UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[Ÿ] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES | |
EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2018 | ||
OR | ||
[ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES | |
EXCHANGE ACT OF 1934 | ||
For the transition period from ____________ to _________________
Commission file number 1-13163
YUM! BRANDS, INC.
(Exact name of registrant as specified in its charter)
North Carolina | 13-3951308 | ||
(State or other jurisdiction of | (I.R.S. Employer | ||
incorporation or organization) | Identification No.) | ||
1441 Gardiner Lane, Louisville, Kentucky | 40213 | ||
(Address of principal executive offices) | (Zip Code) | ||
Registrant’s telephone number, including area code: (502) 874-8300 | |||
Securities registered pursuant to Section 12(b) of the Act | |||
Title of Each Class | Name of Each Exchange on Which Registered | ||
Common Stock, no par value | New York Stock Exchange | ||
Securities registered pursuant to Section 12(g) of the Act: | |||
None | |||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ü No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No ü
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ü No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ü No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ü]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act (Check one): Large accelerated filer: [ü] Accelerated filer: [ ] Non-accelerated filer: [ ] Smaller reporting company: [ ] Emerging growth company: [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ü
The aggregate market value of the voting stock (which consists solely of shares of Common Stock) held by non-affiliates of the registrant as of June 30, 2018 computed by reference to the closing price of the registrant’s Common Stock on the New York Stock Exchange Composite Tape on such date was approximately $24.7 billion. All executive officers and directors of the registrant have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant. The number of shares outstanding of the registrant’s Common Stock as of February 13, 2019 was 306,414,175 shares.
Documents Incorporated by Reference
Portions of the definitive proxy statement furnished to shareholders of the registrant in connection with the annual meeting of shareholders to be held on May 16, 2019 are incorporated by reference into Part III.
Forward-Looking Statements
In this Form 10-K, as well as in other written reports and oral statements, we present “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend all forward-looking statements to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with those safe harbor provisions.
Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and by the use of forward-looking words such as “expect,” “expectation,” “believe,” “anticipate,” “may,” “could,” “intend,” “belief,” “plan,” “estimate,” “target,” “predict,” “likely,” “seek,” “project,” “model,” “ongoing,” “will,” “should,” “forecast,” “outlook” or similar terminology. Forward-looking statements are based on our current expectations, estimates, assumptions and/or projections, our perception of historical trends and current conditions, as well as other factors that we believe are appropriate and reasonable under the circumstances. Forward-looking statements are neither predictions nor guarantees of future events, circumstances or performance and are inherently subject to known and unknown risks, uncertainties and assumptions that could cause our actual results to differ materially from those indicated by those statements. There can be no assurance that our expectations, estimates, assumptions and/or projections will be achieved. Factors that could cause actual results and events to differ materially from our expectations and forward-looking statements include (i) the risks and uncertainties described in the Risk Factors included in Part I, Item 1A of this Form 10-K and (ii) the factors described in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 of this Form 10-K. You should not place undue reliance on forward-looking statements, which speak only as of the date they are made. The forward-looking statements included in this Form 10-K are only made as of the date of this Form 10-K and we disclaim any obligation to publicly update any forward-looking statement to reflect subsequent events or circumstances.
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PART I
Item 1. | Business. |
YUM! Brands, Inc. (referred to herein as “YUM”, the “Registrant” or the “Company”), was incorporated under the laws of the state of North Carolina in 1997. The principal executive offices of YUM are located at 1441 Gardiner Lane, Louisville, Kentucky 40213, and the telephone number at that location is (502) 874-8300. Our website address is http://www.yum.com.
YUM, together with its subsidiaries, is referred to in this Form 10-K annual report (“Form 10-K”) as the Company. The terms “we,” “us” and “our” are also used in the Form 10-K to refer to the Company. Throughout this Form 10-K, the terms “restaurants,” “stores” and “units” are used interchangeably. While YUM does not directly own or operate any restaurants, throughout this document we may refer to restaurants that are owned or operated by our subsidiaries as being Company-owned.
Overview of Business
YUM has over 48,000 restaurants in more than 140 countries and territories primarily operating under the three concepts of KFC, Pizza Hut and Taco Bell (the “Concepts”). These three concepts are global leaders of the chicken, pizza and Mexican-style food categories, respectively. At December 31, 2018, 98% of our units are operated by independent franchisees or licensees under the terms of franchise or license agreements. The terms "franchise" or "franchisee" within this Form 10-K are meant to describe third parties that operate units under either franchise or license agreements.
Following is a summary of our Concepts' operations and a brief description of each Concept as of and for the year ended December 31, 2018:
Number of Units | % of Units International | Number of Countries and Territories | % Franchised | System Sales (in Millions) | ||||||||||||
KFC Division | 22,621 | 82 | % | 136 | 99% | $ | 26,239 | |||||||||
Pizza Hut Division* | 18,431 | 59 | % | 111 | 99% | 12,212 | ||||||||||
Taco Bell Division | 7,072 | 7 | % | 27 | 93% | 10,786 | ||||||||||
YUM* | 48,124 | 62 | % | 145 | 98% | $ | 49,237 | |||||||||
*Unit information includes 1,282 units operating under the Telepizza brand as of December 31, 2018. See Part II, Item 7 for a description of the Telepizza strategic alliance.
KFC
KFC was founded in Corbin, Kentucky by Colonel Harland D. Sanders, an early developer of the quick service food business and a pioneer of the restaurant franchise concept. The Colonel perfected his secret blend of 11 herbs and spices for Kentucky Fried Chicken in 1939 and signed up his first franchisee in 1952. KFC restaurants across the world offer fried and non-fried chicken products such as sandwiches, chicken strips, chicken-on-the-bone and other chicken products marketed under a variety of names.
Pizza Hut
The first Pizza Hut restaurant was opened in 1958 in Wichita, Kansas, and within a year, the first franchise unit was opened. Today, Pizza Hut is the largest restaurant chain in the world specializing in the sale of ready-to-eat pizza products. Pizza Hut operates in the delivery, carryout and casual dining segments around the world.
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Taco Bell
The first Taco Bell restaurant was opened in 1962 by Glen Bell in Downey, California, and in 1964, the first Taco Bell franchise was sold. Taco Bell specializes in Mexican-style food products, including various types of tacos, burritos, quesadillas, salads, nachos and other related items.
Business Strategy
Four growth drivers form the basis of YUM’s strategic plans and repeatable business model to accelerate same-store sales growth and net new restaurant development at KFC, Pizza Hut and Taco Bell around the world over the long term. The Company is focused on becoming best-in-class in:
• | Building Relevant, Easy and Distinctive Brands |
• | Developing Unmatched Franchise Operating Capability |
• | Driving Bold Restaurant Development |
• | Growing Unrivaled Culture and Talent |
Information about Operating Segments
As of December 31, 2018, YUM consists of three operating segments:
• | The KFC Division which includes the worldwide operations of the KFC concept |
• | The Pizza Hut Division which includes the worldwide operations of the Pizza Hut concept |
• | The Taco Bell Division which includes the worldwide operations of the Taco Bell concept |
Franchise Agreements
The franchise programs of the Company are designed to promote consistency and quality, and the Company is selective in granting franchises. The Company is focused on partnering with franchisees who have the commitment, capability and capitalization to grow our Concepts. Franchisees can range in size from individuals owning just one restaurant to large publicly-traded companies.
The Company utilizes both store-level franchise and master franchise programs to grow its businesses. Of our over 47,000 franchised units at December 31, 2018, approximately 30% operate under our master franchise programs, primarily units in China and those operating under the Telepizza strategic alliance (see Part II, Item 7 for a description of the Telepizza strategic alliance). The remainder of our franchise units operate under store-level franchise agreements. Under both types of franchise programs, franchisees supply capital by purchasing or leasing the land, building, equipment, signs, seating, inventories and supplies and, over the longer term, by reinvesting in the business. In certain historical refranchising transactions the Company may have retained ownership of land and building and continues to lease them to the franchisee. Store-level franchise agreements typically require payment to the Company of certain upfront fees such as initial fees paid upon opening of a store, fees paid to renew the term of the franchise agreement and fees paid in the event the franchise agreement is transferred to another franchisee. Franchisees also pay monthly continuing fees based on a percentage of their restaurants' sales (typically 4% - 6%) and are required to spend a certain amount to advertise and promote the brand. Under master franchise arrangements, the Company enters into agreements that allow master franchisees to operate restaurants as well as sub-franchise restaurants within certain geographic territories. Master franchisees are typically responsible for overseeing development within their territories and performing certain other administrative duties with regard to the oversight of sub-franchisees. In exchange, master franchisees retain a certain percentage of fees payable by the sub-franchisees under their franchise agreements and typically pay lower fees for the restaurants they operate. Our largest master franchisee, Yum China, pays the Company a continuing fee of 3% on system sales of our Concepts in mainland China.
The Company believes that it is important to maintain strong and open relationships with its franchisees and their representatives. To this end, the Company invests a significant amount of time working with the franchisee community and their representative organizations on key aspects of the business, including products, equipment, operational improvements and standards and management techniques.
Restaurant Operations
Through its Concepts, YUM develops, operates and franchises a worldwide system of both traditional and non-traditional Quick Service Restaurants ("QSR"). Traditional units can feature dine-in, carryout, drive-thru and delivery services. Non-traditional
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units include express units and kiosks that have a more limited menu, usually generate lower sales volumes and operate in non-traditional locations like malls, airports, gasoline service stations, train stations, subways, convenience stores, stadiums, amusement parks and colleges, where a full-scale traditional outlet would not be practical or efficient.
Most restaurants in each Concept offer consumers the ability to dine in and/or carryout food. In addition, Taco Bell and KFC offer a drive-thru option in many stores. Pizza Hut offers a drive-thru option on a much more limited basis. Pizza Hut typically offers delivery service, while, on a more limited but expanding basis, KFC and Taco Bell allow for consumers to have the Concepts' food delivered either through store-level or third-party delivery services. On February 7, 2018, certain of our subsidiaries entered into a master services agreement with an affiliate of Grubhub, Inc. ("Grubhub"), an online and mobile takeout food-ordering company in the U.S., which is intended to provide dedicated support for the KFC and Taco Bell branded online delivery channels in the U.S. through Grubhub’s online ordering platform, logistics and last-mile support for delivery orders, as well as point-of-sale integration to streamline operations.
Restaurant management structure varies by Concept and unit size. Generally, each restaurant is led by a restaurant general manager (“RGM”), together with one or more assistant managers, depending on the operating complexity and sales volume of the restaurant. Each Concept issues detailed manuals, which may then be customized to meet local regulations and customs. These manuals set forth standards and requirements for all aspects of restaurant operations, including food safety and quality, food handling and product preparation procedures, equipment maintenance, facility standards and accounting control procedures. The restaurant management teams are responsible for the day-to-day operation of each unit and for ensuring compliance with operating standards. CHAMPS – which stands for Cleanliness, Hospitality, Accuracy, Maintenance, Product Quality and Speed of Service – is our proprietary systemwide program for training, measuring and rewarding employee performance against key customer measures. CHAMPS is intended to align the operating processes of our entire system around one core set of standards. RGMs’ efforts, including CHAMPS performance measures, are monitored by Area Coaches, where sufficient scale allows. Area Coaches typically work with approximately six to twelve restaurants.
Supply and Distribution
The Company and franchisees of the Concepts are substantial purchasers of a number of food and paper products, equipment and other restaurant supplies. The principal items purchased include chicken, cheese, beef and pork products, paper and packaging materials. Prices paid for these supplies fluctuate. When prices increase, the Concepts may attempt to pass on such increases to their customers, although there is no assurance that this can be done practically. The Company does not typically experience significant continuous shortages of supplies, and alternative sources for most of these products are generally available.
In the U.S., the Company, along with the representatives of the Company’s KFC, Pizza Hut and Taco Bell franchisee groups, are members of Restaurant Supply Chain Solutions, LLC (“RSCS"), which is responsible for purchasing certain restaurant products and equipment. The core mission of RSCS is to provide the lowest possible sustainable store-delivered prices for restaurant products and equipment. This arrangement combines the purchasing power of the Company-owned and franchisee restaurants, which the Company believes leverages the system’s scale to drive cost savings and effectiveness in the purchasing function. The Company also believes that RSCS fosters closer alignment of interests and a stronger relationship with its franchisee community.
Most food products, paper and packaging supplies, and equipment used in restaurant operations are distributed to individual restaurant units by third-party distribution companies. In the U.S., McLane Foodservice, Inc. is the exclusive distributor for the majority of items used in Company-owned restaurants and for a substantial number of franchisee stores.
Outside the U.S., we and our Concepts' franchisees primarily use decentralized sourcing and distribution systems involving many different global, regional and local suppliers and distributors. We and our franchisees have approximately 6,300 food and paper suppliers, including U.S.-based suppliers that export to many countries.
Advertising and Promotional Programs
Company-owned and franchise restaurants are required to spend a percentage of their respective restaurants’ sales on advertising programs with the goal of increasing sales and enhancing the reputation of the Concepts. Advertising may be conducted nationally, regionally and locally. When multiple franchisees operate in the same country or region the national and regional advertising spending is typically conducted by a cooperative to which the franchisees and Company-owned stores, if any, contribute funds as a percentage of restaurants’ sales. The contributions are primarily used to pay for expenses relating to purchasing media for advertising, market research, commercial production, talent payments and other support functions for the respective Concepts. We control the advertising activities of certain advertising cooperatives through our majority voting rights.
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Trademarks and Patents
The Company and its Concepts own numerous registered trademarks and service marks. The Company believes that many of these marks, including its Kentucky Fried Chicken®, KFC®, Pizza Hut® and Taco Bell® marks, have significant value and are materially important to its business. The Company’s policy is to pursue registration of its important marks whenever feasible and to oppose vigorously any infringement of its marks.
The use of certain of these marks by franchisees has been authorized in our franchise agreements. Under current law and with proper use, the Company’s rights in its marks can generally last indefinitely. The Company also has certain patents on restaurant equipment which, while valuable, are not material to its business.
Working Capital
Information about the Company’s working capital is included in MD&A in Part II, Item 7 and the Consolidated Statements of Cash Flows in Part II, Item 8.
Seasonal Operations
The Company does not consider its operations to be seasonal to any material degree.
Competition
The retail food industry, in which our Concepts compete, is made up of supermarkets, supercenters, warehouse stores, convenience stores, coffee shops, snack bars, delicatessens and restaurants (including those in the QSR segment), and is intensely competitive with respect to price and quality of food products, new product development, digital engagement, advertising levels and promotional initiatives, customer service reputation, restaurant location and attractiveness and maintenance of properties. Competition from delivery aggregators and other food delivery services has also increased in recent years, particularly in urbanized areas. The retail food industry is often affected by changes in consumer tastes; national, regional or local economic conditions; currency fluctuations; demographic trends; traffic patterns; the type, number and location of competing food retailers and products; and disposable purchasing power. Each of our Concepts competes with international, national and regional restaurant chains as well as locally-owned restaurants, not only for customers, but also for management and hourly personnel, suitable real estate sites and qualified franchisees. Given the various types and vast number of competitors, our Concepts do not constitute a significant portion of the retail food industry in terms of number of system units or system sales, either on a worldwide or individual country basis.
Environmental Matters
The Company is not aware of any federal, state or local environmental laws or regulations that will materially affect its earnings or competitive position, or result in material capital expenditures. However, the Company cannot predict the effect on its operations of possible future environmental legislation or regulations. During 2018, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.
Government Regulation
U.S. Operations. The Company and its U.S. operations, as well as our franchisees, are subject to various federal, state and local laws affecting its business, including laws and regulations concerning information security, labor and employment, health, marketing, food labeling, sanitation and safety. Each of our and our Concepts’ franchisees' restaurants in the U.S. must comply with licensing requirements and regulations promulgated by a number of governmental authorities, which include health, sanitation, safety, fire and zoning agencies in the state and/or municipality in which the restaurant is located. In addition, each Concept must comply with various state and federal laws that regulate the franchisor/franchisee relationship. To date, the Company has not been materially adversely affected by such licensing requirements and regulations or by any difficulty, delay or failure to obtain required licenses or approvals.
International Operations. Our and our Concepts' franchisees' restaurants outside the U.S. are subject to national and local laws and regulations which are similar to those affecting U.S. restaurants. The restaurants outside the U.S. are also subject to tariffs and regulations on imported commodities and equipment and laws regulating foreign investment, as well as anti-bribery and anti-corruption laws.
See Item 1A "Risk Factors" for a discussion of risks relating to federal, state, local and international regulation of our business.
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Employees
As of year end 2018, the Company and its subsidiaries employed approximately 34,000 persons. The Company believes that it provides working conditions and compensation that compare favorably with those of its principal competitors. The majority of employees are paid on an hourly basis. Some employees are subject to labor council relationships that vary due to the diverse countries in which the Company operates. The Company and its Concepts consider employee relations to be good.
Available Information
The Company makes available, through the Investor Relations section of its internet website at http://www.yum.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission ("SEC") at http://www.sec.gov.
Our Corporate Governance Principles and our Code of Conduct are also located within the Investor Relations section of the Company's website. The reference to the Company’s website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this document. These documents, as well as our SEC filings, are available in print free of charge to any shareholder who requests a copy from our Investor Relations Department.
Item 1A. | Risk Factors. |
You should carefully review the risks described below as they identify important factors that could cause our actual results to differ materially from our forward-looking statements and historical trends.
Food safety and food-borne illness concerns may have an adverse effect on our business.
Food-borne illnesses, such as E. coli, Listeria, Salmonella and Trichinosis, occur or may occur within our system from time to time. In addition, food safety issues such as food tampering, contamination and adulteration occur or may occur within our system from time to time. Any report or publicity linking us or one of our Concepts’ restaurants, including restaurants operated by us or our Concepts’ franchisees, or linking our competitors or the retail food industry generally, to instances of food-borne illness or food safety issues could adversely affect our Concepts’ brands and reputations as well as our revenues and profits, and possibly lead to product liability claims, litigation and damages. If a customer of one of our Concepts becomes ill from food borne illnesses or as a result of food safety issues, restaurants in our system may be temporarily closed, which could disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. In addition, instances or allegations of food-borne illness or food safety issues, real or perceived, involving our restaurants, restaurants of competitors, or suppliers or distributors (regardless of whether we use or have used those suppliers or distributors), or otherwise involving the types of food served at our restaurants, could result in negative publicity that could adversely affect our sales or the sales of our Concepts’ franchisees. The occurrence of food-borne illnesses or food safety issues could also adversely affect the price and availability of affected ingredients, which could result in disruptions in our supply chain and/or lower margins for us and our Concepts’ franchisees.
Health concerns arising from outbreaks of viruses or other diseases may have an adverse effect on our business.
Our business could be materially and adversely affected by the outbreak of a widespread health epidemic, including various strains of avian flu or swine flu, such as H1N1. The occurrence of such an outbreak of an epidemic, illness or other adverse public health developments could materially disrupt our business and operations. Such events could also significantly impact our industry and cause a temporary closure of restaurants, which could severely disrupt our operations and have a material adverse effect on our business, financial condition and results of operations.
Our operations could be disrupted if any of our employees or employees of our business partners were suspected of having the avian flu or swine flu, or other illnesses such as hepatitis A or norovirus, since this could require us or our business partners to quarantine some or all of such employees or disinfect our restaurant facilities. Outbreaks of avian flu occur from time to time around the world, and such outbreaks have resulted in confirmed human cases. It is possible that outbreaks could reach pandemic levels. Public concern over avian flu generally may cause fear about the consumption of chicken, eggs and other products derived from poultry, which could cause customers to consume less poultry and related products. Because poultry is a menu offering for our Concepts, this would likely result in lower revenues and profits for us and our Concepts’ franchisees. Avian flu outbreaks could also adversely affect the price and availability of poultry, which could negatively impact profit margins and revenues for us and our Concepts' franchisees.
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Furthermore, other viruses may be transmitted through human contact, and the risk of contracting viruses could cause employees or guests to avoid gathering in public places, which could adversely affect restaurant guest traffic or the ability to adequately staff restaurants. We could also be adversely affected if government authorities impose mandatory closures, seek voluntary closures, impose restrictions on operations of restaurants, or restrict the import or export of products, or if suppliers issue mass recalls of products. Even if such measures are not implemented and a virus or other disease does not spread significantly, the perceived risk of infection or health risk may affect our business.
Our operating results and growth strategies are closely and increasingly tied to the success of our Concepts’ franchisees.
A significant and growing portion of our restaurants are operated by our Concepts’ franchisees. At the end of 2018, over 98% of our stores are operated by franchisees. Our refranchising efforts have increased our dependence on the financial success and cooperation of our Concepts’ franchisees. In addition, our long-term system sales growth targets depend on an acceleration of our historical net system unit growth rate. Nearly all of this unit growth is expected to result from new unit openings by our Concepts’ franchisees. If our Concepts’ franchisees do not meet our expectations for new unit development, we may fall short of our system sales targets.
We have limited control over how our Concepts’ franchisees’ businesses are run, and their inability to operate successfully could adversely affect our operating results through decreased royalty payments. If our Concepts’ franchisees fail to adequately capitalize their businesses or incur too much debt, if their operating expenses or commodity prices increase or if economic or sales trends deteriorate such that they are unable to operate profitably or repay existing debt, it could result in their financial distress, including insolvency or bankruptcy. If a significant franchisee of one of our Concepts becomes, or a significant number of our Concepts’ franchisees in the aggregate become, financially distressed, our operating results could be impacted through reduced or delayed royalty payments and reduced new unit development. In addition, we are secondarily liable on certain of our Concepts’ franchisees’ lease agreements, including lease agreements that we have guaranteed or assigned to franchisees in connection with the refranchising of certain Company-owned restaurants. Our operating results could be impacted by any increased rent obligations for such leased properties to the extent our Concepts’ franchisees default on such lease agreements.
Our success also depends on the willingness and ability of our Concepts’ franchisees to implement major initiatives such as restaurant remodels or equipment or technology upgrades, which may require financial investment. Our Concepts may be unable to successfully implement strategies that we believe are necessary for further growth if their franchisees do not participate, which in turn may harm the growth prospects and financial condition of the Company. Additionally, the failure of our Concepts’ franchisees to focus on the fundamentals of restaurant operations, such as quality, service and cleanliness (even if such failures do not rise to the level of breaching the related franchise documents), could have a negative impact on our business.
We may not achieve our target development goals, aggressive development could cannibalize existing sales and new restaurants may not be profitable.
Our growth strategy depends on our and our Concepts’ franchisees’ ability to increase net restaurant count in markets around the world. The successful development of new units depends in large part on the ability of our Concepts’ franchisees to open new restaurants and to operate these restaurants profitably. We cannot guarantee that we, or our Concepts’ franchisees, including Yum China, will be able to achieve our expansion goals or that new restaurants will be operated profitably. Further, there is no assurance that any new restaurant will produce operating results similar to those of our existing restaurants. Other risks that could impact our ability to increase the number of our restaurants include prevailing economic conditions and trade or economic sanctions and our, or our Concepts’ franchisees’, ability to obtain suitable restaurant locations, negotiate acceptable lease or purchase terms for the locations, obtain required permits and approvals in a timely manner, hire and train qualified management teams and restaurant crews, and meet construction schedules.
Expansion into target markets could also be affected by our Concepts’ franchisees’ willingness to invest capital or ability to obtain financing to construct and open new restaurants. If it becomes more difficult or more expensive for our Concepts’ franchisees to obtain financing to develop new restaurants, or if the perceived return on invested capital is not sufficiently attractive, the expected growth of our system could slow and our future revenues and operating cash flows could be adversely impacted.
In addition, the development of new restaurants could impact the sales of our Concepts’ existing restaurants nearby. There can be no assurance that sales cannibalization will not occur or become more significant in the future as we increase our presence in existing markets.
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We may not successfully implement our transformation initiatives or fully realize the anticipated benefits from the transformation.
We are in the process of implementing our previously announced strategic transformation plans to drive global expansion of our KFC, Pizza Hut and Taco Bell brands. Following our becoming 98% franchised as of the end of 2018, the remaining components of this transformation include, among other things, a plan to significantly reduce annual capital expenditures and our general and administrative costs by the end of 2019. We cannot assure you that we will be able to successfully implement our transformation initiatives. Further, our ability to achieve the anticipated benefits of this transformation, including the anticipated levels of cost savings and efficiency, within expected timeframes is subject to many estimates and assumptions, which are, in turn, subject to significant economic, competitive and other uncertainties, some of which are beyond our control. There is no assurance that we will successfully implement, or fully realize the anticipated positive impact of, our transformation initiatives, or execute successfully on our transformation strategy, in the expected timeframes or at all. In addition, there can be no assurance that our efforts, if properly executed, will result in our desired outcome of improved financial performance.
We have significant exposure to the Chinese market through our largest franchisee, Yum China, which subjects us to risks that could negatively affect our business.
In connection with the spin-off of our China business in 2016, we entered into a Master License Agreement with Yum China pursuant to which Yum China is the exclusive licensee of the KFC, Pizza Hut and Taco Bell Concepts and their related marks and other intellectual property rights for restaurant services in China. Following the Separation, Yum China became, and continues to be, our largest franchisee. As a result, our overall financial results are significantly affected by Yum China’s results. Yum China's business is exposed to risks in China, which include, among others, changes in economic conditions (including consumer spending, unemployment levels and wage and commodity inflation), consumer preferences, the regulatory environment, and tax laws and regulations including the tax treatment of the royalty paid to YUM, as well as increased media scrutiny of our Concepts and industry, fluctuations in foreign exchange rates, increased restrictions or tariffs on imported supplies as a result of trade disputes and increased competition. Further, any significant or prolonged deterioration in U.S.-China relations could adversely affect our Concepts in China if Chinese consumers reduce the frequency of their visits to Yum China’s restaurants. Chinese law regulates Yum China's business conducted within China. Our royalty income from the Yum China business is therefore subject to numerous uncertainties based on the policies of the Chinese government, as they may change from time to time. If Yum China’s business is harmed or development of our Concepts’ restaurants is slowed in China due to any of these factors, it could negatively impact the royalty paid by Yum China to us, which would negatively impact our financial results or our growth prospects.
Our relationship with Yum China is governed primarily by a Master License Agreement, which may be terminated upon the occurrence of certain events, such as the insolvency or bankruptcy of Yum China. In addition, if we are unable to enforce our intellectual property or contract rights in China, if Yum China is unable or unwilling to satisfy its obligations under the Master License Agreement, or if the Master License Agreement is otherwise terminated, it could result in an interruption in the operation of our brands that have been exclusively licensed to Yum China for use in China. Such interruption could cause a delay in, or loss of, royalty income to us, which would negatively impact our financial results.
Our international operations subject us to risks that could negatively affect our business.
A significant portion of our Concepts’ restaurants are operated in countries and territories outside of the U.S., including in emerging markets, and we intend to continue expansion of our international operations. As a result, our business and the businesses of our Concepts’ franchisees are increasingly exposed to risks inherent in international operations. These risks, which can vary substantially by country, include political instability, corruption, anti-American sentiment and social and ethnic unrest, as well as changes in economic conditions (including consumer spending, unemployment levels and wage and commodity inflation), the regulatory environment, income and non-income based tax rates and laws, sanctions, foreign exchange control regimes including restrictions on currency conversion, consumer preferences and the laws and policies that govern foreign investment in countries where our Concepts' restaurants are operated. In addition, we and our franchisees do business in jurisdictions that may be subject to trade or economic sanction regimes and such sanctions could be expanded. Any failure to comply with such sanction regimes or other similar laws or regulations could result in the assessment of damages, the imposition of penalties, suspension of business licenses, or a cessation of operations at our or our franchisees’ businesses, as well as damage to our and our Concepts’ brands’ images and reputations, all of which could harm our profitability.
Foreign currency risks and foreign exchange controls could adversely affect our financial results.
Our results of operations and the value of our foreign assets are affected by fluctuations in currency exchange rates, which may adversely affect reported earnings. More specifically, an increase in the value of the U.S. dollar relative to other currencies, such as the Chinese Renminbi (“RMB”), Australian Dollar, the British Pound and the Euro, as well as currencies in certain other markets, such as the Malaysian Ringgit and Russian Ruble, could have an adverse effect on our reported earnings. There can be no assurance
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as to the future effect of any such changes on our results of operations, financial condition or cash flows. In addition, the governments in certain countries where we operate, including China, restrict the conversion of local currency into foreign currencies and, in certain cases, the remittance of currency out of the country. Yum China’s income is almost exclusively derived from the earnings of its Chinese subsidiaries, with substantially all revenues of its Chinese subsidiaries denominated in RMB. Any significant fluctuation in the value of the RMB could materially impact the U.S. dollar value of royalty payments made to us by Yum China, which could result in lower revenues. In addition, restrictions on the conversion of RMB to U.S. dollars or further restrictions on the remittance of currency out of China could result in delays in the remittance of Yum China’s license fee, which could impact our liquidity.
Failure to protect the integrity and security of personal information of our customers and employees could result in substantial costs, expose us to litigation and damage our reputation.
We receive and maintain certain personal, financial and other information about our customers, employees and franchisees. In addition, our vendors and/or franchisees receive and maintain certain personal, financial and other information about our employees and customers. The use and handling of this information is regulated by evolving and increasingly demanding laws and regulations in various jurisdictions, as well as by certain third-party contracts. If our security and information systems are compromised as a result of data corruption or loss, cyber-attack or a network security incident or if our employees, franchisees or vendors fail to comply with these laws and regulations and this information is obtained by unauthorized persons or used inappropriately, it could result in liabilities and penalties and could damage our reputation, cause us to incur substantial costs and result in a loss of customer confidence, which could adversely affect our results of operations and financial condition. Additionally, we could be subject to litigation and government enforcement actions as a result of any such failure.
Further, data privacy is subject to frequently changing rules and regulations, which sometimes conflict among the various jurisdictions and countries where we, our Concepts and our Concepts’ franchisees do business. For example, the European Union adopted a new regulation that became effective in May 2018, The General Data Protection Regulation ("GDPR"), which requires companies to meet new requirements regarding the handling of personal data. In addition, in June 2018 the State of California enacted the California Consumer Privacy Act (the “CCPA”), which will become effective in 2020, requiring companies that process information on California residents to, among other things, make new disclosures to consumers about data collection, use and sharing practices. Our failure to adhere to or successfully implement appropriate processes to adhere to the requirements of GDPR, CCPA and other evolving laws and regulations in this area could result in financial penalties, legal liability and could damage our and our Concepts’ brands’ reputations.
Unreliable or inefficient restaurant or consumer interfacing technology or the failure to successfully implement technology initiatives in the future could adversely impact operating results.
We and our Concepts’ franchisees' rely heavily on information technology systems in the conduct of our business, some of which are managed, hosted, provided and/or used by third parties, including, for example, point-of-sale processing in our restaurants, management of our supply chain and various other processes and procedures. These systems are subject to damage, interruption or failure due to theft, fire, power outages, telecommunications failure, computer viruses, security breaches, malicious cyber-attacks or other catastrophic events. Certain technology systems may also be unreliable or inefficient, and technology vendors may limit or terminate product support and maintenance, which could impact the reliability of critical systems operations. If our or our Concepts' franchisees' information technology systems are damaged or fail to function properly, we may incur substantial costs to repair or replace them, and may experience loss of critical data and interruptions or delays in our ability to manage inventories or process transactions, which could result in lost sales, customer or employee dissatisfaction, or negative publicity that could negatively impact our reputation, results of operations and financial condition.
We and our Concepts’ franchisees rely on technology not only to efficiently operate our restaurants but also to drive the customer experience, sales growth and margin improvement. Execution of our growth strategy will be dependent on our initiatives to implement technology solutions and gather and leverage data to enhance restaurant operations and improve the customer experience. Our strategic technology initiatives may not be timely implemented or may not achieve the desired results. Even if we effectively implement and manage our technology initiatives, they may not result in sales growth or margin improvement. Additionally, implementing the evolving technology demands of the consumer may place a significant financial burden on us and our Concepts’ franchisees.
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There are risks associated with our increasing dependence on digital commerce platforms to maintain and grow sales. Such platforms may experience disruptions, which could harm our ability to compete and conduct our business.
Customers are increasingly using e-commerce websites and apps, both domestically and internationally, like pizzahut.com, Pizza Hut, KFC and Taco Bell apps, as well as apps owned by third-party delivery aggregators such as Grubhub and third-party mobile payment processors, to order and pay for our Concepts’ products. As a result, our Concepts and our Concepts’ franchisees are increasingly reliant on digital ordering and payment as a sales channel. These digital ordering and payment platforms could be damaged or interrupted by power loss, technological failures, user errors, cyber-attacks, other forms of sabotage or acts of God. In particular, Pizza Hut relies on digital orders for a significant portion of its sales and could experience interruptions of its digital ordering platforms, which could limit or delay customers’ ability to order through such platforms. Any such limitation or delay would negatively impact Pizza Hut’s sales and customer experience and perception. In addition, if Pizza Hut’s digital ordering platforms do not meet customers’ expectations in terms of security, speed, attractiveness, or ease of use, customers may be less inclined to return to such digital ordering platforms, which could negatively impact our sales, results of operations and financial condition.
Yum China, our largest franchisee, utilizes third-party mobile payment apps such as Alipay and WeChat as a means through which to generate sales and process payments. Should customers become unable to access mobile payment apps in China, or should the relationship between Yum China and one or more third-party mobile payment processors become interrupted, our results of operations could be negatively impacted.
Our inability or failure to recognize, respond to and effectively manage the accelerated impact of social media could adversely impact our business.
In recent years, there has been a marked increase in the use of social media platforms, including blogs, chat platforms, social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. The rising popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to our interests and/or may be inaccurate. The dissemination of information online could harm our business, reputation, financial condition, and results of operations, regardless of the information’s accuracy. The damage may be immediate without affording us an opportunity for redress or correction.
In addition, social media is frequently used by our Concepts to communicate with their respective customers and the public in general. Failure by our Concepts to use social media effectively or appropriately, particularly as compared to our Concepts’ respective competitors, could lead to a decline in brand value, customer visits and revenue. Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about our Concepts’ brands, exposure of personally identifiable information, fraud, hoaxes or malicious dissemination of false information. The inappropriate use of social media by our customers or employees could increase our costs, lead to litigation or result in negative publicity that could damage our reputation and adversely affect our results of operations.
Shortages or interruptions in the availability and delivery of food and other supplies may increase costs or reduce revenues.
The products sold by our Concepts and their franchisees are sourced from a wide variety of domestic and international suppliers. We, along with our Concepts’ franchisees, are also dependent upon third parties to make frequent deliveries of food products and supplies that meet our specifications at competitive prices. Shortages or interruptions in the supply of food items and other supplies to our Concepts’ restaurants could adversely affect the availability, quality and cost of items we use and the operations of our restaurants. In February 2018, we and our franchisees transitioned to a new distributor for the products supplied to our approximately 900 KFCs in the United Kingdom and Ireland. In connection with this transition, certain of the restaurants experienced supply availability issues which resulted in store closures or stores operating under a limited menu for a period of time. Future, similar shortages or disruptions could be caused by inclement weather, natural disasters, inaccurate forecasting of customer demand, problems in production or distribution, restrictions on imports or exports including due to trade disputes, the inability of vendors to obtain credit, political instability in the countries in which the suppliers and distributors are located, the financial instability of suppliers and distributors, suppliers’ or distributors’ failure to meet our standards or requirements, product quality issues, inflation, other factors relating to the suppliers and distributors and the countries in which they are located, food safety warnings or advisories or the prospect of such pronouncements, product recalls, the cancellation of supply or distribution agreements or an inability to renew such arrangements or to find replacements on commercially reasonable terms, or other conditions beyond our control or the control of our Concepts’ franchisees. The pending withdrawal of the United Kingdom from the European Union, particularly if such withdrawal occurs without a transition agreement in effect, may result in the reimposition of customs and border controls, which in turn may result in shortages or interruptions in supply to our Concepts in the United Kingdom with
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consequences similar to those described above. In the U.S., the Company, along with representatives of the Company’s KFC, Pizza Hut and Taco Bell franchisee groups, are members of Restaurant Supply Chain Solutions, LLC (“RSCS"), which is responsible for purchasing certain restaurant products and equipment. Any failure or inability of RSCS to perform its purchasing obligations could result in shortages or interruptions in the availability of food and other supplies.
A shortage or interruption in the availability of certain food products or supplies could increase costs and limit the availability of products critical to restaurant operations, which in turn could lead to restaurant closures and/or a decrease in sales. In addition, failure by a key supplier or distributor for our Concepts and/or our Concepts’ franchisees to meet its service requirements could lead to a disruption of service or supply until a new supplier or distributor is engaged, and any disruption could have an adverse effect on our business.
Labor shortages or difficulty finding qualified employees could slow our growth, harm our business and reduce our profitability.
Restaurant operations are highly service-oriented and our success depends in part upon our and our Concepts’ franchisees’ ability to attract, retain and motivate a sufficient number of qualified employees, including franchisee management, restaurant managers and other crew members. The market for qualified employees in the retail food industry is very competitive. Any future inability to recruit and retain qualified individuals may delay the planned openings of new restaurants by us and our Concepts’ franchisees and could adversely impact operation of our Concepts’ existing restaurants. Any such delays, material increases in employee turnover rate in franchisee management or existing restaurants or widespread employee dissatisfaction could have a material adverse effect on our and our Concepts’ franchisees’ business and results of operations.
In addition, strikes, work slowdowns or other job actions may become more common. In the event of a strike, work slowdown or other labor unrest, the ability to adequately staff our Concepts’ restaurants could be impaired, which could result in reduced revenue and customer claims, and may distract our management from focusing on our business and strategic priorities.
Changes in labor and other operating costs could adversely affect our results of operations.
An increase in the costs of employee wages, benefits and insurance (including workers’ compensation, general liability, property and health) as well as other operating costs such as rent and energy costs could adversely affect our operating results. Such increases could result from government imposition of higher minimum wages or from general economic or competitive conditions. Any increase in such operating expenses could adversely affect our and our Concepts’ franchisees’ profit margins. In addition, competition for qualified employees could also compel us or our Concepts’ franchisees to pay higher wages to attract or retain key crew members, which could result in higher labor costs and decreased profitability.
A broader standard for determining joint employer status may adversely affect our business operations and increase our liabilities.
The National Labor Relations Board (the “NLRB”) in 2014 adopted a new and broader standard for determining when two or more otherwise unrelated employers may be found to be a joint employer of the same employees under the National Labor Relations Act. If this joint employer liability standard is upheld or adopted by other government agencies and/or applied generally to franchise relationships under other laws like the U.S. Fair Labor Standards Act, it could cause us or our Concepts to be liable or held responsible for unfair labor practices and other violations and could subject our Concepts to other liabilities, and/or require our Concepts to conduct collective bargaining negotiations, regarding employees of totally separate, independent employers, most notably our Concepts’ franchisees. In such event, our operating expenses may increase as a result of required modifications to our business practices, increased litigation, governmental investigations or proceedings, administrative enforcement actions, fines and civil liability.
An increase in food prices may have an adverse impact on our and our Concepts’ franchisees’ profit margins.
Our and our Concepts’ franchisees’ businesses depend on reliable sources of large quantities of raw materials such as proteins (including poultry, pork, beef and seafood), cheese, oil, flour and vegetables (including potatoes and lettuce). Raw materials purchased for use in our Concepts’ restaurants are subject to price volatility caused by any fluctuation in aggregate supply and demand, or other external conditions, such as weather conditions or natural events or disasters that affect expected harvests of such raw materials, or taxes and tariffs including as a result of trade disputes. As a result, the historical prices of raw materials used in the operation of our Concepts’ restaurants have fluctuated. We cannot assure you that we or our Concepts’ franchisees will continue to be able to purchase raw materials at reasonable prices, or that the cost of raw materials will remain stable in the future. In addition, a significant increase in gasoline prices could result in the imposition of fuel surcharges by our distributors.
Because we and our Concepts’ franchisees provide competitively priced food, we may not have the ability to pass through to our customers the full amount of any commodity price increases. If we and our Concepts’ franchisees are unable to manage the cost
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of raw materials or to increase the prices of products proportionately, our and our franchisees’ profit margins may be adversely impacted.
Our Concepts’ brands may be harmed or diluted through franchisee and third-party activity.
Although we monitor and regulate franchisee activities through our Concepts’ franchise agreements, franchisees or other third parties may refer to or make statements about our Concepts’ brands that do not make proper use of our trademarks or required designations, that improperly alter trademarks or branding, or that are critical of our Concepts’ brands or place our Concepts’ brands in a context that may tarnish their reputation. This may result in dilution of, or harm to, our intellectual property or the value of our Concepts’ brands.
Franchisee noncompliance with the terms and conditions of our franchise agreements may reduce the overall goodwill of our Concepts’ brands, whether through the failure to meet health and safety standards, engage in quality control or maintain product consistency, or through the participation in improper or objectionable business practices. Moreover, unauthorized third parties, including our Concepts’ current and former franchisees, may use our intellectual property to trade on the goodwill of our Concepts’ brands, resulting in consumer confusion or brand dilution. Any reduction of our Concepts’ brands’ goodwill, consumer confusion, or brand dilution is likely to impact sales, and could materially and adversely impact our business and results of operations.
Our success depends substantially on our corporate reputation and on the value and perception of our brands.
Our success depends in large part upon our ability and our Concepts’ franchisees’ ability to maintain and enhance the value of our brands and our customers’ loyalty to our brands. Brand value is based in part on consumer perceptions on a variety of subjective qualities. Business incidents, whether isolated or recurring, and whether originating from us, franchisees, competitors, governments, suppliers or distributors, can significantly reduce brand value and consumer trust, particularly if the incidents receive considerable publicity or result in litigation. For example, our Concepts’ brands could be damaged by claims or perceptions about the quality or safety of our products or the quality or reputation of our suppliers, distributors or franchisees, regardless of whether such claims or perceptions are true. Similarly, entities in our supply chain may engage in conduct, including alleged human rights abuses or environmental wrongdoing, and any such conduct could damage our or our Concepts’ brands’ reputations. Any such incidents (even if resulting from actions of a competitor or franchisee) could cause a decline directly or indirectly in consumer confidence in, or the perception of, our Concepts’ brands and/or our products and reduce consumer demand for our products, which would likely result in lower revenues and profits. Additionally, our corporate reputation could suffer from a real or perceived failure of corporate governance or misconduct by a Company officer, or an employee or representative of us or a franchisee.
We could be party to litigation that could adversely affect us by increasing our expenses, diverting management attention or subjecting us to significant monetary damages and other remedies.
We are regularly involved in legal proceedings, which include consumer, employment, real estate related, tort, intellectual property, breach of contract, securities, derivative and other litigation. See the discussion of legal proceedings in Note 19 to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Plaintiffs in these types of lawsuits often seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may not be accurately estimated. Regardless of whether any such claims have merit, or whether we are ultimately held liable or settle, such litigation may be expensive to defend and may divert resources and management attention away from our operations and negatively impact reported earnings. With respect to insured claims, a judgment for monetary damages in excess of any insurance coverage could adversely affect our financial condition or results of operations. Any adverse publicity resulting from these allegations may also adversely affect our Concepts’ reputations, which in turn could adversely affect our results of operations.
In addition, the restaurant industry around the world has been subject to claims that relate to the nutritional content of food products, as well as claims that the menus and practices of restaurant chains have led to customer health issues, including weight gain and other adverse effects. These concerns could lead to an increase in the regulation of the content or marketing of our products. We may also be subject to such claims in the future and, even if we are not, publicity about these matters (particularly directed at the quick service and fast-casual segments of the retail food industry) may harm our Concepts’ reputations and adversely affect our business, financial condition and results of operations.
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Changes in, or noncompliance with, governmental regulations may adversely affect our business operations, growth prospects or financial condition.
Our Concepts and their franchisees are subject to numerous laws and regulations around the world. These laws change regularly and are increasingly complex. For example, we are subject to:
• | The Americans with Disabilities Act in the U.S. and similar state laws that give civil rights protections to individuals with disabilities in the context of employment, public accommodations and other areas. |
• | The U.S. Fair Labor Standards Act, which governs matters such as minimum wages, overtime and other working conditions, as well as family leave mandates and a variety of similar state laws that govern these and other employment law matters. |
• | Laws and regulations in government-mandated health care benefits such as the Patient Protection and Affordable Care Act in the U.S. |
• | Laws and regulations relating to nutritional content, nutritional labeling, product safety, product marketing and menu labeling. |
• | Laws relating to state and local licensing. |
• | Laws relating to the relationship between franchisors and franchisees. |
• | Laws and regulations relating to health, sanitation, food, workplace safety, child labor, including laws regulating the use of certain “hazardous equipment”, and fire safety and prevention. |
• | Laws and regulations relating to union organizing rights and activities. |
• | Laws relating to information security, privacy (including the European Union's GDPR), cashless payments, and consumer protection. |
• | Laws relating to currency conversion or exchange. |
• | Laws relating to international trade and sanctions. |
• | Tax laws and regulations. |
• | Anti-bribery and anti-corruption laws. |
• | Environmental laws and regulations. |
• | Federal and state immigration laws and regulations in the U.S. |
Compliance with new or existing laws and regulations could impact our or our Concepts’ franchisees’ operations. The compliance costs associated with these laws and regulations could be substantial. Any failure or alleged failure to comply with these laws or regulations could adversely affect our reputation, international expansion efforts, growth prospects and financial results or result in, among other things, litigation, revocation of required licenses, internal investigations, governmental investigations or proceedings, administrative enforcement actions, fines and civil and criminal liability. Publicity relating to any such noncompliance could also harm our Concepts’ reputations and adversely affect our revenues.
Failure to comply with anti-bribery or anti-corruption laws could adversely affect our business operations.
The U.S. Foreign Corrupt Practices Act, the UK Bribery Act and other similar applicable laws prohibiting bribery of government officials and other corrupt practices are the subject of increasing emphasis and enforcement around the world. There can be no assurance that our employees, contractors, agents or other third parties will not take actions in violation of our policies or applicable law, particularly as we expand our operations in emerging markets and elsewhere. Any such violations or suspected violations could subject us to civil or criminal penalties, including substantial fines and significant investigation costs, and could also materially damage our reputation, brands, international expansion efforts and growth prospects, business and operating results. Publicity relating to any noncompliance or alleged noncompliance could also harm our Concepts’ reputations and adversely affect our revenues and results of operations.
Tax matters, including changes in tax rates or laws, disagreements with taxing authorities and imposition of new taxes could impact our results of operations and financial condition.
We are subject to income taxes as well as non-income based taxes, such as payroll, sales, use, value-added, net worth, property, withholding and franchise taxes in both the U.S. and various foreign jurisdictions. We are also subject to ongoing and/or regular reviews, examinations and audits by the U.S. Internal Revenue Service (“IRS”) and other taxing authorities with respect to such income and non-income based taxes inside and outside of the U.S. Our accruals for tax liabilities are based on past experience, interpretations of applicable law, and judgments about potential actions by tax authorities, but such accruals require significant judgment which may be incorrect and may result in payments greater than the amounts accrued. If the IRS or another taxing authority disagrees with our tax positions, we could face additional tax liabilities, including interest and penalties. Payment of additional amounts upon final settlement or adjudication of any disputes could have a material impact on our results of operations and financial position.
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In addition, we are directly and indirectly affected by new tax laws and regulation and the interpretation of tax laws and regulations worldwide. Changes in laws, regulation or interpretation of existing laws and regulations in the U.S. and other jurisdictions where we are subject to taxation could increase our taxes and have an adverse effect on our results of operations and financial condition. Changes in tax laws may arise as a result of guidance issued by the Organisation for Economic Co-operation and Development (“OECD”), a coalition of member nations including the United States. The OECD guidance, referred to as the Base Erosion and Profit Shifting (“BEPS”) Action Plan, does not have the force of law, but certain countries may enact tax legislation, modify tax treaties, and/or increase audit scrutiny based on the BEPS guidance. To the extent BEPS principles are adopted by major jurisdictions in which we operate, it could increase our taxes and have a material adverse impact on our results of operations and financial position. In addition, public perception that we are not paying a sufficient amount of taxes could damage our Concepts’ reputations, which could harm our profitability.
The Yum China spin-off and certain related transactions could result in substantial U.S. tax liability.
We received opinions of outside counsel substantially to the effect that, for U.S. federal income tax purposes, the Yum China spin-off and certain related transactions qualified as generally tax-free under Sections 355 and 361 of the U.S. Internal Revenue Code. The opinions relied on various facts and assumptions, as well as certain representations as to factual matters and undertakings (including with respect to future conduct) made by Yum China and us. If any of these facts, assumptions, representations or undertakings are incorrect or not satisfied, we may not be able to rely on these opinions of outside counsel. Accordingly, notwithstanding receipt of the opinions of outside counsel, the conclusions reached in the tax opinions may be challenged by the IRS. Because the opinions are not binding on the IRS or the courts, there can be no assurance that the IRS or the courts will not prevail in any such challenge.
If, notwithstanding receipt of any opinion, the IRS were to conclude that the Yum China spin-off was taxable, in general, we would recognize taxable gain as if we had sold the Yum China common stock in a taxable sale for its fair market value. In addition, each U.S. holder of our Common Stock who received shares of Yum China common stock in connection with the spin-off transaction would generally be treated as having received a taxable distribution of property in an amount equal to the fair market value of the shares of Yum China common stock received. That distribution would be taxable to each such U.S. stockholder as a dividend to the extent of our current and accumulated earnings and profits. For each such U.S. stockholder, any amount that exceeded our earnings and profits would be treated first as a non-taxable return of capital to the extent of such stockholder’s tax basis in our shares of Common Stock with any remaining amount being taxed as a capital gain.
The Yum China spin-off may be subject to China indirect transfer tax.
In February 2015, the Chinese State Administration of Taxation (“SAT”) issued the Bulletin on Several Issues of Enterprise Income Tax on Income Arising from Indirect Transfers of Property by Non-resident Enterprises (“Bulletin 7”). Pursuant to Bulletin 7, an “indirect transfer” of Chinese taxable assets, including equity interests in a China resident enterprise (“Chinese interests”), by a non-resident enterprise, may be recharacterized and treated as a direct transfer of Chinese taxable assets, if such arrangement does not have reasonable commercial purpose and the transferor has avoided payment of Chinese enterprise income tax. Using general anti-tax avoidance provisions, the SAT may treat an indirect transfer as a direct transfer of Chinese interests if the transfer has avoided Chinese tax by way of an arrangement without reasonable commercial purpose. As a result, gains derived from such indirect transfer may be subject to Chinese enterprise income tax, and the transferee or other person who is obligated to pay for the transfer would be obligated to withhold the applicable taxes, currently at a rate of up to 10% of the capital gain in the case of an indirect transfer of equity interests in a China resident enterprise.
We evaluated the potential applicability of Bulletin 7 in connection with the Separation in the form of a tax free restructuring and believe it is more likely than not that Bulletin 7 does not apply. We believe that the restructuring has reasonable commercial purpose.
However, there are significant uncertainties regarding what constitutes a reasonable commercial purpose, how the safe harbor provisions for group restructurings are to be interpreted and how the Chinese tax authorities will ultimately view the spin-off. As a result, our position could be challenged by the Chinese tax authorities resulting in a tax at a rate of 10% assessed on the difference between the fair market value and the tax basis of Yum China. As our tax basis in Yum China was minimal, the amount of such a tax could be significant and have a material adverse effect on our results of operations and our financial condition.
Failure to protect our service marks or other intellectual property could harm our business.
We regard our Yum®, KFC®, Pizza Hut® and Taco Bell® service marks, and other service marks and trademarks related to our restaurant businesses, as having significant value and being important to our marketing efforts. We rely on a combination of
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protections provided by contracts, copyrights, patents, trademarks, service marks and other common law rights, such as trade secret and unfair competition laws, to protect our restaurants and services from infringement. We have registered certain trademarks and service marks in the U.S. and foreign jurisdictions. However, from time to time we become aware of names and marks identical or confusingly similar to our service marks being used by other persons. Although our policy is to oppose any such infringement, further or unknown unauthorized uses or other misappropriation of our trademarks or service marks could diminish the value of our brands and adversely affect our business. In addition, effective intellectual property protection may not be available in every country in which our Concepts have, or may in the future open or franchise, a restaurant. There can be no assurance that these protections will be adequate, and defending or enforcing our service marks and other intellectual property could result in the expenditure of significant resources. We may also face claims of infringement that could interfere with the use of the proprietary know-how, concepts, recipes, or trade secrets used in our business. Defending against such claims may be costly, and we may be prohibited from using such proprietary information in the future or forced to pay damages, royalties, or other fees for using such proprietary information, any of which could negatively affect our business, reputation, financial condition, and results of operations.
Our business may be adversely impacted by changes in consumer discretionary spending and general economic conditions.
Purchases at our Concepts’ restaurants are discretionary for consumers and, therefore, our results of operations are susceptible to economic slowdowns and recessions. Our and our franchisees' results of operations are dependent upon discretionary spending by consumers, which may be affected by general economic conditions globally or in one or more of the markets we serve. Some of the factors that impact discretionary consumer spending include unemployment rates, fluctuations in the level of disposable income, the price of gasoline, stock market performance and changes in the level of consumer confidence. These and other macroeconomic factors could have an adverse effect on our sales, profitability or development plans, which could harm our financial condition and operating results.
The retail food industry in which we operate is highly competitive.
The retail food industry in which our Concepts operate is highly competitive with respect to price and quality of food products, new product development, digital engagement, advertising levels and promotional initiatives, customer service, reputation, restaurant location, and attractiveness and maintenance of properties. If consumer or dietary preferences change, if our marketing efforts are unsuccessful, or if our Concepts’ restaurants are unable to compete successfully with other retail food outlets in new and existing markets, our and our franchisees' businesses could be adversely affected. We also face growing competition as a result of convergence in grocery, convenience, deli and restaurant services, including the offering by the grocery industry of convenient meals, including pizzas and entrees with side dishes. Competition from delivery aggregators and other food delivery services has also increased in recent years, particularly in urbanized areas, and is expected to continue to increase. Increased competition could have an adverse effect on sales, profitability or development plans, which could harm our or our franchisees’ financial condition and operating results.
Our substantial indebtedness makes us more sensitive to adverse economic conditions, may limit our ability to plan for or respond to significant changes in our business, and requires a significant amount of cash to service our debt payment obligations that we may be unable to generate or obtain.
As of December 31, 2018, our total outstanding short-term borrowings and long-term debt was approximately $10 billion. Subject to the limits contained in the agreements governing our outstanding indebtedness, we may incur additional debt from time to time, which would increase the risks related to our high level of indebtedness.
Specifically, our high level of indebtedness could have important potential consequences, including, but not limited to:
• | increasing our vulnerability to, and reducing our flexibility to plan for and respond to, adverse economic and industry conditions and changes in our business and the competitive environment; |
• | requiring the dedication of a substantial portion of our cash flow from operations to the payment of principal of, and interest on, indebtedness, thereby reducing the availability of such cash flow to fund working capital, capital expenditures, acquisitions, dividends, share repurchases or other corporate purposes; |
• | increasing our vulnerability to a downgrade of our credit rating, which could adversely affect our cost of funds, liquidity and access to capital markets; |
• | restricting us from making strategic acquisitions or causing us to make non-strategic divestitures; |
• | placing us at a disadvantage compared to other less leveraged competitors or competitors with comparable debt at more favorable interest rates; |
• | increasing our exposure to the risk of increased interest rates insofar as current and future borrowings are subject to variable rates of interest; |
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• | increasing our exposure to the risk of discontinuance or modification of certain reference rates including LIBOR, which are used to calculate applicable interest rates of our indebtedness and certain derivative instruments that hedge interest rate risk; |
• | making it more difficult for us to repay, refinance or satisfy our obligations with respect to our debt; |
• | limiting our ability to borrow additional funds in the future and increasing the cost of any such borrowing; |
• | imposing restrictive covenants on our operations, which, if not complied with, could result in an event of default, which in turn, if not cured or waived, could result in the acceleration of the applicable debt, and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies; and |
• | increasing our exposure to risks related to fluctuations in foreign currency as we earn profits in a variety of currencies around the world and our debt is primarily denominated in U.S. dollars. |
There is no assurance that we will generate cash flow from operations or that future debt or equity financings will be available to us to enable us to pay our indebtedness or to fund other liquidity needs. If our business does not generate sufficient cash flow from operations in the amounts projected or at all, or if future borrowings are not available to us in amounts sufficient to pay our indebtedness or to fund other liquidity needs, our financial condition and results of operations may be adversely affected. As a result, we may need to refinance all or a portion of our indebtedness on or before maturity. There is no assurance that we will be able to refinance any of our indebtedness on favorable terms, or at all. Any inability to generate sufficient cash flow or refinance our indebtedness on favorable terms could have a material adverse effect on our business and financial condition.
Item 1B. | Unresolved Staff Comments. |
The Company has received no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of its 2018 fiscal year and that remain unresolved.
Item 2. | Properties. |
As of year end 2018, the Company’s Concepts owned land, building or both for 339 units worldwide in connection with the operation of our 856 Company-owned restaurants. These units are further detailed as follows:
• | The KFC Division owned land, building or both for 72 units. |
• | The Pizza Hut Division owned land, building or both for 4 units. |
• | The Taco Bell Division owned land, building or both for 263 units. |
The Company currently owns or leases land, building or both related to approximately 1,000 units, not included in the property counts above, that it leases or subleases to franchisees, principally in the U.S., United Kingdom, Australia, Germany and France.
Company-owned restaurants in the U.S. with leases are generally leased for initial terms of 15 or 20 years and generally have renewal options; however, Pizza Hut delivery/carryout units in the U.S. generally are leased for significantly shorter initial terms with shorter renewal options. Company-owned restaurants outside the U.S. with leases have initial lease terms and renewal options that vary by country.
The KFC Division and Pizza Hut Division corporate headquarters and a KFC and Pizza Hut research facility in Plano, Texas are owned by Pizza Hut. Taco Bell leases its corporate headquarters and research facility in Irvine, California. The YUM corporate headquarters and a KFC research facility in Louisville, Kentucky are owned by KFC. Additional information about the Company’s properties is included in the Consolidated Financial Statements in Part II, Item 8.
The Company believes that its properties are generally in good operating condition and are suitable for the purposes for which they are being used.
Item 3. | Legal Proceedings. |
The Company is subject to various lawsuits covering a variety of allegations. The Company believes that the ultimate liability, if any, in excess of amounts already provided for these matters in the Consolidated Financial Statements, is not likely to have a material adverse effect on the Company’s annual results of operations, financial condition or cash flows. Matters faced by the Company include, but are not limited to, claims from franchisees, suppliers, employees, customers and others related to operational, contractual or employment issues as well as claims that the Company has infringed on third-party intellectual property rights. In addition, the Company brings claims from time-to-time relating to infringement of, or challenges to, our intellectual property, including registered marks. Finally, as a publicly-traded company, disputes arise from time-to-time with our shareholders, including
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allegations that the Company breached federal securities laws or that officers and/or directors breached fiduciary duties. Descriptions of significant current specific claims and contingencies, if any, appear in Note 19, Contingencies, to the Consolidated Financial Statements included in Part II, Item 8, which is incorporated by reference into this item.
Item 4. | Mine Safety Disclosures. |
Not applicable.
Executive Officers of the Registrant.
The executive officers of the Company as of February 20, 2019, and their ages and current positions as of that date are as follows:
Greg Creed, 61, is Chief Executive Officer of YUM. He has served in this position since January 2015. He served as Chief Executive Officer of Taco Bell Division from January 2014 to December 2014 and as Chief Executive Officer of Taco Bell U.S. from 2011 to December 2013. Prior to this position, Mr. Creed served as President and Chief Concept Officer of Taco Bell U.S., a position he held beginning in December 2006.
David Gibbs, 55, is President, Chief Operating Officer and Chief Financial Officer of YUM. He has served as President and Chief Financial Officer since May 2016 and as Chief Operating Officer since January 2019. Prior to these positions, he served as Chief Executive Officer of Pizza Hut Division from January 2015 to April 2016. From January 2014 to December 2014, Mr. Gibbs served as President of Pizza Hut U.S. Prior to this position, Mr. Gibbs served as President and Chief Financial Officer of Yum! Restaurants International, Inc. (“YRI”) from May 2012 through December 2013. Mr. Gibbs served as Chief Financial Officer of YRI from January 2011 to April 2012. He was Chief Financial Officer of Pizza Hut U.S. from September 2005 to December 2010.
Scott Catlett, 42, is General Counsel and Corporate Secretary of YUM. He has severed in this position since July 2018. Prior to serving as General Counsel he served as Vice President and Deputy General Counsel of YUM from November 2015 to June 2018. From September 2007 to October 2015 Mr. Catlett held various Yum positions including Vice President & Associate General Counsel.
Tony Lowings, 60, is Chief Executive Officer of KFC Division, a position he has held since January 2019. Prior to that, he served as President and Chief Operations Officer of KFC Division from August 2018 to December 2018. From November 2016 to July 2018 he served as Managing Director of Asia-Pacific and from February 2013 to October 2016 as Managing Director of KFC SOPAC (Australia and New Zealand). Mr. Lowings served in various positions including Chief Operations Officer of YRI and Managing Director of Latin America and the Caribbean for KFC, Pizza Hut and Taco Bell and General Manager of KFC and Pizza Hut in Australia and New Zealand from January 2010 to January 2013.
David Russell, 49, is Senior Vice President, Finance and Corporate Controller of YUM. He has served as YUM's Corporate Controller since February 2011 and as Senior Vice President, Finance since February 2017. Prior to serving as Corporate Controller, Mr. Russell served in various positions at the Vice President-level in the Yum Finance Department, including Controller-Designate from November 2010 to February 2011 and Vice President, Assistant Controller from January 2008 to December 2010.
Tracy Skeans, 46, is Chief Transformation and People Officer of YUM. She has served as Chief People Officer since January 2016 and Chief Transformation Officer since November 2016. From January 2015 to December 2015, she was President of Pizza Hut International. Prior to this position, Ms. Skeans served as Chief People Officer of Pizza Hut Division from December 2013 to December 2014 and Chief People Officer of Pizza Hut U.S. from October 2011 to November 2013. From July 2009 to September 2011, she served as Director of Human Resources for Pizza Hut U.S and was on the Pizza Hut U.S. Finance team from September 2000 to June 2009.
Executive officers are elected by and serve at the discretion of the Board of Directors.
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PART II
Item 5. | Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
The Company’s Common Stock trades under the symbol YUM and is listed on the New York Stock Exchange ("NYSE"). The following sets forth the dividends per common share declared by quarter for the Company’s Common Stock.
Quarter | 2018 | 2017 | ||||||
First | $ | 0.36 | $ | 0.30 | ||||
Second | 0.36 | 0.30 | ||||||
Third | 0.36 | — | ||||||
Fourth | 0.36 | 0.30 | ||||||
In 2018, the Company paid four cash dividends of $0.36 per share. In 2017, the Company paid four cash dividends of $0.30 per share. This included a dividend distributed February 3, 2017, that had been declared on December 21, 2016. Over the long term, the Company targets an annual dividend payout ratio of 45% to 50% of Net Income, before Special Items.
As of February 13, 2019, there were 43,458 registered holders of record of the Company’s Common Stock.
Issuer Purchases of Equity Securities
The following table provides information as of December 31, 2018, with respect to shares of Common Stock repurchased by the Company during the quarter then ended.
Fiscal Periods | Total number of shares purchased (thousands) | Average price paid per share | Total number of shares purchased as part of publicly announced plans or programs (thousands) | Approximate dollar value of shares that may yet be purchased under the plans or programs (millions) | ||||||||
10/1/18 - 10/31/18 | 1,249 | $ | 89.12 | 1,249 | $ | 1,691 | ||||||
11/1/18- 11/30/18 | 1,478 | $ | 89.44 | 1,478 | $ | 1,559 | ||||||
12/1/18 - 12/31/18 | 5,032 | $ | 90.01 | 5,032 | $ | 1,106 | ||||||
Total | 7,759 | 7,759 | $ | 1,106 | ||||||||
On August 10, 2018, our Board of Directors authorized share repurchases through December 2019 of up to $2 billion (excluding applicable transaction fees) of our outstanding Common Stock. As of December 31, 2018, we have remaining capacity to repurchase up to $1.1 billion of Common Stock under this authorization.
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Stock Performance Graph
This graph compares the cumulative total return of our Common Stock to the cumulative total return of the S&P 500 Index and the S&P 500 Consumer Discretionary Sector Index, a peer group that includes YUM, for the period from December 31, 2013 to December 31, 2018. The graph assumes that the value of the investment in our Common Stock and each index was $100 at December 31, 2013 and that all cash dividends were reinvested.
12/31/2013 | 12/31/2014 | 12/31/2015 | 12/30/2016 | 12/29/2017 | 12/31/2018 | |||||||||||||||||||
YUM | $ | 100 | $ | 98 | $ | 101 | $ | 124 | $ | 163 | $ | 187 | ||||||||||||
S&P 500 | $ | 100 | $ | 114 | $ | 115 | $ | 129 | $ | 157 | $ | 150 | ||||||||||||
S&P Consumer Discretionary | $ | 100 | $ | 110 | $ | 121 | $ | 128 | $ | 157 | $ | 159 | ||||||||||||
Source of total return data: Bloomberg
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Item 6. | Selected Financial Data. |
Selected Financial Data
YUM! Brands, Inc. and Subsidiaries
(in millions, except per share and unit amounts)
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2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
Income Statement Data | |||||||||||||||||||
Revenues | |||||||||||||||||||
Company sales | $ | 2,000 | $ | 3,572 | $ | 4,189 | $ | 4,336 | $ | 4,503 | |||||||||
Franchise and property revenues | 2,482 | 2,306 | 2,167 | 2,082 | 2,084 | ||||||||||||||
Franchise contributions for advertising and other services | 1,206 | — | — | — | — | ||||||||||||||
Total | 5,688 | 5,878 | 6,356 | 6,418 | 6,587 | ||||||||||||||
Refranchising (gain) loss | (540 | ) | (1,083 | ) | (163 | ) | 23 | (16 | ) | ||||||||||
Operating Profit | 2,296 | 2,761 | 1,682 | 1,434 | 1,517 | ||||||||||||||
Other pension (income) expense | 14 | 47 | 32 | 40 | N/A | ||||||||||||||
Interest expense, net | 452 | 445 | 307 | 141 | 146 | ||||||||||||||
Income from continuing operations before income taxes | 1,839 | 2,274 | 1,345 | 1,253 | 1,374 | ||||||||||||||
Income from continuing operations | 1,542 | 1,340 | 1,018 | 926 | 1,006 | ||||||||||||||
Income from discontinued operations, net of tax | N/A | N/A | 625 | 357 | 45 | ||||||||||||||
Net Income | 1,542 | 1,340 | 1,643 | 1,283 | 1,051 | ||||||||||||||
Basic earnings per share from continuing operations | 4.80 | 3.86 | 2.58 | 2.13 | 2.27 | ||||||||||||||
Basic earnings per share from discontinued operations | N/A | N/A | 1.59 | 0.82 | 0.10 | ||||||||||||||
Basic earnings per share | 4.80 | 3.86 | 4.17 | 2.95 | 2.37 | ||||||||||||||
Diluted earnings per share from continuing operations | 4.69 | 3.77 | 2.54 | 2.09 | 2.22 | ||||||||||||||
Diluted earnings per share from discontinued operations | N/A | N/A | 1.56 | 0.81 | 0.10 | ||||||||||||||
Diluted earnings per share | 4.69 | 3.77 | 4.10 | 2.90 | 2.32 | ||||||||||||||
Diluted earnings per share from continuing operations excluding Special Items | 3.17 | 2.96 | 2.46 | 2.31 | 2.20 | ||||||||||||||
Cash Flow Data | |||||||||||||||||||
Provided by operating activities | $ | 1,176 | $ | 1,030 | $ | 1,248 | $ | 1,260 | $ | 1,217 | |||||||||
Capital spending | 234 | 318 | 427 | 442 | 508 | ||||||||||||||
Proceeds from refranchising of restaurants | 825 | 1,773 | 370 | 213 | 83 | ||||||||||||||
Repurchase shares of Common Stock | 2,390 | 1,960 | 5,403 | 1,200 | 820 | ||||||||||||||
Dividends paid on Common Stock | 462 | 416 | 744 | 730 | 669 | ||||||||||||||
Balance Sheet Data | |||||||||||||||||||
Total assets | $ | 4,130 | $ | 5,311 | $ | 5,453 | $ | 4,939 | $ | 5,073 | |||||||||
Long-term debt | 9,751 | 9,429 | 9,059 | 2,988 | 3,003 | ||||||||||||||
Total debt | 10,072 | 9,804 | 9,125 | 3,908 | 3,268 | ||||||||||||||
Other Data | |||||||||||||||||||
Number of units at year end | |||||||||||||||||||
Franchise | 47,268 | 43,603 | 40,834 | 39,320 | 37,959 | ||||||||||||||
Company | 856 | 1,481 | 2,841 | 3,163 | 3,279 | ||||||||||||||
System | 48,124 | 45,084 | 43,675 | 42,483 | 41,238 | ||||||||||||||
System net new unit growth | 7 | % | 3 | % | 3 | % | 3 | % | 3 | % | |||||||||
System and same-store sales | |||||||||||||||||||
KFC Division System sales | $ | 26,239 | $ | 24,515 | $ | 23,242 | $ | 22,628 | $ | 23,458 | |||||||||
System sales growth | 7 | % | 5 | % | 3 | % | (3 | )% | 1 | % | |||||||||
System sales growth, ex FX | 6 | % | 6 | % | 7 | % | 5 | % | 4 | % | |||||||||
Same-store sales growth | 2 | % | 3 | % | 2 | % | 1 | % | 1 | % | |||||||||
Pizza Hut Division System sales | $ | 12,212 | $ | 12,034 | $ | 12,019 | $ | 11,999 | $ | 12,106 | |||||||||
System sales growth (decline) | 1 | % | — | % | — | % | (1 | )% | 1 | % | |||||||||
System sales growth, ex FX | 1 | % | 1 | % | 2 | % | 3 | % | 2 | % | |||||||||
Same-store sales growth (decline) | — | % | — | % | (2 | )% | — | % | (2 | )% | |||||||||
Taco Bell Division System sales | $ | 10,786 | $ | 10,145 | $ | 9,660 | $ | 9,102 | $ | 8,459 | |||||||||
System sales growth | 6 | % | 5 | % | 6 | % | 8 | % | 4 | % | |||||||||
System sales growth, ex FX | 6 | % | 5 | % | 6 | % | 8 | % | 4 | % | |||||||||
Same-store sales growth | 4 | % | 4 | % | 2 | % | 5 | % | 3 | % | |||||||||
Shares outstanding at year end | 306 | 332 | 355 | 420 | 434 | ||||||||||||||
Cash dividends declared per common share | $ | 1.44 | $ | 0.90 | $ | 1.73 | $ | 1.74 | $ | 1.56 | |||||||||
Market price per share at year end | $ | 91.92 | $ | 81.61 | $ | 63.33 | $ | 73.05 | $ | 73.14 | |||||||||
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The table above reflects the impact of the adoption of new revenue recognition accounting standards in fiscal year 2018. Refer to Note 2 in our Consolidated Financial Statements for information regarding our adoption of the new revenue recognition standards.
System unit growth in 2018 includes addition of 1,282 Telepizza units. See Management's Discussion and Analysis ("MD&A") Part II, Item 7 for a description of the Telepizza strategic alliance.
Fiscal years for our U.S. and certain international subsidiaries that operate on a weekly periodic calendar include 52 weeks in 2018, 2017, 2015 and 2014 and 53 weeks in 2016. Refer to Note 2 in our Consolidated Financial Statements for additional details related to our fiscal calendar.
Discontinued operations in 2016, 2015 and 2014 reflects the spin-off of our China business into an independent, publicly traded company (the "Separation"). See Note 1 in our Consolidated Financial Statements.
Historical stock prices prior to November 1, 2016, do not reflect any adjustment for the impact of the Separation.
The non-GAAP measures of System sales, System sales excluding the impacts of foreign currency translation ("FX") and Diluted earnings per share from continuing operations excluding Special Items are discussed in further detail in our MD&A within Part II, Item 7.
See discussion of our 2018, 2017 and 2016 Special Items in our MD&A. Special Items in 2015 negatively impacted Operating Profit by $91 million and negatively impacted Net Income by $95 million, due to costs associated with the KFC Acceleration Agreement and Refranchising losses. Special Items in 2014 positively impacted Operating Profit by $16 million and positively impacted Net Income by $12 million, primarily due to Refranchising gains.
Selected financial data for years 2016 and 2015 has been recast from that originally presented to present the change in our reporting calendar and retroactively adopting a new accounting standard related to the presentation of net periodic pension cost and net periodic postretirement benefit cost. 2014 reflects our Balance Sheet and store count data that were recast for purposes of presenting 2015 Consolidated Statement of Cash Flows and unit growth. No other data presented in 2014 has been recast. Refer to Note 5 in our Consolidated Financial Statements for additional details related to our change in reporting calendar.
The selected financial data should be read in conjunction with the Consolidated Financial Statements.
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Introduction and Overview
The following Management’s Discussion and Analysis (“MD&A”), should be read in conjunction with the Consolidated Financial Statements (“Financial Statements”) in Item 8 and the Forward-Looking Statements and the Risk Factors set forth in Item 1A. All Note references herein refer to the Notes to the Financial Statements. Tabular amounts are displayed in millions of U.S. dollars except per share and unit count amounts, or as otherwise specifically identified. Unless otherwise stated, financial results herein reflect continuing operations of the Company. Percentages may not recompute due to rounding.
YUM! Brands, Inc. (“YUM” or the “Company”) franchises or operates a worldwide system of over 48,000 restaurants in more than 140 countries and territories, primarily under the concepts of KFC, Pizza Hut and Taco Bell (collectively, the "Concepts"). These three Concepts are global leaders of the chicken, pizza and Mexican-style food categories, respectively. Of the over 48,000 restaurants, 98% are operated by franchisees.
As of December 31, 2018, YUM consists of three operating segments:
• | The KFC Division which includes our worldwide operations of the KFC concept |
• | The Pizza Hut Division which includes our worldwide operations of the Pizza Hut concept |
• | The Taco Bell Division which includes our worldwide operations of the Taco Bell concept |
On October 31, 2016, (the “Distribution Date”), we completed the spin-off of our China business (the "Separation") into an independent, publicly-traded company under the name of Yum China Holdings, Inc. (“Yum China”). On the Distribution Date, we distributed to each of our shareholders of record as of the close of business on October 19, 2016 (the “Record Date”) one share of Yum China common stock for each share of YUM common stock (“Common Stock”) held as of the Record Date. The distribution was structured to be a tax free distribution to our U.S. shareholders for federal income tax purposes in the United States. Concurrent with the Separation, a subsidiary of the Company entered into a Master License Agreement with a subsidiary of Yum China for the exclusive right to use and sublicense the use of intellectual property owned by YUM and its affiliates for the development and operation of KFC, Pizza Hut and Taco Bell restaurants in mainland China. Prior to the Separation, our operations in mainland China were reported in our former China Division segment results. As a result of the Separation, the results of operations and cash flows of the separated business are presented as discontinued operations in our Consolidated Statements of Income and Consolidated Statements of Cash Flows for periods prior to the Separation. See additional information related to the impact of the Separation in Note 4.
On October 11, 2016, we announced our strategic transformation plans to drive global expansion of our KFC, Pizza Hut and Taco Bell brands (“YUM’s Strategic Transformation Initiatives”) following the Separation. Major features of the Company’s transformation and growth strategy involve being more focused, franchised and efficient. YUM’s Strategic Transformation Initiatives below represent the continuation of YUM’s transformation of its operating model and capital structure.
• | More Focused. Four growth drivers form the basis of YUM’s strategic plans and repeatable business model to accelerate same-store sales growth and net-new restaurant development at KFC, Pizza Hut and Taco Bell around the world over the long term. The Company is focused on becoming best-in-class in: |
• | Building Relevant, Easy and Distinctive Brands |
• | Developing Unmatched Franchise Operating Capability |
• | Driving Bold Restaurant Development |
• | Growing Unrivaled Culture and Talent |
• | More Franchised. YUM successfully increased franchise restaurant ownership to 98% as of December 31, 2018. |
• | More Efficient. The Company is revamping its financial profile, improving the efficiency of its organization and cost structure globally, by: |
• | Reducing annual capital expenditures to approximately $100 million in 2019; |
• | Lowering General and administrative expenses ("G&A") to 1.7% of system sales in 2019; and |
• | Maintaining an optimized capital structure of ~5.0x Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) leverage. |
From 2017 through 2019, we intend to return an additional $6.5 - $7.0 billion to shareholders through share repurchases and cash dividends. We intend to fund these shareholder returns through a combination of refranchising proceeds, free cash flow generation
24
and maintenance of our five times EBITDA leverage. We generated pre-tax proceeds of $2.8 billion through our refranchising initiatives to achieve targeted franchise ownership of 98%, which were completed in December 2018. Refer to the Liquidity and Capital Resources section of this MD&A for additional details.
Beginning in 2017, we changed our fiscal year from a year ending on the last Saturday of December to a year beginning on January 1 and ending on December 31 of each year. Concurrently, we removed the reporting lags from the fiscal calendars of our international subsidiaries. Our MD&A has been recast to reflect the change in our reporting calendar. See Notes 2 and 5 for additional details related to our fiscal calendar.
We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including performance metrics that management uses to assess the Company's performance. Throughout this MD&A, we commonly discuss the following performance metrics:
• | Same-store sales growth is the estimated percentage change in sales of all restaurants that have been open and in the YUM system for one year or more. |
• | Net new units represents new unit openings, offset by store closures. |
• | Company restaurant profit ("Restaurant profit") is defined as Company sales less expenses incurred directly by our Company-owned restaurants in generating Company sales. Company restaurant margin as a percentage of sales is defined as Restaurant profit divided by Company sales. Within the Company sales and Restaurant profit sections of this MD&A, Store Portfolio Actions represent the net impact of new unit openings, acquisitions, refranchising and store closures, and Other primarily represents the impact of same-store sales as well as the impact of changes in costs such as inflation/deflation. |
In addition to the results provided in accordance with Generally Accepted Accounting Principles in the United States of America ("GAAP"), the Company provides the following non-GAAP measurements.
• | System sales, System sales excluding the impacts of foreign currency translation ("FX"), and System sales excluding FX and the impact of the 53rd week in 2016. System sales include the results of all restaurants regardless of ownership, including Company-owned and franchise restaurants that operate our Concepts. Sales of franchise restaurants typically generate ongoing franchise and license fees for the Company at a rate of 3% to 6% of sales. Franchise restaurant sales are not included in Company sales on the Consolidated Statements of Income; however, the franchise and license fees are included in the Company’s revenues. We believe System sales growth is useful to investors as a significant indicator of the overall strength of our business as it incorporates all of our revenue drivers, Company and franchise same-store sales as well as net unit growth. |
• | Diluted Earnings Per Share from Continuing Operations excluding Special Items (as defined below); |
• | Effective Tax Rate excluding Special Items; |
• | Core Operating Profit and Core Operating Profit excluding the impact of the 53rd week in 2016. Core Operating Profit excludes Special Items and FX and we use Core Operating Profit for the purposes of evaluating performance internally. |
These non-GAAP measurements are not intended to replace the presentation of our financial results in accordance with GAAP. Rather, the Company believes that the presentation of these non-GAAP measurements provide additional information to investors to facilitate the comparison of past and present operations.
Special Items are not included in any of our Division segment results as the Company does not believe they are indicative of our ongoing operations due to their size and/or nature. Our chief operating decision maker does not consider the impact of Special Items when assessing segment performance.
Certain non-GAAP measurements are presented excluding the impact of FX. These amounts are derived by translating current year results at prior year average exchange rates. We believe the elimination of the FX impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.
For 2016 we provided Core Operating Profit excluding 53rd week and System sales excluding 53rd week to further enhance the comparability with the lapping of the 53rd week that was part of our fiscal calendar in 2016.
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Results of Operations
Summary
All comparisons within this summary are versus the same period a year ago.
For 2018, GAAP diluted EPS from continuing operations increased 24% to $4.69 per share, and diluted EPS from continuing operations excluding Special Items, increased 7% to $3.17 per share.
2018 financial highlights:
% Change | |||||||||
System Sales, Ex FX | Same-Store Sales | Net New Units | GAAP Operating Profit | Core Operating Profit | |||||
KFC Division | +6 | +2 | +5 | (2) | (2) | ||||
Pizza Hut Division | +1 | Even | +10 | +2 | +2 | ||||
Taco Bell Division | +6 | +4 | +3 | +2 | +2 | ||||
Worldwide | +5 | +2 | +7 | (17) | Even | ||||
Additionally:
• | During the year, we opened 1,757 net new units and added 1,282 Telepizza units for 7% net new unit growth. |
• | During the year, we refranchised 660 restaurants, including 364 KFC, 97 Pizza Hut and 199 Taco Bell units, for pre-tax proceeds of $825 million. We recorded net refranchising gains of $540 million in Special Items. |
• | During the year, we repurchased 28.2 million shares totaling $2.4 billion at an average share price of $85. |
For 2017, GAAP diluted EPS from continuing operations increased 48% to $3.77 per share, and diluted EPS from continuing operations excluding Special Items, increased 20% to $2.96 per share.
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2017 financial highlights:
% Change | |||||||||
System Sales, Ex FX | Same-Store Sales | Net New Units | GAAP Operating Profit | Core Operating Profit | |||||
KFC Division | +6 | +3 | +4 | +13 | +12 | ||||
Pizza Hut Division | +1 | Even | +2 | (7) | (6) | ||||
Taco Bell Division | +5 | +4 | +4 | +4 | +4 | ||||
Worldwide | +4 | +2 | +3 | +64 | +7 | ||||
Results Excluding 53rd Week in 2016 (% Change) | |||
System Sales, Ex FX | Core Operating Profit | ||
KFC Division | +6 | +14 | |
Pizza Hut Division | +2 | (5) | |
Taco Bell Division | +7 | +6 | |
Worldwide | +5 | +9 | |
Additionally:
• | During the year, we opened 1,407 net new units for 3% net new unit growth. |
• | During the year, we refranchised 1,470 restaurants, including 828 KFC, 389 Pizza Hut and 253 Taco Bell units, for pre-tax proceeds of $1.8 billion. We recorded net refranchising gains of $1.1 billion in Special Items. |
• | During the year, we repurchased 26.6 million shares totaling $1.9 billion at an average share price of $72. |
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Worldwide
GAAP Results
Amount | % B/(W) | ||||||||||||||||||||
2018 | 2017 | 2016 | 2018 | 2017 | |||||||||||||||||
Company sales | $ | 2,000 | $ | 3,572 | $ | 4,189 | (44 | ) | (15 | ) | |||||||||||
Franchise and property revenues | 2,482 | 2,306 | 2,167 | 8 | 6 | ||||||||||||||||
Franchise contributions for advertising and other services | 1,206 | — | — | N/A | N/A | ||||||||||||||||
Total revenues | $ | 5,688 | $ | ||||||||||||||||||