YUM! Brands, Inc. — Q3 2017 Form 10-Q
Business and period. The filing covers the quarter and year to date ended September 30, 2017. YUM operated or franchised more than 44,000 KFC, Pizza Hut and Taco Bell restaurants in 137 countries and territories; 95% of restaurants were franchise-operated. The 2016 China business spin-off is presented as discontinued operations, making total net income comparisons less representative. YUM also changed to a calendar fiscal year in 2017 and removed certain international reporting lags; prior periods were retrospectively adjusted.
Financial performance
| Metric | Q3 2017 | Q3 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Total revenue | $1,436M | $1,518M | $4,301M | $4,470M |
| Operating profit | $643M | $398M | $1,546M | $1,162M |
| Income from continuing operations | $418M | $218M | $904M | $710M |
| Net income | $418M | $640M | $904M | $1,340M |
| Diluted EPS from continuing operations | $1.18 | $0.55 | $2.52 | $1.73 |
Q3 revenue fell 5%; company sales declined 12%, while franchise and license income rose 7%. YTD revenue fell 4%. Reported operating profit rose 61% in Q3 and 33% YTD, substantially reflecting refranchising gains. Excluding special items and foreign exchange, core operating profit increased 11% in Q3 and 13% YTD; diluted EPS from continuing operations excluding special items rose 22% and 20%, respectively. Reported operating margins were approximately 44.8% in Q3 versus 26.2% and 35.9% YTD versus 26.0%, lifted by refranchising gains.
Q3 system sales grew 6% excluding foreign exchange, same-store sales grew 3%, and net new unit growth was 3%. Division same-store sales growth was KFC 4%, Pizza Hut 1% and Taco Bell 3%. Q3 divisional operating profit was KFC $260M (up 14%), Pizza Hut $82M (down 1%) and Taco Bell $147M (up 3%). Worldwide company restaurant margin increased to 17.7% from 16.2%.
Cash, debt and liquidity
YTD operating cash flow from continuing operations was $718M, down from $936M; capital spending was $228M. Refranchising proceeds were $716M, contributing to $489M of net investing cash flow versus $127M used in the prior year. Financing used $1,029M, including $1,348M of share repurchases and $315M of dividends. Cash and cash equivalents were $980M at September 30; cash including restricted balances was $1,051M.
Total debt was approximately $9.9B before issuance costs and current maturities ($9.5B long-term and $372M short-term on the balance sheet), versus $9.2B gross at year-end 2016. Current assets were $2.0B and current liabilities $1.4B. Shareholders’ deficit was $6.1B. YUM reported compliance with debt covenants and approximately $1B of undrawn revolving capacity. Interest expense, net, rose to $109M for the quarter and $322M YTD.
Material changes, outlook and risks
- YUM refranchised 209 restaurants in Q3 for $395M gross proceeds and a $201M net pretax gain; YTD it refranchised 574 for $716M and a $331M gain. Approximately 520 KFC restaurants were classified as held for sale at quarter-end.
- Management expects additional significant refranchising in Q4 2017. It warned that refranchising-related lost operating profit may outpace G&A savings in Q4 and 2018. The lapping of 2016’s 53rd week and refranchising, net of G&A reductions, are expected to reduce Q4 2017 core operating profit growth by 10–12 percentage points; an additional $15M Pizza Hut media investment is expected to reduce growth by 3 points.
- Transformation targets include at least 98% franchise ownership by end-2018, approximately $100M annual capital spending by 2019, and $6.5–$7.0B of shareholder returns during 2017–2019. YUM expects more than $2B net of tax from refranchising over 2017–2018. These are targets, not guarantees.
- Q3 continuing-operations tax rate was 20.2% versus 27.5%, helped by approximately $40M of share-based payment tax benefits and tax benefits tied to an international refranchising transaction; repatriation and expected refranchising gains partly offset these effects. YTD rate was 23.5% versus 27.0%.
- A $51M noncash refranchising charge related to KFC Turkey included accumulated currency translation losses; a $25M Pizza Hut Korea refranchising loss also included translation losses. YTD pension expense included a $22M noncash prior-period data adjustment.
- Potential lease-guarantee payments were approximately $550M undiscounted ($470M present value), but the recorded probable exposure was not material. Franchise lending and other financing guarantee exposures were approximately $3M and $7M, respectively. Management said pending legal matters were not expected to have a material adverse effect.
- Revenue-recognition rules take effect in 2018; YUM said contract liabilities and assets for franchise fees and incentives could be significant, while advertising-cooperative presentation could materially change reported gross revenue and expenses without a significant net-income effect. The 2019 lease standard is expected to materially increase reported balance-sheet assets and liabilities.
Important facts for investors to verify
- How much of reported profit and EPS growth reflects refranchising gains versus underlying operations; compare GAAP results with core measures.
- Execution and timing of refranchising, planned G&A reductions, and the projected Q4 and 2018 earnings headwinds.
- Debt and interest burden, cash generation after refranchising proceeds, and the funding and sustainability of planned shareholder returns.
- Pizza Hut’s same-store sales and operating-profit trajectory, and the results of its U.S. transformation investment.
- Potential effects of new revenue and lease accounting standards and the final scope of restaurants held for sale.