YUM! Brands, Inc. — Q3 2015 Form 10-Q
Business context and period: The filing covers the 12-week quarter ended September 5, 2015, and year-to-date results compared with the periods ended September 6, 2014. YUM operated, franchised or licensed more than 41,000 KFC, Pizza Hut and Taco Bell restaurants in over 125 countries and territories; 79% of units were operated by franchisees, licensees or unconsolidated affiliates.
Financial performance
- Quarter: Revenue was $3.427 billion, up 2%; operating profit was $603 million, up 10%; net income attributable to YUM was $421 million, up 4%; and diluted GAAP EPS was $0.95 versus $0.89. Diluted EPS before Special Items was $1.00 versus $0.87.
- Year to date: Revenue was $9.154 billion, down 1%; operating profit was $1.480 billion, down 7%; net income attributable to YUM was $1.018 billion, down 10%; diluted GAAP EPS was $2.29 versus $2.50. EPS before Special Items was $2.50 versus $2.48.
- Restaurant economics: Worldwide company restaurant profit was $539 million in the quarter, up 25%, and $1.332 billion year to date, up 3%. Restaurant margin was 18.2% versus 14.9% in the quarter and 17.1% versus 16.3% year to date. The company-wide figures include the effect of China’s strong quarterly margin recovery.
- Cash flow: Year-to-date operating cash flow was $1.817 billion, compared with $1.612 billion. Capital spending was $642 million. Investing activities used $522 million and financing activities used $1.019 billion. Cash rose to $861 million from $578 million at fiscal year-end.
- Debt and liquidity: At September 5, short-term borrowings were $566 million and long-term debt was $2.651 billion, totaling $3.217 billion. Current assets were $1.919 billion and current liabilities $2.642 billion. The $1.3 billion revolving credit facility had $995 million unused, net of letters of credit and $300 million of borrowings; the company reported covenant compliance with considerable cushion.
- Other metrics: The reported effective tax rate was 25.3% for the quarter and 25.9% year to date. YUM paid $532 million in dividends and repurchased $370 million of shares year to date.
Material changes and segment trends
- China: Quarterly same-store sales rose 2% (KFC +3%, Pizza Hut Casual Dining −1%) as YUM lapped the prior-year supplier food-handling incident. China operating profit rose 64% excluding foreign exchange for the quarter, but was down 1% year to date excluding foreign exchange; year-to-date same-store sales were down 6%.
- KFC: Same-store sales rose 3% in both the quarter and year to date. Operating profit increased 3% excluding foreign exchange in the quarter and 8% year to date on that basis.
- Pizza Hut: Same-store sales increased 1% in the quarter but were flat year to date. Operating profit was flat excluding foreign exchange in the quarter and down 1% year to date.
- Taco Bell: Same-store sales increased 4% in the quarter and 5% year to date; operating profit rose 6% and 22%, respectively, excluding foreign exchange.
- India: Same-store sales declined 18% in the quarter and 14% year to date; the division reported operating losses of $8 million and $15 million, respectively.
- Foreign exchange reduced reported operating profit by $29 million in the quarter and $70 million year to date. YUM’s year-to-date reported results also include $99 million of net Special Item expense, principally refranchising-related losses and costs under the KFC U.S. agreement.
Outlook, commentary and notable items
- Management revised its full-year 2015 EPS outlook before Special Items to approximately flat to low-single-digit growth, down from its earlier expectation of at least 10% growth. The change reflected weaker-than-expected China trends and an additional 1–2 percentage points of foreign-exchange headwind.
- Management estimated fourth-quarter China same-store sales growth of 0%–4%, with positive KFC and negative Pizza Hut Casual Dining sales; full-year China same-store sales were expected to be low-single-digit negative and China operating profit approximately flat year over year excluding foreign exchange. Management cited material volatility in China sales.
- The KFC U.S. Acceleration Agreement entails approximately $125 million of investment over three years, primarily for franchisee equipment and remodel incentives. YUM recorded $31 million year to date, expected approximately $80 million of charges in 2015, with the balance in 2016–2017; it also committed $60 million to incremental system advertising over the period.
- YUM sold Mexico real estate for approximately $58 million on September 28, after quarter-end. It had recorded $80 million of year-to-date refranchising losses associated with the planned sale, including accumulated currency translation losses.
- Contingencies include lease guarantees with approximately $600 million of potential undiscounted payments (present value approximately $500 million); the recorded probable exposure was not material. Taco Bell wage-and-hour litigation remains ongoing; the company had accrued an estimated loss but could not estimate potential losses beyond the amount provided. Other legal matters were not expected to have a material adverse effect, according to management.
- The interim statements were reviewed, not audited. Management reported effective disclosure controls and no material changes to internal control during the quarter.
Important facts for investors to verify
- Whether China sales trends and the revised full-year EPS outlook developed as management projected; YUM planned monthly China same-store sales reporting beginning in October.
- How much of the gap between GAAP and pre-Special-Item EPS is recurring versus unusual, including the final costs and outcomes of the Mexico sale and KFC U.S. investment program.
- Whether cash generation, debt levels, the 2017 revolving facility maturity, dividends and repurchases remain supportable under the company’s operating outlook.
- Updates to Taco Bell wage-and-hour litigation, lease guarantees and other contingencies, including any change in accrued exposure.