YUM BRANDS INC quarterly report, Q3 FY2018

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YUM! Brands, Inc. — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018. YUM operates KFC, Pizza Hut and Taco Bell, with more than 45,000 restaurants in over 140 countries; approximately 97% of restaurants were franchise-operated.

Financial performance

  • Q3 revenue: $1.391 billion, down 3% year over year. Company sales fell 43% to $499 million, primarily reflecting refranchising. Franchise and property revenue rose 7% to $605 million. Newly presented advertising and other franchise contributions added $287 million, with corresponding expense; this gross presentation under Topic 606 makes reported revenue less directly comparable with 2017.
  • Q3 earnings: Operating profit was $553 million, down 14%; net income was $454 million, up 9%. Diluted EPS increased 18% to $1.40, while EPS excluding special items increased 52% to $1.04. The quarter included $94 million of pre-tax Grubhub investment income and $100 million of refranchising gains.
  • Nine-month results: Revenue was $4.130 billion, down 4%; operating profit was $1.555 billion, up 1%; net income was $1.208 billion, up 34%; diluted EPS was $3.64, up 44%. EPS excluding special items increased 37% to $2.75. Grubhub investment income was $185 million and refranchising gains were $285 million.
  • Sales and margins: Worldwide system sales grew 5% excluding foreign exchange in both Q3 and year to date; same-store sales grew 2% in each period. Q3 company restaurant margin was 20.1%, versus 17.7% a year earlier; nine-month margin was 17.4%, versus 17.1%. Refranchising materially reduced company-operated sales and restaurant profit.
  • Cash flow: Nine-month operating cash flow was $796 million, versus $718 million. Investing cash flow was $89 million, including $445 million of refranchising proceeds and the $200 million Grubhub investment. Financing used $2.161 billion, including $1.684 billion of share repurchases and $349 million of dividends. Cash, cash equivalents and restricted cash ended at $337 million; cash and cash equivalents alone were $198 million.
  • Debt and liquidity: Long-term debt was $9.405 billion and short-term borrowings were $295 million. The company had $273 million outstanding on its $1 billion revolving facility. Current assets of $1.169 billion were slightly below current liabilities of $1.194 billion; management said working-capital deficits are customary for the business and do not significantly affect liquidity.

Material changes and drivers

  • Refranchising and unit growth continued the shift toward a more franchise-heavy model. YUM refranchised 134 restaurants in Q3 and 329 year to date; total units grew 4% year over year to 45,976.
  • Q3 system sales grew 8% at Taco Bell, 7% at KFC and were flat at Pizza Hut, excluding FX. Same-store sales were +5%, +3% and -1%, respectively. Taco Bell operating profit rose 10% in Q3; KFC fell 5%; Pizza Hut rose 7%.
  • Adoption of Topic 606 changed the timing of upfront franchise fees and franchise incentives and required gross presentation of advertising cooperative receipts and expenses. Management said adoption reduced Q3 Core Operating Profit by $4 million and increased nine-month Core Operating Profit by $13 million versus legacy accounting; it expects a 2–3 percentage-point headwind to 2018 Core Operating Profit growth.
  • Lower effective tax rates—15.1% for Q3 and 13.7% year to date, versus 20.2% and 23.5%—reflected the lower U.S. federal tax rate and provisional Tax Act benefits, among other factors. Tax Act amounts remained provisional at quarter-end.

Outlook, commentary and risks

  • Management did not expect overall 2018 Core Operating Profit to increase. It expected the net refranchising drag to be slightly below the low end of its prior 6–7 percentage-point estimate, but anticipated that reduced Pizza Hut contribution—particularly internationally—would offset that improvement.
  • Management expected the 2018 impact of U.K. KFC supply disruptions to reduce full-year KFC same-store sales growth by 50 basis points and YUM growth by 25 basis points, and to reduce Core Operating Profit growth by 2 percentage points for KFC and 1 point for YUM.
  • Strategic targets included at least 98% franchise ownership by the end of 2018; approximately $100 million of annual capital expenditures and G&A of 1.7% of system sales by 2019; and returning $6.5–$7.0 billion to shareholders from 2017 through 2019. YUM had repurchased $1.7 billion of shares and paid $349 million in dividends year to date.
  • After quarter-end, YUM announced an intended $1.2 billion securitization refinancing. The filing cautions that timing, pricing and completion were not assured. The company also expected 2019 lease-accounting adoption to materially increase reported assets and liabilities, without a significant income-statement or cash-flow impact.
  • Contingencies include approximately $600 million of undiscounted potential lease-guarantee payments ($500 million present value); management reported no material recorded liability for probable exposure and believes franchisee cross-default provisions reduce risk. Other pending legal matters were not expected to have a material adverse effect. The Ameranth litigation was settled before trial at an immaterial cost.

Important facts for investors to verify

  • Separate operating trends from refranchising effects and Topic 606’s gross-presentation and timing changes when comparing revenue and margins with 2017.
  • Assess earnings quality excluding the $94 million Q3 and $185 million year-to-date Grubhub fair-value gains, as well as refranchising gains and tax-related special items.
  • Track the stated 2018 Core Operating Profit outlook, Pizza Hut performance and the lasting effects of U.K. supply disruptions.
  • Monitor cash generation against substantial debt, shareholder returns and the company’s stated leverage and refranchising plans; verify completion and terms of the announced refinancing.
  • Review the final Tax Act accounting and the balance-sheet impact of 2019 lease-standard adoption. The interim financial statements were reviewed by KPMG, not audited; the review identified no material modifications needed for GAAP conformity.