YUM! Brands, Inc. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 29, 2012 (52 weeks). The filing includes fourth-quarter data; fiscal 2011 had an extra week, complicating year-over-year comparisons. YUM operated or franchised KFC, Pizza Hut and Taco Bell across more than 39,000 system restaurants in over 125 countries and territories.
Financial performance
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Total revenue | $13.633 billion | $12.626 billion |
| Operating profit | $2.294 billion | $1.815 billion |
| Net income attributable to YUM | $1.597 billion | $1.319 billion |
| Diluted EPS | $3.38 | $2.74 |
| Diluted EPS before Special Items (non-GAAP) | $3.25 | $2.87 |
| Cash from operating activities | $2.294 billion | $2.170 billion |
| Capital spending | $1.099 billion | $940 million |
| Total debt | $2.942 billion | $3.317 billion |
Revenue rose 8%; reported operating profit rose 26% and diluted EPS rose 23%. Excluding Special Items, diluted EPS increased 13%. The reported results included a $74 million non-cash gain on the Little Sheep acquisition and a $84 million pension settlement charge, among other items. Company restaurant profit margin was 16.7%, up from 16.1%; management reported worldwide restaurant margin of 16.6%, up 0.6 percentage points. Operating margin was approximately 16.8%.
China generated $6.898 billion of revenue and $1.015 billion of operating profit; YRI generated $3.281 billion and $715 million, respectively; the U.S. generated $3.352 billion and $666 million. India reported $102 million revenue and a $1 million operating loss. Worldwide system sales grew 5% as reported; management cited 8% growth excluding the effects of the 2011 divestitures, the extra 2011 week and Little Sheep. Same-store sales increased 4% in China, 3% at YRI and 5% in the U.S.
Cash, debt and capital allocation
Operating cash flow was $2.294 billion, while investing and financing activities used $1.005 billion and $1.716 billion, respectively. Cash and cash equivalents ended the year at $776 million, down from $1.198 billion. Capital spending was approximately $1.1 billion, and management estimated a similar amount for 2013. YUM repurchased $965 million of shares in the cash flow statement and paid $544 million in dividends during 2012. The declared annual dividend was $1.24 per share; the company targeted a 35%–40% payout of net income.
YUM had $2.932 billion of long-term debt and $10 million of short-term borrowings at year-end. Its $1.3 billion revolving credit facility had no borrowings outstanding and approximately $1.2 billion of unused capacity after letters of credit. Management reported compliance with debt covenants with considerable cushion. Contractual obligations totaled $11.116 billion, including $5.674 billion of operating lease commitments. The filing does not present a current ratio or a single comparable measure of short-term liquidity.
Material changes and unusual items
- YUM acquired an additional 66% of Little Sheep for $540 million net of cash acquired, bringing ownership to approximately 93%. Consolidation added 472 restaurants and increased China revenue; the remeasurement of YUM’s prior stake generated a $74 million non-cash gain.
- YUM refranchised 897 restaurants worldwide and received $364 million in proceeds. U.S. refranchising generated a $122 million gain; the U.K. Pizza Hut dine-in refranchising contributed to a $70 million YRI loss, including an upfront charge for below-market franchise fees.
- The 2011 sale of Long John Silver’s and A&W continued to affect comparisons, particularly U.S. system sales and franchise revenue.
- In the fourth quarter, China same-store sales fell 6%. Adverse publicity about poultry sourcing sharply affected KFC China sales in the final two weeks of December.
Outlook, risks and contingencies
After the China poultry-supply issue, management revised its 2013 outlook from the earlier expectation of at least 10% EPS growth. It estimated a mid-single-digit decline in full-year EPS excluding Special Items, negative year-over-year China operating-profit growth, and China restaurant margins in the mid-teens. Management expected a significant first-half decline followed by second-half EPS growth, with China same-store sales improving during the year and turning positive in the fourth quarter. It expected at least 700 new China units. These are forward-looking estimates, not guarantees.
China’s food-safety and reputational exposure is a central near-term risk. The Shanghai food regulator concluded its investigation in January 2013 and recommended strengthened supply-chain testing, reporting and supplier management; YUM said it was implementing the recommendations. Management estimated China Division same-store sales fell 37% in January 2013, including a 41% decline at KFC China, and projected a roughly 25% decline for January and February combined, partly reflecting the timing of Chinese New Year.
Other material risks include foreign currency exposure, commodity and labor inflation, competition, franchisee financial health, development and cannibalization risks, changing regulation, and food-supply disruptions. YUM estimated that a uniform 10% weakening of foreign currencies would have reduced 2012 operating profit by approximately $190 million, all else equal.
The IRS disputed the valuation of transferred intangible rights and proposed additional taxes and interest of approximately $920 million for 2004–2006 and $300 million for 2007–2008; YUM also estimated potential additional taxes and interest of approximately $135 million for 2009–2012 on a similar basis. YUM contested the proposals and said resolution was not expected within 12 months; the outcome and timing remain uncertain. The company also disclosed securities litigation filed in January 2013 related to statements about China, as well as employment and accessibility matters; outcomes and potential losses in several cases could not be reasonably estimated.
YUM reported effective internal controls over financial reporting, and its auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether China poultry-supply remediation restores consumer confidence and whether sales recover in line with management’s 2013 assumptions.
- How much of reported growth reflects recurring operations versus Special Items, acquisitions, refranchising and the extra week in 2011.
- The resolution, reserve adequacy and eventual cash impact of the IRS intangible-valuation dispute.
- Debt maturities, lease commitments, franchise-related guarantees and the company’s capacity to sustain capital spending, dividends and repurchases.
- Whether Little Sheep’s integration and YUM’s international development produce returns consistent with management’s targets.