YUM! Brands, Inc. — Q2 2014 Form 10-Q
Business context and period. YUM operates, franchises or licenses KFC, Pizza Hut and Taco Bell, with more than 40,000 restaurants in over 125 countries and territories; approximately 80% of units are operated by franchisees, licensees or unconsolidated affiliates. The quarter ended June 14, 2014; year-to-date figures cover the period through that date. In Q1, YUM reorganized reporting outside China and India by brand, and restated comparable segment data.
Financial performance
| Metric (US$ millions, except per-share data) | Q2 2014 | Q2 2013 | YTD 2014 | YTD 2013 |
|---|---|---|---|---|
| Total revenue | 3,204 | 2,904 | 5,928 | 5,439 |
| Operating profit | 479 | 390 | 1,050 | 877 |
| Net income attributable to YUM | 334 | 281 | 733 | 618 |
| Diluted EPS | $0.73 | $0.61 | $1.61 | $1.33 |
| Operating margin (approx.) | 15.0% | 13.4% | 17.7% | 16.1% |
Q2 revenue rose 10%, operating profit 23%, and YUM-attributable net income 19%; diluted EPS increased 21%. YTD revenue rose 9%, operating profit 20%, net income 19%, and diluted EPS 21%. YUM reported diluted EPS before Special Items of $0.73 for Q2 and $1.60 YTD; 2013 comparatives were $0.56 and $1.26. Special Items were primarily U.S. refranchising gains.
Sales and restaurant margins. Q2 worldwide system sales grew 6% excluding foreign exchange; restaurant margin increased 3.0 percentage points to 15.5%. YUM’s company sales were $2,758 million, while franchise and license fees and income were $446 million. Foreign currency translation reduced operating profit by $7 million in the quarter.
Segment highlights
- China: Q2 system sales rose 21% excluding FX, including 15% same-store sales growth. Operating profit was $194 million versus $68 million; restaurant margin expanded 6.2 points to 16.8%. China’s strong recovery followed significant sales declines in 2013.
- KFC Division: Q2 system sales grew 5% excluding FX; operating profit increased 12% to $155 million and restaurant margin rose 0.3 points to 12.9%.
- Pizza Hut Division: Q2 system sales declined 1% excluding FX, with same-store sales down 3%. Operating profit fell 22% to $63 million; restaurant margin declined 6.4 points to 7.2%. Management cited weaker sales, commodity inflation, self-insurance and litigation costs, and strategic investment.
- Taco Bell Division: Q2 system sales grew 3%, including 2% same-store sales growth. Operating profit fell 2% to $109 million; restaurant margin declined 2.7 points to 17.7%, partly reflecting higher food and labor costs associated with the U.S. breakfast launch.
- India: System sales increased 18% excluding FX, but same-store sales declined 2%; the division reported a $1 million operating loss.
Cash, debt and liquidity
- YTD operating cash flow was $1,084 million, up from $729 million. Investing activities used $614 million, including $408 million of capital spending; financing activities used $433 million.
- Cash was $597 million at June 14, 2014, versus $573 million at year-end; short-term investments were $234 million. Cash increased $24 million YTD.
- Balance-sheet short-term borrowings were $70 million and long-term debt was $3,095 million, compared with $71 million and $2,918 million at December 28, 2013. The company reported $178 million of revolving-credit borrowings and $1.1 billion of unused capacity under its $1.3 billion facility.
- YUM repurchased $300 million of shares and paid $327 million in dividends YTD. The board approved a $0.37-per-share dividend for payment August 1, 2014. Remaining repurchase authorization was $653 million.
Outlook, risks and unusual items
- Management reiterated expected 2014 EPS growth of at least 20% excluding Special Items, driven substantially by China, whose 2014 operating profit was expected to grow significantly above its 15% ongoing target. The company’s longer-term model targets EPS growth of at least 10% annually. These are expectations, not guarantees.
- Management expected a 2014 effective tax rate of 26%–28%. It considered an IRS settlement during 2014 likely concerning the tax value of intangible rights transferred to foreign subsidiaries. IRS proposed additional taxes of approximately $1.11 billion plus approximately $325 million of interest for 2004–2013; the company disputed the position and said settlement timing and outcome were uncertain. Additional reserves could materially affect results, though potential 2014 cash payments were not expected to significantly impair planned discretionary spending.
- Little Sheep sales and profits were below assumptions used in prior impairment valuations. Continued weakness could lead to a further non-cash impairment in the second half of 2014.
- Contingencies include a proposed settlement of Taco Bell accessibility litigation, which had been accrued and was not expected to involve material cash payments if approved; other employment-related litigation; and approximately $675 million of undiscounted contingent lease-guarantee payments ($600 million present value). Management said recorded probable exposure for lease guarantees was not material and cited franchisee cross-default protections.
- Operating cash flow has exceeded $2 billion annually since 2011; management expected cash generation to continue, but warned that an unforeseen downturn could reduce cash flows. The interim financial statements were reviewed by KPMG, not audited; management reported disclosure controls were effective.
Key facts for investors to verify
- Whether China’s sales and profit recovery continued, and whether Little Sheep required further impairment.
- Progress, final terms and cash or reserve effects of the IRS dispute and whether the 26%–28% tax-rate outlook remained achievable.
- Whether Pizza Hut’s same-store sales and restaurant margins recovered, and whether Taco Bell’s breakfast costs were offset by sales growth.
- Cash-flow generation, debt and revolver usage, capital spending, dividends and continued share repurchases.
- Developments in litigation and contingent guarantees, including any losses beyond amounts already accrued.