Business context and reporting period
YUM! Brands, Inc. operates KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W. This unaudited Form 10-Q covers the 12-week quarter and 24 weeks year to date ended June 12, 2010; comparisons are with periods ended June 13, 2009. Its reportable segments are China, YUM Restaurants International (YRI) and the U.S. The interim financial statements received an independent accountant’s review, not an audit.
Financial performance and position
| Metric | Quarter | Year to date |
|---|---|---|
| Total revenue | $2.574 billion, up 4% | $4.919 billion, up 5% |
| Operating profit, GAAP | $421 million, up 7% | $785 million, up 5% |
| Net income attributable to YUM | $286 million, down 6% | $527 million, up 1% |
| Diluted EPS, GAAP | $0.59, down 6% | $1.09, versus $1.08 |
| Diluted EPS before special items | $0.58 versus $0.50 | $1.17 versus $0.97 |
- Company restaurant profit was $366 million for the quarter and $706 million year to date. Restaurant margin rose 1.4 percentage points to 16.5% in the quarter and 1.3 points to 16.8% year to date.
- Quarterly segment operating profit: China $139 million (up 33%), YRI $122 million (up 21%, or 7% excluding favorable currency translation), and U.S. $184 million (up 10%). YRI’s year-to-date profit growth was 4% excluding currency translation; U.S. year-to-date profit was essentially flat.
- Worldwide system sales grew 4% excluding currency in the quarter and 2% year to date. China growth was 15% in both periods; U.S. same-store sales were flat, while YRI same-store sales declined 2% in the quarter.
- Operating cash flow was $833 million year to date, versus $495 million. Capital spending was $327 million. Investing used $239 million; financing used $412 million, including $247 million of share repurchases and $197 million of dividends paid.
- Cash was $530 million at June 12. Short-term borrowings were $717 million and long-term debt $2.518 billion. The filing says $650 million of notes due April 2011 was reclassified to short-term borrowings. Current assets were $1.464 billion and current liabilities $2.213 billion. The company reported about $1.3 billion of unused revolving credit capacity and no borrowings under its credit facilities.
- Quarterly effective tax rate was 23.8%, versus 12.8%; year-to-date rate was 24.0%, versus 19.1%. Management attributed the higher comparisons mainly to nonrecurring favorable tax and transaction items in 2009.
Material changes versus the prior comparable period
- Underlying results improved, while GAAP quarterly EPS and net income fell. The comparison includes a $68 million, nontaxable gain recognized in 2009 on obtaining control of a Shanghai KFC operating entity; before special items, quarterly diluted EPS increased to $0.58 from $0.50.
- China’s growth reflected new-unit development, higher restaurant margins and consolidation of the Shanghai entity. Consolidation added $98 million to year-to-date company sales and $3 million to operating profit, while reducing franchise and license income by $6 million.
- YUM refranchised 217 restaurants year to date, including 71 in the U.S. and all 124 remaining company-operated KFCs in Taiwan. U.S. refranchising activity and offers to sell a substantial group of company-operated KFCs drove a $73 million noncash impairment charge; total year-to-date refranchising loss was $53 million.
- Cash and operating cash flow increased year over year. The increase in short-term borrowings largely reflects reclassification of the 2011 notes, not simply new borrowing. Share repurchases resumed in 2010.
Outlook, commentary, risks and unusual items
- Management described long-term operating-profit growth models of 15% annually for China, 10% for YRI and 5% for the U.S.; these are strategic models, not a clear consolidated 2010 earnings forecast. The filing directs readers to the company website for 2010 guidance details and does not state a specific consolidated guidance figure in the supplied text.
- Management expects moderate full-year China restaurant-margin improvement, with labor and commodity inflation expected to largely offset same-store sales growth. YRI margins declined, primarily due to labor inflation. U.S. margins benefited from improved KFC performance, refranchising and lower insurance expense.
- The IRS issued a proposed adjustment on June 23, 2010 concerning historic intercompany trademark and system rights. The proposal could add approximately $700 million of tax plus $140 million interest for 2004–2006; similar claims through 2009 could add approximately $280 million plus $15 million interest. YUM disputes the proposal and intends to contest it. Final exposure is uncertain, may exceed recorded reserves, and could materially affect financial position or results; resolution is not expected within 12 months.
- Other disclosed exposures include employment-related class and collective actions, an ADA class action involving Taco Bell restaurants, and lease guarantees with approximately $500 million of potential undiscounted payments ($425 million present value). Management said the recorded liability for probable lease-guarantee exposure was not material. Self-insured property and casualty liabilities were $160 million.
- Principal stated business risks include food safety, international and China exposure, currency and commodity fluctuations, supply disruptions, franchisee performance, refranchising execution, litigation, regulation, competition and general economic conditions. Management reported effective disclosure controls and no significant quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Track the IRS dispute, the company’s recorded reserve, and whether subsequent filings revise the estimated tax and interest exposure.
- Assess the underlying trend using GAAP and pre-special-item results together, particularly the prior-year Shanghai gain and the 2010 U.S. KFC impairment and refranchising loss.
- Verify whether China and international growth, same-store sales, margins and new-unit openings sustain the long-term growth models stated by management.
- Review the April 2011 debt maturity, refinancing plans, liquidity availability, covenant headroom and credit ratings; distinguish the debt reclassification from new borrowing.
- Monitor U.S. KFC refranchising offers and related impairment, lease guarantees and litigation developments, including matters for which losses are not reasonably estimable.