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 7, 2013
 
 
 
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. (Check one):  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 9, 2013 was 445,330,577 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 7, 2013 and September 8, 2012
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income - Quarters and Years to date ended September 7, 2013 and September 8, 2012
 
 
 
 
Condensed Consolidated Statements of Cash Flows – Years to date ended
September 7, 2013 and September 8, 2012
 
 
 
 
Condensed Consolidated Balance Sheets – September 7, 2013 and December 29, 2012
 
 
 
 
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
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Company sales
$
3,021


$
3,142


$
7,594


$
8,248

Franchise and license fees and income
445


427


1,311


1,232

Total revenues
3,466


3,569


8,905


9,480

Costs and Expenses, Net
 
 
 
 
 
 
 
Company restaurant expenses
 
 
 
 
 
 
 
Food and paper
996

 
1,029

 
2,481

 
2,712

Payroll and employee benefits
621

 
650

 
1,701

 
1,786

Occupancy and other operating expenses
873

 
864

 
2,238

 
2,288

Company restaurant expenses
2,490


2,543


6,420


6,786

General and administrative expenses
327


332


933


950

Franchise and license expenses
44


32


108


84

Closures and impairment (income) expenses
300


4


310


9

Refranchising (gain) loss
(38
)

(2
)

(87
)

(41
)
Other (income) expense
(7
)

(11
)

(6
)

(97
)
Total costs and expenses, net
3,116


2,898


7,678


7,691

Operating Profit
350


671


1,227


1,789

Interest expense, net
31


32


94


107

Income Before Income Taxes
319


639


1,133


1,682

Income tax provision
182


161


384


410

Net Income – including noncontrolling interests
137


478


749


1,272

Net Income (loss) – noncontrolling interests
(15
)

7


(21
)

12

Net Income – YUM! Brands, Inc.
$
152


$
471


$
770


$
1,260

 
 
 
 
 
 
 
 
Basic Earnings Per Common Share
$
0.34


$
1.02


$
1.70


$
2.72

 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share
$
0.33


$
1.00


$
1.66


$
2.65

 
 
 
 
 
 
 
 
Dividends Declared Per Common Share
$

 
$

 
$
0.67

 
$
0.57

 
 
 
 
 
 
 
 
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
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
 
 
 
 
 
 
 
 
Net Income - including noncontrolling interests
$
137

 
$
478

 
$
749

 
$
1,272

Other comprehensive income (loss), net of tax
 
 
 
 

 

Translation adjustments and gains (losses) from intra-entity transactions of a long-term investment nature
(42
)
 
(21
)
 
(39
)
 
(41
)
        Tax (expense) benefit
(1
)
 
1

 
5

 
1

Reclassification of currency translation adjustments into Net Income

 

 

 
3

        Tax expense (benefit)

 

 

 

Net unrealized gains (losses) arising during the year on pension and post-retirement plans
3

 

 
3

 

        Tax (expense) benefit
(2
)
 

 
(4
)
 

Reclassification of pension and post-retirement losses to Net Income
17

 
15

 
56

 
46

        Tax expense (benefit)
(6
)
 
(5
)
 
(20
)
 
(17
)
Net unrealized gain (loss) on derivative instruments

 

 
2

 

        Tax (expense) benefit

 

 
(1
)
 

Other comprehensive income (loss), net of tax
(31
)
 
(10
)
 
2

 
(8
)
Comprehensive Income - including noncontrolling interests
106

 
468

 
751

 
1,264

Comprehensive Income (loss) - noncontrolling interests
(15
)
 
7

 
(19
)
 
10

Comprehensive Income - YUM! Brands, Inc.
$
121

 
$
461

 
$
770

 
$
1,254

 
 
 
 
 
 
 
 
  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
 
9/7/2013
 
9/8/2012
Cash Flows – Operating Activities
 
 
 
Net Income – including noncontrolling interests
$
749

 
$
1,272

Depreciation and amortization
473

 
442

Closures and impairment (income) expenses
310

 
9

Refranchising (gain) loss
(87
)
 
(41
)
Contributions to defined benefit pension plans
(15
)
 
(46
)
Gain upon acquisition of Little Sheep

 
(74
)
Deferred income taxes
(51
)
 
86

Equity income from investments in unconsolidated affiliates
(17
)
 
(38
)
Distributions of income received from unconsolidated affiliates
15

 
38

Excess tax benefits from share-based compensation
(27
)
 
(52
)
Share-based compensation expense
32

 
35

Changes in accounts and notes receivable
(4
)
 
7

Changes in inventories
19

 
27

Changes in prepaid expenses and other current assets
(22
)
 
(14
)
Changes in accounts payable and other current liabilities
(14
)
 
28

Changes in income taxes payable
115

 
86

Other, net
77

 
53

Net Cash Provided by Operating Activities
1,553

 
1,818

 
 
 
 
Cash Flows – Investing Activities
 
 
 
Capital spending
(699
)
 
(678
)
Proceeds from refranchising of restaurants
218

 
187

Acquisitions
(98
)
 
(542
)
Changes in restricted cash

 
300

Other, net
(8
)
 
(14
)
Net Cash Used in Investing Activities
(587
)
 
(747
)
 
 
 
 
Cash Flows – Financing Activities
 
 
 
Repayments of long-term debt
(5
)
 
(280
)
Short-term borrowings, three months or less, net

 
2

Short-term borrowings, more than three months, net
2

 

Revolving credit facilities, three month or less, net

 
10

Repurchase shares of Common Stock
(510
)
 
(688
)
Excess tax benefits from share-based compensation
27

 
52

Employee stock option proceeds
17

 
27

Dividends paid on Common Stock
(451
)
 
(393
)
Other, net
(55
)
 
(52
)
Net Cash Used in Financing Activities
(975
)
 
(1,322
)
Effect of Exchange Rates on Cash and Cash Equivalents
(14
)
 
(5
)
Net Decrease in Cash and Cash Equivalents
(23
)
 
(256
)
Cash and Cash Equivalents - Beginning of Period
776

 
1,198

Cash and Cash Equivalents - End of Period
$
753

 
$
942

 
 
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
 
 


5



CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
 
YUM! BRANDS, INC. AND SUBSIDIARIES
 
 
 
(in millions)
 
 
 
 
(Unaudited)
 
 
 
9/7/2013
 
12/29/2012
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
753


$
776

Accounts and notes receivable, net
348

 
301

Inventories
300

 
313

Prepaid expenses and other current assets
233

 
272

Deferred income taxes
116

 
127

Advertising cooperative assets, restricted
80

 
136

Total Current Assets
1,830

 
1,925

 
 
 
 
Property, plant and equipment, net
4,257


4,250

Goodwill
882

 
1,034

Intangible assets, net
644

 
690

Investments in unconsolidated affiliates
42

 
72

Other assets
567

 
575

Deferred income taxes
508

 
467

Total Assets
$
8,730

 
$
9,013

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable and other current liabilities
$
1,745

 
$
2,036

Income taxes payable
149

 
97

Short-term borrowings
15

 
10

Advertising cooperative liabilities
80

 
136

Total Current Liabilities
1,989

 
2,279

 
 
 
 
Long-term debt
2,917

 
2,932

Other liabilities and deferred credits
1,524

 
1,490

Total Liabilities
6,430

 
6,701

 
 
 
 
Redeemable noncontrolling interest
40

 
59

 
 
 
 
Shareholders’ Equity
 
 
 
Common Stock, no par value, 750 shares authorized; 445 and 451 shares issued in 2013 and 2012, respectively

 

Retained earnings
2,326

 
2,286

Accumulated other comprehensive income (loss)
(132
)

(132
)
Total Shareholders’ Equity – YUM! Brands, Inc.
2,194

 
2,154

Noncontrolling interests
66

 
99

Total Shareholders’ Equity
2,260

 
2,253

Total Liabilities, Redeemable Noncontrolling Interest and Shareholders’ Equity
$
8,730

 
$
9,013

 
 
 
 
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 29, 2012 (“2012 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 2012 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’s business consists of four reporting segments:  YUM Restaurants China (“China” or “China Division”), YUM Restaurants International (“YRI” or “International Division”), United States ("U.S." or "U.S. Division") and YUM Restaurants India ("India" or "India Division").  The China Division includes mainland China, and the India Division includes India, Bangladesh, Mauritius, Nepal and Sri Lanka. YRI includes the remainder of our international operations.

Our fiscal year ends on the last Saturday in December and, as a result, a 53rd week is added every five or six years.  The first three quarters of each fiscal year consist of 12 weeks and the fourth quarter consists of 16 weeks in fiscal years with 52 weeks and 17 weeks in fiscal years with 53 weeks.  Our subsidiaries operate on similar fiscal calendars except that China, India and certain other international subsidiaries operate on a monthly calendar, and thus never have a 53rd week, with two months in the first quarter, three months in the second and third quarters and four months in the fourth quarter.  YRI closes four weeks earlier to facilitate consolidated reporting.

At the beginning of fiscal 2013, we eliminated the period lag that we previously used to facilitate the reporting of our India Division's results. Accordingly, the India Division's 2013 third quarter results include the months of June through August 2013 and the 2013 year to date results include the months of January through August 2013. Due to the immateriality of the India Division's results we did not restate the prior year operating results for the elimination of this period lag and therefore the 2012 third quarter results continue to include the months of May through July 2012 and the 2012 year to date results include the months of December 2011 through July 2012.

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.

In our opinion, the accompanying Financial Statements include all normal and recurring adjustments considered necessary to present fairly, when read in conjunction with our 2012 Form 10-K, our financial position as of September 7, 2013, and the results of our operations and comprehensive income for the quarters and years to date ended September 7, 2013 and September 8, 2012, and cash flows for the years to date ended September 7, 2013 and September 8, 2012. 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 7, 2013. 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
 
 
9/7/2013

 
9/8/2012

 
9/7/2013

 
9/8/2012

Net Income – YUM! Brands, Inc.
 
$
152

 
$
471

 
$
770

 
$
1,260

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (for basic calculation)
 
451

 
460

 
453

 
463

Effect of dilutive share-based employee compensation
 
10

 
12

 
10

 
13

Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)
 
461

 
472

 
463

 
476

Basic EPS
 
$
0.34

 
$
1.02

 
$
1.70

 
$
2.72

Diluted EPS
 
$
0.33

 
$
1.00

 
$
1.66

 
$
2.65

Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a)
 
4.7

 
3.5

 
5.5

 
3.0


(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 September 7, 2013 and September 8, 2012, 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
 
Authorization Expiration Date
 
2013
 
2012
 
2013
 
2012
 
2013
January 2011
 
June 2012
 

 
 
2,787

 
 
$

 
 
$
188

 
 
$

 
November 2011
 
May 2013
 

 
 
7,986

 
 

 
 
514

 
 

 
November 2012
 
May 2014
 
7,100

 
 

 
 
490

 
 

 
 
463

 
Total
 
 
 
7,100

(a) 
 
10,773

(b) 
 
$
490

(a) 
 
$
702

(b) 
 
$
463

 
 
 
 
 
 

(a)
Amount excludes the effect of $20 million in share repurchases (0.3 million shares) with trade dates prior to the 2012 fiscal year end but cash settlement dates subsequent to the 2012 fiscal year end.

(b)
Amount includes the effect of $14 million in share repurchases (0.2 million shares) with trade dates prior to September 8, 2012 but cash settlement dates subsequent to September 8, 2012.


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 Benefit Plan Losses (a)
 
Net Unrealized Loss on Derivative Instruments
 
Total
Balance at December 29, 2012, net of tax
 
$
166

 
$
(286
)
 
$
(12
)
 
$
(132
)
 
 
 
 
 
 
 
 
 
Amounts classified into OCI, net of tax
 
(36
)
 
(1
)
 
(1
)
 
(38
)
 
 
 
 
 
 
 
 
 
Amounts reclassified from accumulated OCI, net of tax
 

 
36

 
2

 
38

 
 
 
 
 
 
 
 
 
OCI, net of tax
 
(36
)
 
35

 
1

 

 
 
 
 
 
 
 
 
 
Balance at September 7, 2013, net of tax
$
130

 
$
(251
)
 
$
(11
)
 
$
(132
)

(a)
Amounts reclassified from accumulated OCI for pension and post-retirement benefit plan losses include amortization of net losses of $41 million, settlement charges of $14 million, amortization of prior service cost of $1 million, net of the related income tax benefit of $20 million. See Note 10 Pension Benefits for further information.


9




Note 4 - Items Affecting Comparability of Net Income and/or Cash Flows

Little Sheep Acquisition and Impairment

On February 1, 2012 we acquired an additional 66% interest in Little Sheep Group Limited (“Little Sheep”) for $540 million, net of cash acquired of $44 million, increasing our ownership to 93%.  The acquisition was driven by our strategy to build leading brands across China in every significant category.  Prior to our acquisition of this additional interest, our 27% interest in Little Sheep was accounted for under the equity method of accounting.  As a result of the acquisition we obtained voting control of Little Sheep, and thus we began consolidating Little Sheep upon acquisition.  As required by GAAP, we remeasured our previously held 27% ownership in Little Sheep, which had a recorded value of $107 million at the date of acquisition, at fair value based on Little Sheep's traded share price immediately prior to our offer to purchase the business and recognized a non-cash gain of $74 million.  This gain, which resulted in no related income tax expense, was recorded in Other (income) expense on our Condensed Consolidated Statement of Income during the quarter ended March 24, 2012 and was not allocated to any segment for performance reporting purposes.

The purchase price paid for the additional 66% interest and the resulting purchase price allocation assumed same-store sales growth and new-unit development for the brand. As a result of consolidating Little Sheep, the primary assets recorded were an indefinite-lived Little Sheep trademark and goodwill of approximately $400 million and $375 million, respectively. The goodwill was assigned to the newly formed Little Sheep reporting unit within our China Division.

The same-store sales growth and new unit development that we assumed upon acquisition have yet to materialize. Sales growth was negatively impacted initially by a longer than expected purchase approval and ownership transition phase. Our efforts to regain sales momentum were significantly compromised in May 2013 due to negative publicity from quality issues with other unrelated hot pot concepts in China, even though there was not an issue with the quality of Little Sheep products. During the third quarter we saw limited recovery in the Little Sheep business, and sales and profits continued to be below our expectations.

While we remain confident in the long-term potential of Little Sheep, these sustained declines in sales and profits, coupled with the anticipated time it will now take for the business to recover, resulted in a determination during the quarter ended September 7, 2013 that it is not more likely than not that the Little Sheep trademark and reporting unit fair values are 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 comparing the trademark’s fair value of $345 million to its carrying value of $414 million, an impairment charge of $69 million was recorded. Additionally, after determining the fair value of the Little Sheep reporting unit was less than its carrying value, goodwill was written down to $162 million, resulting in an impairment charge of $222 million. The Company also evaluated other Little Sheep long-lived assets for impairment and recorded a $4 million impairment charge related to restaurant-level PP&E.

These non-cash impairment charges totalling $295 million were recorded in Closures and impairment (income) expense on our Condensed Consolidated Statement of Income and were not allocated to any segment for performance reporting purposes, consistent with the classification of the $74 million gain that was recorded upon acquisition. We 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.

The fair values of the Little Sheep trademark and reporting unit were based on the estimated prices a willing buyer would pay. The fair value of the trademark was determined using a relief from royalty valuation approach and included future estimated sales as a significant input. The reporting unit fair value was determined using an income approach with future cash flow estimates generated by the business as a significant input. Future cash flow estimates are impacted by sales growth, margin improvement and new unit development assumptions that are highly correlated as cash flow growth can be achieved through various inter-related strategies such as product pricing, restaurant productivity initiatives and the timing of new unit development. Both fair values incorporated a discount rate of 13% as our estimate of the required rate of return that a third-party buyer would expect to receive when purchasing the Little Sheep trademark or reporting unit.

While future business results are difficult to predict, we believe the recent decline in Little Sheep sales and profits will be reversed over time. As such, the inputs used in determining the fair values of the Little Sheep trademark and reporting unit assume that the business will recover to pre-acquisition sales and profit levels over the next three years. Long-term average growth assumptions subsequent to this assumed recovery include same-store-sales growth of 4% and average annual net unit development of approximately 75 units.

10




Turkey Restaurant Acquisition

In April 2013, we acquired 65 KFC and 41 Pizza Hut restaurants from an existing franchisee in Turkey for $86 million of cash and a potential payment of up to $19 million to be made in 2016 based on results of the business through 2015.

We recognized $85 million of goodwill for the value expected to be generated from the acquisition, primarily through net unit development. The goodwill is not expected to be deductible for income tax purposes and has been allocated to the YRI operating segment.

Refranchising (Gain) Loss

The Refranchising (gain) loss by reportable segment is presented below. We do not allocate such gains and losses to our segments for performance reporting purposes.

 
 
Quarter ended
 
Year to date
 
 
9/7/2013
 
9/8/2012
 
9/7/2013

 
9/8/2012

China
 
$
(1
)
 
$
(3
)
 
$
(2
)
 
$
(7
)
YRI(a)
 

 

 
(3
)
 
19

U.S.(b)
 
(37
)
 
1

 
(82
)
 
(53
)
India
 

 

 

 

Worldwide
 
$
(38
)
 
$
(2
)
 
$
(87
)
 
$
(41
)

(a)
During the fourth quarter of 2012, we refranchised our remaining 331 Company-owned Pizza Hut dine-in restaurants in the United Kingdom ("UK"). For the year to date ended September 8, 2012 we recorded pre-tax losses of $24 million due to the then planned refranchising of these restaurants.

(b)
In the quarter ended September 7, 2013 and in the years to date ended September 7, 2013 and September 8, 2012, U.S. Refranchising (gain) loss primarily relates to gains on the sales of Taco Bell restaurants.


11



Store Closure and Impairment Activity

Store closure (income) costs and Store impairment charges by reportable segment are presented below.
 
Quarter ended September 7, 2013
 
China
 
YRI
 
U.S.
 
India
 
Worldwide
Store closure (income) costs(a)
$
1

 
$
(1
)
 
$
(1
)
 
$

 
$
(1
)
Store impairment charges
5

 
1

 

 

 
6

Closure and impairment (income) expenses(b)
$
6

 
$

 
$
(1
)
 
$

 
$
5


 
Quarter ended September 8, 2012
 
China
 
YRI
 
U.S.
 
India
 
Worldwide
Store closure (income) costs(a)
$
(1
)
 
$
1

 
$

 
$

 
$

Store impairment charges
2

 
1

 
1

 

 
4

Closure and impairment (income) expenses
$
1

 
$
2

 
$
1

 
$

 
$
4

 
 
 
 
 
 
 
 
 
 

 
Year to date ended September 7, 2013
 
China
 
YRI
 
U.S.
 
India
 
Worldwide
Store closure (income) costs(a)
$
(2
)
 
$
(1
)
 
$
(1
)
 
$

 
$
(4
)
Store impairment charges
16

 
1

 
1

 
1

 
19

Closure and impairment (income) expenses(b)
$
14

 
$

 
$

 
$
1

 
$
15


 
Year to date ended September 8, 2012
 
China
 
YRI
 
U.S.
 
India
 
Worldwide
Store closure (income) costs(a)
$
(3
)
 
$
(1
)
 
$
(2
)
 
$

 
$
(6
)
Store impairment charges
7

 
3

 
5

 

 
15

Closure and impairment (income) expenses
$
4

 
$
2

 
$
3

 
$

 
$
9


(a)
Store closure (income) costs include the net gain or loss on sales of real estate on which we formerly operated a Company restaurant that was closed, lease reserves established when we cease using a property under an operating lease and subsequent adjustments to those reserves and other facility-related expenses from previously closed stores.

(b)
This table excludes $295 million of Little Sheep impairment losses that were not allocated to any segment for performance reporting purposes. See the Little Sheep Acquisition and Impairment section of Note 4 for details.

Note 5 - Recently Adopted Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02), that requires an organization to present the effects on the line items of net income of significant amounts reclassified out of Accumulated OCI, but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. ASU 2013-02 is effective for fiscal years beginning after December 15, 2012. All necessary disclosures have been complied with in these Financial Statements.



12



Note 6 - Other (Income) Expense
 
Quarter ended
 
Year to date
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Equity (income) loss from investments in unconsolidated affiliates
$
(13
)
 
$
(16
)
 
$
(17
)
 
$
(38
)
Gain upon acquisition of Little Sheep

 

 

 
(74
)
Foreign exchange net (gain) loss and other(a)
6

 
5

 
11

 
15

Other (income) expense
$
(7
)
 
$
(11
)
 
$
(6
)
 
$
(97
)
 
(a)
The year to date ended September 8, 2012 includes $6 million of deal costs related to the acquisition of Little Sheep that were allocated to the China Division for performance reporting purposes.

Note 7 - Supplemental Balance Sheet Information

Receivables

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.  
 
9/7/2013
 
12/29/2012
Accounts and notes receivable
$
361

 
$
313

Allowance for doubtful accounts
(13
)
 
(12
)
Accounts and notes receivable, net
$
348

 
$
301


Property, Plant and Equipment
 
9/7/2013
 
12/29/2012
Property, plant and equipment, gross
$
7,549

 
$
7,389

Accumulated depreciation and amortization
(3,292
)
 
(3,139
)
Property, plant and equipment, net
$
4,257

 
$
4,250


Assets held for sale at September 7, 2013 and December 29, 2012 total $20 million and $56 million, respectively, and are included in Prepaid expenses and other current assets in our Condensed Consolidated Balance Sheets.

Noncontrolling Interests

Noncontrolling interests primarily include the ownership interests of minority shareholders of the entities that operate the KFCs in Beijing and Shanghai, China.   Redeemable noncontrolling interest comprises the 7% ownership interest in Little Sheep that continues to be held by the Little Sheep founding shareholders. The Redeemable noncontrolling interest 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:

13




 
Noncontrolling Interests
 
Reedemable Noncontrolling Interest
Balance at December 29, 2012
$
99

 
$
59

Net Income (loss) – noncontrolling interests(a)
(1
)
 
(20
)
Acquisition of Little Sheep store-level non-controlling interests
(15
)
 

Dividends declared
(18
)
 

Cumulative translation adjustment arising during the period
1

 
1

Balance at September 7, 2013
$
66

 
$
40


(a)
Amount allocated to Redeemable noncontrolling interest includes the allocable portion of Little Sheep impairment of $19 million. See the Little Sheep Acquisition and Impairment section of Note 4.

Note 8 - Income Taxes

 
Quarter ended
 
Year to date
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Income taxes
$
182

 
$
161

 
$
384

 
$
410

Effective tax rate
57.2
%
 
25.1
%
 
33.9
%
 
24.4
%

Our third quarter and year to date effective tax rates were higher than the prior year primarily due to the impact of the $222 million non-cash impairment of Little Sheep goodwill, which resulted in no related tax benefit, and the unfavorable impact of increasing prior year unrecognized tax benefits related to the continuing dispute with the Internal Revenue Service (the "IRS") regarding a valuation of intangibles which is discussed in further detail below. Our year to date effective rate tax was also negatively impacted by lapping the prior year impact of the $74 million gain recognized upon our acquisition of a controlling interest in Little Sheep, which resulted in no related tax expense.

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.

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 has 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.  The proposed adjustment would result in approximately $700 million of additional taxes plus net interest to date of approximately $240 million for fiscal years 2004-2006.  On January 9, 2013, the Company received an RAR from the IRS for fiscal years 2007 and 2008. As expected, the IRS proposed an adjustment similar to their proposal for 2004-2006 that would result in approximately $270 million of additional taxes plus net interest to date of approximately $40 million for fiscal years 2007 and 2008. Furthermore, the Company expects the IRS to make similar claims for years subsequent to fiscal 2008. The potential additional taxes for 2009 through 2012, computed on a similar basis to the 2004-2008 additional taxes, would be approximately $130 million plus net interest to date of approximately $5 million.

We believe that the Company has properly reported taxable income and paid taxes in accordance with applicable laws and that the proposed adjustments are inconsistent with applicable income tax laws, Treasury Regulations and relevant case law.  We intend to defend our position vigorously and have filed a protest with the IRS.  As the final resolution of the proposed adjustments remains uncertain, the Company continues to provide for its position in this matter based on the tax benefit that we believe is the largest amount that is more likely than not to be realized upon resolution of this issue, which includes the additional provision recorded in the quarter ended September 7, 2013.  There can be no assurance that payments due upon final resolution of this issue will not exceed our currently recorded reserve and such payments could have a material, adverse effect on our financial position.  Additionally, if increases to our reserves are deemed necessary due to future developments related to this issue, such increases could have a material, adverse effect on our results of operations as they are recorded.  The Company does not expect resolution of this matter within twelve months and cannot predict with certainty the timing of such resolution.


14



Note 9 - Reportable Operating Segments

We identify our operating segments based on management responsibility.  The China Division includes mainland China and the India Division includes India, Bangladesh, Mauritius, Nepal and Sri Lanka. YRI includes the remainder of our international operations.  We consider our KFC-U.S., Pizza Hut-U.S. and Taco Bell-U.S. operating segments to be similar and therefore have aggregated them into a single reportable operating segment.

The following tables summarize Revenues and Operating Profit for each of our reportable operating segments:
 
Quarter ended
 
Year to date
Revenues
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
China
$
2,033

 
$
1,988

 
$
4,633

 
$
4,762

YRI
719

 
769

 
2,101

 
2,247

U.S.
684

 
787

 
2,088

 
2,405

India
30

 
25

 
83

 
66

 
$
3,466


$
3,569


$
8,905


$
9,480

 
Quarter ended
 
Year to date
Operating Profit (loss)
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
China(a)
$
335


$
374


$
557


$
812

YRI
163


173


525


491

U.S.
164


162


502


486

India
(4
)



(10
)

(1
)
Unallocated Occupancy and other(b)(f)


3




12

Unallocated and General and administrative expenses(f)
(46
)

(41
)

(133
)

(124
)
Unallocated Other income (expense)(c)(f)
(5
)

(2
)

(6
)

72

Unallocated Closures and impairment expenses(d)(f)
(295
)
 

 
(295
)
 

Unallocated Refranchising gain (loss)(e)(f)
38


2


87


41

Operating Profit
$
350


$
671


$
1,227


$
1,789

Interest expense, net
(31
)

(32
)

(94
)

(107
)
Income Before Income Taxes
$
319


$
639


$
1,133


$
1,682


(a)
Includes equity income from investments in unconsolidated affiliates of $13 million and $16 million for the quarters ended September 7, 2013 and September 8, 2012, respectively. Includes equity income from investments in unconsolidated affiliates of $17 million and $38 million for the years to date ended September 7, 2013 and September 8, 2012, respectively.

(b)
Amounts represent depreciation reduction as a result of impairment losses recognized related to our decisions to refranchise Company operated Pizza Hut dine-in restaurants in the UK (see the Refranchising (Gain) Loss section of Note 4) and Company operated KFC restaurants in the U.S.

(c)
Includes gain upon acquisition of Little Sheep of $74 million for the year to date ended September 8, 2012. See the Little Sheep Acquisition and Impairment section of Note 4.

(d)
Amount represents impairment loss related to Little Sheep for the quarter and year to date ended September 7, 2013. See the Little Sheep Acquisition and Impairment section of Note 4.

(e)
Includes U.S. refranchising gains of $37 million for the quarter ended September 7, 2013. Includes U.S. refranchising gains of $82 million and $53 million for the years to date ended September 7, 2013 and September 8, 2012, respectively, and losses of $24 million related to the planned refranchising of our Pizza Hut UK dine-in business for the year to date ended September 8, 2012. See the Refranchising (Gain)Loss section of Note 4.

(f)
Amounts have not been allocated to any segment for performance reporting purposes.


15




Note 10 - Pension Benefits

We sponsor 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 (the “Plan”), is funded while benefits from the other U.S. plan are paid by the Company as incurred.  During 2001, the plans covering our U.S. salaried employees were amended such that any salaried employee hired or rehired by YUM after September 30, 2001 is not eligible to participate in those plans.  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 the quarter ended March 23, 2013, one of our UK plans was frozen such that existing participants can no longer earn future service credits. Our other UK plan was previously frozen to future service credits in 2011.
  
The components of net periodic benefit cost associated with our U.S. pension plans and significant international pension plans are as follows:

 
U.S. Pension Plans
 
International Pension Plans
 
Quarter ended
 
Quarter ended
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Service cost
$
5

 
$
6

 
$

 
$

Interest cost
13

 
15

 
2

 
2

Expected return on plan assets
(14
)
 
(17
)
 
(3
)
 
(2
)
Amortization of net loss
13

 
15

 

 

Amortization of prior service cost

 
1

 

 

Net periodic benefit cost
$
17

 
$
20

 
$
(1
)
 
$

 
 
 
 
 
 
 
 
Additional loss (gain) recognized due to:
 
 
 
 
 
 
 
Settlement (a)
$
4

 
$

 
$

 
$

Curtailment
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
U.S. Pension Plans
 
International Pension Plans
 
Year to date
 
Year to date
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Service cost
$
15

 
$
18

 
$

 
$
1

Interest cost
38

 
45

 
6

 
6

Expected return on plan assets
(41
)
 
(49
)
 
(8
)
 
(7
)
Amortization of net loss
39

 
44

 
1

 

Amortization of prior service cost
1

 
1

 

 

Net periodic benefit cost
$
52

 
$
59

 
$
(1
)
 
$

 
 
 
 
 
 
 
 
Additional loss (gain) recognized due to:
 
 
 
 
 
 
 
Settlement (a)
$
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 unallocated General and administrative expenses.

(b)
Gain is a result of terminating future service benefits for all participants in one of our UK plans. The gain was recorded in YRI's General and administrative expenses.

We made no contributions to the Plan during the year to date ended September 7, 2013. While we are not required to make any contributions to the Plan in 2013, we may choose to make additional discretionary contributions as part of our overall capital structure strategy. We do not anticipate making any significant contributions to any plan outside of the U.S. in 2013.

16




Note 11 - Derivative Instruments

The Company is exposed to certain market risks relating to its ongoing business operations.  The primary market risks managed by using derivative instruments are interest rate risk and cash flow volatility arising from foreign currency fluctuations.

We enter into interest rate swaps with the objective of reducing our exposure to interest rate risk and lowering interest expense for a portion of our fixed-rate debt.  At September 7, 2013, our interest rate derivative instruments outstanding had notional amounts of $300 million and have been designated as fair value hedges of a portion of our debt.  These fair value hedges meet the shortcut method requirements and no ineffectiveness has been recorded.

We enter into foreign currency forward contracts with the objective of reducing our exposure to cash flow volatility arising from foreign currency fluctuations associated with certain foreign currency denominated intercompany short-term receivables and payables.  The notional amount, maturity date, and currency of these contracts match those of the underlying receivables or payables.  For those foreign currency exchange forward contracts that we have designated as cash flow hedges, we measure ineffectiveness by comparing the cumulative change in the fair value of the forward contract with the cumulative change in the fair value of the hedged item.  At September 7, 2013, foreign currency forward contracts outstanding had a total notional amount of $519 million.

The fair values of derivatives designated as hedging instruments as of September 7, 2013 and December 29, 2012 were:

 
9/7/2013
 
12/29/2012
 
Condensed Consolidated Balance Sheet Location
Interest Rate Swaps - Asset
$
19


$
24

 
Other assets
Foreign Currency Forwards - Asset
2

 

 
Prepaid expenses and other current assets
Foreign Currency Forwards - Liability
(9
)
 
(5
)
 
Accounts payable and other current liabilities
Total
$
12

 
$
19

 
 

The unrealized gains associated with our interest rate swaps that hedge the interest rate risk for a portion of our debt have been reported as an addition of $15 million to Long-term debt at September 7, 2013 and as an addition of $22 million to Long-term debt at December 29, 2012.  During the quarter and year to date ended September 7, 2013, Interest expense, net was reduced by $2 million and $6 million, respectively, for recognized gains on interest rate swaps. During the quarter and year to date ended September 8, 2012, Interest expense, net was reduced by $2 million and $10 million, respectively, for recognized gains on interest rate swaps.

Changes in fair value of derivative instruments:

 
Year to date
 
9/7/2013
 
9/8/2012
Beginning of Year Balance
$
19

 
$
34

Changes in fair value recognized into OCI
(2
)
 
25

Changes in fair value recognized into income
(2
)
 
7

Cash receipts
(3
)
 
(13
)
Ending Balance
$
12

 
$
53


For our foreign currency forward contracts the following effective portions of gains and losses were recognized into Accumulated OCI and reclassified into income from Accumulated OCI in the quarters and years to date ended September 7, 2013 and September 8, 2012:

 
Quarter ended
 
Year to date
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Gains (losses) recognized into Accumulated OCI, net of tax
$
(7
)
 
$
9

 
$
(1
)
 
$
16

Gains (losses) reclassified from Accumulated OCI into income, net of tax
$
(7
)
 
$
9

 
$
(2
)

$
16


17




The gains/losses reclassified from Accumulated OCI into income were recognized as Other income (expense) in our Condensed Consolidated Statements of Income, largely offsetting foreign currency transaction losses/gains recorded when the related intercompany receivables and payables were adjusted for foreign currency fluctuations.  Changes in fair values of the foreign currency forwards recognized directly in our results of operations either from ineffectiveness or exclusion from effectiveness testing were insignificant in the quarters and years to date ended September 7, 2013 and September 8, 2012.

Additionally, we had a net deferred loss of $11 million, net of tax, as of September 7, 2013 within Accumulated OCI due primarily to treasury locks and forward-starting interest rate swaps that were cash settled in prior years.  The majority of this loss arose from the 2007 settlement of forward starting interest rate swaps entered into prior to the issuance of our Senior Unsecured Notes due in 2037, and is being recognized in interest expense through 2037 consistent with interest payments made on the related Senior Unsecured Notes.  In the quarters and years to date ended September 7, 2013 and September 8, 2012, an insignificant amount was reclassified from Accumulated OCI to Interest expense, net as a result of these previously settled cash flow hedges.

As a result of the use of derivative instruments, the Company is exposed to risk that the counterparties will fail to meet their contractual obligations.  To mitigate counterparty credit risk, we only enter into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and continually assess the creditworthiness of counterparties.  At September 7, 2013, all of the counterparties to our interest rate swaps and foreign currency forwards had investment grade ratings according to the three major ratings agencies.  To date, all counterparties have performed in accordance with their contractual obligations.

Note 12 - Fair Value Measurements

At September 7, 2013 the carrying values of cash and cash equivalents, short-term investments, 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.

Recurring Fair Value Measurements

The following table presents the fair values for those assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the measurements fall.  No transfers among the levels within the fair value hierarchy occurred during the year to date ended September 7, 2013.

 
Fair Value
 
Level
 
9/7/2013
 
12/29/2012
Foreign Currency Forwards, net
2
 
$
(7
)
 
$
(5
)
Interest Rate Swaps, net
2
 
19


24

Other Investments
1
 
19

 
17

Total
 
 
$
31

 
$
36


The fair value of the Company’s foreign currency forwards and interest rate swaps were determined based on the present value of expected future cash flows considering the risks involved, including nonperformance risk, and using discount rates appropriate for the duration based upon observable inputs.   The other investments include investments in mutual funds, which are used to offset fluctuations in deferred compensation liabilities where employees have chosen to invest in phantom shares of a Stock Index Fund or Bond Index Fund.  The other investments are classified as trading securities within Other assets on our Condensed Consolidated Balance Sheets and their fair value was determined based on the closing market prices of the respective mutual funds as of September 7, 2013 and December 29, 2012.

Non-Recurring Fair Value Measurements

(Gains) losses recognized from all non-recurring fair value measurements during the quarters and years to date ended September 7, 2013 and September 8, 2012:

18



 
 
Quarter ended
 
 
 
September 7, 2013
 
September 8, 2012
 
Refranchising related impairment - other (Level 3)(b)
 
$

 
$
4

 
Little Sheep impairment (Level 3)(a)
 
295

 

 
Total
 
$
295

 
$
4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year to date
 
 
 
September 7, 2013
 
September 8, 2012
 
Restaurant-level impairment (Level 3)(c)
 
$
5

 
$
6

 
Refranchising related impairment - Pizza Hut UK (Level 2)(a)(b)
 

 
20

 
Refranchising related impairment - other (Level 3)(b)
 

 
4

 
Little Sheep impairment (Level 3)(a)
 
295

 

 
Little Sheep acquisition gain (Level 2)(a)
 

 
(74
)
 
Total
 
$
300

 
$
(44
)
 
 
 
 
 
 
 
(a)
See the Little Sheep Acquisition and Impairment section as well as the Refranchising (Gain) Loss section of Note 4 for further discussion.

(b)
Refranchising related impairment results from writing down the assets of restaurants or restaurant groups offered for refranchising, including certain instances where a decision has been made to refranchise restaurants that are deemed to be impaired. The fair value measurements used in our impairment evaluations were based on estimates of the sales prices we anticipated receiving from a buyer for the restaurant or restaurant groups (Level 3) or actual bids received from potential buyers (Level 2).

(c)
Restaurant-level impairment charges are recorded in Closures and impairment (income) expenses and resulted from our semi-annual impairment evaluation of long-lived assets of individual restaurants that were being operated at the time of impairment and had not been offered for refranchising. The fair value measurements used in these impairment evaluations were based on discounted cash flow estimates using unobservable inputs (Level 3). The remaining net book value of these assets measured at fair value as of September 7, 2013 and September 8, 2012 subsequent to these impairments was not significant.


Note 13 - Guarantees, Commitments and Contingencies

Lease Guarantees

As a result of (a) assigning our interest in obligations under real estate leases as a condition to the refranchising of certain Company restaurants; (b) contributing certain Company restaurants to unconsolidated affiliates; and (c) guaranteeing certain other leases, we are frequently contingently liable on lease agreements.  These leases have varying terms, the latest of which expires in 2066.  As of September 7, 2013, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessees was approximately $750 million.  The present value of these potential payments discounted at our pre-tax cost of debt at September 7, 2013 was approximately $650 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 at September 7, 2013 was not material.

Franchise Loan Pool and Equipment Guarantees

We have agreed to provide financial support, if required, to a variable interest entity that operates a franchisee lending program used primarily to assist franchisees in the development of new restaurants in the U.S. and, to a lesser extent, in connection with the Company’s refranchising programs.  We have provided guarantees of $38 million in support of the franchisee loan program at September 7, 2013.  Loans outstanding under the loan pool totaled $47 million at September 7, 2013 with an additional $33 million available for lending at September 7, 2013. We have determined that we are not required to consolidate this entity as we share the power to direct this entity's lending activity with other parties.

19




In addition to the guarantee program described above, YUM has provided guarantees of $47 million on behalf of franchisees for several financing programs related to specific initiatives.  The total loans outstanding under these financing programs were approximately $55 million at September 7, 2013.

Insurance Programs

We are self-insured for a substantial portion of our current and prior years’ loss exposures including workers’ compensation, employment practices liability, general liability, automobile liability, product liability and property losses (collectively, “property and casualty losses”).  To mitigate the cost of our exposures for certain property and casualty losses, we self-insure the risks of loss up to defined maximum per occurrence retentions on a line-by-line basis.  The Company then purchases insurance coverage, up to a certain limit, for losses that exceed the self-insurance per occurrence retention.  The insurers’ maximum aggregate loss limits are significantly above our actuarially-determined probable losses; therefore, we believe the likelihood of losses exceeding the insurers’ maximum aggregate loss limits is remote.  As of September 7, 2013 and December 29, 2012, we had liabilities recorded for self-insured property and casualty losses of $135 million and $142 million, respectively.

In the U.S. and in certain other countries, we are also self-insured for certain healthcare and long-term disability claims for eligible participating employees subject to certain deductibles and limitations.  We have accounted for our retained liabilities for property and casualty losses, healthcare and long-term disability claims, including both reported and incurred but not reported claims, based on information provided by independent actuaries.

Due to the inherent volatility of actuarially-determined property and casualty loss estimates, it is reasonably possible that we could experience changes in estimated losses which could be material to our growth in quarterly and annual Net Income - YUM! Brands, Inc.  We believe that we have recorded reserves for property and casualty losses at a level which has substantially mitigated the potential negative impact of adverse developments and/or volatility.

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.

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. 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.


20



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. A reasonable estimate of the amount of any possible loss or range of loss cannot be made at this time.

On February 8, 2013, Jennifer Zona, another purported shareholder of the Company, filed a putative derivative action in the U.S. District Court for the Central District of California against certain officers and directors of the Company asserting breaches of fiduciary duty in connection with an alleged scheme to mislead investors about the Company's growth prospects in China.  The shareholder plaintiff did not first submit a demand on the Board of Directors of the Company to bring this action as required under North Carolina law, and on February 13, 2013, the shareholder plaintiff requested voluntary dismissal of the complaint.  The case has been designated as “closed” on the court's docket.  Ms. Zona subsequently submitted a demand letter on February 14, 2013 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. 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.

On May 19, 2009 the court granted Taco Bell's motion to consolidate these matters, 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 District Court rejected three of the proposed classes but granted certification with respect to the late meal break class.

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.

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 (PAGA).

Taco Bell moved to dismiss or stay the action in light of the In Re Taco Bell Wage and Hour Actions case. A hearing on that motion was held on September 27, 2013, and the court subsequently requested additional briefing from both parties.

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.

On December 17, 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. On August 4, 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 approximately 200 Company-owned restaurants in California accessible to the class. Plaintiffs contend 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 do not comply with the U.S. Americans with Disabilities Act

21



(the “ADA”), the Unruh Civil Rights Act (the “Unruh Act”), and the California Disabled Persons Act (the “CDPA”). Plaintiffs have requested: (a) an injunction from the District Court ordering Taco Bell to comply with the ADA and its implementing regulations; (b) that the District 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, are seeking 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 contend that there may be in excess of 100,000 individuals in the class. In February 2004, the District 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 seeking 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.

On December 16, 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. The trial for the exemplar restaurant began on June 6, 2011, and on October 5, 2011 the court issued Findings of Fact and Conclusions of Law 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, however, citing the pendency of Taco Bell's motions to decertify both the injunctive and damages class. 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. On September 13, 2012, the court set a discovery and briefing schedule concerning the trials of the four individual plaintiffs' state law damages claims, which the court stated will be tried before holding further proceedings regarding the possible issuance of an injunction. On September 17, 2012, the court 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.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit. Taco Bell has taken steps to address potential architectural and structural compliance issues at the restaurants in accordance with applicable state and federal disability access laws. The costs associated with addressing these issues have not significantly impacted our results of operations. 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 July 9, 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. On January 4, 2010, plaintiffs filed a motion for conditional certification of a nationwide class of current and former Pizza Hut, Inc. delivery drivers. However, on March 11, 2010, the court granted Pizza Hut's pending motion to dismiss for failure to state a claim, with leave to amend. On March 31, 2010, plaintiffs 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. On August 9, 2010, the court granted plaintiffs' motion to amend. Pizza Hut filed another motion to dismiss the Second Amended Complaint. On July 15, 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 on August 31, 2011, and the Court granted plaintiffs' motion April 21, 2012. The opt-in period closed on August 23, 2012, and approximately 6,000 individuals opted in.

Pizza Hut 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.


22



On August 6, 2010, a putative class action styled Jacquelyn Whittington v. Yum Brands, Inc., Taco Bell of America, Inc. and Taco Bell Corp. was filed in the U.S. District Court for the District of Colorado. The plaintiff seeks to represent a nationwide class, with the exception of California, of salaried assistant managers who were allegedly misclassified and did not receive compensation for all hours worked and did not receive overtime pay after 40 hours worked in a week. The Company has been dismissed from the case without prejudice. Taco Bell filed its answer on September 20, 2010, and the parties commenced class discovery. On September 16, 2011, plaintiffs filed their motion for conditional certification under the FLSA. The court heard plaintiffs' motion for conditional certification under the FLSA on January 10, 2012, granted conditional certification and ordered the notice of the opt-in class be sent to the putative class members. Approximately 488 individuals submitted opt-in forms. On June 14, 2013, the parties agreed to settle this matter. The parties have submitted the settlement to the court for approval. The costs associated with the settlement were not material.




23



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

Introduction and Overview

The following Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with the 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 29, 2012 (“2012 Form 10-K”).  Throughout the MD&A, YUM! Brands, Inc. (“YUM” or the “Company”) makes reference to certain performance measures as described below.

The Company provides the percentage changes excluding the impact of foreign currency translation (“FX” or “Forex”).  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 generate ongoing franchise and license fees for the Company (typically at a rate of 4% to 6% of 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 development.
Same-store sales is the estimated growth in system sales of all restaurants that have been open and in the YUM system one year or more.
Company restaurant profit is defined as Company sales less expenses incurred directly by our Company restaurants in generating Company sales.  Company restaurant margin as a percentage of sales is defined as Company restaurant profit divided by Company sales.
Operating margin is defined as Operating Profit divided by Total revenues.

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.

Description of Business

YUM has nearly 40,000 restaurants in more than 130 countries and territories operating primarily under the KFC, Pizza Hut or Taco Bell brands.  The Company’s primary restaurant brands – KFC, Pizza Hut and Taco Bell – are the global leaders in the quick-service chicken, pizza and Mexican-style food categories, respectively.  Of the nearly 40,000 restaurants, 75% are operated by franchisees and unconsolidated affiliates, 20% are operated by the Company and 5% are operated by licensees.

YUM’s business consists of four reporting segments:  YUM China (“China” or “China Division”), YUM Restaurants International (“YRI” or “International Division”), United States (“U.S.” or "U.S. Division") and YUM Restaurants India ("India" or "India Division").  The China Division includes mainland China and the India Division includes India, Bangladesh, Mauritius, Nepal and Sri Lanka. YRI includes the remainder of our international operations.  The China Division, YRI and Taco Bell-U.S. now represent approximately 85% of the Company’s segment operating profits.  


24



Strategies

The Company continues to focus on four key strategies:

Build Leading Brands in China in Every Significant Category – The Company has developed the KFC and Pizza Hut brands into the leading quick service and casual dining restaurant brands, respectively, in mainland China.  Additionally, the Company owns and operates 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 1.3 billion in mainland China, the Company is rapidly adding KFC and Pizza Hut Casual Dining restaurants and testing the additional restaurant concepts of Pizza Hut Home Service (pizza delivery) and East Dawning (Chinese food).  Additionally, on February 1, 2012 we acquired an additional 66% interest in Little Sheep Group Ltd. ("Little Sheep"), a leading casual dining concept in China. This acquisition brought our total ownership to approximately 93% of the business. Our ongoing earnings growth model in China includes double-digit percentage unit growth, mid-teen system sales growth, mid-single digit same-store sales growth and moderate leverage of our General and Administrative (“G&A”) infrastructure, which we expect to drive Operating Profit growth of 15%.

Drive Aggressive International Expansion and Build Strong Brands Everywhere – Outside the U.S. and China the Company and its franchisees opened over 1,000 new restaurants in 2012, representing 13 straight years of opening over 700 restaurants, and the Company is one of the leading international retail developers in terms of units opened.  The Company expects to continue to experience strong growth by building out existing markets and growing in new markets including India, France, Germany, Russia and across Africa.  As of the year ended 2012, the International Division’s Operating Profit has experienced a 10-year compound annual growth rate of 12%.  Our ongoing earnings growth model for YRI includes Operating Profit growth of 10% driven by 3-4% unit growth, system sales growth of 6%, at least 2-3% same-store sales growth, margin improvement and leverage of our G&A infrastructure.

Dramatically Improve U.S. Brand Positions, Consistency and Returns – The Company continues to focus on improving its U.S. position through differentiated products and marketing and an improved customer experience.  The Company also strives to provide industry-leading new product innovation which adds sales layers and expands day parts.  We continue to evaluate our returns and ownership positions with an earn-the-right-to-own philosophy on Company-owned restaurants.  Our ongoing earnings growth model for the U.S. calls for Operating Profit growth of 5% driven by same-store sales growth of at least 2%, margin improvement and leverage of our G&A infrastructure.  

Drive Industry-Leading, Long-Term Shareholder and Franchisee Value – The Company is focused on delivering high returns and returning substantial cash flows to its shareholders through dividends and share repurchases.  The Company has one of the highest returns on invested capital in the QSR industry.  The Company’s dividend and share repurchase programs have returned over $3.1 billion and $8.2 billion to shareholders, respectively, since 2004.  The Company targets an annual dividend payout ratio of 35% to 40% of net income and has increased the quarterly dividend at a double-digit percentage rate each year since first initiating a dividend in 2004.  Shares are repurchased opportunistically as part of our regular capital structure decisions.

The ongoing earnings growth rates referenced above represent our average annual targets for the next several years. Consistent with these ongoing earnings growth rates, in December 2012 we indicated our expectation of at least 10% EPS growth for 2013. Due to negative publicity surrounding the December 2012 poultry supply incident, we subsequently lowered our 2013 full year expectations in February 2013, at which time we estimated that EPS, excluding Special Items, would decline by a mid-single digit percentage. In October 2013, as a result of a higher than expected full year tax rate and lower than expected China sales, the Company now estimates a high-single to low-double-digit full-year decline in EPS before Special Items. See the Internal Revenue Service Proposed Adjustment and China Poultry Supply Incident and Avian Flu sections within the Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact Comparisons of Reported or Future Results section of this MD&A for further discussion.


25



Quarter Ended September 7, 2013 Highlights

Worldwide system sales grew 1%, prior to foreign currency translation, including 5% growth at YRI. System sales declined 2% in China and were flat in the U.S.
 
 
 
Same-store sales declined 11% in China. Same-store sales grew 1% at YRI and were flat in the U.S.
 
 
Total international development was 364 new restaurants; 79% of this development occurred in emerging markets.
 
 
Worldwide restaurant margin declined 1.3 percentage points to 17.6%, including declines of 1.9 percentage points in China, 0.6 percentage points at YRI and 0.7 percentage points in the U.S.
 
 
Worldwide operating profit declined 9%, prior to foreign currency translation, including declines of 14% in China and 2% at YRI. Operating profit grew 1% in the U.S.
 
 
Worldwide effective tax rate, prior to Special Items, increased to 33.1% from 25.1% due to a tax reserve adjustment. The tax rate increase negatively impacted EPS results by 10 percentage points.
 
 
A non-cash, Special Item net charge of $258 million related to the impairment of Little Sheep intangible assets was recorded in the quarter. This charge impacted reported EPS by 55 percentage points.
 
 
 
On September 19, 2013, the Company announced a 10% increase in its quarterly dividend, marking the ninth consecutive year the dividend increased at a double-digit percentage rate.

All preceding comparisons are versus the same period a year ago and exclude the impact of Special Items.  See the Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact Comparisons of Reported or Future Results section of this MD&A for a description of Special Items.

Results of Operations

 
Quarter ended
 
 
 
 
Year to date
 
 
 
 
9/7/2013
 
9/8/2012
 
% B/(W)
 
9/7/2013
 
9/8/2012
 
% B/(W)
Company sales
$
3,021

 
$
3,142

 
(4
)

 
$
7,594

 
$
8,248

 
(8
)
 
Franchise and license fees and income
445


427

 
4

 
 
1,311


1,232

 
6

 
Total revenues
$
3,466


$
3,569

 
(3
)
 
 
$
8,905


$
9,480

 
(6
)
 
Company restaurant profit
$
531

 
$
599

 
(11
)
 
 
$
1,174

 
$
1,462

 
(20
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
% of Company sales
17.6
%
 
19.1
%
 
(1.5
)
ppts.
 
15.5
%
 
17.7
%
 
(2.2
)
ppts.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Profit
$
350


$
671

 
(48
)
 
 
$
1,227


$
1,789

 
(31
)
 
Interest expense, net
31


32

 
8

 
 
94


107

 
13

 
Income tax provision
182


161

 
(14
)
 
 
384


410

 
6
 
Net Income – including noncontrolling interests
$
137


$
478

 
(71
)
 
 
$
749


$
1,272

 
(41
)
 
Net Income (loss) – noncontrolling interests
(15
)

7

 
NM

 
 
(21
)

12

 
NM

 
Net Income – YUM! Brands, Inc.
$
152


$
471

 
(68
)
 
 
$
770


$
1,260

 
(39
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share (a)
$
0.33


$
1.00

 
(67
)
 
 
$
1.66


$
2.65

 
(37
)
 

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

Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact Comparisons of Reported or Future Results

The following factors impacted comparability of operating performance for the quarters and/or years to date ended September 7, 2013 and September 8, 2012 and/or could impact comparability with the remainder of our results in 2013 or beyond.  Certain of these factors were previously discussed in our 2012 Form 10-K.


26



Special Items

In addition to the results provided in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") throughout this document, the Company has provided non-GAAP measurements which present operating results in 2013 and 2012 on a basis before Special Items.  Included in Special Items are charges associated with the impairment of certain Little Sheep assets in 2013, the gain upon the acquisition of Little Sheep in 2012, U.S. refranchising gain (loss), losses associated with the refranchising of the Pizza Hut UK dine-in business and charges relating to U.S. General and Administrative ("G&A") productivity initiatives and realignment of resources. Other Special Items Income (Expense) in 2013 includes a retirement plan settlement charge related to the continuation of a program that began in the fourth quarter of 2012 to pay out certain deferred vested balances. Other Special Items Income (Expense) in 2012 includes the depreciation reductions from Pizza Hut UK and KFC U.S. restaurants impaired upon our decision or offer to refranchise that remained Company stores for some or all of the periods presented and gains from real estate sales related to our previously refranchised Mexico business.

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 items in the quarters and years to date ended September 7, 2013 and September 8, 2012 that the Company does not believe are indicative of our ongoing operations due to their size and/or nature. 


27



 
 
Quarter ended
 
Year to date
 
 
9/7/2013
 
9/8/2012
 
9/7/2013
 
9/8/2012
Detail of Special Items
 
 
 
 
 
 
 
 
U.S. Refranchising gain (loss)
 
$
37

 
$
(1
)
 
$
82

 
$
53

Little Sheep impairment
 
(295
)
 

 
(295
)
 

Gain upon acquisition of Little Sheep
 

 

 

 
74

Charges relating to U.S. G&A productivity initiatives and realignment of resources
 
(5
)
 

 
(5
)
 

Losses associated with refranchising the Pizza Hut UK dine-in business
 
(1
)
 
(1
)
 
(1
)
 
(24
)
Other Special Items Income (Expense)
 
(3
)
 
5

 
(3
)
 
15

Total Special Items Income (Expense)
 
(267
)
 
3

 
(222
)
 
118

Tax Benefit (Expense) on Special Items(a)
 
12

 

 
(3
)
 
(9
)
Special Items Income (Expense), net of tax - including noncontrolling interests
 
(255
)
 
3

 
(225
)
 
109

Special Items Income (Expense), net of tax - noncontrolling interests
 
19

 

 
19

 

Special Items Income (Expense), net of tax - Yum Brands, Inc.
 
$
(236
)
 
$
3

 
$
(206
)
 
$
109

Average diluted shares outstanding
 
461

 
472

 
463

 
476

Special Items diluted EPS
 
$
(0.52
)
 
$
0.01

 
$
(0.45
)
 
$
0.23

 
 
 
 
 
 
 
 
 
Reconciliation of Operating Profit Before Special Items to Reported Operating Profit
 
 
 
 
 
 
 
 
Operating Profit before Special Items
 
$
617

 
$
668

 
$
1,449

 
$
1,671

Special Items Income (Expense)
 
(267
)
 
3

 
(222
)
 
118

Reported Operating Profit
 
$
350


$
671


$
1,227


$
1,789

 
 
 
 
 
 
 
 
 
Reconciliation of EPS Before Special Items to Reported EPS
 
 
 
 
 
 
 
 
Diluted EPS before Special Items
 
$
0.85

 
$
0.99

 
$
2.11

 
$
2.42

Special Items EPS
 
(0.52
)
 
0.01

 
(0.45
)
 
0.23

Reported EPS
 
$
0.33


$
1.00


$
1.66


$
2.65

 
 
 
 
 
 
 
 
 
Reconciliation of Effective Tax Rate Before Special Items to Reported Effective Tax Rate
 
 
 
 
 
 
 
 
Effective Tax Rate before Special Items
 
33.1
%
 
25.1
%
 
28.2
%
 
25.6
 %
Impact on Tax Rate as a result of Special Items(a)
 
24.1
%
 
%
 
5.7
%
 
(1.2
)%
Reported Effective Tax Rate
 
57.2
%

25.1
%

33.9
%

24.4
 %

(a)
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.


28



U.S. Refranchising Gain (Loss)

In the quarter ended September 7, 2013, we recorded net pre-tax refranchising gains of $37 million in the U.S., primarily related to Taco Bell. In the years to date ended September 7, 2013 and September 8, 2012, we recorded net pre-tax refranchising gains of $82 million and $53 million, respectively, in the U.S., primarily related to Taco Bell. Refranchising activity is more fully discussed in the Refranchising (Gain) Loss section of Note 4 and the Store Portfolio Strategy section of this MD&A.

Little Sheep Acquisition and Impairment

On February 1, 2012 we acquired an additional 66% interest in Little Sheep Group Limited (“Little Sheep”) for $540 million, net of cash acquired of $44 million, increasing our ownership to 93%.  The acquisition was driven by our strategy to build leading brands across China in every significant category.  Prior to our acquisition of this additional interest, our 27% interest in Little Sheep was accounted for under the equity method of accounting.  As a result of the acquisition we obtained voting control of Little Sheep, and thus we began consolidating Little Sheep upon acquisition.  As required by GAAP, we remeasured our previously held 27% ownership in Little Sheep, which had a recorded value of $107 million at the date of acquisition, at fair value based on Little Sheep's traded share price immediately prior to our offer to purchase the business and recognized a non-cash gain of $74 million.  This gain, which resulted in no related income tax expense, was recorded in Other (income) expense on our Condensed Consolidated Statement of Income during the quarter ended March 24, 2012 and was not allocated to any segment for performance reporting purposes.

The purchase price paid for the additional