YUM! Brands, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter ended September 8, 2012 (12 weeks); year to date (YTD) covers 36 weeks. Comparative periods ended September 3, 2011. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The filing was reviewed, not audited.
Business context and results
YUM operates KFC, Pizza Hut and Taco Bell through four reporting segments: China, YUM Restaurants International (YRI), U.S. and India. It reported more than 38,000 restaurants in over 120 countries and territories. The quarter’s results include Little Sheep, consolidated following YUM’s February acquisition of an additional 66% interest, bringing ownership to 93%.
| Metric | Q3 2012 | Q3 2011 | YTD 2012 | YTD 2011 |
|---|---|---|---|---|
| Total revenue | $3,569 | $3,274 | $9,480 | $8,515 |
| Operating profit | $671 | $488 | $1,789 | $1,308 |
| Net income attributable to YUM | $471 | $383 | $1,260 | $963 |
| Diluted EPS | $1.00 | $0.80 | $2.65 | $1.99 |
| Operating cash flow | Not provided for quarter | $1,818 | $1,703 |
Quarterly revenue increased 9%, operating profit 38%, net income 23% and diluted EPS 25%. YTD revenue increased 11%, operating profit 37%, net income 31% and diluted EPS 33%. YUM reported worldwide operating profit growth excluding special items and foreign exchange of 18% for the quarter. Quarterly company restaurant profit was $599, or 19.1% of company sales, versus $494 and 17.3%; YTD it was $1,462, or 17.7%, versus $1,240 and 16.9%.
Quarterly same-store sales grew 6% in China, 2% at YRI and 6% in the U.S.; worldwide system sales grew 6% excluding foreign exchange. The company cited strong same-store sales and new-unit development as profit drivers. China operating profit rose 22% excluding currency effects; YRI rose 14%; U.S. rose 13%. YTD segment operating profit was China $812, YRI $491, U.S. $486 and India $(1).
Cash, debt and liquidity
- YTD operating cash flow was $1,818, compared with $1,703. Investing activities used $747 (prior year $740), including $678 of capital spending and the Little Sheep acquisition. Financing activities used $1,322 (prior year $1,195), including $688 of share repurchases and $393 of dividends.
- Cash and cash equivalents were $942 at September 8, down from $1,198 at December 31, 2011. Long-term debt was $3,003 and short-term borrowings $18; the company repaid $263 of notes at maturity in July.
- A new five-year $1.3 billion revolving credit facility expires in 2017. Available capacity was $1.2 billion, net of $88 of letters of credit and $10 of borrowings. YUM said it met debt covenants with considerable cushion.
Material changes, outlook and unusual items
- Little Sheep acquisition accounting generated a $74 non-cash gain, with no related tax expense. Its consolidation added 3% to China revenue and reduced China operating profit by 1% for the reported quarter and YTD comparisons. Acquisition-related goodwill and intangible assets increased materially.
- Reported YTD results include $53 of U.S. refranchising gains and a $20 non-cash impairment charge tied to Pizza Hut UK dine-in restaurants. Refranchising proceeds were $187 YTD; 396 restaurants were refranchised. Prior-year comparisons included losses and tax benefits associated with the LJS and A&W divestitures. YTD reported effective tax rate was 24.4%, versus 18.4%, primarily reflecting the absence of prior-year tax benefits.
- Management described longer-term annual operating profit growth models of 15% for China, 10% for YRI and 5% for the U.S. These are average expectations for the next several years, not a specific full-year 2012 forecast. The filing refers to 2012 guidance published separately; its numerical details are not provided in the filing text.
- Management expects a $25–$75 pre-tax, non-cash pension settlement charge in Q4 2012 related to voluntary early pension payouts. It also anticipated refranchising the remaining company-operated Pizza Hut UK dine-in restaurants in Q4; transaction terms could result in an additional non-cash charge, for which no clear amount was provided.
- YUM targets annual dividend payout of 35%–40% of net income. After the period, the board approved a $0.335-per-share dividend payable November 2, 2012.
Risks and contingencies
- IRS tax dispute: The IRS proposed approximately $700 of additional tax plus $210 of interest for 2004–2006, and potential additional tax of approximately $350 plus $25 of interest through 2011. YUM disputes the adjustment; resolution timing and ultimate exposure are uncertain. The company warned that an outcome above recorded reserves could materially affect financial position or results.
- Legal matters: The filing discusses employment-related class actions and Taco Bell accessibility litigation. Outcomes and potential losses in several matters could not be reasonably estimated. KFC’s California wage-and-hour matter had a settlement agreement, with final approval scheduled for January 2013.
- Other exposures: YUM reported $675 of undiscounted contingent lease-guarantee payments, though the recorded probable liability was not material. It also noted actuarial volatility in self-insured claims and uncertainty over a new China VAT rule’s applicability; management did not expect a material impact but could not quantify it.
- Little Sheep: YUM identified added risks from limited experience with hot-pot operations, soup-base manufacturing and Little Sheep’s minority interest in a meat-processing facility.
Important facts for investors to verify
- How much reported growth came from underlying same-store sales and operations versus Little Sheep consolidation, refranchising, foreign exchange and nonrecurring gains or charges.
- The final terms and timing of the Pizza Hut UK refranchising and any associated impairment charge, plus the Q4 pension settlement charge.
- Developments in the IRS dispute, the recorded reserve relative to the stated potential exposure, and any change in expected resolution timing.
- Cash generation, capital spending, repurchases and dividends relative to debt levels and the company’s available credit capacity.
- Whether China’s VAT rule applies to YUM’s sales channels, and developments in material litigation and self-insurance estimates.