YUM! Brands, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and 24-week year-to-date ended June 11, 2011; comparable periods ended June 12, 2010. Amounts are in millions of dollars except per-share data. Interim financial statements are unaudited and were reviewed by KPMG.
Business context and operating results
YUM operated KFC, Pizza Hut, Taco Bell, Long John Silver’s (LJS) and A&W through China, International (YRI) and U.S. segments. The company continued international expansion and U.S. refranchising; it also decided to sell LJS and A&W.
| Metric | Q2 2011 | Q2 2010 | Year to date 2011 | Year to date 2010 |
|---|---|---|---|---|
| Total revenues | $2,816 | $2,574 | $5,241 | $4,919 |
| Operating profit | $419 | $421 | $820 | $785 |
| Net income attributable to YUM | $316 | $286 | $580 | $527 |
| Diluted EPS | $0.65 | $0.59 | $1.20 | $1.09 |
| Operating cash flow | Not presented for quarter | $923 | $833 |
Q2 revenue increased 9% and attributable net income rose 10%, while operating profit was nearly flat. The lower effective tax rate—16.4% versus 23.8%—supported earnings growth. Year-to-date operating profit and net income increased 5% and 10%, respectively. Reported diluted EPS includes special items; EPS before special items was $0.66 for Q2 and $1.29 year to date.
Q2 company restaurant profit was $386, up 5%, but restaurant margin fell to 15.9% from 16.5%. Worldwide system sales rose 3% excluding foreign-exchange effects; same-store sales were up 18% in China and 2% in YRI, and down 4% in the U.S. Segment operating profit was $182 in China, $145 in YRI and $132 in the U.S.; U.S. profit declined 28% while China and YRI grew.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $923, versus $833; capital spending was $330.
- Investing cash outflow was $579, including a $300 increase in restricted cash for the proposed Little Sheep acquisition. Financing cash outflow was $840, including $658 of long-term debt repayments, $319 of share repurchases and $234 of dividends.
- Cash and cash equivalents were $955 at June 11, down from $1,426 at fiscal year-end. Restricted cash of $300 was separately reported.
- Short-term borrowings were $19 and long-term debt $3,269, compared with $673 and $2,915, respectively, at December 25, 2010. YUM repaid $650 of notes at maturity in April and had $350 outstanding under its revolving credit facility.
- Management reported approximately $700 million of unused revolving-credit capacity and compliance with debt covenants with considerable cushion. Current assets were $1,841 and current liabilities $1,711.
- Year-to-date repurchases totaled $308; remaining authorization was approximately $613. The quarterly dividend declared was $0.50 per share, including a $0.25 dividend approved for payment in August.
Material changes, outlook and risks
- U.S. performance: U.S. operating profit fell 28% in Q2 and 22% year to date, chiefly from lower sales and restaurant-margin pressure. Management cited commodity inflation, higher operating costs and Taco Bell sales disruption following negative publicity from a January lawsuit, which was withdrawn in April.
- Near-term outlook: Management expected U.S. sales declines and continued food inflation to produce a double-digit U.S. operating-profit decline in Q3 2011 versus Q3 2010; it expected prior-year G&A costs to help stabilize U.S. profit in Q4. Longer-term operating-profit growth models were 15% for China, 10% for YRI and 5% for the U.S.; these are stated expectations, not guarantees.
- Planned divestitures and impairment: The planned LJS/A&W sale led to a $66 non-cash impairment charge in Q1; no additional impairment was recorded in Q2. YUM continued to assess the assets through sale. The company was also pursuing refranchising of U.S. KFC restaurants and continued impairment reviews.
- Little Sheep proposal: YUM, which owned 27%, made a pre-conditional offer of approximately $570 to acquire additional shares, potentially increasing ownership to about 93%. The offer was not reported as completed; $300 was placed in escrow and a $300 letter of credit was provided.
- Tax dispute: The IRS proposed additional taxes of about $700 plus $160 of interest for 2004–2006, and potential additional taxes of about $320 plus $20 of interest through 2010. YUM contested the proposed adjustments. Resolution was not expected within 12 months; the recorded reserve and ultimate exposure are not specified clearly in this filing, and an adverse outcome could materially affect financial position or results.
- Other contingencies: Potential lease-guarantee payments were approximately $525 undiscounted ($475 present value); the recorded probable liability was not material. Self-insured property and casualty liabilities were $146. The filing describes employment, wage-and-hour and accessibility litigation; outcomes and some potential losses could not be reasonably estimated.
- YUM cited commodity inflation, sales trends, foreign exchange, legal matters, insurance estimates, debt-market access and the ability to repatriate foreign earnings as risks. Management said disclosure controls were effective and reported no significant internal-control changes.
Most important facts for investors to verify
- Whether U.S. same-store sales, margins and operating profit recover as management’s Q3/Q4 expectations imply.
- The status and final economics of the Little Sheep offer, including use of escrowed funds and related financing.
- Developments in the IRS dispute, the reserve recorded, and any change in estimated tax or interest exposure.
- Progress and sale proceeds for LJS/A&W and U.S. KFC refranchising, including any additional impairment or lease-guarantee charges.
- Cash generation, borrowing capacity, and the sustainability of dividends and share repurchases amid the company’s debt and investment commitments.