YUM! Brands, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter ended June 11, 2016; year-to-date figures cover the first 24 weeks of fiscal 2016. Amounts are in U.S. dollars unless noted. The interim statements are unaudited; KPMG performed a review, not an audit.
Business context and results
YUM operated, franchised or licensed nearly 43,000 KFC, Pizza Hut and Taco Bell restaurants in more than 130 countries. About 79% of locations were operated by franchisees, licensees or unconsolidated affiliates. Management was preparing to spin off YUM China as a separate public company, targeted around October 31, 2016, subject to approvals and other conditions.
| Metric | Q2 2016 | Q2 2015 | Year to date 2016 | Year to date 2015 |
|---|---|---|---|---|
| Total revenue | $3,008m | $3,105m | $5,627m | $5,727m |
| Operating profit | $491m | $371m | $1,055m | $877m |
| Net income attributable to YUM | $339m | $235m | $730m | $597m |
| Diluted EPS | $0.81 | $0.53 | $1.74 | $1.34 |
| Diluted EPS before special items | $0.75 | $0.69 | $1.71 | $1.50 |
| Operating margin | 16.3% | 12.0% | 18.8% | 15.3% |
Quarterly revenue fell 3% and year-to-date revenue fell 2%; system sales excluding foreign exchange grew 3% and 4%, respectively. Operating profit growth reflected refranchising gains versus a prior-year loss, among other factors. Core operating profit, which excludes special items and foreign exchange, was $478m for the quarter versus $449m and $1,085m year to date versus $950m.
Q2 restaurant profit was $408m, with a 16.0% restaurant margin versus 15.5% a year earlier; year-to-date restaurant profit was $841m and margin was 17.8% versus 16.4%. Segment operating profit for the quarter was China $147m, KFC $149m, Pizza Hut $64m and Taco Bell $139m. China’s year-to-date operating profit rose to $403m from $334m; KFC’s fell to $309m from $315m.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $896m, compared with $947m. Investing used $288m and financing used $538m. Capital spending was $343m; the resulting operating cash flow less capital spending was $553m.
- Cash and cash equivalents were $795m at June 11, 2016, up from $737m at December 26, 2015. Current assets were $1,879m against current liabilities of $2,279m, a $400m working-capital deficit; management said such deficits are common for YUM and not expected to significantly affect liquidity or operations.
- At quarter-end, short-term borrowings were $39m and long-term debt was $5,324m. Debt increased substantially with issuance of $2.3bn in Taco Bell securitization notes. Shareholders’ equity was a deficit of $331m, compared with positive equity of $969m at year-end.
- On June 16, after quarter-end, subsidiaries issued $2.1bn of senior unsecured notes and entered into term-loan facilities totaling $2.5bn plus a $1.0bn revolving facility, undrawn at closing. Proceeds repaid $738m outstanding on the previous revolving facility; the balance was intended for shareholder returns and general purposes. YUM reported approximately $9.2bn of total indebtedness as of the filing date and expected annualized interest expense of $425m–$440m.
- YUM paid $379m in dividends year to date and repurchased 22.3m shares for $1.664bn during the period. The board authorized up to $4.2bn of repurchases through December 2016 under a new authorization.
Material changes, outlook and notable items
- Management raised its 2016 core operating profit growth forecast to at least 14%, from the original 10% target. This assumes China remains part of YUM through year-end and includes a 53rd week for certain businesses. No full-year GAAP operating-profit growth guidance was given because refranchising gains and losses are difficult to forecast.
- China restaurant-margin guidance increased to at least 17%, from 16%. Management cited strong KFC sales and margins and China’s May 1 retail tax reform, partly offset by expected commodity inflation and higher labor costs. China remodel plans rose to nearly 800 in 2016, while unit-opening forecasts were reduced by about 50–100.
- The planned China separation and related recapitalization were expected to return $6.2bn of capital to shareholders, primarily funded by additional borrowing. Management anticipated post-spin company-wide leverage of approximately five times EBITDA and described YUM as having moved to a non-investment-grade credit rating. Completion and timing of the spin-off were not assured.
- Special items included a $53m Q2 refranchising gain versus a $68m prior-year loss; year-to-date refranchising gain was $60m versus a $58m loss. Restaurant-level impairment charges were $35m for the quarter versus $17m. China spin-off and recapitalization costs were $10m in the quarter and $19m year to date; approximately $30m of additional cash costs were expected to complete the transaction, plus an unquantified potential non-cash share-award charge.
- Debt covenants were reported in compliance at June 11. The securitization is backed by specified U.S. Taco Bell franchise-related assets and royalties, with cash-trapping and rapid-amortization triggers. The company identified higher leverage, refinancing, interest-rate, covenant and liquidity risks.
- Legal matters included a Taco Bell wage-and-hour class case with a roughly $0.5m jury award plus about $0.3m prejudgment interest; Taco Bell disputed liability and filed a post-trial motion, with appeals possible. The filing said an estimate of loss in a separate California employee case could not be made; other proceedings were not expected to have a material adverse effect.
Key facts for investors to verify
- Progress, approvals, final terms and completion timing of the planned YUM China spin-off, and how the separation affects reported results and guidance.
- Post-quarter debt balances, use of financing proceeds, actual interest expense, leverage and compliance with credit-agreement and securitization tests.
- Whether China’s tax reform benefit and operating trends support the raised profit and margin outlook, given wage and commodity inflation and reduced unit-opening plans.
- Cash generation after capital spending and shareholder distributions, including the pace and funding of further repurchases or any special dividend.
- Developments in the Taco Bell litigation and the ultimate amount, if any, of additional legal or spin-off-related costs.