YUM! Brands, Inc. — Q1 2017 Form 10-Q
Business context and period. The filing covers the quarter ended March 31, 2017. YUM operates and franchises KFC, Pizza Hut and Taco Bell, with 43,818 restaurants in 136 countries and territories; 94% were franchised. Results are from continuing operations unless noted. YUM China was spun off in October 2016, and its prior-period results are presented as discontinued operations. The company changed to a calendar-year reporting period and removed certain international reporting lags; comparative figures were retrospectively adjusted.
Financial results and key metrics
| Metric (USD millions, except per-share data) | Q1 2017 | Q1 2016, restated |
|---|---|---|
| Total revenue | $1,417 | $1,443 |
| Operating profit | $484 | $349 |
| Income from continuing operations | $280 | $226 |
| Net income | $280 | $364 |
| Diluted EPS, continuing operations | $0.77 | $0.54 |
| Diluted EPS, total | $0.77 | $0.87 |
| Operating cash flow, continuing operations | $288 | $309 |
- Revenue fell 2%; company sales declined 5% to $902 million, while franchise and license fees rose 5% to $515 million. Restaurant profit was $144 million versus $148 million; restaurant margin increased to 16.0% from 15.5%.
- Reported operating profit rose 39%, including a $111 million refranchising gain. Core operating profit, excluding special items and foreign-exchange effects, increased 9% to $390 million. Diluted EPS from continuing operations excluding special items was $0.65, up 17%.
- Continuing-operations income increased 24%, but total net income declined 23%, largely because Q1 2016 included $138 million of income from the China business, which is now discontinued.
- Interest expense rose to $109 million from $42 million, reflecting higher borrowings. The effective tax rate was 19.4%, versus 26.6%; Q1 2017 included a $49 million tax benefit from share-based compensation accounting adoption.
- Operating cash flow was $288 million; investing activities provided $104 million, including $185 million of refranchising proceeds, while capital spending was $76 million. Financing activities used $629 million, including $461 million of share repurchases and $106 million of dividends.
- At March 31, cash and cash equivalents were $525 million ($611 million including restricted cash). Current assets were $1.277 billion and current liabilities $1.558 billion. Short-term borrowings were $393 million and long-term debt $8.715 billion; shareholders’ deficit was $5.812 billion.
Material changes and segment performance
- Worldwide system sales grew 5% excluding foreign exchange; same-store sales rose 2%, and unit count increased 3% year over year.
- KFC: system sales grew 5% excluding FX, same-store sales rose 2%, and operating profit increased 12% to $207 million. Growth and lower G&A were partly offset by higher restaurant costs and refranchising.
- Pizza Hut: system sales were flat excluding FX, same-store sales fell 3%, and operating profit declined 9% to $83 million. The filing cites weaker same-store sales and increased discretionary advertising expense, partly offset by lower G&A.
- Taco Bell: system sales grew 12%, same-store sales rose 8%, and operating profit increased 19% to $141 million, supported by sales growth and lower G&A.
- YUM refranchised 121 restaurants, recording $111 million of net pretax gains and receiving $185 million in proceeds. The gain was primarily associated with Taco Bell.
Outlook, management commentary and risks
- YUM intends to reach at least 98% franchise ownership by the end of 2018 and own fewer than 1,000 stores by then. It expects more than $2 billion, net of tax, in refranchising proceeds during 2017–2018.
- For 2017–2019, the company plans to return $6.5–$7.0 billion to shareholders through repurchases and dividends, funded by free cash flow, refranchising proceeds and maintaining leverage near 5.0x EBITDA. Other targets include reducing annual capital expenditures to about $100 million by 2019, reducing G&A by approximately $300 million cumulatively from 2015 through 2019, and improving free-cash-flow conversion to 100%.
- On May 1, 2017, after quarter-end, YUM reached a Pizza Hut U.S. franchisee agreement. It anticipates about $90 million of equipment, technology and digital investments, mainly in 2017–2018, plus incremental advertising funding of approximately $25 million in 2017 and $12.5 million in 2018.
- Q1 unusual items included a $22 million noncash, out-of-year pension charge, a $111 million refranchising gain, and $7 million of strategic-transformation costs. The KFC U.S. acceleration program generated $3 million of charges; YUM expects about $20 million in related investment charges in 2017 and further advertising funding under that program.
- YUM reported compliance with debt covenants and $1 billion of undrawn revolving-credit capacity. It also disclosed a working-capital deficit, dependence on operating cash flows and refranchising proceeds, and potential higher tax costs if foreign earnings need to be repatriated.
- Contingencies include approximately $550 million of undiscounted potential lease-guarantee payments (present value approximately $465 million); the company said recorded probable exposure was not material. A Taco Bell wage-and-hour case had a proposed settlement in principle, with the accrued amount undisclosed here; related expected cash payments were not expected to be material. Management said other proceedings were not expected to have a material adverse effect.
- The company is evaluating forthcoming revenue-recognition and lease-accounting standards. It expects lease adoption to materially increase balance-sheet assets and liabilities, while anticipating no significant income-statement or cash-flow impact.
Investor verification points
- Assess underlying earnings against reported results: the $111 million refranchising gain, pension charge, and $49 million share-based-compensation tax benefit materially affect comparisons.
- Monitor leverage, interest expense, maturities, liquidity and the funding of planned shareholder returns, including progress toward the 5.0x EBITDA leverage objective.
- Track refranchising execution and proceeds, franchise ownership targets, and the impact of a smaller company-operated restaurant base on revenue and cash generation.
- Review Pizza Hut’s same-store sales and the costs and results of its post-quarter transformation agreement; also monitor KFC and Taco Bell sales momentum.
- Confirm final resolution and payment terms for the Taco Bell settlement, and monitor lease guarantees and other contingencies.