YUM! Brands, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter ended September 4, 2010 (12 weeks); year-to-date period was 36 weeks. Comparisons are with the quarter ended September 5, 2009 and the corresponding year-to-date period. Amounts are in U.S. dollars; financial-statement amounts are in millions unless noted. The interim statements were reviewed by KPMG, not audited.
Business context
YUM operates KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W. Its reporting segments are China, YUM Restaurants International (YRI) and the United States. At quarter-end it reported 35,141 units excluding licensed units; approximately 77% were operated by franchisees, 22% by the Company and 1% by unconsolidated affiliates.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Year to date 2010 | Year to date 2009 |
|---|---|---|---|---|
| Total revenue | $2,862 | $2,778 | $7,781 | $7,471 |
| Operating profit | $544 | $470 | $1,329 | $1,215 |
| Net income attributable to YUM | $357 | $334 | $884 | $855 |
| Diluted EPS | $0.74 | $0.69 | $1.82 | $1.77 |
| Net cash from operating activities | Not reported for quarter | $1,497 | $1,135 |
Quarter revenue increased 3%, operating profit 16%, attributable net income 7% and reported diluted EPS 7%. Year to date, the increases were 4%, 9%, 3% and 3%, respectively. Revenue growth reflects, among other factors, increased China activity and changes in restaurant ownership.
Margins and sales: Company restaurant margin was 19.2% in Q3 versus 17.5% (up 1.7 percentage points); year to date it was 17.7% versus 16.2%. Worldwide system sales grew 5% excluding currency effects in Q3 and 3% year to date; worldwide same-store sales grew 2% and 1%, respectively. Q3 system sales growth excluding currency was 18% in China, 5% in YRI and 1% in the U.S. Segment operating profit increased 24% in China and 18% in YRI in Q3, while U.S. operating profit declined 2%.
Cash, debt and liquidity: Year-to-date operating cash flow was $1,497, versus $1,135; investing cash outflow was $435, versus $505; financing cash outflow was $151, versus $439. Cash rose to $1,274 from $353 at fiscal year-end, partly reflecting a $350 bond issuance. Short-term borrowings were $724 and long-term debt $2,905 at September 4; the short-term balance includes $650 of notes due April 2011. The Company reported approximately $1.3 billion of unused revolving-credit capacity and said it expected to use significant cash toward the April 2011 maturity. Current assets of $2,175 were below current liabilities of $2,301. YUM repurchased $283 of shares and paid $295 in dividends year to date.
Material changes and unusual items
- In August, YUM issued $350 of 3.875% senior unsecured notes due November 2020. Proceeds were temporarily invested in short-term investment-grade securities.
- Year-to-date reported results included a $51 pre-tax U.S. refranchising loss, including a $73 non-cash impairment charge associated with offers to refranchise a substantial group of U.S. KFC restaurants. YUM had not completed those refranchisings by quarter-end and said further impairment was possible.
- YUM completed its Russia/CIS transaction on July 1, acquiring 50 company restaurants and franchisor rights for 81 additional restaurants. It paid $56 net of settling a note receivable, assumed $10 of debt, and expected to pay a further $11 in 2012. Preliminary goodwill included $74.
- Q3 China operating profit included approximately $10 related to the World Expo; management said this benefit would not recur in 2011.
- After quarter-end, YUM agreed to refranchise all company-owned restaurants in Mexico—224 KFCs and 123 Pizza Huts—and anticipated a pre-tax loss of approximately $50 in Q4.
- Reported diluted EPS was $0.74 in Q3; EPS before the Company’s “Special Items” was $0.73, compared with $0.70 in the prior-year quarter. Year-to-date EPS before Special Items was $1.90 versus $1.67. These are non-GAAP measures.
Outlook, commentary and risks
Management’s stated long-term operating-profit growth model is 15% annually for China, 10% for YRI and 5% for the U.S.; these are strategic targets, not a specific full-year 2010 earnings forecast. The filing directs investors to the Company’s website for details of 2010 guidance and does not provide a consolidated numerical EPS outlook in the text provided. Management expected full-year China restaurant-margin improvement, but warned that labor and commodity inflation would pressure Q4 margins. It also planned to complete its U.S. refranchising program, potentially reducing Company ownership below 10% by the end of 2011.
- Tax dispute: The IRS proposed an adjustment concerning transferred intangible rights for 2004–2006, estimating approximately $700 of additional tax plus $145 of interest. Similar claims for 2007–2009 could add approximately $280 of tax plus $15 of interest. YUM disputes the adjustment; the recorded reserve amount is not stated in the filing text. Management said resolution was not expected within 12 months and warned that an unfavorable outcome or higher reserves could materially affect financial position or results.
- Contingencies: Potential undiscounted lease-guarantee payments were approximately $500 (present value approximately $425); the recorded liability for probable exposure was not material. The filing also describes wage-and-hour, accessibility and other litigation; some outcomes or potential losses could not be reasonably estimated. Self-insured property and casualty liabilities were $162.
- Other risks: The filing identifies exposure to food safety and supply disruptions, commodity-cost inflation, competition, economic and regulatory changes, foreign exchange, dependence on franchisees, litigation and international-market risks, particularly in China. The Company reported that debt covenants were met with considerable cushion and disclosure controls were effective.
On September 14, the Board approved a quarterly dividend of $0.25 per share, up from $0.21, payable November 5 to shareholders of record October 15. Management stated a target annual dividend payout ratio of 35%–40% of net income.
Most important facts for investors to verify
- How reported results compare with the Company’s non-GAAP results before Special Items, especially the U.S. KFC impairment and refranchising activity.
- The IRS dispute’s reserve, procedural progress and potential total exposure; the filing does not state the reserve amount.
- Progress, sale terms and final accounting for the U.S. and Mexico refranchisings, including the expected Mexico loss and any additional impairment or lease-guarantee charges.
- Cash available to address the $650 of notes due in April 2011, alongside debt levels, credit-facility availability and any refinancing or repatriation needs.
- Whether China and international growth and margins can offset U.S. performance and anticipated labor and commodity inflation; also monitor the nonrecurring World Expo benefit and material litigation developments.