YUM! Brands, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter ended September 3, 2011 (12 weeks); year-to-date period covers 36 weeks. Comparisons are to the quarter and year-to-date ended September 4, 2010. Financial amounts are in millions of dollars except per-share data.
Business context
YUM operated KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W, with reporting segments in China, International (YRI) and the U.S. The company reported more than 38,000 restaurants across over 110 countries and territories. China and YRI drove growth, while U.S. sales and operating profit weakened.
Financial results and key metrics
| Metric | Q3 2011 | Q3 2010 | Year to date 2011 | Year to date 2010 |
|---|---|---|---|---|
| Total revenue | $3,274 | $2,862 | $8,515 | $7,781 |
| Operating profit | $488 | $544 | $1,308 | $1,329 |
| Net income attributable to YUM | $383 | $357 | $963 | $884 |
| Diluted EPS | $0.80 | $0.74 | $1.99 | $1.82 |
| Operating profit before special items | $576 | $542 | $1,467 | $1,387 |
| Diluted EPS before special items | $0.83 | $0.73 | $2.12 | $1.90 |
- Quarter revenue rose 14%; attributable net income rose 7% and diluted EPS rose 8%. Reported operating profit declined 10%, but increased 6% before special items. Year-to-date revenue, attributable net income and diluted EPS increased 9%, while reported operating profit declined 2% and increased 6% before special items.
- Quarter segment revenue and operating profit were: China $1,600 and $301; YRI $801 and $163; U.S. $873 and $143. Prior-year operating profit was $267, $142 and $168, respectively.
- Worldwide system sales grew 6% excluding foreign exchange (FX): China +29%, YRI +8%, U.S. -3%. Same-store sales were +19% in China, +3% at YRI and -3% in the U.S. FX added $32 to reported quarter operating profit.
- Company restaurant margin was 17.3%, down 1.9 percentage points. Management also reported China restaurant margin declines of 3.9 points in the quarter and 2.3 points year to date. U.S. restaurant margin fell 2.3 points in the quarter.
- Operating cash flow was $1,703 year to date versus $1,497. Capital spending was $553. Investing cash outflow was $740, including $300 placed in restricted escrow; financing cash outflow was $1,195. Cash declined by $190 to $1,236.
- At September 3, cash was $1,236, current assets $2,351 and current liabilities $2,267. Short-term borrowings were $287 and long-term debt $2,940. The company reported approximately $3.0 billion of Senior Unsecured Notes, including $263 classified as current maturities. Debt fair value was estimated at $3.5 billion versus carrying value of $3.0 billion, excluding capital leases.
- YUM repurchased $562 of shares and paid $350 in dividends year to date. It issued $350 of 3.75% senior notes due 2021 and repaid $650 of notes at maturity. Unused revolving credit capacity was approximately $1.1 billion; no borrowings were outstanding under the facilities.
Material changes and unusual items
- Q3 special items reduced operating profit by $88 and diluted EPS by $0.03 after tax; year-to-date special items reduced operating profit by $159 and diluted EPS by $0.13. Items included refranchising-related charges and impairments, U.S. business transformation costs, and LJS/A&W sale-related items.
- YUM decided to refranchise or close about 350 remaining company-operated Pizza Hut dine-in restaurants in the U.K. The decision led to an $80 non-cash write-down and a further $2 loss for probable obligations. No goodwill impairment was identified at quarter-end; further charges, including possible lease-guarantee and foreign-currency impacts, could arise.
- LJS and A&W were classified as held for sale, with $16 of additional Q3 non-cash write-downs and $82 of total year-to-date impairment. Definitive sale agreements were signed September 22, 2011. YUM recognized a $53 tax benefit associated with the planned sales.
- The effective tax rate was 14.6% for Q3 and 18.4% year to date, versus 27.5% and 25.4%. The filing attributes the lower rates mainly to the $53 tax benefit and favorable audit-reserve changes, as well as income earned in lower-tax jurisdictions.
Outlook, commentary and risks
- Management’s stated ongoing growth models call for average annual operating-profit growth of 15% in China, 10% at YRI and 5% in the U.S.; these are longer-term expectations, not a specific Q3-issued full-year EPS forecast. The filing text does not provide a clear numerical full-year 2011 EPS guidance value.
- Management expected China restaurant margins to decline in Q4 due to labor and commodity inflation, with full-year China restaurant margin expected at 20%. In the U.S., management expected sales declines and food inflation to continue pressuring Q4 restaurant margins and operating profit; lapping higher prior-year G&A costs was expected to mitigate the decline.
- YUM had made a pre-conditional offer of approximately $570 to acquire additional Little Sheep shares, potentially increasing ownership from 27% to about 93%. The company had placed $300 in escrow and provided a $300 letter of credit; completion remained subject to approval.
- The IRS proposed additional taxes of approximately $700 plus $165 of interest for 2004–2006, and estimated potential additional taxes of $320 plus $20 interest for 2007–2010 on a similar basis. YUM disputed the adjustment; resolution was not expected within twelve months, and any ultimate payment could exceed recorded reserves.
- Other exposures include lease guarantees with $525 of undiscounted potential payments ($475 present value), employment and accessibility litigation, and self-insured claims whose estimates could change materially. YUM said it complied with debt covenants and its disclosure controls were effective; the interim financial statements received an independent accountant’s review, not an audit.
Important facts for investors to verify
- Whether Little Sheep acquisition approvals are obtained, how it is funded, and the treatment of the restricted $300 escrow and letter of credit.
- Closing terms and proceeds from the LJS/A&W sale, and any additional costs or balance-sheet effects from the U.K. Pizza Hut refranchising plan.
- Trends in U.S. same-store sales, commodity and labor inflation, and China restaurant margins against management’s expectations.
- Developments in the IRS dispute, including reserve adequacy, potential interest and timing of resolution.
- Cash generation, planned shareholder returns, and refinancing of the $263 of notes due in June 2012 and revolving facilities maturing in November 2012.