UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549


FORM 10-Q

(Mark One)
[X]  

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 25, 2006


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
incorporation or organization)
   (I.R.S. Employer
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  x   No    

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12-b-2 of Exchange Act. (Check one): Large accelerated filer: [x]Accelerated filer: [ ] Non-accelerated filer: [ ]

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

     The number of shares outstanding of the Registrant’s Common Stock as of April 24, 2006 was 271,951,742 shares.


 

 

YUM! BRANDS, INC.

 

INDEX

 

 

 

 

 

Page No. 

 

Part I.   Financial Information

 

 

 

 

 

 

 

 

Item 1 - Financial Statements

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income - Quarters ended

March 25, 2006 and March 19, 2005

3

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Quarters ended

March 25, 2006 and March 19, 2005

4

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets – March 25, 2006

and December 31, 2005

5

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

 

 

 

Item 2 - Management’s Discussion and Analysis of Financial Condition

and Results of Operations

15

 

 

 

 

 

 

 

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

26

 

 

 

 

 

 

 

Item 4 - Controls and Procedures

26

 

 

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

27

 

 

 

 

 

 

Part II. Other Information and Signatures

 

 

 

Item 1 – Legal Proceedings

 

28

 

 

 

 

 

 

 

Item 1A – Risk Factors

 

28

 

 

 

 

 

 

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

 

29

 

 

 

 

 

 

 

Item 6 – Exhibits

 

29

 

 

 

 

 

 

 

Signatures

 

30

 

 

2

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

YUM! BRANDS, INC. AND SUBSIDIARIES

(in millions, except per share data)

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Revenues

 

 

 

 

 

 

 

 

 

Company sales

 

$

1,819

 

 

 

$

1,810

 

Franchise and license fees

 

 

266

 

 

 

 

244

 

Total revenues

 

 

2,085

 

 

 

 

2,054

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses, net

 

 

 

 

 

 

 

 

 

Company restaurants

 

 

 

 

 

 

 

 

 

  Food and paper

 

 

557

 

 

 

 

574

 

  Payroll and employee benefits

 

 

477

 

 

 

 

486

 

  Occupancy and other operating expenses

 

 

501

 

 

 

 

491

 

 

 

 

1,535

 

 

 

 

1,551

 

General and administrative expenses

 

 

254

 

 

 

 

247

 

Franchise and license expenses

 

 

8

 

 

 

 

8

 

Closures and impairment expenses

 

 

6

 

 

 

 

9

 

Refranchising (gain) loss

 

 

4

 

 

 

 

2

 

Other (income) expense

 

 

(4

)

 

 

 

(14

)

Wrench litigation (income) expense

 

 

 

 

 

 

 

AmeriServe and other charges (credits)

 

 

 

 

 

 

 

Total costs and expenses, net

 

 

1,803

 

 

 

 

1,803

 

Operating Profit

 

 

282

 

 

 

 

251

 

Interest expense, net

 

 

35

 

 

 

 

28

 

Income Before Income Taxes

 

 

247

 

 

 

 

223

 

Income tax provision

 

 

77

 

 

 

 

70

 

Net Income

 

$

170

 

 

 

$

153

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings Per Common Share

 

$

0.62

 

 

 

$

0.52

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings Per Common Share

 

$

0.59

 

 

 

$

0.50

 

 

 

 

 

 

 

 

 

 

 

Dividends Declared Per Common Share

 

$

0.115

 

 

 

$

0.10

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3

 

 

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

YUM! BRANDS, INC. AND SUBSIDIARIES

(in millions) 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Cash Flows – Operating Activities

 

 

 

 

 

 

 

 

 

Net income

 

$

170

 

 

 

$

153

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

    Depreciation and amortization

 

 

99

 

 

 

 

97

 

    Closures and impairment expenses

 

 

6

 

 

 

 

9

 

    Refranchising (gain) loss

 

 

4

 

 

 

 

2

 

    Contributions to defined benefit pension plans

 

 

 

 

 

 

 

    Other liabilities and deferred credits

 

 

24

 

 

 

 

17

 

    Deferred income taxes

 

 

(51

)

 

 

 

(10

)

    Equity income from investments in unconsolidated affiliates

 

 

(11

)

 

 

 

(15

)

    Distributions of income received from unconsolidated affiliates

 

 

 

 

 

 

 

    Excess tax benefits from share-based compensation

 

 

(20

)

 

 

 

(23

)

    Share-based compensation expense

 

 

16

 

 

 

 

13

 

    Other non-cash charges and credits, net

 

 

19

 

 

 

 

21

 

Changes in operating working capital, excluding effects of acquisitions and dispositions:

 

 

 

 

 

 

 

 

 

    Accounts and notes receivable

 

 

8

 

 

 

 

(6

)

    Inventories

 

 

2

 

 

 

 

 

    Prepaid expenses and other current assets

 

 

(13

)

 

 

 

31

 

    Accounts payable and other current liabilities

 

 

(28

)

 

 

 

(44

)

    Income taxes payable

 

 

72

 

 

 

 

(13

)

    Net change in operating working capital

 

 

41

 

 

 

 

(32

)

Net Cash Provided by Operating Activities

 

 

297

 

 

 

 

232

 

 

 

 

 

 

 

 

 

 

 

Cash Flows – Investing Activities

 

 

 

 

 

 

 

 

 

Capital spending

 

 

(72

)

 

 

 

(94

)

Proceeds from refranchising of restaurants

 

 

22

 

 

 

 

4

 

Acquisition of restaurants from franchisees

 

 

 

 

 

 

 

Short-term investments

 

 

(17

)

 

 

 

(18

)

Sales of property, plant and equipment

 

 

8

 

 

 

 

3

 

Other, net

 

 

(2

)

 

 

 

 

Net Cash Used in Investing Activities

 

 

(61

)

 

 

 

(105

)

 

 

 

 

 

 

 

 

 

 

Cash Flows – Financing Activities

 

 

 

 

 

 

 

 

 

Revolving Credit Facility activity

 

 

 

 

 

 

 

 

 

  Three months or less, net

 

 

71

 

 

 

 

3

 

Repayments of long-term debt

 

 

(4

)

 

 

 

(3

)

Short-term borrowings-three months or less, net

 

 

11

 

 

 

 

(29

)

Repurchase shares of common stock

 

 

(371

)

 

 

 

(116

)

Excess tax benefits from share-based compensation

 

 

20

 

 

 

 

23

 

Employee stock option proceeds

 

 

44

 

 

 

 

46

 

Dividends paid on common shares

 

 

(32

)

 

 

 

(29

)

Net Cash Used in Financing Activities

 

 

(261

)

 

 

 

(105

)

Effect of Exchange Rates on Cash and Cash Equivalents

 

 

1

 

 

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

 

 

(24

)

 

 

 

22

 

Net Increase in Cash and Cash Equivalents of Mainland China for December 2004

 

 

 

 

 

 

34

 

Cash and Cash Equivalents - Beginning of Period

 

 

158

 

 

 

 

62

 

Cash and Cash Equivalents - End of Period

 

$

134

 

 

 

$

118

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4

 

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS

YUM! BRANDS, INC. AND SUBSIDIARIES

(in millions) 

 

 

3/25/06

 

 

12/31/05

ASSETS

 

 

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

134

 

 

 

$

158

 

Short-term investments

 

 

61

 

 

 

 

43

 

Accounts and notes receivable, less allowance: $21 in 2006 and $23 in 2005

 

 

258

 

 

 

 

236

 

Inventories

 

 

84

 

 

 

 

85

 

Prepaid expenses and other current assets

 

 

95

 

 

 

 

75

 

Deferred income taxes

 

 

159

 

 

 

 

163

 

Advertising cooperative assets, restricted

 

 

102

 

 

 

 

77

 

                Total Current Assets

 

 

893

 

 

 

 

837

 

Property, plant and equipment, net of accumulated depreciation and amortization of $2,876
  in 2006 and $2,830 in 2005

 

 

3,295

 

 

 

 

3,356

 

Goodwill

 

 

540

 

 

 

 

538

 

Intangible assets, net

 

 

327

 

 

 

 

330

 

Investments in unconsolidated affiliates

 

 

157

 

 

 

 

173

 

Other assets

 

 

505

 

 

 

 

464

 

                Total Assets

 

$

5,717

 

 

 

$

5,698

 


LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

 

 

Accounts payable and other current liabilities

 

$

1,208

 

 

 

$

1,238

 

Income taxes payable

 

 

118

 

 

 

 

79

 

Short-term borrowings

 

 

223

 

 

 

 

211

 

Advertising cooperative liabilities

 

 

102

 

 

 

 

77

 

                Total Current Liabilities

 

 

1,651

 

 

 

 

1,605

 


Long-term debt

 

 

1,710

 

 

 

 

1,649

 

Other liabilities and deferred credits

 

 

1,026

 

 

 

 

995

 

                Total Liabilities

 

 

4,387

 

 

 

 

4,249

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

 

 

 

 

Preferred stock, no par value, 250 shares authorized; no shares issued

 

 

 

 

 

 

 

Common stock, no par value, 750 shares authorized; 273 shares and 278 shares issued in
  2006 and 2005, respectively

 

 

 

 

 

 

 

Retained earnings

 

 

1,484

 

 

 

 

1,619

 

Accumulated other comprehensive loss

 

 

(154

)

 

 

 

(170

)

                Total Shareholders’ Equity

 

 

1,330

 

 

 

 

1,449

 

                Total Liabilities and Shareholders’ Equity

 

$

5,717

 

 

 

$

5,698

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5

 

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Tabular amounts in millions, except per share data)

 

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 United States generally accepted accounting principles for complete financial statements. Therefore, we suggest that the accompanying Financial Statements be read in conjunction with the Consolidated Financial Statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2005 (“2005 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 2005 Form 10-K.

 

Our Financial Statements include YUM! Brands, Inc. and its wholly-owned subsidiaries (collectively referred to as “YUM” or the “Company”). The Financial Statements include 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.”

 

Our preparation of the accompanying Financial Statements in conformity with U.S. generally accepted accounting principles 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 2005 Form 10-K, our financial position as of March 25, 2006, and the results of our operations and cash flows for the quarters ended March 25, 2006 and March 19, 2005. Our results of operations for these interim periods are not necessarily indicative of the results to be expected for the full year.

 

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

 

We have reclassified certain items in the accompanying Financial Statements and Notes to the Financial Statements in order to be comparable with the current classifications. These reclassifications had no effect on previously reported net income.

 

2.  Share-Based Compensation

 

In the fourth quarter 2005, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaced SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), superseded APB 25, “Accounting for Stock Issued to Employees” and related interpretations and amended SFAS No. 95, “Statement of Cash Flows.” We adopted SFAS 123R using the modified retrospective application transition method effective September 4, 2005, the beginning of our fourth quarter in 2005. As permitted by SFAS 123R, we applied the modified retrospective application transition method to the beginning of the fiscal year of adoption (our fiscal year 2005). As such, the results for the first three quarters of 2005, including the quarter ended March 19, 2005, were adjusted to recognize the compensation cost previously reported in the pro forma footnote disclosures under the provisions of SFAS 123.

 

 

 

6

 

 

 

The following table details the impact of adopting SFAS 123R by financial statement line item.

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Payroll and employee benefits

 

$

2

 

 

 

$

3

 

General and administrative

 

 

13

 

 

 

 

10

 

Operating profit

 

 

15

 

 

 

 

13

 

Income tax benefit

 

 

(5)

 

 

 

 

(5)

 

Net income

 

$

10

 

 

 

$

8

 

 

During the quarter ended March 25, 2006, we granted 3.3 million stock appreciation rights to employees to redeem shares of our Common Stock at an exercise price equal to the average market price on the date of grant. The weighted-average exercise price of these stock appreciation rights was approximately $49.

 

3.  Earnings Per Common Share (“EPS”)

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Net income

 

$

170

 

 

 

$

153

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

276

 

 

 

 

291

 

Basic EPS

 

$

0.62

 

 

 

$

0.52

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

276

 

 

 

 

291

 

Shares assumed issued on exercise of dilutive share equivalents

 

 

33

 

 

 

 

41

 

Shares assumed purchased with proceeds of dilutive share equivalents

 

 

(23

)

 

 

 

(28

)

Shares applicable to diluted earnings

 

 

286

 

 

 

 

304

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS

 

$

0.59

 

 

 

$

0.50

 

 

Unexercised employee stock options to purchase approximately 0.8 million shares of our Common Stock for the quarter ended March 25, 2006 were not included in the computation of diluted EPS because their exercise prices were greater than the average market price of our Common Stock during the quarter. For the quarter ended March 19, 2005, all unexercised employee stock options were included in the computation of diluted EPS because their exercise prices were less than the average market price of our Common Stock during the quarter.

 

4.  Shareholders’ Equity

 

On March 16, 2006, we declared a cash dividend of $0.115 per share of Common Stock to be distributed on May 5, 2006 to shareholders of record at the close of business on April 14, 2006. We had dividends payable of $31 million and $32 million at March 25, 2006 and December 31, 2005, respectively.

 

In March 2006, our Board of Directors authorized a share repurchase program allowing us to repurchase, through March 2007, up to $500 million (excluding applicable transaction fees) of our outstanding Common Stock. Under the authority of our Board of Directors, we repurchased shares of our Common Stock under the following share repurchase programs during the quarters ended March 25, 2006 and March 19, 2005. All amounts exclude applicable transaction fees.

 

7

 

 

 

 

 

Program Authorization Date

 

 

Shares Repurchased

(thousands)

 

Dollar Value of Shares Repurchased

 

 

2006

 

2005

 

2006

 

2005

November 2005

 

 

7,583

 

 

$

      371

 

 

$

 

January 2005

 

 

 

1,789

 

 

      —

 

 

 

      91

 

May 2004

 

 

 

   534

 

 

         —

 

 

 

  25

 

Total

 

 

7,583

 

2,323

 

$

       371

 

 

$

     116

 

 

As of March 25, 2006, we have $598 million available for future repurchases under our November 2005 and March 2006 share repurchase programs combined. Based on market conditions and other factors, repurchases may be made from time to time in the open market or through privately negotiated transactions at the discretion of the Company.

 

Comprehensive income was as follows:

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Net income

 

$

170

 

 

 

$

153

 

Foreign currency translation adjustment arising during the period

 

 

14

 

 

 

 

6

 

Changes in fair value of derivatives, net of tax

 

 

2

 

 

 

 

 

Reclassification of derivative (gains) losses to net income, net of tax

 

 

 

 

 

 

 

Total comprehensive income

 

$

186

 

 

 

$

159

 

 

5.  Facility Actions

 

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

 

 

 

March 25, 2006

 

 

U.S.

 

 

International

Division

 

 

China

Division

 

 

Worldwide

Refranchising net (gain) loss(a)

 

$

3

 

 

 

$

1

 

 

 

$

 

 

 

$

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Store closure costs

 

$

 

 

 

$

1

 

 

 

$

 

 

 

$

1

 

Store impairment charges

 

 

1

 

 

 

 

3

 

 

 

 

1

 

 

 

 

5

 

Closure and impairment expenses

 

$

1

 

 

 

$

4

 

 

 

$

1

 

 

 

$

6

 

 

 

 

March 19, 2005

 

 

U.S.

 

 

International

Division

 

 

China

Division

 

 

Worldwide

Refranchising net (gain) loss(a)

 

$

1

 

 

 

$

1

 

 

 

$

 

 

 

$

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Store closure costs

 

$

4

 

 

 

$

 

 

 

$

 

 

 

$

4

 

Store impairment charges

 

 

4

 

 

 

 

1

 

 

 

 

 

 

 

 

5

 

Closure and impairment expenses

 

$

8

 

 

 

$

1

 

 

 

$

 

 

 

$

9

 

 

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

 

8

 

 

 

 

6.  Other (Income) Expense

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Equity income from investments in unconsolidated affiliates

 

$

(11

)

 

 

$

(15

)

Foreign exchange net (gain) loss

 

 

(1

)

 

 

 

1

 

Contract termination charge (a)

 

 

8

 

 

 

 

 

Other (income) expense

 

$

(4

)

 

 

$

(14

)

 

 

 

 

 

 

 

 

 

 

(a) Reflects an $8 million charge associated with the termination of a beverage agreement in the United States segment.

 

7.  Reportable Operating Segments

 

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

 

 

 

Quarter

Revenues

 

3/25/06

 

 

3/19/05

United States

 

$

1,339

 

 

 

$

1,335

 

International Division

 

 

469

 

 

 

 

484

 

China Division(a)

 

 

277

 

 

 

 

235

 

 

 

$

2,085

 

 

 

$

2,054

 

 

 

 

 

 

 

 

 

 

 

 

 

Quarter

Operating Profit

 

3/25/06

 

 

3/19/05

United States

 

$

188

 

 

 

$

157

 

International Division

 

 

95

 

 

 

 

91

 

China Division

 

 

58

 

 

 

 

52

 

Unallocated and corporate expenses

 

 

(55

)

 

 

 

(46

)

Unallocated other income (expense)

 

 

 

 

 

 

(1

)

Unallocated refranchising gain (loss)(b)

 

 

(4

)

 

 

 

(2

)

Wrench litigation (income) expense

 

 

 

 

 

 

 

AmeriServe and other charges (credits)

 

 

 

 

 

 

 

Operating profit

 

 

282

 

 

 

 

251

 

Interest expense, net

 

 

(35

)

 

 

 

(28

)

Income before income taxes

 

$

247

 

 

 

$

223

 

 

 

(a)

Includes revenues of approximately $234 million and $189 million in mainland China for the quarters ended March 25, 2006 and March 19, 2005, respectively.

 

(b)

Unallocated refranchising gain (loss) is not allocated to the U.S., International Division or China Division segments for performance reporting purposes.

 

8.  Pension and Postretirement Medical Benefits

 

We sponsor defined benefit pension plans covering substantially all full-time U.S. salaried employees, certain U.S. hourly employees and certain international employees. The most significant of these plans, the YUM Retirement Plan (the “Plan”), covers U.S. employees. Our postretirement plan provides health care benefits,

 

9

 

 

principally to U.S. salaried retirees and their dependents, and includes retiree cost sharing provisions. The defined benefit pension plans covering U.S. employees and our postretirement plan were amended during 2001 such that any salaried employee that was hired or rehired after September 30, 2001 is not eligible to participate.

 

The components of net periodic benefit cost for our defined benefit pension plans covering U.S. employees and our postretirement plan are as follows:

 

 

 


Pension Benefits

 

 

Other Postretirement
Benefits

 

 

Quarter

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

 

 

3/25/06

 

 

3/19/05

Service cost

 

$

8

 

 

 

$

7

 

 

 

$

 

 

 

$

1

 

Interest cost

 

 

10

 

 

 

 

10

 

 

 

 

1

 

 

 

 

1

 

Expected return on plan assets

 

 

(11

)

 

 

 

(10

)

 

 

 

 

 

 

 

 

Amortization of prior service cost

 

 

1

 

 

 

 

1

 

 

 

 

 

 

 

 

 

Recognized actuarial loss

 

 

7

 

 

 

 

5

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

 

$

15

 

 

 

$

13

 

 

 

$

1

 

 

 

$

2

 

 

As disclosed in our 2005 Form 10-K, based on current funding rules, we are not required to make contributions to the Plan in 2006. No contributions were made to the Plan during the quarter ended March 25, 2006. While we may make discretionary contributions to the Plan during the year, we do not currently intend to do so. We will make a contribution of approximately $20 million to one of our International plans during the quarter ending June 17, 2006.

 

9.  Guarantees, Commitments and Contingencies

 

Lease Guarantees and Contingencies

 

As a result of (a) assigning our interest in obligations under real estate leases as a condition to the refranchising of certain Company restaurants; (b) contributing certain Company restaurants to unconsolidated affiliates; and (c) guaranteeing certain other leases, we are frequently contingently liable on lease agreements. These leases have varying terms, the latest of which expires in 2031. As of March 25, 2006 and December 31, 2005, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessee was $367 million and $374 million, respectively. The present value of these potential payments discounted at our pre-tax cost of debt at March 25, 2006 was $298 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 March 25, 2006 and December 31, 2005 was not material.

 

Franchise Loan Pool Guarantees - We had provided approximately $16 million of partial guarantees of two franchisee loan pools related primarily to the Company’s historical refranchising programs and, to a lesser extent, franchisee development of new restaurants, at March 25, 2006 and December 31, 2005. In support of these guarantees, we posted letters of credit of $4 million. We also provide a standby letter of credit of $18 million under which we could potentially be required to fund a portion of one of the franchisee loan pools. The total loans outstanding under these loan pools were approximately $74 and $77 million at March 25, 2006 and December 31, 2005, respectively.

 

Any funding under the guarantees or letters of credit would be secured by the franchisee loans and any related collateral. We believe that we have appropriately provided for our estimated probable exposures under these

 

10

 

 

contingent liabilities. These provisions were primarily charged to refranchising (loss) gain. New loans added to the loan pools in the quarter ended March 25, 2006 were not significant.

 

Insurance Programs

 

We are self-insured for a substantial portion of our current and prior years’ coverage including workers’ compensation, employment practices liability, general liability, automobile liability and property losses (collectively, “property and casualty losses”). To mitigate the cost of our exposures for certain property and casualty losses, we make annual decisions to self-insure the risks of loss up to defined maximum per occurrence retentions on a line by line basis or to combine certain lines of coverage into one loss pool with a single self-insured aggregate retention. The Company then purchases insurance coverage, up to a certain limit, for losses that exceed the self-insurance per occurrence or aggregate retention. The insurers’ maximum aggregate loss limits are significantly above our actuarially determined probable losses; therefore, we believe the likelihood of losses exceeding the insurers’ maximum aggregate loss limits is remote.

 

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

 

Change of Control Severance Agreements  

 

The Company has severance agreements with certain key executives (the “Agreements”) that are renewable on an annual basis. These Agreements are triggered by a termination, under certain conditions, of the executive’s employment following a change in control of the Company, as defined in the Agreements. If triggered, the affected executives would generally receive twice the amount of both their annual base salary and their annual incentive, at the higher of target or actual for the preceding year, a proportionate bonus at the higher of target or actual performance earned through the date of termination, outplacement services and a tax gross-up for any excise taxes. These Agreements have a three-year term and automatically renew each January 1 for another three-year term unless the Company elects not to renew the Agreements. If these Agreements had been triggered as of March 25, 2006, payments of approximately $35 million would have been made. In the event of a change of control, rabbi trusts would be established and used to provide payouts under existing deferred and incentive compensation plans.

 

Litigation

 

We are subject to various claims and contingencies related to lawsuits, taxes, environmental and other matters arising out of the normal course of business. We provide reserves for such claims and contingencies when payment is probable and estimable in accordance with SFAS No. 5 “Accounting for Contingencies.”

 

On August 13, 2003, a class action lawsuit against Pizza Hut, Inc., entitled Coldiron v. Pizza Hut, Inc., was filed in the United States District Court, Central District of California. Plaintiff alleges that she and other current and former Pizza Hut Restaurant General Managers (“RGMs”) were improperly classified as exempt employees under the U.S. Fair Labor Standards Act (“FLSA”). There is also a pendent state law claim, alleging that current and former RGMs in California were misclassified under that state’s law. Plaintiff seeks unpaid overtime wages and penalties. On May 5, 2004, the District Court granted conditional certification of a nationwide class of RGMs under the FLSA claim, providing notice to prospective class members and an

 

11

 

 

opportunity to join the class. Approximately 12 percent of the eligible class members have elected to join the litigation. However, on June 30, 2005, the District Court granted Pizza Hut’s motion to strike all FLSA class members who joined the litigation after July 15, 2004. The effect of this order is to reduce the number of FLSA class members to only approximately 88 (or approximately 2.5% of the eligible class members).

 

In November 2005, the parties agreed to a settlement. Pizza Hut believes that definitive settlement documents will be approved by the Court within sixty days following submission of the documents to the Court. We have provided for this settlement amount in our Financial Statements.

 

On November 26, 2001, a lawsuit against Long John Silver’s, Inc. (“LJS”) entitled Kevin Johnson, on behalf of himself and all others similarly situated v. Long John Silver’s, Inc. (“Johnson”) was filed in the United States District Court for the Middle District of Tennessee, Nashville Division. Johnson’s suit alleged that LJS’s former “Security/Restitution for Losses” policy (the “Policy”) provided for deductions from RGMs’ and Assistant Restaurant General Managers’ (“ARGMs”) salaries that violate the salary basis test for exempt personnel under regulations issued pursuant to the FLSA. Johnson alleged that all RGMs and ARGMs who were employed by LJS for the three year period prior to the lawsuit – i.e., since November 26, 1998 – should be treated as the equivalent of hourly employees and thus were eligible under the FLSA for overtime for any hours worked over 40 during all weeks in the recovery period. In addition, Johnson claimed that the potential members of the class are entitled to certain liquidated damages and attorneys fees under the FLSA.

 

LJS believed that Johnson’s claims, as well as the claims of all other similarly situated parties, should be resolved in individual arbitrations pursuant to LJS’s Dispute Resolution Program (“DRP”), and that a collective action to resolve these claims in court was clearly inappropriate under the current state of the law. Accordingly, LJS moved to compel arbitration in the Johnson case. LJS and Johnson also agreed to stay the action effective December 17, 2001, pending mediation and entered into a tolling agreement for that purpose. After mediation did not resolve the case, and after limited discovery and a hearing, the Court determined on June 7, 2004, that Johnson’s individual claims should be referred to arbitration. Johnson appealed, and the decision of the District Court was affirmed in all respects by the United States Court of Appeals for the Sixth Circuit on July 5, 2005.

 

On December 19, 2003, counsel for plaintiff in the above referenced Johnson lawsuit, filed a separate demand for arbitration with the American Arbitration Association (“AAA”) on behalf of former LJS managers Erin Cole and Nick Kaufman (the “Cole Arbitration”). Claimants in the Cole Arbitration demand a class arbitration on behalf of the same putative class - and the same underlying FLSA claims - as were alleged in the Johnson lawsuit. The complaint in the Cole Arbitration subsequently was amended to allege a practice of deductions (distinct from the allegations as to the Policy) in violation of the FLSA salary basis test, and to add Victoria McWhorter, another LJS former manager, as an additional claimant. LJS has denied the claims and the putative class alleged in the Cole Arbitration, and it is LJS’s position that the claims of Cole, Kaufman, and McWhorter should be individually arbitrated.

 

Arbitrations under LJS’s DRP, including the Cole Arbitration, are governed by the rules of the AAA. In October 2003, the AAA adopted its Supplementary Rules for Class Arbitrations (“AAA Class Rules”). The AAA appointed an arbitrator for the Cole Arbitration. On June 15, 2004, the arbitrator issued a clause construction award, ruling that the DRP does not preclude class arbitration. LJS moved to vacate the clause construction award in the United States District Court for the District of South Carolina. On September 15, 2005, the federal court in South Carolina ruled that it did not have jurisdiction to hear LJS’s motion to vacate. LJS has appealed the U.S. District Court’s ruling to the United States Court of Appeals for the Fourth Circuit. LJS has also filed a motion to vacate the clause construction award in South Carolina state court. While judicial review of the clause construction award was pending in the U.S. District Court, the arbitrator permitted claimants to move for a class determination award, which was opposed by LJS. On September 19, 2005, the arbitrator issued a class determination award, certifying a class of LJS’s RGMs and ARGMs employed between December 17, 1998, and August 22, 2004, on FLSA claims, to proceed on an opt-out basis under the AAA Class Rules. That class determination award was upheld on appeal by the United States District Court for the District of South Carolina on January 20, 2006, and the arbitrator declined to reconsider the award. LJS has appealed

 

12

 

 

the ruling of the U.S. District Court to the United States Court of Appeals for the Fourth Circuit. LJS has also filed a motion to vacate the class determination award in South Carolina state court.

 

LJS believes that the DRP provides for individual arbitrations. LJS also believes that if the Cole Arbitration must proceed on a class basis, (i) the proceedings should be governed by the opt-in collective action structure of the FLSA, and (ii) a class should not be certified under the applicable provisions of the FLSA. LJS also believes that each individual should not be able to recover for more than two years (and a maximum three years) prior to the date they file a consent to join the arbitration. We have provided for the estimated costs of the Cole Arbitration, based on a projection of eligible claims, the amount of each eligible claim, the estimated legal fees incurred by the claimants and the results of settlement negotiations in this and other wage and hour litigation matters. But in view of the novelties of proceeding under the AAA Class Rules and the inherent uncertainties of litigation, there can be no assurance that the outcome of the arbitration will not result in losses in excess of those currently provided for.

 

On September 21, 2005, a collective action lawsuit against the Company and KFC Corporation, originally entitled Parler v. Yum Brands, Inc., d/b/a KFC, and KFC Corporation, was filed in the United States District Court for the District of Minnesota. Plaintiff alleges that he and other current and former KFC Assistant Unit Managers (“AUMs”) were improperly classified as exempt employees under FLSA. Plaintiff seeks overtime wages and liquidated damages. On January 17, 2006, the District Court dismissed the claims against the Company with prejudice, leaving KFC Corporation as the sole defendant. Notice was mailed to current and former AUMs advising them of the litigation and providing an opportunity to join the case if they choose to do so.

 

We believe that KFC has properly classified its AUMs as exempt under the FLSA and accordingly intend to vigorously defend against all claims in this lawsuit. However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.

 

On 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 entitled 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 (the “California Restaurants”) 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 (including parking spaces, ramps, counters, restroom facilities and seating) 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. For themselves, the four named plaintiffs have claimed aggregate minimum statutory damages of no less than $16,000, but are expected to claim greater amounts based on the number of Taco Bell outlets they visited at which they claim to have suffered discrimination.

 

On February 23, 2004, the District Court granted Plaintiffs' motion for class certification. The District Court certified a Rule 23(b)(2) mandatory injunctive relief class of all individuals with disabilities who use wheelchairs or electric scooters for mobility who, at any time on or after December 17, 2001, were denied, or are currently being denied, on the basis of disability, the full and equal enjoyment of the California Restaurants. The class includes claims for injunctive relief and minimum statutory damages.

 

Pursuant to the parties’ agreement, on or about August 31, 2004, the District Court ordered that the trial of this action be bifurcated so that stage one will resolve Plaintiffs’ claims for equitable relief and stage two will

 

13

 

 

resolve Plaintiffs’ claims for damages. The parties are currently proceeding with the equitable relief stage of this action. During this stage, Taco Bell filed a motion to partially decertify the class to exclude from the Rule 23(b)(2) class claims for monetary damages. The District Court denied the motion. Plaintiffs filed their own motion for partial summary judgment as to liability relating to a subset of the California Restaurants. The District Court denied that motion as well. Discovery is ongoing as of the date of this report.

 

Taco Bell has denied liability and intends to vigorously defend against all claims in this lawsuit. Although this lawsuit is at a relatively early stage in the proceedings, it is likely that certain of the California Restaurants will be determined to be not fully compliant with accessibility laws and that Taco Bell will be required to take certain steps to make those restaurants fully compliant. However, at this time, it is not possible to estimate with reasonable certainty the potential costs to bring any non compliant California Restaurants into compliance with applicable state and federal disability access laws. Nor is it possible at this time to reasonably estimate the probability or amount of liability for monetary damages on a class wide basis to Taco Bell.

 

Obligations to PepsiCo, Inc. After Spin-off

 

In connection with our October 6, 1997 spin-off from PepsiCo, Inc. (“PepsiCo”) (the “Spin-off”), we entered into separation and other related agreements (the “Separation Agreements”) governing the Spin-off and our subsequent relationship with PepsiCo. These agreements provide certain indemnities to PepsiCo.

 

Under the terms of these agreements, we have indemnified PepsiCo for any costs or losses it incurs with respect to all letters of credit, guarantees and contingent liabilities relating to our businesses under which PepsiCo remains liable. As of March 25, 2006, PepsiCo remains liable for approximately $27 million on a nominal basis related to these contingencies. This obligation ends at the time PepsiCo is released, terminated or replaced by a qualified letter of credit. We have not been required to make any payments under this indemnity.

 

Under the Separation Agreements, PepsiCo maintains full control and absolute discretion with regard to any combined or consolidated tax filings for periods through October 6, 1997. PepsiCo also maintains full control and absolute discretion regarding any common tax audit issues. Although PepsiCo has contractually agreed to, in good faith, use its best efforts to settle all joint interests in any common tax audit issue on a basis consistent with prior practice, there can be no assurance that determinations made by PepsiCo would be the same as we would reach, acting on our own behalf. Through March 25, 2006, there have not been any determinations made by PepsiCo where we would have reached a different determination.

 

10. Subsequent Event

 

Effective April 7, 2006, we filed a Registration Statement on Form S-3 (Registration No. 333-133097) with the SEC relating to $300 million aggregate principal amount of 6.25% Senior Unsecured Notes due April 15, 2016 (the “Notes”). The Notes represent senior, unsecured obligations and rank equally in right of payment with all of our existing and future unsecured unsubordinated indebtedness and senior in right of payment to all of our subordinated indebtedness. We used $200 million of the net proceeds from these Notes to repay our 8.5% Senior Unsecured Notes due in April 2006 and we will use the remainder for general corporate purposes.

 

In anticipation of issuing the Notes, we entered into treasury locks during the quarter ended March 25, 2006 with aggregate notional amounts of $250 million to hedge the risk of changes in future interest payments attributable to changes in United States Treasury rates prior to issuance of the Notes. As these treasury locks were designated and effective in offsetting this variability in cash flows associated with the future interest payments, the resulting gain of approximately $8 million will be amortized over the 10 year life of the Notes as a reduction in interest expense.

 

 

 

 

14

 

 

 

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

 

Introduction and Overview

 

YUM! Brands, Inc. and Subsidiaries (collectively referred to as “YUM” or the “Company”) comprises 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”) and is the world’s largest quick service restaurant (“QSR”) company based on the number of system units. YUM is the second largest QSR company outside the U.S. with over 13,900 units.

 

Through its Concepts, YUM develops, operates, franchises and licenses a system of both traditional and non-traditional QSR restaurants. Traditional units feature dine-in, carryout and, in some instances, drive-thru or delivery services. Non-traditional units, which are typically licensed outlets, include express units and kiosks which have a more limited menu and operate in non-traditional locations like malls, airports, gasoline service stations, convenience stores, stadiums, amusement parks and colleges, where a full-scale traditional outlet would not be practical or efficient.

 

The retail food industry, in which the Company competes, is made up of supermarkets, supercenters, warehouse stores, convenience stores, coffee shops, snack bars, delicatessens and restaurants (including the QSR segment), and is intensely competitive with respect to food quality, price, service, convenience, location and concept. The industry is often affected by changes in consumer tastes; national, regional or local economic conditions; currency fluctuations; demographic trends; traffic patterns; the type, number and location of competing food retailers and products; and disposable purchasing power. Each of the Concepts compete with international, national and regional restaurant chains as well as locally-owned restaurants, not only for customers, but also for management and hourly personnel, suitable real estate sites and qualified franchisees.

 

Our business consists of three reporting segments: United States, the International Division and the China Division. The China Division includes mainland China (“China”), Thailand and KFC Taiwan and the International Division includes the remainder of our international operations.

 

The Company’s key strategies are:

 

 

Building dominant restaurant brands in China

 

Driving profitable international expansion

 

Improving restaurant operations

 

Multibranding category-leading brands

 

The Company is focused on five long-term measures identified as essential to our growth and progress. These five measures and related key performance indicators are as follows:

 

 

China Division and International Division expansion

 

China Division and International Division system-sales growth (local currency)

 

Number of new China Division and International Division restaurant openings

 

 

Net China Division and International Division unit growth

 

 

 

Multibrand innovation and expansion

 

Number of multibrand restaurant locations

 

 

Number of multibrand units added

 

 

Number of franchise multibrand units added

 

 

Portfolio of category-leading U.S. brands

 

U.S. blended same store sales growth

 

 

15

 

 

 

 

Global franchise fees

 

New restaurant openings by franchisees

 

Franchise fee growth

 

 

 

Strong cash generation and returns

 

Cash generated from all sources

 

 

Cash generated from all sources after capital spending

 

Restaurant margins

 

 

U.S. and International operating margins

 

 

Our progress against these measures is discussed throughout the Management’s Discussion and Analysis (“MD&A”).

 

Throughout the MD&A, the Company provides the percentage change excluding the impact of foreign currency translation. These amounts are derived by translating current year results at prior year average exchange rates. We believe the elimination of the foreign currency translation impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.

 

The following MD&A should be read in conjunction with the unaudited Condensed Consolidated Financial Statements (“Financial Statements”), the Cautionary Statements and our annual report on Form 10-K for the fiscal year ended December 31, 2005 (“2005 Form 10-K”).

 

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

 

Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact 2006 Comparisons with 2005

 

The following factors impacted comparability of operating performance for the quarter ended March 25, 2006 or could impact comparisons for the remainder of 2006. Certain of these factors were previously discussed in our 2005 Form 10-K.

 

Mainland China Issues

 

Our KFC business in mainland China was negatively impacted by the interruption of product offerings and negative publicity associated with a supplier ingredient issue experienced in late March, 2005 as well as consumer concerns related to Avian Flu in the fourth quarter of 2005. As a result of the aforementioned issues, the China Division experienced system sales growth in the full year 2005 of 11% excluding foreign currency translation which was below our ongoing target of at least 22%. In the first quarter 2006 we achieved China Division growth rates of 14% for system sales and 16% for Company sales, both excluding foreign currency translation. Additionally, in the first period of the quarter ending June 17, 2006 the China Division had system sales growth, excluding foreign currency translation, of 25%. This included system sales growth, excluding foreign currency translation, of 35% in mainland China. Given these positive trends, we believe KFC sales in mainland China have rebounded from the negative impact of the supplier ingredient issue and Avian Flu.

 

United States Restaurant Costs

 

Restaurant profits in the United States were positively impacted by a decline in commodity costs (principally meats and cheese) in the quarter ended March 25, 2006 versus the quarter ended March 19, 2005. Commodity costs declined by approximately $8 million in the quarter ended March 25, 2006 and are expected to decline by a similar amount in our second quarter ending June 17, 2006. The resulting increases in restaurant profit were, and are expected to be, largely offset by increases in utility costs.

 

 

16

 

 

 

Beverage Agreement Contract Termination

 

During the quarter ended March 25, 2006 we entered into an agreement with a beverage supplier to certain of our Concepts to terminate a long-term supply contract. As a result of the cash payment we will make to the supplier in connection with this termination, we recorded a charge of $8 million in the quarter ended March 25, 2006. We anticipate entering into an agreement with an alternative beverage supplier for these Concepts in the second quarter of 2006 that will provide for more favorable beverage pricing than the agreement being terminated. The contract termination charge we recorded in the quarter ended March 25, 2006 will largely be offset by more favorable beverage pricing for our Concepts recognized the balance of the year such that the net impact on 2006 net income will not be significant. We will continue to benefit from the more favorable pricing in 2007 and beyond.

 

Store Portfolio Strategy

 

From time to time we sell Company restaurants to existing and new franchisees where geographic synergies can be obtained or where their expertise can generally be leveraged to improve our overall operating performance, while retaining Company ownership of key U.S. and international markets. In the U.S., we are in the process of increasing franchise ownership of restaurants from 75% currently to 80%. This two-year plan calls for selling approximately 1,000 Company restaurants to franchisees in 2006 and 2007. Refranchisings reduce our reported revenues and restaurant profits and increase the importance of system sales growth as a key performance measure.

 

The following table summarizes our refranchising activities:

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Number of units refranchised

 

 

81

 

 

 

 

14

 

Refranchising proceeds, pre-tax

 

$

22

 

 

 

$

4

 

Refranchising net losses, pre-tax

 

$

4

 

 

 

$

2

 

 

In addition to our refranchising program, from time to time we close restaurants that are poor performing, we relocate restaurants to a new site within the same trade area or we consolidate two or more of our existing units into a single unit (collectively “store closures”). Store closure costs (income) includes the net of gains or losses on sales of real estate on which we are not currently operating a Company restaurant, 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.

 

The following table summarizes Company store closure activities:

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

Number of units closed

 

 

35

 

 

 

 

43

 

Store closure costs

 

$

1

 

 

 

$

4

 

 

The impact on operating profit arising from refranchising and Company store closures is the net of (a) the estimated reductions in restaurant profit, which reflects the decrease in Company sales, and general and administrative expenses and (b) the estimated increase in franchise fees from the stores refranchised. The amounts presented below reflect the estimated impact from stores that were operated by us for all or some portion of the comparable period in 2005 and were no longer operated by us as of March 25, 2006. The amounts do not include results from new restaurants that we opened in connection with a relocation of an existing unit or any incremental impact upon consolidation of two or more of our existing units into a single unit.

 

17

 

 

 

The following table summarizes the estimated impact on revenue of refranchising and Company store closures:

 

 

 

Quarter Ended 3/25/06

 

 

U.S.

 

 

International

Division

 

 

China

Division

 

 

Worldwide

Decreased Company sales

 

$

(82

)

 

 

$

(30

)

 

 

$

(3

)

 

 

$

(115

)

Increased franchise fees

 

 

3

 

 

 

 

1

 

 

 

 

 

 

 

 

4

 

Decrease in total revenues

 

$

(79

)

 

 

$

(29

)

 

 

$

(3

)

 

 

$

(111

)

 

The following table summarizes the estimated impact on operating profit of refranchising and Company store closures:

 

 

 

Quarter Ended 3/25/06

 

 

U.S.

 

 

International

Division

 

 

China

Division

 

 

Worldwide

Decreased restaurant profit

 

$

(8

)

 

 

$

 

 

 

$

 

 

 

$

(8

)

Increased franchise fees

 

 

3

 

 

 

 

1

 

 

 

 

 

 

 

 

4

 

Decreased general and

administrative expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Decrease in operating profit

 

$

(5

)

 

 

$

1

 

 

 

$

 

 

 

$

(4

)

 

Results of Operations

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

 

 

% B/(W)

Company sales

 

$

1,819

 

 

 

$

1,810

 

 

 

1

 

Franchise and license fees

 

 

266

 

 

 

 

244

 

 

 

9

 

Revenues

 

$

2,085

 

 

 

$

2,054

 

 

 

2

 

Company restaurant profit

 

$

284

 

 

 

$

259

 

 

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

% of Company sales

 

 

15.6%

 

 

 

 

14.3%

 

 

 

1.3

ppts.

Operating profit

 

 

282

 

 

 

 

251

 

 

 

12

 

Interest expense, net

 

 

35

 

 

 

 

28

 

 

 

(22

)

Income tax provision

 

 

77

 

 

 

 

70

 

 

 

(10

)

Net income

 

$

170

 

 

 

$

153

 

 

 

11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share(a)

 

$

0.59

 

 

 

$

0.50

 

 

 

18

 

 

(a)

See Note 3 for the number of shares used in this calculation.

 

18

 

 

 

Restaurant Unit Activity

 

Worldwide

 

 

 

Company

 

 

Unconsolidated
Affiliates

 

 

Franchisees

 

 

Total Excluding Licensees

Beginning of year

 

 

 

7,587

 

 

 

1,648

 

 

 

22,666

 

 

 

31,901

 

New Builds

 

 

 

66

 

 

 

18

 

 

 

154

 

 

 

238

 

Acquisitions

 

 

 

 

 

 

 

 

 

 

 

 

 

Refranchising

 

 

 

(81

)

 

 

 

 

 

81

 

 

 

 

Closures

 

 

 

(35

)

 

 

(11

)

 

 

(132

)

 

 

(178

)

Other

 

 

 

3

 

 

 

(3

)

 

 

2

 

 

 

2

 

End of quarter

 

 

 

7,540

 

 

 

1,652

 

 

 

22,771

 

 

 

31,963

 

% of Total

 

 

 

24%

 

 

 

5%

 

 

 

71%

 

 

 

100%

 

 

The above totals exclude 2,369 and 2,376 licensed units at March 25, 2006 and December 31, 2005, respectively.

 

United States

 

 

 

Company

 

 

Unconsolidated
Affiliates

 

 

Franchisees

 

 

Total Excluding Licensees

Beginning of year

 

 

 

4,686

 

 

 

 

 

 

13,605

 

 

 

18,291

 

New Builds

 

 

 

10

 

 

 

 

 

 

35

 

 

 

45

 

Acquisitions

 

 

 

 

 

 

 

 

 

 

 

 

 

Refranchising

 

 

 

(75

)

 

 

 

 

 

75

 

 

 

 

Closures

 

 

 

(23

)

 

 

 

 

 

(89

)

 

 

(112

)

Other

 

 

 

3

 

 

 

 

 

 

4

 

 

 

7

 

End of quarter

 

 

 

4,601

 

 

 

 

 

 

13,630

 

 

 

18,231

 

% of Total

 

 

 

25%

 

 

 

 

 

 

75%

 

 

 

100%

 

 

The above totals exclude 2,172 and 2,181 licensed units at March 25, 2006 and December 31, 2005, respectively.

 

International Division

 

 

 

Company

 

 

Unconsolidated
Affiliates

 

 

Franchisees

 

 

Total Excluding Licensees

Beginning of year

 

 

 

1,375

 

 

 

1,096

 

 

 

8,848

 

 

 

11,319

 

New Builds

 

 

 

3

 

 

 

4

 

 

 

117

 

 

 

124

 

Acquisitions

 

 

 

 

 

 

 

 

 

 

 

 

 

Refranchising

 

 

 

(5

)

 

 

 

 

 

5

 

 

 

 

Closures

 

 

 

(7

)

 

 

(11

)

 

 

(43

)

 

 

(61

)

Other

 

 

 

 

 

 

(3

)

 

 

(1

)

 

 

(4

)

End of quarter

 

 

 

1,366

 

 

 

1,086

 

 

 

8,926

 

 

 

11,378

 

% of Total

 

 

 

12%

 

 

 

10%

 

 

 

78%

 

 

 

100%

 

 

The above totals exclude 197 and 195 licensed units at March 25, 2006 and December 31, 2005, respectively.

 

 

 

19

 

 

 

 

China Division

 

 

 

Company

 

 

Unconsolidated
Affiliates

 

 

Franchisees

 

 

Total Excluding Licensees

Beginning of year

 

 

 

1,526

 

 

 

552

 

 

 

213

 

 

 

2,291

 

New Builds

 

 

 

53

 

 

 

14

 

 

 

2

 

 

 

69

 

Acquisitions

 

 

 

 

 

 

 

 

 

 

 

 

 

Refranchising

 

 

 

(1

)

 

 

 

 

 

1

 

 

 

 

Closures

 

 

 

(5

)

 

 

 

 

 

 

 

 

(5

)

Other

 

 

 

 

 

 

 

 

 

(1

)

 

 

(1

)

End of quarter

 

 

 

1,573

 

 

 

566

 

 

 

215

 

 

 

2,354

 

% of Total

 

 

 

67%

 

 

 

24%

 

 

 

9%

%

 

 

100%

 

 

There are no licensed units in the China Division.

 

Multibrand restaurants are included in the totals above. Multibrand conversions increase the sales and points of distribution for the second brand added to a restaurant but do not result in an additional unit count. Similarly, a new multibrand restaurant, while increasing sales and points of distribution for two brands, results in just one additional unit count. Franchise unit counts below include both franchisee and unconsolidated affiliate multibrand units. Following are multibrand restaurant totals at March 25, 2006 and December 31, 2005:

 

3/25/06

 

 

 

Company

 

 

Franchise

 

 

Total

United States

 

 

 

1,743

 

 

 

1,417

 

 

 

3,160

 

International Division

 

 

 

17

 

 

 

174

 

 

 

191

 

Worldwide

 

 

 

1,760

 

 

 

1,591

 

 

 

3,351

 

 

12/31/05

 

 

 

Company

 

 

Franchise

 

 

Total

United States

 

 

 

1,696

 

 

 

1,400

 

 

 

3,096

 

International Division

 

 

 

17

 

 

 

176

 

 

 

193

 

Worldwide

 

 

 

1,713

 

 

 

1,576

 

 

 

3,289

 

 

For the quarter ended March 25, 2006, Company and franchise multibrand unit gross additions were 56 and 28, respectively. There are no multibrand units in the China Division.

 

System Sales Growth

 

 

 

 

 


Increase

 

 

Increase excluding
currency translation

 

 

 

 

3/25/06

 

 

3/19/05

 

 

3/25/06

 

 

3/19/05

United States

 

 

 

6%

 

 

 

4%

 

 

 

N/A

 

 

 

N/A

 

International Division

 

 

 

2%

 

 

 

11%

 

 

 

6%

 

 

 

7%

 

China Division

 

 

 

16%

 

 

 

20%

 

 

 

14%

 

 

 

20%

 

Worldwide

 

 

 

5%

 

 

 

7%

 

 

 

6%

 

 

 

6%

 

 

System sales growth includes the results of all restaurants regardless of ownership, including Company-owned, franchise, unconsolidated affiliate and license restaurants. Sales of franchise, unconsolidated affiliate and license restaurants generate franchise and license fees for the Company (typically at a rate of 4% to 6% of sales). Franchise, unconsolidated affiliate and license restaurants sales are not included in Company sales on the Condensed Consolidated Statements of Income; however, the franchise and license fees are included in the

 

20

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.

 

The increase in Worldwide system sales was driven by new unit development and same store sales growth, partially offset by store closures.

 

The increase in U.S. system sales was driven by same store sales growth and new unit development, partially offset by store closures.

 

The increase in International Division system sales was driven by new unit development and same store sales growth, partially offset by store closures.

 

The increase in China Division system sales was driven by new unit development partially offset by same store sales declines.

 

Revenues

 

 

 


Amount

 

 


% Increase/(Decrease)

 

 

% Increase/(Decrease)

excluding currency

translation

 

 

3/25/06

 

 

3/19/05

 

 

 

 

 

 

 

 

Company sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

1,191

 

 

 

$

1,199

 

 

 

(1

)

 

 

N/A

 

International Division

 

 

359

 

 

 

 

384

 

 

 

(7

)

 

 

(5

)

China Division

 

 

269

 

 

 

 

227

 

 

 

18

 

 

 

16

 

Worldwide

 

 

1,819

 

 

 

 

1,810

 

 

 

1

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchise and license fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

148

 

 

 

 

136

 

 

 

9

 

 

 

N/A

 

International Division

 

 

110

 

 

 

 

100

 

 

 

10

 

 

 

13

 

China Division

 

 

8

 

 

 

 

8

 

 

 

8

 

 

 

5

 

Worldwide

 

 

266

 

 

 

 

244

 

 

 

9

 

 

 

10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

1,339

 

 

 

 

1,335

 

 

 

 

 

 

N/A

 

International Division

 

 

469

 

 

 

 

484

 

 

 

(3

)

 

 

(1

)

China Division

 

 

277

 

 

 

 

235

 

 

 

18

 

 

 

16

 

Worldwide

 

$

2,085

 

 

 

$

2,054

 

 

 

2

 

 

 

2

 

 

The increase in Worldwide Company sales was driven by new unit development and same store sales growth, partially offset by refranchising and store closures.

 

The increase in Worldwide franchise and license fees was driven by same store sales growth, new unit development, refranchising, and royalty rate increases, partially offset by store closures.

 

The decrease in U.S. Company sales was driven by refranchising and store closures, partially offset by same store sales growth and new unit development.

 

 

21

 

 

 

U.S same store sales include only Company restaurants that have been open one year or more. U.S. blended same store sales include KFC, Pizza Hut and Taco Bell Company-owned restaurants only. U.S. same store sales for Long John Silver’s and A&W restaurants are not included. Following are the same store sales growth results by brand:

 

 

 

 

 

Quarter ended 3/25/06

 

 

 

 

Same Store

Sales

 

 

Transactions

 

 

Average Guest

Check

KFC

 

 

 

5

%

 

 

 

 

 

5

%

Pizza Hut

 

 

 

(1

)%

 

 

(6

)%

 

 

5

%

Taco Bell

 

 

 

8

%

 

 

5

%

 

 

3

%

 

U.S. blended Company same store sales increased 4% due to increases in average guest check and transactions.

 

The increase in U.S. franchise and license fees was driven by same store sales growth, new unit development and refranchising, partially offset by store closures.

 

The decrease in International Division Company sales was driven by refranchising, store closures, and same store sales declines, partially offset by new unit development.

 

The increase in International Division franchise and license fees was driven by new unit development, same store sales growth, royalty rate increases and refranchising, partially offset by store closures.

 

The increase in China Division Company sales and franchise and license fees was primarily driven by new unit development.

 

Company Restaurant Margins

 


3/25/06

 

 

 


United States

 

 

International
Division

 

 

China
Division

 

 


Worldwide

Company sales

 

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

Food and paper

 

 

 

28.5

 

 

 

33.5

 

 

 

36.0

 

 

 

30.6

 

Payroll and employee benefits

 

 

 

30.2

 

 

 

23.5

 

 

 

12.8

 

 

 

26.3

 

Occupancy and other operating
  expenses

 

 

 

26.3

 

 

 

30.2

 

 

 

29.4

 

 

 

27.5

 

Company restaurant margin

 

 

 

15.0

%

 

 

12.8

%

 

 

21.8

%

 

 

15.6

%

 


3/19/06

 

 

 


United States

 

 

International
Division

 

 

China
Division

 

 


Worldwide

Company sales

 

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

Food and paper

 

 

 

30.3

 

 

 

33.2

 

 

 

36.6

 

 

 

31.7

 

Payroll and employee benefits

 

 

 

30.7

 

 

 

23.9

 

 

 

11.9

 

 

 

26.9

 

Occupancy and other operating
  expenses

 

 

 

25.9

 

 

 

30.0

 

 

 

28.4

 

 

 

27.1

 

Company restaurant margin

 

 

 

13.1

%

 

 

12.9

%

 

 

23.1

%

 

 

14.3

%

 

The increase in U.S. restaurant margins as a percentage of sales was driven by the impact of same store sales growth on restaurant margin and lower food and paper costs partially offset by higher occupancy and other

 

22

 

 

costs. Lower food and paper costs were driven by decreased commodity costs (principally meats and cheese). Higher occupancy and other costs were primarily driven by increases in utility costs.

 

The decrease in International Division restaurant margins as a percentage of sales was driven by higher food and paper costs, higher occupancy and other costs and lower margins associated with new units during the initial periods of operation. The decrease was largely offset by the favorable impact on restaurant margin of refranchising certain restaurants and a 27 basis point favorable impact from foreign currency translation.

 

The impact from foreign currency translation on margins as a percentage of sales is a result of the portfolio of markets effect. International margin percentages in total are impacted favorably when currencies strengthen in markets with above average margins as well as when currencies weaken in markets with below average margins.

 

The decrease in China Division restaurant margins as a percentage of sales was driven by higher labor costs and lower margins associated with new units during the initial periods of operations.

 

Worldwide General and Administrative Expenses

 

General and administrative expenses increased $7 million or 3% in the quarter. Increases in general and administrative expenses were driven by higher compensation related costs, including amounts associated with investments in strategic initiatives in China and other international growth markets, and higher litigation related costs.

 

Worldwide Other (Income) Expense

 

 

Quarter

 

3/25/06

 

3/19/05

Equity income from investments in unconsolidated affiliates

$          (11)

 

$      (15)

Foreign exchange net (gain) loss

    (1)

 

 1

Settlement with supplier

    8

 

Other (income) expense

$           (4)

 

$      (14)

 

Other income decreased $10 million or 68%. The decrease was driven by an $8 million charge associated with the termination of a beverage agreement in the United States segment and a decrease in equity income from investments in unconsolidated affiliates, primarily our unconsolidated affiliate that operates Pizza Hut in the United Kingdom.

 

Worldwide Closure and Impairment Expense and Refranchising (Gain) Loss

 

See the Store Portfolio Strategy section for more detail of our refranchising and closure activities and Note 5 for a summary of closures and impairment expenses and refranchising (gain) loss by reportable operating segment.

 

23

 

 

 

Operating Profit

 

 

 

Quarter

 

 

3/25/06

 

 

3/19/05

 

 

% B/(W)

United States

 

$

188

 

 

 

$

157

 

 

 

19

 

International Division

 

 

95

 

 

 

 

91

 

 

 

3

 

China Division

 

 

58

 

 

 

 

52

 

 

 

10

 

Unallocated and corporate expenses

 

 

(55

)

 

 

 

(46

)

 

 

(16

)

Unallocated other income (expense)

 

 

 

 

 

 

(1

)

 

 

NM

 

Unallocated refranchising gain (loss)

 

 

(4

)

 

 

 

(2

)

 

 

NM

 

Operating profit

 

$

282

 

 

 

$

251

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States operating margin

 

 

14.0%

 

 

 

 

11.8%

 

 

 

2.2

ppts.

International Division operating margin

 

 

20.1%

 

 

 

 

18.9%

 

 

 

1.2

ppts.

 

Neither unallocated and corporate expenses, which comprise general and administrative expenses or unallocated refranchising gain (loss), are allocated to the U.S., International Division or China Division segments for performance reporting purposes.

 

The increase in U.S. operating profit was driven by the impact of same store sales growth on restaurant profit and franchise and license fees, as well as lower closure and impairment expenses. The increase was partially offset by a charge associated with the termination of a beverage agreement in the quarter ended March 25, 2006 and the unfavorable impact of refranchising. The favorable impact on restaurant profit of lower commodity costs was largely offset by higher utility costs.

 

Excluding the unfavorable impact from foreign currency translation, International Division operating profit increased 6%. The increase was driven by the impact of new unit development and same store sales growth on franchise and license fees. The increases were partially offset by lower equity income from unconsolidated affiliates and higher closure and impairment expenses.

 

Excluding the favorable impact from foreign currency translation, China Division operating profit increased 8%. The increase was driven by new unit development partially offset by higher labor costs.

 

Interest Expense, Net

 

 

Quarter

 

 

 

3/25/06

 

3/19/05

 

% B/(W)

Interest expense

$      38

 

$       33

 

(17)

Interest income

(3)

 

 (5)

 

(17)

Interest expense, net

$      35

 

$       28

 

(22)

 

Interest expense increased $5 million or 17%, driven by an increase in interest rates on the variable rate portion of our debt and borrowings under the International Credit Facility that was entered into in the fourth quarter of 2005 .

 

Income Taxes

 

 

 

Quarter

 

 

3/25/06

 

3/19/05

Income taxes

$     77

 

$     70

Effective tax rate

31.3%

 

31.4%

 

 

24

 

 

 

Our effective rate for the quarter was basically flat as the positive impact of year over year valuation allowance adjustments related to changes in judgments regarding the realizability of deferred tax assets was largely offset by the negative impact of lapping certain prior year items that on a net basis benefited our prior year tax rate. In the quarter ended March 19, 2005 we recognized benefit due to the recognition of certain foreign tax credits that we were able to substantiate during the quarter as well as the reversal of certain tax reserves. These prior year benefits were partially offset by the negative impact due to a decrease in tax rates in the quarter ended March 19, 2005 in a state for which we had deferred tax assets.

 

Consolidated Cash Flows

 

Net cash provided by operating activities was $297 million compared to $232 million in 2005. The increase was driven by higher net income in 2006 and increases in operating working capital due to timing of cash receipts related to accounts and notes receivable and timing of payments related to accounts payable and other current liabilities.

 

Net cash used in investing activities was $61 million versus $105 million in 2005. The decrease was driven by a reduction in capital spending and an increase in the proceeds received from refranchising,

 

Net cash used in financing activities was $261 million versus $105 million in 2005. The increase was driven by higher share repurchases in 2006 compared to 2005, partially offset by net borrowings in 2006 compared to net repayments in 2005.

 

Liquidity and Capital Resources

 

Operating in the QSR industry allows us to generate substantial cash flows from the operations of our company stores and from our franchise operations, which require a limited YUM investment. In each of the last four fiscal years, net cash provided by operating activities has exceeded $1 billion. We expect these levels of net cash provided by operating activities to continue in the foreseeable future. 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. Though a decline in revenues could adversely impact our cash flows from operations, we believe our operating cash flows, our ability to reduce discretionary spending, and our borrowing capacity will allow us to meet our cash requirements in 2006 and beyond.

 

During the quarter ended March 25, 2006, we paid a quarterly cash dividend of $32 million. Additionally, on March 16, 2006, our Board of Directors approved a cash dividend of $0.115 per share of common stock to be distributed on May 5, 2006 to shareholders of record at the close of business on April 14, 2006. The Company is targeting an annual payout ratio of 15% to 20% of net income.

 

Our primary bank credit agreement comprises a $1.0 billion senior unsecured Revolving Credit Facility (the “Credit Facility”) which matures in September 2009. At March 25, 2006, our unused Credit Facility totaled $740 million, net of outstanding letters of credit of $221 million. There were borrowings of $39 million outstanding under the Credit Facility at March 25, 2006. We were in compliance with all debt covenants under this facility at March 25, 2006.

 

Additionally, on November 8, 2005, we executed a $350 million, five-year revolving credit facility (the “International Credit Facility” or “ICF”) on behalf of three of our wholly owned international subsidiaries. There were borrowings of $213 million and available credit of $137 million outstanding under the ICF at March 25, 2006. We were in compliance with all debt covenants under the ICF at March 25, 2006.

 

The remainder of our long-term debt primarily comprises Senior Unsecured Notes. Amounts outstanding under Senior Unsecured Notes were $1.5 billion at March 25, 2006. Included in short-term borrowings at March 25, 2006 are $200 million in Senior Unsecured Notes with an April 2006 maturity date. The remaining $1.3 billion in Senior Unsecured Notes comprise the majority of our long-term debt.

 

25

 

 

 

In April 2006, we filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to $300 million aggregate principal amount of 6.25% Senior Unsecured Notes due April 15, 2016. We used $200 million of the net proceeds to repay our 8.5% Senior Unsecured Notes due in April 2006 and we will use the remainder for general corporate purposes. See Note 10 for further details.

 

We estimate that in 2006 capital spending, including acquisitions of restaurants from franchisees, will be approximately $675 million. We also estimate that in 2006 refranchising proceeds, prior to taxes, will be approximately $150 million, employee stock options proceeds, prior to taxes, will be approximately $150 million and sales of property, plant and equipment will be approximately $40 million.

 

In March 2006, the Board of Directors authorized a new share repurchase program for up to $500 million of the Company’s outstanding common stock to be purchased through March 2007. At March 25, 2006, we had remaining capacity to repurchase up to $598 million of our outstanding Common Stock (excluding applicable transaction fees) under programs authorized in November 2005 and March 2006.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

There were no material changes during the quarter ended March 25, 2006 to the disclosures made in Item 7A of the Company’s 2005 Form 10-K.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based on the evaluation, performed under the supervision and with the participation of the Company’s management, including the Chairman, Chief Executive Officer and President (the “CEO”) and the Chief Financial Officer (the “CFO”), the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by the report.

 

Changes in Internal Control

 

There were no significant changes with respect to the Company’s internal control over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, internal control over financial reporting during the quarter ended March 25, 2006.

 

Cautionary Note Regarding Forward-Looking Statements

 

This report may contain forward-looking statements within the meaning of the U.S. federal securities laws. These forward-looking statements are intended to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. The statements include those identified by such words as “may,” “will,” “expect,” “project,” “anticipate,” “believe,” “plan” and other similar terminology. These “forward-looking statements” reflect our current expectations regarding future events and operating and financial performance and are based upon data available at the time of the statements. Actual results involve risks and uncertainties, including both those specific to us and those specific to the industry, and could differ materially from expectations. We do not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on forward-looking statements.

 

 

26

 

 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders

YUM! Brands, Inc.:

 

We have reviewed the accompanying Condensed Consolidated Balance Sheet of YUM! Brands, Inc. and Subsidiaries (“YUM”) as of March 25, 2006, and the related Condensed Consolidated Statements of Income and Cash Flows for the twelve weeks ended March 25, 2006 and March 19, 2005. These condensed consolidated financial statements are the responsibility of YUM’s management.

 

We conducted our review in accordance with standards established by the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheet of YUM as of December 31, 2005, and the related Consolidated Statements of Income, Cash Flows and Shareholders’ Equity and Comprehensive Income for the year then ended not presented herein; and in our report dated March 2, 2006, we expressed an unqualified opinion on those consolidated financial statements. Our report refers to the adoption of the provisions of the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123R (Revised 2004), “Share-Based Payment,” and the change in the method of accounting for share-based payments. In our opinion, the information set forth in the accompanying Condensed Consolidated Balance Sheet as of December 31, 2005 is fairly presented, in all material respects, in relation to the Consolidated Balance Sheet from which it has been derived.

 

 

 

 

KPMG LLP

Louisville, Kentucky

May 2, 2006

 

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PART II – Other Information and Signatures

 

Item 1. Legal Proceedings

 

Information regarding legal proceedings is incorporated by reference from Note 9 to the Company’s Condensed Consolidated Financial Statements set forth in Part I of this report.

 

Item 1A. Risk Factors

 

We face a variety of risks that are inherent in our business and our industry, including operational, legal, regulatory and product risks. The following are some of the more significant factors that could affect our business and our results of operations:

 

 

Health concerns arising from outbreaks of Avian Flu and food safety and food-borne illness concerns may have an adverse effect on our business;

 

 

Our foreign operations, which are significant, subject us to risks that could negatively affect our business such as fluctuations in foreign currency exchange rates and changes in economic conditions, tax systems