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EX-31.1 - CEO CERTIFICATION EX31.1 - YUM BRANDS INCexhib31_1.htm
EX-32.1 - CEO CERTIFICATION EX32.1 - YUM BRANDS INCexhib32_1.htm
EX-32.2 - CFO CERTIFICATION EX32.2 - YUM BRANDS INCexhib32_2.htm
EX-31.2 - CFO CERTIFICATION EX31.2 - YUM BRANDS INCexhib31_2.htm
EXCEL - IDEA: XBRL DOCUMENT - YUM BRANDS INCFinancial_Report.xls
EX-15 - INDEPENDENT ACCOUNTANTS ACKNOWLEDGMENT EX15 - YUM BRANDS INCexhib15.htm

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

FORM 10-Q

(Mark One)
[ü]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
 EXCHANGE ACT OF 1934 for the quarterly period ended September 5, 2009
 
 
 
 
 
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 [Ö]  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 [Ö] 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:  [Ö] 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 [Ö]
 
 
The number of shares outstanding of the Registrant’s Common Stock as of October 5, 2009 was 467,702,275 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 5, 2009 and September 6, 2008
3
 
 
 
 
   
 
 
 
 
Condensed Consolidated Statements of Cash Flows – Years to date ended
      September 5, 2009 and September 6, 2008
4
 
 
 
 
   
 
 
 
 
Condensed Consolidated Balance Sheets – September 5, 2009
   and December 27, 2008
5
 
 
 
 
 
 
 
 
 
 
Notes to Condensed Consolidated Financial Statements
6
 
 
 
 
   
 
 
Item 2 - Management’s Discussion and Analysis of Financial Condition
and Results of Operations
26
 
 
 
 
   
 
 
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
47
 
 
 
 
   
 
 
Item 4 - Controls and Procedures
47
 
 
 
 
   
 
 
Report of Independent Registered Public Accounting Firm
49
 
 
 
 
   
 
Part II.
Other Information and Signatures
   
 
 
 
   
 
 
Item 1 – Legal Proceedings
50
 
 
 
 
 
 
 
 
 
Item 1A – Risk Factors
50
 
 
 
 
 
 
 
 
 
Item 6 – Exhibits
51
 
 
 
 
 
 
 
 
 
Signatures
52
 







 
 

 

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
   
Year to date
Revenues
 
9/5/09
   
9/6/08
   
9/5/09
   
9/6/08
Company sales
 
$
2,432
     
$
2,482
     
$
6,502
     
$
6,899
 
Franchise and license fees and income
   
346
       
360
       
969
       
1,015
 
Total revenues
   
2,778
       
2,842
       
7,471
       
7,914
 
                                       
Costs and Expenses, Net
                                     
Company restaurants
                                     
Food and paper
   
777
       
830
       
2,081
       
2,265
 
Payroll and employee benefits
   
523
       
575
       
1,485
       
1,682
 
Occupancy and other operating expenses
   
707
       
719
       
1,879
       
1,975
 
Company restaurant expenses
   
2,007
       
2,124
       
5,445
       
5,922
 
General and administrative expenses
   
276
       
305
       
812
       
898
 
Franchise and license expenses
   
29
       
25
       
74
       
63
 
Closures and impairment (income) expenses
   
5
       
3
       
31
       
9
 
Refranchising (gain) loss
   
4
       
(8
)
     
(9
)
     
16
 
Other (income) expense
   
(13
)
     
(18
)
     
(97
)
     
(148
)
Total costs and expenses, net
   
2,308
       
2,431
       
6,256
       
6,760
 
Operating Profit
   
470
       
411
       
1,215
       
1,154
 
Interest expense, net
   
42
       
47
       
138
       
152
 
Income Before Income Taxes
   
428
       
364
       
1,077
       
1,002
 
Income tax provision
   
88
       
79
       
212
       
236
 
Net Income – including noncontrolling interest
   
340
       
285
       
865
       
766
 
Net Income – noncontrolling interest
   
6
       
3
       
10
       
6
 
Net Income – YUM! Brands, Inc.
 
$
334
     
$
282
     
$
855
     
$
760
 
                                       
Basic Earnings Per Common Share
 
$
0.71
     
$
0.60
     
$
1.82
     
$
1.59
 
                                       
Diluted Earnings Per Common Share
 
$
0.69
     
$
0.58
     
$
1.77
     
$
1.53
 
                                       
Dividends Declared Per Common Share
 
$
     
$
     
$
0.38
     
$
0.34
 
                                       
See accompanying Notes to Condensed Consolidated Financial Statements.



 
3

 

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
(in millions)
   
Year to date
   
9/5/09
   
9/6/08
Cash Flows – Operating Activities
                 
Net Income – including noncontrolling interest
 
$
865
     
$
766
 
Depreciation and amortization
   
385
       
389
 
Closures and impairment (income) expenses
   
31
       
9
 
Refranchising (gain) loss
   
(9
)
     
16
 
Contributions to defined benefit pension plans
   
(96
)
     
(7
)
Gain upon consolidation of a former unconsolidated affiliate in China
   
(68
)
     
 
Gain on sale of interest in Japan unconsolidated affiliate
   
       
(100
)
Deferred income taxes
   
59
       
(13
)
Equity income from investments in unconsolidated affiliates
   
(29
)
     
(33
)
Distributions of income received from unconsolidated affiliates
   
29
       
40
 
Excess tax benefits from share-based compensation
   
(48
)
     
(32
)
Share-based compensation expense
   
39
       
44
 
Changes in accounts and notes receivable
   
1
       
(18
)
Changes in inventories
   
34
       
(16
)
Changes in prepaid expenses and other current assets
   
(26
)
     
(27
)
Changes in accounts payable and other current liabilities
   
2
       
23
 
Changes in income taxes payable
   
(87
)
     
24
 
Other non-cash charges and credits, net
   
53
       
82
 
Net Cash Provided by Operating Activities
   
1,135
       
1,147
 
                   
Cash Flows – Investing Activities
                 
Capital spending
   
(505
)
     
(583
)
Proceeds from refranchising of restaurants
   
91
       
142
 
Acquisition of restaurants from franchisees
   
(24
)
     
(9
)
Acquisitions and investments
   
(75
)
     
 
Sales of property, plant and equipment
   
16
       
58
 
Other, net
   
(8
)
     
(8
)
Net Cash Used in Investing Activities
   
(505
)
     
(400
)
                   
Cash Flows – Financing Activities
                 
Proceeds from long-term debt
   
499
       
375
 
Repayments of long-term debt
   
(522
)
     
(260
)
Revolving credit facilities, three months or less, net
   
(289
)
     
305
 
Short-term borrowings by original maturity
                 
   More than three months - proceeds
   
       
 
   More than three months - payments
   
       
 
   Three months or less, net
   
5
       
(15
)
Repurchase shares of Common Stock
   
       
(1,513
)
Excess tax benefits from share-based compensation
   
48
       
32
 
Employee stock option proceeds
   
91
       
51
 
Dividends paid on Common Stock
   
(263
)
     
(234
)
Other, net
   
(8
)
     
 
Net Cash Used in Financing Activities
   
(439
)
     
(1,259
)
Effect of Exchange Rates on Cash and Cash Equivalents
   
       
 
Net Increase (Decrease) in Cash and Cash Equivalents
   
191
       
(512
)
Change in Cash and Cash Equivalents due to consolidation of entities in China
   
17
       
17
 
Cash and Cash Equivalents - Beginning of Period
   
216
       
789
 
Cash and Cash Equivalents - End of Period
 
$
424
     
$
294
 
                   
See accompanying Notes to Condensed Consolidated Financial Statements.
                 

 
4

 


 
CONDENSED CONSOLIDATED BALANCE SHEETS
YUM! BRANDS, INC. AND SUBSIDIARIES
(in millions)
   
(Unaudited)
     
   
9/5/09
   
12/27/08
ASSETS
                 
Current Assets
                 
Cash and cash equivalents
 
$
424
     
$
216
 
Accounts and notes receivable, net
   
241
       
229
 
Inventories
   
116
       
143
 
Prepaid expenses and other current assets
   
287
       
172
 
Deferred income taxes
   
54
       
81
 
Advertising cooperative assets, restricted
   
84
       
110
 
Total Current Assets
   
1,206
       
951
 
                   
Property, plant and equipment, net
   
3,844
       
3,710
 
Goodwill
   
686
       
605
 
Intangible assets, net
   
447
       
335
 
Investments in unconsolidated affiliates
   
98
       
65
 
Other assets
   
549
       
561
 
Deferred income taxes
   
291
       
300
 
Total Assets
 
$
7,121
     
$
6,527
 
                   
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
                 
Current Liabilities
                 
Accounts payable and other current liabilities
 
$
1,388
     
$
1,473
 
Income taxes payable
   
27
       
114
 
Short-term borrowings
   
35
       
25
 
Advertising cooperative liabilities
   
84
       
110
 
Total Current Liabilities
   
1,534
       
1,722
 
                   
Long-term debt
   
3,258
       
3,564
 
Other liabilities and deferred credits
   
1,340
       
1,335
 
Total Liabilities
   
6,132
       
6,621
 
                   
Shareholders’ Equity (Deficit)
                 
Common Stock, no par value, 750 shares authorized; 468 shares and 459 shares
issued in 2009 and 2008, respectively
   
202
       
7
 
Retained earnings
   
979
       
303
 
Accumulated other comprehensive income (loss)
   
(279
)
     
(418
)
Total Shareholders’ Equity (Deficit) – YUM! Brands, Inc.
   
902
       
(108
)
Noncontrolling interest
   
87
       
14
 
Total Shareholders’ Equity (Deficit)
   
989
       
(94
)
Total Liabilities and Shareholders’ Equity (Deficit)
 
$
7,121
     
$
6,527
 
                   
See accompanying Notes to Condensed Consolidated Financial Statements.
                 

 
5

 

(Tabular amounts in millions, except per share data)


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 United States (“U.S.”) generally accepted accounting principles for complete financial statements.  Therefore, we suggest that the accompanying Financial Statements be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our annual report on Form 10-K for the fiscal year ended December 27, 2008 (“2008 Form 10-K”).  Except as disclosed herein, there has been no material change in the information disclosed in the Notes to our Consolidated Financial Statements included in the 2008 Form 10-K.

YUM! Brands, Inc. and Subsidiaries (collectively referred to as “YUM” or the “Company”) comprise the worldwide operations of KFC, Pizza Hut, Taco Bell, Long John Silver’s (“LJS”) and A&W All-American Food Restaurants (“A&W”) (collectively the “Concepts”).  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 three reporting segments:  United States, YUM Restaurants International (“YRI” or “International Division”) and YUM Restaurants China (“China Division”).  The China Division includes mainland China (“China”), Thailand, and KFC Taiwan, and 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 certain 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.  All of our international businesses except China close one period or one month earlier to facilitate consolidated reporting.

In 2008, we began consolidating an entity in which we have a majority ownership interest and that operates the KFCs in Beijing, China.  Additionally, as discussed in Note 4, in the quarter ended June 13, 2009 we began consolidating the entity that operates the KFCs in Shanghai, China.  The increases in cash related to the consolidation of these entities’ cash balances ($17 million in both instances) are presented as a single line item on our Condensed Consolidated Statement of Cash Flows.

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

In our opinion, the accompanying Financial Statements include all normal and recurring adjustments considered necessary to present fairly, when read in conjunction with our 2008 Form 10-K, our financial position as of September 5, 2009, and the results of our operations for the quarters and years to date ended September 5, 2009 and September 6, 2008 and cash flows for the years to date ended September 5, 2009 and September 6, 2008.  Our results of operations 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.  Our quarter and year to date tax rates for both 2009 and 2008 are lower than the expected U.S. federal statutory rate of 35% primarily due to the majority of our income being earned outside of the U.S. where tax rates are generally lower than the U.S. rate. 

 
6

 



We have reclassified certain items in the accompanying Financial Statements and Notes to the Financial Statements for the prior periods in order to be comparable with the current classifications.  As discussed in our 2008 Form 10-K, we have begun reporting capital spending on our Condensed Consolidated Statements of Cash Flows excluding the impact of purchases that have been accrued but not yet paid.  For the year to date ended September 6, 2008 this resulted in increased Capital spending of $12 million with an offsetting impact to Changes in accounts payable and other current liabilities.  Also, as rental income from franchisees has increased over time and is anticipated to continue to increase, we believe it is more appropriate to report such income as Franchise and license fees and income as opposed to a reduction in Franchise and license expenses, as it has historically been reported.  For the quarter and year to date ended September 6, 2008 this resulted in an increase of $7 million and $18 million, respectively, in both Franchise and license expenses and Franchise and license fees and income in our Condensed Consolidated Statement of Income.  A similar amount of rental income was reported in Franchise and license fees and income in the quarter and year to date ended September 5, 2009.  These reclassifications had no effect on previously reported Net Income.


   
Quarter ended
   
Year to date
   
9/5/09
     
9/6/08
     
9/5/09
     
9/6/08
 
Net Income – YUM! Brands, Inc.
 
$
334
     
$
282
     
$
855
     
$
760
 
                                       
Weighted-average common shares outstanding (for basic calculation)
   
472
       
470
       
469
       
479
 
Effect of dilutive share-based employee compensation
   
13
       
17
       
13
       
17
 
Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)
   
485
       
487
       
482
       
496
 
Basic EPS
 
$
0.71
     
$
0.60
     
$
1.82
     
$
1.59
 
Diluted EPS
 
$
0.69
     
$
0.58
     
$
1.77
     
$
1.53
 
Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a)
   
12.3
       
6.5
       
13.8
       
5.8
 

(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 year to date ended September 6, 2008, as indicated below.  All amounts exclude applicable transaction fees.  We had no share repurchases in the year to date ended September 5, 2009.

 
 
 
Shares Repurchased
(thousands)
 
Dollar Value of Shares Repurchased
Authorization Date
 
 
2009
 
 
2008
 
 
2009
 
 
2008
 
January 2008
 
 
 
 
 
 
19,584
 
 
$
 
 
$
687
 
October 2007
 
 
 
 
 
 
22,875
 
 
 
 
 
 
813
 
Total
 
 
 
 
 
 
42,459
 
 
$
 
 
$
1,500
(a)

(a)
Amount excludes the effect of $13 million in share repurchases (0.4 million shares) with trade dates prior to the 2007 fiscal year end but cash settlement dates subsequent to the 2007 fiscal year end.

On September 30, 2009, our Board of Directors authorized share repurchases through September 30, 2010 of up to $300 million (excluding applicable transaction fees) of our outstanding Common Stock.

 
7

 



Comprehensive income was as follows:
   
Quarter ended
 
Year to date
   
9/5/09
 
9/6/08
 
9/5/09
   
9/6/08
Net Income – YUM! Brands, Inc.
 
$
334
   
$
282
   
$
855
     
$
760
 
Foreign currency translation adjustment arising during the period
   
61
     
(18
)
   
126
       
10
 
Foreign currency translation adjustment included in Net Income
   
     
     
       
(25
)
Changes in fair value of derivatives, net of tax
   
(15
)
   
2
     
(10
)
     
12
 
Reclassification of derivative (gains) losses to Net Income, net of tax
   
12
     
(4
)
   
15
       
(13
)
Reclassification of pension actuarial losses to Net Income, net of tax
   
3
     
1
     
8
       
4
 
Total comprehensive income
 
$
395
   
$
263
   
$
994
     
$
748
 

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

U.S. Business Transformation

As part of our plan to transform our U.S. business we took several measures in 2008 and are taking similar measures in 2009 (“the U.S. business transformation measures”).  These measures include: expansion of our U.S. refranchising; charges relating to General and Administrative (“G&A”) productivity initiatives and realignment of resources (primarily severance and early retirement costs); and investments in our U.S. Brands made on behalf of our franchisees such as equipment purchases.

In the quarter and year to date ended September 5, 2009, we recorded pre-tax gains of $8 million and $23 million, respectively, from refranchising in the U.S.  In the quarter and year to date ended September 6, 2008, we recorded a pre-tax gain of $3 million and a pre-tax loss of $22 million, respectively, from refranchising in the U.S.  The refranchising losses recorded for the year to date ended September 6, 2008 were primarily due to our refranchising of stores or groups of stores, principally at Long John Silver’s, for prices less than their recorded carrying value.

In connection with our G&A productivity initiatives and realignment of resources we recorded no charges in the quarter ended September 5, 2009 and a pre-tax charge of $1 million in the quarter ended September 6, 2008, and pre-tax charges of $9 million and $8 million in the years to date ended September 5, 2009 and September 6, 2008, respectively.  The unpaid current liability for the severance portion of these charges was $8 million as of September 5, 2009.  Severance payments in the quarter and year to date ended September 5, 2009 totaled approximately $6 million and $22 million, respectively.

Additionally, the Company recognized a reduction to Franchise and license fees and income of $1 million and $32 million, pre-tax, in the quarter and year to date ended September 5, 2009, respectively, related to investments in our U.S. Brands.  These investments reflect our reimbursements to KFC franchisees for installation costs of ovens for the national launch of Kentucky Grilled Chicken.  This reduction to Franchise and license fees and income was recorded in accordance with Emerging Issues Task Force (“EITF”) Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”.  In the quarter and year to date ended September 6, 2008, the Company recognized pre-tax expense of $2 million and $5 million, respectively, related to investments in our U.S. Brands.

We are not including the impacts of these U.S. business transformation measures in our U.S. segment for performance reporting purposes as we do not believe they are indicative of our ongoing operations.

 
8

 



Acquisition of Interest in Little Sheep

On March 24, 2009, our China Division paid approximately $44 million to purchase 14% of the outstanding common shares of Little Sheep Group Limited (“Little Sheep”).  On June 2, 2009, we purchased an additional 6% of Little Sheep for $19 million and obtained Board of Directors representation.  Accordingly, in the quarter ended September 5, 2009 we began reporting our investment in Little Sheep using the equity method of accounting and this investment is now included in Investments in unconsolidated affiliates on our Condensed Consolidated Balance Sheet.  Equity income recognized from our investment in Little Sheep was not significant in the quarter ended September 5, 2009.

Little Sheep is the leading brand in China’s “Hot Pot” restaurant category with approximately 375 restaurants, primarily in China as well as Hong Kong, Japan, Canada and the U.S.

Consolidation of a Former Unconsolidated Affiliate in China

On May 4, 2009 we acquired an additional 7% ownership in the entity that operates more than 200 KFCs in Shanghai, China for $12 million, increasing our ownership to 58%.  The acquisition was driven by our desire to increase our management control over the entity and further integrate the business with the remainder of our KFC operations in China.  This entity has historically been accounted for as an unconsolidated affiliate under the equity method of accounting due to the effective participation of our partners in the significant decisions of the entity that were made in the ordinary course of business as addressed in EITF Issue No. 96-16, “Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights”.  Concurrent with the acquisition we received additional rights in the governance of the entity, and thus we began consolidating the entity upon acquisition.  As required by Statement of Financial Accounting Standards (“SFAS”) No. 141(R), “Business Combinations” (“SFAS 141R”), we remeasured our previously held 51% ownership in the entity, which had a recorded value of $17 million at the date of acquisition, at fair value and recognized a gain of $68 million accordingly.  This gain, which resulted in no related income tax expense, was recorded in Other (income) expense on our Condensed Consolidated Statements of Income during the quarter ended June 13, 2009 and was not allocated to any segment for performance reporting purposes.

Our preliminary estimate of the identifiable assets acquired and liabilities assumed upon acquisition for the consolidated entity is as follows:
 
 
Current assets, including cash of $17
$
27
 
Property, plant and equipment
 
61
 
Goodwill
 
60
 
Intangible assets
 
97
 
Other long-term assets
 
2
 
Total assets acquired
 
247
       
 
Current liabilities
 
55
 
Other long-term liabilities
 
25
 
Total liabilities assumed
 
80
 
Net assets acquired
$
167

Additionally, $70 million was recorded as Noncontrolling interest in our Condensed Consolidated Balance Sheet, representing the fair value of our partner’s interest in the entity’s net assets upon acquisition.  Intangible assets primarily comprise reacquired franchise rights which are being amortized over the franchise contract period of ten years.

Goodwill, which will be allocated to the China Division, is not expected to be deductible for income tax purposes.

 
9

 



Under the equity method of accounting, we previously reported our 51% share of the net income of the unconsolidated affiliate (after interest expense and income taxes) as Other (income) expense in the Condensed Consolidated Statements of Income.  We also recorded a franchise fee for the royalty received from the stores owned by the unconsolidated affiliate. From the date of the acquisition through August 31, 2009 (our China Division’s third quarter end), we reported the results of operations for the entity in the appropriate line items of our Condensed Consolidated Statement of Income.  We no longer recorded franchise fee income for these restaurants nor did we report Other (income) expense as we did under the equity method of accounting.  For the quarter and year to date ended September 5, 2009 the consolidation of this entity increased Company sales by $82 million and $105 million, respectively, and decreased Franchise and license fees and income by $5 million and $6 million, respectively.  The consolidation of this entity positively impacted Operating Profit by $4 million and $5 million for the quarter and year to date ended September 5, 2009, respectively.  The impact on Net Income – YUM! Brands, Inc. was not significant to either the quarter or the year to date ended September 5, 2009.

The pro forma impact on our results of operations if the acquisition had been completed as of the beginning of both 2009 and 2008 would not have been significant.

Cash Tender Offer to Purchase Senior Unsecured Notes

During the quarter ended June 13, 2009 we completed a cash tender offer to repurchase certain of our Senior Unsecured Notes due July 1, 2012 with an aggregate principal amount of $137 million.  In conjunction with this transaction, we settled interest rate swaps with a notional amount of $150 million that were hedging these Senior Unsecured Notes, receiving $14 million in cash.  The net impact of the repurchase of Senior Unsecured Notes and related interest rate swap settlement had no significant impact on Interest expense.

Issuance of Senior Unsecured Notes

On August 20, 2009, we issued $250 million aggregate principal amount of 4.25% Senior Unsecured Notes that are due on September 15, 2015 and $250 million aggregate principal amount of 5.30% Senior Unsecured Notes that are due on September 15, 2019 (together the “2009 Notes”).  We used a portion of the proceeds to repay our variable rate senior unsecured term loan with an aggregate principal amount of $375 million that was scheduled to mature in 2011 and the remainder of the proceeds will be used to make discretionary payments to our pension plans during the fourth quarter of 2009.

In the quarter ended September 5, 2009, in anticipation of issuing the Senior Unsecured Notes due in 2019, we entered into treasury locks with aggregate notional amounts of $188 million to hedge a portion of the interest rate risk attributable to changes in United States Treasury Rates.  As the treasury locks were designated and highly effective in offsetting the variability in cash flows associated with the future interest payments, a resulting $3 million loss from settlement of these instruments is being amortized over ten years as an increase in interest expense.

In connection with the issuance of the $250 million Senior Unsecured Notes due in 2015, we entered into pay-variable interest rate swaps with an aggregate notional amount of $150 million with the objective of reducing our exposure to interest rate risk and lowering interest expenses for a portion of our debt.  These swaps have been designated as fair value hedges of a portion of our fixed rate debt.

 
10

 



Facility Actions

Refranchising (gain) loss, Store closure (income) costs and Store impairment charges by reportable segment are as follows:

   
Quarter ended September 5, 2009
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Refranchising (gain) loss(a)
 
$
(8
)
   
$
2
     
$
10
     
$
4
 
                                       
Store closure (income) costs(b)
 
$
     
$
(1
)
   
$
     
$
(1
)
Store impairment charges
   
4
       
       
2
       
6
 
Closure and impairment (income) expenses
 
$
4
     
$
(1
)
   
$
2
     
$
5
 

   
Quarter ended September 6, 2008
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Refranchising (gain) loss(a)
 
$
(3
)
   
$
(5
)
   
$
     
$
(8
)
                                       
Store closure (income) costs(b)
 
$
2
     
$
(2
)
   
$
     
$
 
Store impairment charges
   
2
       
       
1
       
3
 
Closure and impairment (income) expenses
 
$
4
     
$
(2
)
   
$
1
     
$
3
 

   
Year to date ended September 5, 2009
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Refranchising (gain) loss(a)
 
$
(23
)
   
$
4
     
$
10
     
$
(9
)
                                       
Store closure (income) costs(b)
 
$
3
     
$
     
$
     
$
3
 
Store impairment charges
   
17
       
3
       
8
       
28
 
Closure and impairment (income) expenses
 
$
20
     
$
3
     
$
8
     
$
31
 


 
11

 



   
Year to date ended September 6, 2008
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Refranchising (gain) loss(a)
 
$
22
     
$
(5
)
   
$
(1
)
   
$
16
 
                                       
Store closure (income) costs(b)
 
$
(6
)
   
$
(5
)
   
$
(2
)
   
$
(13
)
Store impairment charges
   
15
       
2
       
5
       
22
 
Closure and impairment (income) expenses
 
$
9
     
$
(3
)
   
$
3
     
$
9
 

(a)
Refranchising (gain) loss is not allocated to segments for performance reporting purposes.
   
(b)
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.

Assets held for sale at September 5, 2009 and December 27, 2008 total $35 million and $31 million, respectively, of U.S. property, plant and equipment and are included in Prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.



 
12

 



In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 157-2, “Effective Date of FASB Statement No. 157” which permitted a one-year deferral for the implementation of SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) with regard to non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  We adopted SFAS 157 at the beginning of 2009 for such non-financial assets and liabilities, which, for the Company, primarily includes long-lived assets, goodwill and intangibles.  The fair values of such non-financial assets and liabilities measured at fair value during 2009 and remaining on our Condensed Consolidated Balance Sheet at September 5, 2009 are included in the required disclosures in Note 12.  The full adoption of SFAS 157 did not materially impact the measurement of these disclosed amounts.

In December 2007, the FASB issued SFAS 141R.  SFAS 141R, which is broader in scope than SFAS 141, applies to all transactions or other events in which an entity obtains control of one or more businesses, and requires that the acquisition method be used for such transactions or events.  SFAS 141R, with limited exceptions, will require an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date.  This will result in acquisition related costs and anticipated restructuring costs related to the acquisition being recognized separately from the business combination.  The Company adopted SFAS 141R on December 28, 2008.  Adoption of SFAS 141R did not significantly impact the accounting for the Company’s acquisitions of franchise restaurants in the quarter or year to date ended September 5, 2009.  SFAS 141R did require that our existing equity interest in the entity that operates the KFCs in Shanghai, China be remeasured at its fair value upon our acquisition of additional ownership in and consolidation of the entity (See Note 4).

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”).  SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and changed the accounting and reporting for noncontrolling interests, which are the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent.  SFAS 160 was effective for the quarter ended March 21, 2009 for the Company and requires retroactive adoption of its presentation and disclosure requirements.  SFAS 160 requires us to report net income attributable to the noncontrolling interests separately on the face of our Condensed Consolidated Statements of Income.  Additionally, SFAS 160 requires that the portion of equity in the entity not attributable to the Company be reported within equity, separately from the Company’s equity on the Condensed Consolidated Balance Sheets.

In 2008, the Company consolidated one entity for which a third party owned a noncontrolling interest.  This entity operates the KFCs in Beijing, China.  Prior to the adoption of SFAS 160, we reported Operating Profit attributable to the noncontrolling interest in the Beijing entity in Other (income) expense and the related tax impact as a reduction to our Income tax provision.  Additionally, we reported the equity attributable to the noncontrolling interest in the Beijing entity within Other liabilities and deferred credits.  As required, the presentation requirements of SFAS 160 were applied retroactively to the quarter and year to date ended September 6, 2008 for this noncontrolling interest.

During second quarter 2009, we began consolidating the entity that operates the KFCs in Shanghai, China in which a third party owns a noncontrolling interest (See Note 4).  We are accounting for the noncontrolling interest in this entity in accordance with SFAS 160.

A reconciliation of the beginning and ending carrying amount of the equity attributable to noncontrolling interests is as follows:
 
 
Noncontrolling interest as of December 27, 2008
$
14
   
 
Net income – noncontrolling interest
 
10
   
 
Purchase of subsidiary shares from noncontrolling interest (See Note 4)
 
70
   
 
Dividends declared
 
(7
)
 
 
Noncontrolling interest as of September 5, 2009
$
87
   


 
13

 



In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”).  SFAS 161 amends and expands the disclosure requirements in SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”.  SFAS 161 was effective for the quarter ended March 21, 2009 for the Company, and we have included the required disclosures in Note 11.

In April 2009, the FASB issued FSP No. FAS 157-4 (“FSP FAS 157-4”), “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions That Are Not Orderly” and FSP No. FAS 115-2 and FAS 124-2 (“FSP FAS 115-2”), “Recognition and Presentation of Other-Than-Temporary Impairments”.  These two FSPs were issued to provide additional guidance about (1) measuring the fair value of financial instruments when the markets become inactive and quoted prices may reflect distressed transactions, and (2) recording impairment charges on investments in debt instruments.  Additionally, the FASB issued FSP No. FAS 107-1 and APB 28-1 (“FSP FAS 107-1”), “Interim Disclosures about Fair Value of Financial Instruments,” to require disclosures of fair value of certain financial instruments in interim financial statements.  These FSPs were effective for the quarter ended September 5, 2009 for the Company.  The adoption of these FSPs did not significantly impact the Company’s results of operations.  We have expanded our fair value disclosures in accordance with these FSPs.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”).  SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  SFAS 165 was effective for the quarter ended September 5, 2009 for the Company.  The Company evaluated subsequent events through the date the financial statements were issued and filed with the Securities and Exchange Commission. 
 
Note 6 - New Accounting Pronouncements Not Yet Adopted

In December 2008, the FASB issued FSP No. FAS 132(R)-1 (“FSP FAS 132(R)-1”), “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which expands the disclosure requirements about plan assets for defined benefit pension plans and postretirement plans.  FSP FAS 132(R)-1 is effective for financial statements issued for fiscal years ending after December 15, 2009, the year ending December 26, 2009 for the Company.

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” (“SFAS 166”) and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”).  SFAS 166 will require more information about transfers of financial assets, eliminates the qualifying special purpose entity (QSPE) concept, changes the requirements for derecognizing financial assets and requires additional disclosures.  SFAS 167 amends FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities” regarding certain guidance for determining whether an entity is a variable interest entity and modifies the methods allowed for determining the primary beneficiary of a variable interest entity.  In addition, SFAS 167 requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosures related to an enterprise’s involvement in a variable interest entity.  We are evaluating whether the adoption of SFAS 166 and SFAS 167 will require the Company to consolidate an entity that provides loans used primarily to assist franchisees in the development of new restaurants and, to a lesser extent, in connection with the Company’s historical refranchising programs.  If required, the consolidation of this entity would increase the Company’s long-term debt by approximately $52 million with a corresponding increase to receivables.  See Note 13 for additional information regarding this franchisee loan program.  SFAS 166 and SFAS 167 are effective for the first annual reporting period that begins after November 15, 2009, our fiscal 2010.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162” (“SFAS 168”).  SFAS 168 provides for the FASB Accounting Standards CodificationTM (the “Codification”) to become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (“GAAP”).  The Codification did not change GAAP but reorganizes the literature.  SFAS 168 is effective for interim and annual periods ending after September 15, 2009, the year ending December 26, 2009 for the Company.

 
14

 



Note 7 - Other (Income) Expense

   
Quarter ended
 
Year to date
   
9/5/09
 
9/6/08
 
9/5/09
 
9/6/08
Equity income from investments in unconsolidated affiliates
 
$
(12
)
 
$
(13
)
 
$
(29
)
 
$
(33
)
Gain upon consolidation of former unconsolidated affiliate in China(a)
   
     
     
(68
)
   
 
Gain upon sale of investment in unconsolidated affiliate(b)
   
     
     
     
(100
)
Foreign exchange net (gain) loss and other
   
(1
)
   
(5
)
   
     
(15
)
Other (income) expense
 
$
(13
)
 
$
(18
)
 
$
(97
)
 
$
(148
)

(a)
See Note 4 for further discussion of the consolidation of a former unconsolidated affiliate in China.
   
(b)
Reflects the gain recognized on the sale of our interest in our unconsolidated affiliate in Japan. See our 2008 Form 10-K for further discussion of this transaction.

Note 8 – Supplemental Balance Sheet Information

   
9/5/09
   
12/27/08
Accounts and notes receivable
 
$
271
     
$
252
 
Allowance for doubtful accounts
   
(30
)
     
(23
)
Accounts and notes receivable, net
 
$
241
     
$
229
 

Property, plant and equipment, gross
 
$
7,213
     
$
6,897
 
Accumulated depreciation and amortization
   
(3,369
)
     
(3,187
)
Property, plant and equipment, net
 
$
3,844
     
$
3,710
 


In connection with our U.S. business transformation measures our reported segment results began reflecting increased allocations of certain expenses in 2009 that were previously reported in Unallocated and corporate expenses.  While our consolidated results were not impacted, we believe the revised allocation better aligns costs with accountability of our segment managers.  These revised allocations are being used by our Chairman and Chief Executive Officer, in his role as chief operating decision maker, in his assessment of operating performance.  We have restated segment information for the quarter and year to date ended September 6, 2008 to be consistent with the current period presentation.  This resulted in a $13 million decrease in Unallocated and corporate expense and increases in U.S. and YRI G&A expense of $12 million and $1 million, respectively, for the quarter ended September 6, 2008, and a $40 million decrease in Unallocated and corporate G&A expense and increases in U.S. and YRI G&A expense of $36 million and $4 million, respectively, for the year to date ended September 6, 2008.

The following tables summarize revenue and operating profit for each of our reportable operating segments:

   
Quarter ended
 
Year to date
Revenues
 
9/5/09
 
9/6/08
 
9/5/09
 
9/6/08
United States
 
$
1,055
   
$
1,215
   
$
3,200
   
$
3,633
 
YRI(a)
   
661
     
753
     
1,830
     
2,184
 
China Division (b)
   
1,063
     
874
     
2,473
     
2,097
 
Unallocated Franchise and license fees and income(c)(f)
   
(1
)
   
     
(32
)
   
 
   
$
2,778
   
$
2,842
   
$
7,471
   
$
7,914
 

 
15

 



   
Quarter ended
 
Year to date
Operating Profit
 
9/5/09
 
9/6/08
 
9/5/09
 
9/6/08
United States
 
$
171
   
$
146
   
$
497
   
$
447
 
YRI
   
119
     
137
     
342
     
393
 
China Division (d)
   
217
     
165
     
453
     
360
 
Unallocated Franchise and license fees and income(c)(f)
   
(1
)
   
     
(32
)
   
 
Unallocated and corporate expenses(f)
   
(33
)
   
(50
)
   
(122
)
   
(145
)
Unallocated Other income (expense)(e)(f)
   
1
     
5
     
68
     
115
 
Unallocated Refranchising gain (loss)(f)
   
(4
)
   
8
     
9
     
(16
)
Operating Profit
   
470
     
411
     
1,215
     
1,154
 
Interest expense, net
   
(42
)
   
(47
)
   
(138
)
   
(152
)
Income Before Income Taxes
 
$
428
   
$
364
   
$
1,077
   
$
1,002
 

(a)
Includes revenues of $268 million and $300 million for the quarters ended September 5, 2009 and September 6, 2008, respectively, and $737 million and $891 million for the years to date ended September 5, 2009 and September 6, 2008, respectively, for entities in the United Kingdom.
   
(b)
Includes revenues of approximately $994 million and $803 million for the quarters ended September 5, 2009 and September 6, 2008, respectively, and approximately $2.3 billion and $1.9 billion for the years to date ended September 5, 2009 and September 6, 2008, respectively, in mainland China.
   
(c)
Amount consists of reimbursements to KFC franchisees for installation costs of ovens for the national launch of Kentucky Grilled Chicken (See Note 4).
   
(d)
Includes equity income from investments in unconsolidated affiliates of $12 million and $13 million for the quarters ended September 5, 2009 and September 6, 2008, respectively, and $29 million and $32 million for years to date ended September 5, 2009 and September 6, 2008, respectively, for the China Division.
   
(e)
The year to date ended September 5, 2009 includes a $68 million gain recognized upon our acquisition of  additional ownership in, and consolidation of, the operating entity that owns the KFCs in Shanghai, China.  See Note 4 for further discussion of this transaction.  The year to date ended September 6, 2008 includes a $100 million gain recognized on the sale of our interest in our unconsolidated affiliate in Japan.  See our 2008 Form 10-K for further discussion of this transaction.
   
(f)
Amounts have not been allocated to the U.S., YRI or China Division segments for performance reporting purposes.


 
16

 




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 United Kingdom (“U.K.”).  Our plans in the U.K. have previously been amended such that new employees are not eligible to participate in these plans.

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
   
9/5/09
   
9/6/08
   
9/5/09
   
9/6/08
Service cost
 
$
6
     
$
7
     
$
2
     
$
2
 
Interest cost
   
13
       
13
       
2
       
2
 
Expected return on plan assets
   
(13
)
     
(12
)
     
(1
)
     
(2
)
Amortization of net loss
   
3
       
1
       
       
 
Net periodic benefit cost
 
$
9
     
$
9
     
$
3
     
$
2
 

   
U.S. Pension Plans
   
International Pension Plans
   
Year to date
   
Year to date
   
9/5/09
   
9/6/08
   
9/5/09
   
9/6/08
Service cost
 
$
18
     
$
21
     
$
4
     
$
6
 
Interest cost
   
40
       
37
       
5
       
6
 
Expected return on plan assets
   
(40
)
     
(36
)
     
(4
)
     
(7
)
Amortization of net loss
   
9
       
4
       
1
       
 
Net periodic benefit cost
 
$
27
     
$
26
     
$
6
     
$
5
 

We made contributions of $84 million and $8 million to the Plan and our U.K. plans, respectively, during the year to date ended September 5, 2009.  We anticipate making additional discretionary contributions of $150 to $200 million to our pension plans during the fourth quarter of 2009.

 
17

 




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 5, 2009, our interest rate derivative instruments outstanding had notional amounts of $775 million.  These swaps have reset dates and floating rate indices which match those of our underlying fixed-rate debt and have been designated as fair value hedges of a portion of that debt.  As the swaps qualify for the short-cut method under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, 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 forward contract with the cumulative change in the hedged item.  At September 5, 2009, foreign currency forward contracts outstanding had a total notional amount of $505 million.

The fair values of derivatives designated as hedging instruments under SFAS 133 at the quarter ended September 5, 2009 were:
           
   
Fair Value
 
Condensed Consolidated Balance Sheet Location
 
 
Interest Rate Swaps
$
46
 
Other assets
 
 
Foreign Currency Forwards – Asset
 
10
 
Prepaid expenses and other current assets
 
 
Foreign Currency Forwards – Liability
 
(16)
 
Accounts payable and other current liabilities
 
 
Total
$
40
     

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 $41 million to long-term debt at September 5, 2009.  During the quarter and year to date ended September 5, 2009, Interest expense, net was reduced by $5 million and $23 million, respectively, for recognized gains on these interest rate swaps, including $13 million in the year to date ended September 5, 2009 related to the settlement of interest rate swaps that were hedging the 2012 Senior Unsecured Notes that were extinguished (See Note 4).

For our foreign currency forward contracts the following effective portions of gains and losses were recognized into Other Comprehensive Income (“OCI”) and reclassified into income from OCI in the quarter and year to date ended September 5, 2009.

     
Quarter ended
 
Year to date
 
Gains (losses) recognized into OCI, net of tax
 
$
(15)
 
$
(10)
 
Gains (losses) reclassified from Accumulated OCI into income, net of tax
 
$
(12)
 
$
(15)

The gains/losses reclassified from Accumulated OCI into income were recognized as Other income (expense) in our Condensed Consolidated Statement 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 quarter and year to date ended September 5, 2009.

 
18

 


Additionally, we had a net deferred loss of $12 million, net of tax, as of September 5, 2009 within Accumulated OCI due to treasury locks and forward starting interest rate swaps that have been cash settled, including $2 million, net of tax, for treasury locks settled during the quarter ended September 5, 2009 associated with the 2009 Notes.  In the quarter and year to date ended September 5, 2009, 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 the 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 5, 2009, all of the counterparties to our interest rate swaps and foreign currency forwards had investment grade ratings.  To date, all counterparties have performed in accordance with their contractual obligations.

Note 12 - Fair Value Disclosures

The following table presents the fair values for those assets and liabilities measured at fair value on a recurring basis as of September 5, 2009:

       
Fair Value Measurements at September 5, 2009
Description
 
Total
 
 Level 1(a)
 
 Level 2(b)
 
 Level 3(c)
Foreign Currency Forwards, net
 
$
(6
)
 
$
   
$
(6
)
 
$
 
Interest Rate Swaps, net
   
46
     
     
46
     
 
Other Investments(d)
   
12
     
12
     
     
 
Total
 
$
52
   
$
12
   
$
40
   
$
 

The following table presents the fair values for those assets and liabilities measured at fair value during 2009 on a non-recurring basis, and remaining on our Condensed Consolidated Balance Sheet as of September 5, 2009. Total losses include losses recognized from all non-recurring fair value measurements during the quarter and year to date ended September 5, 2009:

       
Fair Value Measurements Using
 
Total Losses
 
Description
 
As of
September 5, 2009
 
Level 1(a)
 
Level 2(b)
 
Level 3(c)
 
Quarter ended
 
Year to date
 
Long-lived assets held for use
 
$
31
   
$
 
   
$
   
$
31
   
$
10
   
$
34
   

(a)
Inputs based upon quoted prices in active markets for identical assets.
   
(b)
Inputs other than quoted prices included within Level 1 that are observable for the asset, either directly or indirectly.
   
(c)
Inputs that are unobservable for the asset.
   
(d)
The Other Investments include investments in mutual funds, which are used to offset fluctuations in deferred compensation liabilities that employees have chosen to invest in phantom shares of a Stock Index Fund or Bond Index Fund.

Long-lived assets (primarily property, plant and equipment and allocated intangible assets subject to amortization) of  restaurants or groups of restaurants that are currently operating and have not been offered for refranchise are reviewed for impairment semi-annually or whenever events or changes in circumstances indicate that the carrying amount of the restaurants’ assets may not be recoverable.

 
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Additionally, we test for impairment when we have offered to refranchise a restaurant or groups of restaurants for a price less than their carrying value but do not believe the restaurants have met the criteria to be classified as held for sale.  Any such impairment is recorded at the offer date and is classified as refranchising loss.  Our impairment of long-lived assets policy is fully described in our 2008 Form 10-K.

Long-lived assets held for use presented in the table above include restaurants or groups of restaurants that were impaired as a result of our semi-annual impairment review or restaurants not meeting held for sale criteria that have been offered for sale at a price less than their carrying value during the quarter and year to date ended September 5, 2009.  All $10 million in impairment charges shown in the table above for the quarter ended September 5, 2009 was included in Refranchising (gain) loss in the Condensed Consolidated Statements of Income.  For the $34 million of impairment charges shown in the table above for the year to date ended September 5, 2009, $17 million was included in both Closures and impairment (income) expenses and Refranchising (gain) loss.

At September 5, 2009 the carrying values of cash and cash equivalents, 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 $3.3 billion, compared to their carrying value of $3.0 billion.  We estimated the fair value of debt using market quotes and calculations based on market rates.

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 2031.  As of September 5, 2009, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessee was approximately $450 million.  The present value of these potential payments discounted at our pre-tax cost of debt at September 5, 2009 was approximately $375 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 5, 2009 was not material.

Franchise Loan Pool and Equipment Guarantees

We have provided a partial guarantee of approximately $15 million of a franchisee loan program used primarily to assist franchisees in the development of new restaurants and, to a lesser extent, in connection with the Company’s historical refranchising programs at September 5, 2009.  We have also provided two letters of credit totaling approximately $23 million in support of the franchisee loan program.  One such letter of credit could be used if we fail to meet our obligations under our guarantee.  The other letter of credit could be used, in certain circumstances, to fund our participation in the funding of the franchisee loan program.  The total loans outstanding under the loan pool were approximately $52 million at September 5, 2009.

 
20

 



In addition to the guarantee described above, YUM has provided guarantees of approximately $42 million on behalf of franchisees for several equipment financing programs related to specific initiatives, the most significant of which was the purchase of ovens by KFC franchisees for the launch of Kentucky Grilled Chicken.  The total loans outstanding under these equipment financing programs were approximately $56 million at September 5, 2009.

Insurance Programs

We are self-insured for a substantial portion of our current and prior years’ coverage including workers’ compensation, employment practices liability, general liability, automobile liability and property losses (collectively, “property and casualty losses”).  To mitigate the cost of our exposures for certain property and casualty losses, we make annual decisions to self-insure the risks of loss up to defined maximum per occurrence retentions on a line by line basis or to combine certain lines of coverage into one loss pool with a single self-insured aggregate retention.  The Company then purchases insurance coverage, up to a certain limit, for losses that exceed the self-insurance per occurrence or aggregate 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 5, 2009, we had approximately $180 million of liabilities recorded for property and casualty losses.

In the U.S. and in certain other countries, we are also self-insured for healthcare claims and long-term disability 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 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.  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.

 
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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.  We provide reserves for such claims and contingencies when payment is probable and reasonably estimable in accordance with SFAS No. 5, “Accounting for Contingencies.”

On November 26, 2001, Kevin Johnson, a former Long John Silver’s (“LJS”) restaurant manager, filed a collective action against LJS in the United States District Court for the Middle District of Tennessee alleging violation of the Fair Labor Standards Act (“FLSA”) on behalf of himself and allegedly similarly-situated LJS general and assistant restaurant managers.  Johnson alleged that LJS violated the FLSA by perpetrating a policy and practice of seeking monetary restitution from LJS employees, including Restaurant General Managers (“RGMs”) and Assistant Restaurant General Managers (“ARGMs”), when monetary or property losses occurred due to knowing and willful violations of LJS policies that resulted in losses of company funds or property, and that LJS had thus improperly classified its RGMs and ARGMs as exempt from overtime pay under the FLSA.  Johnson sought overtime pay, liquidated damages, and attorneys’ fees for himself and his proposed class.

LJS moved the Tennessee district court to compel arbitration of Johnson’s suit.  The district court granted LJS’s motion on June 7, 2004, and the United States Court of Appeals for the Sixth Circuit affirmed on July 5, 2005.

On December 19, 2003, while the arbitrability of Johnson’s claims was being litigated, former LJS managers Erin Cole and Nick Kaufman, represented by Johnson’s counsel, initiated arbitration with the American Arbitration Association (“AAA”) (the “Cole Arbitration”).  The Cole Claimants sought a collective arbitration on behalf of the same putative class as alleged in the Johnson lawsuit and alleged the same underlying claims.

On June 15, 2004, the arbitrator in the Cole Arbitration issued a Clause Construction Award, finding that LJS’s Dispute Resolution Policy did not prohibit Claimants from proceeding on a collective or class basis.  LJS moved unsuccessfully to vacate the Clause Construction Award in federal district court in South Carolina.  On September 19, 2005, the arbitrator issued a Class Determination Award, finding, inter alia, that a class would be certified in the Cole Arbitration on an “opt-out” basis, rather than as an “opt-in” collective action as specified by the FLSA.

On January 20, 2006, the district court denied LJS’s motion to vacate the Class Determination Award and the United States Court of Appeals for the Fourth Circuit affirmed the district court’s decision on January 28, 2008.  A petition for a writ of certiorari filed in the United States Supreme Court seeking a review of the Fourth Circuit’s decision was denied on October 7, 2008.  The parties participated in mediation on April 24, 2008, and again on February 28, 2009, without reaching resolution.  Arbitration on liability during a portion of the alleged restitution policy period is currently scheduled for November, 2009.

Based on the rulings issued to date in this matter, LJS expects that the Cole Arbitration will proceed as an “opt-out” class action, rather than as an “opt-in” collective action.  LJS denies liability and is vigorously defending the claims in the Cole Arbitration.  We have provided for a reasonable estimate of the cost of the Cole Arbitration, taking into account a number of factors, including our current projection of eligible claims, the estimated amount of each eligible claim, the estimated claim recovery rate, the estimated legal fees incurred by Claimants and the reasonable settlement value of this and other wage and hour litigation matters.  However, in light of the inherent uncertainties of litigation, the fact-specific nature of Claimants’ claims, and the novelty of proceeding in an FLSA lawsuit on an “opt-out” basis, there can be no assurance that the arbitration will not result in losses in excess of those currently provided for in our Condensed Consolidated Financial Statements.

 
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On August 4, 2006, a putative class action lawsuit against Taco Bell Corp. styled Rajeev Chhibber vs. Taco Bell Corp. was filed in Orange County Superior Court.  On August 7, 2006, another putative class action lawsuit styled Marina Puchalski v. Taco Bell Corp. was filed in San Diego County Superior Court.  Both lawsuits were filed by a Taco Bell RGM purporting to represent all current and former RGMs who worked at corporate-owned restaurants in California from August 2002 to the present.  The lawsuits allege violations of California’s wage and hour laws involving unpaid overtime and meal period violations and seek unspecified amounts in damages and penalties.  The cases were consolidated in San Diego County as of September 7, 2006.

Based on plaintiffs’ revised class definition in their class certification motion, Taco Bell removed the case to federal court in San Diego on August 29, 2008.  On March 17, 2009, the court granted plaintiffs’ motion to remand.  A hearing on plaintiffs’ class certification motion has been continued to December 4, 2009.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit.  However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time.  Likewise, the amount of any potential loss cannot be reasonably estimated.

On September 10, 2007, a putative class action against Taco Bell Corp., the Company and other related entities styled Sandrika Medlock v. Taco Bell Corp., was filed in United States District Court, Eastern District, Fresno, California.  The case was filed on behalf of all hourly employees who have worked for the defendants within the last four years and alleges numerous violations of California labor laws including unpaid overtime, failure to pay wages on termination, denial of meal and rest breaks, improper wage statements, unpaid business expenses and unfair or unlawful business practices in violation of California Business & Professions Code §17200.  The Company was dismissed from the case without prejudice on January 10, 2008.

On April 11, 2008, Lisa Hardiman filed a Private Attorneys General Act (“PAGA”) complaint in the Superior Court of the State of California, County of Fresno against Taco Bell Corp., the Company and other related entities.  This lawsuit, styled Lisa Hardiman vs. Taco Bell Corp., et al., was filed on behalf of Hardiman individually and all other aggrieved employees pursuant to PAGA.  The complaint seeks penalties for alleged violations of California’s Labor Code.  On June 25, 2008, Hardiman filed an amended complaint adding class action allegations on behalf of hourly employees in California very similar to the Medlock case, including allegations of unpaid overtime, missed meal and rest periods, improper wage statements, non-payment of wages upon termination, unreimbursed business expenses and unfair or unlawful business practices in violation of California Business & Professions Code §17200.

On June 16, 2008, a putative class action lawsuit against Taco Bell Corp. and the Company, styled Miriam Leyva vs. Taco Bell Corp., et al., was filed in Los Angeles Superior Court.  The case was filed on behalf of Leyva and purportedly all other California hourly employees and alleges failure to pay overtime, failure to provide meal and rest periods, failure to pay wages upon discharge, failure to provide itemized wage statements, unfair business practices and wrongful termination and discrimination.  The Company was dismissed from the case without prejudice on August 20, 2008.

On November 5, 2008, a putative class action lawsuit against Taco Bell Corp. and the Company styled Loraine Naranjo vs. Taco Bell Corp., et al., was filed in Orange County Superior Court.  The case was filed on behalf of Naranjo and purportedly all other California employees and alleges failure to pay overtime, failure to reimburse for business related expenses, improper wage statements, failure to pay accrued vacation wages, failure to pay minimum wage and unfair business practices.  The Company filed a motion to dismiss on December 15, 2008, which was denied on January 20, 2009.

Taco Bell moved to consolidate the Medlock, Hardiman, Leyva and Naranjo matters, and the court granted the motion to consolidate on May 19, 2009.  The consolidated case is styled In Re Taco Bell Wage and Hour Actions.  Plaintiffs filed a consolidated complaint on June 29, 2009, and the court set a filing deadline of August 26, 2010 for motions regarding class certification.  The hearing on any class certification motion is currently scheduled for January 10, 2011.  Discovery is underway.

 
23

 



Taco Bell and the Company deny liability and intend to vigorously defend against all claims in this lawsuit.  However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time.  Likewise, the amount of any potential loss cannot be reasonably estimated.

On March 26, 2009, Taco Bell was served with a putative class action lawsuit filed in Orange County Superior Court against Taco Bell and the Company styled Endang Widjaja vs. Taco Bell Corp., et al.  The case was filed on behalf of Widjaja, a former California hourly assistant manager, and purportedly all other individuals employed in Taco Bell’s California restaurants as managers and alleges failure to reimburse for business related expenses, failure to provide rest periods, unfair business practices and conversion.  This case appears to be duplicative of Taco Bell’s pending consolidated hourly class action case (In Re Taco Bell Wage and Hour Actions).  Taco Bell removed the case to federal district court and filed a notice of related case.  On June 18, 2009 the case was transferred to the Eastern District of California where the In Re Taco Bell Wage and Hour Actions case is pending and was subsequently transferred to the same district court judge.  Taco Bell filed a motion on July 22, 2009 to dismiss, stay or consolidate this case with the In Re Taco Bell Wage and Hour Actions, and the hearing on this motion is scheduled for October 19, 2009.

Taco Bell and the Company deny liability and intend to vigorously defend against all claims in this lawsuit.  However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time.  Likewise, the amount of any potential loss cannot be reasonably estimated.

On October 14, 2008, a putative class action, styled Kenny Archila v. KFC U.S. Properties, Inc., was filed in California state court on behalf of all California hourly employees alleging various California Labor Code violations, including rest and meal break violations, overtime violations, wage statement violations and waiting time penalties.  KFC removed the case to the United States District Court for the Central District of California on January 7, 2009.  On July 7, 2009, the Judge ruled that the case would not go forward as a class action.  Plaintiff also sought recovery of civil penalties under the California Private Attorney General Act as a representative of other “aggrieved employees.”  On August 3, 2009, the Court ruled that the Plaintiff could not assert such claims and the case had to proceed as a single plaintiff action.  On the eve of the August 18, 2009 trial, the Plaintiff stipulated to a dismissal of his individual claims with prejudice but reserved his right to appeal the Court’s rulings regarding class and PAGA claims.  KFC reserved its right to make any and all challenges to the appeal.  On or about September 16, 2009, Plaintiff filed a notice of appeal.

KFC denies liability and intends to vigorously defend against all claims in this lawsuit. However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.

On December 17, 2002, Taco Bell was named as the defendant in a class action lawsuit filed in the United States 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 that alleges, 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 220 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 (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.

On February 23, 2004, the District Court granted plaintiffs’ motion for class certification.  The class includes claims for injunctive relief and minimum statutory damages.

 
24

 



Pursuant to the parties’ agreement, on or about August 31, 2004, the District Court ordered that the trial of this action be bifurcated so that stage one will resolve plaintiffs’ claims for equitable relief and stage two will resolve plaintiffs’ claims for damages.  The parties are currently proceeding with the equitable relief stage of this action.

On May 17, 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.  On August 8, 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.

The parties participated in mediation on March 25, 2008, and again on March 26, 2009, without reaching resolution.  The court granted Taco Bell’s request for an extension to file its motion for summary judgment on the ADA claims until October 20, 2009.  A hearing on the motion is now scheduled for December 16, 2009.

Taco Bell has denied liability and intends to vigorously defend against all claims in this lawsuit.  Taco Bell has taken certain 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.  It is not possible at this time to reasonably estimate the probability or amount of liability for monetary damages on a class wide basis to Taco Bell.

On March 14, 2007, a lawsuit styled Boskovich Farms, Inc. v. Taco Bell Corp. and Does 1 through 100 was filed in the Superior Court of the State of California, Orange County.  Boskovich Farms, a supplier of produce to Taco Bell, alleges in its complaint, among other things, that it suffered damage to its reputation and business as a result of publications and/or statements it claims were made by Taco Bell in connection with Taco Bell’s reporting of results of certain tests conducted during investigations on green onions used at Taco Bell restaurants.  The parties participated in mediation on April 10, 2008, without reaching resolution.  The arbitration panel heard the parties’ cross motions for summary judgment on August 12, 2009.  On August 14, 2009, the arbitration panel issued an opinion granting Taco Bell’s motion for summary judgment and dismissing all of Boskovich’s claims with prejudice.  On September 23, 2009, Boskovich filed a motion to vacate the arbitration award.  The hearing on Boskovich’s motion has been scheduled for January 6, 2010.  Taco Bell denies liability and intends to vigorously defend against all claims in any arbitration and the lawsuit.  However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time.  Likewise, the amount of any potential loss cannot be reasonably estimated.

On July 9, 2009, a putative class action styled Mark Smith v. Pizza Hut, Inc. was filed in the United States District Court for the District of Colorado.  The complaint alleges 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 September 15, 2009, a putative class action styled Sue Blackwood and Scott Lewis v. Pizza Hut of America, Inc. was filed in the United States District Court for the District of Kansas.  The Blackwood complaint alleges that delivery drivers received insufficient reimbursement and seeks to represent a nationwide class under the FLSA.

Pizza Hut denies liability and intends to vigorously defend against all claims in these lawsuits.  However, in view of the inherent uncertainties of litigation, the outcome of these cases cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.



 
25

 


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 27, 2008.  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.  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.  Sales of franchise, unconsolidated affiliate and license restaurants generate 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 sales of all restaurants that have been open one year or more.
   
·
Company restaurant margin as a percentage of sales is defined as Company sales less expenses incurred directly by our Company restaurants in generating Company sales 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 Condensed Consolidated Financial Statements.  Tabular amounts are displayed in millions except per share and unit count amounts, or as otherwise specifically identified.

Description of Business

YUM is the world’s largest restaurant company based on number of system units, with more than 36,000 units in more than 110 countries and territories operating under the KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W All-American Food Restaurants brands.  Four of the Company’s restaurant brands – KFC, Pizza Hut, Taco Bell and Long John Silver’s – are the global leaders in the quick-service chicken, pizza, Mexican-style food and seafood categories, respectively.  Of the over 36,000 restaurants, 21% are operated by the Company, 73% are operated by franchisees and unconsolidated affiliates and 6% are operated by licensees.

YUM’s business consists of three reporting segments:  United States, YUM Restaurants International (“YRI” or “International Division”) and YUM Restaurants China (“China Division”).  The China Division includes mainland China (“China”), Thailand and KFC Taiwan, and YRI includes the remainder of our international operations.  The China Division and YRI have been experiencing dramatic growth and now represent approximately 60% of the Company’s operating profits.  The U.S. business operates in a highly competitive marketplace resulting in slower profit growth, but continues to produce strong cash flows.

 
26

 



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 restaurants, respectively, in mainland China.  Additionally, the Company owns and operates the distribution system for its restaurants in mainland China which we believe provides a significant competitive advantage.  Given this strong competitive position, a rapidly 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).  Our ongoing earnings growth model includes annual system-sales growth of 20% in mainland China driven by new unit development each year, which we expect to drive annual Operating Profit growth of 20% in the China Division.

Drive Aggressive International Expansion and Build Strong Brands Everywhere – The Company and its franchisees opened over 900 new restaurants in 2008 in the Company’s International Division, representing 9 straight years of opening over 700 restaurants.  The International Division generated $528 million in Operating Profit in 2008 up from $186 million in 1998.  The Company expects to continue to experience strong growth by building our existing markets and growing in new markets including India, France and Russia.  Our ongoing earnings growth model includes annual Operating Profit growth of 10% driven by new unit development and same store sales growth for YRI.  New unit development is expected to contribute to system sales growth of at least 6% each year.

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 are the leader in multibranding, with more than 5,000 restaurants providing customers two or more of our brands at a single location.  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 calls for annual Operating Profit growth of 5% in the U.S. with same store sales growth of 2% to 3% and leverage of our General and Administrative (“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 via share repurchases and dividends.  The Company has one of the highest returns on invested capital in the Quick Service Restaurants (“QSR”) industry.  Additionally, 2008 was the fourth consecutive year in which the Company returned over $1.1 billion to its shareholders through share repurchases and dividends.  The Company is targeting an annual dividend payout ratio of 35% to 40% of net income.

Details of our 2009 Guidance by division and updates can be found online at http://www.yum.com/investors.


 
27

 



Quarter Ended September 5, 2009 Highlights

·
International development of 267 new restaurants including 88 in mainland China and 165 in YRI.
   
·
System sales growth of 10% in the China Division and 4% in YRI was offset by a 5% decline in the U.S. resulting in flat Worldwide system sales in local currency.  Worldwide system sales declined 4% after foreign currency translation.
   
·
Worldwide restaurant margin improved over 3 percentage points driven by improvement in the U.S. and near record levels in the China Division.
   
·
Worldwide operating profit growth of 14% was driven by growth of 32% in China Division and 18% in the U.S.  YRI profit declined 13% driven by foreign currency translation.  Worldwide operating profit growth was 18% prior to foreign currency translation.
   
·
Foreign currency translation negatively impacted EPS by $0.02 per share.

All preceding comparisons are versus the same period a year ago.

 
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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 5, 2009 and September 6, 2008 and/or could impact comparability with the remainder of our results in 2009 or beyond.  Certain of these factors were previously discussed in our 2008 Form 10-K.

Restaurant Margin

In the U.S., restaurant margin as a percentage of sales increased 3.3 percentage points and 2.1 percentage points versus the quarter and year to date ended September 6, 2008, respectively.  In the China Division, restaurant margin as a percentage of sales increased 2.3 percentage points and 1.8 percentage points versus the quarter and year to date ended September 6, 2008, respectively.  These improvements were largely driven by commodity deflation.  For the quarter ended September 5, 2009, we experienced commodity deflation of $16 million and $21 million for our U.S. and China Divisions, respectively.  For the year to date ended September 5, 2009, U.S. and China Division commodity deflation was $11 million and $22 million, respectively.  We expect commodity deflation of about $10 million in the U.S. and about $30 million in the China Division in the fourth quarter of 2009.  For the full year, the impact on U.S. restaurant margin as a result of the anticipated commodity deflation benefit is expected to be partially offset by same store sales declines.

YRI has not experienced the benefit of commodity decreases, compared to the U.S. and China Divisions, as YRI has been more significantly impacted by a higher percentage of fixed price commodity commitments.

Impact of Foreign Currency Translation on Operating Profit

Changes in foreign currency exchange rates negatively impacted the translation of our foreign currency denominated Operating Profit in our International Division by $17 million and $62 million for the quarter and year to date ended September 5, 2009, respectively, and positively impacted Operating Profit in our China Division by $1 million and $10 million for the quarter and year to date ended September 5, 2009, respectively.  Given the nature and volatility of the foreign currency markets the full year forecasted foreign currency impact is difficult to quantify.  However, we do not anticipate that the impact of foreign currency translation on either YRI or the China Division’s Operating Profit will be significant in the fourth quarter of 2009.

 
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U.S. Business Transformation

As part of our plan to transform our U.S. business we took several measures in 2008 and are taking similar measures in 2009 that we do not believe are indicative of our ongoing operations.  These measures (“the U.S. business transformation measures”) include: expansion of our U.S. refranchising; charges relating to G&A productivity initiatives and realignment of resources (primarily severance and early retirement costs); and investments in our U.S. Brands made on behalf of our franchisees such as equipment purchases.  As discussed in Note 4, we are not including the impacts of these U.S. business transformation measures in our U.S. segment for performance reporting purposes.

We recorded pre-tax gains of $8 million and $23 million from refranchising in the U.S. for the quarter and year to date ended September 5, 2009, respectively.  We recorded a pre-tax gain of $3 million and a pre-tax loss of $22 million from refranchising in the U.S. for the quarter and year to date ended September 6, 2008, respectively.  The refranchising gains and losses are more fully discussed in Note 4 and the Store Portfolio Strategy Section of the MD&A.

In connection with our G&A productivity initiatives and realignment of resources we recorded no charges in the quarter ended September 5, 2009 and a pre-tax charge of $1 million in the quarter ended September 6, 2008.  In the years to date ended September 5, 2009 and September 6, 2008, we recorded pre-tax charges of $9 million and $8 million, respectively.

Additionally, the Company recognized a reduction to Franchise and license fees and income of $1 million and $32 million, pre-tax, in the quarter and year to date ended September 5, 2009, respectively, related to investments in our U.S. Brands.  These investments reflect our reimbursements to KFC franchisees for installation costs of ovens for the national launch of Kentucky Grilled Chicken.  In the quarter and year to date ended September 6, 2008, the Company recognized pre-tax expense of $2 million and $5 million, respectively, related to the investments in our U.S. Brands.

In 2009, we currently expect to refranchise 500 restaurants in the U.S.  The impact of this refranchising on our 2009 results will be determined by the stores that we are able to sell and the specific prices we are able to obtain for these stores.


 
30

 



Consolidation of a Former Unconsolidated Affiliate in China

On May 4, 2009 we acquired an additional 7% ownership in the entity that operates more than 200 KFCs in Shanghai, China for $12 million, increasing our ownership to 58%.  This entity has historically been accounted for as an unconsolidated affiliate under the equity method of accounting.  Concurrent with the acquisition we received additional rights in the governance of the entity and thus we began consolidating the entity upon acquisition.  As required by Statement of Financial Accounting Standards (“SFAS”) No. 141(R), “Business Combinations”, we remeasured our previously held 51% ownership, which had a recorded value of $17 million at the date of acquisition, in the entity at fair value and recognized a gain of $68 million accordingly.  This gain, which resulted in no related income tax expense, was recorded in Other (income) expense in our Condensed Consolidated Statements of Income during the quarter ended June 13, 2009 and was not allocated to any segment for performance reporting purposes.

Under the equity method of accounting, we previously reported our 51% share of the net income of the unconsolidated affiliate (after interest expense and income taxes) as Other (income) expense in the Condensed Consolidated Statements of Income.  We also recorded a franchise fee for the royalty received from the stores owned by the unconsolidated affiliate. From the date of the acquisition through August 31, 2009 (our China Division’s third quarter end), we reported the results of operations for the entity in the appropriate line items of our Condensed Consolidated Statement of Income.  We no longer recorded franchise fee income for these restaurants nor did we report Other (income) expense as we did under the equity method of accounting.  Net income attributable to our partner’s ownership percentage is recorded as Net Income-noncontrolling interest within our Condensed Consolidated Statements of Income.  For the quarter and year to date ended September 5, 2009 the consolidation of this entity increased Company sales by $82 million and $105 million, respectively and decreased Franchise and license fees and income by $5 million and $6 million, respectively.  The consolidation of this entity positively impacted Operating Profit by $4 million and $5 million for the quarter and year to date ended September 5, 2009, respectively.  For the full year we expect the China Division’s Company sales to increase by approximately $200 million, Franchise and license fees and income to decrease by approximately $12 million and Operating Profit to increase by approximately $10 million as a result of this transaction.  The impact on Net Income – YUM! Brands, Inc. was not significant to either the quarter or the year to date ended September 5, 2009 and is not expected to be significant on a full year basis.

Sale of our Interest in Our Unconsolidated Affiliate in Japan

During the year to date ended September 6, 2008 we recorded a pre-tax gain of approximately $100 million related to the sale of our interest in our unconsolidated affiliate in Japan.  This gain was recorded in Other (income) expenses in our Condensed Consolidated Statement of Income and was not allocated to any segment for performance reporting purposes.

Segment Reporting Changes

In connection with our U.S. business transformation measures our reported segment results began reflecting increased allocations of certain expenses in 2009 that were previously reported as unallocated and corporate G&A expenses.  While our consolidated results were not impacted, we believe the revised allocation better aligns costs with accountability of our segment managers.  These revised allocations are being used by our Chairman and Chief Executive Officer, in his role as chief operating decision maker, in his assessment of operating performance.  We have restated segment information for the quarter and year to date ended September 6, 2008 to be consistent with the current period presentation and will restate previously reported 2008 quarters as they are reported in 2009.

 
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The following table summarizes the 2008 quarterly impact of the revised allocations by segment:
 
                     
   
First
 
Second
 
Third
 
Fourth
   
Increase/(Decrease)
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Total
U.S. G&A
 
$
11
   
$
13
   
$
12
   
$
17
   
$
53
 
YRI G&A
   
1
     
2
     
1
     
2
     
6
 
Unallocated and corporate G&A expenses
   
(12
)
   
(15
)
   
(13
)
   
(19
)
   
(59
)

Store Portfolio Strategy

From time to time we sell Company restaurants to existing and new franchisees where geographic synergies can be obtained or where franchisees’ expertise can generally be leveraged to improve our overall operating performance, while retaining Company ownership of strategic U.S. and international markets.  In the U.S., we are targeting Company ownership of restaurants potentially below 10%, down from its current level of 17%.  Consistent with this strategy, 286 Company restaurants in the U.S. were sold to franchisees in the year to date ended September 5, 2009.  A net gain from refranchising in the U.S. of $23 million has been recognized in the year to date ended September 5, 2009, including losses on certain stores which we have offered to sell but have not yet sold.  We currently anticipate refranchising 500 units in the U.S. in 2009 for approximately $175 million in proceeds.

Refranchisings reduce our reported revenues and restaurant profits and increase the importance of system sales growth as a key performance measure.  Additionally, G&A expenses will decline over time as a result of these refranchising activities.  The timing of G&A declines will vary and often lag the actual refranchising activities as the synergies are typically dependent upon the size and geography of the respective deals.  G&A expenses included in the tables below reflect only direct G&A that we no longer incurred as a result of stores that were operated by us for all or some portion of the respective comparable period in 2008 and were no longer operated by us as of the last day of the current quarter.

The following table summarizes our refranchising activities:
   
Quarter ended
   
Year to date
   
9/5/09
   
9/6/08
   
9/5/09
   
9/6/08
Number of units refranchised
   
119
       
255
       
324
       
462
 
Refranchising proceeds, pre-tax
 
$
28
     
$
76
     
$
91
     
$
142
 
Refranchising (gain) loss, pre-tax
 
$
4
     
$
(8
)
   
$
(9
)
   
$
16
 

The refranchising loss recognized in the quarter ended September 5, 2009 includes $10 million as a result of our decision to offer to refranchise an equity market outside the U.S. at a loss.

The impact on Operating Profit arising from refranchising is the net of (a) the estimated reductions in restaurant profit, which reflects the decrease in Company sales, and G&A expenses and (b) the increase in franchise fees from the restaurants that have been refranchised.  The tables presented below reflect the impacts on Total revenues and on Operating Profit from stores that were operated by us for all or some portion of the prior year period and were no longer operated by us as of the last day of the current quarter.  In these tables, Decreased Company sales and Decreased Restaurant profit represents the amount of sales or restaurant profit earned by the refranchised restaurants during the period we owned them in the prior year but did not own them in the current year.  Increased Franchise and license fees and income represents the franchise and license fees from the refranchised restaurants that were recorded by the Company in the current year during periods in which the restaurants were Company stores in the prior year.

 
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The following tables summarize the impact of refranchising as described above:
   
Quarter ended 9/5/09
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Decreased Company sales
 
$
(143
)
   
$
(19
)
   
$
(1
)
   
$
(163
)
Increased Franchise and license fees and income
   
9
       
1
       
       
10
 
Decrease in Total revenues
 
$
(134
)
   
$
(18
)
   
$
(1
)
   
$
(153
)

   
Year to date ended 9/5/09
   
U.S.
   
YRI
   
China
Division
   
Worldwide
Decreased Company sales
 
$
(467
)
   
$
(56
)
   
$
(3
)