YUM! Brands, Inc. — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 22, 2014; the first three fiscal quarters generally comprise 12 weeks. Amounts are in U.S. dollars unless noted. YUM operates, franchises, or licenses KFC, Pizza Hut, and Taco Bell, with more than 40,000 restaurants in over 125 countries and territories.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total revenue | $2.724 billion | $2.535 billion |
| Operating profit | $571 million | $487 million |
| Net income attributable to YUM | $399 million | $337 million |
| Diluted EPS | $0.87 | $0.72 |
| Operating cash flow | $570 million | $401 million |
| Capital spending | $172 million | $237 million |
- Revenue rose 7%; company sales increased 9%, while franchise and license fees and income declined 1%.
- Company restaurant profit was $441 million, up 32%; restaurant margin improved to 19.2% from 15.9%. Operating margin was approximately 21.0%, versus 19.2%.
- Reported diluted EPS increased 21%; EPS before special items was $0.87, up 24% from $0.70. Special items contributed no material EPS in 2014 versus $0.02 in 2013.
- Cash and cash equivalents were $734 million at March 22, up from $573 million at year-end 2013. Current assets were $1.809 billion and current liabilities $2.150 billion.
- Balance-sheet short-term borrowings and long-term debt totaled approximately $3.019 billion, compared with $2.989 billion at year-end. The company reported $1.2 billion of unused revolving credit capacity, net of letters of credit and borrowings.
- Cash used in financing was $237 million, including $124 million of share repurchases and $164 million of dividends paid. The declared quarterly dividend was $0.37 per share.
Material changes and segment results
- YUM changed its reporting structure in Q1, presenting operations outside China and India by KFC, Pizza Hut, and Taco Bell brands. Comparable segment information was restated; consolidated results were unaffected.
- China led the improvement: system sales excluding foreign exchange grew 17%, same-store sales rose 9%, restaurant margin increased to 23.4% from 16.6%, and operating profit rose 80% excluding FX. Management attributed the rebound in part to recovery from 2013 sales declines.
- KFC Division system sales grew 4% excluding FX, while operating profit grew 4%; restaurant margin slipped to 12.9% from 13.2%.
- Pizza Hut system sales were flat excluding FX, with same-store sales down 2%; operating profit fell 14% and restaurant margin declined to 10.8% from 15.0%.
- Taco Bell system sales were flat, with same-store sales down 1%; operating profit fell 16% and restaurant margin declined to 15.6% from 18.2%.
- Worldwide system sales grew 4% excluding FX, and the restaurant base increased 3% year over year to 40,324 units. International development totaled 249 new restaurants, 86% in emerging markets.
Outlook, risks, and contingencies
- Management reiterated an expectation for at least 10% annual EPS growth under its ongoing earnings model and forecast 2014 EPS growth of at least 20% before special items, driven largely by China operating profit growth significantly above its ongoing 15% target. These are forward-looking expectations, not guarantees.
- Management’s ongoing annual operating-profit growth targets are 10% for KFC, 8% for Pizza Hut, and 6% for Taco Bell; these depend on sales, unit growth, margins, and other assumptions.
- The company’s effective tax rate was 25.9%, versus 26.4% a year earlier. Management expected a full-year rate of 26%–28%, including any additional reserves related to IRS discussions.
- The IRS has proposed adjustments concerning transfers of intangible rights for tax years 2004–2008; YUM also estimated potential similar adjustments for 2009–2013. The company said a 2014 settlement was reasonably possible, but resolution remained uncertain and could require significant cash payments or additional reserves. YUM disputes the IRS position.
- Potential payments under contingent restaurant lease guarantees were approximately $700 million undiscounted, or $600 million present value; the recorded liability for probable exposure was not material. Franchisee financing guarantees totaled $44 million.
- YUM disclosed securities and shareholder derivative litigation related to China operations, Taco Bell wage-and-hour and accessibility matters, and a Pizza Hut delivery-driver case. Possible losses for several matters could not be reasonably estimated; the accessibility matter was agreed to be settled, subject to court approval, with expected cash payments described as immaterial.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter. The independent accountant’s interim review identified no material modifications needed to the statements; it was not an audit.
Key facts for investors to verify
- Whether China’s sales and margin recovery continued, and how much of Q1 growth reflected same-store sales versus unit expansion.
- Whether weak Pizza Hut and Taco Bell same-store sales, margin pressure, and operating-profit declines persisted.
- Progress and potential financial impact of the IRS tax dispute, including any new reserves, settlement terms, or cash payments.
- Debt maturities, liquidity and covenant headroom, and the company’s continued ability to fund dividends, repurchases, and capital spending.
- Developments in disclosed litigation and lease guarantees, including any material changes in estimated exposure.