive Officer and President of YUM. He has served in this position since January 2001. From December 1999 to January 2001, Mr. Novak served as Vice Chairman of the Board, Chief Executive Officer and President of YUM. From October 1997 to December 1999, he served as Vice Chairman and President of YUM. Mr. Novak previously served as Group President and Chief Executive Officer, KFC and Pizza Hut from August 1996 to July 1997. Mr. Novak joined Pizza Hut in 1986 as Senior Vice President, Marketing. In 1990, he became Executive Vice President, Marketing and National Sales, for Pepsi-Cola Company. In 1992, he became Chief Operating Officer, Pepsi-Cola North America, and in 1994 he became President and Chief Executive Officer of KFC North America. Mr. Novak is also a director of Bank One Corporation.

David J. Deno is Chief Financial Officer of YUM. He has served in this position since November 1999. From August 1997 to November 1999, Mr. Deno served as Senior Vice President and Chief Financial Officer of YRI. From August 1996 to August 1997, Mr. Deno served as Senior Vice President and Chief Financial Officer for Pizza Hut. From 1994 to August 1996, Mr. Deno was Division Vice President for the Florida Division of Pizza Hut. Mr. Deno joined Pizza Hut in 1991 as Vice President and Controller.

Aylwin B. Lewis is President, Chief Multibranding and Operating Officer for YUM. He was appointed to this title in January 2003. From December 1999 to January 2003, Mr. Lewis served as YUM’s Chief Operating Officer. From July 1997 to December 1999, he served as Chief Operating Officer of Pizza Hut. Mr. Lewis previously served as Senior Vice President, Operations for Pizza Hut, a position he assumed in 1996. He served in various positions at KFC, including Senior Director of Franchising and Vice President of Restaurant Support Services, becoming Division Vice President, Operations for KFC in 1993, and Senior Vice President, New Concepts for KFC in 1995. Mr. Lewis joined KFC in 1991 as a Regional General Manager. Mr. Lewis is also a director of Halliburton Company.

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Christian L. Campbell is Senior Vice President, General Counsel, Secretary and Chief Franchise Policy Officer of YUM. He has served as Senior Vice President, General Counsel and Secretary since September 1997. In January 2003, his title and job responsibilities were expanded to include Chief Franchise Policy Officer. From 1995 to September 1997, Mr. Campbell served as Senior Vice President, General Counsel and Secretary of Owens Corning, a building products company. Before joining Owens Corning, Mr. Campbell served as Vice President, General Counsel and Secretary of Nalco Chemical Company in Naperville, Illinois, from 1990 through 1994.

Jonathan D. Blum is Senior Vice President – Public Affairs for YUM. He has served in this position since July 1997. Mr. Blum previously served as Vice President of Public Affairs for Taco Bell, a position that he held since joining Taco Bell in 1993.

Charles E. Rawley, III is Chief Development Officer of YUM, a position he assumed in January of 2001. Prior to that, he served as President and Chief Operating Officer of KFC. Mr. Rawley assumed his position of Chief Operating Officer in 1995 and President in 1998. Mr. Rawley joined KFC in 1985 as a Director of Operations. He served as Vice President of Operations for the Southwest, West, Northeast, and Mid-Atlantic Divisions from 1988 to 1994, when he became Senior Vice President, Concept Development for KFC.

Anne P. Byerlein is Chief People Officer of YUM. From October 1997 to December 2002, she was Vice President of Human Resources of YUM. From October 2000 to December 2002, she also served as KFC’s Chief People Officer. Ms. Byerlein has also served as Vice President of Corporate Human Resources of PepsiCo. From 1988 to 1996, Ms. Byerlein served in a variety of human resources positions within the restaurant divisions of PepsiCo.

Brent A. Woodford is Vice President and Controller of YUM. He has served in this position since April 2000. Mr. Woodford previously served as Controller of YRI from March 1998 to April 2000. From October 1997 to March of 1998, he served as YRI’s Assistant Controller. From 1995 until the spin-off of YUM from PepsiCo Inc. in 1997, he held a number of positions in the financial planning department of PepsiCo Restaurants International.

Peter A. Bassi is President of YRI. He has served in this position since July 1997. Mr. Bassi served as Executive Vice President, Asia, of PepsiCo Restaurants International from February 1996 to July 1997. From 1995 to 1996, he served as Senior Vice President and Chief Financial Officer at PepsiCo Restaurants International. He served as Senior Vice President, Finance and Chief Financial Officer at Taco Bell from 1987 to 1994. He joined the Pepsi-Cola Company in 1972 and served in various management positions at Frito-Lay, Pizza Hut and PepsiCo Food Service International. Mr. Bassi is also a director of The Pep Boys - Manny, Moe & Jack.

Cheryl A. Bachelder is President and Chief Concept Officer of KFC. She has served in this position since January of 2001. Ms. Bachelder served as Executive Vice President, Build the Brand for Domino’s Pizza LLC from June 1995 until December 2000. She joined Domino’s Pizza in May 1995 as Executive Vice President of Marketing and Product Development, overseeing all marketing, public relations, product development and quality assurance programs.

Peter R. Hearl is President and Chief Concept Officer of Pizza Hut. Prior to this position, he was Chief People Officer and Executive Vice President of YUM, a position he held from January 1, 2002 until November 2002. From December 1998 to January 2002, he served as Executive Vice President of YRI. Prior to that, he was Region Vice President for YRI in Asia Pacific, a position he assumed in October 1997. From March 1996 to September 1997, Mr. Hearl was Regional Vice President for YRI with responsibility for Australia, New Zealand and South Africa. Prior to that, he was Regional Vice President for KFC with responsibility for the United Kingdom, Ireland and South Africa, a position he assumed in January 1995. From September 1993 to December 1994, Mr. Hearl was Regional Vice President for KFC Europe. Mr. Hearl is also a director of Westport Resources Corporation.

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Emil J. Brolick is President and Chief Concept Officer of Taco Bell. He has served in this position since July of 2000. Prior to joining Taco Bell, Mr. Brolick served as Senior Vice President of New Product Marketing, Research & Strategic Planning for Wendy’s International, Inc. from August 1995 to July of 2000. From March 1988 to August 1995, he held various positions at Wendy’s including Manager, Planning and Evaluation and Vice President, Strategic Planning and Research.

Executive officers are elected by and serve at the discretion of the Board of Directors.

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PART II

The Company’s common stock trades under the symbol YUM and is listed on the New York Stock Exchange (“NYSE”). The following sets forth the high and low NYSE composite closing sale prices by quarter for the Company’s common stock. All prices shown have been adjusted to reflect the two-for-one stock split distributed on June 17, 2002.

As of February 28, 2003, there were approximately 108,000 registered holders of record of the Company’s common stock.

The Company has not and does not presently intend to pay dividends on its common stock.

The Company had no sales of unregistered securities during 2002 or 2001.

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Selected Financial Data
YUM! Brands, Inc. and Subsidiaries
(in millions, except per share and unit amounts)

Fiscal years 2002, 2001, 1999 and 1998 include 52 weeks. Since May 7, 2002, fiscal year 2002 includes Long John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”), which were added when we acquired Yorkshire Global Restaurants, Inc. Fiscal year 2002 includes the impact of the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). See Note 12 to the Consolidated Financial Statements for further discussion of SFAS 142. Fiscal year 2000 includes 53 weeks. The selected financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto.

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Introduction

On May 16, 2002, TRICON Global Restaurants, Inc. changed its name to YUM! Brands, Inc. in order to better reflect our expanding portfolio of brands. In addition, on the same day, Tricon Restaurants International changed its name to YUM! Restaurants International.

YUM! Brands, Inc. and Subsidiaries (collectively referred to as “YUM” or the “Company”) comprises the worldwide operations of KFC, Pizza Hut, Taco Bell, Long John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”) (collectively “the Concepts”) and is the world’s largest quick service restaurant (“QSR”) company based on the number of system units. LJS and A&W were added when YUM acquired Yorkshire Global Restaurants, Inc. (“YGR”) on May 7, 2002. Separately, KFC, Pizza Hut and Taco Bell rank in the top ten among QSR chains in U.S. system sales and units. With 11,798 international units, YUM is the second largest QSR company outside the U.S. YUM became an independent, publicly owned company on October 6, 1997 (the “Spin-off Date”) via a tax-free distribution of our Common Stock (the “Distribution” or “Spin-off”) to the shareholders of our former parent, PepsiCo, Inc. (“PepsiCo”).

Throughout Management’s Discussion and Analysis (“MD&A”), we make reference to ongoing operating profit which represents our operating profit excluding the impact of facility actions net loss (gain) and unusual items income (expense). See Note 7 to the Consolidated Financial Statements for a detailed discussion of these exclusions. We use ongoing operating profit as a key performance measure of our results of operations for purposes of evaluating performance internally. Ongoing operating profit is not a measure defined in accounting principles generally accepted in the United States of America and should not be considered in isolation or as a substitute for measures of performance in accordance with accounting principles generally accepted in the United States of America.

All references to per share and share amounts in the following MD&A have been adjusted to reflect the two-for-one stock split distributed on June 17, 2002.

In 2002, our international business, YUM! Restaurants International (“YRI” or “International”) accounted for 35% of system sales, 31% of revenues and 32% of ongoing operating profit excluding unallocated and corporate expenses. We anticipate that, despite the inherent risks and typically higher general and administrative expenses required by international operations, we will continue to invest in certain international markets with substantial growth potential.

This MD&A should be read in conjunction with our Consolidated Financial Statements on pages 41 through 79 and the Cautionary Statements on pages 39 and 40. All Note references herein refer to the Notes to the Consolidated Financial Statements on pages 46 through 79. Tabular amounts are displayed in millions except per share and unit count amounts, or as otherwise specifically identified.

Critical Accounting Policies

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 judgements could significantly affect our results of operations, financial condition and cash flows in future years. A description of what we consider to be our most significant critical accounting policies follows.

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Impairment or Disposal of Long-Lived Assets

We evaluate our long-lived assets for impairment at the individual restaurant level. Restaurants held and used are evaluated for impairment on a semi-annual basis or whenever events or circumstances indicate that the carrying amount of a restaurant may not be recoverable (including a decision to close a restaurant). Our semi-annual test includes those restaurants that have experienced two consecutive years of operating losses. These impairment evaluations require an estimation of cash flows over the remaining useful life of the primary asset of the restaurant, which can be for a period of over 20 years, and any terminal value. We limit assumptions about important factors such as sales growth and margin improvement to those that are supportable based upon our plans for the unit and actual results at comparable restaurants.

If the long-lived assets of a restaurant on a held and used basis are not recoverable based upon forecasted, undiscounted cash flows, we write the assets down to their fair value. This fair value is determined by discounting the forecasted cash flows, including terminal value, of the restaurant at an appropriate rate. The discount rate used is our cost of capital, adjusted upward when a higher risk is believed to exist.

When it is probable that we will sell a restaurant we write down the restaurant to its fair value. We often refranchise restaurants in groups and therefore perform impairment evaluations at the group level. Fair value is based on the expected sales proceeds less applicable transaction costs. Estimated sales proceeds are based on the most relevant of historical sales multiples or bids from buyers, and have historically been reasonably accurate estimations of the proceeds ultimately received.

See Note 2 for a further discussion of our policy regarding the impairment or disposal of long-lived assets.

Impairment of Investments in Unconsolidated Affiliates

We record impairment charges related to an investment in an unconsolidated affiliate whenever events or circumstances indicate that a decrease in the value of an investment has occurred which is other than temporary. In addition, we evaluate our investments in unconsolidated affiliates for impairment when they have experienced two consecutive years of operating losses. Our impairment measurement test for an investment in an unconsolidated affiliate is similar to that for our restaurants except that we use discounted cash flows after interest and taxes instead of discounted cash flows before interest and taxes as used for our restaurants.

See Note 2 for a further discussion of our policy regarding the impairment of investments in unconsolidated affiliates.

Impairment of Goodwill

We evaluate goodwill for impairment on an annual basis through the comparison of fair value of our reporting units to their carrying values. Our reporting units are our operating segments in the U.S. and our business management units internationally (typically individual countries). Fair value is the price a willing buyer would pay for the reporting unit, and is generally estimated by discounting expected future cash flows from the reporting units over twenty years plus an expected terminal value. We limit assumptions about important factors such as sales growth and margin improvement to those that are supportable based upon our plans for the reporting unit.

We impaired $5 million of goodwill during 2002 related to our Pizza Hut France reporting unit. For the remainder of our reporting units with goodwill, the fair value is generally significantly in excess of the recorded carrying value. Thus, we do not believe that we have material goodwill that is at risk to be impaired given current business performance.

See Note 2 for a further discussion of our policies regarding goodwill.

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Allowances for Franchise and License Receivables and Contingent Liabilities

We reserve a franchisee’s or licensee’s entire receivable balance based upon pre-defined aging criteria and upon the occurrence of other events that indicate that we may not collect the balance due. As a result of reserving using this methodology, we have an immaterial amount of receivables that are past due that have not been reserved for at December 28, 2002. See Note 2 for a further discussion of our policies regarding franchise and license operations.

Primarily as a result of our refranchising efforts, we remain liable for certain lease assignments and guarantees. We record a liability for our exposure under these lease assignments and guarantees when such exposure is probable and estimable. At December 28, 2002, we have recorded an immaterial liability for our exposure which we consider to be probable and estimable. The potential total exposure under such leases is significant, with $278 million representing the present value of the minimum payments of the assigned leases at December 28, 2002, discounted at our pre-tax cost of debt. Current franchisees are the primary lessees under the vast majority of these leases. We generally have cross-default provisions with these franchisees that would put them in default of their franchise agreement in the event of non-payment under the lease. We believe these cross-default provisions significantly reduce the risk that we will be required to make payments under these leases and, historically, we have not been required to make such payments in significant amounts. See Note 24 for a further discussion of our lease guarantees.

Self-Insured Property and Casualty Losses

We record our best estimate of the remaining cost to settle incurred self-insured property and casualty claims. The estimate is based on the results of an independent actuarial study and considers historical claim frequency and severity as well as changes in factors such as our business environment, benefit levels, medical costs and the regulatory environment that could impact overall self-insurance costs. Additionally, a risk margin to cover unforeseen events that may occur over the several years it takes for claims to settle is included in our reserve, increasing our confidence level that the recorded reserve is adequate.

See Note 24 for a further discussion of our insurance programs.

Income Tax Valuation Allowances and Tax Reserves

At December 28, 2002, we have recorded a valuation allowance of $137 million primarily to reduce our net operating loss and tax credit carryforwards of $176 million to an amount that will more likely than not be realized. These net operating loss and tax credit carryforwards exist in many state and foreign jurisdictions and have varying carryforward periods and restrictions on usage. The estimation of future taxable income in these state and foreign jurisdictions and our resulting ability to utilize net operating loss and tax credit carryforwards can significantly change based on future events, including our determinations as to the feasibility of certain tax planning strategies. 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 provide reserves for potential exposures when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our position. We evaluate these reserves, including interest thereon, on a quarterly basis to insure that they have been appropriately adjusted for events that may impact our ultimate payment for such exposures.

See Note 22 for a further discussion of our income taxes.

Factors Affecting Comparability of 2002 Results to 2001 Results and 2001 Results to 2000 Results

YGR Acquisition

On May 7, 2002, the Company completed its acquisition of YGR, the parent company of LJS and A&W. See Note 4 for a discussion of the acquisition.

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As of the date of the acquisition, YGR consisted of 742 and 496 company and franchise LJS units, respectively, and 127 and 742 company and franchise A&W units, respectively. In addition, 133 multibranded LJS/A&W restaurants were included in the LJS unit totals. Except as discussed in certain sections of the MD&A, the impact of the acquisition on our results of operations in 2002 was not significant.

Impact of Recently Adopted Accounting Pronouncement

Effective December 30, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), in its entirety. In accordance with the requirements of SFAS 142, we ceased amortization of goodwill and indefinite-lived intangibles as of December 30, 2001. The following table summarizes the favorable effect of SFAS 142 on restaurant profit, restaurant margin and ongoing operating profit had SFAS 142 been effective in 2001.

Additionally, if SFAS 142 had been effective in 2001, reported net income would have increased approximately $26 million and diluted earnings per common share (“EPS”) would have increased $0.09.

Unusual Items (Income) Expense

We recorded unusual items income of $27 million in 2002 and $3 million in 2001 and unusual items expense of $204 million in 2000. See Note 7 for a detailed discussion of our unusual items (income) expense.

Impact of New Unconsolidated Affiliates

Consistent with our strategy to focus our capital on key international markets, we formed ventures in Canada and Poland with our largest franchisee in each market. The venture in Canada was formed in the third quarter of 2000 and the venture in Poland was effective in the first quarter of 2001. At the date of formation, the Canadian venture operated over 700 stores and the Poland venture operated approximately 100 stores. We did not record any gain or loss on the transfer of assets to these new ventures.

Previously, the results from the restaurants we contributed to these ventures were consolidated. The impact of these transactions on operating results is similar to the impact of our refranchising activities, which is described in the Store Portfolio Strategy section below. Consequently, these transactions resulted in a decline in our Company sales, restaurant margin dollars and general and administrative (“G&A”) expenses as well as higher franchise fees. We also record equity income (loss) from investments in unconsolidated affiliates (“equity income”) and, in Canada, higher franchise fees since the royalty rate was increased for those stores contributed by our partner to the venture. The formation of these ventures did not have a significant net impact on ongoing operating profit in 2001.

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Store Portfolio Strategy

Since 1995, we have been strategically reducing our share of total system units by selling Company restaurants to existing and new franchisees where their expertise can generally be leveraged to improve the restaurants’ overall operating performance, while retaining Company ownership of key U.S. and International markets. This portfolio-balancing activity reduces our reported revenues and restaurant profits, which increases the importance of system sales as a key performance measure. We substantially completed our U.S. refranchising program in 2001.

The following table summarizes our refranchising activities:

In addition to our refranchising program, we have closed certain restaurants over the past several years. Restaurants closed include poor performing restaurants, restaurants relocated to a new site within the same trade area or U.S. Pizza Hut delivery units consolidated with a new or existing dine-in traditional store within the same trade area.

The following table summarizes Company store closure activities:

The impact on ongoing operating profit arising from our refranchising and store closure initiatives as well as the contribution of Company stores to new unconsolidated affiliates is the net of (a) the estimated reduction in Company sales, restaurant profit and G&A expenses; (b) the estimated increase in franchise fees from the stores refranchised; and (c) the estimated change in equity income (loss). The amounts presented below reflect the estimated impact from stores that were operated by us for all or some portion of the respective previous year and were no longer operated by us as of the last day of the respective year.

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The following table summarizes the estimated impact on revenue of refranchising, Company store closures and, in 2001, the contribution of Company stores to unconsolidated affiliates:

The following table summarizes the estimated impact on ongoing operating profit of refranchising, Company store closures and, in 2001, the contribution of Company stores to unconsolidated affiliates:

Franchisee Financial Condition

Like others in the QSR industry, from time to time, some of our franchise operators experience financial difficulties with respect to their franchise operations.

Depending upon the facts and circumstances of each situation, and in the absence of an improvement in the franchisee’s business trends, there are a number of potential resolutions of these financial issues. These include a sale of some or all of the operator’s restaurants to us or a third party, a restructuring of the operator’s business and/or finances, or, in the more unusual cases, bankruptcy of the operator. It is our practice to proactively work with financially troubled franchise operators in an attempt to positively resolve their issues.

Since 2000, certain of our franchise operators, principally in the Taco Bell system, have experienced varying degrees of financial problems. Through December 28, 2002, restructurings have been completed for approximately 1,778 Taco Bell franchise restaurants. In connection with these restructurings, Taco Bell has acquired 147 restaurants for approximately $76 million. In addition to these acquisitions, Taco Bell has purchased land, buildings and/or equipment related to 52

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restaurants from franchisees for approximately $28 million and simultaneously leased it back to these franchisees under long-term leases. As part of the restructurings, Taco Bell committed to fund approximately $45 million of future franchise capital expenditures, principally through leasing arrangements, approximately $26 million of which has been funded through December 28, 2002. We substantially completed the Taco Bell franchisee restructurings in 2002 and expect to finalize any remaining restructurings in the first quarter of 2003.

In the fourth quarter of 2000, Taco Bell also established a $15 million loan program to assist certain franchisees. All fundings had been advanced by the end of the first quarter of 2001. A remaining net balance of $7 million at December 28, 2002 for these notes receivable is included primarily in other assets.

We believe that the general improvement in business trends at Taco Bell has helped alleviate financial problems in the Taco Bell franchise system which were due to past downturns in sales. As described in the U.S. revenues section, Company same-store sales growth at Taco Bell increased 7% in 2002. This follows an 8% increase in Company same-store sales growth at Taco Bell in the fourth quarter of 2001. Generally, franchisees have experienced similar or better growth over these time frames. Accordingly, the cost of restructurings of Taco Bell franchise restaurants was less in 2002 than in 2001 and, though we continue to monitor this situation, we expect these costs to be less again in 2003.

In 2002 and 2001, the Company charged expenses of $8 million and $18 million, respectively, to ongoing operating profit related to allowances for doubtful Taco Bell franchise and license fee receivables. These costs are reported as part of franchise and license expenses. On an ongoing basis, we assess our exposure from franchise-related risks, which include estimated uncollectibility of franchise and license receivables, contingent lease liabilities, guarantees to support third party financial arrangements of franchisees and potential claims by franchisees. The contingent lease liabilities and guarantees are more fully discussed in the Lease Guarantees section of Note 24. Although the ultimate impact of these franchise financial issues cannot be predicted with certainty at this time, we have provided for our current estimate of the probable exposure as of December 28, 2002. It is reasonably possible that there will be additional costs; however, these costs are not expected to be material to quarterly or annual results of operations, financial condition or cash flows.

Impact of AmeriServe Bankruptcy Reorganization Process

See Note 25 for a discussion of the impact of the AmeriServe Food Distribution, Inc. (“AmeriServe”) bankruptcy reorganization process on the Company.

Impact of the Consolidation of an Unconsolidated Affiliate

At the beginning of 2001, we consolidated a previously unconsolidated affiliate in our Consolidated Financial Statements as a result of a change in our intent to temporarily retain control of this affiliate. As a result of this change, Company sales, restaurant margin and G&A increased approximately $100 million, $6 million and $9 million, respectively, in 2001. Also as a result of the change, franchise fees and equity income decreased approximately $4 million and $2 million, respectively, in 2001. At the date of consolidation, this previously unconsolidated affiliate operated over 100 stores.

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Fifty-third Week in 2000

Our fiscal calendar results in a fifty-third week every 5 or 6 years. Fiscal year 2000 included a fifty-third week in the fourth quarter. The estimated favorable impact in net income was $10 million or $0.03 per diluted share in 2000. The following table summarizes the estimated favorable/(unfavorable) impact of the fifty-third week on system sales, revenues and ongoing operating profit in 2000:

The Company’s next fiscal year with fifty-three weeks will be 2005.

Worldwide Results of Operations

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Worldwide Restaurant Unit Activity

Worldwide System Sales

System sales represents the combined sales of Company, unconsolidated affiliates, franchise and license restaurants. Sales of unconsolidated affiliates and franchise and license restaurants result in franchise and license fees for us but are not included in the Company sales figure we present on the Consolidated Statements of Income. However, we believe that system sales is useful to investors as a significant indicator of our Concepts’ market share and the overall strength of our business as it incorporates all of our revenue drivers, company and franchise same store sales as well as net unit development.

System sales increased approximately $1,891 million or 8% in 2002. The impact from foreign currency translation was not significant. Excluding the favorable impact of the YGR acquisition, system sales increased 5%. The increase resulted from new unit development and same store sales growth, partially offset by store closures.

System sales increased $169 million or 1% in 2001, after a 2% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, system sales increased 5%. This increase was driven by new unit development and same store sales growth, partially offset by store closures.

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Worldwide Revenues

Company sales increased $753 million or 12% in 2002. The impact from foreign currency translation was not significant. Excluding the favorable impact of the YGR acquisition, Company sales increased 6%. The increase was driven by new unit development and same store sales growth. The increase was partially offset by refranchising and store closures.

Company sales decreased $167 million or 3% in 2001, after a 2% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, Company sales were flat. An increase due to new unit development was offset by refranchising.

Franchise and license fees increased $51 million or 6% in 2002. The impact from foreign currency translation was not significant. Excluding the favorable impact of the YGR acquisition, franchise and license fees increased 4%. The increase was driven by new unit development and same store sales growth, partially offset by store closures.

Franchise and license fees increased $27 million or 3% in 2001, after a 2% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, franchise and license fees increased 7%. The increase was driven by new unit development, units acquired from us and same store sales growth. This increase was partially offset by store closures.

Worldwide Company Restaurant Margin

Restaurant margin as a percentage of sales increased approximately 120 basis points in 2002. The increase included the favorable impact of approximately 50 basis points from the adoption of SFAS 142, partially offset by the unfavorable impact of approximately 15 basis points from the YGR acquisition. U.S. restaurant margin increased approximately 80 basis points and International restaurant margin increased approximately 210 basis points.

Restaurant margin as a percentage of sales decreased approximately 30 basis points in 2001. U.S. restaurant margin was flat and International restaurant margin declined approximately 120 basis points.

Worldwide General And Administrative Expenses

G&A expenses increased $117 million or 15% in 2002. Excluding the unfavorable impact of the YGR acquisition, G&A expenses increased 10%. The increase was primarily driven by higher compensation-related costs and higher corporate and project spending.

G&A expenses decreased $34 million or 4% in 2001. Excluding the favorable impact of lapping the fifty-third week in 2000, G&A expenses decreased 3%. The decrease was driven by lower corporate and project spending, the formation of unconsolidated affiliates and refranchising. The decrease was partially offset by higher compensation-related costs.

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Worldwide Franchise and License Expenses

Franchise and license expenses decreased $10 million or 18% in 2002. The decrease was primarily attributable to lower allowances for doubtful franchise and license fee receivables and the favorable impact of lapping support costs related to the financial restructuring of certain Taco Bell franchisees in 2001. The decrease was partially offset by higher marketing support costs in certain international markets.

Franchise and license expenses increased $10 million or 20% in 2001. The increase was primarily due to support costs related to the financial restructuring of certain Taco Bell franchisees. The increase was partially offset by lower allowances for doubtful franchise and license fee receivables.

Worldwide Other (Income) Expense

Other (income) expense is comprised of equity (income) loss from investments in unconsolidated affiliates and foreign exchange net (gain) loss.

Other (income) expense increased $7 million or 28% in 2002. Equity income increased $3 million or 12%. The impact from foreign currency translation was not significant on equity income. The increase included a $4 million favorable impact from the adoption of SFAS 142.

Other (income) expense decreased $2 million or 8% in 2001. Equity income increased $1 million or 3%, after a 6% unfavorable impact from foreign currency translation.

Worldwide Facility Actions Net Loss (Gain)

We recorded facility actions net loss of $32 million in 2002 and $1 million in 2001 and facility actions net gain of $176 million in 2000. See the Store Portfolio Strategy section for more detail of our refranchising and closure activities and Note 7 for a summary of the components of facility actions net loss (gain) by reportable operating segment.

Worldwide Ongoing Operating Profit

The changes in U.S. and International ongoing operating profit for 2002 and 2001 are discussed in the respective sections.

Unallocated and corporate expenses increased $30 million or 20% in 2002. The increase was primarily driven by higher compensation-related costs and higher corporate and project spending.

Unallocated and corporate expenses decreased $15 million or 9% in 2001. Excluding the favorable impact of lapping the fifty-third week in 2000, G&A decreased 8%. The decline was primarily due to lower corporate and project spending partially offset by higher compensation-related costs.

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Worldwide Interest Expense, Net

Net interest expense increased $14 million or 8% in 2002. Interest expense increased $8 million or 5% in 2002. Excluding the impact of the YGR acquisition, interest expense decreased 12%. The decrease was driven by a reduction in our average debt balance partially offset by an increase in our average interest rate. Our average interest rate increased due to a reduction in our variable-rate borrowings using proceeds from the issuance of longer term, fixed-rate notes.

Net interest expense decreased $18 million or 10% in 2001. The decrease was primarily due to a decrease in our average interest rate.

Worldwide Income Taxes

The following table reconciles the U.S. federal statutory tax rate to our ongoing effective tax rate:

The 2002 ongoing effective tax rate decreased 1.8 percentage points to 31.3%. The decrease in the ongoing effective tax rate was primarily due to adjustments related to prior years and an increase in the benefit from claiming credit against our current and future U.S. income tax liability for foreign taxes paid, partially offset by reduced valuation allowance reversals. See Note 22 for a discussion of valuation allowances.

In 2002, the effective tax rate attributable to foreign operations was lower than the U.S. federal statutory rate primarily due to the benefit of claiming credit against our current and future U.S. income tax liability for foreign taxes paid.

The 2001 ongoing effective tax rate decreased 4.6 percentage points to 33.1%. The decrease in the ongoing effective tax rate was primarily due to adjustments related to prior years, partially offset by reduced valuation allowance reversals.

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In 2001, the effective tax rate attributable to foreign operations was slightly higher than the U.S. federal statutory rate because losses of foreign operations for which no benefit could be currently recognized and other adjustments more than offset the effect of claiming credit against our U.S. income tax liability for foreign taxes paid.

U.S. Results of Operations

U.S. Restaurant Unit Activity

U.S. System Sales

System sales increased approximately $1,243 million or 9% in 2002. Excluding the favorable impact of the YGR acquisition, system sales increased 4%. The increase resulted from same store sales growth and new unit development, partially offset by store closures.

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System sales increased $82 million or 1% in 2001. Excluding the unfavorable impact of lapping the fifty-third week in 2000, system sales increased 2%. The increase was driven by new unit development and same store sales growth at KFC and Pizza Hut, partially offset by store closures.

U.S. Revenues

Company sales increased $491 million or 11% in 2002. Excluding the favorable impact of the YGR acquisition, company sales increased 3%. The increase was driven by new unit development and same store sales growth. The increase was partially offset by store closures and refranchising.

For 2002, blended Company same store sales for KFC, Pizza Hut and Taco Bell were up 2% due to increases in both transactions and average guest check. Same store sales at Taco Bell increased 7%, primarily driven by a 4% increase in transactions. Same store sales at both Pizza Hut and KFC were flat due to a 2% increase in average guest check offset by transaction declines.

Company sales decreased $246 million or 5% in 2001. Excluding the unfavorable impact of lapping the fifty-third week in 2000, Company sales decreased 4%. The decrease was driven by refranchising, partially offset by new unit development.

For 2001, blended Company same store sales for KFC, Pizza Hut and Taco Bell were up 1% on a comparable fifty-two week basis. An increase in the average guest check was partially offset by transaction declines. Same store sales at KFC were up 3%, primarily due to an increase in transactions. Same store sales at both Pizza Hut and Taco Bell were flat. A 2% increase in the average guest check at Pizza Hut and a 3% increase in the average guest check at Taco Bell were both offset by transaction declines.

Franchise and license fees increased $29 million or 5% in 2002. Excluding the favorable impact of the YGR acquisition, franchise and license fees increased 3%. The increase was driven by same store sales growth and new unit development, partially offset by store closures.

Franchise and license fees grew $11 million or 2% in 2001. Excluding the unfavorable impact of lapping the fifty-third week in 2000, franchise and license fees increased 4%. The increase was driven by units acquired from us and new unit development, partially offset by store closures.

U.S. Company Restaurant Margin

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Restaurant margin as a percentage of sales increased approximately 80 basis points in 2002. The increase includes the favorable impact of approximately 50 basis points from the adoption of SFAS 142, which was partially offset by the unfavorable impact of approximately 20 basis points from the YGR acquisition. The increase was primarily driven by the favorable impact of same store sales growth on margin and lower food and paper costs, partially offset by an increase in labor costs. The decrease in food and paper costs was primarily driven by cheese costs. The increase in labor costs was primarily driven by wage rates.

Restaurant margin as a percentage of sales was flat in 2001. The favorable impact of same store sales growth on margin was offset by increases in occupancy and other costs, food and paper costs and labor costs. The increase in food and paper costs was primarily driven by cheese costs. The increase in labor costs was primarily driven by wage rates.

U.S. Ongoing Operating Profit

Ongoing operating profit increased $103 million or 14% in 2002, including a 3% favorable impact from the adoption of SFAS 142. Excluding the favorable impact of both SFAS 142 and the YGR acquisition, ongoing operating profit increased 8%. The increase was driven by same store sales growth and the favorable impact of lapping franchise support costs related to the restructuring of certain Taco Bell franchisees in 2001. The increase was partially offset by higher restaurant operating costs, primarily due to higher labor costs, and the unfavorable impact of refranchising and store closures. The higher labor costs were driven by wage rates.

Ongoing operating profit decreased $20 million or 3% in 2001. Excluding the unfavorable impact of lapping the fifty-third week in 2000, ongoing operating profit decreased 1%. The decrease was driven by the unfavorable impact of refranchising and store closures, higher restaurant operating costs and higher franchise support costs related to the restructuring of certain Taco Bell franchisees. The decrease was partially offset by same store sales growth and new unit development.

International Results of Operations

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International Restaurant Unit Activity

International System Sales

System sales increased approximately $648 million or 8% in 2002, after a 1% unfavorable impact from foreign currency translation. Excluding the impact of foreign currency translation and the favorable impact of the YGR acquisition, system sales increased 8%. The increase resulted from new unit development and same store sales growth, partially offset by store closures.

System sales increased approximately $87 million or 1% in 2001, after a 7% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, system sales increased 9%. The increase was driven by new unit development and same store sales growth, partially offset by store closures.

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International Revenues

Company sales increased $262 million or 14% in 2002, after a 1% favorable impact from foreign currency translation. The increase was driven by new unit development, partially offset by refranchising and store closures. The unfavorable impact of refranchising primarily resulted from the sale of the Singapore business in the third quarter of 2002.

Company sales increased $79 million or 5% in 2001, after a 5% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, Company sales increased 11%. The increase was driven by new unit development and acquisitions of restaurants from franchisees. The increase was partially offset by the contribution of Company stores to new unconsolidated affiliates.

Franchise and license fees increased $22 million or 8% in 2002, after a 1% unfavorable impact from foreign currency translation. Excluding the impact of foreign currency translation and the favorable impact of the YGR acquisition, franchise and license fees increased 8%. The increase was driven by new unit development and same store sales growth, partially offset by store closures.

Franchise and license fees increased $16 million or 6% in 2001, after a 6% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, franchise and license fees increased 13%. The increase was driven by new unit development, same store sales growth and the contribution of Company stores to new unconsolidated affiliates. The increase was partially offset by store closures.

International Company Restaurant Margin

Restaurant margin as a percentage of sales increased approximately 210 basis points in 2002, including the favorable impact of approximately 60 basis points from the adoption of SFAS 142. The increase was primarily driven by the favorable impact of lower restaurant operating costs and the elimination of lower average margin units through store closures. Lower restaurant operating costs primarily resulted from lower food and paper costs, partially offset by higher labor costs.

Restaurant margin as a percentage of sales decreased approximately 120 basis points in 2001. The decrease was primarily attributable to higher restaurant operating costs and the acquisition of below average margin stores from franchisees. The decrease was partially offset by the favorable impact of same store sales growth.

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International Ongoing Operating Profit

Ongoing operating profit increased $71 million or 22% in 2002, after a 1% unfavorable impact from foreign currency translation. Excluding the impact of foreign currency translation and the favorable impact from the adoption of SFAS 142, ongoing operating profit increased 17%. The increase was driven by new unit development and the favorable impact of lower restaurant operating costs, primarily lower cost of food and paper. The increase was partially offset by higher G&A expenses, primarily compensation-related costs.

Ongoing operating profit increased $9 million or 3% in 2001, after a 7% unfavorable impact from foreign currency translation. Excluding the unfavorable impact of foreign currency translation and lapping the fifty-third week in 2000, ongoing operating profit increased 12%. The increase was driven by new unit development and same store sales growth, partially offset by higher restaurant operating costs.

Consolidated Cash Flows

Net cash provided by operating activities was $1,088 million compared to $832 million in 2001. Excluding the impact of the AmeriServe bankruptcy reorganization process, cash provided by operating activities was $1,043 million versus $704 million in 2001. This increase was primarily driven by higher operating profit and timing of tax receipts and payments.

In 2001, net cash provided by operating activities was $832 million compared to $491 million in 2000. Excluding the impact of the AmeriServe bankruptcy reorganization process, cash provided by operating activities was $704 million versus $734 million in 2000.

Net cash used in investing activities was $885 million versus $503 million in 2001. The increase in cash used was primarily due to the acquisition of YGR and higher capital spending in 2002, partially offset by the acquisition of fewer restaurants from franchisees in 2002.

In 2001, net cash used in investing activities was $503 million versus $237 million in 2000. The increase in cash used was primarily due to lower gross refranchising proceeds as a result of selling fewer restaurants in 2001 and increased acquisitions of restaurants from franchisees and capital spending. The increase was partially offset by lapping the funding of a debtor-in-possession revolving credit facility to AmeriServe in 2000.

Although we report gross proceeds in our Consolidated Statements of Cash Flows, we also consider refranchising proceeds on an “after-tax” basis. We define after-tax proceeds as gross refranchising proceeds less the settlement of working capital liabilities (primarily accounts payable and property taxes) related to the units refranchised and payment of taxes on the gains. The after-tax proceeds can be used to pay down debt or repurchase shares. After-tax proceeds were approximately $71 million in 2002 which reflects a 21% decrease from 2001. This decrease was due to the refranchising of fewer restaurants in 2002 versus 2001.

Net cash used in financing activities was $187 million versus $352 million in 2001. The decrease is primarily due to lower debt repayments and higher proceeds from stock option exercises versus 2001, partially offset by higher shares repurchased in 2002.

In 2001, net cash used in financing activities was $352 million compared to $207 million in 2000. The increase in cash used is primarily due to higher repayment of debt, partially offset by fewer shares repurchased in 2001 compared to 2000.

In November 2002, our Board of Directors authorized a new share repurchase program. This program authorizes us to repurchase, through November 20, 2004, up to $300 million of our outstanding Common Stock (excluding applicable transaction fees). During 2002, we repurchased approximately 1.2 million shares for approximately $28 million under this program.

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In February 2001, our Board of Directors authorized a share repurchase program. This program authorized us to repurchase up to $300 million of our outstanding Common Stock (excluding applicable transaction fees). This share repurchase program was completed in 2002. During 2002, we repurchased approximately 7.0 million shares for approximately $200 million under this program. During 2001, we repurchased approximately 4.8 million shares for approximately $100 million.

In September 1999, our Board of Directors authorized a share repurchase program. This program authorized us to repurchase up to $350 million of our outstanding Common Stock (excluding applicable transaction fees). This share repurchase program was completed in 2000. During 2000, we repurchased approximately 12.8 million shares for approximately $216 million.

See Note 21 for a discussion of the share repurchase programs.

Financing Activities

On June 25, 2002, we closed on a new $1.4 billion senior unsecured Revolving Credit Facility (the “New Credit Facility”). The New Credit Facility replaced the existing bank credit agreement which was comprised of a senior unsecured Term Loan Facility and a $1.75 billion senior unsecured Revolving Credit Facility (collectively referred to as the “Old Credit Facilities”) that were scheduled to mature on October 2, 2002. On December 27, 2002, we voluntarily reduced our maximum borrowings under the New Credit Facility from $1.4 billion to $1.2 billion. The New Credit Facility matures on June 25, 2005. We used the initial borrowings under the New Credit Facility to repay the indebtedness under the Old Credit Facilities.

The New Credit Facility is unconditionally guaranteed by our principal domestic subsidiaries and contains other terms and provisions (including representations, warranties, covenants, conditions and events of default) similar to those set forth in the Old Credit Facilities. Specifically, the New Credit Facility contains financial covenants relating to maintenance of leverage and fixed charge coverage ratios. The New Credit Facility also contains affirmative and negative covenants including, among other things, limitations on certain additional indebtedness, guarantees of indebtedness, cash dividends, aggregate non-U.S. investment and certain other transactions as defined in the agreement.

Under the terms of the New Credit Facility, we may borrow up to the maximum borrowing limit less outstanding letters of credit. At December 28, 2002, our unused New Credit Facility totaled $0.9 billion, net of outstanding letters of credit of $0.2 billion. The interest rate for borrowings under the New Credit Facility ranges from 1.00% to 2.00% over the London Interbank Offered Rate (“LIBOR”) or 0.00% to 0.65% over an Alternate Base Rate, which is the greater of the Prime Rate or the Federal Funds Effective Rate plus 1%. The exact spread over LIBOR or the Alternate Base Rate, as applicable, will depend upon our performance under specified financial criteria. Interest is payable at least quarterly. In the third quarter of 2002, we capitalized debt issuance costs of approximately $9 million related to the New Credit Facility. These debt issuance costs will be amortized into interest expense over the life of the New Credit Facility.

In June 2002, we issued $400 million of 7.70% Senior Unsecured Notes due July 1, 2012 (the “2012 Notes”). The net proceeds from the issuance of the 2012 Notes were used to repay indebtedness under the New Credit Facility. Interest on the 2012 Notes is payable January 1 and July 1 of each year and commenced on January 1, 2003. We capitalized debt issuance costs of approximately $5 million related to the 2012 Notes in third quarter of 2002. Subsequent to this issuance, we have $150 million available for issuance under a $2 billion shelf registration filed in 1997.

As discussed in Note 4, upon the acquisition of YGR, we assumed approximately $168 million in present value of future rent obligations related to certain sale-leaseback agreements entered into by YGR involving approximately 350 LJS units. As a result of liens held by the buyer/lessor on certain personal property within the units, the sale-leaseback agreements have been accounted for as financings and are reflected as debt in our Consolidated Financial Statements as of December 28, 2002. Rental payments made under these agreements will be made on a monthly basis through 2019 with an effective interest rate of approximately 11%.

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Consolidated Financial Condition

Assets increased $975 million or 22% to $5.4 billion. This increase was primarily due to the acquisition of YGR and the impact of capital spending. The decrease in the allowance for doubtful accounts from $77 million to $42 million was primarily the result of recoveries related to the AmeriServe bankruptcy reorganization process (see Note 25) and the write-off of receivables previously fully reserved. The increase in assets classified as held for sale is due primarily to classification of our Puerto Rico market as held for sale during the fourth quarter of 2002.

Liabilities increased $485 million or 11% to $4.8 billion. The increase was primarily due to additional financing associated with the acquisition of YGR. As discussed in Note 14, the decrease in short-term borrowings of $550 million and the increase in long-term debt of $747 million are primarily the result of the replacement of our Old Credit Facilities that were to expire in October 2002 with the New Credit Facility that will expire in 2005. The increase in current income taxes payable was primarily the result of a reclassification from other liabilities and deferred credits for taxes that are now expected to be paid within the next twelve months.

Liquidity

Operating in the QSR industry allows us to generate substantial cash flows from the operations of our company stores and from our franchise operations, which require a limited YUM investment in operating assets. Typically, our cash flows include a significant amount of discretionary capital spending. Though a decline in revenues could adversely impact our cash flows from operations, we believe our operating cash flows and ability to adjust discretionary capital spending and borrow funds will allow us to meet our cash requirements in 2003 and beyond.

Significant contractual obligations and payments as of December 28, 2002 due by period included:

See Note 14 for a discussion of short-term borrowings and long-term debt and Note 15 for a discussion of leases.

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In addition, we have certain other commercial commitments where payment is contingent upon the occurrence of certain events. As of December 28, 2002, the maximum exposure under these commercial commitments, which are shown on a nominal basis, included:

See Notes 14 and 24 for a further discussion of these commitments.

Other Significant Known Events, Trends or Uncertainties Expected to Impact 2003 Operating Profit Comparisons with 2002

New Accounting Pronouncements

See Note 2.

Pension Plan Funded Status

Certain of our employees are covered under noncontributory defined benefit pension plans. The most significant of these plans was amended in 2001 such that employees hired after September 30, 2001 are no longer eligible to participate. As of our September 30, 2002 measurement date, these plans had a projected benefit obligation (“PBO”) of $501 million, an accumulated benefit obligation (“ABO”) of $448 million and a fair value of plan assets of $251 million. Subsequent to the measurement date but prior to December 28, 2002, we made an additional $25 million contribution to the plans which is not included in this fair value of plan assets. As a result of the $250 million underfunded status of the plans relative to the PBO at September 30, 2002, we have recorded a $71 million charge to shareholders’ equity (net of tax of $43 million) as of December 28, 2002.

The PBO and ABO reflect the actuarial present value of all benefits earned to date by employees. The PBO incorporates assumptions as to future compensation levels while the ABO reflects only current compensation levels. Due to the relatively long time frame over which benefits earned to date are expected to be paid, our PBO and ABO are highly sensitive to changes in discount rates. We measured our PBO and ABO using a discount rate of 6.85% at September 30, 2002. A 50 basis point increase in this discount rate would have decreased our PBO by approximately $49 million at September 30, 2002. Conversely, a 50 basis point decrease in this discount rate would have increased our PBO by approximately $56 million at September 30, 2002.

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Due to recent stock market declines, our pension plan assets have experienced losses in value in 2002 and 2001 totaling approximately $75 million. We changed our expected long-term rate of return on plan assets from 10% to 8.5% for the determination of our 2002 expense. We believe that this assumption is appropriate given the composition of our plan assets and historical market returns thereon. This change resulted in the recognition of approximately $5 million in incremental expense in comparison to 2001. We will continue to use the 8.5% expected rate of return on plan assets assumption for the determination of pension expense in 2003. Given no change to the market-related value of our plan assets as of September 30, 2002, a one percentage point increase or decrease in our expected rate of return on plan assets assumption would decrease or increase, respectively, our pension plan expense by approximately $3 million.

The losses our plan assets have experienced, along with the decrease in discount rates, have largely contributed to the unrecognized actuarial loss of $169 million in our plans as of September 30, 2002. For purposes of determining 2002 expense our funded status was such that we recognized $1 million of unrecognized actuarial loss in 2002. We will recognize approximately $7 million of unrecognized actuarial loss in 2003. Given no change to the assumptions at our September 30, 2002 measurement date, actuarial loss recognition will increase gradually over the next few years, however, we do not believe the increase will materially impact our results of operations.

In total, we expect pension expense to increase approximately $14 million to $41 million in 2003. We have incorporated this incremental expense into our operating plans and outlook. The increase is driven by an increase in interest cost because of the higher PBO and the recognition of actuarial losses as discussed in the preceding paragraph. Service cost will also increase as a result of the lower discount rate, though as previously mentioned the plans are closed to new participants. A 50 basis point change in our discount rate assumption of 6.85% at September 30, 2002 would impact our pension expense by approximately $11 million.

We do not believe that the underfunded status of the pension plans will materially affect our financial position or cash flows in 2003 or future years. Given current funding levels and discount rates we would anticipate making contributions to fully fund the pension plans over the course of the next five years. We believe that our cash flows from operating activities of approximately $1 billion per year are sufficient to allow us to make necessary contributions to the plans, and anticipated fundings have been incorporated into our cash flow projections. We have included known and expected increases in our pension expense as well as future expected plan contributions in our operating plans and outlook.

Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to financial market risks associated with interest rates, foreign currency exchange rates and commodity prices. In the normal course of business and in accordance with our policies, we manage these risks through a variety of strategies, which may include the use of derivative financial and commodity instruments to hedge our underlying exposures. Our policies prohibit the use of derivative instruments for trading purposes, and we have procedures in place to monitor and control their use.

Interest Rate Risk

We have a significant market risk exposure to changes in interest rates, principally in the United States. We attempt to minimize this risk and lower our overall borrowing costs through the utilization of derivative financial instruments, primarily interest rate swaps. These swaps are entered into with financial institutions and have reset dates and critical terms that match those of the underlying debt. Accordingly, any change in market value associated with interest rate swaps is offset by the opposite market impact on the related debt.

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At December 28, 2002 and December 29, 2001, a hypothetical 100 basis point increase in short-term interest rates would result in a reduction of $6 million and $4 million, respectively, in annual income before taxes. The estimated reductions are based upon the unhedged portion of our variable rate debt and assume no changes in the volume or composition of debt. In addition, the fair value of our derivative financial instruments at December 28, 2002 and December 29, 2001 would decrease approximately $8 million and $5 million, respectively. The fair value of our Senior Unsecured Notes at December 28, 2002 and December 29, 2001 would decrease approximately $93 million and $72 million, respectively. Fair value was determined by discounting the projected cash flows.

Foreign Currency Exchange Rate Risk

International ongoing operating profit constitutes approximately 32% of our ongoing operating profit in 2002, excluding unallocated and corporate expenses. In addition, the Company’s net asset exposure (defined as foreign currency assets less foreign currency liabilities) totaled approximately $1 billion as of December 28, 2002. Operating in international markets exposes the Company to movements in foreign currency exchange rates. The Company’s primary exposures result from our operations in Asia-Pacific, the Americas and Europe. Changes in foreign currency exchange rates would impact the translation of our investments in foreign operations, the fair value of our foreign currency denominated financial instruments and our reported foreign currency denominated earnings and cash flows. For the fiscal year ended December 28, 2002, operating profit would have decreased $43 million if all foreign currencies had uniformly weakened 10% relative to the U.S. dollar. The estimated reduction assumes no changes in sales volumes or local currency sales or input prices.

We attempt to minimize the exposure related to our investments in foreign operations by financing those investments with local currency debt when practical. In addition, we attempt to minimize the exposure related to foreign currency denominated financial instruments by purchasing goods and services from third parties in local currencies when practical. Consequently, foreign currency denominated financial instruments consist primarily of intercompany short-term receivables and payables. At times, we utilize forward contracts to reduce our exposure related to these foreign currency denominated financial instruments. The notional amount and maturity dates of these contracts match those of the underlying receivables or payables such that our foreign currency exchange risk related to these instruments is eliminated.

Commodity Price Risk

We are subject to volatility in food costs as a result of market risk associated with commodity prices. Our ability to recover increased costs through higher pricing is, at times, limited by the competitive environment in which we operate. We manage our exposure to this risk primarily through pricing agreements as well as, on a limited basis, commodity future and option contracts. Commodity future and option contracts entered into for the fiscal years ended December 28, 2002, and December 29, 2001, did not significantly impact our financial position, results of operations or cash flows.

Cautionary Statements

From time to time, in both written reports and oral statements, we present “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The statements include those identified by such words as “may,” “will,” “expect,” “anticipate,” “believe,” “plan” and other similar terminology. These “forward-looking statements” reflect our current expectations regarding future events and operating and financial performance and are based upon data available at the time of the statements. Actual results involve risks and uncertainties, including both those specific to the Company and those specific to the industry, and could differ materially from expectations.

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Company risks and uncertainties include, but are not limited to, potentially substantial tax contingencies related to the Spin-off, which, if they occur, require us to indemnify PepsiCo, Inc.; our substantial debt leverage and the attendant potential restriction on our ability to borrow in the future, as well as our substantial interest expense and principal repayment obligations; potential unfavorable variances between estimated and actual liabilities; our ability to secure distribution of products and equipment to our restaurants on favorable economic terms and our ability to ensure adequate supply of restaurant products and equipment in our stores; the ongoing financial viability of our franchisees and licensees; volatility of actuarially determined losses and loss estimates; and adoption of new or changes in accounting policies and practices including pronouncements promulgated by standard setting bodies.

Industry risks and uncertainties include, but are not limited to, global and local business, economic and political conditions; legislation and governmental regulation; competition; success of operating initiatives and advertising and promotional efforts; volatility of commodity costs; increases in minimum wage and other operating costs; availability and cost of land and construction; consumer preferences, spending patterns and demographic trends; political or economic instability in local markets and changes in currency exchange and interest rates; any adverse economic or operational repercussions from terrorist activities and any governmental response thereto; and war or risk of war.

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INDEX TO FINANCIAL INFORMATION

No schedules are required because either the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the above listed financial statements or notes thereto.

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Consolidated Statements of Income
YUM! Brands, Inc. and Subsidiaries
Fiscal years ended December 28, 2002, December 29, 2001 and December 30, 2000
(in millions, except per share data)

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows
YUM! Brands, Inc. and Subsidiaries
Fiscal years ended December 28, 2002, December 29, 2001 and December 30, 2000
(in millions)

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Balance Sheets
YUM! Brands, Inc. and Subsidiaries
December 28, 2002 and December 29, 2001
(in millions)

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Shareholders’ Equity (Deficit) and Comprehensive Income (Loss)
YUM! Brands, Inc. and Subsidiaries
Fiscal years ended December 28, 2002, December 29, 2001 and December 30, 2000
(in millions)

See accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements
(Tabular amounts in millions, except share data)

Note 1 – Description of Business

On May 16, 2002, Tricon Global Restaurants, Inc. changed its name to YUM! Brands, Inc. in order to better reflect our expanding portfolio of brands. In addition, on the same day, Tricon Restaurants International changed its name to YUM! Restaurants International.

YUM! Brands, Inc. and Subsidiaries (collectively referred to as “YUM” or the “Company”) comprises the worldwide operations of KFC, Pizza Hut, Taco Bell and since May 7, 2002, Long John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”) (collectively the “Concepts”), which were added when we acquired Yorkshire Global Restaurants, Inc. (“YGR”). YUM is the world’s largest quick service restaurant company based on the number of system units, with nearly 33,000 units in more than 100 countries and territories of which approximately 36% are located outside the U.S. YUM was created as an independent, publicly owned company on October 6, 1997 (the “Spin-off Date”) via a tax-free distribution by our former parent, PepsiCo, Inc. (“PepsiCo”), of our Common Stock (the “Distribution” or “Spin-off”) to its shareholders. References to YUM throughout these Consolidated Financial Statements are made using the first person notations of “we,” “us ” or “our.”

Through our widely-recognized Concepts, we develop, operate, franchise and license a system of both traditional and non-traditional quick service restaurants. 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. Our traditional restaurants feature dine-in, carryout and, in some instances, drive-thru or delivery service. Non-traditional units, which are principally licensed outlets, include express units and kiosks which have a more limited menu and operate in non-traditional locations like airports, gasoline service stations, convenience stores, stadiums, amusement parks and colleges, where a full-scale traditional outlet would not be practical or efficient. We are actively pursuing the strategy of multibranding, where two or more of our Concepts are operated in a single unit. In addition, we are testing multibranding options involving one of our Concepts and a restaurant concept not owned or affiliated with YUM.

Note 2 - Summary of Significant Accounting Policies

Our preparation of the accompanying Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.

Principles of Consolidation and Basis of Preparation. Intercompany accounts and transactions have been eliminated. Certain investments in businesses that operate our Concepts are accounted for by the equity method. Generally, we possess 50% ownership of and 50% voting rights over these affiliates. Our lack of majority voting rights precludes us from controlling these affiliates, and thus we do not consolidate these affiliates. Our share of the net income or loss of those unconsolidated affiliates is included in other (income) expense.

We participate in various advertising cooperatives with our franchisees and licensees. In certain of these cooperatives we possess majority voting rights, and thus control the cooperatives. We have previously netted assets of the cooperatives we control with the related advertising payables. We have shown the assets and liabilities of these cooperatives on a gross basis in the Consolidated Balance Sheet for December 28, 2002, and reclassified amounts in the Consolidated Balance Sheet for December 29, 2001 accordingly. As the contributions are designated for advertising expenditures, any cash held by these cooperatives is considered restricted and is included in prepaid expenses and other current assets. Such restricted cash was approximately $44 million and $18 million at December 28, 2002 and December 29, 2001, respectively. Additionally, these cooperatives had receivables from franchisees of $13 million and $15 million and other

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current assets of $3 million and $4 million at December 28, 2002 and December 29, 2001, respectively, which have been included in our Consolidated Balance Sheets. As the contributions to these cooperatives are designated and segregated for advertising, we act as an agent for the franchisees and licensees with regard to these contributions. Thus, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 45, “Accounting for Franchise Fee Revenue,” we do not reflect franchisee and licensee contributions to these cooperatives in our Consolidated Statements of Income.

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 year 2000 included 53 weeks. The Company’s next fiscal year with 53 weeks will be 2005. The first three quarters of each fiscal year consist of 12 weeks and the fourth quarter consists of 17 weeks in fiscal years with 53 weeks and 16 weeks in fiscal years with 52 weeks. Our subsidiaries operate on similar fiscal calendars with period end dates suited to their businesses. The subsidiaries’ period end dates are within one week of YUM’s period end date with the exception of our international businesses, which close one period or one month earlier to facilitate consolidated reporting.

Reclassifications. We have reclassified certain items in the accompanying Consolidated Financial Statements and Notes thereto for prior periods to be comparable with the classification we adopted for the fiscal year ended December 28, 2002. These reclassifications had no effect on previously reported net income.

Franchise and License Operations. We execute franchise or license agreements for each unit which sets out the terms of our arrangement with the franchisee or licensee. Our franchise and license agreements typically require the franchisee or licensee to pay an initial, non-refundable fee and continuing fees based upon a percentage of sales. Subject to our approval and payment of a renewal fee, a franchisee may generally renew the franchise agreement upon its expiration.

We recognize initial fees as revenue when we have performed substantially all initial services required by the franchise or license agreement, which is generally upon the opening of a store. We recognize continuing fees as earned with an appropriate provision for estimated uncollectible amounts, which is included in franchise and license expenses. We recognize renewal fees in income when a renewal agreement becomes effective. We include initial fees collected upon the sale of a restaurant to a franchisee in refranchising gains (losses). Fees for development rights are capitalized and amortized over the life of the development agreement.

We incur expenses that benefit both our franchise and license communities and their representative organizations and our company operated restaurants. These expenses, along with other costs of sales and servicing of franchise and license agreements are charged to general and administrative expenses as incurred. Certain direct costs of our franchise and license operations are charged to franchise and license expenses. These costs include provisions for estimated uncollectible fees, franchise and license marketing funding, amortization expense for franchise related intangible assets and certain other direct incremental franchise and license support costs. Franchise and license expenses also includes rental income from subleasing restaurants to franchisees net of the related occupancy costs.

We monitor the financial condition of our franchisees and licensees and record provisions for estimated losses on receivables when we believe that our franchisees or licensees are unable to make their required payments. While we use the best information available in making our determination, the ultimate recovery of recorded receivables is also dependent upon future economic events and other conditions that may be beyond our control. Included in franchise and license expenses are provisions for uncollectible franchise and license receivables of $15 million, $24 million and $30 million in 2002, 2001 and 2000, respectively.

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Direct Marketing Costs. We report substantially all of our direct marketing costs in occupancy and other operating expenses. We charge direct marketing costs to expense ratably in relation to revenues over the year in which incurred and, in the case of advertising production costs, in the year first shown. Deferred direct marketing costs, which are classified as prepaid expenses, consist of media and related advertising production costs which will generally be used for the first time in the next fiscal year. To the extent we participate in advertising cooperatives, we expense our contributions as incurred. At the end of 2002 and 2001, we had deferred marketing costs of $8 million and $2 million, respectively. Our advertising expenses were $384 million, $328 million and $325 million in 2002, 2001 and 2000, respectively.

Research and Development Expenses. Research and development expenses, which we expense as incurred, were $23 million in 2002, $23 million in 2001 and $24 million in 2000.

Impairment or Disposal of Long-Lived Assets. Effective December 30, 2001, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 retained many of the fundamental provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (“SFAS 121”), but resolved certain implementation issues associated with that Statement. The adoption of SFAS 144 did not have a material impact on the Company’s consolidated results of operations.

In accordance with SFAS 144, we review our long-lived assets related to each restaurant to be held and used in the business, including any allocated intangible assets subject to amortization, 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. Based on the best information available, we write down an impaired restaurant to its estimated fair market value, which becomes its new cost basis. We generally measure estimated fair market value by discounting estimated future cash flows. In addition, when we decide to close a restaurant it is reviewed for impairment and depreciable lives are adjusted. The impairment evaluation is based on the estimated cash flows from continuing use through the expected disposal date and the expected terminal value.

Store closure costs include costs of disposing of the assets as well as other facility-related expenses from previously closed stores. These store closure costs are expensed as incurred. Additionally, at the date the closure is considered probable, we record a liability for the net present value of any remaining operating lease obligations subsequent to the expected closure date, net of estimated sublease income, if any.

Refranchising gains (losses) includes the gains or losses from the sales of our restaurants to new and existing franchisees and the related initial franchise fees, reduced by transaction costs and direct administrative costs of refranchising. In executing our refranchising initiatives, we most often offer groups of restaurants. We classify restaurants as held for sale and suspend depreciation and amortization when (a) we make a decision to refranchise; (b) the stores can be immediately removed from operations; (c) we have begun an active program to locate a buyer; (d) significant changes to the plan of sale are not likely; and (e) the sale is probable within one year. We recognize losses on refranchisings when the restaurants are classified as held for sale. We recognize gains on restaurant refranchisings 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. If the criteria for gain recognition are not met, we defer the gain to the extent we have a remaining financial exposure in connection with the sales transaction. Deferred gains are recognized when the gain recognition criteria are met or as our financial exposure is reduced. When we make a decision to retain a store previously held for sale, we revalue the store at the lower of its (a) net book value at our original sale decision date less normal depreciation and amortization that would have been recorded during the period held for sale or (b) its current fair market value. This value becomes the store’s new cost basis. We charge (or credit) any difference between the store’s carrying amount and its new cost basis to refranchising gains (losses). When we make a decision to close a store previously held for sale, we reverse any previously recognized refranchising loss and then record impairment and store closure costs as described above. Refranchising gains (losses) also include charges for estimated exposures related to

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those partial guarantees of franchisee loan pools and contingent lease liabilities which arose from refranchising activities. These exposures are more fully discussed in Note 24.

SFAS 144 also requires the results of operations of a component entity that is classified as held for sale or has been disposed of be reported as discontinued operations in the Consolidated Statements of Income if certain conditions are met. These conditions include elimination of the operations and cash flows of the component entity from the ongoing operations of the Company and no significant continuing involvement by the Company in the operations of the component entity after the disposal transaction. The results of operations of stores meeting both these conditions that were disposed of in 2002 or classified as held for sale at December 28, 2002 were not material for any of the three years ended December 28, 2002.

Considerable management judgment is necessary to estimate future cash flows, including cash flows from continuing use, terminal value, closure costs, sublease income, and refranchising proceeds. Accordingly, actual results could vary significantly from our estimates.

Impairment of Investments in Unconsolidated Affiliates. Our methodology for determining and measuring impairment of our investments in unconsolidated affiliates is similar to the methodology we use for our restaurants except we use cash flows after interest and taxes instead of cash flows before interest and taxes as we use for our restaurants. Also, we record impairment charges related to investments in unconsolidated affiliates if circumstances indicate that a decrease in the value of an investment has occurred which is other than temporary.

Considerable management judgment is necessary to estimate future cash flows. Accordingly, actual results could vary significantly from our estimates.

Cash and Cash Equivalents. Cash equivalents represent funds we have temporarily invested (with original maturities not exceeding three months) as part of managing our day-to-day operating cash receipts and disbursements.

Inventories. We value our inventories at the lower of cost (computed on the first-in, first-out method) or net realizable value.

Property, Plant and Equipment. We state property, plant and equipment at cost less accumulated depreciation and amortization, impairment writedowns and valuation allowances. We calculate depreciation and amortization on a straight-line basis over the estimated useful lives of the assets as follows: 5 to 25 years for buildings and improvements, 3 to 20 years for machinery and equipment and 3 to 7 years for capitalized software costs. As discussed above, we suspend depreciation and amortization on assets related to restaurants that are held for sale.

Internal Development Costs and Abandoned Site Costs. We capitalize direct costs associated with the site acquisition and construction of a Company unit on that site, including direct internal payroll and payroll-related costs. Only those site-specific costs incurred subsequent to the time that the site acquisition is considered probable are capitalized. We consider acquisition probable upon final site approval. If we subsequently make a determination that a site for which internal development costs have been capitalized will not be acquired or developed, any previously capitalized internal development costs are expensed and included in general and administrative expenses.

Goodwill and Intangible Assets. The Company has adopted SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141 requires the use of the purchase method of accounting for all business combinations and modifies the application of the purchase accounting method. Goodwill represents the excess of the cost of a business acquired over the net of the amounts assigned to assets acquired, including identifiable intangible assets, and liabilities assumed. SFAS 141 specifies criteria to be used in determining whether intangible assets acquired in a purchase method business combination must be recognized and reported separately from goodwill. We base amounts assigned to goodwill and other identifiable intangible assets on independent appraisals or internal estimates.

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The Company has also adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 eliminates the requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life, and addresses impairment testing and recognition for goodwill and indefinite-lived intangible assets. SFAS 142 applies to goodwill and intangible assets arising from transactions completed both before and after its effective date. As a result of adopting SFAS 142, we ceased amortization of goodwill and indefinite-lived intangible assets beginning December 30, 2001. Prior to the adoption of SFAS 142, we amortized goodwill on a straight-line basis up to 20 years and indefinite-lived intangible assets on a straight-line basis over 3 to 40 years. Amortizable intangible assets continue to be amortized on a straight-line basis over 3 to 40 years. As discussed above, we suspend amortization on those intangible assets with a defined life that are allocated to restaurants that are held for sale.

In accordance with the requirements of SFAS 142, goodwill has been assigned to reporting units for purposes of impairment testing. Our reporting units are our operating segments in the U.S. (see Note 23) and our business management units internationally (typically individual countries). Goodwill impairment tests consist of a comparison of each reporting unit’s fair value with its carrying value. The fair value of a reporting unit is the amount for which the unit as a whole could be sold in a current transaction between willing parties. We generally estimate fair value based on discounted cash flows. If the carrying value of a reporting unit exceeds its fair value, goodwill is written down to its implied fair value. As required by SFAS 142, we completed transitional impairment tests of goodwill as of December 30, 2001, which indicated that there was no impairment. We have selected the beginning of our fourth quarter as the date on which to perform our ongoing annual impairment test. As a result of the poor performance by our Pizza Hut France reporting unit from the date of the transitional impairment test through September 8, 2002 (the beginning of our fourth quarter), goodwill assigned to that reporting unit of $5 million was deemed impaired and written off in the fourth quarter.

See Note 12 for further discussion of SFAS 142.

Stock-Based Employee Compensation. At December 28, 2002, the Company had four stock-based employee compensation plans in effect, which are described more fully in Note 18. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

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Derivative Financial Instruments. Our policy prohibits the use of derivative instruments for trading purposes, and we have procedures in place to monitor and control their use. Our use of derivative instruments has included interest rate swaps and collars, treasury locks and foreign currency forward contracts. In addition, on a limited basis we utilize commodity futures and options contracts. Our interest rate and foreign currency derivative contracts are entered into with financial institutions while our commodity derivative contracts are exchange traded.

We account for derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). SFAS 133 requires that all derivative instruments be recorded on the Consolidated Balance Sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument is dependent upon whether the derivative has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in the results of operations. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Any ineffective portion of the gain or loss on the derivative instrument is recorded in the results of operations immediately. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the results of operations immediately. See Note 16 for a discussion of our use of derivative instruments, management of credit risk inherent in derivative instruments and fair value information related to debt and interest rate swaps.

New Accounting Pronouncements Not Yet Adopted.

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). SFAS 143 addresses the financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 is effective for the Company for fiscal year 2003. We currently do not anticipate that the adoption of SFAS 143 will have a material impact on our Consolidated Financial Statements.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs associated with exit or disposal activities, and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Costs addressed by SFAS 146 include costs to terminate a contract that is not a capital lease, costs of involuntary employee termination benefits pursuant to a one-time benefit arrangement, costs to consolidate facilities, and costs to relocate employees. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Although SFAS 146 will change the timing of expense recognition for certain costs we incur while closing restaurants or undertaking other exit or disposal activities, the timing difference is not expected to be significant in length. We do not anticipate that the adoption of SFAS 146 will have a material impact on our Consolidated Financial Statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”). SFAS 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as required by SFAS 123. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. Our disclosure regarding the effects of stock-based compensation included in these Notes is in compliance with SFAS 148.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34” (“FIN 45”). FIN 45 elaborates on the disclosures to be made by a

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guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The disclosure requirements of FIN 45 are included in Note 24. The initial recognition and measurement provisions are applicable to guarantees issued or modified after December 31, 2002. As described in Note 24, we have in the past provided certain guarantees that would have required recognition upon issuance or modification under the provisions of FIN 45. While the nature of our business will likely result in issuance of certain guarantee liabilities in the future, we do not anticipate that FIN 45 will have a material impact on the Consolidated Financial Statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (“FIN 46”). FIN 46 addresses the consolidation of entities whose equity holders have either (a) not provided sufficient equity at risk to allow the entity to finance its own activities or (b) do not possess certain characteristics of a controlling financial interest. FIN 46 requires the consolidation of these entities, known as variable interest entities (“VIEs”), by a primary beneficiary of the entity. A primary beneficiary is the entity, if any, that is subject to a majority of the risk of loss from the VIEs activities, entitled to receive a majority of the VIEs residual returns, or both. FIN 46 applies immediately to variable interests in VIEs created or obtained after January 31, 2003. For variable interests in a VIE created before February 1, 2003, FIN 46 is applied to the VIE no later than the end of the first interim or annual reporting period beginning after June 15, 2003 (the quarter ending September 6, 2003 for the Company). The Interpretation requires certain disclosures in financial statements issued after January 31, 2003, if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.

As discussed further in Note 24, we have posted $32 million of letters of credit supporting our guarantee of franchisee loan pools. Additionally, we have provided a standby letter of credit under which we could potentially be required to fund a portion (up to $25 million) of one of the franchisee loan pools. The letters of credit were issued under our existing bank credit agreement (see Note 14). These franchisee loan pools primarily funded purchases of restaurants from the Company and, to a lesser extent, franchisee development of new restaurants. The total loans outstanding under these loan pools were approximately $153 million and $180 million at December 28, 2002 and December 29, 2001, respectively. Our maximum exposure to loss as a result of our involvement with these franchisee loan pools was $57 million at December 28, 2002. We are in the process of determining if we are the primary beneficiary of these VIEs. We currently believe that it is reasonably possible we are the primary beneficiary and thus we would be required to consolidate these VIEs, as they are currently structured, upon FIN 46 becoming effective for the Company. We are currently evaluating alternative structures related to these franchisee loan pools.

The Company along with representatives of the franchisee groups of each of its Concepts has formed purchasing cooperatives for the purpose of purchasing certain restaurant products and equipment in the U.S. Our equity ownership in each cooperative is generally proportional to our percentage ownership of the U.S. system units for the Concept. We are continuing to evaluate whether any of these cooperatives are VIEs under the provisions of FIN 46 and, if so, whether we are the primary beneficiary. We do not currently believe that consolidation will be required for these cooperatives as a result of our adoption of FIN 46.

Note 3 - Two-for-One Common Stock Split

On May 7, 2002, the Company announced that its Board of Directors approved a two-for-one split of the Company’s outstanding shares of Common Stock. The stock split was effected in the form of a stock dividend and entitled each shareholder of record at the close of business on June 6, 2002 to receive one additional share for every outstanding share of Common Stock held on the record date. The stock dividend was distributed on June 17, 2002, with approximately 149 million shares of common stock distributed. All per share and share amounts in the accompanying Consolidated Financial Statements and Notes to the Financial Statements have been adjusted to reflect the stock split.

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Note 4 – YGR Acquisition

On May 7, 2002, YUM completed its acquisition of YGR. At the date of acquisition, YGR consisted of 742 and 496 company and franchise LJS units, respectively, and 127 and 742 company and franchise A&W units, respectively. In addition, 133 multibranded LJS/A&W restaurants were included in the LJS unit totals. This acquisition was made to facilitate our strategic objective of achieving growth through multibranding, where two or more of our Concepts are operated in a single restaurant unit.

We paid approximately $275 million in cash and assumed approximately $48 million of bank indebtedness in connection with the acquisition of YGR. The purchase price was allocated to the assets acquired and liabilities assumed based on estimates of their fair values at the date of acquisition. We determined these fair values with the assistance of a third party valuation expert.

The following table summarizes the fair values of YGR’s assets acquired and liabilities assumed at the date of acquisition.

Of the $250 million in acquired intangible assets, $212 million was assigned to brands/trademarks, which have indefinite lives and are not subject to amortization. The remaining acquired intangible assets primarily consist of franchise contract rights which will be amortized over thirty years, the typical term of a YGR franchise agreement including renewals. Of the $212 million in brands/trademarks approximately $191 million and $21 million were assigned to the U.S. and International operating segments, respectively. Of the $38 million in intangible assets subject to amortization, approximately $31 million and $7 million were assigned to the U.S. and International operating segments, respectively.

The $209 million in goodwill was primarily assigned to the U.S. operating segment. As we acquired the stock of YGR, none of the goodwill is expected to be deductible for income tax purposes.

Liabilities assumed included approximately $48 million of bank indebtedness that was paid off prior to the end of the second quarter of 2002 and approximately $11 million in capital lease obligations. We also assumed approximately $168 million in present value of future rent obligations related to existing sale-leaseback agreements entered into by YGR involving approximately 350 LJS units. As a result of liens held by the buyer/lessor on certain personal property within the units, the sale-leaseback agreements have been accounted for as financings and reflected as debt.

Additionally, as of the date of acquisition we recorded approximately $49 million of reserves (“exit liabilities”) related to our plans to consolidate certain support functions, and exit certain markets through store refranchisings and closures, as presented in the table below. The consolidation of certain support functions included the termination of approximately

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100 employees. Plans associated with exiting certain markets through store refranchisings and closures are expected to be finalized prior to May 7, 2003. Adjustments to the purchase price allocation related to the finalization of these plans are not expected to be material. The unpaid exit liabilities as of December 28, 2002 have been reflected on our Consolidated Balance Sheet as accounts payable and other current liabilities ($30 million) and other liabilities and deferred credits ($10 million). Amounts recorded as other liabilities and deferred credits are expected to result in payments principally in 2004.

Additionally, we expensed approximately $6 million of integration costs related to the acquisition in 2002. These costs were recorded as unusual items expense. See Note 7 for further discussion regarding unusual items (income) expense.

The results of operations for YGR have been included in our Consolidated Financial Statements since the date of acquisition. If the acquisition had been completed as of the beginning of the years ended December 28, 2002 and December 29, 2001, pro forma Company sales, and franchise and license fees would have been as follows:

The impact of the acquisition, including interest expense on debt incurred to finance the acquisition, on net income and diluted earnings per share would not have been significant in 2002 and 2001.

The pro forma information is not necessarily indicative of the results of operations had the acquisition actually occurred at the beginning of each of these periods nor is it necessarily indicative of future results.

Note 5 – Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss), net of tax, includes:

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Note 6 - Earnings Per Common Share (“EPS”)

Unexercised employee stock options to purchase approximately 1.4 million, 5.1 million and 21.7 million shares of our Common Stock for the years ended December 28, 2002, December 29, 2001 and December 30, 2000, respectively, were not included in the computation of diluted EPS because their exercise prices were greater than the average market price of our Common Stock during the year.

Note 7 – Items Affecting Comparability of Net Income

Facility Actions Net Loss (Gain)

Facility actions net loss (gain) consists of the following components as described in Note 2:

• Refranchising net (gains) losses;
  
• Store closure costs;
  
• Impairment of long-lived assets for stores we intend to continue to use in the business and stores we intend to close;
  
• Impairment of goodwill subsequent to the adoption of SFAS 142.

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The following table summarizes the 2002 and 2001 activity related to reserves for remaining lease obligations for stores closed or stores we intend to close.

The following table summarizes the carrying values of the major classes of assets held for sale at December 28, 2002 and December 29, 2001. The carrying values of liabilities held for sale at December 28, 2002 and December 29, 2001 were not significant. U.S. amounts primarily represent land on which we previously operated restaurants and are net of impairment charges of $4 million and $5 million, respectively. The carrying values in International at December 28,

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2002 relate primarily to our Puerto Rico business. The carrying values in International at December 29, 2001 relate primarily to our Singapore business, net of impairment charges of $11 million. We subsequently sold the Singapore business during the third quarter of 2002 at a price approximately equal to its carrying value, net of impairment.

The following table summarizes Company sales and restaurant profit related to stores held for sale at December 28, 2002 or disposed of through refranchising or closure during 2002, 2001 and 2000. As discussed in Note 2, the operations of such stores classified as held for sale as of December 28, 2002 or disposed of during 2002 which meet the conditions of SFAS 144 for reporting as discontinued operations were not material. Restaurant profit represents Company sales less the cost of food and paper, payroll and employee benefits and occupancy and other operating expenses.

Restaurant margin includes a benefit from the suspension of depreciation and amortization of approximately $6 million, $1 million and $2 million in 2002, 2001 and 2000, respectively.

Unusual Items (Income) Expense

Unusual items income in 2002 primarily included: (a) recoveries of approximately $39 million related to the AmeriServe Food Distribution Inc. (“AmeriServe”) bankruptcy reorganization process; less (b) integration costs of approximately $6 million related to the YGR acquisition; and (c) costs to defend certain wage and hour litigation. See Note 25 for discussions of the AmeriServe bankruptcy reorganization process.

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Unusual items income in 2001 primarily included: (a) recoveries of approximately $21 million related to the AmeriServe bankruptcy reorganization process; less (b) aggregate settlement costs of $15 million associated with certain litigation; and (c) expenses, primarily severance, related to decisions to streamline certain support functions. The reserves established related to decisions to streamline certain support functions were utilized in 2002.

Unusual items expense in 2000 included: (a) $170 million of expenses related to the AmeriServe bankruptcy reorganization process; (b) an increase in the estimated costs of settlement of certain wage and hour litigation along with the associated defense costs incurred in 2000; (c) costs associated with the formation of new unconsolidated affiliates; less (d) the reversal of excess provisions arising from the resolution of a dispute associated with the disposition of our non-core businesses, which is discussed in Note 24.

Note 8 – Supplemental Cash Flow Data

Note 9 – Franchise and License Fees