Attached files

file filename
EX-32.1 - CEO CERTIFICATION EX32.1 - YUM BRANDS INCexhib32_1.htm
EX-15 - INDEPENDENT ACCOUNTANT ACKNOWLEDEGMENT EX15 - YUM BRANDS INCexhib15.htm
EX-32.2 - CFO CERTIFICATION EX32.2 - YUM BRANDS INCexhib32_2.htm
EX-31.1 - CEO CERTIFICATION EX31.1 - YUM BRANDS INCexhib31_1.htm
EX-31.2 - CFO CERTIFICATION EX31.2 - YUM BRANDS INCexhib31_2.htm
EXCEL - IDEA: XBRL DOCUMENT - YUM BRANDS INCFinancial_Report.xls
 
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 June 12, 2010
 
 
 
 
 
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 July 12, 2010 was 467,001,090 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 endedJune 12, 2010 and June 13, 2009
3
 
 
 
 
   
 
 
 
 
Condensed Consolidated Statements of Cash Flows –Years to date ended
June 12, 2010 and June 13, 2009
4
 
 
 
 
   
 
 
 
 
Condensed Consolidated Balance Sheets – June 12, 2010
and December 26, 2009
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
48
 
 
 
 
   
 
Part II.
Other Information and Signatures
   
 
 
 
   
 
 
Item 1 – Legal Proceedings
49
 
 
 
 
 
 
 
 
 
Item 1A – Risk Factors
49
 
 
 
 
 
 
 
   
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
50
 
         
 
 
Item 6 – Exhibits
51
 
 
 
 
 
 
 
 
 
Signatures
52
 





 
2

 

PART I - FINANCIAL INFORMATION

Item 1.
Financial Statements
   
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
YUM! BRANDS, INC. AND SUBSIDIARIES
(in millions, except per share data)
   
Quarter
   
Year to date
Revenues
 
6/12/10
   
6/13/09
   
6/12/10
   
6/13/09
Company sales
 
$
2,220
     
$
2,152
     
$
4,216
     
$
4,070
 
Franchise and license fees and income
   
354
       
324
       
703
       
623
 
Total revenues
   
2,574
       
2,476
       
4,919
       
4,693
 
                                       
Costs and Expenses, Net
                                     
Company restaurants
                                     
Food and paper
   
699
       
693
       
1,324
       
1,304
 
Payroll and employee benefits
   
503
       
505
       
964
       
962
 
Occupancy and other operating expenses
   
652
       
630
       
1,222
       
1,172
 
Company restaurant expenses
   
1,854
       
1,828
       
3,510
       
3,438
 
General and administrative expenses
   
283
       
281
       
528
       
536
 
Franchise and license expenses
   
24
       
25
       
47
       
45
 
Closures and impairment (income) expenses
   
12
       
22
       
16
       
26
 
Refranchising (gain) loss
   
(10)
       
1
       
53
       
(13
)
Other (income) expense
   
(10)
       
(75
)
     
(20)
       
(84
)
Total costs and expenses, net
   
2,153
       
2,082
       
4,134
       
3,948
 
Operating Profit
   
421
       
394
       
785
       
745
 
Interest expense, net
   
42
       
43
       
83
       
96
 
Income Before Income Taxes
   
379
       
351
       
702
       
649
 
Income tax provision
   
90
       
45
       
168
       
124
 
Net Income – including noncontrolling interest
   
289
       
306
       
534
       
525
 
Net Income – noncontrolling interest
   
3
       
3
       
7
       
4
 
Net Income – YUM! Brands, Inc.
 
$
286
     
$
303
     
$
527
     
$
521
 
                                       
Basic Earnings Per Common Share
 
$
0.61
     
$
0.65
     
$
1.11
     
$
1.11
 
                                       
Diluted Earnings Per Common Share
 
$
0.59
     
$
0.63
     
$
1.09
     
$
1.08
 
                                       
Dividends Declared Per Common Share
 
$
0.21
     
$
0.38
     
$
0.42
     
$
0.38
 
                                       
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
 
   
6/12/10
   
6/13/09
 
Cash Flows – Operating Activities
                 
Net Income – including noncontrolling interest
 
$
534
     
$
525
 
Depreciation and amortization
   
256
       
246
 
Closures and impairment (income) expenses
   
16
       
26
 
Refranchising (gain) loss
   
53
       
(13
)
Contributions to defined benefit pension plans
   
(19
)
     
(92
)
Gain upon consolidation of a former unconsolidated affiliate in China
   
       
(68
)
Deferred income taxes
   
(78
)
     
(29
)
Equity income from investments in unconsolidated affiliates
   
(20
)
     
(17
)
Distributions of income received from unconsolidated affiliates
   
8
       
8
 
Excess tax benefits from share-based compensation
   
(23
)
     
(43
)
Share-based compensation expense
   
24
       
26
 
Changes in accounts and notes receivable
   
28
       
(2
)
Changes in inventories
   
(19
)
     
15
 
Changes in prepaid expenses and other current assets
   
2
       
(18
)
Changes in accounts payable and other current liabilities
   
29
       
(140
)
Changes in income taxes payable
   
54
       
15
 
Other, net
   
(12
)
     
56
 
Net Cash Provided by Operating Activities
   
833
       
495
 
                   
Cash Flows – Investing Activities
                 
Capital spending
   
(327
)
     
(342
)
Proceeds from refranchising of restaurants
   
83
       
63
 
Acquisition of restaurants from franchisees
   
(2
)
     
(22
)
Acquisitions and investments
   
       
(56
)
Sales of property, plant and equipment
   
13
       
8
 
Other, net
   
(6
)
     
(7
)
Net Cash Used in Investing Activities
   
(239
)
     
(356
)
                   
Cash Flows – Financing Activities
                 
Repayments of long-term debt
   
(8
)
     
(144
)
Revolving credit facilities, three months or less, net
   
(5
)
     
108
 
Short-term borrowings by original maturity
                 
   More than three months - proceeds
   
       
 
   More than three months - payments
   
       
 
   Three months or less, net
   
(3
)
     
4
 
Repurchase shares of Common Stock
   
(247
)
     
 
Excess tax benefits from share-based compensation
   
23
       
43
 
Employee stock option proceeds
   
44
       
77
 
Dividends paid on Common Stock
   
(197
)
     
(175
)
Other, net
   
(19
)
     
5
 
Net Cash Used in Financing Activities
   
(412
)
     
(82
)
Effect of Exchange Rates on Cash and Cash Equivalents
   
(5
)
     
(6
)
Net Increase in Cash and Cash Equivalents
   
177
       
51
 
Change in Cash and Cash Equivalents due to consolidation of an entity in China
   
       
17
 
Cash and Cash Equivalents - Beginning of Period
   
353
       
216
 
Cash and Cash Equivalents - End of Period
 
$
530
     
$
284
 
                   
See accompanying Notes to Condensed Consolidated Financial Statements.
                 
 
 
4

 



CONDENSED CONSOLIDATED BALANCE SHEETS
YUM! BRANDS, INC. AND SUBSIDIARIES
(in millions)
   
(Unaudited)
     
   
6/12/10
   
12/26/09
ASSETS
                 
Current Assets
                 
Cash and cash equivalents
 
$
530
     
$
353
 
Accounts and notes receivable, net
   
260
       
239
 
Inventories
   
138
       
122
 
Prepaid expenses and other current assets
   
340
       
314
 
Deferred income taxes
   
107
       
81
 
Advertising cooperative assets, restricted
   
89
       
99
 
Total Current Assets
   
1,464
       
1,208
 
                   
Property, plant and equipment, net
   
3,694
       
3,899
 
Goodwill
   
613
       
640
 
Intangible assets, net
   
444
       
462
 
Investments in unconsolidated affiliates
   
132
       
144
 
Other assets
   
529
       
544
 
Deferred income taxes
   
269
       
251
 
Total Assets
 
$
7,145
     
$
7,148
 
                   
LIABILITIES AND SHAREHOLDERS’ EQUITY
                 
Current Liabilities
                 
Accounts payable and other current liabilities
 
$
1,338
     
$
1,413
 
Income taxes payable
   
69
       
82
 
Short-term borrowings
   
717
       
59
 
Advertising cooperative liabilities
   
89
       
99
 
Total Current Liabilities
   
2,213
       
1,653
 
                   
Long-term debt
   
2,518
       
3,207
 
Other liabilities and deferred credits
   
1,188
       
1,174
 
Total Liabilities
   
5,919
       
6,034
 
                   
Shareholders’ Equity
                 
Common Stock, no par value, 750 shares authorized; 467 shares and 469 shares
issued in 2010 and 2009, respectively
   
87
       
253
 
Retained earnings
   
1,325
       
996
 
Accumulated other comprehensive income (loss)
   
(263)
       
(224
)
Total Shareholders’ Equity – YUM! Brands, Inc.
   
1,149
       
1,025
 
Noncontrolling interest
   
77
       
89
 
Total Shareholders’ Equity
   
1,226
       
1,114
 
Total Liabilities and Shareholders’ Equity
 
$
7,145
     
$
7,148
 
                   
See accompanying Notes to Condensed Consolidated Financial Statements.
                 

 
5

 

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

Note 1 - Financial Statement Presentation

We have prepared our accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information.  Accordingly, they do not include all of the information and footnotes required by Generally Accepted Accounting Principles (“GAAP”) in the United States (“U.S.”) 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 26, 2009 (“2009 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 2009 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:  YUM Restaurants China (“China Division”), YUM Restaurants International (“YRI” or “International Division”) and United States.  The China Division includes mainland China (“China”) and YRI includes the remainder of our international operations.

At the beginning of 2010 we began reporting information for our Thailand and KFC Taiwan businesses within our International Division as a result of changes to our management reporting structure.  These businesses now report to the President of YRI, whereas previously they reported to the President of the China Division.  While this reporting change did not impact our consolidated results, segment information for previous periods has been restated to be consistent with the current period presentation throughout the Financial Statements and Notes thereto.  For the quarter and year to date ended June 13, 2009 this restatement resulted in a decrease in Company sales of $64 million and $111 million, respectively, for the China Division.  For the quarter and year to date ended June 13, 2009, this restatement resulted in an insignificant impact on and a decrease to operating profit of $3 million, respectively, for the China Division. Any impact of the restatement on the China Division reported figures was offset by the impact to the International Division reported figures.

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.

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 increase in cash related to the consolidation of this entity’s cash balance ($17 million) is presented as a single line item on our Condensed Consolidated Statement of Cash Flows.

Our preparation of the accompanying Financial Statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Financial Statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from 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 2009 Form 10-K, our financial position as of June 12, 2010, and the results of our operations for the quarters and years to date ended June 12, 2010 and June 13, 2009 and cash flows for the years to date ended June 12, 2010 and June 13, 2009.  Our results of operations and cash flows for these interim periods are not necessarily indicative of the results to be expected for the full year.

 
6

 



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.

Note 2 - Earnings Per Common Share (“EPS”)

   
Quarter ended
   
Year to date
   
6/12/10
     
6/13/09
     
6/12/10
     
6/13/09
 
Net Income – YUM! Brands, Inc.
 
$
286
     
$
303
     
$
527
     
$
521
 
                                       
Weighted-average common shares outstanding (for basic calculation)
   
473
       
470
       
474
       
468
 
Effect of dilutive share-based employee compensation
   
12
       
13
       
11
       
13
 
Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)
   
485
       
483
       
485
       
481
 
Basic EPS
 
$
0.61
     
$
0.65
     
$
1.11
     
$
1.11
 
Diluted EPS
 
$
0.59
     
$
0.63
     
$
1.09
     
$
1.08
 
Unexercised employee stock options and stock appreciation rights (in millions) excluded from the diluted EPS computation(a)
   
0.9
       
13.9
       
4.7
       
14.6
 

(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 June 12, 2010, as indicated below.  All amounts exclude applicable transaction fees.  We had no share repurchases in the year to date ended June 13, 2009.

 
     
Shares Repurchased (thousands)
 
Dollar Value of Shares Repurchased
 
Remaining Dollar Value of Shares that may be Repurchased
Authorization Date
 
Authorization Expiration Date
   
2010
     
2010
       
 
2010
 
September 2009
 
September 2010
   
6,848
       
$
252
     
$
48
 
March 2010
 
March 2011
   
         
       
300
 
Total
       
6,848
       
$
252
(a)
   
$
348
 
                                   

(a)
Amount includes the effect of $5 million in share repurchases (0.1 million shares) with trade dates prior to June 12, 2010 but with settlement dates subsequent to June 12, 2010.


 
7

 



Comprehensive income was as follows:
   
Quarter ended
 
Year to date
   
6/12/10
 
6/13/09
 
6/12/10
   
6/13/09
Net Income – YUM! Brands, Inc.
 
$
286
   
$
303
   
$
527
     
$
521
 
Foreign currency translation adjustment
   
(16
)
   
73
     
(47
)
     
65
 
Changes in fair value of derivatives, net of tax
   
10
     
(12
)
   
34
       
1
 
Reclassification of derivative (gains) losses to Net Income, net of tax
   
(13
)
   
12
     
(35
)
     
7
 
Reclassification of pension actuarial losses to Net Income,
net of tax
   
5
     
3
     
9
       
5
 
Total comprehensive income
 
$
272
   
$
379
   
$
488
     
$
599
 

A reconciliation of the beginning and ending carrying amount of the equity attributable to noncontrolling interests is as follows:
 
 
Noncontrolling interest as of December 26, 2009
$
89
   
 
Net Income – noncontrolling interest
 
7
   
 
Dividends declared
 
(19
)
 
 
Noncontrolling interest as of June 12, 2010
$
77
   
 
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 2010 and 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 June 12, 2010, we recorded a pre-tax refranchising gain of $5 million and a pre-tax refranchising loss of $51 million, respectively, in the U.S.  In the quarter and year to date ended June 13, 2009, we recorded pre-tax gains of $1 million and $15 million, respectively, from refranchising in the U.S.  The loss recorded in the year to date ended June 12, 2010 is the net result of gains from 71 restaurants sold and non-cash impairment charges related to our offers to refranchise restaurants in the U.S. in the quarter ended March 20, 2010, principally a substantial portion of our Company operated KFC restaurants.  See the Facility Actions section for further detail.

In connection with our G&A productivity initiatives and realignment of resources we recorded pre-tax charges of $2 million and $5 million in the quarters ended June 12, 2010 and June 13, 2009, respectively, and pre-tax charges of $5 million and $9 million in the years to date ended June 12, 2010 and June 13, 2009, respectively.  The unpaid current liability for the severance portion of these charges was $3 million as of June 12, 2010.  Severance payments in the quarter and year to date ended June 12, 2010 totaled approximately $2 million and $4 million, respectively.

Additionally, the Company recognized a reduction to Franchise and license fees and income of $4 million and $31 million pre-tax, in the quarter and year to date ended June 13, 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.  The reimbursements were recorded as a reduction to franchise and license fees and income as we would not have provided the reimbursements absent the ongoing franchise relationship.

 
8

 



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.  Additionally , we are not including the depreciation reduction of $3 million for the quarter ended June 12, 2010 arising from the impairment of the KFCs offered for sale in the quarter ended March 20, 2010 within our U.S. segment for performance reporting purposes.  Rather, we are recording such reduction as a credit within unallocated Occupancy and other operating expenses resulting in depreciation expense for these restaurants continuing to be recorded in the U.S. segment at the rate at which it was prior to the impairment charge being recorded.

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.  Prior to our acquisition of this additional interest this entity was 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.  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 GAAP, 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.

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 we have reported the results of operations for the entity in the appropriate line items of our Condensed Consolidated Statements 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 in Net Income – noncontrolling interest.  For the quarter and year to date ended June 12, 2010 the consolidation of the existing restaurants upon acquisition increased Company sales by $46 million and $98 million, respectively, and decreased Franchise and license fees and income by $3 million and $6 million, respectively.  For the quarter and year to date ended June 12, 2010, the consolidation of the existing restaurants upon acquisition increased Operating Profit by $1 million and $3 million, respectively.

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

 
9

 



Facility Actions

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

   
Quarter ended June 12, 2010
   
China
Division
   
YRI
   
U.S.
   
Worldwide
Refranchising (gain) loss(a)
 
$
(4
)
   
$
(1
)
   
$
(5
)
   
$
(10
)
                                       
Store closure (income) costs(d)
 
$
     
$
(1
)
   
$
     
$
(1
)
Store impairment charges
   
5
       
2
       
6
       
13
 
Closure and impairment (income) expenses
 
$
5
     
$
1
     
$
6
     
$
12
 

   
Quarter ended June 13, 2009
   
China
Division
   
YRI
   
U.S.
   
Worldwide
Refranchising (gain) loss(a)
 
$
     
$
2
     
$
(1
)
   
$
1
 
                                       
Store closure (income) costs(d)
 
$
(1
)
   
$
     
$
2
     
$
1
 
Store impairment charges
   
4
       
5
       
12
       
21
 
Closure and impairment (income) expenses
 
$
3
     
$
5
     
$
14
     
$
22
 

   
Year to date ended June 12, 2010
   
China
Division
   
YRI
   
U.S.
   
Worldwide
Refranchising (gain) loss(a)(b)(c)
 
$
(4
)
   
$
6
     
$
51
     
$
53
 
                                       
Store closure (income) costs(d)
 
$
     
$
(1
)
   
$
1
     
$
 
Store impairment charges
   
5
       
4
       
7
       
16
 
Closure and impairment (income) expenses
 
$
5
     
$
3
     
$
8
     
$
16
 


 
10

 



   
Year to date ended June 13, 2009
   
China
Division
   
YRI
   
U.S.
   
Worldwide
Refranchising (gain) loss(a)
 
$
     
$
2
     
$
(15
)
   
$
(13
)
                                       
Store closure (income) costs(d)
 
$
     
$
1
     
$
3
     
$
4
 
Store impairment charges
   
4
       
5
       
13
       
22
 
Closure and impairment (income) expenses
 
$
4
     
$
6
     
$
16
     
$
26
 


(a)
Refranchising (gain) loss is not allocated to segments for performance reporting purposes.
   
(b)
During the quarter ended March 20, 2010 we refranchised all of our remaining company restaurants in Taiwan, which consisted of 124 KFCs.  We included in our financial statements a non-cash write off of $7 million of goodwill in determining the loss on refranchising of Taiwan.  The amount of goodwill write-off was based on the relative fair values of the Taiwan business disposed of and the portion of the business that was retained.  The fair value of the business disposed of was determined by reference to the discounted value of the future cash flows expected to be generated by the restaurants and retained by the franchisee, which include a deduction for the anticipated royalties the franchisee will pay the Company associated with the franchise agreement entered into in connection with this refranchising transaction. The fair value of the Taiwan business retained consists of expected, net cash flows to be derived from royalties from franchisees, including the royalties associated with the franchise agreement entered into connection with this refranchising transaction.  We believe the terms of the franchise agreement entered into in connection with the Taiwan refranchising are substantially consistent with market.  The remaining carrying value of goodwill related to our Taiwan business of $30 million, after the aforementioned write-off, was determined not to be impaired as the fair value of the Taiwan reporting unit exceeds its carrying amount.
   
(c)
U.S. refranchising loss for the year to date ended June 12, 2010 is the net result of gains from 71 restaurants sold and non-cash impairment charges related to our offers to refranchise restaurants in the U.S.  During the quarter ended March 20, 2010 we offered to refranchise a substantial portion of our Company operated KFCs in the U.S.  While we do not yet believe this restaurant group meets the criteria to be classified as held for sale, we did, consistent with our historical policy, review the restaurant group for impairment as a result of our offer to refranchise.  We determined that the carrying value of the restaurant group was not recoverable based upon our estimate of expected refranchising proceeds and holding period cash flows anticipated while we continue to operate the restaurants as company units.  Accordingly, we wrote this restaurant group down to our estimate of its fair value, which is based on the sales price we would expect to receive from a franchisee for the restaurant group.  This fair value determination considered current market conditions, real-estate values, trends in the KFC-U.S. business, prices for similar transactions in the restaurant industry and preliminary offers for the restaurant group to date and resulted in a non-cash write down of the restaurants’ carrying value totaling $73 million.  No further impairment was recorded in the quarter ended June 12, 2010 as we believe the current carrying value of the restaurants, adjusted for the write down described in the previous sentence, is recoverable at June 12, 2010.  We continued to depreciate the pre-impairment charge carrying value of these restaurants through the quarter ended March 20, 2010  and in the quarter ended June 12, 2010 continued to depreciate the post-impairment charge carrying value.  We will continue to depreciate the post-impairment charge carrying value going forward until the date we believe the held for sale criteria for the restaurant group are met.  Additionally, we will continue to review the restaurant group for any further necessary impairment.  The $73 million write down does not include any allocation of the KFC reporting unit goodwill in the restaurant group carrying value.  This additional non-cash write down would be recorded, consistent with our historical policy, if the restaurant group ultimately  meets the criteria to be classified as held for sale.  If the restaurant group is ultimately sold, we will also be required to record a charge for the fair value of our guarantee of future lease payments for leases we assign to the franchisee.
 

 
11

 


   
(d)
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 June 12, 2010 and December 26, 2009 total $26 million and $32 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.

Note 5 - Recently Adopted Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued new guidance and clarifications for improving disclosures about fair value measurements.  This guidance requires enhanced disclosures regarding transfers in and out of the levels within the fair value hierarchy.  Separate disclosures are required for transfers in and out of Level 1 and 2 fair value measurements, and the reasons for the transfers must be disclosed.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009.

In June 2009, the FASB issued guidance on transfers and servicing of financial assets, requiring more information about transfers of financial assets, eliminating the qualifying special purpose entity concept, changing the requirements for derecognizing financial assets and requiring additional disclosures.  The FASB also issued guidance for determining whether an entity is a variable interest entity, that modifies the methods allowed for determining the primary beneficiary of a variable interest entity, that requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and that requires enhanced disclosures related to an enterprise’s involvement in a variable interest entity.  The adoption of this guidance did not impact the Company’s Condensed Consolidated Financial Statements for the quarter or year to date ended June 12, 2010.  See Note 13 for additional information on an entity that operates a lending program on behalf of the Company’s franchisees.


 
12

 



Note 6 - Other (Income) Expense

   
Quarter ended
 
Year to date
   
6/12/10
 
6/13/09
 
6/12/10
 
6/13/09
Equity income from investments in unconsolidated affiliates
 
$
(8
)
 
$
(7
)
 
$
(20
)
 
$
(17
)
Gain upon consolidation of former unconsolidated affiliate in China(a)
   
     
(68
)
   
     
(68
)
Foreign exchange net (gain) loss and other
   
(2
)
   
     
     
1
 
Other (income) expense
 
$
(10
)
 
$
(75
)
 
$
(20
)
 
$
(84
)

(a)
See Note 4 for further discussion of the consolidation of a former unconsolidated affiliate in China.
 
Note 7 – Supplemental Balance Sheet Information

   
6/12/10
   
12/26/09
Accounts and notes receivable
 
$
294
     
$
274
 
Allowance for doubtful accounts
   
(34
)
     
(35
)
Accounts and notes receivable, net
 
$
260
     
$
239
 

Accounts and notes receivable consist primarily of amounts due from franchisees and licensees, including initial and continuing fees.  The financial condition of these franchisees and licensees is largely dependent upon the underlying business trends of our concepts.  This concentration of credit risk is mitigated, in part, by the large number of franchisees and licensees of each concept and the short-term nature of the franchisee and licensee fee receivables.

   
6/12/10
   
12/26/09
Property, plant and equipment, gross
 
$
7,081
     
$
7,247
 
Accumulated depreciation and amortization
   
(3,387
)
     
(3,348
)
Property, plant and equipment, net
 
$
3,694
     
$
3,899
 

Note 8 – Income Taxes

   
Quarter ended
 
Year to date
   
6/12/10
 
6/13/09
 
6/12/10
 
6/13/09
Income taxes
 
$
90
   
$
45
   
$
168
   
$
124
 
Effective tax rate
   
23.8
%
   
12.8
%
   
24.0
%
   
19.1
%

Our second quarter and year to date 2010 and 2009 effective tax rates were 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.

Our second quarter 2010 rate was higher than the prior year primarily due to lapping certain items from 2009.  These items include: the reversal of foreign valuation allowances associated with certain deferred tax assets we now believe are more likely than not to be utilized on future tax returns; a one-time $68 million gain recognized upon our acquisition of additional interest in, and consolidation of, the entity that operates the KFCs in Shanghai, China, which resulted in no related tax expense; and adjustments to reserves in certain foreign jurisdictions and prior year foreign tax credit balances.

Year to date, our effective tax rate was higher than the prior year due to lapping 2009 items, as described above.  This was partially offset by the favorable impact of foreign and U.S. tax effects attributable to ongoing foreign operations, including a recent foreign law change.

 
13

 



On June 23, 2010, the Company received a Revenue Agent Report (“RAR”) from the Internal Revenue Service (the “IRS”) relating to its examination of our U.S. federal income tax returns for fiscal years 2004 through 2006.  The RAR includes a proposed adjustment related to buy-in payments in connection with the sale of ownership rights of trademarks and systems between Yum and certain foreign subsidiaries.  The proposed adjustment would result in additional taxable income of approximately $2 billion for these years and approximately $700 million of additional taxes plus net interest to date of approximately $140 million.  Furthermore, if the IRS prevails it is likely to make similar claims for years subsequent to fiscal 2006.  The potential additional taxes for these later years, through 2009, computed on a similar basis to the 2004-2006 additional taxes, would be approximately $280 million plus net interest to date of approximately $15 million.

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


 
14

 

 


Note 9 - Reportable Operating Segments

We identify our operating segments based on management responsibility.  The China Division includes mainland China and YRI includes the remainder of our international operations.  See Note 1 regarding a 2010 change in segments impacting the China Division and YRI.  In the U.S., we consider LJS and A&W to be a single operating segment.  We consider our KFC-U.S., Pizza Hut-U.S., Taco Bell-U.S. and LJS/A&W-U.S. operating segments to be similar and therefore have aggregated them into a single reportable operating segment.

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

   
Quarter ended
 
Year to date
Revenues
 
6/12/10
 
6/13/09
 
6/12/10
 
6/13/09
China Division
 
$
887
   
$
728
   
$
1,595
   
$
1,297
 
YRI(a)
   
693
     
653
     
1,397
     
1,282
 
U.S.
   
994
     
1,099
     
1,927
     
2,145
 
Unallocated Franchise and license fees and income(b)(c)
   
     
(4
)
   
     
(31
)
   
$
2,574
   
$
2,476
   
$
4,919
   
$
4,693
 

   
Quarter ended
 
Year to date
Operating Profit
 
6/12/10
 
6/13/09
 
6/12/10
 
6/13/09
China Division (d)
 
$
139
   
$
105
   
$
315
   
$
233
 
YRI
   
122
     
100
     
263
     
226
 
United States
   
184
     
169
     
327
     
326
 
Unallocated Franchise and license fees and income(b)(c)
   
     
(4
)
   
     
(31
)
Unallocated Occupancy and other(c)
   
3
     
     
3
     
 
Unallocated and corporate expenses(c)
   
(37
)
   
(43
)
   
(70
)
   
(89
)
Unallocated Other income (expense)(c)(e)
   
     
68
     
     
67
 
Unallocated Refranchising gain (loss)(c)
   
10
     
(1
)
   
(53
)
   
13
 
Operating Profit
   
421
     
394
     
785
     
745
 
Interest expense, net
   
(42
)
   
(43
)
   
(83
)
   
(96
)
Income Before Income Taxes
 
$
379
   
$
351
   
$
702
   
$
649
 

(a)
Includes revenues of $247 million and $236 million for the quarters ended June 12, 2010 and June 13, 2009, respectively, and $504 million and $469 million for the years to date ended June 12, 2010 and June 13, 2009, respectively, for entities in the United Kingdom.
   
(b)
Amount consists of reimbursements to KFC franchisees for installation costs of ovens for the national launch of Kentucky Grilled Chicken (See Note 4).
   
(c)
Amounts have not been allocated to the China Division, YRI or U.S. segments for performance reporting purposes.
   
(d)
Includes equity income from investments in unconsolidated affiliates of $8 million and $7 million for the quarters ended June 12, 2010 and June 13, 2009, respectively, and $20 million and $17 million for the years to date ended June 12, 2010 and June 13, 2009, respectively.
   
(e)
The quarter and year to date ended June 13, 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.


 
15

 


Note 10 - Pension Benefits

We sponsor noncontributory defined benefit pension plans covering certain full-time salaried and hourly U.S. employees.  The most significant of these plans, the YUM Retirement Plan (the “Plan”), is funded while benefits from the other U.S. plan are paid by the Company as incurred.  During 2001, the plans covering our U.S. salaried employees were amended such that any salaried employee hired or rehired by YUM after September 30, 2001 is not eligible to participate in those plans.  We also sponsor various defined benefit pension plans covering certain of our non-U.S. employees, the most significant of which are in the 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
   
6/12/10
   
6/13/09
   
6/12/10
   
6/13/09
Service cost
 
$
6
     
$
6
     
$
2
     
$
1
 
Interest cost
   
14
       
14
       
2
       
1
 
Expected return on plan assets
   
(16
)
     
(14
)
     
(3
)
     
(2
)
Amortization of net loss
   
6
       
3
       
1
       
1
 
Net periodic benefit cost
 
$
10
     
$
9
     
$
2
     
$
1
 

   
U.S. Pension Plans
   
International Pension Plans
   
Year to date
   
Year to date
   
6/12/10
   
6/13/09
   
6/12/10
   
6/13/09
Service cost
 
$
12
     
$
12
     
$
3
     
$
2
 
Interest cost
   
28
       
27
       
4
       
3
 
Expected return on plan assets
   
(32
)
     
(27
)
     
(5
)
     
(3
)
Amortization of net loss
   
11
       
6
       
1
       
1
 
Net periodic benefit cost
 
$
19
     
$
18
     
$
3
     
$
3
 

We made no contributions to the Plan during the year to date ended June 12, 2010 and no contributions to the Plan are anticipated in 2010.  We made contributions of $15 million to our U.K. Plans during the year to date ended June 12, 2010.

Note 11 - Derivative Instruments

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

We enter into interest rate swaps with the objective of reducing our exposure to interest rate risk and lowering interest expense for a portion of our fixed-rate debt.  At June 12, 2010, our interest rate derivative instruments outstanding had notional amounts of $925 million and have been designated as fair value hedges of a portion of our debt.  The critical terms of these swaps, including reset dates and floating rate indices match those of our underlying fixed-rate debt and no ineffectiveness has been recorded.

 
16

 



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 June 12, 2010, foreign currency forward contracts outstanding had a total notional amount of $368 million.

The fair values of derivatives designated as hedging instruments as of June 12, 2010 and December 26, 2009 were:
               
   
6/12/2010
 
12/26/09
 
Condensed Consolidated Balance Sheet Location
 
 
Interest Rate Swaps - Asset
$
15
 
$
 
Prepaid expenses and other current assets
 
 
Interest Rate Swaps - Asset
 
31
   
44
 
Other assets
 
 
Foreign Currency Forwards - Asset
 
36
   
6
 
Prepaid expenses and other current assets
 
 
Foreign Currency Forwards - Liability
 
(4)
   
(3)
 
Accounts payable and other current liabilities
 
 
Total
$
78
 
$
47
     

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 $12 million and $26 million to Short-term borrowings and long-term debt, respectively, at June 12, 2010 and as an addition of $36 million to long-term debt at December 26, 2009.  During the quarter and year to date ended June 12, 2010, Interest expense, net was reduced by $8 million and $15 million, respectively, for recognized gains on these interest rate swaps.  During the quarter and year to date ended June 13, 2009, Interest expense, net was reduced by $15 million and $18 million, respectively for recognized gains on these interest rate swaps.

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:

   
Quarter ended
   
Year to date
   
6/12/10
   
6/13/09
   
6/12/10
   
6/13/09
Gains (losses) recognized into OCI, net of tax
 
$
10
     
$
(12
)
   
$
34
     
$
1
 
Gains (losses) reclassified from Accumulated OCI into income, net of tax
 
$
13
     
$
(12
)
   
$
35
     
$
(7
)

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 quarters and years to date ended June 12, 2010 and June 13, 2009.

Additionally, we had a net deferred loss of $13 million, net of tax, as of June 12, 2010 within Accumulated OCI due to treasury locks and forward starting interest rate swaps that have been cash settled, as well as outstanding foreign currency forward contracts.  The majority of this loss arose from the settlement of forward stating interest rate swaps entered into prior to the issuance of our Senior Unsecured Notes due in 2037, and is being reclassed into earnings through 2037 to interest expense.  In the quarters and years to date ended June 12, 2010 and June 13, 2009, an insignificant amount was reclassified from Accumulated OCI to Interest expense, net as a result of 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 June 12, 2010, 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.

 
17

 


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 and the level within the fair value hierarchy in which the measurements fall.  No transfers among the levels within the fair value hierarchy occurred during the year to date ended June 12, 2010.

       
Fair Value
       
Level
 
6/12/10
 
12/26/09
Foreign Currency Forwards, net
           
2
   
$
32
   
$
3
 
Interest Rate Swaps, net
           
2
     
46
     
44
 
Other Investments
           
1
     
13
     
13
 
Total
                 
$
91
   
$
60
 

The fair value of the Company’s foreign currency forwards and interest rate swaps were determined based on the present value of expected future cash flows considering the risks involved, including nonperformance risk, and using discount rates appropriate for the duration based upon observable inputs.  The other investments include investments in mutual funds, which are used to offset fluctuations in deferred compensation liabilities that employees have chosen to invest in phantom shares of a Stock Index Fund or Bond Index Fund.  The other investments are classified as trading securities and their fair value is determined based on the closing market prices of the respective mutual funds as of June 12, 2010 and December 26, 2009.

In the quarter and year to date ended June 12, 2010, we recorded impairment charges of $10 million and $87 million, respectively, to write down long-lived assets of certain restaurants or groups of restaurants to their estimated fair values.  The long-lived assets of these restaurants were deemed to be impaired on a held for use basis.  The fair value measurements used in these impairment evaluations were made using significant unobservable inputs (Level 3).  The $10 million impairment charge in the quarter ended June 12, 2010 was recorded in Closures and impairment (income) expenses.  Of the $87 million impairment charge recorded in the year to date June 12, 2010, $10 million was recorded in Closures and impairment (income) expenses and $77 million was recorded in Refranchising (gain) loss.
 
In both the quarter and year to date ended June 12, 2010, we recorded impairment charges of $10 million in Closure and impairment (income) expenses resulting from our semi-annual impairment evaluation of  long lived assets of individual restaurants that are currently being operated and have not been offered for refranchising.  In the year to date ended June 12, 2010, we recorded non-cash impairment charges of $77 million in Refranchising (gain) loss to write down the long-lived assets of restaurant groups being offered for refranchising to their estimated fair value.  The long-lived assets of these restaurant groups, which consist of approximately 650 restaurants, were deemed impaired on a held for use basis.  The fair values used in our impairment evaluations were an estimate of the sales prices we would anticipate receiving from a franchisee for the restaurants groups.
 
At June 12, 2010 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 billion.  We estimated the fair value of debt using market quotes and calculations based on market rates.

 
18

 
 
 
 
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 2026.  As of June 12, 2010, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessee was approximately $500 million.  The present value of these potential payments discounted at our pre-tax cost of debt at June 12, 2010 was approximately $425 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 June 12, 2010 was not material.

Franchise Loan Pool and Equipment Guarantees

We have agreed to provide financial support, if required, to a variable interest entity that operates a franchisee lending program used primarily to assist franchisees in the development of new restaurants and, to a lesser extent, in connection with the Company’s historical refranchising programs.  As part of this agreement, we have provided a partial guarantee of approximately $15 million and two letters of credit totaling approximately $23 million in support of the franchisee loan program at June 12, 2010.  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 $61 million with an additional $19 million available for lending at June 12, 2010.  We have determined that we are not required to consolidate this entity as we share the power to direct this entity’s lending activity with other parties.

In addition to the guarantee described above, YUM has provided guarantees of $33 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 $37 million at June 12, 2010.

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, product 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 June 12, 2010 and December 26, 2009, we had liabilities recorded for self-insured property and casualty losses of $160 million and $173 million, respectively.


 
19

 
 
 
 
In the U.S. and in certain other countries, we are also self-insured for healthcare claims and for long-term disability claims for eligible participating employees subject to certain deductibles and limitations.  We have accounted for our retained liabilities for property and casualty losses, healthcare and long-term disability claims, including 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.
 

 
20

 


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.

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 (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, on February 28, 2009, and again on November 18, 2009 without reaching resolution.  Arbitration on liability during a portion of the alleged restitution policy period began in November, 2009 and, after a delay at the request of the plaintiffs, concluded in June, 2010 and a ruling on liability for that portion of the policy period is expected in August.  Arbitration with respect to the remaining alleged restitution policy period has not been scheduled.

Based on the rulings issued to date in this matter, the Cole Arbitration is proceeding 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 a reasonable settlement value of Claimants’ claims.  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 Cole Arbitration will not result in losses in excess of those currently provided for in our Condensed Consolidated Financial Statements.

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 since August 2002.  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.

 
21

 



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.  On January 29, 2010, the court granted the plaintiffs’ class certification motion with respect to the unpaid overtime claims of RGMs and Market Training Managers but denied class certification on the meal period claims.  The parties participated in mediation on May 26, 2010 without reaching resolution.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit.  We have provided for a reasonable estimate of the cost of this lawsuit.  However, in view of the inherent uncertainties of litigation, there can be no assurance that this lawsuit will not result in losses in excess of those currently provided for in our Condensed Consolidated Financial Statements.

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 at corporate-owned restaurants in California since September 2003 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.

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.  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.

On May 19, 2009 the court granted Taco Bell’s motion to consolidate the Medlock, Hardiman, Leyva and Naranjo matters, and the consolidated case is styled In Re Taco Bell Wage and Hour Actions.  On July 22, 2009, Taco Bell filed a motion to dismiss, stay or consolidate the Widjaja case with the In Re Taco Bell Wage and Hour Actions, and Taco Bell’s motion to consolidate was granted on October 19, 2009.

 
22

 



The In Re Taco Bell Wage and Hour Actions plaintiffs filed a consolidated complaint on June 29, 2009, and on March 30, 2010 the court approved the parties’ stipulation to dismiss YUM from the action.  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.

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 28, 2009, a putative class action styled Marisela Rosales v. Taco Bell Corp. was filed in Orange County Superior Court.  The plaintiff, a former Taco Bell crew member, alleges that Taco Bell failed to timely pay her final wages upon termination, and seeks restitution and late payment penalties on behalf of herself and similarly situated employees.  This case appears to be duplicative of the In Re Taco Bell Wage and Hour Actions case described above.  Taco Bell removed the case to federal court on November 5, 2009, and subsequently filed a motion to dismiss, stay or transfer the case to the same district court as the In Re Taco Bell Wage and Hour Actions case.  The parties stipulated to remand of the case to Orange County Superior Court on March 18, 2010.  The state court granted Taco Bell’s motion to stay the Rosales case on May 28, 2010, but required Taco Bell to give notice to Rosales’ counsel of the In Re Taco Bell Wage and Hour Actions mediation.

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 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.  Plaintiff filed his opening appellate brief on March 31, 2010, KFC filed its opposition brief on May 28, 2010 and plaintiff filed his reply brief on June 25, 2010.

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 October 2, 2009, a putative class action, styled Domonique Hines 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.  Plaintiff is a current non-managerial KFC restaurant employee represented by the same counsel that filed the Archila action described above.  KFC filed an answer on October 28, 2009, in which it denied plaintiff’s claims and allegations.  KFC removed the action to the United States District Court for the Southern District of California on October 29, 2009.  KFC filed a motion to transfer the action to the Central District of California due to the overlapping nature of the claims in this action and the Archila action.  Plaintiff filed a motion to remand the action to state court.  The District Court denied both motions.  Plaintiff filed a motion for class certification on May 20, 2010, and a hearing with respect to plaintiff’s motion, which KFC has opposed, is scheduled for July 30, 2010.  Discovery with respect to the class certification motion is ongoing.  No trial date has been set.

 
23

 



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.

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.  On December 16, 2009, the court denied Taco Bell’s motion for summary judgment on the ADA claims and ordered plaintiff to file a definitive list of remaining issues and to select one restaurant to be the subject of a trial. The trial will be bifurcated and the first stage will address equitable relief and whether violations existed at the restaurant.  Taco Bell will have the opportunity to renew its motion for summary judgment on those issues.  Depending on the findings in the first stage of the trial, the court may address the issue of damages in a separate, second stage.

Taco Bell denies liability and intends to vigorously defend against all claims in this lawsuit.  Taco Bell has taken steps to address potential architectural and structural compliance issues at the restaurants in accordance with applicable state and federal disability access laws.  The costs associated with addressing these issues have not significantly impacted our results of operations.  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.

 
24

 



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, alleged 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.  On January 6, 2010 the court heard oral arguments on Boskovich’s motion to vacate and took the matter under submission.  On March 24, 2010, the court denied plaintiff’s motion and confirmed the arbitration award.  Boskovich appealed to the Kentucky Court of Appeals on April 23, 2010.  Taco Bell filed its response on May 19, 2010 and reserved the right to seek attorneys’ fees for the cost of the appeals.  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 January 4, 2010, plaintiffs filed a motion for conditional certification of a nationwide class of current and former Pizza Hut, Inc. delivery drivers.  However, on March 11, 2010, the court granted Pizza Hut’s pending motion to dismiss for failure to state a claim, with leave to amend.  On March 31, 2010, plaintiffs filed an amended complaint, which in addition to the federal FLSA claims asserts state-law class action claims under the laws of 16 different states.  Pizza Hut has filed a motion to dismiss the amended complaint.

Pizza Hut 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 these cases cannot be predicted at this time.  Likewise, the amount of any potential loss cannot be reasonably estimated.

We are engaged in various other legal proceedings and have certain unresolved claims pending, the ultimate liability for which, if any, cannot be determined at this time.  However, based upon consultation with legal counsel, we are of the opinion that such proceedings and claims are not expected to have a material adverse effect, individually or in the aggregate, on our consolidated financial condition or results of operations.





 
25

 


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

Introduction and Overview

The following Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with the unaudited Condensed Consolidated Financial Statements (“Financial Statements”), the Cautionary Note Regarding Forward-Looking Statements and our annual report on Form 10-K for the fiscal year ended December 26, 2009 (“2009 Form 10-K”).  Throughout the MD&A, YUM! Brands, Inc. (“YUM” or the “Company”) makes reference to certain performance measures as described below.

·
The Company provides the percentage changes excluding the impact of foreign currency translation (“FX” or “Forex”).  These amounts are derived by translating current year results at prior year average exchange rates.  We believe the elimination of the foreign currency translation impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.
   
·
System sales growth includes the results of all restaurants regardless of ownership, including Company-owned, franchise, unconsolidated affiliate and license restaurants that operate our concepts.  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 profit is defined as Company sales less expenses incurred directly by our Company restaurants in generating Company sales.  Company restaurant margin as a percentage of sales is defined as Company restaurant profit divided by Company sales.
 
 
·
Operating margin is defined as Operating Profit divided by Total revenues.

All Note references herein refer to the accompanying Notes to the Condensed Consolidated Financial Statements.  Tabular amounts are displayed in millions except per share and unit count amounts, or as otherwise specifically identified.

 
26

 



Description of Business

YUM is the world’s largest restaurant company based on number of system units, with over 37,000 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 37,000 restaurants, 20% are operated by the Company, 74% are operated by franchisees and unconsolidated affiliates and 6% are operated by licensees.

YUM’s business consists of three reporting segments:  YUM Restaurants China (“China Division”), YUM Restaurants International (“YRI” or “International Division”) and United States (“U.S.”).  The China Division includes mainland China (“China”) and YRI includes the remainder of our international operations.  The China Division, YRI and Taco Bell-U.S. now represent approximately 85% of the Company’s operating profits.  Our KFC-U.S. and Pizza Hut-U.S. businesses operate in a highly competitive marketplace resulting in slower profit growth, but continue to produce strong cash flows.

At the beginning of 2010 we began reporting information for our Thailand and KFC Taiwan businesses within our International Division as a result of changes to our management reporting structure.  These businesses now report to the President of YRI, whereas previously they reported to the President of our China Division.  While this reporting change did not impact our consolidated results, segment information for previous periods has been restated to be consistent with the current period presentation.

The following table summarizes the 2009 quarterly increases to selected line items within the YRI segment as a result of these segment reporting changes (with equal and offsetting decreases impacting the China Division):
                     
   
First
 
Second
 
Third
 
Fourth
   
   
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Total
Company sales
 
$
47
   
$
64
   
$
68
   
$
91
   
$
270
 
Company restaurant expenses
   
42
     
57
     
62
     
83
     
244
 
Operating Profit
   
3
     
     
1
     
2
     
6
 


 
27

 



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 China.  Additionally, the Company owns and operates the distribution system for its restaurants in China which we believe provides a significant competitive advantage.  Given this strong competitive position, a growing economy and a population of 1.3 billion in 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 in China is driven by new unit development each year and modest same store sales growth, which we expect to drive annual Operating Profit growth of 15%.

Drive Aggressive International Expansion and Build Strong Brands Everywhere – The Company and its franchisees opened over 900 new restaurants in 2009 in the Company’s International Division, representing the 10th straight year of opening over 700 restaurants, and is the leading international retail developer in terms of units opened.  The Company expects to continue to experience strong growth by building our existing markets and growing in new markets including France, Russia and India.  Through 2009 the International Division’s Operating Profit has experienced a 7 year compound annual growth rate of 10%.  Our ongoing earnings growth model includes annual Operating Profit growth of 10% driven by new unit development, modest same store sales growth, modest margin improvement and leverage of our General and Administrative (“G&A”) infrastructure for YRI.

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

Drive Industry-Leading, Long-Term Shareholder and Franchisee Value – The Company is focused on delivering high returns and returning substantial cash flows to its shareholders via dividends and share repurchases.  The Company has one of the highest returns on invested capital in the Quick Service Restaurants (“QSR”) industry.  The Company’s dividend and share repurchase programs have returned over $1 billion and $6 billion to shareholders, respectively, since 2004.  The Company is targeting an annual dividend payout ratio of 35% to 40% of net income and has increased the quarterly dividend each year since inception in 2004.  Shares are repurchased opportunistically as part of our regular capital structure decisions.

Details of our 2010 Guidance by division and updates, if available, can be found online at http://www.yum.com/investors.


 
28

 



Quarter Ended June 12, 2010 Highlights

·
Diluted EPS growth of 17% or $0.58 per share.
   
·
Worldwide operating profit grew 21% prior to foreign currency translation, including 33% in China,  10% in the U.S., and 7% in YRI.
   
·
Worldwide system sales growth prior to foreign currency translation of 4% including 15% in China, 4% in YRI, and 1% in the U.S.
   
·
Worldwide restaurant margin improvement of over 1 percentage point driven by China and the U.S.
   
·
Share repurchases, on a trade date basis, totaled $115 million for 2.8 million shares at an average price of $40 per share.
   

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

 
29

 


Results of Operations

   
Quarter ended
 
Year to date
   
6/12/10
 
6/13/09
 
% B/(W)
 
6/12/10
 
6/13/09
 
% B/(W)
Company sales
 
$
2,220
   
$
2,152
   
3
   
$
4,216
   
$
4,070
   
4
 
Franchise and license fees and income
   
354
     
324
   
9
     
703
     
623
   
13
 
Total revenues
 
$
2,574
   
$
2,476
   
4
   
$
4,919
   
$
4,693
   
5
 
Company restaurant profit
 
$
366
   
$
324
   
13
   
$
706
   
$
632
   
12
 
 
                                           
% of Company sales
   
16.5%
     
15.1%
   
1.4
 ppts
   
16.8%
     
15.5%
   
1.3
 ppts
                                             
Operating Profit
   
421
     
394
   
7
     
785
     
745
   
5
 
Interest expense, net
   
42
     
43
   
5
     
83
     
96
   
13
 
Income tax provision
   
90
     
45
   
NM
     
168
     
124
   
(36
)
Net Income – including noncontrolling interest
   
289
     
306
   
(5
)
   
534
     
525
   
2
 
Net Income – noncontrolling interest
   
3
     
3
   
(35
)
   
7
     
4
   
(78
)
Net Income – YUM! Brands, Inc.
 
$
286
   
$
303
   
(6
)
 
$
527
   
$
521
   
1
 
 
                                           
Diluted earnings per share (a)
 
$
0.59
   
$
0.63
   
(6
)
 
$
1.09
   
$
1.08
   
 

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

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

The following factors impacted comparability of operating performance for the quarters and/or years to date ended June 12, 2010 and June 13, 2009 and/or could impact comparability with the remainder of our results in 2010 or beyond.  Certain of these factors were previously discussed in our 2009 Form 10-K.

Special Items

In addition to the results provided in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) above and throughout this document, the Company has provided non-GAAP measurements which present operating results for the quarters and years to date ended June 12, 2010 and June 13, 2009 on a basis before Special Items.  Included in Special Items are the impact of measures we took to transform our U.S. business (“the U.S. business transformation measures”) including the U.S. refranchising gain (loss), the depreciation reduction arising from the impairment of KFC restaurants we offered to sell in the first quarter of 2010, charges relating to U.S. G&A productivity initiatives, realignment of resources and investments in our U.S. Brands, as well as the 2010 loss recognized upon refranchising of an equity market outside the U.S. and the 2009 gain upon our acquisition of additional ownership in, and consolidation of, the operating entity that owns the KFCs in Shanghai, China.  These amounts are further described below.

 
The Company uses earnings before Special Items as a key performance measure of results of operations for the purpose of evaluating performance internally and Special Items are not included in our China Division, YRI or U.S. segment results.  This non-GAAP measurement is not intended to replace the presentation of our financial results in accordance with GAAP.  Rather, the Company believes that the presentation of earnings before Special Items provides additional information to investors to facilitate the comparison of past and present operations, excluding items in the quarters and years to date ended June 12, 2010 and June 13, 2009 that the Company does not believe are indicative of our ongoing operations due to their size and/or nature.

 
30

 



   
Quarter ended
 
Year to date
   
6/12/10
 
6/13/09
 
6/12/10
 
6/13/09
 
Detail of Special Items
                       
Gain upon consolidation of a former unconsolidated affiliate in China
 
$
 
$
68
 
$
 
$
68
Loss upon refranchising of an equity market outside the U.S.
   
   
   
(7)
   
U.S. Refranchising gain (loss)
   
5
   
1
   
(51)
   
15
Depreciation reduction from KFC restaurants impaired upon offer to sell
   
3
   
   
3
   
Charges relating to U.S. G&A productivity initiatives and realignment of resources
   
(2)
   
(5)
   
(5)
   
(9)
Investments in our U.S. Brands
   
   
(4)
   
   
(31)
Total Special Items Income (Expense)
   
6
   
60
   
(60)
   
43
Tax Benefit (Expense) on Special Items(a)
   
(2)
   
3
   
20
   
9
Special Items Income (Expense), net of tax
 
$
4
 
$
63
 
$
(40)
 
$
52
Average diluted shares outstanding
   
485
   
483
   
485
   
481
Special Items diluted EPS
 
$
0.01
 
$
0.13
 
$
(0.08)
 
$
0.11
                         
Reconciliation of Operating Profit Before Special Items to Reported Operating Profit
                       
Operating Profit before Special Items
 
$
415
 
$
334
 
$
845
 
$
702
Special Items Income (Expense)
   
6
   
60
   
(60)
   
43
Reported Operating Profit
 
$
421
 
$
394
 
$
785
 
$
745
                         
Reconciliation of EPS Before Special Items to Reported EPS
                       
Diluted EPS before Special Items
 
$
0.58
 
$
0.50
 
$
1.17
 
$
0.97
Special Items EPS
   
0.01
   
0.13
   
(0.08)
   
0.11
Reported EPS
 
$
0.59
 
$
0.63
 
$
1.09
 
$
1.08
                         
Reconciliation of Effective Tax Rate Before Special Items to Reported Effective Tax Rate
                       
Effective Tax Rate before Special Items
   
23.6%
   
16.4%
   
24.7%
   
22.0%
Impact on Tax Rate as a result of Special Items(a)
   
0.2
   
(3.6)
   
(0.7)
   
(2.9)
Reported Effective Tax Rate
   
23.8%
   
12.8%
   
24.0%
   
19.1%

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


 
31

 



U.S. Business Transformation Measures

The U.S. business transformation measures in 2010 and 2009 included: expansion of our U.S. refranchising; a reduced emphasis on multi-branding as a long-term growth strategy; 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.  We do not believe these measures are indicative of our ongoing operations and are not including the impacts of these U.S. business transformation measures in our U.S. segment for performance reporting purposes.

In the quarter and year to date ended June 12, 2010, we recorded a pre-tax refranchising gain of $5 million and a pre-tax refranchising loss of $51 million, respectively, in the U.S.  The loss recorded in the year to date ended June 12, 2010 is the net result of gains from 71 restaurants sold and non-cash impairment charges related to our offers to refranchise restaurants in the U.S., principally a substantial portion of our Company operated KFCs.  The non-cash impairment charges related to our offers to refranchise a substantial portion of our Company operated KFC restaurants in the U.S. decreased depreciation expense by $3 million in the quarter and year to date ended June 12, 2010.  This depreciation reduction was recorded as a Special Item, resulting in depreciation expense in the U.S. segment results continuing to be recorded at the rate at which it was prior to the impairment charge being recorded for these restaurants.  In the quarter and year to date ended June 13, 2009, we recorded pre-tax refranchising gains of $1 million and $15 million, respectively, in the U.S.  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 (primarily severance and early retirement costs) we recorded pre-tax charges of $2 million and $5 million in the quarters ended June 12, 2010 and June 13, 2009, respectively.  In the years to date ended June 12, 2010 and June 13, 2009, we recorded pre-tax charges of $5 million and $9 million, respectively.

Additionally, the Company recognized a reduction to Franchise and license fees and income of $4 million and $31 million, pre-tax, in the quarter and year to date ended June 13, 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.  The reimbursements were recorded as a reduction to franchise and license fees and income as we would not have provided the reimbursements absent the ongoing franchisee relationship.

Refranchising of an International Equity Market

During the quarter ended March 20, 2010 we refranchised all of our remaining company restaurants in Taiwan, which consisted of 124 KFCs.  We included in our financial statements a non-cash write off of $7 million of goodwill in determining the loss on refranchising of Taiwan.  The amount of goodwill write-off was based on the relative fair values of the Taiwan business disposed of and the portion of the business that was retained.  The fair value of the business disposed of was determined by reference to the discounted value of the future cash flows expected to be generated by the restaurants and retained by the franchisee, which include a deduction for the anticipated royalties the franchisee will pay the Company associated with the franchise agreement entered into in connection with this refranchising transaction. The fair value of the Taiwan business retained consists of expected, net cash flows to be derived from royalties from franchisees, including the royalties associated with the franchise agreement entered into connection with this refranchising transaction.  We believe the terms of the franchise agreement entered into in connection with the Taiwan refranchising are substantially consistent with market.  The remaining carrying value of goodwill related to our Taiwan business of $30 million, after the aforementioned write-off, was determined not to be impaired as the fair value of the Taiwan reporting unit exceeds its carrying amount.


 
32

 



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%.  Prior to our acquisition of this additional interest, this entity was 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 GAAP, 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.

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.  Subsequent to the date of the acquisition, we reported the results of operations for the entity in the appropriate line items of our Condensed Consolidated Statements 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.  For the quarter and year to date ended June 12, 2010 the consolidation of the existing restaurants upon acquisition increased Company sales by $46 million and $98 million, respectively, and decreased Franchise and license fees and income by $3 million and $6 million, respectively.  The consolidation of the existing restaurants upon acquisition increased Operating Profit by $1 million and $3 million for the quarter and year to date ended June 12, 2010, respectively.  The impact on Net Income – YUM! Brands, Inc. was not significant to the quarter and year to date ended June 12, 2010.

Restaurant Profit

Worldwide restaurant margin increased 1.4 percentage points and 1.3 percentage points, respectively, in the quarter and year to date ended June 12, 2010.  These increases were driven by our China Division and the U.S.

The China Division restaurant margins increased 1.7 percentage points and 2.1 percentage points, respectively, in the quarter and year to date ended June 12, 2010.  These improvements were largely driven by Company Same Store Sales growth of 5% in both the quarter and year to date ended June 12, 2010 and commodity deflation of $14 million and $29 million in the quarter and year to date ended June 12, 2010, respectively.  For the full year in the China Division, we continue to expect moderate year-over-year margin improvement as we anticipate labor and commodity inflation to largely offset same store sales growth.

The YRI restaurant margins decreased 0.4 percentage points and 0.5 percentage points, respectively, in the quarter and year to date ended June 12, 2010 primarily due to labor inflation.

The U.S. restaurant margins increased 1.4 percentage points and 0.2 percentage points, respectively, in the quarter and year to date ended June 12, 2010 due to improved margin performance at KFC and refranchising.  Additionally, the quarter ended June 12, 2010 was favorably impacted by lower insurance expense.

Impact of Foreign Currency Translation on Operating Profit

Changes in foreign currency exchange rates positively impacted the translation of our foreign currency denominated Operating Profit in our YRI Division by $14 million and $28 million for the quarter and year to date ended June 12, 2010, respectively.  The impact on our China Division was not significant for the quarter or  year to date ended June 12, 2010.

 
33

 


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 16%.  Consistent with this strategy, 71 Company restaurants in the U.S. were sold to franchisees in the year to date ended June 12, 2010.

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 2009 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
   
6/12/10
   
6/13/09
   
6/12/10
   
6/13/09
Number of units refranchised
   
42
       
85
       
217
       
205
 
Refranchising proceeds, pre-tax
 
$
41
     
$
27
     
$
83
     
$
63
 
Refranchising (gain) loss, pre-tax(a)
 
$
(10
)
   
$
1
     
$
53
     
$
(13
)

(a)
The year to date ended June 12, 2010 includes a non-cash impairment charge of $73 million related to our offer to refranchise a substantial portion of our Company operated KFC restaurants in the U.S.  See Note 4 for further discussion.

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.

The following tables summarize the impact of refranchising as described above:
   
Quarter ended 6/12/10
   
China
Division
   
YRI
   
U.S.
   
Worldwide
Decreased Company sales
 
$
(4
)
     
(44
)
     
(99
)
     
(147
)
Increased Franchise and license fees and income
   
       
2
       
6
       
8