YUM! Brands, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. YUM operates KFC, Pizza Hut and Taco Bell, with more than 45,000 restaurants in over 140 countries and territories; 97% of restaurants were franchised at period-end. Dollar amounts below are in millions unless noted.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $1,368 | $1,448 | $2,739 | $2,865 |
| Operating profit | $449 | $419 | $1,002 | $903 |
| Net income | $321 | $206 | $754 | $486 |
| Diluted EPS | $0.97 | $0.58 | $2.25 | $1.34 |
| GAAP effective tax rate | 9.9% | 33.8% | 12.9% | 26.2% |
- Management reported diluted EPS excluding special items of $0.82 for Q2, up 20%, and $1.71 year to date, up 29%. Core operating profit, excluding special items and foreign exchange, was $412 in Q2, down 6%, and $796 year to date, down 3%.
- Worldwide system sales excluding foreign exchange grew 4% in both periods; same-store sales grew 1%. YUM opened 243 net new units in Q2 and 482 year to date, for 4% net unit growth.
- Q2 restaurant profit was $91, with a 17.8% margin, versus $161 and 17.7% a year earlier. Year-to-date restaurant profit was $165, with a 16.1% margin, versus $305 and 16.8%. Company sales fell mainly as restaurants were refranchised.
- Segment operating profit: KFC $235 in Q2 and $456 year to date; Pizza Hut $81 and $169; Taco Bell $149 and $281. Year-to-date core operating profit declined at all three segments: KFC 3%, Pizza Hut 2%, and Taco Bell 4%.
- Operating cash flow was $381 year to date, versus $439. Investing cash use was $42, including the $200 Grubhub investment; financing cash use was $1,579, including $1,168 of share repurchases and $236 of dividends. Cash, cash equivalents and restricted cash ended at $409; balance-sheet cash and cash equivalents were $313.
- Long-term debt was $9,612 and short-term borrowings were $54 at June 30. Shareholders’ deficit was $7,247. The company had about $200 outstanding under its $1 billion revolving facility.
Material changes and unusual items
- Revenue comparisons are affected by adopting Topic 606 in 2018. Advertising cooperative contributions and related expenses are now reported gross, adding $272 of revenue and $274 of expense in Q2 and $547 of revenue and $546 of expense year to date. This substantially changes reported revenue presentation without a comparable prior-year restatement. Topic 606 did not affect Q2 GAAP operating profit; year-to-date GAAP operating profit was $4 higher than under legacy accounting, while core operating profit was $9 lower.
- Q2 and year-to-date refranchising gains were $29 and $185, respectively, compared with gains of $19 and $130 in 2017. Proceeds from refranchising were $47 in Q2 and $252 year to date. Refranchising reduced company-operated restaurant sales but increased franchise revenue.
- The Grubhub investment generated $25 of Q2 and $91 of year-to-date investment income, including fair-value changes. YUM invested $200 for approximately 2.8 million shares; the investment was valued at $291 at June 30.
- The lower tax rate reflected the U.S. federal tax-rate reduction, lapping prior-year repatriation costs and Tax Act-related benefits. Q2 included a $32 provisional Tax Act benefit, partly offset by a $19 charge correcting tax on a prior-year divestiture. Tax Act accounting remained provisional.
Outlook, management commentary and risks
- Management maintained full-year core operating profit growth guidance despite disruption to KFC supply in the UK and Ireland. It estimated that the disruption would reduce 2018 core operating profit growth by 1 percentage point for YUM and 2 points for KFC; full-year same-store sales growth impacts were estimated at 25 and 50 basis points, respectively. All affected restaurants had returned to full menus by mid-May, and management expected no further impact.
- Management estimated that refranchising, net of G&A reductions, would reduce 2018 core operating profit growth by 6 to 7 percentage points. The adoption of Topic 606 was expected to reduce 2018 core operating profit growth by 2 to 3 points, weighted toward Q4.
- Strategic targets include at least 98% franchised ownership by end-2018, annual recurring capital expenditures of about $100 by 2019, G&A of 1.7% of system sales by 2019, and leverage of approximately 5.0 times EBITDA. YUM intended to return $6.5 billion to $7.0 billion to shareholders during 2017–2019.
- YUM identified the Ameranth patent litigation involving Pizza Hut and its service provider, with a September 2018 trial date; the company denied liability, and the possible loss could not be reasonably estimated. Potential undiscounted payments under lease guarantees were about $600, but the recorded liability was not material. Other proceedings were not expected to have a material adverse effect.
- The filing cited ordinary-course operational, legal, regulatory and product risks and referred readers to the 2017 Form 10-K for risk factors. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Separate underlying operating performance from Topic 606’s gross presentation of advertising cooperative activity and from refranchising gains.
- Assess whether refranchising-related profit pressure, KFC supply normalization and brand-level sales trends align with management’s 2018 outlook.
- Review the quality and sustainability of earnings, including Grubhub fair-value gains, Tax Act benefits and the divestiture-related tax correction.
- Monitor leverage, refinancing needs, liquidity and shareholder returns against operating cash flow; Q2 cash flow was below the prior-year period and debt remained substantial.
- Track the provisional Tax Act estimates, the Ameranth litigation and the expected balance-sheet effects of adopting lease accounting in 2019.