David Novak, CEO Yum! Brands

David C. Novak

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

Dear Partners,

2013 was clearly a challenging year, as full-year EPS declined 9% to $2.97 per share, excluding special items. While these results were driven by the underperformance of our KFC China business, the rest of Yum! delivered essentially on-target results.

If you’ve followed us over the years, you know one of the things we’re most proud of as a company is our ability to drive what we call dynasty-like performance, which is generating at least 10% growth in earnings per share year after year. As you know, when a company does that, its stock price takes care of itself. And we achieved at least 13% EPS growth, excluding special items, for 11 consecutive years until 2013.

I’d go as far to say that we did some of our very best work in 2013 readying for the future. I want to highlight the work we did last year to set us up for a strong bounce-back year in 2014, and re-establish our track record of consistent double-digit EPS growth in the years ahead.

Let me start with our decision to reorganize the business. As of January 1, 2014, we combined our Yum! Restaurants International and U.S. divisions into three global brand divisions: KFC, Pizza Hut and Taco Bell. China and India will remain separate divisions given their strategic importance and tremendous growth potential.

Going forward, our three new divisions will define and drive the strategic positioning and operating models for KFC, Pizza Hut and Taco Bell, and will work closely with our China and India teams to ensure tight integration on brand initiatives. We believe having 100% focused brand teams will enable us to more aggressively accelerate growth in a way that generates higher returns and enhances shareholder value. We also believe know-how sharing will be more powerful by bringing the U.S. and international businesses together.

 

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CHINA

Let me now address KFC China, which was obviously our biggest challenge last year. Specifically, we are in the process of overcoming two issues that significantly impacted KFC sales in 2013: negative publicity from the poultry supply incident in late December 2012 and subsequent news of Avian Flu. Here are some of the major actions we took in 2013 to strengthen our KFC business in China.

First, in an effort to build and reinforce positive consumer perceptions around the safety of our food, our ongoing “Operation Thunder” initiatives strengthened our poultry supply chain. I assure you, we are always in the process of improving our supply chain. We also introduced a powerful quality assurance campaign called “I Commit.”

As a result, we are happy to see significant progress in rebuilding trust at KFC, with our key brand attribute scores now nearly back to where they were in 2012.

While we experienced significant sales deleverage at KFC, the China team deserves a lot of credit for doing an excellent job managing costs. We sharpened our ability in the areas of sales forecasting, labor scheduling and how best to optimize service levels with fewer labor hours. This capability will help us drive profitability going forward.

Now, as I’ve always said, the bedrock of our success in China has been our outstanding restaurant operations, which are getting stronger and stronger. In 2013, we hired over 8,000 new management recruits into our Whampoa Management Training Academy because we’ll be opening thousands of new restaurants in the years ahead. Nearly 100% of our restaurant managers have a college degree, and about 50% of our restaurant team members are university students.

With world-class operations as our foundation, we opened 428 new KFCs this past year and now have almost 4,600 KFCs in over 900 cities in China…that’s more than twice the size of our nearest competitor. KFC also has the largest home delivery business in China, with 70% of our delivery orders being placed online. As a testament to our success, we were named the #1 foreign brand in China in a 2013 report published by the BBC. There’s no doubt KFC has been, and continues to be, a power brand.


Our focus now is to bring more innovation and energetic news to our customers. In fact, we have an aggressive and comprehensive plan to restage the KFC brand in the second quarter, which includes breakthrough innovations in our products, menu management, marketing calendar, advertising and the digital customer experience. Overall at KFC China, we know we still have work to do but we’re confident we are making progress rebuilding trust with consumers and improving same-store sales.

PIZZA HUT CASUAL DINING CHINA

For Pizza Hut Casual Dining, 2013 was a strong year as we grew same-store sales by 4% and opened 247 new restaurants, surpassing the 1,000 unit milestone. With over 1,000 units in 277 cities, we are clearly the number one western casual dining chain, with a 6:1 lead over our nearest competitor.

Pizza Hut Casual Dining is arguably one of the greatest success stories in our industry. In the last three years, we have more than doubled our store count, grown average unit volumes by 30% and achieved home-run economics with restaurant margins above 20%.

Pizza Hut Casual Dining goes well beyond pizza as almost two-thirds of sales are non-pizza items. We also continue to leverage our assets throughout the day and have expanded our breakfast offering into over 120 restaurants. This is a huge opportunity for us as our long-term goal is to create and own the midscale casual dining breakfast occasion in China on a scale that matches what exists in the U.S. today. In fact, we will be expanding breakfast into an additional 200 units in 2014.

All this is leading to an amazingly strong economic model that generates two-year cash paybacks on new unit openings, so it’s full speed ahead for our Pizza Hut Casual Dining new unit development and expanding into lower-tier cities.

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PIZZA HUT HOME SERVICE CHINA

Now, the other thing that’s exciting about China is our Pizza Hut Home Service business, or home delivery. Pizza Hut Home Service now has over 200 units in 25 cities and is the only “All Meal” replacement delivery brand in China. Forty percent of our menu consists of Chinese food. So not only are we delivering pizza, but we’re also delivering a full array of Chinese menu options. We now have a proven economic model which positions us to begin to scale this brand rapidly across the country.

EAST DAWNING AND LITTLE SHEEP

Along with Pizza Hut Home Service, we have two other emerging Chinese food concepts in China that give us the confidence we will eventually become a dominant player in the massive Chinese food category. We are developing our own Chinese fast food concept, East Dawning, and are now testing it in lower-tier cities. Admittedly, this is taking longer than we expected, but we believe our persistence will pay off.

The same could be said for Little Sheep, the concept we acquired in 2012 because it is the leader in the extremely popular hot pot category. While we’ve had some major setbacks and are working hard to improve the concept, we remain optimistic this brand will become a significant growth driver down the road.

NEW UNITS IN CHINA

Of course, the biggest opportunity we have in China is to penetrate the country with new restaurants. Looking at China’s new unit development in total, we strengthened our category-leading positions with 740 new restaurants in 2013, exceeding our target of at least 700 new units for the year. Going forward, we expect another strong year of development in 2014 with plans to open at least 700 new units as we continue to deploy capital into these high-return investments.

Remember, Yum! currently has four restaurants per million people in China, where the consuming class is expected to grow from 300 million people just a couple of years ago to over 600 million by 2020. This compares to 58 restaurants per million people in the U.S., where the consuming class is over 300 million people today. Clearly, we’re on the ground floor of global growth.

Make no mistake, we wouldn’t trade our position in China with any other restaurant company in what remains the #1 retail opportunity in the world.

 

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India

India

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In India, we’ve made the strategic decision to invest ahead of the growth curve to best position KFC, Pizza Hut and Taco Bell to expand even more rapidly as the country develops. This year we opened 157 new units, including Yum!’s 40,000th restaurant in Goa, and expect to open an additional 150 new units in 2014. While our 2013 results haven’t been as strong as we’d like, we’re investing in the future of a country that has well over a billion people and is forecasted to have the largest consuming class in the world by 2030.

 

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Yum! Restaurants International

At Yum! Restaurants International, the business delivered another solid year of profit growth led by high-growth emerging markets in regions like Russia, Southeast Asia, Africa and Latin America.

Yum! is the clear restaurant leader in emerging markets, and we continued to build upon this position in 2013.

In fact, we entered four new emerging market countries this past year: Tanzania, Ukraine, Argentina and even Mongolia. And with each new restaurant opening, people lined up out the door to experience our brands. It’s clear our brands are loved around the world.

Having said this, given the economic and political volatility in some emerging countries, we know there will be ups and downs. We remain extremely bullish on our long-term prospects in emerging markets as the consuming class rapidly expands. Remember, emerging market economies are expected to grow at almost three times the rate of developed market economies for the foreseeable future. So Yum!’s strongest businesses are located where the highest growth in the world is expected to occur. This bodes well for Yum! Brands.

Importantly, the bulk of our emerging markets’ business will continue to be capitalized by franchisees. We now have about 1,000 international franchisees who are passionate about our brands. As evidence, YRI opened a record 1,055 new restaurants last year, 936 of which were developed by franchisees. Looking ahead, our international franchisee development pipeline is robust as we expect to open at least 1,000 new international units in 2014 outside of China and India. This franchise-led growth is great news for our shareholders as the capital-free franchise business is about as high a return business as you can possibly have.

We’ve also made targeted investments in emerging markets to accelerate growth. We acquired about 100 restaurants from a franchisee in Turkey and expect to increase our pace of development in this country going forward. We opened our first company-operated Pizza Hut in Russia, and look to do the same in South Africa. We also opened a company-operated KFC in Brazil. While it’s still early, we believe these types of investments set us up to achieve higher growth and higher returns in the years ahead.

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U.S.

Our U.S. business is on a path for consistent growth, led by Taco Bell, which represents approximately two-thirds of our U.S. profits. Taco Bell delivered another solid year in 2013 with the fourth-quarter representing the eighth consecutive quarter of same-store sales growth.

I’m extremely proud of Taco Bell CEO Greg Creed and his team for being named Advertising Age’s Marketer of the Year in recognition of our Live Más campaign. More importantly, Taco Bell was the only restaurant company to receive top tier rankings from QSR Magazine’s independent customer survey on three key operational measures: speed, accuracy and hospitality. Greg has done a sensational job leading the way.

We expect some truly innovative products to wow customers in 2014, but the big news for Taco Bell will be the national launch of breakfast. We have three terrific destination breakfast products at incredible price points.

Our economic model at Taco Bell remains strong with restaurant level margins over 19%. With the strength of these unit economics, we are seeing an acceleration of new unit development, with 86 net new units in 2013 and an even better development pipeline heading into 2014. We’re confident in our ability to achieve our goal of going from about 5,300 Taco Bell restaurants to at least 8,000 in the U.S.

The combination of innovation and strong operational capability gives us confidence Taco Bell will eventually become our third global brand.

At Pizza Hut, we are pleased we opened 116 net new units this year, our third consecutive year of positive net-unit growth. However, we significantly lagged our competitors in same-store sales as we simply weren’t competitive enough on value. We are aligning with our franchisees to tackle this issue and bring even more innovation to the marketplace. In 2014, we expect to fare much better with competitive value and our plan to nationally advertise WingStreet for the first time, featuring our award-winning kitchen fried wings and eventually chicken strip meals.

KFC also under-performed in the U.S. in 2013, but we have exciting new product innovations and more compelling value planned to improve our performance in the growing chicken category.

We clearly have some catch-up work to do in the U.S. versus the competition for both Pizza Hut and KFC, and intend to make significant progress in 2014. All in all, the momentum at Taco Bell, net new unit openings, and the fact our refranchising program has been largely completed, puts us on a path for consistent growth in the U.S.

 

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Summary

So to sum things up, we’re uniquely positioned for a strong bounce-back year in 2014, primarily driven by our expected same-store sales recovery at KFC in China. This sales recovery, our new-unit development and the actions we’ve taken to strengthen our global business give us confidence in our ability to deliver at least 20% EPS growth in 2014.

Importantly, we believe we’re stronger and better positioned than ever to deliver on the three things that drive shareholder value in retail:

DRIVING NEW-UNIT DEVELOPMENT

Our new unit opportunity in China and other emerging markets remains the best in retail and our opportunity to expand is huge. We have three iconic brands consumers love and more than 40,000 restaurants in 128 countries and territories. We’re especially strong in high-growth emerging markets with more than 14,000 units and more than 50% of our operating profit in 2013 coming from the emerging world.

While we have 58 restaurants per million people in the U.S. today, we have only 2 restaurants per million in the emerging markets. That is a long runway for growth and gives us tremendous confidence in our ability to continue our aggressive expansion for years to come.

GROWING SAME-STORE SALES

Our more than 40,000 restaurants have significant capacity to drive even higher same-store sales growth and profitability around the world. We’re growing our brands with a powerful combination of innovative new sales layers, expanded day parts, menu variety, strong value offers and by opening new channels with digital. Harnessing the power of digital technology, we’re expanding the use of online and mobile ordering platforms across our Pizza Hut and KFC delivery businesses worldwide. We’re also on track to launch a new mobile ordering app for our Taco Bell U.S. business in 2014.

GENERATING HIGH RETURNS

Finally, our returns on invested capital have consistently been among the best in the retail industry. Our growth is franchise-led, with franchisees investing virtually all the capital to own and operate what is now 78% of our restaurants. In 2013, this model generated nearly $2 billion in franchise fees, which combined with the profit from our company-operated restaurants, enabled us to invest over $1 billion in capital expenditures for the future growth of the business. And for the ninth consecutive year, we increased our dividend payment by at least 10% while returning almost $1.4 billion in cash to shareholders in the form of dividends and share repurchases. It takes a company with considerable economic strength and growth potential to do that, particularly in a down year.

 

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COMPANY WITH A HUGE HEART

Finally, I want you to know how incredibly proud I am of the many ways we stepped up to show that we are a Company with a Huge Heart. Leading the world’s largest private sector hunger relief effort, we’ve set the bar high year after year in support of World Hunger Relief. Nearly one billion people go to bed hungry every night and our relief efforts are more important than ever. 2013 was our strongest campaign on record with $37 million in cash and food donations! In the last seven years, our efforts have resulted in more than $185 million in cash and food donations resulting in 740 million meals going to those in need. While there is certainly reason to pause and celebrate this great achievement, we know that there is much more we can do in the fight to end hunger. Hunger is the world’s most solvable problem and together we can make a difference. I am deeply grateful for committed employees, franchisees and customers who have joined our movement to save lives and truly change the world by serving others.

After reading this Annual Report, I hope you recognize the power of Yum! and agree the best is yet to come. I want to thank all our team members, restaurant general managers, franchisees, community partners and restaurant support leaders who are putting our customers front and center in everything they do. I’m so privileged to be able to work with such smart people who have such heart. It’s their collective talent and people capability that make this company special and it has never been better than it is today.

That’s why there’s no doubt in my mind that 2014 will be a strong bounce-back year as we continue to build the defining global company that feeds the world.

Yum! to You!

David Novak Signature
David C. Novak Chairman & Chief Executive Officer,
Yum! Brands, Inc.

 

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2013 Financial Highlights

Download Financials (In millions, except for per share amounts)
Year-end 2013 2012 % B/(W) change
Company sales $11,184 $11,833 (5)
Franchise and license fees and income 1,900 1,800 6
Total revenues $13,084 $13,633 (4)
Operating Profit $1,798 $2,294 (22)
Net Income - Yum! Brands, Inc. $1,091 $1,597 (32)
Diluted Earnings Per Common Share before Special Items (a) $2.97 $3.25 (9)
Special Items Earnings Per Common Share (a) (0.61) 0.13 NM
Reported Diluted Earnings Per Common Share $2.36 $3.38 (30)
Cash Flows Provided by Operating Activities $2,139 $2,294 (7)
(a) See our 2013 Form 10-K for further discussion of Special Items.


Worldwide System Units

Year-end 2013 2012 2011 2010 (a) 2009 (a)
Company 8,131 7,578 7,437 7,271 7,666
Unconsolidated Affiliates 716 660 587 525 469
Franchisees 29,349 28,608 26,928 26,219 25,085
Licensees 2,115 2,168 2,169 2,186 2,199
Total 40,311 39,014 37,121 36,201 35,419

Year-end 2013 2012 2011 2010 (a) 2009 (a) 5-year growth

CHINA

KFC 4,563 4,260 3,701 3,244 2,872 13%
Pizza Hut 1,264 987 764 642 562 20%
Little Sheep 389 451 -- -- -- NM
East Dawning 27 28 28 20 19 10%
Total China 6,243 5,726 4,493 3,906 3,453 16%

INTERNATIONAL

KFC 9,460 9,040 8,717 8,411 8,123 4%
Pizza Hut 5,490 5,304 5,123 5,039 4,963 2%
Taco Bell 279 282 272 260 251 3%
Total International 15,229 14,626 14,112 13,710 13,337 3%

INDIA

KFC 361 280 203 143 107 37%
Pizza Hut 367 310 260 209 190 14%
Taco Bell 5 3 3 2 -- NM
Total India 733 593 466 354 297 23%

UNITED STATES

KFC 4,491 4,618 4,780 5,055 5,162 (3%)
Pizza Hut 7,846 7,756 7,600 7,542 7,566 1%
Taco Bell 5,769 5,695 5,670 5,634 5,604 1%
Total U.S. 18,106 18,069 18,050 18,231 18,332 0%
Total 40,311 39,014 37,121 36,201 35,419 3%
(a) Excludes LJS and A&W units sold in 2011.


Breakdown of Worldwide System Units

Year-end 2013 Franchised Company Unconsolidated Affiliates Licensed Total

CHINA

KFC 278 3,569 716 -- 4,563
Pizza Hut 2 1,262 -- -- 1,264
East Dawning -- 27 -- -- 27
Little Sheep 221 168 -- -- 389
Total China 501 5,026 716 -- 6,243

INTERNATIONAL

KFC 8,340 1,085 -- 35 9,460
Pizza Hut 5,198 241 -- 51 5,490
Taco Bell 246 -- -- 33 279
Total International 13,784 1,326 -- 119 15,229

INDIA

KFC 192 169 -- -- 361
Pizza Hut 350 17 -- -- 367
Taco Bell -- 5 -- -- 5
Total India 542 191 -- -- 733

UNITED STATES

KFC 4,232 206 -- 53 4,491
Pizza Hut 5,835 491 -- 1,520 7,846
Taco Bell 4,455 891 -- 423 5,769
Total U.S. 14,522 1,588 -- 1,996 18,106
Total 29,349 8,131 716 2,115 40,311

 

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