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EXCEL - IDEA: XBRL DOCUMENT - YUM BRANDS INCFinancial_Report.xls


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

FORM 10-Q

(Mark One)
[Ÿ]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
EXCHANGE ACT OF 1934 for the quarterly period ended September 6, 2014
 
 
 
OR
 
 
 
[  ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ____________ to _________________
 
 Commission file number 1-13163
________________________
YUM! BRANDS, INC.
(Exact name of registrant as specified in its charter)

 
North Carolina
 
13-3951308
 
(State or other jurisdiction of
 
(I.R.S. Employer
 
incorporation or organization)
 
Identification No.)
 
 
 
 
 
1441 Gardiner Lane, Louisville, Kentucky
 
40213
 
(Address of principal executive offices)
 
(Zip Code)
 
 
 
 
Registrant’s telephone number, including area code:  (502) 874-8300

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ü]  No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ü] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer:  [ü] Accelerated filer:  [  ] Non-accelerated filer:  [  ] Smaller reporting company:  [  ]

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

 The number of shares outstanding of the Registrant’s Common Stock as of October 8, 2014 was 437,492,810 shares.
 




YUM! BRANDS, INC.

INDEX
 
 
 
Page
 
 
No.
Part I.
Financial Information
 
 
 
 
 
Item 1 - Financial Statements
 
 
 
 
 
Condensed Consolidated Statements of Income - Quarters and Years to date ended
September 6, 2014 and September 7, 2013
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income - Quarters and Years to date ended September 6, 2014 and September 7, 2013
 
 
 
 
Condensed Consolidated Statements of Cash Flows – Years to date ended
September 6, 2014 and September 7, 2013
 
 
 
 
Condensed Consolidated Balance Sheets – September 6, 2014 and December 28, 2013
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
 
Item 2 - Management’s Discussion and Analysis of Financial Condition
              and Results of Operations
 
 
 
 
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
Item 4 – Controls and Procedures
 
 
 
 
Report of Independent Registered Public Accounting Firm
 
 
 
Part II.
Other Information and Signatures
 
 
 
 
 
Item 1 – Legal Proceedings
 
 
 
 
Item 1A – Risk Factors
 
 
 
 
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
Item 6 – Exhibits
 
 
 
 
Signatures


2



PART I - FINANCIAL INFORMATION

Item 1.
Financial Statements
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
 
 
 
 
(in millions, except per share data)
 
 
 
 
 
 
 
 
Quarter ended
 
Year to date
Revenues
9/6/2014
 
9/7/2013
 
9/6/2014
 
9/7/2013
Company sales
$
2,891


$
3,021


$
7,941


$
7,594

Franchise and license fees and income
463


445


1,341


1,311

Total revenues
3,354


3,466


9,282


8,905

Costs and Expenses, Net
 
 
 
 
 
 
 
Company restaurant expenses
 
 
 
 
 
 
 
Food and paper
951

 
996

 
2,562

 
2,481

Payroll and employee benefits
642

 
621

 
1,755

 
1,701

Occupancy and other operating expenses
869

 
873

 
2,326

 
2,238

Company restaurant expenses
2,462


2,490


6,643


6,420

General and administrative expenses
323


327


946


933

Franchise and license expenses
42


44


109


108

Closures and impairment (income) expenses
6


300


30


310

Refranchising (gain) loss
(20
)

(38
)

(27
)

(87
)
Other (income) expense
(9
)

(7
)

(19
)

(6
)
Total costs and expenses, net
2,804


3,116


7,682


7,678

Operating Profit
550


350


1,600


1,227

Interest expense, net
28


31


90


94

Income Before Income Taxes
522


319


1,510


1,133

Income tax provision
119


182


370


384

Net Income – including noncontrolling interests
403


137


1,140


749

Net Income (loss) – noncontrolling interests
(1
)

(15
)

3


(21
)
Net Income – YUM! Brands, Inc.
$
404


$
152


$
1,137


$
770

 
 
 
 
 
 
 
 
Basic Earnings Per Common Share
$
0.91


$
0.34


$
2.55


$
1.70

 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share
$
0.89


$
0.33


$
2.50


$
1.66

 
 
 
 
 
 
 
 
Dividends Declared Per Common Share
$

 
$

 
$
0.74

 
$
0.67

 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 
 
 
 


3



CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
 
 
 
 
(in millions)
 
 
 
 
 
 
 
 
Quarter ended
 
Year to date
 
9/6/2014
 
9/7/2013
 
9/6/2014
 
9/7/2013
 
 
 
 
 
 
 
 
Net Income - including noncontrolling interests
$
403

 
$
137

 
$
1,140

 
$
749

Other comprehensive income (loss), net of tax
 
 
 
 

 

Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature
 
 
 
 
 
 
 
Adjustments and gains (losses) arising during the year
33

 
(42
)
 
(29
)
 
(39
)
Reclassification of adjustments and (gains) losses into Net Income

 

 
2

 

 
33

 
(42
)
 
(27
)
 
(39
)
Tax (expense) benefit
1

 
(1
)
 
(2
)
 
5

 
34

 
(43
)
 
(29
)
 
(34
)
Changes in pension and post-retirement benefits
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the year
(9
)
 
3

 
(20
)
 
3

Reclassification of (gains) losses into Net Income
6

 
17

 
20

 
56

 
(3
)
 
20

 

 
59

Tax (expense) benefit
1

 
(8
)
 

 
(24
)
 
(2
)
 
12

 

 
35

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

 

 

 
2

Reclassification of (gains) losses into Net Income

 

 
(1
)
 

 

 

 
(1
)
 
2

Tax (expense) benefit

 

 

 
(1
)
 

 

 
(1
)
 
1

Other comprehensive income (loss), net of tax
32

 
(31
)
 
(30
)
 
2

Comprehensive Income - including noncontrolling interests
435

 
106

 
1,110

 
751

Comprehensive Income (loss) - noncontrolling interests
1


(15
)
 
1


(19
)
Comprehensive Income - YUM! Brands, Inc.
$
434

 
$
121

 
$
1,109

 
$
770

 
 
 
 
 
 
 
 
  See accompanying Notes to Condensed Consolidated Financial Statements.
 
 


4



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
 
 
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
(in millions)
 
 
 
 
Year to date
 
9/6/2014
 
9/7/2013
Cash Flows – Operating Activities
 
 
 
Net Income – including noncontrolling interests
$
1,140

 
$
749

Depreciation and amortization
501

 
473

Closures and impairment (income) expenses
30


310

Refranchising (gain) loss
(27
)

(87
)
Deferred income taxes
(94
)
 
(51
)
Equity income from investments in unconsolidated affiliates
(31
)
 
(17
)
Distributions of income received from unconsolidated affiliates
12

 
15

Excess tax benefits from share-based compensation
(29
)
 
(27
)
Share-based compensation expense
36

 
32

Changes in accounts and notes receivable
(25
)
 
(4
)
Changes in inventories
24

 
19

Changes in prepaid expenses and other current assets
(3
)
 
(22
)
Changes in accounts payable and other current liabilities
59

 
(14
)
Changes in income taxes payable
(24
)
 
115

Other, net
43

 
62

Net Cash Provided by Operating Activities
1,612

 
1,553

 
 
 
 
Cash Flows – Investing Activities
 
 
 
Capital spending
(655
)
 
(699
)
Changes in short-term investments, net
(315
)
 
1

Proceeds from refranchising of restaurants
66

 
218

Acquisitions
(26
)
 
(98
)
Other, net
10

 
(9
)
Net Cash Used in Investing Activities
(920
)
 
(587
)
 
 
 
 
Cash Flows – Financing Activities
 
 
 
Repayments of long-term debt
(7
)
 
(5
)
Short-term borrowings by original maturity
 
 
 
More than three months - proceeds
2

 
56

More than three months - payments

 
(54
)
Three months or less, net

 

Revolving credit facilities, three month or less, net
397

 

Repurchase shares of Common Stock
(510
)
 
(510
)
Excess tax benefits from share-based compensation
29

 
27

Employee stock option proceeds
21

 
17

Dividends paid on Common Stock
(490
)
 
(451
)
Other, net
(28
)
 
(55
)
Net Cash Used in Financing Activities
(586
)
 
(975
)
Effect of Exchange Rates on Cash and Cash Equivalents
6

 
(14
)
Net Increase (Decrease) in Cash and Cash Equivalents
112

 
(23
)
Cash and Cash Equivalents - Beginning of Period
573

 
776

Cash and Cash Equivalents - End of Period
$
685

 
$
753

 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 


5



CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
 
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
(in millions)
 
 
 
 
(Unaudited)
 
 
 
9/6/2014
 
12/28/2013
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
685


$
573

Accounts and notes receivable, net
373

 
319

Inventories
266

 
294

Prepaid expenses and other current assets
226

 
276

Short-term investments
326

 
10

Deferred income taxes
121

 
123

Advertising cooperative assets, restricted
73

 
96

Total Current Assets
2,070

 
1,691

 
 
 
 
Property, plant and equipment, net
4,480


4,459

Goodwill
886

 
889

Intangible assets, net
622

 
638

Investments in unconsolidated affiliates
58

 
53

Other assets
561

 
566

Deferred income taxes
500

 
399

Total Assets
$
9,177

 
$
8,695

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable and other current liabilities
$
1,771

 
$
1,929

Income taxes payable
196

 
169

Short-term borrowings
72

 
71

Advertising cooperative liabilities
73

 
96

Total Current Liabilities
2,112

 
2,265

 
 
 
 
Long-term debt
3,315

 
2,918

Other liabilities and deferred credits
1,146

 
1,244

Total Liabilities
6,573

 
6,427

 
 
 
 
Redeemable noncontrolling interest
36

 
39

 
 
 
 
Shareholders’ Equity
 
 
 
Common Stock, no par value, 750 shares authorized; 437 and 443 shares issued in 2014 and 2013, respectively
7

 

Retained earnings
2,462

 
2,102

Accumulated other comprehensive income (loss)
36


64

Total Shareholders’ Equity – YUM! Brands, Inc.
2,505

 
2,166

Noncontrolling interests
63

 
63

Total Shareholders’ Equity
2,568

 
2,229

Total Liabilities, Redeemable Noncontrolling Interest and Shareholders’ Equity
$
9,177

 
$
8,695

 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 

6



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

Note 1 - Financial Statement Presentation

We have prepared our accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information.  Accordingly, they do not include all of the information and footnotes required by Generally Accepted Accounting Principles in the United States (“GAAP”) for complete financial statements.  Therefore, we suggest that the accompanying Financial Statements be read in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 (“2013 Form 10-K”).  Except as disclosed herein, there has been no material change in the information disclosed in our Consolidated Financial Statements included in the 2013 Form 10-K.

YUM! Brands, Inc. and Subsidiaries (collectively referred to herein as “YUM” or the “Company”) comprises primarily the worldwide operations of KFC, Pizza Hut and Taco Bell (collectively the “Concepts”).  References to YUM throughout these Notes to our Financial Statements are made using the first person notations of “we,” “us” or “our.”

YUM now consists of five reporting segments:  

YUM China (“China” or “China Division”) which includes all operations in mainland China
YUM India ("India" or "India Division") which includes all operations in India, Bangladesh, Nepal and Sri Lanka
The KFC Division which includes all operations of the KFC concept outside of China Division and India Division
The Pizza Hut Division which includes all operations of the Pizza Hut concept outside of China Division and India Division
The Taco Bell Division which includes all operations of the Taco Bell concept outside of India Division

Previously, our reporting segments consisted of YUM Restaurants International, the United States, China and India. In the first quarter of 2014 we changed our management reporting structure to align our global operations outside of China and India by brand. As a result, our YUM Restaurants International and United States reporting segments were combined, and we began reporting this information by three new reporting segments: KFC Division, Pizza Hut Division and Taco Bell Division. China and India remain separate reporting segments. This new structure is designed to drive greater global brand focus, enabling us to more effectively share know-how and accelerate growth. While our consolidated results have not been impacted, we have restated our comparable segment information for consistent presentation.

YUM’s fiscal year ends on the last Saturday in December.  The first three quarters of each fiscal year consist of 12 weeks and the fourth quarter consists of 16 weeks. Our subsidiaries operate on similar fiscal calendars except that China, India and certain other international subsidiaries operate on a monthly calendar with two months in the first quarter, three months in the second and third quarters and four months in the fourth quarter.  International businesses within our KFC, Pizza Hut and Taco Bell divisions close approximately one month earlier to facilitate consolidated reporting.

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

The accompanying Financial Statements include all normal and recurring adjustments considered necessary to present fairly, when read in conjunction with our 2013 Form 10-K, our financial position as of September 6, 2014, and the results of our operations and comprehensive income for the quarters and years to date ended September 6, 2014 and September 7, 2013, and cash flows for the years to date ended September 6, 2014 and September 7, 2013. Our results of operations, comprehensive income and cash flows for these interim periods are not necessarily indicative of the results to be expected for the full year.

Our significant interim accounting policies include the recognition of certain advertising and marketing costs, generally in proportion to revenue, and the recognition of income taxes using an estimated annual effective tax rate.

We have reclassified certain items in the Financial Statements for the prior periods to be comparable with the classification for the quarter and year to date ended September 6, 2014. These reclassifications had no effect on previously reported Net Income - YUM! Brands, Inc.


7





Note 2 - Earnings Per Common Share (“EPS”)
 
 
Quarter ended
 
Year to date
 
 
2014
 
2013
 
2014
 
2013
Net Income – YUM! Brands, Inc.
 
$
404

 
$
152

 
$
1,137

 
$
770

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (for basic calculation)
 
443


451

 
445

 
453

Effect of dilutive share-based employee compensation
 
9

 
10

 
10

 
10

Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)
 
452


461

 
455


463

Basic EPS
 
$
0.91

 
$
0.34

 
$
2.55

 
$
1.70

Diluted EPS
 
$
0.89

 
$
0.33

 
$
2.50

 
$
1.66

Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a)
 
5.2

 
4.7

 
5.4

 
5.5


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

Note 3 - Shareholders’ Equity

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

 
 
 
Shares Repurchased (thousands)
 
Dollar Value of Shares Repurchased
 
Remaining Dollar Value of Shares that may be Repurchased
 
Authorization Date
 
2014
 
2013
 
2014
 
2013
 
2014
 
November 2012
 
2,737

 
 
7,100

 
 
$
203

 
 
$
490

 
 
$

 
 
November 2013
 
4,093

 
 

 
 
307

 
 

 
 
443

 
 
Total
 
6,830

 
 
7,100

(a) 
 
$
510

 
 
$
490

(a) 
 
$
443

 
 
 
 
 

(a)
Amount excludes the effect of $20 million in share repurchases (0.3 million shares) with trade dates prior to 2013 and cash settlement dates during 2013.


8



Changes in accumulated other comprehensive income ("OCI") are presented below.
 
 
Translation Adjustments and Gains (Losses) From Intra-Entity Transactions of a Long-Term Nature
 
Pension and Post-Retirement Benefits
 
Derivative Instruments
 
Total
Balance at December 28, 2013, net of tax
 
$
170

 
$
(97
)
 
$
(9
)
 
$
64

 
 
 
 
 
 
 
 
 
Gains (losses) arising during the year classified into accumulated OCI, net of tax
 
(29
)
 
(12
)
 

 
(41
)
 
 
 
 
 
 
 
 
 
(Gains) losses reclassified from accumulated OCI, net of tax
 
2

 
12

 
(1
)
 
13

 
 
 
 
 
 
 
 
 
OCI, net of tax
 
(27
)
 

 
(1
)
 
(28
)
 
 
 
 
 
 
 
 
 
Balance at September 6, 2014, net of tax
$
143

 
$
(97
)
 
$
(10
)
 
$
36



9



Note 4 - Little Sheep Impairment

As a result of sustained declines in sales and profits in our Little Sheep business, coupled with the anticipated time it would take for the business to recover,we made the determination during the quarter ended September 7, 2013 that it was not more likely than not that the Little Sheep trademark and reporting unit fair values were in excess of their carrying values. Therefore, our Little Sheep trademark and goodwill were tested for impairment in the quarter ended September 7, 2013, prior to the annual impairment reviews performed in the fourth quarter of each year in accordance with our accounting policy.

As a result of this impairment testing, non-cash impairment charges of $295 million were recorded in Closures and impairment (income) expense on our Condensed Consolidated Statement of Income for the quarter ended September 7, 2013. We also recorded an $18 million tax benefit associated with these impairments and allocated $19 million of the net impairment charges to Net Income (loss) - noncontrolling interests, which resulted in a net impairment charge of $258 million allocated to Net Income - YUM! Brands, Inc. See our 2013 Form 10-K for further details.



Note 5 - Other (Income) Expense
 
Quarter ended
 
Year to date
 
2014
 
2013
 
2014
 
2013
Equity (income) loss from investments in unconsolidated affiliates
$
(9
)
 
$
(13
)
 
$
(31
)
 
$
(17
)
Foreign exchange net (gain) loss and other

 
6

 
12

 
11

Other (income) expense
$
(9
)
 
$
(7
)
 
$
(19
)
 
$
(6
)
 
Note 6 - Supplemental Balance Sheet Information

Accounts and Notes Receivable, net

The Company’s receivables are primarily generated as a result of ongoing business relationships with our franchisees and licensees as a result of royalty and lease agreements.  Trade receivables consisting of royalties from franchisees and licensees are generally due within 30 days of the period in which the corresponding sales occur and are classified as Accounts and notes receivable on our Condensed Consolidated Balance Sheets.  
 
9/6/2014
 
12/28/2013
Accounts and notes receivable, gross
$
387

 
$
330

Allowance for doubtful accounts
(14
)
 
(11
)
Accounts and notes receivable, net
$
373

 
$
319


Property, Plant and Equipment, net
 
9/6/2014
 
12/28/2013
Property, plant and equipment, gross
$
8,100

 
$
7,850

Accumulated depreciation and amortization
(3,620
)
 
(3,391
)
Property, plant and equipment, net
$
4,480

 
$
4,459


Assets held for sale at September 6, 2014 and December 28, 2013 total $20 million and $16 million, respectively, and are included in Prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.

Noncontrolling Interests

Noncontrolling interests primarily include the ownership interests of minority shareholders of the entities that operate KFC restaurants in Beijing and Shanghai, China.  The redeemable noncontrolling interest comprises the 7% ownership interest in Little Sheep that continues to be held by the Little Sheep founding shareholders, and is classified outside of permanent equity on our Condensed Consolidated Balance Sheets due to redemption rights held by the founding Little Sheep shareholders. A reconciliation of the beginning and ending carrying amount of the equity attributable to noncontrolling interests is as follows:

10




 
Noncontrolling Interests
 
Reedemable Noncontrolling Interest
Balance at December 28, 2013
$
63

 
$
39

Net Income (loss) – noncontrolling interests
5


(2
)
Currency translation adjustments
(1
)
 
(1
)
Dividends declared
(4
)
 

Balance at September 6, 2014
$
63

 
$
36


Note 7 - Income Taxes
 
Quarter ended
 
Year to date
 
2014
 
2013
 
2014
 
2013
Income tax provision
$
119


$
182

 
$
370


$
384

Effective tax rate
22.7
%
 
57.2
%
 
24.5
%
 
33.9
%

Our overall effective tax rate continues to be favorably impacted by the majority of our income being earned outside the U.S. where tax rates are generally lower than the U.S. tax rate.

Our third quarter and year to date effective tax rates were lower than the prior year primarily due to the impact of lapping a $222 million non-cash impairment of Little Sheep goodwill, which resulted in no related tax benefit, and lapping the unfavorable impact of increasing prior year unrecognized tax benefits related to a dispute with the Internal Revenue Service (the “IRS”) regarding the valuation of intangibles. This dispute was settled in the quarter ended September 6, 2014 and is discussed in further detail below. The third quarter 2014 effective tax rate was lower than our full year expected tax rate primarily due to a change in the estimated cost of repatriating foreign earnings.

On June 23, 2010, the Company received a Revenue Agent Report ("RAR") from the IRS relating to its examination of our U.S. federal income tax returns for fiscal years 2004 through 2006.  The IRS proposed an adjustment to increase the taxable value of rights to intangibles used outside the U.S. that YUM transferred to certain of its foreign subsidiaries.  On January 9, 2013, the Company received a RAR from the IRS for fiscal years 2007 and 2008 proposing a similar adjustment. The valuation issue impacted tax returns for fiscal years 2004 through 2013.

On July 31, 2014, the Company reached a final agreement with the IRS Appeals Division regarding the valuation issue. As a result of this agreement, we closed out our 2004-2006 audit cycle and made a cash payment of $120 million to the IRS, which was effectively fully reserved, during the quarter ended September 6, 2014 to settle all issues for this audit cycle. The agreement also resolves the valuation issue for all later, impacted years. Additional cash payments of lesser amounts, for which we are fully reserved, will be required related to the valuation issue upon the closure of the examinations of fiscal years 2007-2013.

The resolution of this issue resulted in a reduction in the Company’s unrecognized tax benefits. As of September 6, 2014, the Company had $125 million of unrecognized tax benefits, $30 million of which, if recognized, would impact the effective income tax rate.


Note 8 - Reportable Operating Segments

We identify our operating segments based on management responsibility, which changed beginning the first quarter of 2014. See Note 1. We have restated our comparable segment information for consistent presentation in this Form 10-Q. The following tables summarize Revenues, Operating Profit (loss) and Identifiable Assets for each of our reportable operating segments:

11



 
Quarter ended
 
Year to date
Revenues
2014
 
2013
 
2014
 
2013
China
$
1,840

 
$
2,033

 
$
4,928

 
$
4,633

KFC Division
771

 
704

 
2,189

 
2,066

Pizza Hut Division
264

 
264

 
796

 
798

Taco Bell Division
443


435

 
1,273


1,325

India
36


30

 
96


83

 
$
3,354


$
3,466


$
9,282


$
8,905

 
Quarter ended
 
Year to date
Operating Profit (loss)
2014
 
2013
 
2014
 
2013
China(a)
$
202


$
335


$
681


$
557

KFC Division
169


147


487


457

Pizza Hut Division
68


71


215


250

Taco Bell Division
124


109

 
317


320

India
(3
)

(4
)

(7
)

(10
)
Unallocated closures and impairment expenses(b)

 
(295
)
 

 
(295
)
Corporate and Other unallocated(c)
(10
)

(13
)

(93
)

(52
)
Operating Profit
$
550


$
350


$
1,600


$
1,227

Interest expense, net
(28
)

(31
)

(90
)

(94
)
Income Before Income Taxes
$
522


$
319


$
1,510


$
1,133

 
9/6/2014
 
12/28/2013
Identifiable Assets
 
China(d)
$
4,093

 
$
3,720

KFC Division
2,481

 
2,432

Pizza Hut Division
731

 
723

Taco Bell Division
1,069

 
1,017

India
109

 
99

Corporate and unallocated(e)
694

 
704

 
$
9,177

 
$
8,695


(a)
Includes equity income from investments in unconsolidated affiliates. See Note 5.
 
(b)
Impairment loss related to Little Sheep for the quarter and year to date ended September 7, 2013. See Note 4.

(c)
Primarily Corporate general and administrative ("G&A") expenses and refranchising gains and (losses).

(d)
Includes investments in 4 unconsolidated affiliates totaling $58 million and $53 million as of September 6, 2014 and December 28, 2013, respectively.

(e)
Primarily includes cash, deferred tax assets and property, plant and equipment, net, related to our office facilities.


Note 9 - Pension Benefits

We sponsor qualified and supplemental (non-qualified) noncontributory defined benefit pension plans covering certain full-time salaried and hourly U.S. employees.  The most significant of these plans, the YUM Retirement Plan, is funded. We fund our other U.S. plans as benefits are paid.  The YUM Retirement Plan and our most significant non-qualified plan in the U.S. are closed to new salaried participants.  We also sponsor various defined benefit pension plans covering certain of our non-U.S. employees, the most significant of which are in the UK. During 2013, our Pizza Hut UK plan was frozen such that existing participants can no longer earn future service credits. Our KFC UK plan was frozen to future service credits in 2011.

12



  
The components of net periodic benefit cost associated with our significant U.S. pension plans and significant international pension plans are as follows:

 
U.S. Pension Plans
 
International Pension Plans
 
Quarter ended
 
2014
 
2013
 
2014
 
2013
Service cost
$
4

 
$
5

 
$

 
$

Interest cost
12

 
13

 
2

 
2

Expected return on plan assets
(13
)
 
(14
)
 
(3
)
 
(3
)
Amortization of net loss
4

 
13

 

 

Amortization of prior service cost
1

 

 

 

Net periodic benefit cost
$
8

 
$
17

 
$
(1
)
 
$
(1
)
 
 
 
 
 
 
 
 
Additional loss (gain) recognized due to:
 
 
 
 
 
 
 
Settlement (a)
$
1

 
$
4

 
$

 
$

Curtailment
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
U.S. Pension Plans
 
International Pension Plans
 
Year to date
 
2014
 
2013
 
2014
 
2013
Service cost
$
12

 
$
15

 
$

 
$

Interest cost
37

 
38

 
7

 
6

Expected return on plan assets
(39
)
 
(41
)
 
(10
)
 
(8
)
Amortization of net loss
12

 
39

 

 
1

Amortization of prior service cost
1

 
1

 

 

Net periodic benefit cost
$
23

 
$
52

 
$
(3
)
 
$
(1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional loss (gain) recognized due to:
 
 
 
 
 
 
 
Settlement (a)
$
6

 
$
14

 
$

 
$

Curtailment (b)
$

 
$

 
$

 
$
(5
)

(a)
Losses are a result of settlement transactions from a non-funded plan which exceeded the sum of annual service and interest costs for that plan. These losses were recorded in G&A expenses.

(b)
During 2013, our Pizza Hut UK Plan recorded a curtailment gain within G&A expenses as a result of terminating future service credits for all participants.


Note 10 - Fair Value Measurements

As of September 6, 2014 the carrying values of cash and cash equivalents, short-term investments (primarily six month term deposits outside of the U.S.), accounts receivable and accounts payable approximated their fair values because of the short-term nature of these instruments.  The fair value of notes receivable net of allowances and lease guarantees less subsequent amortization approximates their carrying value.  The Company’s debt obligations, excluding capital leases, were estimated to have a fair value of $3.1 billion (Level 2), compared to their carrying value of $2.8 billion.  We estimated the fair value of debt using market quotes and calculations based on market rates.

The Company has interest rate swaps accounted for as fair value hedges, foreign currency forwards accounted for as cash flow hedges and other investments, all of which are required to be measured at fair value on a recurring basis. Interest rate swaps are used to reduce our exposure to interest rate risk and lower interest expense for a portion of our fixed-rate debt, and foreign currency

13



forwards are used to reduce our exposure to cash flow volatility arising from foreign currency fluctuations associated with certain foreign currency denominated intercompany short-term receivables and payables. The fair value of these swaps, forwards and other investments were not material as of September 6, 2014 or December 28, 2013. In addition, certain of the Company’s assets such as property, plant and equipment, goodwill and intangible assets, are measured at fair value on a non-recurring basis if determined to be impaired. During the year to date ended September 6, 2014, we recorded restaurant-level impairment (Level 3) of $15 million. The remaining net book value of the assets measured at fair value during the year as of September 6, 2014, subsequent to these impairments, was not significant. During the year to date ended September 7, 2013, we recorded restaurant-level impairment (Level 3) of $5 million and impairment losses (Level 3) of $295 million related to our Little Sheep business in China. (See Note 4.)

Note 11 - Recently Adopted Accounting Pronouncements

In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2013-05, Foreign Currency Matters, (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (ASU 2013-05), to resolve a diversity in accounting for the cumulative translation adjustment of foreign currency upon derecognition of a foreign subsidiary or group of assets. ASU 2013-05 requires the parent to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets within a foreign entity. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. Further, ASU 2013-05 clarified that the parent should apply the guidance in Subtopic 810-10 if there is a sale of an investment in a foreign entity, including both (1) events that result in the loss of a controlling financial interest in a foreign entity and (2) events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date. Accordingly, the cumulative translation adjustment should be released into net income upon the occurrence of those events. ASU 2013-05 was effective for the Company during the quarter ended March 22, 2014. The adoption of this standard has not had an impact on our Condensed Consolidated Financial Statements.

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11), to require that in certain cases, an unrecognized tax benefit, or portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when such items exist in the same taxing jurisdiction. ASU 2013-11 was effective for the Company during the quarter ended March 22, 2014. The adoption of this standard did not have a significant impact on our Condensed Consolidated Financial Statements.

Note 12 - Guarantees, Commitments and Contingencies

Lease Guarantees

As a result of having (a) assigned our interest in obligations under real estate leases as a condition to the refranchising of certain Company restaurants; (b) contributed certain Company restaurants to former unconsolidated affiliates; and (c) guaranteed certain other leases, we are frequently contingently liable on lease agreements.  These leases have varying terms, the latest of which expires in 2065.  As of September 6, 2014, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessees was approximately $650 million.  The present value of these potential payments discounted at our pre-tax cost of debt at September 6, 2014 was approximately $575 million.  Our franchisees are the primary lessees under the vast majority of these leases.  We generally have cross-default provisions with these franchisees that would put them in default of their franchise agreement in the event of non-payment under the lease.  We believe these cross-default provisions significantly reduce the risk that we will be required to make payments under these leases.  Accordingly, the liability recorded for our probable exposure under such leases as of September 6, 2014 was not material.

Other Franchise Guarantees

We have agreed to provide guarantees of $37 million on behalf of franchisees for several financing programs related to specific initiatives.  The total loans outstanding under these financing programs were $69 million as of September 6, 2014.

Legal Proceedings

We are subject to various claims and contingencies related to lawsuits, real estate, environmental and other matters arising in the normal course of business. An accrual is recorded with respect to claims or contingencies for which a loss is determined to be probable and reasonably estimable.

14




In early 2013, four putative class action complaints were filed in the U.S. District Court for the Central District of California against the Company and certain executive officers alleging claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934.  Plaintiffs alleged that defendants made false and misleading statements concerning the Company’s current and future business and financial condition.  The four complaints were subsequently consolidated and transferred to the U.S. District Court for the Western District of Kentucky.  On August 5, 2013, lead plaintiff, Frankfurt Trust Investment GmbH, filed a Consolidated Class Action Complaint (“Amended Complaint”) on behalf of a putative class of all persons who purchased the Company’s stock between February 6, 2012 and February 4, 2013 (the “Class Period”).  The Amended Complaint no longer includes allegations relating to misstatements regarding the Company’s business or financial condition and instead alleges that, during the Class Period, defendants purportedly omitted information about the Company’s supply chain in China, thereby inflating the prices at which the Company’s securities traded.  On October 4, 2013, the Company and individual defendants filed a motion to dismiss the Amended Complaint.  Briefing on the motion to dismiss is complete. The Company denies liability and intends to vigorously defend against all claims in the Amended Complaint.  A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

On January 24, 2013, Bert Bauman, a purported shareholder of the Company, submitted a letter demanding that the Board of Directors initiate an investigation of alleged breaches of fiduciary duties by directors, officers and employees of the Company.  The breaches of fiduciary duties are alleged to have arisen primarily as a result of the failure to implement proper controls in connection with the Company’s purchases of poultry from suppliers to the Company’s China operations.  Subsequently, similar demand letters by other purported shareholders were submitted.  Those letters were referred to a special committee of the Board of Directors (the “Special Committee”) for consideration.  The Special Committee, upon conclusion of an independent inquiry of the matters described in the letters, unanimously determined that it is not in the best interests of the Company to pursue the claims described in the letters and, accordingly, rejected each shareholder’s demand.

On May 9, 2013, Mr. Bauman filed a putative derivative action in Jefferson Circuit Court, Commonwealth of Kentucky against certain current and former officers and directors of the Company asserting breach of fiduciary duty, waste of corporate assets and unjust enrichment in connection with an alleged failure to implement proper controls in the Company’s purchases of poultry from suppliers to the Company’s China operations and with an alleged scheme to mislead investors about the Company’s growth prospects in China.  By agreement of the parties, the matter is temporarily stayed pending the outcome of the motion to dismiss the securities class action. A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

On February 14, 2013, Jennifer Zona, another purported shareholder of the Company, submitted a demand letter similar to the demand letters described above.  On May 21, 2013, Ms. Zona filed a putative derivative action in the U.S. District Court for the Western District of Kentucky against certain officers and directors of the Company asserting claims similar to those asserted by Mr. Bauman.  The case was subsequently reassigned to the same judge that the securities class action is before.  On October 14, 2013, the Company filed a motion to dismiss on the basis of the Special Committee’s findings. By agreement of the parties, the matter is temporarily stayed pending the outcome of the motion to dismiss the securities class action. A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

On May 17, 2013, Sandra Wollman, another purported shareholder of the Company, submitted a demand letter similar to the demand letters described above. On December 9, 2013, Ms. Wollman filed a putative derivative action in the U.S. District Court for the Western District of Kentucky against certain current and former officers and directors of the Company asserting claims similar to those asserted by Mr. Bauman and Ms. Zona. By agreement of the parties, the matter was consolidated with the Zona action and is temporarily stayed pending the outcome of the motion to dismiss the securities class action. A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

Taco Bell was named as a defendant in a number of putative class action suits filed in 2007, 2008, 2009 and 2010 alleging violations of California labor laws including unpaid overtime, failure to timely pay wages on termination, failure to pay accrued vacation wages, failure to pay minimum wage, denial of meal and rest breaks, improper wage statements, unpaid business expenses, wrongful termination, discrimination, conversion and unfair or unlawful business practices in violation of California Business & Professions Code §17200. Some plaintiffs also seek penalties for alleged violations of California’s Labor Code under California’s Private Attorneys General Act as well as statutory “waiting time” penalties and allege violations of California’s Unfair Business Practices Act. Plaintiffs seek to represent a California state-wide class of hourly employees.

These matters were consolidated, and the consolidated case is styled In Re Taco Bell Wage and Hour Actions. The In Re Taco Bell Wage and Hour Actions plaintiffs filed a consolidated complaint in June 2009, and in March 2010 the court approved the parties’ stipulation to dismiss the Company from the action. Plaintiffs filed their motion for class certification on the vacation and final pay claims in December 2010, and on September 26, 2011 the court issued its order denying the certification of the vacation and final pay claims. Plaintiffs then sought to certify four separate meal and rest break classes. On January 2, 2013, the court

15



rejected three of the proposed classes but granted certification with respect to the late meal break class. The parties thereafter agreed on a list of putative class members, and the class notice and opportunity to opt out of the litigation were mailed on January 21, 2014.

Per order of the court, plaintiffs filed a second amended complaint to clarify the class claims. Plaintiffs also filed a motion for partial summary judgment. Taco Bell filed motions to strike and to dismiss, as well as a motion to alter or amend the second amended complaint. On August 29, 2014, the court denied plaintiffs’ motion for partial summary judgment. On that same date, the court granted Taco Bell’s motion to dismiss all but one of the California Private Attorney General Act claims and ruled that the plaintiffs were barred from seeking class certification for any of the nine claims where class certification had been denied or no class certification motion was filed. On October 6, 2014, plaintiffs filed a motion for interlocutory appeal of the court’s dismissal order.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit. We have provided for a reasonable estimate of the possible loss relating to this lawsuit. However, in view of the inherent uncertainties of litigation, there can be no assurance that this lawsuit will not result in losses in excess of those currently provided for in our Condensed Consolidated Financial Statements. A reasonable estimate of the amount of any possible loss or range of loss in excess of that currently provided for in our Condensed Consolidated Financial Statements cannot be made at this time.

On May 16, 2013, a putative class action styled Bernardina Rodriguez v. Taco Bell Corp. was filed in California Superior Court. The plaintiff seeks to represent a class of current and former California hourly restaurant employees alleging various violations of California labor laws including failure to provide meal and rest periods, failure to pay hourly wages, failure to provide accurate written wage statements, failure to timely pay all final wages, and unfair or unlawful business practices in violation of California Business & Professions Code §17200. This case appears to be duplicative of the In Re Taco Bell Wage and Hour Actions case described above. Taco Bell removed the case to federal court and, on June 25, 2013, plaintiff filed a first amended complaint to include a claim seeking penalties for alleged violations of California’s Labor Code under California’s Private Attorneys General Act. Taco Bell's motion to dismiss or stay the action in light of the In Re Taco Bell Wage and Hour Actions case was denied on October 30, 2013. In April 2014 the parties stipulated to address the sufficiency of plaintiff’s legal theory as to her meal break claim before conducting full discovery. A hearing on the parties’ cross-summary judgment motions is set for October 22, 2014.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit. A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

In December 2002, Taco Bell was named as the defendant in a class action lawsuit filed in the U.S. District Court for the Northern District of California styled Moeller, et al. v. Taco Bell Corp. In August 2003, plaintiffs filed an amended complaint alleging, among other things, that Taco Bell has discriminated against the class of people who use wheelchairs or scooters for mobility by failing to make its restaurants in California accessible to the class. Plaintiffs contended that queue rails and other architectural and structural elements of the Taco Bell restaurants relating to the path of travel and use of the facilities by persons with mobility-related disabilities did not comply with the U.S. Americans with Disabilities Act (the “ADA”), the Unruh Civil Rights Act (the “Unruh Act”), and the California Disabled Persons Act (the “CDPA”). Plaintiffs requested: (a) an injunction ordering Taco Bell to comply with the ADA and its implementing regulations; (b) that the court declare Taco Bell in violation of the ADA, the Unruh Act, and the CDPA; and (c) monetary relief under the Unruh Act or CDPA. Plaintiffs, on behalf of the class, sought the minimum statutory damages per offense of either $4,000 under the Unruh Act or $1,000 under the CDPA for each aggrieved member of the class. Plaintiffs contended that there may have been more than 100,000 individuals in the class. In February 2004, the court granted plaintiffs’ motion for class certification. The class included claims for injunctive relief and minimum statutory damages.

In May 2007, a hearing was held on plaintiffs’ Motion for Partial Summary Judgment, which sought a judicial declaration that Taco Bell was in violation of accessibility laws as to three specific issues: indoor seating, queue rails and door opening force. In August 2007, the court granted plaintiffs’ motion in part with regard to dining room seating. In addition, the court granted plaintiffs’ motion in part with regard to door opening force at some restaurants (but not all) and denied the motion with regard to queue lines.

In December 2009, the court denied Taco Bell’s motion for summary judgment on the ADA claims and ordered plaintiffs to select one restaurant to be the subject of a trial. Following the trial, the court issued Findings of Fact and Conclusions of Law in October 2011 ruling that plaintiffs established that classwide injunctive relief was warranted with regard to maintaining compliance as to corporate Taco Bell restaurants in California. The court declined to order injunctive relief at the time. The court also found that twelve specific items at the exemplar store were once out of compliance with applicable state and/or federal accessibility standards.

Taco Bell filed a motion to decertify the class in August 2011, and in July 2012, the court granted Taco Bell’s motion to decertify the previously certified state law damages class but denied Taco Bell’s motion to decertify the ADA injunctive relief class. In September 2012, the court set a discovery and briefing schedule concerning the trials of the four individual plaintiffs’ state law

16



damages claims, which the court stated would be tried before holding further proceedings regarding the possible issuance of an injunction. The court subsequently issued an order modifying its October 2011 Findings of Facts and Conclusions of Law deleting the statement that an injunction was warranted. Plaintiffs appealed that order, and on June 24, 2013 the Ninth Circuit Court of Appeals dismissed plaintiff’s appeal. On January 15, 2014, plaintiffs filed a motion seeking issuance of a classwide injunction, and Taco Bell filed a motion to dismiss both the individual and class ADA claims based on a lack of jurisdiction.

On April 24, 2014, the parties agreed to settle this matter. On June 4, 2014, the court granted preliminary approval of the settlement and on September 24, 2014, the court granted final approval. The proposed settlement amount has been accrued in our Condensed Consolidated Financial Statements, and the associated cash payments will not be material.

In July 2009, a putative class action styled Mark Smith v. Pizza Hut, Inc. was filed in the U.S. District Court for the District of Colorado. The complaint alleged that Pizza Hut did not properly reimburse its delivery drivers for various automobile costs, uniforms costs, and other job-related expenses and seeks to represent a class of delivery drivers nationwide under the Fair Labor Standards Act (FLSA) and Colorado state law. In January 2010, plaintiffs filed a motion for conditional certification of a nationwide class of current and former Pizza Hut, Inc. delivery drivers. However, in March 2010, the court granted Pizza Hut’s pending motion to dismiss for failure to state a claim, with leave to amend. Plaintiffs subsequently filed an amended complaint, which dropped the uniform claims but, in addition to the federal FLSA claims, asserted state-law class action claims under the laws of sixteen different states. Pizza Hut filed a motion to dismiss the amended complaint, and plaintiffs sought leave to amend their complaint a second time. In August 2010, the court granted plaintiffs’ motion to amend. Pizza Hut filed another motion to dismiss the Second Amended Complaint. In July 2011, the court granted Pizza Hut’s motion with respect to plaintiffs’ state law claims but allowed the FLSA claims to go forward. Plaintiffs filed their Motion for Conditional Certification in August 2011, and the court granted plaintiffs’ motion in April 2012. The opt-in period closed on August 23, 2012, and 6,049 individuals opted in.  On February 28, 2014, Pizza Hut filed a motion to decertify the collective action, along with a motion for partial summary judgment seeking an order from the court that the FLSA does not require Pizza Hut to reimburse certain fixed costs that delivery drivers would have incurred regardless of their employment with Pizza Hut.

On September 24, 2014, the parties entered into a Term Sheet setting forth the terms upon which the parties had agreed to settle this matter. The parties intend to execute a settlement agreement and file a motion with the court for settlement approval on or before November 3, 2014. Pursuant to the parties’ agreement, one issue, the mileage of an average round trip, remains outstanding and will be submitted for arbitration. The proposed settlement amount has been accrued in our Condensed Consolidated Financial Statements, and the associated cash payments will not be material. Likewise, any potential incremental amounts associated with the mileage arbitration are not expected to be material.

We are engaged in various other legal proceedings and have certain unresolved claims pending, the ultimate liability for which, if any, cannot be determined at this time. However, based upon current information and consultation with legal counsel, we expect that the final disposition of such proceedings and claims will not have a material adverse effect, individually or in the aggregate, on our Condensed Consolidated Financial Statements.






17



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction and Overview

Yum! Brands, Inc. (“YUM” or the “Company”) operates, franchises or licenses a worldwide system of over 40,000 restaurants in more than 125 countries and territories, primarily through the concepts of KFC, Pizza Hut and Taco Bell. These three concepts are the global leaders in the chicken, pizza and Mexican-style food categories, respectively. Of the more than 40,000 restaurants, 20% are operated by the Company and 80% are operated by franchisees, licensees or unconsolidated affiliates.

The Company is focused on the following key growth strategies:

Building Powerful Brands Through Superior Marketing, Breakthrough Innovation and Compelling Value with a Foundation Built on Winning Food and World Class Operations

Driving Aggressive Unit Expansion Everywhere, Especially in Emerging Markets, and Building Leading Brands in Every Significant Category in China and India

Creating Industry Leading Returns Through Franchising and Disciplined Use of Capital, Maximizing Long-term Shareholder Value

YUM now consists of five reporting segments:  

YUM China (“China” or “China Division”) which includes all operations in mainland China
YUM India ("India" or "India Division") which includes all operations in India, Bangladesh, Nepal and Sri Lanka
The KFC Division which includes all operations of the KFC concept outside of China Division and India Division
The Pizza Hut Division which includes all operations of the Pizza Hut concept outside of China Division and India Division
The Taco Bell Division which includes all operations of the Taco Bell concept outside of India Division

Previously, our reporting segments consisted of YUM Restaurants International, the United States, China and India. In the first quarter of 2014 we changed our management reporting structure to align our global operations outside of China and India by brand. As a result, our YUM Restaurants International and United States reporting segments were combined, and we began reporting this information by three new reporting segments: KFC Division, Pizza Hut Division and Taco Bell Division. China and India remain separate reporting segments. This new structure is designed to drive greater global brand focus, enabling us to more effectively share know-how and accelerate growth. While our consolidated results have not been impacted, we have restated our comparable segment information for consistent presentation.

This Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited Condensed Consolidated Financial Statements (“Financial Statements”), the Cautionary Note Regarding Forward-Looking Statements and our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 (“2013 Form 10-K”). References to YUM throughout this discussion are made in first person notations of “we,” “us” or “our.”

We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including performance metrics that management uses to assess the Company's performance. Throughout this MD&A, we commonly discuss the following performance metrics:

The Company provides certain percentage changes excluding the impact of foreign currency translation (“FX”).  These amounts are derived by translating current year results at prior year average exchange rates.  We believe the elimination of the foreign currency translation impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.

System sales growth includes the results of all restaurants regardless of ownership, including company-owned, franchise, unconsolidated affiliate and license restaurants that operate our concepts, except for non-company-owned restaurants for which we do not receive a sales-based royalty.  Sales of franchise, unconsolidated affiliate and license restaurants typically generate ongoing franchise and license fees for the Company (typically at a rate of 4% to 6% of restaurant sales).  Franchise, unconsolidated affiliate and license restaurant sales are not included in Company sales on the Condensed Consolidated Statements of Income; however, the franchise and license fees are included in the Company’s revenues.  We believe system sales growth is useful to investors as a significant indicator of the overall strength of our business as it incorporates all of our revenue drivers, Company and franchise same-store sales as well as net unit growth.

18




Same-store sales is the estimated change in system sales of all restaurants that have been open and in the YUM system one year or more.

Company Restaurant profit ("Restaurant profit") is defined as Company sales less expenses incurred directly by our company-owned restaurants in generating Company sales.  Company restaurant margin as a percentage of sales is defined as Restaurant profit divided by Company sales. Within the Company Sales and Restaurant Profit analysis, Store Portfolio Actions represent the net impact of new unit openings, acquisitions, refranchising and store closures, and Other primarily represents the impact of same-store sales as well as the impact of changes in costs such as inflation/deflation.

Operating margin is defined as Operating Profit divided by Total revenues.

In addition to the results provided in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") throughout this MD&A, the Company provides non-GAAP measurements which present operating results on a basis before items that we have deemed Special. The Company uses earnings before Special Items as a key performance measure of results of operations for the purpose of evaluating performance internally and Special Items are not included in any of our segment results.  This non-GAAP measurement is not intended to replace the presentation of our financial results in accordance with GAAP.  Rather, the Company believes that the presentation of earnings before Special Items provides additional information to investors to facilitate the comparison of past and present operations, excluding those items that the Company does not believe are indicative of our ongoing operations due to their size and/or nature.

All Note references herein refer to the accompanying Notes to the Financial Statements.  Tabular amounts are displayed in millions of U.S. dollars except per share and unit count amounts, or as otherwise specifically identified. Percentages may not recompute due to rounding.


19



Results of Operations

Worldwide

Our ongoing earnings growth model, which includes the ongoing earnings growth rates described within each of our reportable segment sections below, is expected to generate EPS growth of at least 10% annually. In December, 2013 we communicated that our 2014 EPS excluding Special Items was expected to grow at least 20% due in large part to an expectation that our China Division Operating Profit for 2014 would grow at a rate significantly above the ongoing rate of 15%. Details of our December, 2013 Guidance by division can be found online at http://yum.com.
   
In July, 2014 adverse publicity surrounding a minor supplier to KFC and Pizza Hut surfaced which has significantly impacted China sales and profits; we subsequently terminated our relationship with this supplier. China sales are rebounding but same-store sales continue to be negative. Our brands have proven resilient over time which we expect to be the case with this situation as well. With the assumption that China same-store sales continue to improve but will be negative for the fourth quarter, we now expect 2014 EPS excluding Special Items to grow between 6% and 10%. See the China Division discussion below for details of our results of operations.

The Consolidated Results of Operations for the quarters and years to date ended September 6, 2014 and September 7, 2013 are presented below:
 
Quarter ended
 
Year to date
 
2014
 
2013
 
% B/(W)
 
2014
 
2013
 
% B/(W)
Company sales
$
2,891

 
$
3,021

 
(4
)
 
 
$
7,941


$
7,594

 
5

 
Franchise and license fees and income
463

 
445

 
4

 
 
1,341


1,311

 
2

 
Total revenues
$
3,354

 
$
3,466

 
(3
)
 
 
$
9,282


$
8,905

 
4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restaurant profit
$
429


$
531

 
(19
)
 
 
$
1,298


$
1,174

 
11

 
Restaurant margin %
14.9
%
 
17.6
%
 
(2.7
)
ppts.
 
16.3
%
 
15.5
%
 
0.8

ppts.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
G&A expenses
$
323

 
$
327

 
1

 
 
$
946


$
933

 
(1
)
 
Franchise and license expenses
42


44

 
6

 
 
109


108

 
(1
)
 
Closures and impairment (income) expenses
6


300

 
98

 
 
30


310

 
90

 
Refranchising (gain) loss
(20
)

(38
)
 
(47
)
 
 
(27
)

(87
)
 
(69
)
 
Other (income) expense
(9
)

(7
)
 
43

 
 
(19
)

(6
)
 
NM

 
Operating Profit
$
550


$
350

 
57

 
 
$
1,600


$
1,227

 
30

 
Interest expense, net
28

 
31

 
6

 
 
90

 
94

 
4

 
Income tax provision
119


182

 
35

 
 
370

 
384

 
4
 
Effective Tax Rate
22.7
%

57.2
%
 
34.5

ppts.
 
24.5
%

33.9
%
 
9.4
ppts.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income – including noncontrolling interests
$
403


$
137

 
195

 
 
$
1,140


$
749

 
52

 
Net Income (loss) – noncontrolling interests
(1
)

(15
)
 
94

 
 
3


(21
)
 
NM

 
Net Income – YUM! Brands, Inc.
$
404


$
152

 
166

 
 
$
1,137


$
770

 
48

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share (a)
$
0.89


$
0.33

 
171

 
 
$
2.50


$
1.66

 
50

 
Diluted earnings per share before Special Items (a)
$
0.87

 
$
0.85

 
3

 
 
$
2.48

 
$
2.11

 
17

 

(a)
See Note 2 for the number of shares used in this calculation.

20



 
Quarter ended
 
 
 
 
Year to date
 
 
 
 
2014
 
2013
 
 
 
2014
 
2013
 
 
System Sales Growth, reported
1
%
 
1
%
 
 
 
2
%
 
%
 
 
 
System Sales Growth, excluding FX
1
%
 
1
%
 
 
 
4
%
 
1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unit Count
9/6/2014

 
9/7/2013

 
% Increase (Decrease)
 
 
 
 
 
Franchise & License
31,588

 
30,967

 
2
 
 
 
 
 
 
Company-owned
8,295

 
7,830

 
6
 
 
 
 
 
 
Unconsolidated Affiliates
735

 
689

 
7
 
 
 
 
 
 
 
40,618

 
39,486

 
3
 


 


 
 


21



Special Items

Special Items, along with the reconciliation to the most comparable GAAP financial measure, are presented below.

 
 
Quarter ended
 
Year to date
Detail of Special Items
 
2014
 
2013
 
2014
 
2013
U.S. Refranchising gain (loss)(a)
 
$
8

 
$
37

 
$
11

 
$
82

Little Sheep impairment(b)
 

 
(295
)
 

 
(295
)
Other Special Items Income (Expense)(c)
 
7

 
(9
)
 
7

 
(9
)
Total Special Items Income (Expense)
 
15

 
(267
)
 
18

 
(222
)
Tax Benefit (Expense) on Special Items(d)
 
(5
)
 
12

 
(6
)
 
(3
)
Special Items Income (Expense), net of tax - including noncontrolling interests
 
10

 
(255
)
 
12

 
(225
)
Special Items Income (Expense), net of tax - noncontrolling items
 

 
19

 

 
19

Special Items Income (Expense), net of tax - Yum Brands, Inc.
 
$
10

 
$
(236
)
 
$
12

 
$
(206
)
Average diluted shares outstanding
 
452


461

 
455


463

Special Items diluted EPS
 
$
0.02

 
$
(0.52
)
 
$
0.02

 
$
(0.45
)
 
 
 
 
 
 
 
 
 
Reconciliation of Operating Profit Before Special Items to Reported Operating Profit
 
 
 
 
 
 
 
 
Operating Profit before Special Items
 
$
535

 
$
617

 
$
1,582

 
$
1,449

Special Items Income (Expense)
 
15

 
(267
)
 
18

 
(222
)
Reported Operating Profit
 
$
550


$
350


$
1,600


$
1,227

 
 
 
 
 
 
 
 
 
Reconciliation of EPS Before Special Items to Reported EPS
 
 
 
 
 
 
 
 
Diluted EPS before Special Items
 
$
0.87

 
$
0.85

 
$
2.48

 
$
2.11

Special Items EPS
 
0.02

 
(0.52
)
 
0.02

 
(0.45
)
Reported EPS
 
$
0.89


$
0.33


$
2.50


$
1.66

 
 
 
 
 
 
 
 
 
Reconciliation of Effective Tax Rate Before Special Items to Reported Effective Tax Rate
 
 
 
 
 
 
 
 
Effective Tax Rate before Special Items
 
22.4
%
 
33.1
%
 
24.4
%
 
28.2
%
Impact on Tax Rate as a result of Special Items(d)
 
0.3
%
 
24.1
%
 
0.1
%
 
5.7
%
Reported Effective Tax Rate
 
22.7
%

57.2
%

24.5
%

33.9
%

(a)
U.S. refranchising gains and losses have not historically been allocated to our segments for performance reporting purposes due to the scope of our U.S. refranchising program in recent years and the volatility in associated gains and losses. The 2013 gains primarily relate to sales of Taco Bell restaurants in the U.S.

(b)
See Note 4 for discussion regarding Little Sheep impairment.

(c)
Other Special Items Income (Expense) includes gains from real estate sales in 2014 related to our previously refranchised Mexico business and charges related to U.S. General and Administrative productivity initiatives and realignment of resources due to the outsourcing of certain information technology, accounting and payroll services in 2013.

(d)
The tax benefit (expense) was determined based upon the impact of the nature, as well as the jurisdiction of the respective individual components within Special Items.


22



Quarter Highlights

The following quarterly highlights are variances versus the same period a year ago and exclude the impact of Special Items. System sales and Operating Profit in the quarterly highlights below exclude the impact of foreign currency translation.

Worldwide system sales grew 1%. Worldwide restaurant margin decreased 2.7 percentage points to 14.9%, and worldwide operating profit decreased 12%.
 
 
 
Total international development was 400 new restaurants; 77% of this development occurred in emerging markets.
 
 
China Division system sales declined 9%, as 6% unit growth was offset by a 14% same-store sales decline. Restaurant margin decreased 4.6 percentage points to 14.9%. Operating profit decreased 38%.
 
 
KFC Division system sales increased 6%, driven by 2% unit growth and 3% same-store sales growth. Restaurant margin increased 1.0 percentage point to 13.4%. Operating profit increased 16%.
 
 
Pizza Hut Division system sales were even, as 2% unit growth was offset by a 1% same-store sales decline. Restaurant margin decreased 1.0 percentage point to 8.9%. Operating profit decreased 2%.
 
 
Taco Bell Division system sales increased 4%, driven by 2% unit growth and 3% same-store sales growth. Restaurant margin increased 1.8 percentage points to 20.7%. Operating profit increased 14%.
 
 
Worldwide effective tax rate decreased to 22.4% from 33.1%, benefiting EPS by 14 percentage points.
 
 
Foreign currency translation negatively impacted operating profit by $6 million.
 
 
 
On September 10, 2014, the Company announced an 11% increase in its quarterly dividend, marking the tenth consecutive year the dividend increased at a double-digit percentage rate.

China Division

The China Division has 6,419 units, predominately KFC and Pizza Hut Casual Dining restaurants which are the leading quick service and casual dining restaurant brands, respectively, in mainland China. Additionally, the Company operates a majority of the distribution system for its restaurants in China which we believe provides a significant competitive advantage. Given this strong competitive position, a growing economy and a population of approximately 1.4 billion in mainland China, the Company is rapidly adding KFC and Pizza Hut Casual Dining restaurants, accelerating the development of Pizza Hut Home Service (home delivery), integrating the Little Sheep brand (hot pot) we acquired in 2012 and testing the additional restaurant concept of East Dawning (Chinese food). Our ongoing earnings growth model in China includes low double-digit percentage unit growth, mid-single digit same-store sales growth and moderate margin improvement, which we expect to drive annual Operating Profit growth of 15%.

We previously communicated that our 2014 China Division Operating Profit was expected to grow significantly above our ongoing 15% target due to KFC China recovering from significant sales declines in 2013. See our 2013 Form 10-K for additional discussion regarding the significant sales declines in 2013.

On July 20, 2014, an undercover report was televised in China depicting improper food handling practices by supplier Shanghai Husi, a division of OSI, which is a large, global supplier to many in the restaurant industry. This triggered extensive news coverage in China that has shaken consumer confidence and impacted brand usage. Subsequently, the Shanghai FDA launched an investigation into this matter, alleging illegal activity by OSI. Upon learning of these events, we terminated our relationship with OSI globally, with minimal disruption to our menu offerings in China. Even though OSI was a minor supplier, sales at KFC and Pizza Hut were disproportionately impacted given our category-leading positions. As a result, since July 21st, China Division has experienced a significant, negative impact to sales and profits at both KFC and Pizza Hut. While sales are rebounding, same-store sales continue to be negative. See the Worldwide section within the Results of Operations above for discussion on the impact of this matter on the Company’s 2014 EPS expectations.


23



 
 
Quarter ended
 
Year to date
 
 
 
 
 
 
% B/(W)
 
 
 
 
 
% B/(W)
 
 
2014
 
2013
 
Reported
 
Ex FX
 
2014
 
2013
 
Reported
 
Ex FX
Company sales
 
$
1,809


$
2,001

 
(10
)
 
 
(8
)
 
 
$
4,848


$
4,563

 
6

 
 
6

 
Franchise and license fees and income
 
31


32

 
(7
)
 
 
(6
)
 
 
80


70

 
14

 
 
14

 
Total revenues
 
$
1,840


$
2,033

 
(10
)
 
 
(8
)
 
 
$
4,928


$
4,633

 
6

 
 
6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restaurant profit
 
$
269

 
$
389

 
(31
)
 
 
(30
)
 
 
$
869

 
$
729

 
19

 
 
19

 
Restaurant margin %
 
14.9
%
 
19.5
%
 
(4.6
)
ppts.
 
(4.5
)
ppts.
 
17.9
%
 
16.0
%
 
1.9

ppts.
 
1.9

ppts.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
G&A expenses
 
$
95


$
88

 
(7
)
 
 
(8
)
 
 
$
259

 
$
233

 
(11
)
 
 
(11
)
 
Operating Profit
 
$
202


$
335

 
(40
)
 
 
(38
)
 
 
$
681


$
557

 
22

 
 
22

 
 
 
Quarter ended
 
Year to date
 
 
2014
 
2013
 
2014
 
2013
System Sales Growth, reported
 
(10
)%
 
1
 %
 
7
%
 
(5
)%
System Sales Growth, excluding FX
 
(9
)%
 
(2
)%
 
7
%
 
(7
)%
Same-Store Sales Growth %
 
(14
)%
 
(11
)%
 
1
%
 
(16
)%

 
 
 
 
 
 
% Increase (Decrease)
 
Unit Count
 
9/6/2014

 
9/7/2013

 
 
Company-owned
 
5,158

 
4,852

 
6
 
 
Unconsolidated Affiliates
 
735

 
689

 
7
 
 
Franchise & License
 
526

 
494

 
6