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 and 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.
Introduction
Yum China Holdings, Inc. is the largest restaurant company inChina in terms of system sales, with over 12,000 restaurants covering over 1,700 cities primarily inChina as ofMarch 31, 2022 . Our growing restaurant base consists of our flagshipKFC and Pizza Hut brands, as well as emerging brands such as Little Sheep,Huang Ji Huang , Lavazza, COFFii & JOY 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 ,Macau andTaiwan , and own the intellectual property of the Little Sheep,Huang Ji Huang and COFFii & JOY concepts outright.KFC was the first major global restaurant brand to enter China as early as 1987. With more than 30 years of operations, we have developed extensive operating experience in the China market. We have since grown to become the largest restaurant company inChina in terms of system sales. We believe that there are significant opportunities 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, 2022 ,KFC operated over 8,400 restaurants in over 1,700 cities across China. During the fourth quarter of 2021, the Company completed the acquisition of a 28% equity interest inHangzhou Catering Service Group ("Hangzhou Catering "), which holds a 45% equity interest in an unconsolidated affiliate that operatesKFC stores in and aroundHangzhou, China ("Hangzhou KFC"), increasing our equity interest to approximately 60% directly and indirectly, and allowing the Company to consolidateHangzhou KFC .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, 2022 ,Pizza Hut operated over 2,600 restaurants in over 600 cities. In the second quarter of 2020, the Company partnered withLuigi Lavazza S.p.A . ("Lavazza Group "), the world renowned family-owned Italian coffee company, and entered into a joint venture to explore and develop the Lavazza coffee shop concept inChina . InSeptember 2021 , the Company andLavazza Group entered into agreements for the previously formed joint venture ("Lavazza joint venture") to accelerate the expansion of Lavazza coffee shops inChina . Upon execution of these agreements, the Company controls and consolidates the joint venture with its 65% equity interest. OnApril 15, 2022 , the Company and YUM, through their respective subsidiaries, entered into an amendment to the master license agreement to amend the development milestones for the Taco Bell brand. The Company has committed to expanding theTaco Bell store network to at least 100 stores by the end of 2022 and at least 225 stores by the end of 2025, with certain investment support from YUM. Subject to achieving these milestones, the Company will have the exclusive right to operate and sublicense the Taco Bell brand inChina for 50 years. The Company's common stock is listed on the NYSE under the symbol "YUMC". OnSeptember 10, 2020 , the Company completed its secondary listing on the Main Board of the HKEX under the stock code "9987", in connection with a global offering of 41,910,700 shares of its common stock. Net proceeds raised by the Company from the global offering after deducting underwriting fees and the offering expenses amounted toUS$2.2 billion .
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.
24
--------------------------------------------------------------------------------•
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 an average 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 is useful to investors as a significant indicator of the overall strength of our business as it incorporates all of our revenue drivers, Company and franchise same-store sales as well as net unit growth.
•
EffectiveJanuary 1, 2018 , the Company revised its definition of 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 management measures performance internally and focuses on trends of a more stable base of stores.
•
Company sales represent revenues from Company-owned restaurants.Company Restaurant profit ("Restaurant profit") is defined as Company sales less expenses incurred directly by our Company-owned restaurants in generating Company sales. Company restaurant margin 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.
All Note references in this MD&A refer to the Notes to the Condensed
Consolidated Financial Statements. Tabular amounts are displayed in millions of
Quarters Ended
Results of Operations
Summary
The Company has two reportable segments:KFC andPizza Hut . Our remaining operating segments, including the operations of Little Sheep,Huang Ji Huang , Lavazza, COFFii & JOY,Taco Bell , East Dawning, Daojia 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 14.
Quarterly highlights:
% Change
System Sales(a) Same-Store Sales(a) Net New Units Operating Profit Operating Profit
(Reported) (Ex F/X)
KFC (4 ) (9 ) +14 (33 ) (34 )
Pizza Hut (1 ) (5 ) +12 (50 ) (51 )
All Other Segments(b) (14 ) (15 ) +3 NM NM
Total (4 ) (8 ) +13 (44 ) (45 )
25--------------------------------------------------------------------------------
NM refers to not meaningful.
(a)
System sales and same-store sales percentages as shown in tables exclude the impact of F/X. EffectiveJanuary 1, 2018 , temporary store closures are 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, 2022 , the Company operated over 12,000 units, predominatelyKFC andPizza Hut restaurants, which are the leading and largest QSR and CDR brands, respectively, in mainland China in terms of system sales. We believe that there are significant opportunities to expand within China, and we intend to focus our efforts on increasing our geographic footprint in both existing and new cities. The highly transmissible Omicron variant caused significant volatility in the Company's business operations in the first quarter of 2022. After a relatively stable period in January and February, the situation rapidly deteriorated in March, resulting in the largest outbreak inChina since COVID-19 first emerged in early 2020. InMarch 2022 , over 1,700 of our stores, on average, were temporarily closed or offered only takeaway and delivery services. Same-store sales in March decreased by more than 20%. As a result, the Company incurred an operating loss in March. As compared to the first quarter of 2021, Company sales in the first quarter of 2022 increased 9%, or 7% excluding the impact of F/X. The increase in Company sales for the quarter, excluding the impact of F/X, was attributable to net unit growth of 24% in Company-owned stores including the acquisition ofHangzhou KFC , partially offset by same-store sales decline of 8% and substantially more temporary store closures due to the impact of the COVID-19 pandemic. The decrease in Operating profit for the quarter, excluding the impact of F/X, was primarily driven by same-store sales decline, temporary store closures due to the impact of the COVID-19 pandemic, wage inflation of 5%, increased rider cost associated with a rise of approximately five percentage points in delivery sales mix from the prior year period due to more severe outbreaks and commodity inflation of 1%, partially offset by the acquisition ofHangzhou KFC . 26 -------------------------------------------------------------------------------- The Consolidated Results of Operations for the quarters endedMarch 31, 2022 and 2021 are presented below: Quarter Ended % B/(W) (a) 3/31/2022 3/31/2021 Reported Ex F/X Company sales$ 2,548 $ 2,331 9 7 Franchise fees and income 24 42 (42 ) (44 ) Revenues from transactions with franchisees and unconsolidated affiliates 77 171 (55 ) (56 ) Other revenues 19 13 46 43 Total revenues$ 2,668 $ 2,557 4 2 Restaurant profit$ 351 $ 435 (20 ) (21 ) Restaurant Margin % 13.8 % 18.7 % (4.9 ) ppts. (4.9 ) ppts. Operating Profit$ 191 $ 342 (44 ) (45 ) Interest income, net 12 15 (19 ) (20 ) Investment loss (37 ) (12 ) NM NM Income tax provision (55 ) (102 ) 46 47 Equity in net earnings (losses) from equity method investments (1 ) - NM NM Net Income - including noncontrolling interests 110 243 (55 ) (56 ) Net Income - noncontrolling interests 10 13 21 23 Net Income - Yum China Holdings, Inc.$ 100 $ 230 (57 ) (58 ) Diluted Earnings Per Common Share$ 0.23 $ 0.53 (57 ) (57 ) Effective tax rate 33.1 % 29.6 % Supplementary information - Non-GAAP Measures(b) Adjusted Operating Profit$ 193 $ 345 Adjusted Net Income - Yum China Holdings, Inc.$ 102 $ 233 Adjusted Diluted Earnings Per Common Share$ 0.24 $ 0.54 Adjusted Effective Tax Rate 32.7 % 29.3 % Adjusted EBITDA$ 365 $ 476 (a)
Represents the period-over-period change in percentage.
(b)
See "Non-GAAP Measures" below for definitions and reconciliations of the most directly comparable GAAP financial measures to the non-GAAP measures.
Performance Metrics
Quarter Ended 3/31/2022
% Change
System Sales Decline (2 )%
System Sales Decline, excluding F/X (4 )%
Same-Store Sales Decline (8 )%
% Increase
Unit Count 3/31/2022 3/31/2021 (Decrease)
Company-owned(a) 10,385 8,371 24
Unconsolidated affiliates(a) - 709 (100 )
Franchisees 1,732 1,645 5
12,117 10,725 13
(a)
As a result of the acquisition of
27
--------------------------------------------------------------------------------Non-GAAP Measures
In addition to the results provided in accordance with GAAP throughout this
MD&A, the Company provides non-GAAP measures adjusted for Special Items, which
include Adjusted Operating Profit, Adjusted Net Income, Adjusted Earnings Per
Common Share ("EPS"), Adjusted Effective Tax Rate and Adjusted EBITDA, which we
define as net income including noncontrolling interests adjusted for equity in
net earnings (losses) from equity method investments, income tax, interest
income, net, investment gain or loss, certain non-cash expenses, consisting of
depreciation and amortization as well as store impairment charges and Special
Items.
The following table sets forth the reconciliations of the most directly
comparable GAAP financial measures to the non-GAAP adjusted financial measures.
Quarter Ended
3/31/2022 3/31/2021
Non-GAAP Reconciliations
Reconciliation of Operating Profit to Adjusted
Operating Profit
Operating Profit $ 191 $ 342
Special Items, Operating Profit (2 ) (3 ) Adjusted Operating Profit$ 193 $
345
Reconciliation of Net Income to Adjusted Net Income
Net Income -
$ 100 $
230
Special Items, Net Income - Yum China Holdings, Inc. (2 ) (3 ) Adjusted Net Income - Yum China Holdings, Inc.$ 102 $
233
Reconciliation of EPS to Adjusted EPS Basic Earnings Per Common Share$ 0.23 $
0.55
Special Items, Basic Earnings Per Common Share (0.01 )
-
Adjusted Basic Earnings Per Common Share$ 0.24 $
0.55
Diluted Earnings Per Common Share$ 0.23 $
0.53
Special Items, Diluted Earnings Per Common Share (0.01 ) (0.01 ) Adjusted Diluted Earnings Per Common Share$ 0.24 $
0.54
Reconciliation of Effective Tax Rate to Adjusted Effective Tax Rate Effective tax rate (See Note 13) 33.1 % 29.6 % Impact on effective tax rate as a result of Special Items 0.4 % 0.3 % Adjusted effective tax rate 32.7 % 29.3 %
Net income, along with the reconciliation to Adjusted EBITDA, is presented below.
Quarter Ended
Reconciliation of Net Income to Adjusted EBITDA3/31/2022
Net Income - Yum China Holdings, Inc. $ 100 $ 230
Net Income - noncontrolling interests 10 13
Equity in net (earnings) losses from equity method
investments 1 -
Income tax provision 55 102
Interest income, net (12 ) (15 )
Investment loss 37 12
Operating Profit 191 342
Special Items, Operating Profit 2 3
Adjusted Operating Profit 193 345
Depreciation and amortization 164 128
Store impairment charges 8 3
Adjusted EBITDA $ 365 $ 476
28--------------------------------------------------------------------------------
Details of Special Items are presented below:
Quarter Ended
Details of Special Items3/31/2022
Share-based compensation expense for Partner PSU Awards(1) $ (2 ) $ (3 ) Special Items, Operating Profit (2 ) (3 ) Tax Expenses on Special Items(2) -
-
Special items, net income - including noncontrolling interests
(2 ) (3 )
Special items, net income - noncontrolling interests - -
Special Items, Net Income -
(3 )
Weighted-average diluted shares outstanding (in
millions) 430 434
Special Items, Diluted Earnings Per Common Share
(0.01 )
(1)
In February 2020 , the Company granted Partner PSU Awards to select employees 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 expenses of $2 million and $3 million associated with
the Partner PSU Awards for the quarters ended March 31, 2022 and 2021,
respectively.
(2)
The tax expense was determined based upon the nature, as well as the jurisdiction, of each Special Item at the applicable tax rate.
The Company 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, store impairment charges
and Special Items. Store impairment charges included as an adjustment item in
Adjusted EBITDA primarily resulted from our semi-annual impairment evaluation of
long-lived assets of individual restaurants, and additional impairment
evaluation whenever events or changes in circumstances indicate that the
carrying value of the assets may not be recoverable. If these restaurant-level
assets were not impaired, depreciation of the assets would have been recorded
and included in EBITDA. Therefore, store impairment charges were a non-cash item
similar to depreciation and amortization of our long-lived assets of
restaurants. The Company believes that investors and analysts may find it useful
in measuring operating performance without regard to such non-cash item.
These adjusted measures are not intended to replace the presentation of our
financial 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.
29
--------------------------------------------------------------------------------Segment ResultsKFC Quarter Ended % B/(W) 3/31/2022 3/31/2021 Reported Ex F/X Company sales$ 1,991 $ 1,783 12 9 Franchise fees and income 16 33 (51 ) (52 )
Revenues from transactions with
franchisees and unconsolidated affiliates 8 15 (47 ) (48 ) Other revenues 2 1 53 49 Total revenues$ 2,017 $ 1,832 10 8 Restaurant profit$ 302 $ 355 (15 ) (17 ) Restaurant margin % 15.2 % 19.9 % (4.7 ) ppts. (4.7 ) ppts. G&A expenses$ 65 $ 55 (20 ) (17 ) Franchise expenses $ 9$ 16 47 48
Expenses for transactions with
franchisees and unconsolidated affiliates $ 8$ 15 50 51 Other operating costs and expenses $ 1 $ - NM NM Closures and impairment (income) expenses, net$ (1 ) $ - NM NM Other expenses (income), net$ 26 $ (9 ) NM NM Operating Profit$ 220 $ 327 (33 ) (34 ) Quarter Ended 3/31/2022 % Change System Sales Decline (2 )% System Sales Decline, excluding F/X (4 )% Same-Store Sales Decline (9 )% % Increase Unit Count 3/31/2022 3/31/2021 (Decrease) Company-owned(a) 7,668 6,030 27 Unconsolidated affiliates(a) - 704 (100 ) Franchisees 773 639 21 8,441 7,373 14 (a)
As a result of the acquisition of
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2021 Actions Other F/X 3/31/2022
Company sales $ 1,783 $ 326 $ (158 ) $ 40 $ 1,991
Cost of sales (540 ) (102 ) 34 (13 ) (621 )
Cost of labor (398 ) (90 ) (3 ) (10 ) (501 )
Occupancy and other
operating expenses (490 ) (95 ) 29 (11 ) (567 )
Restaurant profit $ 355 $ 39 $ (98 ) $ 6 $ 302
30-------------------------------------------------------------------------------- The increase in Company sales for the quarter, excluding the impact of F/X, was primarily driven by net unit growth including the acquisition ofHangzhou KFC , partially offset by same-store sales decline and temporary store closures due to the impact of the COVID-19 pandemic. The decrease in Restaurant profit for the quarter, excluding the impact of F/X, was primarily driven by wage inflation of 5%, increased rider cost associated with a rise of approximately six percentage points in delivery sales mix from the prior year period due to more severe outbreaks and commodity inflation of 2%, partially offset by the increase in Company sales.
Franchise Fees and Income/Revenues from Transactions with Franchisees and Unconsolidated Affiliates
The decrease in Franchise fees and income and Revenues from transactions with franchisees and unconsolidated affiliates for the quarter, excluding the impact of F/X, was primarily driven by the acquisition ofHangzhou KFC inDecember 2021 .
G&A Expenses
The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by the acquisition ofHangzhou KFC inDecember 2021 and merit increases. 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.
Pizza Hut Quarter Ended % B/(W) 3/31/2022 3/31/2021 Reported Ex F/X Company sales$ 542 $ 538 1 (1 ) Franchise fees and income 2 2 7 5
Revenues from transactions with
franchisees and unconsolidated affiliates 1 1 (28 ) (29 ) Other revenues 2 - NM NM Total revenues$ 547 $ 541 1 (1 ) Restaurant profit$ 58 $ 82 (29 ) (31 ) Restaurant margin % 10.7 % 15.3 %
(4.6 ) ppts. (4.6 ) ppts.
G&A expenses$ 29 $ 25 (15 ) (13 ) Franchise expenses $ 1 $ 1 (5 ) (3 )
Expenses for transactions with
franchisees and unconsolidated affiliates $ 1 $ 1 29 30
Other operating costs and expenses $ 1 $ - NM
NM
Closures and impairment expenses
(income), net $ 1 $ (2 ) NM NM
Operating Profit $ 30 $ 60 (50 ) (51 )
Quarter Ended 3/31/2022
% Change
System Sales Growth 1 %
System Sales Decline, excluding F/X (1 )%
Same-Store Sales Decline (5 )%
Unit Count 3/31/2022 3/31/2021 % Increase
Company-owned 2,543 2,255 13
Franchisees 136 127 7
2,679 2,382 12
31--------------------------------------------------------------------------------
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2021 Actions Other F/X 3/31/2022
Company sales $ 538 $ 18 $ (25 ) $ 11 $ 542
Cost of sales (160 ) (5 ) 3 (4 ) (166 )
Cost of labor (143 ) (9 ) (2 ) (3 ) (157 )
Occupancy and other
operating expenses (153 ) (9 ) 4 (3 ) (161 )
Restaurant profit $ 82 $ (5 ) $ (20 ) $ 1 $ 58
The decrease in Company sales 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, partially offset by net unit growth. The
decrease in Restaurant profit for the quarter, excluding the impact of F/X, was
primarily driven by the decrease in Company sales and wage inflation of 6%.
G&A Expenses
The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by merit increases.
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.
All Other Segments
All Other Segments reflects the results of Little Sheep,Huang Ji Huang , Lavazza, COFFii & JOY,Taco Bell , East Dawning, Daojia and our e-commerce business. Quarter Ended % B/(W) 3/31/2022 3/31/2021 Reported Ex F/X Company sales$ 15 $ 10 38 35 Franchise fees and income 6 7 (11 ) (13 ) Revenues from transactions with franchisees and unconsolidated affiliates 11 26 (59 ) (60 ) Other revenues 131 35 NM NM Total revenues$ 163 $ 78 NM NM Restaurant loss$ (7 ) $ (2 ) NM NM Restaurant margin % (50.9 )% (13.3 )% (37.6 ) ppts. (37.6 ) ppts. G&A expenses$ 13 $ 9 (37 ) (34 ) Expenses for transactions with franchisees and unconsolidated affiliates $ 9$ 24 61 62 Other operating costs and expenses$ 134 $ 33 NM NM Closures and impairment expenses, net $ 2 $ - NM NM Other expenses, net $ - $ 3 NM NM Operating Loss$ (17 ) $ (3 ) NM NM Quarter Ended 3/31/2022 % Change Same-Store Sales Decline (15 )% 32
--------------------------------------------------------------------------------
Total Revenues
The increase in Total revenues of all other segments for the quarter, excluding the impact of F/X, was primarily driven by inter-segment revenue generated by our delivery team for services provided toKFC andPizza Hut restaurants and the consolidation of the Lavazza joint venture.
Restaurant Loss
The increase in Restaurant loss for the quarter, excluding the impact of F/X, was primarily driven by the consolidation of the Lavazza joint venture.
G&A Expenses
The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by the consolidation of the Lavazza joint venture.
Operating Loss
The increase in Operating loss for the quarter, excluding the impact of F/X, was
primarily driven by the increase of Operating loss from certain emerging brands.
Corporate and Unallocated
Quarter Ended
% B/(W)
3/31/2022 3/31/2021 Reported Ex F/X
Revenues from transactions
with
franchisees and
unconsolidated affiliates $ 57 $ 129 (55 ) (56 )
Other revenues $ 10 $ 2 NM NM
Expenses for transactions
with
franchisees and
unconsolidated affiliates $ 57 $ 129 55 56
Other operating costs and
expenses $ 9 $ 3 NM NM
Corporate G&A expenses $ 44 $ 41 (7 ) (5 )
Other unallocated income,
net $ (1 ) $ - NM NM
Interest income, net $ 12 $ 15 (19 ) (20 )
Investment loss $ (37 ) $ (12 ) NM NM
Income tax provision (See
Note 13) $ (55 ) $ (102 ) 46 47
Equity in net earnings
(losses) from
equity method
investments $ (1 ) $ - NM NM
Effective tax rate (See
Note 13) 33.1 % 29.6 % (3.5 )% (3.5 )%
Revenues from Transactions with Franchisees and Unconsolidated Affiliates
Revenues from transactions with franchisees and unconsolidated affiliates primarily include revenues derived from the Company's central procurement model whereby food and paper products are centrally purchased and then mainly sold toKFC andPizza Hut franchisees and unconsolidated affiliates that operate our concepts. The decrease for the quarter, excluding the impact of F/X, was mainly due to the acquisition ofHangzhou KFC inDecember 2021 .
Other Revenues/Operating Costs and Expenses
The increase in Other revenues/operating costs and expenses for the quarter, excluding the impact of F/X, was mainly driven by logistics and warehousing services provided to third parties.
G&A Expenses
The increase in Corporate G&A expenses for the quarter, excluding the impact of F/X, was primarily due to merit increases.
33
--------------------------------------------------------------------------------Investment Loss
The increase in investment loss for the quarter mainly relates to the decline in fair value of our investment in Meituan, partially offset by lapping the investment loss from our investment in Sunner recognized in the first quarter of 2021. See Note 7 for additional information.
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. The higher effective tax rate for the quarter endedMarch 31, 2022 as compared to prior year was primarily due to higher impact of foreign withholding tax due to lower pre-tax income and less tax benefit from equity income from investments in unconsolidated affiliates.
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 and financial results. The highly transmissible Omicron variant caused significant volatility in our business operations in the first quarter of 2022. After a relatively stable period in January and February, the situation rapidly deteriorated in March, resulting in the largest outbreak inChina since COVID-19 first emerged in early 2020. As a result, the Company incurred an operating loss inMarch 2022 . Looking into the second quarter of 2022, the situation is even more challenging. Many cities across large swaths of China have been fully or partially locked down for weeks or even months, including several economically important regions, such asShanghai . Drastic public health measures are being stepped up nationwide, in line with the strict enforcement of the "dynamic zero-COVID" policy, resulting in further reductions of social activities, travel and consumption. In April, over 3,000 of our stores, on average, were either temporarily closed or offered only takeaway and delivery services, of which approximately 50% of the stores were temporarily closed. Same-store sales in April decreased by more than 20%. Unless conditions significantly improve in May and June, we expect to incur an operating loss in the second quarter of 2022. Management at this time cannot ascertain the extent to which our operations will continue to be impacted by the COVID-19 pandemic, which depends largely on future developments that are highly uncertain and cannot be accurately predicted, including resurgences and further spread of existing or new COVID-19 variants, the actions by government authorities to contain or treat its impact, the availability and effectiveness of vaccines, the economic recovery within China and globally, the impact on consumer behavior and other related factors. The Company expects that further developments related to the COVID-19 pandemic may continue to have a material and extended adverse impact on the Company's results of operations, as well as the Company's cash flows and financial condition.
Tax Examination on Transfer Pricing
We are subject to reviews, examinations and audits by Chinese tax authorities, the Internal Revenue Service and other tax 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 and views currently exchanged with the tax authorities focus on our franchise arrangement with YUM. We continue to provide information requested by the tax authorities 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 and decision of the STA will depend upon further review of the information provided, as well as 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 at this time. 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. 34
--------------------------------------------------------------------------------
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 Condensed 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. As ofMarch 31, 2022 , an input VAT credit asset of$324 million and payable of$3 million were recorded in Other assets and Accounts payable and other current liabilities, respectively, on the Condensed Consolidated Balance Sheets. The Company has not made an allowance for the recoverability of the input VAT credit asset, as the balance is expected to be utilized to offset against VAT payables more than one year fromMarch 31, 2022 . Any input VAT credit asset would be classified as Prepaid expenses and other current assets if the credit expected to be used within one year can be reasonably determined. We have been benefiting from the retail tax structure reform since it was implemented onMay 1, 2016 . However, the amount of our expected benefit from this VAT regime depends on a number of factors, some of which are outside of our control. The interpretation and application of the new VAT regime are not settled at some local governmental levels. In addition, the timetable for enacting the prevailing VAT regulations into national VAT law, including ultimate enacted VAT rates, is not clear. As a result, for the foreseeable future, the benefit of this significant and complex VAT reform has the potential to fluctuate from quarter to quarter.
Foreign Currency Exchange Rate
The reporting currency of the Company is the US$. 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 further discussion.
Condensed Consolidated Cash Flows
Our cash flows for the quarters ended
Net cash provided by operating activities was$171 million in 2022 as compared to$331 million in 2021. The decrease was primarily driven by the decrease in net income along with working capital changes. Net cash provided by investing activities was$13 million in 2022 as compared to net cash used in investing activities of$347 million in 2021. The change was mainly due to lapping the impact of$261 million cash consideration for the acquisition of equity investment in Sunner in 2021 and net impact on cash flow resulting from purchases and maturities of short-term investments. Net cash used in financing activities was$274 million in 2022 as compared to$55 million in 2021. The increase was primarily due to the resumption of share repurchases starting in the third quarter of 2021 and the increase in dividends paid to noncontrolling interests mainly due to the acquisition ofHangzhou KFC . 35 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Historically we have funded our operations through cash generated from the operation of our Company-owned stores, our franchise operations and dividend payments from our unconsolidated affiliates. Our global offering inSeptember 2020 provided us with$2.2 billion in net proceeds. Our ability to fund our future operations and capital needs will primarily 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 capital expenditures for accelerating store network expansion and store remodeling, to step up investments in digitalization, automation and logistics infrastructure, to provide returns to our stockholders, as well as to explore opportunities for acquisitions or investments that build and support our ecosystem. We believe that our future cash from operations, together with our funds on hand and access to the 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.
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,
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
InMarch 2022 , our Board of Directors increased the share repurchase authorization by$1 billion to an aggregate of$2.4 billion .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. Starting in the second quarter of 2020 throughJuly 2021 , our share repurchases were suspended due to the impact of the COVID-19 pandemic. During the quarter endedMarch 31, 2022 , the Company repurchased$232 million or 5.0 million shares of common stock under the repurchase program.
For the quarters ended
OnMay 3, 2022 , the Board of Directors declared a cash dividend of$0.12 per share, payable onJune 21, 2022 , to stockholders of record as of the close of business onMay 31, 2022 . The total estimated cash dividend payable is approximately$51 million . Our ability to declare and pay any dividends on our stock may be restricted by our 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. 36 --------------------------------------------------------------------------------
Borrowing Capacity
As ofMarch 31, 2022 , the Company had credit facilities ofRMB3,468 million (approximately$547 million ), comprised of onshore credit facilities ofRMB2,200 million (approximately$347 million ) in aggregate and offshore credit facilities of$200 million in aggregate. The credit facilities had remaining terms ranging from less than one year to two years as ofMarch 31, 2022 . Each credit facility bears interest based on the Loan Prime Rate ("LPR") published by the National Interbank Funding Centre of the PRC or London 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, 2022 , we had outstanding bank guarantees ofRMB 181 million (approximately$28 million ) mainly to secure our lease payments to landlords for certain Company-owned restaurants. The credit facilities were therefore reduced by the same amount, while there were no bank borrowings outstanding as ofMarch 31, 2022 .
Off-Balance Sheet Arrangements
See the Guarantees section of Note 15 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
InOctober 2021 , the FASB issued ASU 2021-08, Business Combinations (Topic 805) - Accounting for Contract Assets and Contract Liabilities from Contracts with Customers ("ASU 2021-08"). It requires issuers to apply ASC 606 Revenue from Contracts with Customers to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination. ASU 2021-08 is effective for the Company fromJanuary 1, 2023 , with early adoption permitted. We are currently evaluating the impact the adoption of this standard may have on our financial statements. InNovember 2021 , the FASB issued ASU 2021-10, Government Assistance (Topic 832) - Disclosures by Business Entities about Government Assistance ("ASU 2021-10"). It requires issuers to make annual disclosures about government assistance, including the nature of the transaction, the related accounting policy, the financial statement line items affected and the amounts applicable to each financial statement line item, as well as any significant terms and conditions, including commitments and contingencies. We will adopt ASU 2021-10 in the fourth quarter of 2022, and do not expect the adoption of this standard will have a material impact on our financial statements. InMarch 2022 , the FASB issued ASU 2022-01 Fair Value Hedging-Portfolio Layer Method ("ASU 2022-01"), which allows entities to expand their use of the portfolio layer method for fair value hedges of interest rate risk. Under the guidance, entities can hedge all financial assets under the portfolio layer method and designate multiple hedged layers within a single closed portfolio. The guidance also clarifies the accounting for fair value hedge basis adjustments in portfolio layer hedges and how these adjustments should be disclosed. ASU 2022-01 is effective for the Company fromJanuary 1, 2023 with early adoption permitted. We are currently evaluating the impact the adoption of this standard may have on our financial statements. InMarch 2022 , the FASB issued ASU 2022-02 Financial Instrument-Credit Losses ("ASU 2022-02"), amending ASC 310 to eliminate the recognition and measurement guidance for a troubled debt restructuring for creditors that have adopted ASC 326 and requiring them to make enhanced disclosures about loan modifications for borrowers experiencing financial difficulty. The guidance also requires entities to present gross write-offs by year of origination in their vintage disclosures. ASU 2022-02 is effective for the Company fromJanuary 1, 2023 with early adoption permitted. We are currently evaluating the impact the adoption of this standard may have on our financial statements. 37 --------------------------------------------------------------------------------
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," "aim," "commit," "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 foodborne illness concerns, (b) significant failure to maintain effective quality assurance 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 the operation of our restaurants is subject to the terms of the master license agreement with YUM, (f) the fact that substantially all of our revenue is derived from our operations inChina , (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 our target development goals, the potential cannibalization of existing sales by aggressive development and the possibility that new restaurants will not be profitable, (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 to protect 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 Lavazza and COFFii & JOY may not be successful, (u) the anticipated benefits of our acquisitions may not be realized in a timely manner or at all, (v) challenges and risks related to our new retail and e-commerce businesses, (w) our inability or failure to recognize, respond to and effectively manage the impact of social media, (x) failure to comply with anti-bribery or anti-corruption laws, (y)U.S. federal income taxes, changes in tax rates, disagreements with tax authorities and imposition of new taxes, (z) changes in consumer discretionary spending and general economic conditions, (aa) the fact that the restaurant industry in which we operate is highly competitive, (bb) loss of or failure to obtain or renew any or all of the approvals, licenses and permits to operate our business, (cc) our inability to adequately protect the intellectual property we own or have the right to use, (dd) our licensor's failure to protect its intellectual property, (ee) seasonality and certain major events inChina , (ff) our failure to detect, deter and prevent all instances of fraud or other misconduct committed by our employees, customers or other third parties, (gg) the fact that our success depends on the continuing efforts of our key management and experienced and capable personnel as well as our ability to recruit new talent, (hh) our strategic investments or acquisitions may be unsuccessful; (ii) our investment in technology and innovation may not generate the expected level of returns, (jj) fair value changes for our investment in equity securities and lower yields of our short-term investments may adversely affect our financial condition and results of operations, and (kk) our operating results may be adversely affected by our investment in unconsolidated affiliates;
•
Risks related to doing business inChina , 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) audit reports included in our annual reports are prepared by auditors who are not currently inspected by thePublic Company Accounting Oversight Board and, as such, our stockholders are deprived of the benefits of such inspection and our common stock is subject to the risk of delisting from theNew York Stock Exchange in the future, (d) changes in political, business, economic and trade relations betweenthe United States and China, (e) fluctuation in the value of the Chinese Renminbi, (f) the fact that we face increasing focus on environmental sustainability issues, (g) limitations on our ability to utilize our cash balances effectively due to governmental control of currency conversion and payments of foreign currency and the Chinese Renminbi out of mainland China, (h) changes in the laws and regulations of China or noncompliance with applicable laws and regulations, (i) reliance on dividends and other distributions on equity paid by our principal subsidiaries inChina to fund offshore cash requirements, (j) potential unfavorable tax consequences resulting from our classification as a China resident enterprise for Chinese enterprise income tax purposes, (k) uncertainty regarding indirect transfers of equity interests inChina resident enterprises and enhanced scrutiny by Chinese tax authorities, (l) difficulties in effecting service of legal process, conducting investigations, collecting evidence, enforcing foreign judgments or bringing original actions inChina against us, 38 -------------------------------------------------------------------------------- (m) the Chinese government may determine that the variable interest entity structure of Daojia does not comply with Chinese laws on foreign investment in restricted industries, (n) inability to use properties due to defects caused by non-registration of lease agreements related to certain properties, (o) risk in relation to unexpected land acquisitions, building closures or demolitions, (p) potential fines and other legal or administrative sanctions for failure to comply with Chinese regulations regarding our employee equity incentive plans and various employee benefit plans, (q) proceedings instituted by theSEC against certain China-based accounting firms, including our independent registered public accounting firm, could result in our financial statements being determined to not be in compliance with the requirements of the Exchange Act, (r) restrictions on our ability to make loans or additional capital contributions to our Chinese subsidiaries due to Chinese regulation of loans to, and direct investment in, Chinese entities by offshore holding companies and governmental control of currency conversion, and (s) 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 forU.S. federal income tax 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, (d) the indemnity provided by YUM to us with respect to certain liabilities in connection with the separation may be insufficient to insure us against the full amount of such liabilities, (e) the possibility that a court would require that we assume responsibility for obligations allocated to YUM under the separation and distribution agreement, and (f) potential liabilities due to fraudulent transfer considerations;
•
General risks, such as (a) potential legal proceedings, (b) changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters, (c) failure of our insurance policies to provide adequate coverage for claims associated with our business operations, (d) unforeseeable business interruptions, and (e) failure by us to maintain effective disclosure controls and procedures and internal control over financial reporting in accordance with the rules of theSEC . 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 theSEC (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 endedDecember 31, 2021 ) 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. 39
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