YUM BRANDS INC quarterly report, Q2 FY2023

Business context and reporting period

Yum! Brands, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2023. It franchises or operates more than 56,000 KFC, Taco Bell, Pizza Hut and Habit Burger Grill restaurants in over 155 countries and territories; 98% of restaurants are franchised. Amounts below are in U.S. dollars unless noted.

Financial and operating performance

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Revenue	$1.687bn	$1.636bn	$3.332bn	$3.183bn
Operating profit	$573m	$554m	$1.096bn	$1.063bn
Net income	$418m	$224m	$718m	$623m
Diluted EPS	$1.46	$0.77	$2.51	$2.13
Operating cash flow	Not separately stated for the quarter	$678m	$522m

Q2 revenue increased 3%, operating profit 4%, net income 86% and diluted EPS 89% year over year. Six-month revenue rose 5%, operating profit 3%, net income 15% and diluted EPS 18%.
Global system sales grew 13% excluding foreign exchange (FX) in Q2 and 12% year to date; same-store sales grew 9% and 8%, respectively. Reported system sales growth was 11% in Q2 and 8% year to date.
Core operating profit, a company-defined non-GAAP measure excluding special items and FX, increased 12% in Q2 and 11% year to date. Diluted EPS excluding special items was $1.41 in Q2, up 33%, and $2.46 year to date, up 17%.
Q2 company restaurant margin was 18.9%, versus 16.8%; the year-to-date margin was 17.0%, versus 15.7%. Management cited sales growth as a benefit and commodity inflation as a partial offset; Taco Bell also cited labor costs.
Q2 divisional operating profit: KFC $326m (up 11%), Taco Bell $228m (up 6%), Pizza Hut $91m (down 2%) and Habit Burger Grill $3m versus a $2m loss. Q2 system sales excluding FX grew across all divisions: KFC 19%, Taco Bell 7%, Pizza Hut 7% and Habit 9%.
Cash from operations was $678m; investing activities provided $26m, including $121m from the KFC Russia sale, while financing activities used $698m. Capital spending was $122m and dividends paid were $339m. Cash and cash equivalents were $437m at June 30; cash including restricted amounts was $659m.
Balance-sheet long-term debt was $11.194bn and short-term borrowings $374m. The company reported 4.7x consolidated net leverage, approximately 94% of debt fixed (including swaps), and an approximately 4.5% effective overall interest rate. A $1.25bn revolving facility had $30m outstanding. Shareholders’ deficit was $8.436bn.
Quarterly declared dividends were $0.605 per share; $50m of shares were repurchased during the first half, with no repurchases in Q2.

Material changes versus the prior period

Results benefited from stronger system sales, same-store sales and unit growth. Yum ended Q2 with 56,425 restaurants, up 6% year over year; it opened 1,025 gross units and added 742 net units during the quarter.
Q2 GAAP earnings growth was substantially greater than operating-profit growth, alongside a 12.6% effective tax rate versus 42.6% a year earlier. The comparison includes a $71m Russia-related tax expense in Q2 2022; Q2 2023 also included $18m from a favorable foreign tax audit resolution and a $10m benefit from additional foreign net operating loss deferred tax assets.
Q2 investment income included a $28m pretax fair-value gain on Yum’s approximately 5% Devyani International investment; the first-half result was a $5m gain. FX reduced divisional operating profit by $17m in Q2 and $44m year to date.
Yum completed its exit from Russia by selling KFC Russia in April 2023 for cash proceeds of $121m and recorded a $4m loss on the sale. The prior-year comparison also includes the suspension or transfer of Russian operations and related tax and operating items.
General and administrative expense rose to $291m in Q2 from $254m, with management citing incentive compensation, travel, headcount and salaries, digital and technology costs, professional fees, software costs and expenses related to the ransomware incident, depending on the period and division.

Outlook, risks and unusual items

Yum said it expects 2023 operating cash flow to remain above $1.3bn, consistent with each of the prior four years, and believes operating cash, cash on hand and available revolving credit will cover requirements over the next 12 months. It expects FX to have an insignificant effect on divisional operating profit in the second half of 2023. The filing provides no specific full-year EPS or revenue guidance.
The IRS proposed a $2.1bn tax underpayment for fiscal 2014, plus $418m in penalties and estimated interest of approximately $880m through Q2 2023, relating primarily to corporate reorganizations. Yum disputes the position, is contesting it through IRS appeals, believes its tax position is more likely than not to be sustained, and has recorded no reserve. An unfavorable resolution could materially adversely affect future financial statements.
An Indian regulatory matter includes a penalty order of approximately $135m against a subsidiary and certain former directors. The penalty remains stayed; hearings were rescheduled for October and December 2023. Yum denies liability and does not consider significant loss probable.
Potential undiscounted lease-guarantee payments were approximately $400m (present value approximately $325m); the recorded expected-loss liability was not material. Yum noted franchisee default or bankruptcy as a risk to the mitigants.
The January 2023 ransomware attack caused a one-day closure of fewer than 300 restaurants in one market and affected certain systems and data. Yum said its investigation found limited personal information of current and former employees affected and no evidence customer databases were accessed; expenses and employee class-action litigation remain possible.
Interim statements are unaudited and not necessarily indicative of full-year results. The independent accountant’s review found no material modifications needed for GAAP conformity; it was not an audit opinion on the interim statements.

Important facts for investors to verify

Track the IRS dispute, potential exposure, appeal progress and any change in the company’s no-reserve assessment.
Assess underlying earnings and cash generation apart from tax benefits, Devyani fair-value movements, FX, Russia-related items and other special-item adjustments.
Monitor leverage, interest costs, debt maturities and refinancing needs alongside the company’s stated liquidity and cash-flow expectations.
Review sustained same-store sales, unit growth, restaurant margins and franchisee health, including whether inflation and higher labor costs continue to pressure profitability.
Follow developments in the India regulatory action, lease guarantees and ransomware-related costs or litigation.