YUM! Brands, Inc. — Form 10-Q Summary
Reporting period: Quarter and year to date ended September 3, 2016, compared with September 5, 2015; balance sheet compared with December 26, 2015. YUM operates KFC, Pizza Hut and Taco Bell and reported China, KFC, Pizza Hut and Taco Bell as its four segments. Financial amounts below are in U.S. dollars unless noted.
Financial performance
| Metric | Quarter | Year to date |
|---|---|---|
| Total revenue | $3.316 billion, down 3% | $8.943 billion, down 2% |
| Operating profit | $654 million, up 8% | $1.709 billion, up 15% |
| Net income attributable to YUM | $622 million, versus $421 million | $1.352 billion, versus $1.018 billion |
| Diluted EPS | $1.56, up 64%; $1.09 excluding special items, up 9% | $3.28, up 43%; $2.79 excluding special items, up 12% |
| Operating margin | 19.7%, versus 17.6% | 19.1%, versus 16.2% |
| Restaurant margin | 20.0%, versus 18.2% | 18.7%, versus 17.1% |
| Operating cash flow | Not presented separately | $1.542 billion, versus $1.817 billion |
Company sales declined 4% for the quarter and 3% year to date, while franchise and license fees and income rose 4% and 3%, respectively. Reported system sales grew 1% in both periods; excluding foreign currency effects, growth was 4% in both. Foreign currency translation reduced operating profit by $34 million for the quarter and $78 million year to date.
Segment operating profit increased year to date in China (14%), KFC (2%), Pizza Hut (3%) and Taco Bell (4%). For the quarter, China grew 7%, KFC 11% and Taco Bell 9%; Pizza Hut declined 6%.
Balance sheet, debt and liquidity
- At September 3, cash and cash equivalents were $2.885 billion; current assets were $4.003 billion and current liabilities were $2.299 billion.
- Short-term borrowings were $48 million and long-term debt was $9.119 billion, versus $922 million and $3.041 billion, respectively, at year-end 2015. YUM reported shareholders’ deficit of $1.830 billion, compared with equity of $969 million at year-end.
- YUM issued $6.9 billion of debt year to date and repurchased $3.8 billion of shares. Management said the recapitalization was complete and anticipated company-wide leverage of about 5 times EBITDA after the China separation. The company was in compliance with debt covenants at quarter-end.
- Investing cash use was $346 million, including $546 million of capital spending and $165 million of refranchising proceeds. Financing cash provided was $983 million; cash increased by $2.148 billion to $2.885 billion.
Outlook, material developments and risks
- Guidance: YUM raised its 2016 core operating profit growth forecast to at least 15%, from 10%. China’s 2016 restaurant margin was expected to be at least 17%. These are management forecasts, not guarantees.
- China spin-off: The board approved a distribution of one YUM China share per YUM share, with a planned completion after October 31, 2016, subject to regulatory, tax and other conditions. YUM expected to reclassify China-related historical results as discontinued operations after the separation.
- Transformation: Management targeted at least 98% franchised restaurants by the end of 2018, annual capital spending of about $100 million in 2019, lower G&A over three years and leverage of about 5 times EBITDA. It expected about $50 million of additional transformation costs in fourth-quarter 2016.
- Tax and unusual items: A $233 million tax benefit related to previously recorded Little Sheep losses drove the quarter’s negative 11.6% GAAP effective tax rate; the benefit was enabled by legal-entity restructuring and is expected to yield cash tax savings as future U.S. refranchising gains are recognized. The China VAT reform supported restaurant margins, with management estimating at least a two-percentage-point ongoing benefit, though input-credit collection and interpretation remained uncertain.
- China trading risk: YUM estimated South China Sea-related protests and boycotts reduced China same-store sales by 400–500 basis points in the quarter. China same-store sales were down 1% for the quarter, while year-to-date growth was 1%.
- Costs and contingencies: The company expected full-year 2016 interest expense of about $300 million and annualized interest expense of about $430 million at existing debt levels and rates. A pension payout program could produce a fourth-quarter non-cash settlement charge of $30–$50 million. Potential payments under lease guarantees were about $525 million undiscounted; the recorded probable exposure was not material. Taco Bell wage-and-hour litigation resulted in a plaintiffs’ award, and appeals were pending; YUM had accrued a reasonable loss estimate but warned losses could exceed the amount provided.
- Cash flow and leverage: Year-to-date operating cash flow fell $275 million, which management attributed largely to higher tax payments and restricted cash associated with securitization. Increased borrowing materially raised interest expense and leverage.
Investor verification points
- Track completion and final terms of the China spin-off, including tax opinions, approvals, allocation of debt and the post-spin financial statements.
- Separate recurring earnings from the Little Sheep tax benefit, refranchising gains and other special items; reconcile GAAP and adjusted EPS.
- Monitor debt maturities, variable-rate exposure, covenant headroom and whether the targeted leverage is achieved after the separation.
- Assess whether China’s VAT-related margin benefit persists and whether sales recover from the reported protests, labor inflation and commodity pressures.
- Verify delivery of the 2016 profit forecast and transformation targets, including refranchising progress, restructuring costs and capital spending reductions.