YUM! Brands, Inc. — Q1 2011 Form 10-Q
Reporting period: Twelve weeks ended March 19, 2011; comparisons are with the twelve weeks ended March 20, 2010. YUM operated KFC, Pizza Hut, Taco Bell, Long John Silver’s (LJS) and A&W through its China, International (YRI) and U.S. segments. Amounts below are in millions of dollars, except per-share data and percentages.
Financial results
| Metric | Q1 2011 | Q1 2010 | Change / context |
|---|---|---|---|
| Total revenue | $2,425 | $2,345 | Up 3% |
| Operating profit | $401 | $364 | Up 10% reported; $466 vs. $430 before Special Items |
| Net income attributable to YUM | $264 | $241 | Up 10% |
| Diluted EPS | $0.54 | $0.50 | $0.63 vs. $0.59 before Special Items |
| Company restaurant profit margin | 17.6% | 17.0% | Improved 0.6 percentage points |
| Cash from operations | $508 | $392 | Increase attributed mainly to timing of tax payments and higher operating profit before Special Items |
| Capital spending | $173 | $163 | Net operating cash less capital spending was $335 |
Segment operating profit was $215 for China (up 22%, or 18% excluding foreign exchange), $158 for YRI (up 12%, or 8% excluding foreign exchange), and $123 for the U.S. (down 13%). Worldwide system sales grew 5% excluding foreign exchange: China +24%, YRI +6%, U.S. flat. Same-store sales were +13% in China, +2% in YRI and -1% in the U.S.
Balance sheet, debt and liquidity
- At March 19, 2011, cash and equivalents were $1,529, total current assets $2,436 and current liabilities $2,288; the current ratio was approximately 1.06.
- Short-term borrowings were $670 and long-term debt was $2,918. The filing reports $3.3 billion of Senior Unsecured Notes outstanding at quarter-end, including $650 million repaid at maturity on April 15, 2011 using cash on hand.
- YUM had no borrowings under its revolving credit facilities. Unused capacity was approximately $1.4 billion in total, including $1.01 billion under the domestic facility and $350 million under the international facility. The facilities mature in November 2012; the company reported covenant compliance with considerable cushion.
- Cash increased $103 during the quarter. Investing used $156 and financing used $261; financing outflows included $152 of share repurchases and $118 of dividends paid.
Material changes and unusual items
- YUM decided during the quarter to sell LJS and A&W. The decision triggered a non-cash $66 impairment charge, primarily against trademarks and franchise contract rights. The brands were not classified as held for sale at quarter-end, and further impairment review will continue until sale.
- Reported results included $65 of net pre-tax Special Item expense in Q1 2011, compared with $66 in Q1 2010. Q1 2010 included a $63 refranchising loss, principally associated with U.S. KFC refranchising impairments; the prior period also included a $7 Taiwan refranchising goodwill write-off. These items affect reported comparisons.
- Revenue growth was partly offset by portfolio changes: refranchising reduced revenue by $182 and operating profit by approximately $1 compared with the prior-year ownership base. YUM refranchised 21 restaurants in the quarter and reported 35,701 system units at quarter-end.
- The reported effective tax rate was 25.2%, versus 24.1% a year earlier. Before Special Items, the rate was 27.1% versus 25.7%. Management attributed the increase primarily to the absence of more favorable prior-year tax effects.
Outlook, management commentary and risks
- Management described longer-term operating-profit growth models of 15% for China, 10% for YRI and 5% for the U.S.; these are stated ongoing growth expectations, not a new specific full-year 2011 forecast in this filing. The company’s 2011 guidance had been presented earlier.
- Management warned that Taco Bell sales weakened after a consumer-protection lawsuit concerning its “seasoned beef” advertising was filed in late January. The suit was voluntarily withdrawn April 18, but the negative sales trends continued into Q2; management expected weak Taco Bell sales and continued food inflation to significantly hurt U.S. Q2 operating profit.
- The Japan earthquake and tsunami disrupted franchise operations. Because Japanese restaurants are entirely franchise-owned, YUM did not expect a material company-wide impact; it estimated a $3 Q2 YRI operating-profit effect and up to $6 for the full year.
- The IRS proposed additional taxes of approximately $700 plus $155 of net interest for 2004–2006, and estimated potential additional taxes of $320 plus $20 of interest for 2007–2010 on a similar basis. YUM disputes the adjustment and is contesting it. Resolution is not expected within twelve months; the filing warns payments or reserve increases could materially affect financial position or results.
- Other contingencies include lease guarantees with approximately $500 of undiscounted potential payments (present value approximately $450), franchise lending guarantees, self-insured claims and litigation. The filing describes wage-and-hour claims and an ADA class action, among other matters; some outcomes or potential losses could not be reasonably estimated.
- YUM repurchased 2.9 million shares for $142 at an average $49.41 per share and paid $118 in dividends. A $0.25-per-share dividend was approved after quarter-end. A January 2011 authorization permits up to $750 of additional repurchases through June 2012.
- After quarter-end, YUM announced a preliminary proposal to acquire all Little Sheep shares other than a minority interest for the founders. No formal offer had been made, and completion was uncertain.
Key investor verification points
- Track Taco Bell U.S. sales trends, food-cost inflation and resulting Q2 performance against management’s warning.
- Monitor the planned LJS/A&W sale, sale timing and any additional impairment charges.
- Review developments in the IRS tax dispute, including reserve adequacy and possible exposure.
- Confirm the April 15, 2011 $650 debt repayment and assess remaining debt maturities, liquidity and refinancing needs.
- Check whether the Little Sheep proposal advanced to a formal offer and whether it received required approvals.
- Distinguish underlying operating performance from reported figures affected by Special Items and refranchising.