YUM! Brands, Inc. — Q1 2010 Form 10-Q
Reporting period: Twelve weeks ended March 20, 2010; comparisons are with the twelve weeks ended March 21, 2009. Amounts are in millions except per-share data. The interim financial statements were reviewed by KPMG, not audited.
Business context and results
YUM operates KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W through China, International (YRI) and U.S. divisions. It reported more than 37,000 restaurants in over 110 countries and territories.
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Total revenue | $2,345 | $2,217 | +6% |
| Operating profit | $364 | $351 | +4% |
| Net income attributable to YUM | $241 | $218 | +10% |
| Diluted EPS | $0.50 | $0.46 | +9% |
| Company restaurant profit / margin | $340 / 17.0% | $308 / 16.1% | Margin +0.9 pts |
| Operating cash flow | $392 | $297 | +$95 |
Reported operating margin was approximately 15.5% versus 15.8%. Diluted EPS before special items was $0.59, up 23% from $0.48; special items reduced reported EPS by $0.09 in 2010 and $0.02 in 2009. Interest expense, net, declined 20% to $41. The effective tax rate fell to 24.1% from 26.5%, primarily reflecting foreign earnings and tax effects.
Segments and operating trends
- China: Revenue was $708 versus $569; operating profit rose 37% to $176. Same-store sales grew 4%, and restaurant margin increased 2.5 points, supported by $15 of commodity deflation and new-unit growth.
- YRI: Revenue was $704 versus $629; operating profit rose 13% to $141, including a favorable $14 foreign-exchange translation impact. Excluding currency, operating profit increased 2%. Same-store sales declined 2%.
- U.S.: Revenue was $933 versus $1,046; operating profit fell 9% to $143. Same-store sales declined 1% systemwide and 2% at company restaurants. Refranchising reduced company sales; U.S. restaurant margin declined 0.9 points.
Worldwide system sales grew 1% excluding foreign currency translation (5% including it). YUM opened 205 restaurants during the quarter, including 96 in China, and refranchised 175 units.
Cash, debt and liquidity
- Cash and cash equivalents were $444 at March 20, 2010, up from $353 at December 26, 2009. Operating, investing and financing cash flows were +$392, -$116 and -$190, respectively.
- Capital spending was $163. The company repurchased approximately 4.0 million shares for about $137 (cash-flow statement repurchases: $132, excluding unsettled trades) and paid $99 in dividends.
- Short-term borrowings were $56 and long-term debt was $3,219. Cash plus operating cash flow supported liquidity; current assets were $1,404 and current liabilities $1,596.
- YUM disclosed approximately $1.3 billion of unused revolving capacity overall. At quarter-end, the domestic facility had $965 available and the international facility $337 available; both mature in November 2012. The company reported compliance with debt covenants and substantial covenant cushion.
- Management said it was managing capital to maintain investment-grade ratings (S&P BBB-; Moody’s Baa3). It cited historically strong operating cash generation, while noting a downturn or inability to refinance could constrain cash flow and potentially require higher-tax repatriation of foreign earnings.
Material changes, outlook and notable items
- U.S. refranchising and related actions produced a $56 pretax loss, versus a $14 gain in the prior-year quarter. The 2010 result included a $73 noncash write-down tied to offers to refranchise a substantial group of U.S. KFC restaurants; the group had not yet met held-for-sale criteria.
- YUM refranchised its remaining 124 company-operated KFC restaurants in Taiwan and recorded a $7 noncash goodwill write-off. The company was discussing an alternative accounting interpretation with SEC staff that could require an additional $30 write-off for Taiwan and approximately $40 for historical refranchisings, principally in the U.S.
- YUM’s strategic growth model cited annual operating-profit growth targets of 15% for China, 10% for YRI and 5% for the U.S. These are strategic targets, not a specific consolidated 2010 earnings forecast. Management expected moderate full-year China margin improvement, with anticipated second-half commodity and labor inflation offsetting some same-store sales growth. Detailed 2010 guidance was referred to online and is not stated in the filing text provided.
- YUM said U.S. ownership could decline from 16% of restaurants to below 10%. Refranchising may reduce reported revenue and restaurant profit while increasing franchise-fee contribution; G&A savings may lag transactions.
- Contingencies include approximately $500 of undiscounted potential lease-guarantee payments ($425 present value); management said the recorded probable liability was not material. Franchise-loan support included a $15 partial guarantee and $23 in letters of credit; equipment-program guarantees were $39. Self-insured property and casualty liabilities were $173.
- Key litigation includes an LJS wage-and-hour arbitration proceeding as an opt-out class, with proceedings scheduled to resume in May 2010, and multiple California wage-and-hour and accessibility claims involving Taco Bell and KFC. YUM stated some potential losses could not be reasonably estimated. The company identifies food safety, international-market, currency, commodity, franchisee, regulatory, litigation and competitive risks.
Important facts for investors to verify
- Reconcile reported EPS of $0.50 with the $0.59 non-GAAP figure before special items, and assess the recurring impact of U.S. operating weakness and refranchising.
- Monitor the SEC accounting discussions and any resulting additional goodwill write-offs, including possible amounts related to Taiwan and prior refranchisings.
- Review progress and realized proceeds from the U.S. KFC refranchising plan, including whether further impairment or lease-guarantee charges arise.
- Track China’s growth and margins against commodity and labor inflation, and YRI results excluding favorable currency translation.
- Assess liquidity, debt maturities, credit ratings and shareholder returns alongside planned capital spending, repurchases and dividends.
- Follow material litigation developments and changes in self-insurance reserves or guarantee exposure.