YUM CHINA HOLDINGS, INC. References to the Company throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations (this "MD&A") are made using the first person notations of "we," "us" or "our." This MD&A contains forward-looking statements, including statements with respect to the ongoing transfer pricing audit, the retail tax structure reform, impacts of COVID-19, our growth plans, future capital resources to fund our operations and anticipated capital expenditures, share repurchases, our ability to pay dividends and the impact of new accounting pronouncements not yet adopted. See "Cautionary Note Regarding Forward-Looking Statements" at the end of this Item 2 for information regarding forward-looking statements. IntroductionYum China Holdings, Inc. is the largest restaurant company inChina in terms of system sales, with over 9,200 restaurants as ofMarch 31, 2020 . Our growing restaurant base consists of our flagshipKFC and Pizza Hut brands, as well as emerging brands such as Little Sheep, COFFii & JOY, East Dawning andTaco Bell . We have the exclusive right to operate and sublicense theKFC ,Pizza Hut and, subject to achieving certain agreed-upon milestones, Taco Bell brands inChina , excludingHong Kong ,Taiwan andMacau (the "PRC" or "China"), and own the intellectual property of the Little Sheep, COFFii & JOY and East Dawning concepts outright. We were the first major global restaurant brand to enter China in 1987 and with over 30 years of operations, we have developed deep operating experience in the China market. We have since grown to become one of China's largest restaurant developers with locations in over 1,400 cities as ofMarch 31, 2020 . We believe that there is significant opportunity to expand within China, and we intend to focus our efforts on increasing our geographic footprint in both existing and new cities.KFC is the leading and the largest quick-service restaurant ("QSR") brand inChina in terms of system sales. As ofMarch 31, 2020 ,KFC operated over 6,600 restaurants in over 1,400 cities across China.Pizza Hut is the leading and the largest casual dining restaurant ("CDR") brand inChina in terms of system sales and number of restaurants. As ofMarch 31, 2020 ,Pizza Hut operated over 2,200 restaurants in over 500 cities. Overview We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including metrics that management uses to assess the Company's performance. Throughout this MD&A, we discuss the following performance metrics:
• The Company provides certain percentage changes excluding the impact of
foreign currency translation ("F/X"). These amounts are derived by
translating current year results at prior year average exchange rates. We
believe the elimination of the F/X impact provides better year-to-year
comparability without the distortion of foreign currency fluctuations.
• System sales growth reflects the results of all restaurants regardless of
ownership, including Company-owned, franchise and unconsolidated affiliate
restaurants that operate our concepts, except for sales from
non-Company-owned restaurants for which we do not receive a sales-based
royalty. Sales of franchise and unconsolidated affiliate restaurants
typically generate ongoing franchise fees for the Company at a rate of
approximately 6% of system sales. Franchise and unconsolidated affiliate
restaurant sales are not included in Company sales in the Condensed
Consolidated Statements of Income; however, the franchise fees are
included in the Company's revenues. We believe system sales growth isuseful 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.
27
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• Effective
same-store sales growth to represent the estimated percentage change in
sales of food of all restaurants in the Company system that have been open
prior to the first day of our prior fiscal year, excluding the period
during which stores are temporarily closed. We refer to these as our
"base" stores. Previously, same-store sales growth represented the
estimated percentage change in sales of all restaurants in the Company
system that have been open for one year or more, including stores
temporarily closed, and the base stores changed on a rolling basis from
month to month. This revision was made to align with how managementmeasures performance internally and focuses on trends of a more stable
base of stores.
• Company Restaurant profit ("Restaurant profit") is defined as Companysales less expenses incurred directly by our Company-owned restaurants in
generating Company sales. Company restaurant margin percentage is defined
as Restaurant profit divided by Company sales. Within the Company sales
and Restaurant profit analysis, 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 restaurant operating costs such as
inflation/deflation.
• In addition to the results provided in accordance with GAAP throughout
this MD&A, the Company provides measures adjusted for Special Items, which
include Adjusted Operating Profit, Adjusted Net Income, Adjusted Earnings
Per Common Share, Adjusted Effective Tax Rate and Adjusted EBITDA, which
we define as net income including noncontrolling interests adjusted forincome tax, interest income, net, investment gain or loss, depreciation
and amortization, and other items, including store impairment charges and
Special Items. The Special Item for the quarter ended
represents share-based compensation cost recognized for a special award of
performance stock units ("Partner PSU Awards") granted to select
employees. The Special Item for the quarter ended March 31, 2019
represents impact from the Tax Cuts and Jobs Act (the "Tax Act"). TheCompany excludes impact from Special Items for the purpose of evaluating
performance internally. Special Items are not included in any of our
segment results. In addition, the Company provides Adjusted EBITDA because
we believe that investors and analysts may find it useful in measuring
operating performance without regard to items such as income tax, interest
income, net, investment gain or loss, depreciation and amortization, and
other items, including store impairment charges and Special Items. These
adjusted measures are not intended to replace the presentation of ourfinancial results in accordance with GAAP. Rather, the Company believes
that the presentation of these adjusted measures provides additional
information to investors to facilitate the comparison of past and present
results, excluding those items that the Company does not believe are
indicative of our ongoing operations due to their nature.
All Note references in this MD&A refer to the Notes to the Condensed
Consolidated Financial Statements. Tabular amounts are displayed in millions of
28
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Quarters to Date Ended
Results of Operations Summary The Company has two reportable segments:KFC andPizza Hut . Our remaining operating segments, including the operations of Little Sheep, East Dawning,Taco Bell , Daojia, COFFii & JOY and our e-commerce business, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate. Additional details on our reportable operating segments are included in Note 13. Quarterly highlights: % Change Operating Operating Same-Store Profit Profit System Sales(a) Sales(a) Net New Units (Reported) (Ex F/X) KFC (15 ) (11 ) +10 (47 ) (45 ) Pizza Hut (38 ) (31 ) +1 NM NM All Other Segments(b) (48 ) (30 ) +11 NM NM Total (20 ) (15 ) +7 (68 ) (67 )
NM refers to changes over 100%, from negative to positive amounts or from zero to an amount.
(a) System sales and same-store sales percentages as shown in tables exclude the
impact of F/X. Effective
normalized in the same-store sales calculation by excluding the period during
which stores are temporarily closed.
(b) Sales from non-Company-owned restaurants, for which we do not receive a
sales-based royalty, are excluded from system sales and same-store sales.
As ofMarch 31, 2020 , the Company operated over 9,200 units, predominatelyKFC andPizza Hut restaurants, which are the leading and largest QSR and CDR brand, respectively, in mainland China in terms of system sales. We believe that there is significant opportunity to expand within China, and we intend to focus our efforts on increasing our geographic footprint in both existing and new cities. Starting in lateJanuary 2020 , the COVID-19 pandemic has significantly impacted the Company's operations in the first quarter of 2020. The first three weeks of January were strong, but then the pandemic led to subsequent same-store sales declines of 40-50% compared to the comparableChinese New Year holiday period in 2019. Approximately 35% of stores were closed by mid-February at the peak of the outbreak, with significant regional differences. For restaurants that remained open, same-store sales declined due to shortened operating hours and reduced traffic, with a significant portion of stores providing only delivery and takeaway services. As the quarter progressed, sales performance recovered gradually, with same-store sales down approximately 20% in late March. The pace of recovery is uneven with recent sales and traffic still below pre-outbreak levels as people continue to avoid going out and practice social distancing. As of the end of April, approximately 99% of our stores inChina were either partially or fully open. However, in April same-store sales were still down by more than 10%. As compared to the first quarter of 2019, Company sales in the first quarter of 2020 decreased 26%, or 24% if excluding the impact of F/X. The decrease in Company sales for the quarter, excluding the impact of F/X, was driven by same-store sales decline and temporary store closures due to the impact of the COVID-19 pandemic, partially offset by net unit growth. 29 -------------------------------------------------------------------------------- The decrease in Operating profit for the quarter, excluding the impact of F/X, was primarily driven by same-store sales declines, temporary store closures, increased rider labor costs due to higher delivery sales, and commodity inflation, partially offset by labor efficiency, one-time reductions in social security contributions and lease concessions, lower G&A expenses mainly due to timing of government incentives received, and utilities savings.
The Consolidated Results of Operations for the quarters to date ended
Quarter Ended % B/(W) (a)
3/31/2020 3/31/2019 Reported Ex F/X
Company sales $ 1,548 $ 2,089 (26 ) (24 )
Franchise fees and income 35 39 (10 ) (7 )
Revenues from transactions with
franchisees and unconsolidated
affiliates 161 170 (5 ) (2 )
Other revenues 10 6 70 78
Total revenues $ 1,754 $ 2,304 (24 ) (21 )
Restaurant profit $ 165 $ 386 (57 ) (56 )
Restaurant Margin % 10.7 % 18.5 % (7.8 ) ppts. (7.8 ) ppts.
Operating Profit $ 97 $ 303 (68 ) (67 )
Interest income, net 9 9 (7 ) (4 )
Investment (loss) gain (8 ) 10 NM NM
Income tax provision (32 ) (93 ) 65 65
Net Income - including
noncontrolling interests 66 229 (71 ) (70 )
Net Income - noncontrolling
interests 4 7 36 35
Net Income - Yum China Holdings,
Inc. $ 62 $ 222 (72 ) (71 )
Diluted Earnings Per Common
Share $ 0.16 $ 0.57 (72 ) (72 )
Effective tax rate 32.7 % 28.9 %
Adjusted Operating Profit $ 98 $ 303
Adjusted Net Income - Yum China
Holdings, Inc. $ 63 $ 230
Adjusted Diluted Earnings Per
Common Share $ 0.16 $ 0.59
Adjusted Effective Tax Rate 32.4 % 26.5 %
Adjusted EBITDA $ 219 $ 428 (a) Represents the period-over-period change in percentage.
Performance Metrics
Quarter Ended
3/31/2020 3/31/2019
System Sales (Decline) Growth (23 )% 3 %
System Sales (Decline) Growth, excluding F/X (20 )% 9 %
Same-Store Sales (Decline) Growth (15 )% 4 %
Unit Count 3/31/2020 3/31/2019 % Increase
Company-owned 7,432 6,974 7
Unconsolidated affiliates 924 834 11
Franchisees 939 845 11
9,295 8,653 7
30
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Special Items
Special Items, along with the reconciliation of the most directly comparable
GAAP financial measures to the adjusted financial measures, are presented below.
Quarter Ended
Detail of Special Items 3/31/2020 3/31/2019
Share-based compensation expense for Partner PSU
Awards(a) $ (1 ) $ -
Special Items, Operating Profit (1 )
-
Tax Expenses on Special Items(b) -
-
Impact from the Tax Act(c) -
(8 ) Special items, net income - including noncontrolling interests
(1 ) (8 )
Special items, net income - noncontrolling interests - -
Special Items, Net income -
(8 )
Weighted-average diluted shares outstanding (in
millions) 386 388
Special Items, Diluted Earnings Per Common Share $ -$ (0.02 ) Reconciliation of Operating Profit to Adjusted Operating Profit Operating Profit $ 97 $
303
Special Items, Operating Profit (1 )
-
Adjusted Operating Profit $ 98 $
303
Reconciliation of Net Income to Adjusted Net Income
Net Income -
$ 62 $ 222
Special Items, Net Income - Yum China Holdings, Inc. (1 ) (8 ) Adjusted Net Income - Yum China Holdings, Inc. $ 63 $
230
Reconciliation of EPS to Adjusted EPS Basic Earnings Per Common Share$ 0.16 $
0.59
Special Items, Basic Earnings Per Common Share (0.01 ) (0.02 ) Adjusted Basic Earnings Per Common Share$ 0.17 $
0.61
Diluted Earnings Per Common Share$ 0.16 $
0.57
Special Items, Diluted Earnings Per Common Share - (0.02 ) Adjusted Diluted Earnings Per Common Share$ 0.16 $
0.59
Reconciliation of Effective Tax Rate to Adjusted Effective Tax Rate Effective tax rate (See Note 12) 32.7 % 28.9 % Impact on effective tax rate as a result of Special Items(b)(c) 0.3 % 2.4 % Adjusted effective tax rate 32.4 % 26.5 %
(a) In
who were deemed critical to the Company's execution of its strategic
operating plan. These PSU awards will only vest if threshold performance
goals are achieved over a four-year performance period, with the payout
ranging from 0% to 200% of the target number of shares subject to the PSU
awards. Partner PSU Awards were granted to address increased competition for
executive talent, motivate transformational performance and encourage
management retention. Given the unique nature of these grants, the
Compensation Committee does not intend to grant similar, special grants to
the same employees during the performance period. The impact from these
special awards is excluded from metrics that management uses to assess the
Company's performance. The Company recognized share-based compensation cost
of
2020.
(b) The tax expense was determined based upon the nature, as well as the
jurisdiction, of each Special Item at the applicable tax rate.
(c) We completed the evaluation of the impact on our transition tax computation
based on the final regulations released by the
the
additional amount of $8 million for the transition tax accordingly.
31
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Adjusted EBITDA
Net income, along with the reconciliation to Adjusted EBITDA, is presented below.
Quarter Ended
Reconciliation of Net Income to Adjusted EBITDA
$ 62 $
222
Net Income - noncontrolling interests 4 7 Income tax provision 32 93 Interest income, net (9 ) (9 ) Investment loss (gain) 8 (10 ) Operating Profit 97 303 Special Items, Operating Profit 1 - Adjusted Operating Profit 98
303
Depreciation and amortization 109 111 Store impairment charges 12 14 Adjusted EBITDA$ 219 $ 428 Segment Results KFC Quarter Ended % B/(W) 3/31/2020 3/31/2019 Reported Ex F/X Company sales$ 1,220 $ 1,539 (21 ) (18 ) Franchise fees and income 33 36 (8 ) (5 ) Revenues from transactions with franchisees and unconsolidated affiliates 16 17 (3 ) - Total revenues$ 1,269 $ 1,592 (20 ) (18 ) Restaurant profit$ 166 $ 309 (46 ) (44 ) Restaurant margin % 13.6 % 20.0 % (6.4 ) ppts. (6.4 ) ppts. G&A expenses$ 46 $ 49 5 2 Franchise expenses$ 16 $ 19 12 10 Expenses for transactions with franchisees and unconsolidated affiliates$ 16 $ 17 2 (1 ) Closures and impairment expenses, net $ 1 $ 7 86 85 Other income, net$ (17 ) $ (18 ) (6 ) (3 ) Operating Profit$ 153 $ 288 (47 ) (45 ) Quarter Ended 3/31/2020 3/31/2019 System Sales (Decline) Growth (18 )% 5 % System Sales (Decline) Growth, excluding F/X (15 )% 11 % Same-Store Sales (Decline) Growth (11 )% 5 % 32
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Unit Count 3/31/2020 3/31/2019 % Increase
Company-owned 5,174 4,732 9
Unconsolidated affiliates 924 834 11
Franchisees 563 512 10
6,661 6,078 10
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2019 Actions Other F/X 3/31/2020
Company sales $ 1,539 $ (110 ) $ (169 ) $ (40 ) $ 1,220
Cost of sales (476 ) 31 40 13 (392 )
Cost of labor (320 ) (2 ) 26 9 (287 )
Occupancy and other
operating expenses (434 ) (2 ) 49 12 (375 )
Restaurant profit $ 309 $ (83 ) $ (54 ) $ (6 ) $ 166
The decrease in Company sales and Restaurant profit for the quarter, excluding
the impact of F/X, was primarily driven by the same-store sales decline and
temporary store closures due to the impact of the COVID-19 pandemic, increased
rider labor costs due to higher delivery sales, and commodity inflation of 3%,
partially offset by labor efficiency, one-time reductions in social security
contributions and lease concessions, and utility savings.
Franchise Fees and Income
The decrease in Franchise fees and income for the quarter, excluding the impact
of F/X, was primarily driven by same-store sales decline and temporary closures
of restaurants operated by unconsolidated affiliates and franchisees, partially
offset by the net unit growth.
G&A Expenses
The decrease in G&A expenses for the quarter, excluding the impact of F/X, was
primarily driven by cost control measures to lower travel expenses and higher
government incentives received, partially offset by higher compensation costs.
Operating Profit
The decrease in Operating profit for the quarter, excluding the impact of F/X,
was primarily driven by the decrease in Restaurant profit, partially offset by
lower store impairment charges.
33
--------------------------------------------------------------------------------Pizza Hut Quarter Ended % B/(W) 3/31/2020 3/31/2019 Reported Ex F/X Company sales$ 322 $ 541 (41 ) (39 ) Franchise fees and income 1 1 (1 ) 2 Revenues from transactions with franchisees and unconsolidated affiliates 1 1 2 6 Total revenues$ 324 $ 543 (40 ) (39 ) Restaurant profit $ 1$ 77 (99 ) (99 ) Restaurant margin % 0.3 % 14.3 % (14.0 ) ppts. (14.0 ) ppts. G&A expenses$ 24 $ 24 3 (1 ) Franchise expenses $ 1 $ 1 2 (1 ) Expenses for transactions with franchisees and unconsolidated affiliates $ 1 $ 1 (23 ) (27 ) Closures and impairment expenses, net $ 5 $ 3 (48 ) (55 ) Operating (Loss) Profit$ (28 ) $ 50 NM NM Quarter Ended 3/31/2020 3/31/2019 System Sales (Decline) (40 )% (3 )% System Sales (Decline) Growth, excluding F/X (38 )% 3 % Same-Store Sales (Decline) Growth (31 )% 1 % % Increase Unit Count 3/31/2020 3/31/2019 (Decrease) Company-owned 2,166 2,190 (1 ) Franchisees 105 59 78 2,271 2,249 1
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2019 Actions Other F/X 3/31/2020
Company sales $ 541 $ (68 ) $ (141 ) $ (10 ) $ 322
Cost of sales (159 ) 20 34 3 (102 )
Cost of labor (143 ) 11 24 4 (104 )
Occupancy and other
operating expenses (162 ) 10 33 4 (115 )
Restaurant profit $ 77 $ (27 ) $ (50 ) $ 1 $ 1
34
-------------------------------------------------------------------------------- The decrease in Company sales and Restaurant profit for the quarter, excluding the impact of F/X, was primarily driven by same-store sales decline and temporary store closures due to the impact of the COVID-19 pandemic, increased rider labor costs due to higher delivery sales, and commodity inflation of 4%, partially offset by labor efficiency, one-time reductions in social security contributions and lease concessions, and lower promotion costs. G&A Expenses The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by lower government incentives received and higher compensation costs, partially offset by cost control measures to lower travel expenses. Operating (Loss) Profit
The Operating loss for the quarter, excluding the impact of F/X, was primarily driven by the decrease in Restaurant profit and higher store impairment charges.
All Other Segments
All Other Segments reflects the results of Little Sheep, COFFii & JOY, East
Dawning,
Quarter Ended
% B/(W)
3/31/2020 3/31/2019 Reported Ex F/X
Company sales $ 6 $ 9 (32 ) (30 )
Franchise fees and income 1 2 (62 ) (62 )
Revenues from transactions
with franchisees and
unconsolidated affiliates 5 7 (36 ) (34 )
Other revenues 16 14 17 21
Total revenues $ 28 $ 32 (14 ) (11 )
Restaurant loss $ (3 ) $ (1 ) NM NM
Restaurant margin % (45.1 )% (5.6 )% (39.5 ) ppts. (39.5 ) ppts.
G&A expenses $ 8 $ 8 7 5
Expenses for transactions
with franchisees and
unconsolidated affiliates $ 4 $ 6 44 42
Other operating costs and expenses
(30 ) (35 )
Closures and impairment expenses, net $ 2 $ 1
NM NM
Operating Loss $ (10 ) $ (5 ) NM NM
Quarter Ended
3/31/2020 3/31/2019
Same-Store Sales Decline (30 )% (15 )%
The decrease in Company sales for the quarter, excluding the impact of F/X, was
primarily driven by same-store sales declines and temporary store closures due
to the impact of the COVID-19 pandemic.
35
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The increase in Other revenue and Other operating costs and expenses for the
quarter, excluding the impact of F/X, was primarily driven by the increase in
demand of online orders of certain product categories (mainly fresh grocery
products).
The increase in Operating loss for the quarter, excluding the impact of F/X, was
primarily driven by the increase in Restaurant loss and higher store impairment
charges.
Corporate and Unallocated
Quarter Ended
% B/(W)
3/31/2020 3/31/2019 Reported Ex F/X
Revenues from transactions
with franchisees and
unconsolidated affiliates $ 139 $ 145 (4 ) (1 )
Other revenue 1 1 (34 ) (32 )
Expenses for transactions
with franchisees and
unconsolidated affiliates 135 143 6 3
Other operating costs and expenses 1 1 (17 ) (21 )
Corporate G&A expenses 21 33 36 35
Other unallocated (loss) income (1 ) 1 NM NM
Interest income, net 9 9 (7 ) (4 )
Investment (loss) gain (8 ) 10 NM NM
Income tax provision (See Note 12) (32 ) (93 ) 65 65
Effective tax rate (See Note 12) 32.7 % 28.9 % (3.8 )% (3.8 )%
Revenues from Transactions with Franchisees and Unconsolidated Affiliates
The decrease in Revenues from transactions with franchisees and unconsolidated affiliates for the quarter, excluding the impact of F/X, was mainly driven by system sales decline of franchisees and unconsolidated affiliates, partially offset by an increase in the selling prices of food and paper products due to commodity inflation. G&A Expenses
The decrease in Corporate G&A expenses for the quarter, excluding the impact of F/X, was mainly driven by higher government incentives received.
Investment Gain (Loss)
The Investment gain or loss represents the unrealized gain or loss related to our investment in equity securities of Meituan Dianping ("Meituan"). See Note 6.
Income Tax Provision Our income tax provision includes tax on our earnings at the Chinese statutory tax rate of 25%, withholding tax on repatriation of earnings outside of China andU.S. corporate income tax, if any. Our effective tax rate was 32.7% and 28.9% for the quarters endedMarch 31, 2020 and 2019, respectively. The higher effective tax rate for the quarter was primarily due to a non-deductible loss in the first quarter of 2020, while non-taxable gain in the first quarter of 2019 related to our investment in equity securities of Meituan. 36 --------------------------------------------------------------------------------
Significant Known Events, Trends or Uncertainties Expected to Impact Future Results
Impact of COVID-19 Pandemic Starting in lateJanuary 2020 , the COVID-19 pandemic has significantly impacted the Company's operations. The pace of recovery is uneven with recent sales and traffic still below pre-outbreak levels as people continue to avoid going out and practice social distancing. As of the end of April, approximately 99% of our stores inChina were either partially or fully open. However, in April, same-store sales were still down by more than 10%. Management cannot ascertain the full impact of the COVID-19 pandemic on the Company's operations, which depends on the evolving nature of the COVID-19 pandemic and governmental responses thereto, the economic recovery within China and globally, the impact on consumer behavior and other related factors. The Company expects that COVID-19 will have a material adverse impact on the Company's results of operations, cash flows and financial condition for the full year 2020. For further information on the risks associated with the COVID-19 pandemic, see "Item 1A. Risk Factors."
Tax Examination on Transfer Pricing
We are subject to reviews, examinations and audits by Chinese tax authorities, theIRS and other taxing authorities with respect to income and non-income based taxes. Since 2016, we have been under a national audit on transfer pricing by the STA inChina regarding our related party transactions for the period from 2006 to 2015. The information currently exchanged with the tax authorities focuses on our franchise arrangement with YUM. We have submitted information to the extent it is available to the Company. It is reasonably possible that there could be significant developments, including expert review and assessment by the STA, within the next 12 months. The ultimate assessment will depend upon further review of the information provided and ongoing technical and other discussions with the STA and in-charge local tax authorities, and therefore it is not possible to reasonably estimate the potential impact. We will continue to defend our transfer pricing position. However, if the STA prevails in the assessment of additional tax due based on its ruling, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations and cash flows. PRC Value-Added Tax ("VAT") EffectiveMay 1, 2016 , a 6% output VAT replaced the 5% business tax ("BT") previously applied to certain restaurant sales. Input VAT would be creditable to the aforementioned 6% output VAT. The latest VAT rates imposed on our purchase of materials and services included 13%, 9% and 6%, which were gradually changed from 17%, 13%, 11% and 6% since 2017. These rate changes impact our input VAT on all materials and certain services, mainly including construction, transportation and leasing. However, the impact on our operating results is not expected to be significant. Entities that are VAT general taxpayers are permitted to offset qualified input VAT paid to suppliers against their output VAT upon receipt of appropriate supplier VAT invoices on an entity-by-entity basis. When the output VAT exceeds the input VAT, the difference is remitted to tax authorities, usually on a monthly basis; whereas when the input VAT exceeds the output VAT, the difference is treated as an input VAT credit asset which can be carried forward indefinitely to offset future net VAT payables. VAT related to purchases and sales which have not been settled at the balance sheet date is disclosed separately as an asset and liability, respectively, on the Consolidated Balance Sheets. At each balance sheet date, the Company reviews the outstanding balance of any input VAT credit asset for recoverability, giving consideration to the indefinite life of the input VAT credit assets as well as its forecasted operating results and capital spending, which inherently includes significant assumptions that are subject to change. 37 -------------------------------------------------------------------------------- As ofMarch 31, 2020 , an input VAT credit asset of$241 million and payable of$2 million were recorded in Other assets and Accounts payable and other current liabilities, respectively, on the Consolidated Balance Sheets. The Company has not made an allowance for the recoverability of the input VAT credit asset, as the balance is expected to be utilized to offset against VAT payables more than one year fromMarch 31, 2020 . Any input VAT credit asset would be classified as Prepaid expenses and other current assets if the Company expected to use the credit within one year. We have been benefiting from the retail tax structure reform since it was implemented onMay 1, 2016 . However, the amount of our expected benefit from this VAT regime depends on a number of factors, some of which are outside of our control. The interpretation and application of the new VAT regime are not settled at some local governmental levels. In addition, the timetable for enacting the prevailing VAT regulations into national VAT law, including ultimate enacted VAT rates, is not clear. As a result, for the foreseeable future, the benefit of this significant and complex VAT reform has the potential to fluctuate from quarter to quarter.
Foreign Currency Exchange Rate
The reporting currency of the Company is the US$. Most of the revenues, costs,
assets and liabilities of the Company are denominated in Chinese Renminbi
("RMB"). Any significant change in the exchange rate between US$ and RMB may
materially affect the Company's business, results of operations, cash flows and
financial condition, depending on the weakening or strengthening of RMB against
the US$. See "Item 3. Quantitative and Qualitative Disclosures About Market
Risk" for a further discussion.
Consolidated Cash Flows
Our cash flows for the years to date ended
Net cash provided by operating activities was$60 million in 2020 as compared to$344 million in 2019. The decrease was primarily driven by net income decrease and timing of payments for inventory along with other working capital changes. Net cash provided by investing activities was$2 million in 2020 as compared to$267 million of net cash used in investing activities in 2019. The change is mainly due to the net impact on cash flow resulting from purchases and maturities of short-term investments. Net cash used in financing activities was$52 million in 2020 as compared to$113 million in 2019. The decrease was primarily driven by a decrease in the number of shares repurchased in 2020.
Liquidity and Capital Resources
Historically we have funded our operations through cash generated from the operation of our Company-owned stores and from our franchise operations and dividend payments from our unconsolidated affiliates.
Our ability to fund our future operations and capital needs will depend on our
ongoing ability to generate cash from operations. We believe our principal uses
of cash in the future will be primarily to fund our operations and to make
capital expenditures, distributions to our stockholders and share repurchases as
well as any acquisition or investment we may make. As a result of the COVID-19
pandemic, we have taken, and continue to take, certain actions to provide
additional liquidity and flexibility, which include temporarily suspending our
share repurchase program and, for the next two quarters, dividends, as well as
increasing our credit facilities. We believe that our future cash from
operations, together with our access to funds on hand and capital markets, will
provide adequate resources to fund these uses of cash and that our existing
cash, net cash from operations and credit facilities will be sufficient to fund
our operations and anticipated capital expenditures for the next 12 months.
38
--------------------------------------------------------------------------------If our cash flows from operations are less than we require, we may need to access the capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future or at all will be impacted by many factors, including, but not limited to:
• our financial performance; • our credit ratings; • the liquidity of the overall capital markets; and
• the state of the Chinese,
between the Chinese and U.S. governments.
There can be no assurance that we will have access to the capital markets on terms acceptable to us or at all.
Generally our income is subject to the Chinese statutory tax rate of 25%. However, to the extent our cash flows from operations exceed our China cash requirements, the excess cash may be subject to an additional 10% withholding tax levied by the Chinese tax authority, subject to any reduction or exemption set forth in relevant tax treaties or tax arrangements.
Share Repurchases and Dividends
Our Board of Directors has authorized an aggregate of$1.4 billion for our share repurchase program.Yum China may repurchase shares under this program from time to time in open market or privately negotiated transactions, including block trades, accelerated share repurchase transactions and the use of Rule 10b5-1 trading plans. During the quarters endedMarch 31, 2020 and 2019, the Company repurchased$7 million or 0.2 million and$65 million or 1.7 million shares of common stock, respectively, under the repurchase program.
For the quarters ended
Due to the unprecedented effects of the COVID-19 pandemic and associated
economic uncertainty, the Company announced in
Our ability to declare and pay any dividends on our stock may be restricted by earnings available for distribution under applicable Chinese laws. The laws, rules and regulations applicable to our Chinese subsidiaries permit payments of dividends only out of their accumulated profits, if any, determined in accordance with applicable Chinese accounting standards and regulations. Under Chinese law, an enterprise incorporated inChina is required to set aside at least 10% of its after-tax profits each year, after making up previous years' accumulated losses, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of its registered capital. As a result, our Chinese subsidiaries are restricted in their ability to transfer a portion of their net assets to us in the form of dividends. At the discretion of the Board of Directors, as an enterprise incorporated inChina , each of our Chinese subsidiaries may allocate a portion of its after-tax profits based on Chinese accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. Borrowing Capacity As ofMarch 31, 2020 , the Company had credit facilities ofRMB 3,216 million (approximately$454 million ), comprised of onshore credit facilities ofRMB1,800 million (approximately$254 million ) in aggregate and offshore credit facilities of$200 million in aggregate. 39
-------------------------------------------------------------------------------- The credit facilities had remaining terms ranging from less than one year to three years as ofMarch 31, 2020 . Each credit facility bears interest based on the prevailing rate stipulated by thePeople's Bank of China , Loan Prime Rate ("LPR") published by the National Interbank Funding Centre of the PRC orLondon Interbank Offered Rate ("LIBOR") administered by theICE Benchmark Administration . Each credit facility contains a cross-default provision whereby our failure to make any payment on a principal amount from any credit facility will constitute a default on other credit facilities. Some of the credit facilities contain covenants limiting, among other things, certain additional indebtedness and liens, and certain other transactions specified in the respective agreement. Some of the onshore credit facilities contain sublimits for overdrafts, non-financial bonding, standby letters of credit and guarantees. As ofMarch 31, 2020 , we had outstanding bank guarantees ofRMB 86 million (approximately$12 million ) to secure our lease payment to landlords for certain Company-owned restaurants. The credit facilities were therefore reduced by the same amount, while there were no borrowings outstanding as ofMarch 31, 2020 .
Off-Balance Sheet Arrangements
See the Guarantees section of Note 14 for discussion of our off-balance sheet arrangements.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
See Note 2 for details of recently adopted accounting pronouncements.
New Accounting Pronouncements Not Yet Adopted
InDecember 2019 , the FASB issued ASU 2019-12, Income Tax (Topic 740), Simplifying the Accounting for Income Taxes ("ASU 2019-12"), which simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in Topic 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The guidance also simplifies the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 is effective for the Company fromJanuary 1, 2021 , with early adoption permitted. We are currently evaluating the impact the adoption of this standard will have on our financial statements. InJanuary 2020 , the FASB issued ASU 2020-01,Investments-Equity Securities (Topic 321),Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) ("ASU 2020-01"), which clarifies the interaction for equity securities under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815. ASU 2020-01 is effective for the Company fromJanuary 1, 2021 , with early adoption permitted. We are currently evaluating the impact the adoption of this standard will have on our financial statements. 40
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Cautionary Note Regarding Forward-Looking Statements
Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. These statements often include words such as "may," "will," "estimate," "intend," "seek," "expect," "project," "anticipate," "believe," "plan," "could," "target," "predict," "likely," "should," "forecast," "outlook," "model," "continue," "ongoing" or other similar terminology. Forward-looking statements are based on our expectations, estimates, assumptions or projections concerning future results or events as of the date of the filing of this Form 10-Q. 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 and events to differ materially from those indicated by those statements. We cannot assure you that any of our assumptions are correct or any of our expectations, estimates or projections will be achieved. Numerous factors could cause our actual results to differ materially from those expressed or implied by forward-looking statements, including, without limitation, the following:
• Risks related to our business and industry, such as (a) food safety and
food-borne illness concerns, (b) significant failure to maintain effective
quality control systems for our restaurants, (c) significant liability
claims, food contamination complaints from our customers or reports of
incidents of food tampering, (d) health concerns arising from outbreaks of
viruses or other illnesses, including the COVID-19 pandemic, (e) the fact
that we derive substantially all of our revenue from our operations in
China, (f) the fact that the operation of our restaurants is subject to
the terms of the master license agreement with YUM, (g) the fact that our
success is tied to the success of YUM's brand strength, marketing
campaigns and product innovation, (h) shortages or interruptions in the
availability and delivery of food products and other supplies, (i)
fluctuation of raw materials prices, (j) our inability to attain ourtarget development goals and the potential cannibalization of existing
sales by aggressive development, (k) risks associated with leasing real
estate, (l) inability to obtain desirable restaurant locations on
commercially reasonable terms, (m) labor shortages or increases in labor
costs, (n) the fact that our success depends substantially on our
corporate reputation and on the value and perception of our brands, (o)
the occurrence of security breaches and cyber-attacks, (p) failure toprotect the integrity and security of our customer or employee personal,
financial or other data or our proprietary or confidential information
that is stored in our information systems or by third parties on our
behalf, (q) failures or interruptions of service or security breaches in
our information technology systems, (r) the fact that our business depends
on the performance of, and our long-term relationships with, third-party
mobile payment processors, internet infrastructure operators, internet
service providers and delivery aggregators, (s) failure to provide timely
and reliable delivery services by our restaurants, (t) our growth strategy
with respect to COFFii & JOY may not be successful, (u) challenges and
risks related to our e-commerce business, (v) the anticipated benefits of
the acquisition of Daojia may not be realized in a timely manner or at
all, (w) the Chinese government may determine that the VIE structure of
Daojia does not comply with Chinese laws on foreign investment in
restricted industries, (x) our inability or failure to recognize, respond
to and effectively manage the impact of social media, (y) litigation and
failure to comply with anti-bribery or anti-corruption laws, (z) U.S.
federal income taxes, changes in tax rates, disagreements with tax
authorities (including with respect to the transfer pricing audit) andimposition of new taxes, (aa) changes in consumer discretionary spending
and general economic conditions, (bb) competition in the retail food
industry, (cc) loss or failure to obtain or renew any or all of the
approvals, licenses and permits to operate our business, (dd) our
inability to adequately protect the intellectual property we own or havethe right to use, (ee) YUM's failure to protect its intellectual property,
(ff) seasonality and certain major events in
detect, deter and prevent all instances of fraud or other misconduct
committed by our employees, customers or other third parties, (hh) changes
in accounting standards and subjective assumptions, estimates and
judgments by management related to complex accounting matters, (ii)
failure of our insurance policies to provide adequate coverage for claims
associated with our business operations, (jj) unforeseeable business
interruptions, (kk) failure by us to maintain effective disclosure
controls and procedures and internal control over financial reporting in
accordance with the rules of the
depends on the continuing efforts of our key management and experienced
and capable personnel as well as our ability to recruit new talent, (mm)
our investment in technology and innovation may not generate the expected
level of returns, and (nn) our strategic investments or acquisitions may
be unsuccessful;
41
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• Risks related to doing business in China , such as (a) changes in Chinese
political policies and economic and social policies or conditions, (b)
uncertainties with respect to the interpretation and enforcement of
Chinese laws, rules and regulations, (c) changes in trade relations
between
higher taxes on goods imported from
the value of the Chinese Renminbi, (e) limitations on our ability to
utilize our cash balances effectively due to governmental control ofcurrency conversion and payments of foreign currency, (f) changes in laws
and regulations, (g) reliance on distributions by our operating
subsidiaries in
unfavorable tax consequences resulting from our classification as a China
resident enterprise for Chinese enterprise income tax purposes, (i)
uncertainty regarding indirect transfers of equity interests and enhanced
scrutiny by Chinese tax authorities, (j) difficulties in effecting service
of legal process, enforcing foreign judgments or bringing original actions
in
by non-registration of lease agreements related to certain properties, (l)
risk in relation to unexpected land acquisitions, building closures or
demolitions, (m) potential fines for failure to comply with law, (n)
restrictions on our ability to make loans or additional capital
contributions to our Chinese subsidiaries due to Chinese regulation ofloans to, and direct investment in, Chinese entities by offshore holding
companies and governmental control of currency conversion and (o)
difficulties in pursuing growth through acquisitions due to regulations
regarding acquisitions;
• Risks related to the separation and related transactions, such as (a)incurring significant tax liabilities if the distribution does not qualify
as a transaction that is generally tax-free for
purposes and the Company could be required to indemnify YUM for material
taxes and other related amounts pursuant to indemnification obligations
under the tax matters agreement, (b) being obligated to indemnify YUM for
material taxes and related amounts pursuant to indemnification obligations
under the tax matters agreement if YUM is subject to Chinese indirect
transfer tax with respect to the distribution, (c) potential
indemnification liabilities owing to YUM pursuant to the separation and
distribution agreement and there being no assurance that the indemnity
provided by YUM with respect to certain liabilities in connection with the
separation will be sufficient to insure us against the full amount of such
liabilities, (d) the possibility that a court would require that we assume
responsibility for obligations allocated to YUM under the separation and
distribution agreement and (e) potential liabilities due to fraudulent
transfer considerations.
In addition, other risks and uncertainties not presently known to us or that we
currently believe to be immaterial could affect the accuracy of any such
forward-looking statements. All forward-looking statements should be evaluated
with the understanding of their inherent uncertainty. You should consult our
filings with the Securities and Exchange Commission (including the information
set forth under the captions "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Risk Factors" included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2019 and
this Form 10-Q) for additional information regarding factors that could affect
our financial and other results. You should not place undue reliance on
forward-looking statements, which speak only as of the date of the filing of
this Form 10-Q. We are not undertaking to update any of these statements, except
as required by law.
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