YUM! Brands, Inc. — Q1 2013 Form 10-Q
Business context and period. The filing covers the unaudited 12 weeks ended March 23, 2013, compared with the 12 weeks ended March 24, 2012. YUM operates KFC, Pizza Hut and Taco Bell through China, International (YRI), U.S. and India segments. The interim statements were reviewed by KPMG, not audited.
Financial results
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $2,535 | $2,743 | -8% |
| Company sales | $2,099 | $2,344 | -10% |
| Franchise and license fees and income | $436 | $399 | +9% |
| Operating profit | $487 | $645 | -25% |
| Net income attributable to YUM | $337 | $458 | -27% |
| Diluted EPS | $0.72 | $0.96 | -25% |
| Company restaurant profit margin | 15.9% | 18.8% | -2.9 percentage points |
| Operating margin | 19.2% | 23.5% | -4.3 percentage points |
| Operating cash flow | $401 | $473 | -$72 |
| Capital spending | $237 | $173 | +$64 |
Segment performance: China revenue was $1,151 and operating profit $154, versus $1,218 and $256 a year earlier. YRI revenue was $669 and operating profit $199, versus $708 and $168. U.S. revenue was $695 and operating profit $165, versus $800 and $158. India revenue was $20 and operating loss $2, versus revenue of $17 and operating profit of $1.
Cash, debt and liquidity: Cash and cash equivalents were $762 at quarter-end, down from $776 at fiscal year-end. Short-term borrowings were $21 and long-term debt $2,924. Current assets were $1,898 versus current liabilities of $2,089. YUM reported $1.2 billion of unused capacity under its revolving credit facility, with no facility borrowings outstanding. Cash used in investing was $153; cash used in financing was $259, including $151 of dividends and $98 of share repurchases. The declared quarterly dividend was $0.335 per share.
Material changes and unusual items
- China same-store sales fell 20% (KFC China down 24%); worldwide system sales declined 3%, or grew 1% excluding foreign currency translation. China’s restaurant margin fell 7 percentage points, contributing to a 41% China operating-profit decline excluding currency effects.
- YRI and U.S. operating profit increased 19% and 5%, respectively. Worldwide restaurant margin declined to 15.9% from 18.6% according to management’s segment discussion of worldwide restaurant margins.
- Reported results include special items. Q1 2013 included a $17 million U.S. refranchising gain; Q1 2012 included a $74 million non-cash gain on the Little Sheep acquisition, a $45 million U.S. refranchising gain and a $21 million loss related to planned Pizza Hut UK refranchising. Special-item income after tax was $11 million in 2013 versus $94 million in 2012. Diluted EPS before special items was $0.70 versus $0.76, an 8% decline.
- Franchise-led growth and refranchising reduced company sales; 92 restaurants were refranchised during the quarter, generating $81 million in proceeds. YUM said refranchising can reduce reported revenue while increasing franchise-fee income.
Outlook, risks and contingencies
- Management lowered its prior 2013 expectation. Assuming China same-store sales turn positive in Q4, YUM continued to expect a mid-single-digit percentage decline in full-year EPS before special items. It anticipated a significant double-digit percentage decline in that measure for the quarter ending June 15, 2013, which it expected to be the year’s weakest year-over-year quarter. Recovery timing remained uncertain.
- Management attributed China weakness to adverse publicity following poultry-supply concerns and, from April, avian-flu publicity. It estimated China same-store sales would decline about 30% in April; these were estimates, not reported results.
- The IRS proposed tax adjustments for 2004–2008 and YUM estimated potential similar adjustments for 2009–2012. The amounts disclosed total approximately $1.1 billion in additional taxes plus about $270 million in interest through the filing date. YUM disputes the proposals and intends to defend its position; resolution is not expected within 12 months. The filing warns any payment above recorded reserves could materially affect financial position or results.
- Potential undiscounted payments under lease guarantees were approximately $750 million ($675 million present value); the recorded liability for probable exposure was not material. The company also disclosed franchise-loan and other financing guarantees.
- New securities class actions and shareholder demands related to alleged statements and poultry-supplier controls were disclosed; YUM denied liability, and a reasonable loss estimate could not be made. Other labor and accessibility lawsuits remain, with some loss provisions recorded and further exposure not estimable.
- Management said operating cash flow had exceeded $1 billion in each of the prior 11 fiscal years and expected comparable levels to continue, while noting that an unforeseen downturn could adversely affect cash generation. Disclosure controls were judged effective; no significant internal-control changes were reported.
Important facts for investors to verify
- Whether China sales and margins recover as assumed, and the realized effect of avian-flu and poultry-supply publicity on full-year EPS.
- How much of the reported year-over-year earnings decline reflects operating performance versus the prior-year Little Sheep acquisition gain and other special items.
- The status and potential reserve exposure of the IRS tax dispute, including proposed assessments for later tax years.
- Cash generation, debt maturities and access to the revolving facility if operating conditions weaken; confirm the reported debt and liquidity figures against the full statements and notes.
- Developments in the disclosed securities, shareholder, employment and accessibility litigation, along with lease guarantees and self-insurance estimates.