YUM! Brands, Inc. — 2014 Q3 Form 10-Q
Business context and period. The 12-week quarter ended September 6, 2014; year-to-date (YTD) results cover the first three fiscal quarters. 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 franchisee-, licensee- or affiliate-operated. Segment reporting was reorganized in 2014; comparative segment figures were restated.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q3 2014 | Q3 2013 | YTD 2014 | YTD 2013 |
|---|---|---|---|---|
| Total revenue | $3,354 | $3,466 | $9,282 | $8,905 |
| Operating profit | $550 | $350 | $1,600 | $1,227 |
| Net income attributable to YUM | $404 | $152 | $1,137 | $770 |
| Diluted EPS, reported | $0.89 | $0.33 | $2.50 | $1.66 |
| Diluted EPS, before special items | $0.87 | $0.85 | $2.48 | $2.11 |
| Effective tax rate | 22.7% | 57.2% | 24.5% | 33.9% |
- Q3 revenue decreased 3% year over year; company sales declined 4%, while franchise and license fees increased 4%. YTD revenue rose 4%.
- Q3 operating profit rose 57% and reported diluted EPS rose 171%, principally reflecting comparison with 2013’s $295 million Little Sheep impairment charge. Before special items, Q3 diluted EPS increased 3%; YTD increased 17%.
- Worldwide restaurant margin fell 2.7 percentage points to 14.9% in Q3; YTD margin increased 0.8 points to 16.3%. Q3 worldwide system sales grew 1%; YTD growth was 2% reported and 4% excluding currency effects.
- Quarterly segment results: China operating profit was $202 million, down 38% excluding foreign exchange; KFC Division $169 million, up 16%; Pizza Hut Division $68 million, down 2%; Taco Bell Division $124 million, up 14%; India recorded a $3 million operating loss.
Cash flow, balance sheet and liquidity
- YTD operating cash flow was $1,612 million versus $1,553 million; capital spending was $655 million. Investing activities used $920 million and financing activities used $586 million. Ending cash was $685 million.
- At September 6, cash and short-term investments totaled $1,011 million. Current assets were $2,070 million and current liabilities $2,112 million.
- Long-term debt was $3,315 million and short-term borrowings $72 million, versus $2,918 million and $71 million, respectively, at year-end 2013. Debt obligations’ estimated fair value was $3.1 billion versus carrying value of $2.8 billion, excluding capital leases.
- The $1.3 billion revolving credit facility had $397 million drawn, $56 million of letters of credit and $0.8 billion unused. The company reported covenant compliance with considerable cushion.
- YTD share repurchases were $510 million and dividends paid were $490 million. The board announced an 11% quarterly dividend increase to $0.41 per share; the company targets an ongoing payout ratio of 40%–45% of net income before special items.
Changes, outlook and material matters
- China supplier incident: In July 2014, reports of improper food handling by supplier Shanghai Husi/OSI adversely affected consumer confidence and sales at KFC and Pizza Hut in China. YUM terminated its relationship with OSI globally. China sales were rebounding, but same-store sales remained negative.
- Guidance: YUM lowered its 2014 diluted EPS growth expectation excluding special items from at least 20% to 6%–10%, assuming China same-store sales continue improving but remain negative in Q4. The company’s ongoing earnings growth model targets at least 10% annual EPS growth. Full-year effective tax rate was expected to be 25%–26%.
- Potential impairment: Little Sheep sales and profits through the first three quarters were below assumptions used in its 2013 valuation. If negative trends continued, further non-cash impairment in Q4 2014 could be required.
- Tax settlement: YUM reached agreement with the IRS on an intangible-valuation dispute affecting tax years 2004–2013. It paid $120 million in Q3, effectively fully reserved; additional fully reserved payments were expected as later examinations closed. Unrecognized tax benefits were $125 million at quarter-end.
- Contingencies: The filing describes securities and shareholder derivative litigation concerning China supply-chain disclosures and controls, and labor-related cases involving Taco Bell and Pizza Hut. Some matters have accrued amounts, but potential losses beyond recorded provisions are not estimable. Lease guarantees had $650 million of potential undiscounted payments; the recorded probable exposure was not material, and management cited franchisee cross-default protections.
- The interim financial statements were reviewed by KPMG, not audited. Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Key facts for investors to verify
- Whether China same-store sales continued to recover after the supplier incident, and the resulting effect on Q4 results and 2014 EPS guidance.
- Whether Little Sheep’s operating performance triggered a further impairment in Q4.
- How segment performance and restaurant margins developed, particularly at China and Pizza Hut.
- Debt, facility usage, cash generation and capital returns, including the effect of increased dividends and repurchases.
- Final cash payments and accounting outcomes for the IRS settlement and material litigation contingencies.