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YUM BRANDS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 14, 2014]

YUM BRANDS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Introduction and Overview Yum! Brands, Inc. ("YUM" or the "Company") operates, franchises or licenses a worldwide system of over 40,000 restaurants in more than 125 countries and territories, primarily through the concepts of KFC, Pizza Hut and Taco Bell.



These three concepts are the global leaders in the chicken, pizza and Mexican-style food categories, respectively. Of the more than 40,000 restaurants, 20% are operated by the Company and 80% are operated by franchisees, licensees or unconsolidated affiliates.

The Company is focused on the following key growth strategies: • Building Powerful Brands Through Superior Marketing, Breakthrough Innovation and Compelling Value with a Foundation Built on Winning Food and World Class Operations • Driving Aggressive Unit Expansion Everywhere, Especially in Emerging Markets, and Building Leading Brands in Every Significant Category in China and India • Creating Industry Leading Returns Through Franchising and Disciplined Use of Capital, Maximizing Long-term Shareholder Value YUM now consists of five reporting segments: • YUM China ("China" or "China Division") which includes all operations in mainland China • YUM India ("India" or "India Division") which includes all operations in India, Bangladesh, Nepal and Sri Lanka • The KFC Division which includes all operations of the KFC concept outside of China Division and India Division • The Pizza Hut Division which includes all operations of the Pizza Hut concept outside of China Division and India Division • The Taco Bell Division which includes all operations of the Taco Bell concept outside of India Division Previously, our reporting segments consisted of YUM Restaurants International, the United States, China and India. In the first quarter of 2014 we changed our management reporting structure to align our global operations outside of China and India by brand. As a result, our YUM Restaurants International and United States reporting segments were combined, and we began reporting this information by three new reporting segments: KFC Division, Pizza Hut Division and Taco Bell Division. China and India remain separate reporting segments. This new structure is designed to drive greater global brand focus, enabling us to more effectively share know-how and accelerate growth. While our consolidated results have not been impacted, we have restated our comparable segment information for consistent presentation.


This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the unaudited Condensed Consolidated Financial Statements ("Financial Statements"), the Cautionary Note Regarding Forward-Looking Statements and our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 ("2013 Form 10-K"). References to YUM throughout this discussion are made in first person notations of "we," "us" or "our." We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including performance metrics that management uses to assess the Company's performance. Throughout this MD&A, we commonly discuss the following performance metrics: • The Company provides certain percentage changes excluding the impact of foreign currency translation ("FX"). These amounts are derived by translating current year results at prior year average exchange rates. We believe the elimination of the foreign currency translation impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.

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

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

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

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

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

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

Percentages may not recompute due to rounding.

19 -------------------------------------------------------------------------------- Results of Operations Worldwide Our ongoing earnings growth model, which includes the ongoing earnings growth rates described within each of our reportable segment sections below, is expected to generate EPS growth of at least 10% annually. In December, 2013 we communicated that our 2014 EPS excluding Special Items was expected to grow at least 20% due in large part to an expectation that our China Division Operating Profit for 2014 would grow at a rate significantly above the ongoing rate of 15%. Details of our December, 2013 Guidance by division can be found online at http://yum.com.

In July, 2014 adverse publicity surrounding a minor supplier to KFC and Pizza Hut surfaced which has significantly impacted China sales and profits; we subsequently terminated our relationship with this supplier. China sales are rebounding but same-store sales continue to be negative. Our brands have proven resilient over time which we expect to be the case with this situation as well.

With the assumption that China same-store sales continue to improve but will be negative for the fourth quarter, we now expect 2014 EPS excluding Special Items to grow between 6% and 10%. See the China Division discussion below for details of our results of operations.

The Consolidated Results of Operations for the quarters and years to date ended September 6, 2014 and September 7, 2013 are presented below: Quarter ended Year to date 2014 2013 % B/(W) 2014 2013 % B/(W) Company sales $ 2,891 $ 3,021 (4 ) $ 7,941 $ 7,594 5 Franchise and license fees 463 445 1,341 1,311 and income 4 2 Total revenues $ 3,354 $ 3,466 (3 ) $ 9,282 $ 8,905 4 Restaurant profit $ 429 $ 531 (19 ) $ 1,298 $ 1,174 11 Restaurant margin % 14.9 % 17.6 % (2.7 ) ppts. 16.3 % 15.5 % 0.8 ppts.

G&A expenses $ 323 $ 327 1 $ 946 $ 933 (1 ) Franchise and license 109 108 expenses 42 44 6 (1 ) Closures and impairment 30 310 (income) expenses 6 300 98 90 Refranchising (gain) loss (20 ) (38 ) (47 ) (27 ) (87 ) (69 ) Other (income) expense (9 ) (7 ) 43 (19 ) (6 ) NM Operating Profit $ 550 $ 350 57 $ 1,600 $ 1,227 30 Interest expense, net 28 31 6 90 94 4 Income tax provision 119 182 35 370 384 4 Effective Tax Rate 22.7 % 57.2 % 34.5 ppts. 24.5 % 33.9 % 9.4 ppts.

Net Income - including noncontrolling interests $ 403 $ 137 195 $ 1,140 $ 749 52 Net Income (loss) - (1 ) (15 ) 3 (21 ) noncontrolling interests 94 NM Net Income - YUM! Brands, Inc. $ 404 $ 152 166 $ 1,137 $ 770 48 Diluted earnings per share $ 0.89 $ 0.33 171 $ 2.50 $ 1.66 (a) 50 Diluted earnings per share before Special Items (a) $ 0.87 $ 0.85 3 $ 2.48 $ 2.11 17 (a) See Note 2 for the number of shares used in this calculation.

20 -------------------------------------------------------------------------------- Quarter ended Year to date 2014 2013 2014 2013 System Sales Growth, reported 1 % 1 % 2 % - % System Sales Growth, excluding FX 1 % 1 % 4 % 1 % Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Franchise & License 31,588 30,967 2 Company-owned 8,295 7,830 6 Unconsolidated Affiliates 735 689 7 40,618 39,486 3 21--------------------------------------------------------------------------------Special Items Special Items, along with the reconciliation to the most comparable GAAP financial measure, are presented below.

Quarter ended Year to date Detail of Special Items 2014 2013 2014 2013 U.S. Refranchising gain (loss)(a) $ 8 $ 37 $ 11 $ 82 Little Sheep impairment(b) - (295 ) - (295 ) Other Special Items Income (Expense)(c) 7 (9 ) 7 (9 ) Total Special Items Income (Expense) 15 (267 ) 18 (222 ) Tax Benefit (Expense) on Special Items(d) (5 ) 12 (6 ) (3 ) Special Items Income (Expense), net of tax - including noncontrolling interests 10 (255 ) 12 (225 ) Special Items Income (Expense), net of tax - noncontrolling items - 19 - 19 Special Items Income (Expense), net of tax - Yum Brands, Inc. $ 10 $ (236 ) $ 12 $ (206 ) Average diluted shares outstanding 452 461 455 463 Special Items diluted EPS $ 0.02 $ (0.52 ) $ 0.02 $ (0.45 ) Reconciliation of Operating Profit Before Special Items to Reported Operating Profit Operating Profit before Special Items $ 535 $ 617 $ 1,582 $ 1,449 Special Items Income (Expense) 15 (267 ) 18 (222 ) Reported Operating Profit $ 550 $ 350 $ 1,600 $ 1,227 Reconciliation of EPS Before Special Items to Reported EPS Diluted EPS before Special Items $ 0.87 $ 0.85 $ 2.48 $ 2.11 Special Items EPS 0.02 (0.52 ) 0.02 (0.45 ) Reported EPS $ 0.89 $ 0.33 $ 2.50 $ 1.66 Reconciliation of Effective Tax Rate Before Special Items to Reported Effective Tax Rate Effective Tax Rate before Special Items 22.4 % 33.1 % 24.4 % 28.2 % Impact on Tax Rate as a result of Special Items(d) 0.3 % 24.1 % 0.1 % 5.7 % Reported Effective Tax Rate 22.7 % 57.2 % 24.5 % 33.9 % (a) U.S. refranchising gains and losses have not historically been allocated to our segments for performance reporting purposes due to the scope of our U.S. refranchising program in recent years and the volatility in associated gains and losses. The 2013 gains primarily relate to sales of Taco Bell restaurants in the U.S.

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

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

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

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

? Worldwide system sales grew 1%. Worldwide restaurant margin decreased 2.7 percentage points to 14.9%, and worldwide operating profit decreased 12%.

? Total international development was 400 new restaurants; 77% of this development occurred in emerging markets.

? China Division system sales declined 9%, as 6% unit growth was offset by a 14% same-store sales decline. Restaurant margin decreased 4.6 percentage points to 14.9%. Operating profit decreased 38%.

? KFC Division system sales increased 6%, driven by 2% unit growth and 3% same-store sales growth. Restaurant margin increased 1.0 percentage point to 13.4%. Operating profit increased 16%.

? Pizza Hut Division system sales were even, as 2% unit growth was offset by a 1% same-store sales decline. Restaurant margin decreased 1.0 percentage point to 8.9%. Operating profit decreased 2%.

? Taco Bell Division system sales increased 4%, driven by 2% unit growth and 3% same-store sales growth. Restaurant margin increased 1.8 percentage points to 20.7%. Operating profit increased 14%.

? Worldwide effective tax rate decreased to 22.4% from 33.1%, benefiting EPS by 14 percentage points.

? Foreign currency translation negatively impacted operating profit by $6 million.

? On September 10, 2014, the Company announced an 11% increase in its quarterly dividend, marking the tenth consecutive year the dividend increased at a double-digit percentage rate.

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

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

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

See the Worldwide section within the Results of Operations above for discussion on the impact of this matter on the Company's 2014 EPS expectations.

23 -------------------------------------------------------------------------------- Quarter ended Year to date % B/(W) % B/(W) 2014 2013 Reported Ex FX 2014 2013 Reported Ex FXCompany sales $ 1,809 $ 2,001 (10 ) (8 ) $ 4,848 $ 4,563 6 6 Franchise and license fees and income 31 32 (7 ) (6 ) 80 70 14 14 Total revenues $ 1,840 $ 2,033 (10 ) (8 ) $ 4,928 $ 4,633 6 6 Restaurant profit $ 269 $ 389 (31 ) (30 ) $ 869 $ 729 19 19 Restaurant margin % 14.9 % 19.5 % (4.6 ) ppts. (4.5 ) ppts. 17.9 % 16.0 % 1.9 ppts. 1.9 ppts.

G&A expenses $ 95 $ 88 (7 ) (8 ) $ 259 $ 233 (11 ) (11 ) Operating Profit $ 202 $ 335 (40 ) (38 ) $ 681 $ 557 22 22 Quarter ended Year to date 2014 2013 2014 2013 System Sales Growth, reported (10 )% 1 % 7 % (5 )% System Sales Growth, excluding FX (9 )% (2 )% 7 % (7 )% Same-Store Sales Growth % (14 )% (11 )% 1 % (16 )% Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Company-owned 5,158 4,852 6 Unconsolidated Affiliates 735 689 7 Franchise & License 526 494 6 6,419 6,035 6 12/28/2013 New Builds Closures Refranchised Acquired 9/6/2014 Company-owned 5,026 315 (135 ) (49 ) 1 5,158 Unconsolidated Affiliates 716 26 (7 ) - - 735 Franchise & License 501 11 (34 ) 49 (1 ) 526 Total 6,243 352 (176 ) - - 6,419 24--------------------------------------------------------------------------------Company Sales and Restaurant Profit The changes in Company sales and Restaurant profit were as follows: Quarter ended Income / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 2,001 $ 82 $ (250 ) $ (24 ) $ 1,809 Cost of sales (664 ) (24 ) 83 7 (598 ) Cost of labor (357 ) (18 ) 5 4 (366 ) Occupancy and other (591 ) (29 ) 37 7 (576 ) Restaurant profit $ 389 $ 11 $ (125 ) $ (6 ) $ 269 19.5 % 14.9 % Year to date Income / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 4,563 $ 273 $ 8 $ 4 $ 4,848 Cost of sales (1,508 ) (78 ) 41 (2 ) (1,547 ) Cost of labor (907 ) (51 ) 16 (2 ) (944 ) Occupancy and other (1,419 ) (86 ) 17 - (1,488 ) Restaurant profit $ 729 $ 58 $ 82 $ - $ 869 16.0 % 17.9 % The increase in Company sales and Restaurant profit for the quarter associated with store portfolio actions was driven by net new unit growth. Significant other factors impacting Company sales and/or Restaurant profit for the quarter were company same-store sales declines of 13%, including transaction declines of 17% which led to inefficiencies in Cost of sales and labor. Additionally, Restaurant profit for the quarter was also impacted by wage rate inflation of 10%, partially offset by lower advertising expense. Excluding the impact of Little Sheep, Restaurant margin would have been 15.9% in the quarter ended September 6, 2014.

The year to date increase in Company sales and Restaurant profit associated with store portfolio actions was driven by net new unit growth. Significant other factors impacting year to date Company sales and/or Restaurant profit were the favorable impact of pricing, partially offset by transaction declines.

Additionally, Restaurant profit for the year to date was impacted by labor efficiencies and lower advertising expense, partially offset by wage rate inflation of 9%. Year to date company same-store sales were even. Excluding the impact of Little Sheep, Restaurant margin would have been 18.7% in the year to date ended September 6, 2014.

Franchise and License Fees and Income The decrease in Franchise and license fees and income for the quarter, excluding the impact of foreign currency translation, was driven by the impact of same-store sales declines, partially offset by refranchising.

The year to date increase in Franchise and license fees and income, excluding the impact of foreign currency translation, was driven by the impact of refranchising and same-store sales growth.

G&A Expenses The increases in G&A expenses for the quarter and year to date, excluding the impact of foreign currency translation, were driven by compensation costs due to higher headcount and wage inflation.

Operating Profit The decrease in Operating Profit for the quarter, excluding the impact of foreign currency translation, was driven by the impact of same-store sales declines and higher restaurant operating costs and higher G&A expenses, partially offset by net new unit growth.

25 -------------------------------------------------------------------------------- The year to date increase in Operating Profit, excluding the impact of foreign currency translation, was driven by the favorable impact of pricing and net new unit growth, partially offset by higher G&A expenses.

KFC Division The KFC Division has 13,961 units, approximately 70% of which are located outside the U.S. The KFC Division has experienced significant unit growth in emerging markets, which comprised approximately 35% and 50% of the Division's units and profits, respectively, as of the end of 2013. Additionally, 91% of the KFC Division units were operated by franchisees and licensees as of the end of 2013. Our ongoing earnings growth model for the KFC Division includes mid single-digit percentage net unit and same-store sales growth for our emerging markets and flat net unit growth and low single-digit same-store sales growth for our developed markets. This combined with restaurant margin improvement and leverage of our G&A structure is expected to drive annual Operating Profit growth of 10%.

Quarter ended Year to date % B/(W) % B/(W) 2014 2013 Reported Ex FX 2014 2013 Reported Ex FX Company sales $ 566 $ 514 10 9 $ 1,593 $ 1,486 7 9 Franchise and license fees and income 205 190 8 9 596 580 3 6 Total revenues $ 771 $ 704 10 9 $ 2,189 $ 2,066 6 8 Restaurant profit $ 76 $ 65 19 17 $ 209 $ 189 10 12 Restaurant margin % 13.4 % 12.4 % 1.0 ppts. 0.9 ppts. 13.1 % 12.7 % 0.4 ppts. 0.3 ppts.

G&A expenses $ 91 $ 88 (4 ) (4 ) $ 261 $ 261 - (2 ) Operating Profit $ 169 $ 147 16 16 $ 487 $ 457 7 10 Quarter ended Year to date 2014 2013 2014 2013System Sales Growth, reported 6 % (1 )% 2 % 1 % System Sales Growth, excluding FX 6 % 2 % 5 % 3 % Same-Store Sales Growth % 3 % - % 2 % 1 % Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Franchise & License 12,667 12,521 1 Company-owned 1,294 1,222 6 13,961 13,743 2 12/28/2013 New Builds Closures Refranchised Acquired Other 9/6/2014 Franchise & License 12,647 272 (262 ) 12 (1 ) (1 ) 12,667 Company-owned 1,257 65 (17 ) (12 ) 1 - 1,294 Total 13,904 337 (279 ) - - (1 ) 13,961 26--------------------------------------------------------------------------------Company Sales and Restaurant Profit The changes in Company sales and Restaurant profit were as follows: Quarter ended Income / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 514 $ 21 $ 24 $ 7 $ 566 Cost of sales (179 ) (8 ) (9 ) (1 ) (197 ) Cost of labor (123 ) (4 ) (5 ) (3 ) (135 ) Occupancy and other (147 ) (6 ) (3 ) (2 ) (158 ) Restaurant profit $ 65 $ 3 $ 7 $ 1 $ 76 12.4 % 13.4 % Year to dateIncome / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 1,486 $ 87 $ 48 $ (28 ) $ 1,593 Cost of sales (518 ) (33 ) (18 ) 14 (555 ) Cost of labor (356 ) (19 ) (12 ) 3 (384 ) Occupancy and other (423 ) (29 ) (1 ) 8 (445 ) Restaurant profit $ 189 $ 6 $ 17 $ (3 ) $ 209 12.7 % 13.1 % The increase in Company sales for the quarter associated with store portfolio actions was driven by net new unit growth, partially offset by refranchising.

Significant other factors impacting Company sales and/or Restaurant profit were company same-store sales growth of 4%, which was partially offset by higher restaurant operating costs in certain international markets.

The increase in Company sales for the year to date associated with store portfolio actions was driven by net new unit growth and the impact of the acquisition of restaurants in Turkey from an existing franchisee in April 2013, partially offset by refranchising. Significant other factors impacting Company sales and/or Restaurant profit were company same-store sales growth of 4%, which was partially offset by higher restaurant operating costs in certain international markets.

Franchise and License Fees and Income The increase in Franchise and license fees and income for the quarter and year to date, excluding the impact of foreign currency translation, was driven by international growth in net new units and same-store sales growth.

G&A Expenses The increase in G&A expenses for the quarter, excluding the impact of foreign currency translation, was driven primarily by higher headcount in strategic international markets, partially offset by lower pension costs in the U.S.

The year to date increase in G&A expenses, excluding the impact of foreign currency translation, was driven primarily by higher headcount in strategic international markets and the impact of the Turkey acquisition, partially offset by lower pension costs in the U.S.

Operating Profit Operating Profit for the quarter was positively impacted by 2% due to lapping franchise convention costs recorded in Franchise and license expenses. Excluding this item and impact of foreign currency translation, the increase was driven by growth in same-store sales and net new units, partially offset by higher restaurant operating costs.

27 --------------------------------------------------------------------------------The year to date increase in Operating Profit, excluding the impact of foreign currency translation, was driven by growth in same-store sales and net new units, partially offset by higher restaurant operating costs.

Pizza Hut Division The Pizza Hut Division has 13,393 units, approximately 60% of which are located in the U.S. The Pizza Hut Division operates as one brand that uses multiple distribution channels including delivery, dine-in and express (e.g. airports).

Emerging markets comprised approximately 20% of both units and profits for the Division as of the end of 2013. Additionally, 94% of the Pizza Hut Division units were operated by franchisees and licensees as of the end of 2013. Our ongoing earnings growth model for the Pizza Hut Division includes mid single-digit percentage net unit and same-store sales growth for our emerging markets and low single-digit percentage net unit and same-store sales growth for our developed markets. This combined with restaurant margin improvement and leverage of our G&A structure is expected to drive annual Operating Profit growth of 8%.

Quarter ended Year to date % B/(W) % B/(W) 2014 2013 Reported Ex FX 2014 2013 Reported Ex FXCompany sales $ 140 $ 140 - (2 ) $ 422 $ 422 - - Franchise and license fees and income 124 124 - - 374 376 (1 ) - Total revenues $ 264 $ 264 - (1 ) $ 796 $ 798 - - Restaurant profit $ 13 $ 14 (11 ) (13 ) $ 38 $ 54 (30 ) (31 ) Restaurant margin % 8.9 % 9.9 % (1.0 ) ppts. (1.1 ) ppts. 9.0 % 12.8 % (3.8 ) ppts. (4.0 ) ppts.

G&A expenses $ 58 $ 54 (4 ) (3 ) $ 165 $ 150 (9 ) (10 ) Operating Profit $ 68 $ 71 (2 ) (2 ) $ 215 $ 250 (14 ) (13 ) Quarter ended Year to date 2014 2013 2014 2013System Sales Growth, reported - % 1 % (1 )% 1 % System Sales Growth, excluding FX - % 2 % - % 2 % Same-Store Sales Growth % (1 )% (1 )% (2 )% (1 )% Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Franchise & License 12,631 12,405 2 Company-owned 762 715 7 13,393 13,120 2 12/28/2013 New Builds Closures Refranchised Acquired Other 9/6/2014 Franchise & License 12,601 285 (240 ) 4 (18 ) (1 ) 12,631 Company-owned 732 45 (29 ) (4 ) 18 - 762 Total 13,333 330 (269 ) - - (1 ) 13,393 28--------------------------------------------------------------------------------Company Sales and Restaurant Profit The changes in Company sales and Restaurant profit were as follows: Quarter ended Income / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 140 $ 3 $ (5 ) $ 2 $ 140 Cost of sales (40 ) (2 ) 1 - (41 ) Cost of labor (42 ) (2 ) 3 (1 ) (42 ) Occupancy and other (44 ) - - - (44 ) Restaurant profit $ 14 $ (1 ) $ (1 ) $ 1 $ 13 9.9 % 8.9 % Year to dateIncome / (Expense) 2013 Store Portfolio Actions Other FX 2014 Company sales $ 422 $ 13 $ (14 ) $ 1 $ 422 Cost of sales (119 ) (5 ) (2 ) - (126 ) Cost of labor (127 ) (5 ) 4 (1 ) (129 ) Occupancy and other (122 ) (4 ) (4 ) 1 (129 ) Restaurant profit $ 54 $ (1 ) $ (16 ) $ 1 $ 38 12.8 % 9.0 % The increase in Company sales for the quarter associated with store portfolio actions was driven by the acquisitions of restaurants in the U.S. and net new unit growth, partially offset by refranchising. Significant other factors impacting Company sales and/or Restaurant profit for the quarter were company same-store sales declines of 4% and commodity inflation primarily in the U.S.

The year to date increase in Company sales associated with store portfolio actions was driven by the impact of the acquisition of restaurants in Turkey and the U.S. and net new unit growth, partially offset by refranchising. Significant other factors impacting year to date Company sales and/or Restaurant profit were company same-store sales declines of 4%, commodity inflation, primarily in the U.S., and higher self-insurance costs.

Franchise and License Fees and Income Franchise and license fees and income for the quarter and year to date, excluding the impact of foreign currency translation, were even with prior year, with the positive impact of net new unit growth offset by same-store sales declines.

G&A Expenses The increase in G&A expenses for the quarter, excluding the impact of foreign currency translation, was driven by higher litigation costs and strategic investments in international G&A, partially offset by lower pension costs in the U.S.

The year to date increase in G&A expenses, excluding the impact of foreign currency translation, was driven by strategic investments in international G&A, higher litigation costs and lapping a pension curtailment gain in the first quarter of 2013 related to our UK pension plan, partially offset by lower pension costs in the U.S.

Operating Profit Operating Profit for the quarter was positively impacted by 4% due to lapping franchise convention costs recorded in Franchise and license expenses. Excluding this item and the impact of foreign currency translation, the decrease in Operating Profit was driven by same-store sales declines and higher G&A, partially offset by net new unit growth.

29 -------------------------------------------------------------------------------- Year to date Operating Profit was positively impacted by 1% due to lapping franchise convention costs recorded in Franchise and license expenses. Excluding this item and the impact of foreign currency translation, the decrease in Operating Profit was driven by same-store sales declines, higher G&A and higher restaurant operating costs, partially offset by net new unit growth.

Taco Bell Division The Taco Bell Division has 6,109 units, the vast majority of which are in the U.S. The Company owns 16% of the Taco Bell units in the U.S., where the brand has historically achieved high restaurant margins and returns. While we believe expansion of Taco Bell outside of the U.S. is a long-term growth driver, our current ongoing earnings model only includes U.S.-generated growth, which includes low single-digit percentage net unit growth, mid-single-digit same-store sales growth and leverage of our G&A structure, which we expect to drive annual Operating Profit growth of 6%.

Quarter ended Year to date % B/(W) % B/(W) 2014 2013 Reported Ex FX 2014 2013 Reported Ex FX Company sales $ 344 $ 340 1 1 $ 992 $ 1,051 (6 ) (6 ) Franchise and license fees and income 99 95 4 4 281 274 2 3 Total revenues $ 443 $ 435 1 1 $ 1,273 $ 1,325 (4 ) (4 ) Restaurant profit $ 70 $ 64 10 10 $ 179 $ 202 (11 ) (11 ) Restaurant margin % 20.7 % 18.9 % 1.8 ppts. 1.8 ppts. 18.1 % 19.2 % (1.1 ) ppts. (1.1 ) ppts.

G&A expenses $ 40 $ 45 8 8 $ 128 $ 138 6 6 Operating Profit $ 124 $ 109 14 14 $ 317 $ 320 (1 ) (1 ) Quarter ended Year to date 2014 2013 2014 2013 System Sales Growth, reported 4 % 3 % 3 % 5 % System Sales Growth, excluding FX 4 % 3 % 3 % 5 % Same-Store Sales Growth % 3 % 2 % 1 % 3 % Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Franchise & License 5,200 5,100 2 Company-owned 909 903 1 6,109 6,003 2 12/28/2013 New Builds Closures Refranchised Acquired Other 9/6/2014 Franchise & License 5,157 98 (48 ) 1 (12 ) 4 5,200 Company-owned 891 8 (1 ) (1 ) 12 - 909 Total 6,048 106 (49 ) - - 4 6,109 30--------------------------------------------------------------------------------Company Sales and Restaurant Profit The changes in Company sales and Restaurant profit were as follows: Quarter ended Income / (Expense) 2013 Store Portfolio Actions Other 2014 Company sales $ 340 $ (2 ) $ 6 $ 344 Cost of sales (100 ) 1 (2 ) (101 ) Cost of labor (96 ) 1 - (95 ) Occupancy and other (80 ) 1 1 (78 ) Restaurant profit $ 64 $ 1 $ 5 $ 70 18.9 % 20.7 % Year to date Income / (Expense) 2013 Store Portfolio Actions Other 2014 Company sales $ 1,051 $ (59 ) $ - $ 992 Cost of sales (303 ) 18 (12 ) (297 ) Cost of labor (301 ) 18 (4 ) (287 ) Occupancy and other (245 ) 16 - (229 ) Restaurant profit $ 202 $ (7 ) $ (16 ) $ 179 19.2 % 18.1 % The changes in Company sales and Restaurant profit for the quarter associated with store portfolio actions were driven by refranchising offset by net new unit growth. Significant other factors impacting Company sales and/or Restaurant profit for the quarter were company same-store sales growth of 1%, driven by breakfast sales and the favorable impact of pricing, partially offset by commodity inflation.

The year to date decrease in Company sales and Restaurant profit associated with store portfolio actions was driven by refranchising, partially offset by net new unit growth. Significant other factors impacting year to date Restaurant profit were commodity inflation and higher food and labor costs due to the launch of breakfast in the U.S. Year to date company same-store sales were even.

Franchise and License Fees and Income The increase in Franchise and license fees and income for the quarter, excluding the impact of foreign currency translation, was driven by same-store sales growth, net new unit growth and refranchising.

The year to date increase in Franchise and license fees and income, excluding the impact of foreign currency translation, was driven by refranchising, same-store sales growth and net new unit growth, partially offset by franchise incentives provided in the first quarter of 2014 related to the launch of breakfast in the U.S.

G&A Expenses The decrease in G&A expenses for the quarter, excluding the impact of foreign currency translation, was driven by lower incentive compensation costs and lower pension costs.

The year to date decrease in G&A expenses, excluding the impact of foreign currency translation, was driven by lower pension costs, refranchising and lower incentive compensation costs.

31 --------------------------------------------------------------------------------Operating Profit The increase in Operating Profit for the quarter was driven by same-store sales growth, lower G&A and net new unit growth, partially offset by higher restaurant operating costs.

The year to date decrease in Operating Profit was driven by higher restaurant operating costs, partially offset by same-store sales growth, lower G&A and net new unit growth.

India Division The India Division has 736 units, predominately KFC and Pizza Hut restaurants.

While we believe India is a significant long-term growth driver, our ongoing earnings model currently assumes no impact from India growth.

Quarter ended Year to date % B/(W) % B/(W) 2014 2013 Reported Ex FX 2014 2013 Reported Ex FX Total revenues(a) $ 36 $ 30 22 22 $ 96 $ 83 17 25 Operating Profit (loss)(a) $ (3 ) $ (4 ) 18 18 $ (7 ) $ (10 ) 24 17 Quarter ended Year to date 2014 2013 2014 2013System Sales Growth, reported(a) 5 % 12 % 1 % 12 % System Sales Growth, excluding FX(a) 4 % 20 % 7 % 19 % Same-Store Sales Growth % (4 )% (1 )% (3 )% (2 )% Unit Count 9/6/2014 9/7/2013 % Increase (Decrease) Franchise & License 564 447 26 Company-owned 172 138 25 736 585 26 12/28/2013 New Builds Closures Refranchised 9/6/2014 Franchise & License 514 43 (13 ) 20 564 Company-owned 191 7 (6 ) (20 ) 172 Total 705 50 (19 ) - 736 (a) Effective the beginning of 2014, results from our 28 Mauritius stores are included in KFC and Pizza Hut Divisions as applicable. Prior year units have been adjusted for comparability while division System Sales Growth, Total Revenues and Operating Profit have not been restated due to the immaterial dollar impact of this change. While there was no impact to our consolidated results, this change negatively impacted India's quarterly and year to date System Sales Growth and Total Revenues by 10% and 2%, respectively. This change negatively impacted India's quarter and year to date Operating Profit (loss) by less than $1 million and $1 million, respectively.

32-------------------------------------------------------------------------------- Corporate & Unallocated Quarter ended Year to date (Expense) / Income 2014 2013 % B/(W) 2014 2013 % B/(W) Corporate G&A $ (33 ) $ (46 ) 28 $ (116 ) $ (133 ) 13 Unallocated closures and impairments - (295 ) NM - (295 ) NM Other unallocated 23 33 (33 ) 23 81 (72 ) Interest expense, net (28 ) (31 ) 6 (90 ) (94 ) 4 Income tax provision (119 ) (182 ) 35 (370 ) (384 ) 4 Effective tax rate 22.7 % 57.2 % 34.5 ppts. 24.5 % 33.9 % 9.4 ppts.

Corporate G&A The decrease in Corporate G&A for the quarter was driven by lower pension costs, including lapping pension settlement charges, lapping costs associated with the outsourcing of certain information technology, accounting and payroll services in the U.S. and lower current year incentive compensation costs.

The year to date decrease in Corporate G&A was driven by lower pension costs, including lapping pension settlement charges, and lapping costs associated with the outsourcing of certain information technology, accounting and payroll services in the U.S.

Unallocated Closures and Impairments Unallocated closures and impairments for the 2013 quarter and year to date represents Little Sheep impairment. (See Note 4.) Other Unallocated The decrease in Other unallocated for the quarter was driven by lapping higher refranchising gains, partially offset by lapping foreign exchange losses.

The year to date decrease in Other unallocated was driven by lapping higher refranchising gains.

Interest Expense, Net The decrease in Interest expense, net for quarter and year to date was driven by interest income from higher short term investment balances and lower interest rates on average borrowings in 2014.

Income Tax Provision Our third quarter and year to date effective tax rates were lower than the prior year primarily due to the impact of lapping the $222 million non-cash impairment of Little Sheep goodwill, which resulted in no related tax benefit, and lapping the unfavorable impact of increasing prior year unrecognized tax benefits related to a dispute with the IRS regarding a valuation of intangibles. This dispute was settled in the quarter ended September 6, 2014, which is discussed in further detail in Note 7. The third quarter 2014 effective tax rate was lower than our full year expected tax rate primarily due to a change in the estimated cost of repatriating foreign earnings. The Company's full year effective tax rate is now expected to be between 25% and 26%.

Potential Little Sheep Impairment In the quarter ended September 7, 2013, as discussed further in our 2013 Form 10-K, we recorded impairment charges related to the Little Sheep trademark and goodwill. The inputs used in determining the fair values of the Little Sheep trademark and reporting unit in 2013 for purposes of calculating these impairment charges assumed increases in average-unit sales volumes and profit levels that would support future new unit development of the concept. Through the first three quarters of 2014, Little Sheep sales and profits have been below the amounts assumed in the 2013 fair value determinations.

Our accounting policies require us to review our goodwill and indefinite-lived intangible assets, including the Little Sheep trademark, for impairment on an annual basis in the fourth quarter or more often if an event occurs or circumstances change that indicate impairment might exist. If the negative Little Sheep business trends continue, it may result in a determination that the fair value 33 -------------------------------------------------------------------------------- of the Little Sheep trademark, reporting unit or both are currently less than their carrying value, requiring us to record further impairment in the fourth quarter of 2014. If such determination were made, we anticipate that any non-cash impairment would be recorded as a Special Item within our Financial Statements.

34--------------------------------------------------------------------------------Liquidity and Capital Resources Liquidity Net cash provided by operating activities was $1,612 million in 2014 versus $1,553 million in 2013. The increase was primarily driven by higher operating profit before Special Items, partially offset by higher income tax payments.

Operating in the QSR industry allows us to generate substantial cash flows from the operations of our company-owned stores and from our extensive franchise operations which require a limited YUM investment. Net cash provided by operating activities has exceeded $2 billion annually since 2011. We expect these levels of net cash provided by operating activities to continue in the foreseeable future. However, unforeseen downturns in our business could adversely impact our cash flows from operations from the levels historically realized.

In the event our cash flows from operating activities are negatively impacted by business downturns, we believe we have the ability to temporarily reduce our discretionary spending without significant impact to our long-term business prospects. Our discretionary spending includes capital spending for new restaurants, acquisitions of restaurants from franchisees, repurchases of shares of our Common Stock and dividends paid to our shareholders.

Net cash used in investing activities was $920 million in 2014 versus $587 million in 2013. The increase was primarily driven by higher short-term investments and lower refranchising proceeds, partially offset by lapping the acquisition of restaurants in Turkey.

We invested $655 million in capital spending, including $336 million in China, $179 million in the KFC Division, $35 million in the Pizza Hut Division, $89 million in the Taco Bell Division and $10 million in India.

Net cash used in financing activities was $586 million in 2014 versus $975 million in 2013. The decrease was primarily driven by higher borrowings on our revolving credit facility.

We repurchased shares of our Common Stock for $510 million. As of September 6, 2014, we had remaining capacity to repurchase up to $443 million (excluding applicable transaction fees) of our outstanding Common Stock under the November 2013 authorization. See Note 3.

We paid cash dividends of $490 million. Additionally, on September 10, 2014 our Board of Directors approved an 11% increase in the quarterly dividend including a cash dividend of $0.41 per share of Common Stock, to be distributed on November 7, 2014 to shareholders of record at the close of business on October 17, 2014. With the increased dividend, the Company now targets an ongoing annual dividend payout ratio of 40% to 45% of net income, before Special Items.

To the extent we have needed to repatriate international cash to fund our U.S.

discretionary cash spending, including share repurchases, dividends and debt repayments, we have historically been able to do so in a tax efficient manner. If we experience an unforeseen decrease in our cash flows from our U.S.

business or are unable to refinance future U.S. debt maturities, we may be required to repatriate future international earnings at tax rates higher than we have historically experienced.

Capital Resources We fund our working capital requirements primarily through cash generated from operations, supplemented, as needed, by short-term bank borrowings. Our primary bank credit agreement comprises a $1.3 billion syndicated senior unsecured revolving credit facility (the "Credit Facility") which matures in March 2017.

As of September 6, 2014, our unused Credit Facility totaled $0.8 billion net of outstanding letters of credit of $56 million and outstanding borrowings of $397 million. The interest rate for borrowings under the Credit Facility ranges from 1.00% to 1.75% over the London Interbank Offered Rate. The Credit Facility is unconditionally guaranteed by our principal domestic subsidiaries and contains financial covenants relating to maintenance of leverage and fixed-charge coverage ratios and also contains affirmative and negative covenants including, among other things, limitations on certain additional indebtedness and liens, and certain other transactions specified in the agreement. Given the Company's strong balance sheet and cash flows we were able to comply with all debt covenant requirements as of September 6, 2014 with a considerable amount of cushion. Additionally, the Credit Facility contains cross-default provisions whereby our failure to make any payment on our indebtedness in a principal amount in excess of $125 million, or the acceleration of the maturity of any such indebtedness, will constitute a default under the Credit Facility.

35 -------------------------------------------------------------------------------- The majority of our remaining long-term debt primarily comprises Senior Unsecured Notes with varying maturity dates from 2014 through 2043 and interest rates ranging from 2.38% to 6.88%. These notes represent senior, unsecured obligations and rank equally in right of payment with all of our existing and future unsecured unsubordinated indebtedness. Amounts outstanding under Senior Unsecured Notes were $2.8 billion at September 6, 2014. Our Senior Unsecured Notes provide that the acceleration of the maturity of any of our indebtedness in a principal amount in excess of $50 million will constitute a default under the Senior Unsecured Notes if such acceleration is not annulled, or such indebtedness is not discharged, within 30 days after notice.

Recently Adopted Accounting Pronouncements and New Accounting Pronouncements Not Yet Adopted See Note 11 for details of recently adopted accounting pronouncements.

In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (ASU 2014-08), which limits dispositions that qualify for discontinued operations presentation to those that represent strategic shifts that have or will have a major effect on an entity's operations and financial results.

Strategic shifts could include a disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of the business. ASU 2014-08 is effective prospectively for the Company in our first quarter of fiscal 2015, with early adoption permitted. We do not believe the adoption of this standard will have a significant impact on our consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), to provide principles within a single framework for revenue recognition of transactions involving contracts with customers across all industries. ASU 2014-09 is effective for the Company in our first quarter of fiscal 2017 with no early adoption permitted. The standard allows for either a full retrospective or modified retrospective transition method. We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management of the Company to evaluate whether there is substantial doubt about the Company's ability to continue as a going concern. ASU 2014-15 is effective for the Company in our first quarter of fiscal 2017, with early adoption permitted. The Company does not expect this standard to have an impact on the Company's consolidated financial statements upon adoption.

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