YUM! Brands, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2017; year-to-date figures cover the six months ended that date. YUM operates or franchises KFC, Pizza Hut and Taco Bell, with nearly 44,000 restaurants in 137 countries and territories. Approximately 94% of restaurants were franchised. The company spun off Yum China in October 2016; China results appear as discontinued operations in the 2016 comparisons.
Beginning in 2017, YUM changed to a calendar fiscal year and removed reporting lags for certain international subsidiaries. Comparative periods were retrospectively adjusted, and interim results are not necessarily indicative of full-year performance.
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data, percentages and unit counts.
| Metric | Q2 2017 | Q2 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Total revenue | $1,448 | $1,509 | $2,865 | $2,952 |
| Operating profit | $419 | $415 | $903 | $764 |
| Income from continuing operations | $206 | $266 | $486 | $492 |
| Net income | $206 | $336 | $486 | $700 |
| Diluted EPS from continuing operations | $0.58 | $0.64 | $1.34 | $1.18 |
| Core operating profit growth, excluding special items and FX | 19% | — | 14% | — |
| Diluted continuing-operations EPS growth, excluding special items | 21% | — | 19% | — |
Q2 revenue declined 4% and continuing-operations diluted EPS declined 10%; excluding special items, EPS increased 21%. YTD revenue declined 3%, while continuing-operations diluted EPS increased 14% GAAP and 19% excluding special items. Company sales fell as restaurants were refranchised, while franchise and license income increased. Worldwide system sales grew 6% excluding FX in Q2 and 5% YTD; same-store sales grew 2% in both periods.
Restaurant margin was 17.7% in Q2 versus 16.6% a year earlier, and 16.8% YTD versus 16.1%. Taco Bell led reported same-store sales growth (4% Q2; 6% YTD); KFC grew 3% in both periods, while Pizza Hut declined 1% Q2 and 2% YTD.
YTD operating cash flow from continuing operations was $439 million versus $587 million; investing activities provided $173 million versus using $90 million, principally reflecting higher refranchising proceeds. Financing activities used $410 million versus providing $2,820 million, primarily due to lower net borrowing. Capital spending was $150 million; refranchising proceeds were $321 million. Cash, cash equivalents and restricted cash totaled $1,056 million at June 30.
At June 30, cash and cash equivalents were $970 million, current assets $1,785 million, and current liabilities $1,478 million. Short-term borrowings were $375 million and long-term debt $9,474 million. YUM reported compliance with debt covenants and approximately $1.1 billion of undrawn revolving capacity. Interest expense, net, was $104 million in Q2 and $213 million YTD, up from $51 million and $93 million, respectively, mainly due to higher outstanding borrowings.
Material changes and unusual items
- Q2 net income fell to $206 million from $336 million; the prior-year quarter included $70 million of income from discontinued China operations. YTD 2016 included $208 million from discontinued operations.
- YTD operating profit benefited from $130 million of refranchising gains, compared with $54 million in 2016. YUM refranchised 365 restaurants YTD for $321 million in proceeds.
- Q2 special items included $19 million of refranchising gains, $12 million of Pizza Hut transformation costs, $16 million of non-cash share-based compensation charges and other transformation-related charges. YTD also included a $22 million non-cash pension adjustment. Special items and FX affect comparisons; management’s core operating profit measure excludes them.
- YTD income tax included $64 million of excess share-based compensation tax benefits following adoption of a new accounting standard. The Q2 effective tax rate was 33.8%, versus 27.0%, reflecting refranchising-related tax effects and other items described in the filing.
- YUM issued $750 million of 4.75% senior notes due 2027 and repriced term loans and its revolving facility, reducing applicable interest-rate margins by 75 basis points.
Outlook, management commentary and risks
- Management aims to increase franchised ownership to at least 98% by the end of 2018, own fewer than 1,000 stores by then, and reduce annual capital expenditures to about $100 million by 2019. It also targets reducing 2015 G&A by approximately $300 million cumulatively by 2019 and maintaining leverage of about 5.0x EBITDA.
- YUM intends to return $6.5–$7.0 billion to shareholders through repurchases and dividends in 2017–2019, supported by cash flow, refranchising proceeds and leverage. It anticipates more than $2 billion, net of tax, from refranchising over 2,000 stores during 2017–2018.
- YTD repurchases totaled $856 million and dividends paid were $211 million. YUM declared dividends of $0.30 per share in Q2. These are stated plans and targets, not guaranteed outcomes.
- YUM expects the new lease accounting standard, effective for the company in 2019, to materially increase reported assets and liabilities, but does not anticipate a significant income-statement or cash-flow effect. Revenue-standard adoption is required in 2018; possible effects on upfront franchise fees and advertising cooperative reporting remain under evaluation.
- Potential undiscounted lease-guarantee payments were approximately $550 million; the recorded probable liability was not material. Franchise-loan and other financing guarantee exposures were approximately $4 million and $8 million, respectively. The filing says other unresolved legal matters are not expected to have a material adverse effect; the disclosed Taco Bell wage-and-hour settlement was approved and paid.
- Management identified operating, legal, regulatory and product risks and cautioned that forward-looking statements are subject to uncertainty. No material changes to previously disclosed risk factors or market-risk disclosures were reported. Management concluded disclosure controls were effective; the interim financial statements received an independent accountant’s review, not an audit.
Important facts for investors to verify
- Whether continued refranchising and comparable-sales trends support the company’s growth and margin targets, especially at Pizza Hut.
- How much of reported operating-profit growth reflects recurring operations versus refranchising gains, transformation costs and other special items.
- Debt maturity, interest costs, leverage and liquidity capacity as shareholder distributions continue; also assess the effect of the planned store sales on cash generation.
- Progress against the stated franchise mix, capital spending, cost-reduction and shareholder-return targets.
- The eventual financial-statement effects of revenue and lease accounting changes, including potential contract liabilities and balance-sheet expansion.