YUM! Brands, Inc. — FY2010 Form 10-K
Reporting period: Fiscal year ended December 25, 2010 (52 weeks). The filing is an annual report, with fourth-quarter results also presented. Unless noted otherwise, financial amounts are in U.S. dollars.
Business context
YUM operated KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W, with 37,835 system units in more than 110 countries and territories at year-end. The reporting segments were China, YUM Restaurants International (YRI) and the U.S. Most system restaurants were operated by franchisees, unconsolidated affiliates or licensees.
Financial performance and liquidity
| Metric | FY2010 | FY2009 | Change |
|---|---|---|---|
| Total revenue | $11.343 billion | $10.836 billion | Up 5% |
| Operating profit | $1.769 billion | $1.590 billion | Up 11% |
| Net income attributable to YUM | $1.158 billion | $1.071 billion | Up 8% |
| Diluted EPS | $2.38 | $2.22 | Up 7% |
| Diluted EPS before Special Items | $2.53 | $2.17 | Up 17% |
| Cash from operating activities | $1.968 billion | $1.404 billion | Higher |
| Capital spending | $796 million | $797 million | Nearly unchanged |
Company sales were $9.783 billion, up 4%; franchise and license fees and income were $1.560 billion, up 10%. Company restaurant profit rose 12% to $1.663 billion, and its margin increased to 17.0% from 15.7%. Worldwide restaurant margin was 17.0%, up 1.3 percentage points. Reported operating margin was approximately 15.6% of revenue.
System sales grew 4% excluding currency translation: China 17%, YRI 4% and the U.S. 2%. Same-store sales increased 6% in China and 1% in the U.S.; YRI was flat. Operating profit by segment was $755 million in China (up 27%), $589 million at YRI (up 19% reported; 11% excluding currency effects) and $668 million in the U.S. (up 3%).
At year-end, cash and cash equivalents were $1.426 billion, total debt was $3.588 billion and total assets were $8.316 billion. The company had $673 million of short-term borrowings, including $650 million of notes due April 2011, and $2.915 billion of long-term debt. It reported approximately $1.3 billion of unused revolving credit capacity, with no revolver borrowings outstanding, and stated that it was in compliance with debt covenants. Operating cash flow increased substantially, primarily due to higher operating profit before Special Items and lower pension contributions.
YUM paid $412 million in dividends and repurchased shares for $390 million during 2010. The declared dividend was $0.92 per share. Management targeted an ongoing annual dividend payout ratio of 35%–40% of net income.
Material changes and unusual items
- Revenue and operating profit improved, while reported net income and EPS also rose. EPS before Special Items increased faster than reported EPS because 2010 included net Special Item expenses of $77 million before tax, versus net Special Item income of $18 million in 2009.
- 2010 Special Items included $63 million of net refranchising losses, including a $52 million Mexico market loss and losses associated with Taiwan and U.S. refranchising; the company also recorded a $9 million depreciation reduction related to impaired KFC restaurants offered for sale. The U.S. KFC impairment write-downs included $85 million of non-cash charges.
- China operating profit included a $16 million benefit from participation in the 2010 World Expo; management said this benefit would not recur in 2011. China same-store sales growth and new-unit development also supported results.
- YUM refranchised 949 restaurants worldwide and received $265 million in proceeds. U.S. ownership of KFC, Pizza Hut and Taco Bell restaurants was targeted to decline from about 15% to about 12% by the end of 2011. Refranchising reduces reported company sales and restaurant profit while increasing franchise-fee revenue.
- The effective tax rate rose to 26.1% from 22.4%, partly reflecting tax reserve adjustments and other tax items. The company’s 2010 fourth-quarter revenue was $3.562 billion and diluted EPS was $0.56, compared with $3.365 billion and $0.45, respectively, in the prior-year quarter.
Outlook, commentary and risks
Management’s stated ongoing annual operating-profit growth models were 15% for China, 10% for YRI and 5% for the U.S.; the U.S. model included 6% growth for Taco Bell. These were management expectations for the foreseeable future, not a guarantee. The company estimated 2011 capital spending of approximately $900 million and noted that fiscal 2011 would have 53 weeks.
After year-end, YUM decided to put LJS and A&W up for sale and anticipated a non-cash pre-tax impairment charge in the first quarter of 2011; the amount was not yet clear. In late January 2011, a Taco Bell lawsuit concerning “seasoned beef” advertising generated adverse publicity that management said had negatively affected sales, though the duration and 2011 financial impact were uncertain.
A major contingency is the IRS’s proposed adjustment concerning transfers of intangible rights to foreign subsidiaries. The IRS proposed approximately $700 million of additional tax plus about $150 million of interest for 2004–2006, and YUM estimated potential further taxes of about $320 million plus about $20 million of interest through 2010 on a similar basis. YUM disputed the adjustment and intended to defend its position; it warned that a final payment exceeding recorded reserves could materially affect financial position or results. Resolution was not expected within 12 months.
Other material risks include commodity, wage and supply-cost inflation; food safety and brand reputation; dependence on franchisee performance and development; foreign exchange, political and regulatory risks, particularly in China; consumer demand and competition; and employment, accessibility and other litigation. The company disclosed multiple wage-and-hour and other legal matters, as well as approximately $450 million present value of contingent exposure under assigned or guaranteed leases; the recorded liability for probable lease-guarantee exposure was not material. U.S. and U.K. pension plans were underfunded by $201 million and $23 million, respectively, at year-end.
Important facts for investors to verify
- Reconcile GAAP results with management’s non-GAAP “before Special Items” measures, particularly the 2010 refranchising and impairment charges and the 2009 China consolidation gain.
- Track payment or refinancing of the $650 million notes due in April 2011, cash levels, and revolving-credit availability.
- Monitor the IRS intangible-transfer dispute, recorded tax reserves and any related developments or additional assessments.
- Assess whether China and YRI growth, U.S. same-store sales and the stated segment growth models are sustained, including the nonrecurrence of the World Expo benefit.
- Follow the LJS/A&W sale process and impairment, Taco Bell publicity-related sales effects, and material litigation or guarantee exposures.