YUM! Brands, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; the filing also reports fourth-quarter results. Financial amounts are in U.S. dollars unless noted. Comparisons are with 2016, whose results were affected by a 53rd week. China operations were spun off in October 2016 and are reported as discontinued operations for periods before the separation.
Business context
YUM operates and franchises KFC, Pizza Hut and Taco Bell, with 45,084 restaurants in more than 135 countries and territories at year-end. Approximately 97% of units were franchised. Yum China is now a separate company and YUM’s largest franchisee; it pays a 3% license fee on system sales in mainland China.
Financial performance
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $5.878 billion | $6.356 billion |
| Operating profit | $2.761 billion | $1.682 billion |
| Income from continuing operations | $1.340 billion | $1.018 billion |
| Net income | $1.340 billion | $1.643 billion |
| Diluted EPS, continuing operations | $3.77 | $2.54 |
| Diluted EPS, continuing operations, excluding special items | $2.96 | $2.46 |
| Operating cash flow, continuing operations | $1.030 billion | $1.248 billion |
| Capital spending | $318 million | $427 million |
| Total debt | $9.804 billion | $9.125 billion |
Revenue fell 8%, mainly as refranchising reduced company-operated restaurant sales; franchise and license income increased 6%. Operating profit included $1.083 billion in refranchising gains, compared with $163 million in 2016. Excluding special items and foreign exchange, core operating profit rose 7% (9% excluding the 2016 extra week). Company restaurant margin increased to 17.3% from 16.7%, despite lower restaurant profit in dollars as the company-operated portfolio shrank.
Worldwide system sales grew 4% excluding foreign exchange, or 5% excluding both foreign exchange and the 2016 extra week. Same-store sales grew 2%; net new units grew 3%, with 1,407 net additions. KFC same-store sales rose 3%, Pizza Hut was flat, and Taco Bell rose 4%. Segment operating profit was $981 million at KFC (up 13%), $341 million at Pizza Hut (down 7%) and $619 million at Taco Bell (up 4%).
Fourth quarter: Revenue was $1.577 billion, operating profit $1.215 billion, net income $436 million and diluted continuing-operations EPS $1.26. The quarter included $752 million of refranchising gains; therefore, the reported operating-profit increase should not be read as recurring growth.
Cash, debt and liquidity
Year-end cash and cash equivalents were $1.522 billion; current assets were $2.507 billion and current liabilities $1.512 billion. Cash provided by operations declined to $1.030 billion, principally due to higher interest payments and retirement and deferred-compensation payouts. Refranchising generated $1.773 billion in proceeds; investing activities provided net cash of $1.472 billion. YUM returned $2.4 billion to shareholders in 2017 through buybacks and dividends, including $1.960 billion of share repurchases and $416 million of dividends paid.
Total debt was approximately $9.8 billion, with about 90% effectively fixed-rate and an overall effective interest rate of approximately 4.7%. The company targets leverage of approximately five times EBITDA and reported compliance with debt covenants at year-end. It had $1 billion of undrawn revolving-credit capacity. Shareholders’ deficit was $6.334 billion. Management states that working-capital deficits are common in its business model and do not significantly affect liquidity.
Outlook, management commentary and notable items
- YUM expects refranchising to continue significantly in 2018 and targets at least 98% franchised by the end of 2018. It expects the net effect of refranchising, before offsetting cost reductions, to reduce 2018 core operating-profit growth by 6–7 percentage points; management expects G&A reductions to largely offset the lost company-restaurant profit by 2019.
- Transformation targets for 2019 include approximately $100 million in annual capital spending, G&A of 1.7% of system sales, and leverage of approximately five times EBITDA. The company aims to return $6.5–$7.0 billion to shareholders over 2017–2019.
- Following the Tax Cuts and Jobs Act, YUM recorded a provisional $434 million tax expense in 2017, including estimated deemed-repatriation tax, deferred-tax remeasurement and a valuation allowance on foreign tax credits. The filing estimates an ongoing effective tax rate of 20%–22%; 2018 was expected to be slightly below that range. Estimates remained subject to review.
- New revenue-recognition rules effective in 2018 were expected to reduce opening shareholders’ equity by about $230 million and 2018 operating profit by about $45 million. The rules were also expected to increase reported revenue and expenses by approximately $1.0 billion through gross presentation of certain advertising-cooperative and reimbursement activity, without significant net-income impact.
- After a February 2018 distributor transition, some KFC restaurants in the UK and Ireland experienced supply shortages, closures or limited menus. The ultimate duration and financial effect were uncertain; prolonged disruption could materially affect revenue.
- In February 2018, YUM agreed to invest $200 million in Grubhub for approximately 2.8 million shares, subject to closing conditions, and entered a delivery-services agreement supporting U.S. KFC and Taco Bell digital ordering.
- Key risks include high leverage and refinancing needs; dependence on franchisees and Yum China; currency exposure; food safety and supply interruptions; commodity and labor inflation; intense competition, including delivery platforms; cybersecurity and privacy; and tax, regulatory and litigation uncertainty. Lease guarantees had approximately $600 million of undiscounted potential exposure, though the recorded liability was not material. Management did not expect current litigation to materially adversely affect the consolidated financial statements.
Material changes versus 2016
- Company sales decreased 15% as the company-operated restaurant base fell from 2,841 to 1,481, while franchise and license fees increased from $2.167 billion to $2.306 billion.
- Refranchising gains rose to $1.083 billion from $163 million, substantially boosting GAAP operating profit. Adjusted diluted continuing-operations EPS increased 20% to $2.96.
- Debt increased by about $679 million, while operating cash flow declined by $218 million. Capital spending fell by $109 million.
- Net income declined from $1.643 billion to $1.340 billion, partly because 2016 included $625 million of discontinued-operation income from China before the spin-off. 2017 also included the provisional Tax Act expense.
Investor verification priorities
- Reconcile GAAP operating profit and EPS to recurring performance, especially the $1.083 billion refranchising gain and the $434 million provisional Tax Act charge.
- Track 2018 refranchising execution, the projected 6–7 percentage-point core-profit headwind, and progress toward 2019 cost and capital-spending targets.
- Review debt maturities, covenant headroom, leverage and cash generation against shareholder-return commitments.
- Monitor the KFC UK and Ireland supply disruption and its effect on franchisees, restaurant operations and royalties.
- Confirm final Tax Act accounting and the realized impact of the new revenue-recognition standard.
- Assess YUM’s exposure to Yum China, including royalty collections, Chinese regulatory and currency risks, and the terms and closing of the Grubhub investment.