Business context and reporting period
Yum! Brands, Inc. operates and franchises KFC, Pizza Hut and Taco Bell worldwide. This unaudited Form 10-Q covers the 12 weeks ended March 19, 2016; comparisons are with the quarter ended March 21, 2015. The company reported four segments: China, KFC outside China, Pizza Hut outside China and Taco Bell. India operations were integrated into the brand divisions in January 2016, with prior segment data restated.
Financial performance
Amounts are in millions of dollars except per-share data. Changes below are year over year unless stated otherwise.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $2,619 | $2,622 | Flat |
| Operating profit | $564 | $506 | +12% |
| Operating margin | 21.5% | 19.3% | +2.2 percentage points |
| Net income attributable to Yum | $391 | $362 | +8% |
| Diluted EPS, reported | $0.93 | $0.81 | +14% |
| Diluted EPS before special items | $0.95 | $0.80 | +19% |
| Operating cash flow | $659 | $516 | +$143 |
| Capital spending | $160 | $227 | -$67 |
Company restaurant sales were $2,165 million, down 1%, while franchise and license fees and income rose 3% to $454 million. Restaurant profit increased 13% to $433 million; company restaurant margin rose to 20.0% from 17.5%. The effective tax rate was 25.0%, compared with 23.4%. Foreign currency translation reduced reported operating profit by $28 million, including $13 million in China.
Segments
- China: Revenue $1,303 million (+4% reported; +9% excluding FX); operating profit $256 million (+35% reported; +42% excluding FX). Same-store sales rose 6%, including 12% at KFC.
- KFC Division: Revenue $625 million (-5% reported; +3% excluding FX); operating profit $160 million (-4% reported; +4% excluding FX). Same-store sales rose 1%.
- Pizza Hut Division: Revenue $265 million (-3% reported; flat excluding FX); operating profit $87 million (+7% reported; +9% excluding FX). Same-store sales rose 3%.
- Taco Bell Division: Revenue $426 million (-1% reported and excluding FX); operating profit $119 million (+4%). Same-store sales rose 1%.
Liquidity, debt and capital returns
Cash and cash equivalents were $934 million at March 19, 2016, up from $737 million at year-end. Current assets were $1,963 million and current liabilities $4,648 million. Short-term borrowings were $2,321 million and long-term debt $2,510 million. The company drew the full $2.0 billion Bridge Facility; it also had $177 million outstanding under its revolving credit facility and $1.1 billion of unused capacity there. Management said it complied with debt covenants with considerable cushion. Operating, investing and financing cash flows were +$659 million, -$201 million and -$243 million, respectively. The company repurchased $925 million of shares and paid $192 million in dividends during the quarter; it declared a $0.46-per-share dividend payable in May.
Material changes, outlook and commentary
Management raised its 2016 core operating profit growth expectation from 10% to 12%, citing strong first-quarter results, particularly KFC China, and an expected benefit from China’s retail tax reform. It maintained its China full-year same-store sales growth expectation at 2%-3%. Segment 2016 targets disclosed in the filing included China same-store sales growth of 2%-3% and at least 425 net new units; KFC 3% same-store sales growth and at least 475 net new international units; Pizza Hut 3% and at least 325 net new international units; and Taco Bell 3% and at least 225 net new units. The overall target included 10% core operating profit growth before the later increase to 12%.
Yum planned to spin off its China business as a publicly traded company before year-end 2016, subject to board, regulatory, tax and other conditions; completion and timing were not assured. It targeted 96% franchisee ownership of restaurants by the end of 2017 and intended to return up to $6.2 billion to shareholders before the separation, largely funded with incremental borrowing. Management described a transition toward non-investment-grade credit and targeted company-wide leverage of approximately 5.0x EBITDA. A proposed Taco Bell royalty securitization of at least $2.0 billion and further secured borrowing/high-yield notes were expected in Q2, subject to market and other conditions. China’s new VAT structure was scheduled to take effect May 1, 2016; the company expected a positive benefit but said the impact was difficult to estimate before implementation.
Unusual items, risks and contingencies
- Special items reduced Q1 2016 reported EPS by $0.02: $9 million of China spin-off/recapitalization costs and $9 million of KFC U.S. acceleration costs, partly offset by refranchising gains. Special items totaled a $15 million pre-tax expense.
- The KFC U.S. franchisee agreement is expected to require approximately $125 million of investment from 2015-2017. The company expected about $30 million of related charges and $20 million of incremental system advertising in 2016.
- Potential undiscounted lease-guarantee payments were approximately $575 million; the recorded liability for probable exposure was not material. The company also guaranteed $21 million of franchisee financing.
- In a Taco Bell California wage-and-hour class action, a jury awarded plaintiffs approximately $0.5 million on one claim and the court awarded approximately $0.3 million in prejudgment interest. Taco Bell planned a post-trial motion; the company noted possible losses could exceed recorded provisions. Another related case was dismissed with prejudice, but an appeal remained pending.
- Foreign exchange, labor and commodity costs, China operating performance, execution and conditions for the planned spin-off and debt transactions are relevant uncertainties. The filing reported no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether the China spin-off and planned financing transactions close on the stated timetable and terms, and how the separation affects earnings, leverage and cash flows.
- Whether the raised 12% core operating profit growth outlook is achieved, including the assumed benefit of China’s VAT reform and continuing China sales trends.
- The company’s debt and liquidity position after recapitalization, including refinancing needs, leverage and credit-rating implications.
- Progress toward the 96% franchisee-ownership target and the associated effects on revenue mix, margins and capital spending.
- Developments in the Taco Bell litigation, including the post-trial motion and appeal, and any change to estimated exposure.