Yum China Holdings, Inc. — 10-Q Summary
Reporting period: Quarter and year to date ended August 31, 2017; dollar amounts are in U.S. millions unless noted. Yum China operated 7,747 restaurants, primarily KFC and Pizza Hut, and had separated from Yum! Brands in October 2016. The prior-year comparison includes combined pre-separation results and certain costs allocated by Yum! Brands, which may not reflect standalone costs.
Financial performance
| Metric | Quarter 2017 | Quarter 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Total revenue | $2,038 | $1,883 | $4,916 | $4,774 |
| Operating profit | $317 | $286 | $714 | $582 |
| Net income attributable to Yum China | $211 | $192 | $493 | $414 |
| Diluted EPS | $0.53 | $0.53 | $1.24 | $1.14 |
| Restaurant margin | 20.0% | 19.2% | 19.3% | 17.0% |
- Quarterly revenue and operating profit rose 8% and 11%, respectively; attributable net income rose 9%. YTD revenue rose 3%, operating profit 23%, and attributable net income 19%.
- Quarterly diluted EPS was unchanged despite higher earnings, with weighted-average diluted shares increasing to 398.5 million from 363.8 million. YTD diluted EPS increased 9%.
- System sales grew 10% in the quarter and 7% YTD excluding foreign exchange; same-store sales grew 6% and 4%, respectively. Restaurant count increased 6% year over year.
- KFC quarterly operating profit increased 20% and YTD profit increased 20%. Pizza Hut quarterly operating profit was $80 million versus $82 million; YTD profit increased to $177 million from $132 million. All Other Segments reported an $8 million operating loss in both YTD periods shown for 2017 and 2016, respectively, versus losses of $6 million and $8 million as presented in the filing.
- Effective tax rates increased to 31.7% for the quarter and 29.3% YTD, from 29.8% and 28.0%. Management attributed the increase primarily to higher costs of repatriating current-year earnings to the U.S.
Cash flow, balance sheet and capital
- YTD operating cash flow was $987 million, versus $824 million. Investing used $294 million, including $262 million of capital spending and the Daojia acquisition; financing used $142 million, including $128 million of share repurchases. Ending cash was $1,477 million, up from $885 million at year-end 2016.
- At August 31, cash and short-term investments totaled $1,568 million; current assets were $2,054 million and current liabilities $1,212 million. Total liabilities were $1,514 million. Capital lease obligations were $28 million; no borrowings were outstanding under the company’s approximately $350 million credit facilities, which were fully available.
- YTD capital spending was $262 million. The company repurchased 3.36 million shares for $128 million under its $300 million authorization; on October 4, 2017, the Board increased the authorization to $550 million.
- On October 4, the Board also approved a quarterly dividend program and declared an initial dividend of $0.10 per share, payable December 21, 2017 to holders of record November 30. Future dividends remain subject to Board approval.
Outlook, commentary and risks
- Management said existing cash and expected operating cash flow should fund operations and anticipated capital expenditures for the next 12 months. The filing provides no numerical earnings or revenue guidance.
- Management cited same-store and unit growth as profit drivers, partly offset by wage, commodity and promotion costs. YTD restaurant profitability also benefited from China’s retail tax/VAT reform; management cautioned that the benefit may fluctuate as implementation and interpretation evolve.
- Operating lease commitments were approximately $3 billion, with terms expiring within 20 years. The company expects the new lease accounting standard to materially affect its financial statements, primarily through recognition of operating lease assets and liabilities.
- A potential Chinese indirect-transfer tax related to the separation remains uncertain. The tax could be 10% of the difference between fair market value and YUM’s tax basis, and a settlement under the tax matters agreement could be significant and materially adversely affect Yum China. No contingent payment liability was considered probable or estimable.
- Yum China reported approximately $2 million of maximum guarantees for franchisee loans. It said outstanding legal matters were not expected to have a material adverse effect. The filing reported no material changes to the risk factors in the 2016 Form 10-K.
- Most assets and operating results are RMB-denominated, and the company does not hedge currency earnings. Management estimated a 10% RMB weakening would reduce quarterly operating profit by approximately $29 million, assuming no changes in sales or local prices.
- Daojia, acquired during the quarter ended May 31, 2017, became an operating segment. The filing identifies risks around integration, expected synergies and the PRC regulatory treatment of its variable-interest-entity structure.
- Quarter special items included $3 million of income from reversing contingent consideration; YTD impairment charges were $20 million, compared with $36 million in the prior-year period. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether KFC same-store sales momentum and Pizza Hut profitability persist, and whether wage, commodity and promotional pressures affect margins.
- How much of reported growth and earnings improvement reflects operating performance versus currency movements, tax reform, and other nonrecurring items.
- The potential exposure, allocation and timing of any Chinese indirect-transfer tax associated with the separation.
- The expected balance-sheet impact of approximately $3 billion in operating lease commitments and the related accounting-standard adoption.
- Daojia’s integration, contribution to results and regulatory status; and the company’s ability to fund growth, repurchases and dividends while managing China-specific cash-transfer and tax constraints.