David C. Novak

Chairman & Chief Executive Officer,
Yum! Brands, Inc.

Dear Partners,

I’m pleased to report that in 2012 we delivered full-year EPS growth of 13% or $3.25 per share, excluding special items, marking the eleventh consecutive year we achieved at least 13% and exceeded our annual target of at least 10%. This kind of consistent performance puts us in an elite group of high-growth companies.

We set a new record for international development by opening nearly 2,000 new restaurants in 2012. We also grew worldwide system sales 5% and operating profit 12%, both prior to foreign currency translation and special items. We generated $1.6 billion in net income and almost $2.3 billion in cash from operations. And with our disciplined approach to capital deployment, we remained an industry leader with a Return on Invested Capital of 22%. Our strong cash flow generation allowed us to increase our dividend rate 18%, to an annual rate of $1.34 per share. Our share price increased 13% for the full year, on top of 20% in 2011. Looking back, we are extremely proud that our five year average annual shareholder return, including stock appreciation and dividend reinvestment, is 14% versus the S&P 500 average of 2%.

We are proud of our track record of consistency which we believe is a result of getting better and better at executing the same growth strategies we identified over a decade ago. So as tempting as it might be to unveil some new revolutionary thinking that will drive our company’s growth, I have to admit my message this year might be a bit boring: we’re simply going to STAY THE COURSE with our strategies to build the defining global company that feeds the world.

Yet when I step back and think about it, I’ve concluded and hope you agree, staying the course is actually good news for you as a long-term shareholder. For you see, we don’t have to dream up a dramatic new approach or totally revamp our business model because the strategies we have are working.

In fact, unlike other companies that have to scramble to find new paths for growth, we have enormous opportunities that are staring us in the face. That’s because we have powerful global brands with a proven high performance organization, capable and determined to rapidly expand around the world.

Every year in December we host our Investor and Analyst Day in New York. This meeting gives us the opportunity to “go public” with our goals and commitments as well as showcase our management talent from around the world. The theme of our 2012 meeting was “On the Ground Floor of Global Growth: China and a Whole Lot More.” No statement could better describe Yum! Brands.

We, of course, highlighted our 11-year track record but, even more importantly, the future growth prospects of our company. We have a portfolio of brands with leadership positions in China and other emerging markets, with a long runway for growth. We have an asset base of over 39,000 restaurants and we continue to make progress leveraging these assets further by building sales layers and expanding dayparts. Additionally, we invested over $1.1 billion in 2012 in the future growth of our business and expect to invest at least that same amount in 2013.

All of this adds up to a growing confidence in our business model.

As a matter of fact, we believe the best is yet to come as we pursue our objective to be the defining global company that feeds the world.

Let me highlight some of the reasons I’m confident we must STAY THE COURSE on our four growth strategies.

At Yum! China, we crossed the billion dollar profit mark in 2012, opened our 4,000th KFC, our 800th Pizza Hut Casual Dining Restaurant, and opened 889 restaurants (that’s right, 889 restaurants!) – a remarkable achievement by anyone’s standards.

KFC now has 4,260 restaurants in more than 850 cities throughout the country, and continues to expand into new cities and increase its penetration levels in existing markets. At 826 units, Pizza Hut Casual Dining is the leader in its category. Both KFC and Pizza Hut are developing rapidly across China in cities large and small, including lower tier cities where we enjoy first mover advantage, a favorable cost structure and fantastic cash on cash returns. I’ve said it before – our single biggest advantage in China is we have the finest operating and development teams in the world. We are really in tune with the consumer and infrastructure development trends that will accelerate our brands’ penetration across the country.

As I’m sure you’re well aware, urbanization and the rapidly growing consumer class point to China as the #1 retail growth opportunity in the world and certainly for Yum!. Rising incomes are making our brands even more affordable for an increasing number of people. Think about this. In the U.S., McDonald’s has over 14,000 traditional units in a population of more than 310 million. In China, we expect to have at least that many KFC units with the consuming class growing from 300 million to more than 600 million in the next 10 years. With this tailwind, new unit development across China should continue at a high rate, and same-store sales should continue to grow. And remember, I’m only talking about KFC. Pizza Hut Casual Dining, with its dramatic sales increase and strong margins in the past few years, is far and away the largest and most successful full-scale restaurant in China with fantastic new-unit returns.

Yet, as I write this letter, there is no doubt we recently suffered a setback in China following an investigation into KFC China’s poultry supply and the resulting negative publicity. These events significantly impacted consumer confidence in KFC, and resulted in a sharp decline in sales beginning in the last two weeks of December.

Hindsight is always 20/20 and history is only good for two things: first, to learn from and second, to inspire your belief about what can be done in the future. We are aggressively applying our learnings from this incident, and we are committed to regaining consumer confidence and rebuilding sales.

Because our China business accounted for 42% of our segments’ profits in 2012, and because it’s clear it will take time for sales to recover, there is no question we will fall well short of our targeted growth of at least 10% EPS in 2013.

In spite of this challenge, looking back at history also gives us confidence we have the capability to fully recover and grow. We have faced SARS, Avian Flu, Sudan Red and in every case, we bounced back. No two crises are the same, and we don’t know how long it will take us to recover. Nevertheless, we expect to weather this storm and come out stronger. So let me be very clear… we will STAY THE COURSE in China and are fully committed to our #1 Growth Strategy. We will continue to grow the business with leading brands in every significant category. This includes continuing to build our two big brands KFC and Pizza Hut Casual Dining. We will also continue to invest behind Pizza Hut Home Service, Little Sheep and East Dawning. Our new unit target of at least 700 remains unchanged for 2013.

As a matter of fact, we are more confident than ever in our long-term business models in China and our ability to leverage the strengths that make our company so unique. As I said earlier, we view China as the best restaurant growth opportunity of the 21st century, and quite simply, I wouldn’t trade our place with anyone.

In addition to the unprecedented opportunity in China, we have tremendous growth opportunity around the world. Consider this, we only have about 2 restaurants per million people in the top 10 emerging markets, compared to 58 restaurants per million in the U.S. In 2012, Yum! Restaurants International (YRI) which includes all countries outside the U.S., China and India Divisions, grew system sales 5%, before foreign currency translation, and developed a record 949 new units, with 65% of them in emerging markets. It’s clear we are a leader in emerging market development.

We made India a separate division in 2012 because of the great potential of the country as well as our strong local capability. The team is successfully adapting the China business model for India to leverage iconic brands with broad appeal. In its first year as a standalone division, India was a powerhouse developer of 138 new units, including 80 KFCs. This is the second year in a row we have built more than 100 new units, and we expect that number to grow as we build even more capability in India. Our concepts appeal to a growing middle class and youth looking for aspirational, affordable and innovative experiences with KFC, Pizza Hut Casual Dining, Pizza Hut Home Service and Taco Bell. We will invest behind building each of these brands in India and expect all of them to drive tremendous future growth. We are on our way to making this business the next big growth engine for Yum!.

And there is no question we are in the right place at the right time because India is forecasted to have the largest consuming class in the world, ahead of the U.S. and China by 2030.

For the past two years, Russia has had the highest same-store sales growth out of our 20 business units around the world. System sales grew 46% in 2012 and we opened approximately 40 new restaurants. After buying the Rostik’s business (Russia’s leading chicken chain) in 2010, we have now converted nearly all these units to KFC. When you see the impact of our new branding and the overwhelming customer response to KFC products, we are confident Russia will be a sizable, profitable business for us for years to come.

We are also making major progress in Africa, a continent with endless possibilities where we clearly have first mover advantage. Africa has more than 1 billion people and we currently have about 1,000 restaurants. We are driving major growth building off our dominant base of about 700 KFCs in South Africa, where we expect to add another 45 restaurants in 2013. By the end of 2012, we expanded to 14 African countries, including the biggest ones, Nigeria, Kenya and Zambia. In 2013, we intend to expand to Tanzania, Uganda and Zimbabwe.

I’m also gratified to see our persistence paying off in France and Germany where we have been working hard over the past decade to reach scale. We now have about 150 KFCs in France and 100 KFCs in Germany. We have only one restaurant for every ten McDonald’s in France and Germany. We see closing that gap between our footprint and McDonald’s as a huge opportunity. Our business in France again generated the highest unit volumes of all the markets in our system around the world. In fact, the average KFC in France generates $3.5 million a year, roughly three times our global average. We have started extending this success to Germany which now has enough brand presence to justify national televised advertising for the first time. We are beginning to build a strong business in Spain and intend to expand across Western Europe over the long term.

At the same time, we are very optimistic about the new unit opportunities and sales growth we are seeing across Asia, the Middle East and Latin America. In our top-performing countries, we are the market leader by a wide margin appealing to an expanding consumer base in countries such as Indonesia and Vietnam. With great operating capability and committed franchisees investing in our brands for the long term, we are positioned to deliver consistent returns in the years ahead.

In the U.S. this year, we made major headway building each of our brands. Operating profit grew 13%, and same-store sales increased 5% for the year, including growth of 8% at Taco Bell, 3% at Pizza Hut and 3% at KFC.

Taco Bell earned its place in QSR and social media history with the “most talked about” launch of Doritos® Locos Taco, a taco reinvented from Frito-Lay’s enormously popular Nacho Cheese Doritos.®

The launch drove record sales of 375 million tacos in one year! Equally exciting was Taco Bell’s launch of the Cantina Bell menu, inspired by celebrity chef Lorena Garcia. We are very proud that QSR Magazine ranked Taco Bell as the top performer in Cleanliness and the only QSR to rank in the Top 3 on Cleanliness, Hospitality, Accuracy and Speed in the 2012 Annual QSR Drive-Thru Study. The combination of innovation and strong operational capability gives us confidence Taco Bell will lead even greater growth in the future.

Pizza Hut is now leading the highly competitive pizza category in terms of both value and quality, winning with its pizza innovation and everyday $10 large pizza offers. Given its sales and unit margin success, Pizza Hut stepped up new unit development on Delco Lites, a smaller, more efficient building design focused in rural areas. While we still have a lot of wood to chop with KFC in the U.S., KFC successfully reversed the past 4 years of negative same-store sales growth with product innovation and improved franchise relations.

Overall in the U.S., we made very good progress with our development and were net-unit positive for the year. We added 150 net new units at Pizza Hut and over 30 net new units at Taco Bell.

With improved unit-level economics and strong growth at all three brands, our U.S. business is now firmly positioned for more consistent profit growth in the years ahead. Our long-term goal is for Taco Bell to go from about 5,000 to 8,000 units and Pizza Hut to expand from over 6,000 to 8,000 units.

DORITOS, NACHO CHEESE DORITOS and LOCOS TACOS are owned by their respective trademark owners and used under license.

Our success executing our strategies has driven our Return on Invested Capital to 22%, placing us among industry leaders. We generated almost $2.3 billion in cash from operations in 2012. As I hope I’ve conveyed in this letter, we’re fortunate to have many high-return, long-term growth opportunities. We are also fortunate to have a strong investment grade balance sheet and all the capital we need to grow our core business. At the same time, in addition to buying back stock ($985 million in 2012), we are paying shareholders a solid dividend that has increased at a double-digit rate the past 8 years.

Importantly, we are improving returns by executing our strategy of reducing ownership in highly penetrated markets like Pizza Hut UK and increasing our exposure in emerging and under-penetrated markets. We also build company units or increase our ownership in international markets where we can achieve scale, realize high growth and yield high returns. Our investments in India and past acquisitions in Russia (2010) and South Africa (2011) are great examples of this strategy. Along these lines, as we entered 2013, we agreed on terms to acquire the operations of our franchise partner in Turkey, a high-growth emerging market that has over 100 KFC and Pizza Hut restaurants.

Lastly, I want you to know how proud I am of all the work we do across the globe to give back to local communities. Our employees and franchisees are fully committed to make a lasting impact on the world through corporate social responsibility. I’m especially proud of our global commitment to World Hunger Relief in partnership with the United Nations World Food Programme and many other hunger relief agencies. In the six years since we launched this program, we have raised nearly $150 million and volunteered millions of hours to move those less fortunate from hunger to hope. We are committed to demonstrating that we’re a company with a huge heart and we recognize there is much more we can and will do to live up to that.

After reading this Annual Report, I hope you’ll agree our plan to STAY THE COURSE is great news for 2013 and beyond. I want to thank all our team members, restaurant general managers, franchisees, community partners and restaurant support leaders who are giving their all to win customers and drive our growth around the world.

Yum! To You!