KFC Holdings Japan / 9873

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1 COVERAGE INITIATED ON: Shared Research Inc. has produced this report by request from the company discussed in the report. The aim is to provide an owner s manual to investors. We at Shared Research Inc. make every effort to provide an accurate, objective, and neutral analysis. In order to highlight any biases, we clearly attribute our data and findings. We will always present opinions from company management as such. Our views are ours where stated. We do not try to convince or influence, only inform. We appreciate your suggestions and feedback. Write to us at sr_inquiries@sharedresearch.jp or find us on Bloomberg. Research Report by Shared Research Inc.

2 INDEX How to read a Shared Research report: This report begins with the trends and outlook section, which discusses the company s most recent earnings. First-time readers should start at the business section later in the report. Executive summary Key financial data Recent updates Highlights Trends and outlook Monthly trends Quarterly trends and results Outlook Business Overview KFC business Pizza Hut business Other business Earnings structure Market and value chain Strengths and weaknesses Historical financial statements Income statement News and topics Balance sheet Cash flow statement Other information History Corporate governance and top management Dividend policy Major shareholders (as of March 31, 2017) Principal group companies (as of June 2017) Employees By the way Profile /53

3 Executive summary Core businesses Under a master franchise agreement with Yum! Brands Inc., KFC Holdings Japan operates KFC brand restaurants in Japan. The company also acts as a franchisor in Japan for the KFC brand, earning royalties and other revenues. The company projects that the KFC business (78. of company revenues and 59. of operating profit before eliminations in FY03/17) had a leading domestic market share, at 37% of the fried chicken market in As of end March 2017 the company had 326 directly operated restaurants primarily in Greater Tokyo, and 823 restaurants run by franchisees mainly in regional areas. According to the company, Japan s fried chicken market has been relatively flat since 2000, and since 2003 major convenience stores have entered the fried chicken market. In this difficult environment, KFC is distinctive due to the brand power of its original chicken, which it has cultivated since its launch in Japan in 1970, and procurement arrangements with major trading company Mitsubishi Corporation (TSE1: 8058) for high-quality chicken. Convenience stores primarily use imported frozen chicken 50 days old or older, while KFC uses only Japan-raised chickens (about 40 days old), which are more tender but make stable procurement difficult. Trends and outlook (to be updated following interviews with the company) Total revenues have been in the upper JPY80bn-region since FY03/11. The company s restaurant sales are sensitive to consumers disposable income because its meals are higher priced and often purchased for special occasions, rather than as casual dining options (average customer spend: over JPY1,000 for KFC and nearly JPY2,800 for Pizza Hut). Operating profit declined from a peak of JPY3.5bn in FY03/11 to JPY700mn in FY03/15 due to higher ingredient and personnel costs, but recovered to JPY2.6bn in FY03/17(+27.2% YoY) on cost cuts in the Pizza Hut business. For FY03/18, the company expects total revenues of JPY77.4bn (-12.1% YoY), operating profit of JPY1.2bn (-53.1%), recurring profit of JPY1.0bn (-58.8%), and net income of JPY1.5bn (+9.8%). KFC forecasts a JPY2bn revenue increase after new store openings and renovations. Even so, overall revenues are expected to decline because Pizza Hut was sold to an investment fund in June Operating profit and recurring profit are projected to fall because of the sale of Pizza Hut and frontloaded spending intended to accelerate new store openings and renovations to attract more customers to KFC restaurants. Net income is forecast to rise after adjustments for corporate taxes related to the sale of Pizza Hut. Outside Japan, the company plans to expand the earnings of the Thai KFC business (an equity-method affiliate) by opening new stores. The Japanese parent acquired the Thai affiliate in August 2016 through a Singapore subsidiary. Note that Shared Research analysis showed that as of Q3 the company is unlikely to achieve its sales and operating profit targets. Strengths and weaknesses Shared Research thinks that the company s strengths are brand power cultivated since its founding; a business model built on a relationship with Mitsubishi; and economies of scale. We think that its weaknesses are constraints imposed by franchise agreements with Yum! Brands; Pizza Hut store locations suited to home delivery not visibility, and constraints on KFC sales promotions due to using 10 domestically raised chicken. 03/53

4 Key financial data Income statement FY11/08 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17 FY03/18 FY03/19 (JPYmn) Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Est. Total revenues 86, ,815 88,823 88,124 85,864 83,436 84,605 88,180 88,032 73,457 73,000 YoY 2.2% % -2.6% -2.8% 1.4% 4.2% -0.2% -16.6% -17.1% Gross profit 40,745 59,116 41,108 39,683 39,656 38,460 38,206 39,364 39,887 31,604 GPM % 46.3% % 46.1% 45.2% 44.6% 45.3% 43. SG&A expenses 39,627 53,862 37,576 37,293 37,261 36,638 37,536 37,352 37,328 31,127 YoY % -30.2% -0.8% -0.1% -1.7% 2.5% -0.5% -0.1% -16.6% SG&A ratio 45.7% 43.2% 42.3% 42.3% 43.4% 43.9% 44.4% 42.4% 42.4% 42.4% Operating profit 1,117 5,253 3,531 2,390 2,395 1, ,011 2, ,000 YoY -60.6% 370.3% -32.8% -32.3% 0.2% -23.9% -63.2% 200.1% 27.2% -81.4% 109.6% OPM 1.3% 4.2% % 2.8% 2.2% 0.8% 2.3% 2.9% 0.6% 1.4% Recurring profit 1,207 5,459 3,708 2,469 2,506 1, ,866 2, ,100 YoY -57.6% 352.3% -32.1% -33.4% 1.5% -25.9% -64.1% 179.8% % 75.4% RPM 1.4% 4.4% 4.2% 2.8% 2.9% 2.2% 0.8% 2.1% 2.8% 0.9% 1.5% Net income attributable to parent company shareholders 483 2,570 1,891 1,102 1, , YoY -65.1% 432.1% -26.4% -41.7% 9.2% -63.3% % -57.8% 21. Net margin 0.6% 2.1% 2.1% 1.3% 1.4% 0.5% -0.6% 0.8% 1.6% 0.8% 1. Per share data (JPY, adjusted for stock sp Shares issued (year end; '000) 22,983 22,783 22,783 22,783 22,783 22,783 22,783 22,783 22,783 22,783 EPS EPS (fully diluted) Dividend per share Book value per share 1, , , , , , Balance sheet (JPYmn) Current assets 19,902 23,549 22,549 23,500 23,340 21,682 22,332 21,390 20,721 15,194 Cash and cash equivalents 13,888 13,596 15,808 13,058 13,502 16,146 16,804 15,339 14,571 9,757 Accounts receivable 3,336 3,093 2,947 3,729 3,544 3,701 3,546 3,855 4,007 3,562 Inventories Others 1,866 6,210 3,123 5,980 5,565 1,317 1,585 1,499 1,693 1,461 Fixed assets 21,032 18,836 18,461 17,882 16,968 16,301 16,085 17,902 18,762 20,552 Tangible fixed assets 8,899 7,925 7,228 6,681 6,184 5,703 6,093 7,178 8,506 7,734 Intangible fixed assets 1,052 1,763 2,555 3,128 2,950 2,924 2,874 2,828 2,206 1,704 Investments and other assets 11,081 9,148 8,678 8,073 7,834 7,674 7,118 7,896 8,050 11,113 Total assets 40,934 42,385 41,011 41,383 40,308 37,984 38,418 39,292 39,484 35,746 Current liabilities 13,922 13,470 13,046 13,837 13,029 11,203 13,166 13,070 13,033 10,929 Accounts payable 7,621 5,699 5,680 7,603 6,568 5,754 5,978 6,232 5,824 5,735 Short-term debt Other current liabilities 6,301 7,771 7,226 6,041 6,250 5,256 7,001 6,307 6,591 4,663 Fixed liabilities 3,829 4,271 4,648 4,392 4,065 4,283 4,031 5,317 5,272 4,190 Long-term debt ,533 1, Others 3,829 4,271 4,289 4,033 3,858 4,095 3,599 3,784 4,130 3,524 Net assets 23,181 24,643 23,317 23,153 23,214 22,497 21,219 20,904 21,178 20,626 Capital stock 7,297 7,297 7,297 7,297 7,297 7,297 7,297 7,297 7,297 7,297 Capital surplus 10,430 10,430 10,430 10,430 10,430 10,430 10,430 10,430 10,430 10,430 Retained earnings 5,910 6,945 6,105 6,083 6,165 5,485 4,228 3,837 4,082 3,539 Treasury stock Accumulated other comprehensive income Share subscription rights Minority interests Total liabilities and capital 40,934 42,385 41,011 41,383 40,308 37,984 38,418 39,292 39,484 35,746 Statement of cash flows (JPYmn) Cash flows from operating activities 4,171 6,108 4,186 3,814 3,370 1,717 4,574 1,519 4,424 1,928 Cash flows from investing activities -1,929-6,485 1,869-5,108-1,558 2,287-1, ,679-4,863 Cash flows from financing activities -1,332-1,212-3,343-1,456-1,367-1,360-1,360-1,686-1,512-1,878 Financial ratios Interest-bearing debt ,064 1,760 1,197 Net cash 13,888 13,596 15,309 12,506 13,084 15,765 16,185 13,275 12,811 8,560 ROA (RP-based) % 8.9% % 4.7% 1.7% 4.8% 6.2% 1.7% ROE % 7.9% 4.7% 5.2% 1.9% -2.4% 3.5% 6.5% 2.8% Current ratio 143% 175% 173% % 194% % 159% 139% Fixed ratio 90.7% 76.4% 79.2% 77.2% 73.1% 72.5% 75.8% 85.6% 88.6% 99.6% Equity ratio 56.6% 58.1% 56.9% 55.9% 57.6% 59.2% 55.2% 53.2% 53.6% 57.7% Note: Data for FY03/10 are for 16 months due to change in balance date Note: Accounts receivable figures are after deducting bad debt provisions Figures may differ from company materials due to differences in rounding methods 04/53

5 Recent updates Highlights On May 9, 2018, KFC Holdings Japan announced earnings results for full-year FY03/18; see the results section for details. On May 7, 2018, the company announced monthly sales data for April 2018; see the monthly trends section for details On April 9, 2018, the company announced monthly sales data for March 2018 On March 7, 2018, the company announced monthly sales data for February On March 5, 2018, Shared Research updated the report following interviews with the company. On February 23, 2018, the company announced a capital and business alliance with restaurant operator BYO Co., Ltd. Reasons for the capital and business alliance Since its foundation in 1991, BYO, which positions itself as a creative company that passes on Japanese culture through gastronomy, has created unique restaurants under brand names such as washoku sake EN, Obon de Gohan, and Dashichazuke EN. It currently operates 117 restaurants, of which 111 are in Japan and six overseas. KFC Holdings and BYO share the same business philosophy that focuses on hand-made products using selected ingredients, and provision of food that is enriching. The two companies decided to enter into a capital and business alliance thinking that the partnership will allow them to create new business opportunities and generate synergies that would increase the corporate value of both companies in the medium to long-term. As stated in the new medium-term plan Building the Future 2017 (announced in 2015), KFC Holdings considers M&A and business alliances as one of its growth strategies and intends to achieve further growth through such initiatives. Overview of the capital and business alliance KFC Holdings plans to acquire a certain amount of BYO common shares from existing shareholders. At the same time, it plans to subscribe to the shares newly issued by BYO through third party allocation (25% of voting rights). Details of the business alliance will be discussed between the two companies going forward. The capital and business alliance agreement was signed on February 23, 2018 and the payment date for share acquisition is scheduled for late March. The company believes the impact of this event on its FY03/18 consolidated earnings will be marginal and it plans to promptly disclose any information on matters requiring public announcement. For previous releases and developments, please refer to the News and topics section. 05/53

6 Trends and outlook Monthly trends FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17 FY03/18 FY03/19* Average system sales per store 5.7% -2.6% % 3.5% 7.4% -0.9% -1.7% -6.3% Sales at directly operated comparable stores 4.2% -3.5% -4.1% -3.4% 2.9% 8.8% -0.8% -1.4% -5.5% Customer count 3.7% -2.5% -1.5% % 1.6% -2.5% -4.2% -8.5% Spend per customer 0.5% -0.9% -2.7% 0.6% 2.6% 7.1% 1.7% % FY03/13 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores 8.9% -0.3% 6.9% % % -8.3% -8.8% -5.4% -11.8% -10.6% -5. Directly operated comp. stores 10.1% -0.8% 7.7% -11.5% % -7.7% -6.8% -7.9% -5.1% -7.4% -11.9% -4.1% Customer count 10.2% 7.3% 5.5% -4.8% % -7.7% -6.5% -3.1% -1.3% -6.7% -10.5% -1.5% Spend per customer -0.1% -7.5% 2.1% % 1.6% 0.1% -0.4% % -0.8% -1.5% -2.7% FY03/14 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores -7.3% -9.7% -8.9% -11.3% -6.3% -2.8% -5.4% -0.5% % -3.3% Directly operated comp. stores -8.6% -9.1% -10.4% -12.1% % 1.5% 0.4% 1.1% 8.6% -3.4% Customer count -6.5% -11.2% -7.5% -9.3% -7.4% -1.3% 0.5% 0.8% -4.6% -3.1% -3.4% 8.7% -4. Spend per customer -2.2% 2.3% -3.1% -3.1% 0.4% -1.7% -3.4% % 3.5% 4.6% -0.1% 0.6% FY03/15 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores % 6.4% 3.1% 0.8% 5.7% -0.6% 15.2% 2.8% 6.1% 1.6% 0.6% 3.5% Directly operated comp. stores 0.8% 3.1% 6.2% 4.1% -1.4% 5.1% 0.2% % 5.8% -0.5% -1.7% 2.9% Customer count 1.1% -0.5% 1.6% 2.3% -1.3% 1.7% -2.3% 6.3% 1.5% 1.2% -5.1% -3.9% 0.2% Spend per customer -0.3% 3.6% 4.6% 1.8% % 2.6% 4.4% % 4.8% 2.2% 2.6% FY03/16 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores -7.8% 20.2% 9.5% 14.5% 16.9% -10.1% 12.1% 7.9% 4.5% 7.3% 6.6% 10.6% 7.4% Directly operated comp. stores -5.6% 18.4% 8.3% 13.3% 19.6% -5.8% 13.5% 9.2% 6.7% 10.7% 6.7% 13.1% 8.8% Customer count -9.4% 6.6% -1.2% 3.9% 10.1% -7.2% 6.6% 0.3% 0.2% 3.5% 2.9% % Spend per customer 4.2% 11.1% 9.6% 9.1% 8.6% 1.5% 6.5% 8.8% 6.4% % 8.8% 7.1% FY03/17 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores 6.2% -8.1% -9.9% 9.1% -10.7% 9.8% 8.2% -0.2% 2.1% -2.7% -6.3% -7.2% -0.9% Directly operated comp. stores 6.4% % 8.8% -9.6% % 1.4% 2.2% -3.9% -4.9% -7.9% -0.8% Customer count 3.1% -5.2% -3.9% 3.7% -8.5% 0.6% 0.1% -1.4% -1.7% -6.2% -5.6% -4.6% -2.5% Spend per customer 3.3% -1.9% -3.4% 4.8% -1.3% 5.4% 6.2% 2.8% % 0.7% -3.5% 1.7% FY03/18 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores Directly operated stores Franchised stores YoY All stores 4.3% -3.7% 8.2% -9.5% -2.1% 6.5% % -3.4% -7.5% -3.4% -1.7% Directly operated comp. stores 2.6% -2.8% 6.9% -8.3% -2.8% 6.6% -3.7% -4.1% -1.3% -2.5% -4.4% -0.9% -1.4% Customer count 0.7% -4.5% 0.5% -11.2% -7.1% 3.2% -6.2% -4.4% -4.7% -4.6% -6.2% -4.9% -4.2% Spend per customer 1.9% 1.8% 6.3% 3.3% 4.6% 3.3% 2.6% 0.3% 3.6% 2.2% 1.9% 4.1% 3. FY03/19 (JPYmn) Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY Avg. monthly sales All stores 6.96 Directly operated stores - Franchised stores - YoY All stores -6.3% Directly operated comp. stores -5.5% Customer count -8.5% Spend per customer 3.4% Note: * FY03/19 growth is on a year-to-date basis from April 2018 Note: Figures may differ from company materials due to differences in rounding methods 06/53

7 Quarterly trends and results Quarterly earnings FY03/16 FY03/17 FY03/18 FY03/16 FY03/17 FY03/18 FY03/19 (JPYmn) Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 FY FY FY Est. % of FY Est. Total revenues 20,034 22,368 25,199 20,579 19,207 22,544 25,983 20,298 18,968 17,890 20,895 15,704 88,180 88,032 73,457 77, % 73,000 KFC 15,459 17,364 19,710 15,877 14,884 17,969 20,487 15,911 15,449 17,057 19,761 15,114 68,410 69,251 67,381 Pizza Hut 3,580 3,949 4,175 3,721 3,516 3,695 4,178 3,533 2, ,425 14,922 2,721 Other 3,243 2,957 3,384 2,809 2,669 2,878 3,473 2,634 2,515 2,410 2,912 2,130 12,393 11,654 9,967 Adjustments -2,249-1,901-2,070-1,829-1,862-1,998-2,156-1,780-1,718-1,577-1,778-1,540-8,049-7,796-6,613 YoY 6.3% 5.6% % -4.1% 0.8% 3.1% -1.4% -1.2% -20.6% -19.6% -22.6% 4.2% -0.2% -16.6% -12.1% -0.6% KFC 7.3% 7.3% 6.2% % 3.5% 3.9% 0.2% 3.8% -5.1% -3.5% % -2.7% Pizza Hut 3.6% 4.7% -4.7% -5.1% -1.8% -6.4% 0.1% -5.1% -22.6% % -3.3% -81.8% Other 24.6% 0.3% 5.9% -14.7% -17.7% -2.7% 2.6% -6.2% -5.8% -16.3% -16.2% -19.1% 2.9% % Gross profit 8,933 10,123 11,223 9,085 8,656 10,188 11,748 9,295 8,391 7,585 8,842 6,786 39,364 39,887 31,604 GPM 44.6% 45.3% 44.5% 44.1% 45.1% 45.2% 45.2% 45.8% 44.2% 42.4% 42.3% 43.2% 44.6% 45.3% 43. SG&A expenses 9,267 9,221 9,803 9,061 8,763 9,246 10,053 9,266 8,501 7,347 7,967 7,312 37,352 37,328 31,127 YoY % -2.6% % 0.3% 2.6% 2.3% % -20.8% -21.1% -0.5% -0.1% -16.6% SG&A ratio 46.3% 41.2% 38.9% % % 45.6% 44.8% 41.1% 38.1% 46.6% 42.4% 42.4% 42.4% Operating profit , , ,011 2, , % 1,000 KFC , , ,020 1, Pizza Hut Other Adjustments YoY % 58.9% % 19.5% 20.8% % -48.3% % 27.2% -81.4% -53.1% 109.6% KFC % 19.5% % -6.3% % - 9.2% -23.8% - Pizza Hut Other % % % -6.7% 212.7% 14.3% -65.7% % OPM -1.7% % 0.1% -0.6% 4.2% 6.5% 0.1% -0.6% 1.3% 4.2% -3.3% 2.3% 2.9% 0.6% 1.6% 1.4% KFC -0.7% % -1.6% 2.5% 5.5% -0.7% -1.4% -0.5% 3.2% -5.2% 2.3% 1.7% -0.7% Pizza Hut -1.5% 0.1% -0.2% -0.1% -0.7% 0.2% 0.7% 0.2% % 0.2% -0. Other 2.5% 0.8% -0.3% -1.7% 1.6% 1.4% 0.2% 1.2% 0.7% 1.6% 0.8% 1.8% 0.3% % Non-operating income (expenses) Net financial income Rent income (expenses) Equity in earnings of affiliates Outsourcing income Other Recurring profit , , ,866 2, , % 1,100 YoY % 56.7% % 22.4% % -43.1% % % -58.8% 75.4% RPM % 5.4% 0.1% -0.7% % -0.1% -0.3% 1.6% 4.6% -3.5% 2.1% 2.8% 0.9% 1.3% 1.5% Net income attrib. to parent company shareholders , , , % 700 YoY % 97.1% % 18.9% % -43.8% % 9.9% 21.1% Net margin -1.7% 2.4% 3.5% -1.6% -0.6% 2.4% % 3.4% 1.1% 2.8% -5.4% 0.8% 1.6% 0.8% 1.9% 1. KFC directly operated store sales YoY % 5.9% 7.9% -5.3% 0.1% % -0.9% % -1.5% Store count (year end) 1,150 1,144 1,148 1,152 1,154 1,149 1,150 1,153 1,157 1,153 1,144 1,149 1,153 1,159 1,159 Directly operated Franchised Openings Directly operated Franchised Renovations Directly operated % - Franchised Figures may differ from company materials due to differences in rounding methods Note: Revenues and operating profit tend to peak in Q3, which includes Christmas 07/53

8 Full-year FY03/18 results (out on May 9, 2018) FY03/18: Operating profit down 81%, JPY500mn (versus JPY1.2bn forecast). Mainly due to higher personnel expenses in KFC business and an increase in store renovation costs Revenue of JPY73.5bn (-JPY14.6bn YoY): Franchise revenue decreased due to a significant impact from the sale of Pizza Hut. KFC also negatively impacted by franchise revenue decline. JPY477mn operating profit (-JPY2.1bn): Dragged down by a lower GPM owing to higher raw materials and changes in the sales mix, and an increase in personnel and renovation costs KFC: Revenue dropped 2.7% due to a decline in franchise revenue and drop in customer numbers (-4.2%) at directly operated restaurants. Operating loss at JPY500mndue to higher personnel costs and renovation expenses. FY03/19: KFC s business is expected to grow based on an increase in store openings centered on priority areas, ongoing renovations, aggressive product development, and new business developments. The company will respond carefully to cost increases by raising set prices (average spend per customer), etc. It will also further limit SG&A expenses Medium-term management plan: Reworking the medium-term plan ending in FY03/21 ahead of its 50th anniversary (July 2020) Strengthening its domestic base with growth driven by the addition of new brands through M&A and other methods including the opening of KFC stores, and seeks to expand overseas Topics: In February the company announced capital and business alliance with BYO, which operates 117 unique restaurants in Japan and overseas Quarterly performance (JPYbn) 6% -6% -12% -18% % FY03/ FY03/ FY03/ Revenues 22.5 FY03/ YoY (left axis) FY03/ (JPYbn) % 5% 4% 3% 2% 1% -1% % FY03/ FY03/15 Operating profit FY03/ OPM (left axis) FY03/ FY03/ (JPYbn) /53

9 Monthly KFC sales (upper: average monthly sales; lower: YoY) (JPYmn) 14 FY03/14 FY03/15 FY03/16 FY03/17 FY03/18 (JPYmn) 14 FY03/14 FY03/15 FY03/16 FY03/17 FY03/ Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 6 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 25% All stores 25% Directly operated comp. stores Customer count Customer spend % 15% 1 1 5% 5% -5% -5% % Apr FY03/15 Oct Apr FY03/16 Oct Apr FY03/17 Oct Apr FY03/18 Oct Apr FY03/19 Oct -15% Apr FY03/15 Oct Apr FY03/16 Oct Apr FY03/17 Oct Apr FY03/18 Oct Apr FY03/19 Oct Note: Revenues and operating profit tend to peak in Q3 which includes Christmas Results overview In full-year FY03/18, revenue was JPY73.5bn (down JPY14.6bn YoY or -16.6%) and operating profit was JPY477mn (down JPY2.1bn or -81.4%), a decline in both revenue and profits. Net income attributable to parent company shareholders was JPY578mn (down JPY787mn or -57.7%), negatively impacted by booking of extraordinary losses incurred from the sale of the Pizza Hut business and an increase in tax payments due to the partial reversal of deferred tax assets. Revenue and operating income fell short of targets (JPY77.4bn and JPY1.2bn respectively). In the core KFC business, revenue was JPY67.4bn (down JPY1.9bn): Customer numbers dropped due to decreased demand from repeaters and franchise revenues declined (down JPY1.6bn YoY). The company booked an operating loss of JPY499mn (down JPY2.0bn from the previous year s operating profit): In addition to lower GPM owing to more expensive raw materials and changes in the sales mix, rising labor costs and aggressive spending on renovations had impacts. In the three months of Q4 FY 03/18 alone, revenue dropped 5. YoY and operating loss was JPY821mn. As of Q3, store openings were largely on track and renovations (161 stores planned) had progressed steadily. The company expected the number of renovations (may reach 200 stores) to significantly exceed its forecast, particularly at franchise stores, due in part to benefits linked to renovations. The number of stores was 1,153 as of end-fy03/18, a net increase of 4, which fell short of the plan (10 stores), while the number of renovations ended up at 219 stores (51 directly operated restaurants, 168 franchises), above the plan. The company aggressively renovated exiting restaurants, resulting in higher renovation expenses than expected. Effects of renovation could contribute to the results in FY03/19. Revenue Overall revenue hurt by a decline in franchise revenue; directly operated restaurant revenue unchanged from the previous year at JPY33.8bn, but franchise revenue dropped JPY1.6bn YoY to JPY79.4bn. Revenue at existing directly operated restaurants declined 1.4%, down for the second consecutive year, mainly due to a 4.2% drop in the number of customers. According to the company, while it acquired new customers, revenue was hurt by a decline in the number of repeaters visits per month. Average spend per customer was up 3., extended the increase to 13 consecutive month since March 2017 thanks to strategic measures to raise set prices by increasing the number of items purchased rather than raising prices. 09/53

10 Operating profit Operating profit declined due to A) lower GPM: a rise in chicken prices in the KFC business; B) lower sales: a decline in gross profit due to lower sales; C) higher SG&A expenses: an increase in personnel expenses, including an impact from revisions to the social insurance system and higher expenses as the company aggressively proceeded with renovations. However, sales are likely to increase gradually because a) the impact from revisions to the social insurance system (October 2016) will be eased YoY from 2H and b) benefits from renovations are steadily emerging. Topics In cumulative Q3: Menu revisions: Menu revisions conducted in June led to an increase in customer spend Renovations: Planned for 161 stores in FY03/18 (61 directly operated, 100 franchises); 134 in Q3 (38 directly operated, 96 franchises). Directly operated stores were slightly below plan and franchises may significantly exceed plans. New store format: A total of 10 stores in the new format. In 1H, one KFC Plus store was added. In Q3, the company opened one KFC Plus store and one other store in another format R&D Department: Established in April, separate from the Product Development Division Revenue in the Christmas sales season (December 23 25) increased by 1.4% YoY to roughly JPY6.0bn. However, the company did not sell out of Moomin character goods, which were procured for the Christmas sales season. The main topic in Q4 FY03/18 was the business and capital alliance with BYO the company announced in February. Since its foundation in 1991, BYO, which positions itself as a creative company that passes on Japanese culture through gastronomy, has created unique restaurants under brand names such as washoku sake EN, Obon de Gohan, and Dashichazuke EN. It currently operates 117 restaurants, of which 111 are in Japan and six overseas. KFC Holdings and BYO share the same business philosophy that focuses on hand-made products using selected ingredients, and provision of food that is enriching. The two companies decided to enter into a capital and business alliance thinking that the partnership will allow them to create new business opportunities and generate synergies that would increase the corporate value of both companies in the medium to long-term. As stated in the new medium-term plan Building the Future 2017 (announced in 2015), KFC Holdings considers M&A and business alliances as one of its growth strategies and intends to achieve further growth through such initiatives. Christmas sales season: Three days from December 23 to 25 at 1,135 KFC stores nationwide. Revenues were JPY59.2bn in 2016 at 1,132 stores. Toward FY03/19 (for reference: as of Q3 FY03/18) Heading into FY03/19, the company is considering conducting aggressive renovations, strengthening product development, and developing new business as in FY03/18. In addition, the company plans to aggressively open franchise stores, centered on priority areas where it s possible to open stores. In terms of costs, the company will respond to rising raw materials and labor costs by carefully raising prices paid per set by each customer, etc., further limiting SG&A expenses, increasing the number of items purchased, and developing attractive products. Medium-term management plan The company will commemorate its 50th anniversary in July Regarding the current medium-term management plan, due to the sale of the Pizza Hut business in June and in light of changes in the business environment, the company plans to formulate a new medium-term business plan that will begin in FY03/19 and end in FY03/21. Driven by the KFC business, the company will strengthen its domestic base with the addition of new brands through M&A and other methods and appears poised to expand overseas. KFC s franchise stores are largely owned by companies, including major companies. Franchise owners have indicated that they are eager to develop stores using a new brand, and supposing KFC is able to acquire a new brand, it may be able to quickly increase store openings. 10/53

11 KFC business Quarterly earnings (cumulative) 8% 6% 4% 2% -2% -4% Revenues YoY (left axis) (JPYbn) % % 12 4% 9 2% Operating profit OPM (left axis) (JPYbn) % FY03/15 FY03/16 FY03/17 FY03/18 0-2% FY03/15 FY03/16 FY03/17 FY03/ FY03/16 FY03/17 FY03/18 FY03/16 FY03/17 FY03/18 FY03/19 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 FY FY FY Est. Revenues 15,459 17,364 19,710 15,877 14,884 17,969 20,487 15,911 15,449 17,057 19,761 15,114 68,410 69,251 67,381 - YoY 7.3% 7.3% 6.2% % 3.5% 3.9% 0.2% 3.8% -5.1% -3.5% % -2.7% - Operating profit , , ,020 1, YoY % 19.5% % -6.3% % - 9.2% -23.8% - - OPM -0.9% 3.9% 7.7% -0.2% -2.1% 3.1% 6.9% -0.9% -1.8% -0.5% 3.4% -5.4% % -0.7% - Store count - 1,150-1,144 1,148 1,152 1,154 1,149 1,150 1,153 1,157 1,153 1,144 1,149 1,153 1,159 Directly operated Franchised Net increase Openings Closures Renovations KFC: Revenue dropped 2.7% due to a decline in franchise revenue and drop in customer numbers (-4.2%) at directly operated restaurants. Operating loss at JPY500mndue to higher personnel costs and renovation expenses Revenues: While store sales increased, revenues were affected by a decrease in franchise revenues. Fewer customer numbers than expected due to a decline in repeaters is a significant issue Operating profit: Declined JPY2.0bn YoY. Lower gross profit owing to a decrease in GPM and sales, and higher SG&A expenses hurt operating profit The decrease in GPM was caused by a rise in chicken prices. Higher SG&A expenses was mainly due to an increase in personnel expenses owing to revisions to the social insurance system and a strategic increase in expenses related to aggressive renovations. Expansion of stores under new formats: Expanded bar format (serving alcohol menus at night), KFC Plus (offering relaxing space), and takeout stores Expansion of product lineup: R&D Department established in April separate from the Product Development Division. Development of a leading product as a follow-up to original chicken is anticipated Launched hypoallergenic menus and menus using domestic fresh vegetables FY03/19: KFC s business is expected to grow amid ongoing renovations, aggressive product development, and new business developments. The company is responding carefully to cost increases with set prices, etc. Medium-term management plan: Reworking the medium-term management plan ending in FY03/21 ahead of its 50th anniversary (July 2020) Strengthening its domestic base with growth driven by the addition of new brands through M&A and other methods including the opening of KFC stores, and seeks to expand overseas 11/53

12 Pizza Hut business Quarterly earnings (cumulative) 1 5% -5% -1-15% % FY03/15 FY03/16 FY03/ Revenues YoY (left axis) FY03/ (JPYbn) % 4% 2% -2% -4% -6% -8% -1-12% -14% FY03/ Operating profit 0.0 FY03/ FY03/17 OPM (left axis) FY03/18 (JPYbn) Sale of business Earnings results of this business are through June 11, when the company sold off this business. At the Board of Directors meeting on May 10, the company resolved to sell the shares of Pizza Hut Japan Ltd., which operates the Pizza Hut business, and Phoenix Foods Inc. to Endeavour United Partners Six, Co., Ltd., an investment fund. The company decided to sell the shares in light of intensifying competition in the pizza market. CEO Masaki Kondo, at the company s FY03/17 earnings briefing session on May 10, 2017, commented as follows: Pizza Hut Restaurants Asia Pte. Ltd., the global operational headquarters of Pizza Hut, wanted us to open new stores at a tremendously rapid pace. However, we wanted to build a solid foundation for growth before opening new stores (to ensure profitability). We did not share the same approach when it came to the pace of growth. As we were considering our options, there came a new (potential) buyer who was in perfect accord with the growth strategy of Pizza Hut Restaurants Asia. On June 12, 2017, the company sold and transferred all shares of the two companies mentioned above to an investment fund Endeavour United Partners Six, Co., Ltd. KFC Holdings aims to enhance its medium- and long-term enterprise value based on the strategy for its new business portfolio following the stock transfer. Other Quarterly earnings (cumulative) Revenues YoY (left axis) (JPYbn) Operating profit OPM (left axis) (JPYbn) FY03/15 FY03/16 FY03/17 FY03/ FY03/15 FY03/ FY03/17 FY03/ For details on previous quarterly and annual results, please refer to the Historical performance section. 12/53

13 Full-year company forecasts Earnings (JPYmn) 1H 2H FY 1H 2H FY 1H 2H FY FY Total revenues 42,402 45,778 88,180 41,751 46,281 88,032 36,858 36,599 73,457 73,000 YoY % 4.2% -1.5% 1.1% -0.2% -11.7% -20.9% -16.6% -0.6% Operating profit 568 1,443 2, ,724 2, ,000 YoY 294.4% 174.3% 200.1% 46.8% 19.5% 27.2% -84.8% -79.7% -81.4% 109.6% OPM 1.3% 3.2% 2.3% % 2.9% 0.3% % 1.4% Recurring profit 479 1,387 1, ,642 2, ,100 YoY 203.2% 172.5% 179.8% 63.5% 18.4% 29.9% -70.8% -75.8% -74.1% 75.4% RPM 1.1% % 1.9% 3.5% 2.8% 0.6% 1.1% 0.9% 1.5% Net income attributable to parent company shareholders , YoY % % % 124.2% 74.3% 86.8% 102.4% % -57.8% 21. Net margin 0.4% 1.2% 0.8% % 2.3% -0.7% 0.8% 1. Earnings by segment FY03/16 FY03/16 Figures may differ from company materials due to differences in rounding methods FY03/17 FY03/17 FY03/18 FY03/18 (JPYmn) 1H 2H FY 1H 2H FY 1H 2H FY FY Total revenues 42,402 45,778 88,180 41,751 46,281 88,032 36,858 36,599 73,457 73,000 KFC 32,553 35,325 67,878 32,554 36,080 68,634 32,506 34,875 67,381 - Pizza Hut 7,391 7,769 15,160 7,101 7,621 14,722 2,721-2,721 - Other 2,457 2,684 5,141 2,094 2,581 4,675 4,925 5,042 9,967 - YoY % 4.2% -1.5% 1.1% -0.2% -11.7% -20.9% -16.6% -0.6% KFC 7.2% 4.9% % 1.1% -0.1% -3.3% -1.8% Pizza Hut 3.6% -5.2% -1.1% -3.9% -1.9% -2.9% -61.7% % Other -2.3% -1.6% -1.9% -14.8% -3.8% -9.1% 135.2% 95.4% 113.2% Operating profit 568 1,443 2, ,724 2, ,000 KFC 528 1,492 2, ,284 1, Pizza Hut Other Adjustments YoY 294.4% 174.3% 200.1% 46.8% 19.5% 27.2% -84.8% -79.7% -81.4% 109.6% KFC -16.9% 22.9% 9.2% -51.7% -13.9% -23.8% Pizza Hut Other 174.6% % -8.4% % % 50.8% -3.4% OPM 1.3% 3.2% 2.3% % 2.9% 0.3% % 1.4% KFC 1.6% 4.2% % 3.6% 2.2% -1.1% -0.4% -0.7% Pizza Hut -3.8% -0.9% -2.3% -1.2% 3.1% Other 27.3% -16.1% 4.6% 29.3% 11.6% 19.5% 8.8% 8.9% 8.8% FY03/19 FY03/19 Management policy for FY03/18 The company had three main business strategies for FY03/18. Focus on raw materials, ingredients, and hand-made products Improve product development Further improve on-site capabilities The first strategy, a focus on raw materials, ingredients, and hand-made products, entails a thorough reapplication of the FHH&H principles (Fresh, Healthy, Handmade, and Hospitality) to deliver a safe and tasty product and enhance the company s brand power. This involves close attention to food safety and security, the steady supply of quality products, and on-site meal preparation. The second strategy, improved product development, involves establishing and maintaining the company s position as a specialist in chicken (KFC). The company will pursue innovations such as curly fries dubbed Coloneling Potato and conduct a total review of the side menu, creating items that target health-conscious consumers, children and seniors. Further improvement in on-site capabilities entails the following five key initiatives: 1) About 4,600 nationwide shift managers (seasoned part-time workers) are being invited to the corporate headquarters between April 2016 and March 2018 as the company seeks to promote better understanding 13/53

14 2) Community activities, such as Kids School (where children learn cooking) and town meetings with KFC fans 3) Better decorations at KFC restaurants with digital signage; strengthened marketing through IT 4) Introduction of new kitchen equipment, and use of foreign-language menus and translation devices for inbound tourists (foreign visitors) 5) Expansion of KFC stores under new formats, such as KFC Sweets & Coffee, KFC Restaurant, KFC Café & Bar, KFC Plus, and takeout-only KFC outlets 14/53

15 Outlook The following comments were based on the company s medium-term management plan Building the Future 2017 released on August 7, The company explains that it may revise the medium-term plan in light of the planned sale of Pizza Hut announced in May Medium- to long-term targets In 2020, when KFC Japan marks its 50th anniversary, it aims to have 2,000 KFC and Pizza Hut stores (+32.3% versus 1,512 as of March 31, 2016) and system sales of JPY200bn (+42.9% versus JPY139.9bn). In April 2014, KFC Japan adopted a holding company structure. By separating group management and oversight from business execution, the roles and responsibilities of the holding company and group companies have been clarified, streamlining business execution. Medium-term plan The company has a three-year medium-term plan started in August In FY03/18, the last year of the plan, targets are for system sales (directly operated plus franchise store sales) of JPY150bn (average annual growth of 3.9%). It also targets total revenues (directly operated store sales plus licensing fee revenue) of JPY96.0bn (average annual growth of 4.3%) and operating profit of JPY3.6bn (75.1%). The key themes in the medium-term plan are on personnel, improved profitability, and growth. FY03/17 targets (JPYmn) Initial medium-term plan targets Average annual growth FY03/15 FY03/16 FY03/17CE FY03/16CE FY03/17CE FY03/18CE (FY03/15-FY03/18) System sales 133, , , , , , % Number of stores 1,523 1,512 1,546 1,563 1,599 1,637 - Revenues 84,605 88,180 92,000 90,000 93,000 96, % Operating profit 670 2,011 2,500 1,500 2,500 3, % OPM 0.8% 2.3% 2.7% 1.7% 2.7% 3.8% - Recurring profit , ,300 2,000 - Personnel strategy The company is focusing on building inviting restaurants. On April 1, 2015, it established a Communication Division to connect customers and employees and facilitate the creation of restaurants that are welcoming, appealing, and positive for customers. At the same time, the strategy aims to create stores that employees consider fun and that they can confidently recommend to friends and family. Specific plans of the personnel strategy: Promote the participation of women. In the KFC business, women are the key customer segment (7 of customers), and in order to meet their needs the company aims to create an organization that can reflect the ideas of female employees. Increase the employment of women and seniors. Revamp systems such as implementing measures that improve restaurant hospitality and repositioning toward smaller operating areas to support closer ties between stores and the community. Roll out planning and public relations initiatives that improve internal information sharing. One initiative to obtain personnel for future restaurant openings is a shift from individual stores hiring part-time and temporary workers to the head office overseeing all hiring. This reduces the burden on individual stores and enables working patterns (more flexible working hours) that make it easier for homemakers and seniors to work. 15/53

16 Strategy to improve profitability After peaking at 4. in FY03/11 (excluding 4.2% in the 16-month period of FY03/10), KFC Holdings Japan s OPM slumped to 0.8% in FY03/15. The company aims to extend the headquarter functions of the holding company by consolidating and streamlining each group company s shared operations, while optimizing operations from the customer s view. To control head office personnel expenses, the company plans to increase labor productivity by improving employee training. It also aims to reduce head office management costs by sharing IT infrastructure among group companies. Growth strategy To meet its target of 2,000 stores by 2020 and system sales of JPY200bn, the company is considering the following three M&A and alliance options. 1) Consider food businesses that could support domestic operations and leverage the company s expertise in running restaurant chains. 2) In overseas growth markets, tap into new markets through brands (companies) that have a competitive edge. 3) Consider overseas rollout of existing KFC brand (expand outside Japan with approval of Yum! Brands). In August 2016, the company established the holding company Fast Restaurant International Pte. Ltd. (FRI) to invest in the restaurant industry in Southeast Asia. The company s first foray overseas was in August 2016, when it began to participate in the KFC business in Thailand through FRI. The company said that it would utilize the knowledge and expertise gained over 45+ years of operating KFC in Japan to grow the KFC business Thailand, a promising market. The company intends to actively tap into new markets by investing overseas through FRI. Targets by segment KFC business (Kentucky Fried Chicken Japan Limited) The company plans to grow year-end restaurant count from 1,155 in FY03/15 to 1,234 in FY03/18, and system sales from JPY109.9bn to JPY122.5bn. Targets for KFC business in FY03/18 (JPYmn) KFC system sales KFC: number of stores (year-end) (Number of stores) 125,000 1, ,500 1, ,000 1,234 1, , ,943 1,180 1, , ,487 1, ,150 1,150 1,155 1,161 1,180 1,144 1, ,000 1, , ,860 1, , ,618 1,120 1, ,000 1,080 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17CE FY03/18CE 16/53

17 Business Overview Under a franchise agreement with Yum! Brands Inc., KFC Holdings Japan operates KFC and Pizza Hut restaurants in Japan. It also acts as a franchisor for the KFC and Pizza Hut brands and earns royalties and other revenue. Yum! Brands Inc. Yum! Brands Inc. is a major global fast food chain operator, with the restaurant brands including Kentucky Fried Chicken (KFC), Pizza Hut, and Taco Bell. The company was established via a spinoff from major soft drink manufacturer PepsiCo in 1997 (at that time the company name was Tricon Global Restaurants, Inc.). The KFC brand was acquired by PepsiCo Inc. in 1986 after a series of M&A deals following the sale of franchise rights by its founder, Colonel Harland Sanders in Master franchises and sublicenses KFC Holdings Japan has both master franchisee and sublicense agreements. It is a master franchisee of KFC Restaurants Asia Pte Ltd. and Pizza Hut Restaurants Asia Pte Ltd. (members of the Yum Brands Inc. group). The company pays initial setup fees to the Yum! Brands group for opening restaurants, as well as renewal fees and ongoing royalties. In turn, KFC Holdings Japan provides sublicensing rights to franchisees in Japan and receives initial setup payments when restaurants are opened, as well as renewal payments and ongoing royalties. (For details refer to discussion of business models for KFC and Pizza Hut). Two layers of franchise agreements Master franchise contract Sublicense contract Master license agreement Sublicense agreement Yum! Brands, Inc. Initial set-up fee Renewal fee KFC Holdings Japan, Ltd. Initial (store opening) fee Renewal fee Franchise restaurants Continuing fee (royalty) Continuing fee (royalty) Since FY11/05 (excluding the 16-month period of FY03/10 due to a change in balance date), the company has received royalties of JPY bn and paid royalties of JPY bn annually, for steady net royalty revenue of JPY bn. Net royalty revenue Royalty FY11/05 FY11/06 FY11/07 FY11/08 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 (JPYmn) Par. Par. Par. Par. Par. Par. Par. Par. Par. Royalty received 2,153 2,063 2,042 1,931 2,639 1,958 1,889 1,812 1,761 Royalty paid 1,186 1,270 1,364 1,333 1,858 1,303 1,280 1,268 1,291 Net royalty revenue Note: FY03/10 was a 16-month period due to balance date change. Data not disclosed for FY03/15 onwards. In April 2014, KFC Holdings Japan moved to a holding company structure to maximize the corporate value of the group. Under the management of KFC Holdings Japan, restaurants are managed by Kentucky Fried Chicken Japan, Ltd. and Pizza Hut Japan Ltd. Advertising for each company is handled by K Ad, Ltd. 17/53

18 Business organization Yum! Brands, Inc. group KFC Restaurants Asia Pte. Ltd. Pizza Hut Restaurants Asia Pte. Ltd. Pay royalty KFC Holdings Japan, Ltd. Pay royalty Grant master license K Ad Ltd. (Contract advertising services) Grant master license Kentucky Fried Chicken Japan Limited Grant sublicense; supply ingredients and materials Pizza Hut Japan, Ltd. Grant sublicense; supply ingredients and materials Directly operated store K Foods Franchisee Directly operated store Phoenix Foods Franchisee Pay royalty; pay for ingredients and materials Pay royalty; pay for ingredients and materials Food Food Food Food Food Food The company has three business segments: KFC, Pizza Hut, and Other. In FY03/17, the breakdown of total revenues was KFC, 78.; Pizza Hut, 16.7%; and Other, 5.3%. The operating profit breakdown (before eliminations) was KFC, 59.1%; Pizza Hut, 5.9%; and Other, 35.. Consumers The company operates KFC and Pizza Hut separately because the fried chicken and pizza markets have unique characteristics and different target customer segments. Roughly 7 of KFC s customers are women in their 30s through 50s, whereas Pizza Hut s key demographic is people in their 30s and 40s with families. The Other business is subsidiary K Ad s advertising operations for KFC and Pizza Hut. Share of segment revenues and operating profit (before eliminations) in FY03/ KFC Pizza Hut Other 59.1% % 16.7% % Sales Operating profit Japan s restaurant market (dining out plus prepared meals) has shown steady annual average growth of 1.4% since 2010, due to the shift to nuclear families and increasing female participation in the labor force (Japan Food Service Association survey). Yet total revenues for KFC Holdings Japan have trended sideways since FY03/11. Shared Research thinks this is because the company s revenues tend to be affected by economic fluctuations rather than structural shifts in society. Revenues track the Total Cash Earnings Index published by the Ministry of Health, Labour and Welfare. KFC Japan s operating profit declined from a peak of JPY3.5bn in FY03/11 to JPY700mn in FY03/15 due to increases in ingredient and personnel costs, but recovered to JPY2.6bn in FY03/17 (+27.2% YoY) due to cost cutting in the Pizza Hut business. The company was able to generate steady operating profit and avoid losses despite tough operating conditions. This is partly due to its efforts to cut fixed costs by shifting the emphasis from directly operated restaurants to franchises. In the KFC business, the 18/53

19 company reduced the number of directly operated restaurants from 348 at the end of FY11/05 to 326 (-6.3%) by the end of FY03/17. Meanwhile, it increased the number of franchises from 805 to 823 (+2.2%) over the same timeframe. The company reduced the number of directly operated Pizza Hut restaurants from 207 at the end of FY11/05 to 155 (-25.1%) by the end of FY03/16, and increased the number of franchises from 141 to 215 (+52.5%) over the same period. Consolidated results (JPYmn) 140, , ,000 80,000 60,000 40,000 20,000 0 Total revenues Operating profit (right axis) (JPYmn) 5,253 6,000 5,000 3,583 3,506 3,531 4,000 2,755 2,865 2,833 2,472 2,249 2,390 2,395 2,558 3,000 1,822 2,011 1,308 2,000 1, ,000 82,942 84,967 80,528 73,787 73,654 77,667 80,579 84,900 86, ,815 88,823 88,124 85,864 83,436 84,605 88,180 88,032 0 Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. FY11/00 FY11/01 FY11/02 FY11/03 FY11/04 FY11/05 FY11/06 FY11/07 FY11/08 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17 Note: FY03/10 was a 16-month period due to balance date change 19/53

20 KFC business Business model Overview Under a holding company structure, Kentucky Fried Chicken Japan runs the KFC business. KFC had a 37% share of Japan s fried chicken market in 2015 (worth nearly JPY120bn, according to the company). It had 326 directly operated restaurants primarily in Greater Tokyo, and 823 franchises mainly in regional areas as of end March KFC revenue breakdown In FY03/17, the breakdown of the JPY69.3bn in KFC revenue before eliminations were directly operated restaurant sales, around 5; revenues from providing ingredients and materials to franchisees, around 45%; and equipment rental revenues and franchise royalties from franchisee restaurants, around 5%. Franchise agreement The master license agreement between the company and KFC Restaurants Asia Pte. Ltd. covers the following: 1) Use trademarks relating to the KFC business in restaurants. 2) Selling products using methods and trade secrets disclosed by the licensor that meet the licensor s quality standards. 3) The above rights and conditions may be sublicensed to restaurants. Compensation under the master franchise and sublicense agreements with franchisees is as shown below. Compensation under franchise agreements in KFC business Master franchise agreement Sublicense agreement Initial (store opening) fee JPY1.5mn/store* JPY2.5mn/store* Renewal fee July 11, 2004 November 30, 2014 December 1, 2014 November 30, 2019 December 1, 2019 November 30, 2024 Per store renewed JPY250,000 JPY360,000 JPY180,000 Per store renewed No charge JPY180,000 JPY180,000 Continuing fee July 11, 2004 November 30, 2005 December 1, 2005 November 30, 2011 December 1, 2011 November 30, 2014 December 1, 2014 November 30, 2019 December 1, 2019 November 30, 2024 Share of total sales 2.3% +0.1pp p.a. from Dec. 1, Share of total sales Store certification period July 11, 2004 November 30, 2014 December 1, 2014 November 30, 2019 December 1, 2019 November 30, 2024 For directly operated stores Seven-year contract period Ten-year contract period Five-year contract period For franchise stores Two-year contract period Five-year contract period Five-year contract period Contributions for advertising Contributions of a minimum of 4% of total sales to the KFC Advertising Association, an organization formed by the company and franchisees, (outsourced to 10 subsidiary K Ad) to create nationwide ad campaigns Note: Adjusted for inflation starting from December 1, 2014 Note: Continuing fee under sublicense agreements (% share of total sales) includes portion retained by KFC Japan. The approval of the master franchisor, Yum! Brands, is required for all aspects of franchise agreements including products, ingredients, restaurants, and equipment. Mainstay product: original chicken KFC s mainstay original chicken is made from chicken raised in Japan on feed mixed with herbs that mask certain chicken odors, and accounts for roughly 4 of KFC s system sales (FY03/17). Once a chick has hatched and has undergone a health check, the chicken is raised at one of 200 KFC-registered farms nationwide, which all meet strict standards for equipment, animal breeding methods, feed, and health management. The chickens are 20/53

21 slaughtered and cut into nine pieces using KFC s original nine-cut method when they are days old. They are slaughtered in the morning and shipped to individual stores on the same afternoon. KFC s original nine-cut chicken cutting method Breast Wings Ribs Thigh Drumstick Breast Soft, drier meat. Ribs Ribs Wing Wing Fuller flavor, high gelatin and fat content, rich in collagen. Thigh Thigh With a deep umami flavor, even meat surrounding the bone can be enjoyed. High iron content, with a richer taste. Easy to hold, making it popular among children. Drumstick Drumstick Both tender and firm. Employees conduct further quality checks of the meat in the restaurants, assessing temperature, freshness, and whether any feathers remain, preparing only the chickens that meet stringent standards. Original chicken is prepared by staff accredited as chicken specialists under the company s certification system. Distribution chart for original chicken chickens Hatcheries KFC registered breeding farms Factories accredited to produce KFC cut chicken Direct delivery to stores Chicken distribution centers Directly-operated stores and franchise stores Consumers Number of farms: 200 Breeding period: days Number of factories: 7 (nationwide) Number of centers: 10 Hatching and selection Check the health of chicks Raise chicks feeding herbal raw materials Ensure safety and quality maintenance based on the STAR standards Herb-fed chickens cut in the morning are shipped out in the afternoon - Check temperature, freshness, cut conditions, and weight - Hand-cooked by staffs supervised by "Chicken Specialist" title holders STAR (Supplier Tracking Assessment & Recognition) standards: Global food safety and quality management standards for KFC and Pizza Hut set by the US headquarters of Yum! Brands Inc. In Japan, factories accredited to produce KFC cut chicken must reach a certain level of STAR standards to fulfill the company s safety and quality maintenance requirements. The standards cover a wide scope, including facility equipment, machinery, and surrounding environment, conditions, organization, and management structure. Customer demographic Some 7 of KFC s customers are women in their 30s through 50s. Around 7 of customers order takeout such as original chicken meals, and the remaining 3 dine in, ordering sets such as chicken fillet sandwiches or chicken cutlet sandwiches that come with a soft drink. Customers in their 40s and 50s are familiar with the taste of KFC since their younger days, and tend to be big KFC fans. Since 2013, when convenience stores entered the fried chicken market, it appears that customers in their 20s, who are more accustomed to convenience stores, have become less frequent at KFC. The company plans to capture this younger generation by opening KFC cafes and other new formats. Spend per customer At directly operated restaurants in Greater Tokyo, average spend per customer is JPY900 1,000, whereas in regional areas it is JPY1,200 1,300. Average spend per customer is lower in Greater Tokyo due to the trend toward smaller, nuclear families. The 21/53

22 all-store average spend per customer figure is around JPY1,000. Around lunchtime, average spend is under JPY900 due to value sets of JPY featuring items such as chicken fillet sandwiches and chicken cutlet sandwiches. At dinnertime, many customers purchase larger meals such as chicken buckets to take home to their families for dinner, so average sales are JPY1,200 1,500. Although for most of the year average customer spend is JPY1,000, Q3 is the peak season for spend per customer and reaches nearly JPY1,200, as it includes Christmas (when it has become common in Japan to eat fried chicken). Restaurant openings and closures Directly operated restaurants Store openings are primarily in the Kanto and Kansai regions, and consider the scope for new openings and trends in commercial areas. Locations also take into account profit and loss simulations based on restaurant format, i.e. stores in busy shopping areas, drive-through stores, or shopping center stores. Restaurants with negative operating cash flow are designated as closure candidates. For restaurants where performance does not recover, the closure method and timing are based on overall expenses, such as the costs of restoring premises to their original condition. Franchise restaurants The company makes recommendations regarding franchise restaurant openings based on the scope for new openings and trends in commercial areas. The final decision is made by individual franchisees, who receive support from KFC Holdings Japan. Regarding closures, supervisors who are part of the company s sales division provide management advice for underperforming restaurants, with the final decision left up to the franchisee. Core strategy of KFC business There are three key elements of the core strategy in the KFC business (see below for details): Further strengthen the KFC brand Analyze consumer needs and plan initiatives Develop systems to strengthen on-site capabilities The company wants to strengthen the KFC brand and establish its position as an operator of unique fast-food restaurants that combine both sit-down and takeout restaurant elements. As convenience stores increase the proportion of food prepared on site and shift to higher value-added products, the company plans to work harder to differentiate and provide products that better appeal to its target customers. KFC direction High Value Establish itself as a fast casual restaurant Delicatessen at department stores, and side dish chain stores Convenience stores Fast food chain stores Family restaurants and chain stores High Degree of in-store preparation of food Beef bowl chain stores 22/53

23 The company s strategy to differentiate itself entails providing a safe and tasty product not available anywhere else by maintaining high standards for its raw materials, ingredients, and handmade food, and enhancing product development. It is also tailoring restaurant services to each location, and developing different formats with various product lineups such as cafes, buffet restaurants, and café-bars. It plans to meet the growing demand for prepared meals by actively rolling out takeout-only restaurants, bicycle delivery, food carts, and drive-through restaurants in shopping centers. New format 1: Café New format 2: Restaurant New format 3: Café-bar In analyzing customer needs and creating business strategies, the company plans to use data taken from Ponta, a loyalty-point network shared by various businesses in Japan, as well as point-of-sales information from its nationwide stores. The company also plans to create databases for each of its restaurants. Further, to strengthen on-site capabilities, it plans to reorganize toward smaller operating areas and implement monitoring and control systems. Distinctive elements of KFC business Brand power underpinned by tasty food prepared on-site KFC is a global brand, with a presence in more than 125 countries worldwide and roughly 20,000 restaurants as of September The KFC brand is sustained by its mainstay product, original chicken, developed by Colonel Harland Sanders in It is prepared using 11 secret herbs and spices, and fried with pure vegetable oil in a pressure cooker. The 11 secret herbs and spices are shrouded in mystery and attract much attention. The Chicago Tribune in August 2016 published an article stating that a memo with the secret recipe had been discovered. According to the company, even internally information on the 11 herbs and spices is closely guarded so that no individual knows the secret combination. First mover advantage gives KFC high market share KFC was established in Japan in 1970 and opened its first location in Nagoya, one year before McDonald s Corporation established McDonald's Japan. Subsequently, the KFC brand spread, along with statues of Colonel Sanders. In much of the world the custom is to eat turkey at Christmas, but in Japan chicken is the typical Christmas dinner. The company s successful marketing has established a culture of eating fried chicken at Christmas. KFC Holdings Japan is the only company that has succeeded in establishing a fast food chain specialized in fried chicken. KFC leads the domestic fried chicken market, with a market share of 37% in 2015, according to a company survey. 23/53