YUM! Brands, Inc. — Q1 2015 Form 10-Q
Business context and period: The filing covers the 12-week quarter ended March 21, 2015, compared with the quarter ended March 22, 2014. YUM operates, franchises or licenses KFC, Pizza Hut and Taco Bell, with more than 41,000 restaurants in over 125 countries and territories; approximately 79% of restaurants were operated by franchisees, licensees or unconsolidated affiliates.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total revenue | $2.622 billion | $2.724 billion |
| Operating profit | $506 million | $571 million |
| Net income attributable to YUM | $362 million | $399 million |
| Diluted EPS, reported | $0.81 | $0.87 |
| Operating cash flow | $516 million | $570 million |
| Capital spending | $227 million | $172 million |
| Cash and cash equivalents, quarter-end | $675 million | $578 million at Dec. 27, 2014 |
| Total debt: short-term borrowings plus long-term debt | $3.387 billion | $3.344 billion at Dec. 27, 2014 |
Company restaurant margin fell to 17.5% from 19.2%. The reported effective tax rate was 23.4%, versus 25.9%. The filing’s MD&A reports diluted EPS before special items of $0.80, down 8% year over year; reported diluted EPS was $0.81, including $0.01 per share of net special-item income. Total revenues declined 4%; system sales grew 4% excluding foreign exchange. Foreign currency translation reduced operating profit by $20 million.
Operating cash flow declined by $54 million, primarily due to lower operating profit before special items and higher pension contributions. Investing cash outflow was $196 million, versus $168 million, mainly reflecting higher capital spending. Financing cash outflow was $246 million, versus $237 million, including $178 million of dividends paid and $124 million of share repurchases. The company contributed $75 million to its principal U.S. pension plan and said it did not anticipate additional significant contributions in 2015.
Segment results and material changes
- China: Revenue was $1.256 billion versus $1.379 billion; operating profit was $190 million versus $285 million. Excluding FX, system sales fell 6%, same-store sales fell 12%, and operating profit fell 31%. Management attributed weakness to the 2014 adverse publicity involving improper food handling by a former supplier. Same-store sales decline improved from 16% in Q4 2014.
- KFC Division: Revenue was $642 million versus $664 million; operating profit was $169 million versus $163 million. Excluding FX, system sales increased 8%, same-store sales increased 5%, and operating profit increased 11%.
- Pizza Hut Division: Revenue was $271 million versus $267 million; operating profit was $81 million versus $84 million. Excluding FX, system sales increased 2%; same-store sales were flat and operating profit declined 2%.
- Taco Bell Division: Revenue was $431 million versus $391 million; operating profit was $115 million versus $84 million. System sales increased 9% and same-store sales increased 6%.
- India: Revenue was $22 million versus $23 million; operating loss was $4 million versus $3 million. Same-store sales declined 11%.
Company sales decreased 5%, while franchise and license fees and income increased 3%. General and administrative expense rose to $295 million from $271 million. The company cited higher compensation and headcount costs in China and higher corporate compensation and professional fees. A $91 million translation-related loss, net of tax, contributed to comprehensive income of $281 million, down from $362 million.
Outlook, capital plans and risks
- Management expected full-year 2015 EPS growth of at least 10% before special items, following EPS declines in the first half and a stronger second half. This outlook depended largely on recovery in China. Management anticipated Q2 EPS before special items to decline approximately 20% year over year, citing the prior-year comparison and an expected higher tax rate.
- YUM’s ongoing growth model targets at least 10% EPS growth, with annual operating-profit growth targets of 15% in China, 10% for KFC, 8% for Pizza Hut and 6% for Taco Bell. These are management targets, not guarantees.
- Under an agreement with KFC U.S. franchisees, YUM anticipated about $125 million of investment over three years for equipment and remodel incentives, including an estimated $90 million charge in 2015. It also agreed to fund $60 million of incremental system advertising over three years; approximately $10 million was expected in 2015, with expense beginning in Q2.
- At March 21, 2015, the company had $3.1 billion of long-term debt and $266 million of short-term borrowings. Its $1.3 billion revolving credit facility had $781 million of unused capacity after outstanding borrowings and letters of credit. YUM reported covenant compliance with considerable cushion.
- Lease guarantees could require undiscounted payments of approximately $625 million ($550 million present value) if primary lessees defaulted; the recorded liability for probable exposure was not material. Franchisee financing guarantees totaled $27 million, against $75 million of loans outstanding.
- Legal matters included an appeal of the dismissal of a securities class action, shareholder derivative claims stayed pending that appeal, California employment litigation, and a Pizza Hut delivery-driver settlement approved March 26, 2015. The settlement was accrued and expected cash payments were described as not material. The filing states that some potential losses cannot be reasonably estimated.
- Management cited potential business downturns and the possibility of higher tax costs if international earnings had to be repatriated. It reported no material change in previously disclosed risk factors or market-risk disclosures. Disclosure controls were considered effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether China sales and profit recovery continued, and the effects of the food-safety publicity and foreign exchange.
- Whether the full-year EPS growth outlook and expected Q2 decline were achieved, including the assumptions behind recovery and tax-rate estimates.
- Execution, timing and expense treatment of the KFC U.S. franchisee investment and advertising commitments.
- Debt maturities, revolving-credit availability, covenant headroom, and the company’s capacity to sustain dividends and repurchases alongside capital spending.
- Developments in the disclosed litigation and lease guarantees, including any losses beyond amounts accrued.