YUM BRANDS INC quarterly report, Q3 FY2020

Yum! Brands, Inc. — Q3 2020 Form 10-Q

Reporting period: Quarter and year to date ended September 30, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. The company operates KFC, Pizza Hut, Taco Bell and, since March 18, 2020, Habit Burger Grill. It had over 50,000 restaurants in more than 150 countries and territories; 98% were franchisee-operated.

Financial performance

Metric	Q3 2020	Q3 2019	Year to date 2020	Year to date 2019
Total revenue	$1,448	$1,339	$3,909	$3,903
Operating profit	$471	$480	$1,021	$1,384
Net income	$283	$255	$572	$806
Diluted EPS	$0.92	$0.81	$1.86	$2.57
Operating cash flow	Not presented quarterly	$853	$883

Q3 revenue increased 8%, while operating profit decreased 2%; year-to-date revenue was nearly flat, but operating profit fell 26% and net income fell 29%.
Company restaurant profit was $87 million in Q3 versus $72 million; restaurant margin was 17.8% versus 20.2%. Year-to-date restaurant profit was $198 million versus $206 million, with margin of 15.9% versus 19.6%.
Worldwide same-store sales declined 2% in Q3 and 8% year to date. System sales grew 1% in Q3, but declined 6% year to date (excluding foreign exchange: +1% and -5%, respectively).
Q3 GAAP diluted EPS rose 14%; diluted EPS excluding special items was $1.01, up 27%. Year-to-date adjusted diluted EPS was $2.47, down 3%. The filing’s non-GAAP measures exclude specified special items and are not substitutes for GAAP results.
Cash and cash equivalents were $1.11 billion at September 30, 2020; cash, restricted cash and restricted cash equivalents totaled $1.375 billion. Current assets were $2.03 billion and current liabilities $1.553 billion.
Long-term debt was $10.647 billion and short-term borrowings $444 million on the balance sheet. Management reported $11.1 billion of total debt excluding finance leases; about 93% was fixed-rate, with an effective overall rate of approximately 4.7%. The $1.0 billion revolving facility was undrawn at quarter-end.

Material changes and drivers

COVID-19-related closures and dining-room restrictions materially affected sales and operations. Closures peaked at about 11,000 restaurants in early April; about 1,000 remained fully closed on October 29, when approximately 98% of the system was open in full or limited capacity. Off-premise and digital sales helped mitigate dine-in weakness.
Segment trends diverged: Q3 operating profit rose at KFC to $278 million, Pizza Hut to $89 million and Taco Bell to $186 million; Habit Burger Grill reported a $7 million operating loss. Year-to-date operating profit declined at KFC and Pizza Hut, while Taco Bell increased.
Q3 results included $8 million of pre-tax income from the change in fair value of the Grubhub investment; the full investment was sold for $206 million. The year-to-date fair-value gain was $69 million. Year-over-year comparisons also reflect a $60 million Q3 2019 investment loss.
Operating cash flow declined to $853 million year to date from $883 million. Investing cash outflow was $269 million, including the $408 million Habit acquisition, partly offset by Grubhub sale proceeds. Financing cash flow was positive $24 million, compared with $440 million of outflow in 2019, primarily reflecting fewer share repurchases.
Yum acquired Habit for $408 million net of cash acquired. It recorded a $139 million pre-tax goodwill impairment in Q1, adjusted upward by $5 million in Q3; the reported year-to-date impairment charge was $144 million.

Outlook, risks and unusual items

Management said the pandemic’s duration and effects were difficult to forecast and expected continuing adverse impacts. Renewed restrictions, reduced dining access, weaker demand, operating-cost increases, supply or labor disruptions, and further store closures could affect results.
Management estimated total unit count at year-end 2020 would be approximately flat with September 30 levels: expected growth at KFC, Taco Bell and Habit was expected to be offset by Pizza Hut declines. Pizza Hut recorded a net decline of 860 units year to date; management expected continued pressure on its unit and operating-profit growth into Q4 and the following year.
Pizza Hut franchisee NPC International filed for Chapter 11 protection. Yum consented to up to 300 selected underperforming-unit closures and expected approximately 900 remaining NPC units to transfer to other franchise partners; timing and outcome remain uncertain.
Yum provided certain franchisees payment grace periods and development/remodel deferrals. Approximately $23 million was outstanding under grace periods at September 30, mostly due in 2020. Franchisee financial distress could reduce collections, prompt closures or create lease-related obligations for Yum.
Yum issued $600 million of 7.75% notes due 2025 and $1.05 billion of 3.625% notes due 2031; proceeds and cash were used in part to redeem $1.05 billion of 5.00% subsidiary notes due 2024. The redemption generated $34 million of Q3 interest expense classified as a special item, including a $26 million call premium and related charges.
The share-repurchase program was suspended early in 2020 and resumed in Q4. Management stated a target of returning to approximately 5.0x consolidated net leverage by Q2 2021.
Other notable items included a $50 million contribution to the Yum! Brands Foundation and $32 million of employee retirement/severance charges year to date. Q3 tax rate was 10.5% versus 15.1%; year-to-date rate was 14.4% versus 17.4%, primarily reflecting UK deferred-tax remeasurement and tax-return adjustments.
An Indian regulatory action imposed a penalty of approximately $150 million on a Yum subsidiary and former directors. The penalty was stayed pending a further hearing; Yum denied liability and said a significant loss was not probable. Potential undiscounted lease-guarantee payments were approximately $450 million; the recorded expected-loss liability was not material.

Key facts for investors to verify

Whether sales, restaurant margins and franchisee collections recover as restrictions and dining-room limitations change.
Whether the forecast of approximately flat year-end unit count is achieved, particularly given Pizza Hut closures and NPC’s restructuring.
Future credit losses, franchisee distress, lease-guarantee exposure and any additional goodwill or asset impairment charges.
Debt, leverage and interest costs after the refinancing and resumed share repurchases; management’s stated leverage target is forward-looking.
Progress and final accounting for the Habit acquisition purchase-price allocation and impairment.
The outcome of the Indian regulatory action and the timing of the next court hearing.

The independent accountant reported that its interim review found no material modifications needed for the financial information to conform with U.S. GAAP; this was a review, not an audit.