YUM! Brands, Inc. — Q3 2013 Form 10-Q
Business context and reporting period
YUM operates KFC, Pizza Hut and Taco Bell, with nearly 40,000 restaurants in more than 130 countries and territories. The quarter ended September 7, 2013 covered 12 weeks; year-to-date results covered 36 weeks. Comparisons are with the corresponding 2012 periods unless noted. The filing is unaudited interim financial information.
Key financial metrics
| Metric ($ millions, except per-share data) | Q3 2013 | Q3 2012 | YTD 2013 | YTD 2012 |
|---|---|---|---|---|
| Total revenue | 3,466 | 3,569 | 8,905 | 9,480 |
| Operating profit | 350 | 671 | 1,227 | 1,789 |
| Net income attributable to YUM | 152 | 471 | 770 | 1,260 |
| Diluted EPS | $0.33 | $1.00 | $1.66 | $2.65 |
| Operating cash flow | Not presented quarterly | 1,553 | 1,818 |
Q3 company restaurant profit was $531 million, 17.6% of company sales, versus $599 million and 19.1% a year earlier. Worldwide restaurant margin declined 1.3 percentage points to 17.6%. Reported operating margin was approximately 10.1% for Q3 and 13.8% YTD; both figures include significant special items.
Before special items, diluted EPS was $0.85 for Q3 and $2.11 YTD, versus $0.99 and $2.42, respectively, in 2012. Operating profit before special items was $617 million for Q3 and $1,449 million YTD. These are company-defined non-GAAP measures.
At September 7, 2013, cash and cash equivalents were $753 million; current assets were $1,830 million and current liabilities $1,989 million. Long-term debt was $2,917 million and short-term borrowings $15 million. The company reported $1.2 billion of unused revolving credit capacity, no revolver borrowings, and compliance with debt covenants. YTD capital spending was $699 million; share repurchases were $490 million and dividends paid were $451 million.
Material changes versus the prior comparable period
- Q3 revenue fell 3% and YTD revenue fell 6%; reported operating profit fell 48% and 31%, respectively. Reported YUM net income declined 68% in Q3 and 39% YTD.
- The main exceptional driver was a $295 million non-cash Little Sheep impairment charge, including $222 million of goodwill impairment and $69 million for the trademark; after tax and noncontrolling interests, $258 million reduced YUM-attributable income. The prior-year YTD comparison included a $74 million non-cash gain on acquiring control of Little Sheep.
- Excluding foreign currency, worldwide system sales grew 1% in Q3. China system sales declined 2%, with same-store sales down 11%; YRI system sales grew 5%, and U.S. system sales were flat. China operating profit declined 14% excluding currency translation, while U.S. operating profit rose 1%.
- YTD operating cash flow declined to $1.553 billion from $1.818 billion, primarily due to lower operating profit before special items. YTD investing cash use was $587 million and financing cash use was $975 million. Cash ended at $753 million, down $23 million from fiscal year-end.
- YTD company sales were also affected by refranchising, which reduced revenue while increasing franchise fees. The company recorded $87 million of net refranchising gains YTD, primarily from U.S. restaurant sales.
Outlook, commentary, risks and unusual items
- In October 2013, management revised its 2013 full-year outlook to a high-single- to low-double-digit decline in EPS before special items, compared with its February estimate of a mid-single-digit decline. Cited factors were a higher-than-expected full-year tax rate and weaker-than-expected China sales.
- China KFC same-store sales fell 14% in Q3, an improvement from declines of 24% and 26% in the first and second quarters. September sales declined 13%; management said positive China Division same-store sales for Q4 had become unlikely and recovery timing remained difficult to forecast.
- The Q3 effective tax rate was 57.2%, versus 25.1%; excluding special items it was 33.1%, versus 25.1%. The increase reflected the Little Sheep goodwill impairment, which had no related tax benefit, and additional tax reserves related to an IRS dispute.
- The IRS proposed adjustments concerning transferred intangible rights for tax years 2004–2008 that could mean approximately $970 million in additional tax plus about $280 million in interest to date. YUM expects similar claims for 2009–2012, estimated at a further $130 million plus about $5 million interest. The company disputes the adjustments, has filed a protest, and says resolution is not expected within 12 months. It warns payments could exceed recorded reserves and materially adversely affect financial position; the reserve amount is not stated here.
- Little Sheep impairment valuations assume recovery to pre-acquisition sales and profit levels within three years, followed by 4% same-store sales growth and roughly 75 net new units annually. These are assumptions, not assured outcomes.
- Other exposures include contingent lease guarantees with $750 million of undiscounted potential payments ($650 million present value), franchise financing guarantees, self-insured claims and ongoing litigation. Management says probable lease exposure accrued was not material; loss estimates for several lawsuits cannot be made. The company reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether China sales and restaurant margins recover, and the actual impact on full-year EPS relative to management’s revised outlook.
- The status and potential cash cost of the IRS intangible-valuation dispute, including reserve adequacy and any further proposed tax years.
- Little Sheep’s operating recovery against the assumptions underlying the impairment valuation, and whether further impairments are required.
- Underlying performance excluding impairments, refranchising gains and other special items; reconcile the company’s non-GAAP measures to GAAP results.
- Cash generation, debt maturities, access to revolving credit and the sustainability of dividends and share repurchases amid weaker earnings.
- Developments in disclosed litigation, lease guarantees and self-insurance exposures that could change potential losses.