YUM CHINA HOLDINGS, INC.
The following Management's Discussion and Analysis ("MD&A") should be read in
conjunction with the Consolidated Financial Statements in Item 8, the
"Forward-Looking Statements" section at the beginning of this Form 10-K and the
"Risk Factors" section set forth in Item 1A.
All Note references in this MD&A refer to the Notes to the Consolidated
Financial Statements included in Item 8. of this Form 10-K. Tabular amounts are
displayed in millions of U.S. dollars except per share and unit count amounts,
or as otherwise specifically identified. Percentages may not recompute due to
rounding. Throughout this Form 10-K when we refer to the "financial statements,"
we are referring to the "Consolidated Financial Statements," unless the context
indicates otherwise. This MD&A includes a discussion of our results of
operations for the year ended December 31, 2022 compared to the year ended
December 31, 2021 . For a discussion of our operating results for the year ended
December 31, 2021 compared to the year ended December 31, 2020 , please refer to
Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in our Annual Report on Form 10-K for the year ended
December 31, 2021 .
Overview
Yum China Holdings, Inc. is the largest restaurant company in China in terms of
system sales, with $9.6 billion of revenues in 2022 and nearly 13,000
restaurants as of year-end 2022. Our growing restaurant network consists of our
flagship KFC and Pizza Hut brands, as well as emerging brands such as Taco Bell ,
Lavazza, Little Sheep and Huang Ji Huang . We have the exclusive right to operate
and sublicense the KFC , Pizza Hut and, subject to achieving certain agreed-upon
milestones, Taco Bell brands in China , (excluding Hong Kong , Macau and Taiwan ),
and own the intellectual property of the Little Sheep and Huang Ji Huang
concepts outright. We also established a joint venture with Lavazza Group , the
world-renowned family-owned Italian coffee company, to explore and develop the
Lavazza coffee concept in China . KFC was the first major global restaurant brand
to enter China in 1987. With more than 35 years of operations, we have developed
extensive operating experience in the China market. We have since grown to
become the largest restaurant company in China in terms of 2022 system sales,
with nearly 13,000 restaurants covering over 1,800 cities primarily in China as
of December 31, 2022 . 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 in
China in terms of system sales. As of December 31, 2022 , KFC operated over 9,000
restaurants in more than 1,800 cities across China . KFC primarily competes with
western QSR brands in China , such as McDonald's, Dicos and Burger King, among
which we believe KFC had an approximate two-to-one lead over its nearest
competitor in terms of store count as of the end of 2022. In the third quarter
of 2020, the Company completed the acquisition of an additional 25% interest in
an unconsolidated affiliate that operates KFC stores in and around Suzhou, China
("Suzhou KFC"), increasing our equity interest to 72% and allowing the Company
to consolidate the entity. In December 2022 , the Company acquired an additional
20% equity interest in Suzhou KFC, bringing our total ownership to 92%. In the
fourth quarter of 2021, the Company completed the acquisition of a 28% equity
interest in Hangzhou Catering Service Group ("Hangzhou Catering "), which holds a
45% equity interest in an unconsolidated affiliate that operates KFC stores in
and around Hangzhou, China ("Hangzhou KFC"), increasing our equity interest to
approximately 60% directly and indirectly, and allowing the Company to
consolidate Hangzhou KFC .
Pizza Hut is the leading and the largest casual dining restaurant ("CDR") brand
in China in terms of system sales and number of restaurants. As of December 31,
2022 , Pizza Hut operated over 2,900 restaurants in over 650 cities. Measured by
number of restaurants, we believe Pizza Hut had an approximate five-to-one lead
over its nearest western CDR competitor in China as of the end of 2022.
We have two reportable segments: KFC and Pizza Hut . Our remaining non-reportable
operating segments, including the operations of Taco Bell , Lavazza, Little
Sheep, Huang Ji Huang , COFFii & JOY, East Dawning, our delivery operating
segment and our e-commerce business, are combined and referred to as All Other
Segments, as these operating segments are insignificant both individually and in
the aggregate. The Company decided to wind down the operations of the East
Dawning brand in 2021, and closed all stores by March 2022 . In addition, the
Company decided to wind down the operations of COFFii & JOY and closed all
stores in 2022. The Company will leverage its experience in COFFii & JOY to
better capture growing coffee market opportunities in China . Additional details
on our reportable operating segments are included in Note 18 to the Consolidated
Financial Statements.
63
2022 Form 10-K-------------------------------------------------------------------------------- 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 an average rate of approximately 6% of system sales. Franchise and unconsolidated affiliate restaurant sales are not included in Company sales in the 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. Prior years have been adjusted accordingly.
•
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, including cost of food and paper, restaurant-level payroll and employee benefits, rent, depreciation and amortization of restaurant-level assets, advertising expenses, and other operating expenses. 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. Results of Operations Summary
All comparisons within this summary are versus the same period a year ago. Refer to Item 1. Business for a discussion of the seasonality of our operations.
Starting in the first quarter of 2020, the COVID-19 pandemic significantly impacted the Company's operations. Since then, fluid COVID-19 conditions have caused significant volatility in our operations. During the first half of 2022, severe COVID-19 outbreaks inChina continued to significantly affect the Company's business and operating profit. Operating profit increased in the third quarter of 2022 when COVID-19 conditions were relatively calmer. However, in October andNovember 2022 , sporadic occurrences of COVID infections quickly evolved into major regional outbreaks, leading to tightened COVID-related health measures and lockdowns. The number of our stores that were either temporarily closed or offered only takeaway and delivery services reached a peak of over 4,300 in lateNovember 2022 . InDecember 2022 , the government issued a series of new COVID response guidelines that significantly changed its COVID policies, including removing mass testing and central quarantine requirements as well as lifting travel restrictions. A massive wave of infections quickly surged in the country. Due to widespread infections, we experienced a shortage of restaurant staff which led to over 1,300 stores on average being either temporarily closed or offering limited services inDecember 2022 . As a significant portion of the population was either infected or chose to stay home to avoid infection, dine-in traffic declined substantially. As a result, the Company's operation and financial results were adversely affected in the fourth quarter of 2022. 64 2022 Form 10-K -------------------------------------------------------------------------------- In 2022, the Company's total revenues decreased 3%, or increased 1% excluding the impact of F/X, mainly attributable to 1,159 net new stores and the acquisition ofHangzhou KFC , partially offset by same-store sales decline of 7% and 6% atKFC andPizza Hut , respectively, and temporary store closures due to the impact of the COVID-19 pandemic. Operating profit decreased 55%, or 53% excluding the impact of F/X, primarily driven by lapping the re-measurement gain of our previously held equity interest inHangzhou KFC and Lavazza at fair value upon acquisition in 2021, inflation in commodities and wages, increased rider cost associated with rising delivery volumes and an increase in G&A expenses primarily due to higher compensation cost, partially offset by the increase in Company sales, higher labor productivity, operational efficiency and temporary relief provided by landlords and government agencies. Net income for 2022 decreased 55%, or 54% excluding the impact of F/X, mainly due to the decrease in operating profit, partially offset by lower income tax expenses in line with the decrease in pre-tax income.
2022 financial highlights are below:
% Change
System Sales(a) Same-Store Net New Units Operating Profit Operating Profit
Sales(a) (Reported) (Ex F/X)
KFC (4 ) (7 ) +11 (5 ) (1 )
Pizza Hut (3 ) (6 ) +12 (36 ) (36 )
All Other Segments(b) (28 ) (22 ) (8 ) (75 ) (82 )
Total (5 ) (7 ) +10 (55 ) (53 )
(a)
System Sales and Same-Store Sales percentages as shown in 2022 financial
highlights exclude the impact of F/X. Effective January 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.
65
2022 Form 10-K
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The Consolidated Results of Operations for the years ended
% B/(W)(a)
2022 2021 Reported Ex F/X
Company sales $ 9,110 $ 8,961 2 6
Franchise fees and income 81 153 (47 ) (45 )Revenues from transactions with
franchisees and unconsolidated affiliates 287 663 (57 ) (55 ) Other revenues 91 76 20 26 Total revenues$ 9,569 $ 9,853 (3 ) 1 Company restaurant expenses$ 7,829 $ 7,734 (1 ) (5 ) Operating Profit$ 629 $ 1,386 (55 ) (53 ) Interest income, net 84 60 40 43 Investment loss (26 ) (54 ) 51 51 Income tax provision (207 ) (369 ) 44 42
Equity in net earnings (losses) from
equity method investments (2 ) - NM NM Net income - including noncontrolling interests 478 1,023 (53 ) (51 ) Net income - noncontrolling interests 36 33 (9 ) (15 )
Net Income -
(55 ) (54 ) Diluted Earnings Per Common Share$ 1.04 $ 2.28 (54 ) (53 ) Effective tax rate 30.1 % 26.5 % Supplementary information - Non-GAAP Measures(b) Restaurant profit$ 1,281 $ 1,227 4 8 Restaurant margin % 14.1 % 13.7 % 0.4 ppts. 0.4 ppts. Adjusted Operating Profit$ 633 $ 766 Adjusted Net Income$ 446 $ 525
Adjusted Diluted Earnings Per Common Share
29.9 % 27.8 %
Adjusted EBITDA $ 1,286 $ 1,330 NM refers to not meaningful.
(a)
Represents year-over-year 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
2022
% Change
System Sales Decline (8 )%
System Sales Decline, excluding F/X (5 )%
Same-Store Sales Decline (7 )%
Unit Count 2022 2021 % Increase
Company-owned 11,161 10,051 11
Franchisees 1,786 1,737 3
12,947 11,788 10
66
2022 Form 10-K--------------------------------------------------------------------------------
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. We also use Restaurant profit and restaurant margin (as defined in the
Overview section within MD&A above) for the purpose of internally evaluating the
performance of our Company-owned restaurants and we believe Company restaurant
profit and restaurant margin provide useful information to investors as to the
profitability of our Company-owned restaurants.
The following table sets forth the reconciliations of the most directly comparable GAAP financial measures to the non-GAAP adjusted financial measures.
Non-GAAP Reconciliations
Reconciliation of GAAP Operating Profit to Restaurant Profit
Year Ended 12/31/2022
Corporate
All Other and
KFC Pizza Hut Segments Unallocated Elimination Total
GAAP Operating Profit (Loss) $ 787 $ 70 $ (50 ) $ (178 ) $ - $ 629
Less:
Franchise fees and income 56 7 18 - - 81
Revenues from transactions
with
franchisees and
unconsolidated affiliates 33 4 39 211 - 287
Other revenues 10 10 563 42 (534 ) 91
Add:
General and administrative
expenses 254 110 46 184 - 594
Franchise expenses 29 4 1 - - 34
Expenses for transactions
with
franchisees and
unconsolidated affiliates 30 3 35 211 - 279
Other operating costs and
expenses 7 8 557 39 (533 ) 78
Closures and impairment
expenses, net 16 4 12 - - 32
Other expenses (income), net 97 - - (3 ) - 94
Restaurant profit (loss) $ 1,121 $ 178 $ (19 ) $ - $ 1 $ 1,281
Company sales 7,120 1,939 51 - - 9,110
Restaurant margin % 15.7 % 9.2 % (37.6 )% N/A N/A 14.1 %
67
2022 Form 10-K--------------------------------------------------------------------------------
Year Ended 12/31/2021
Corporate
All Other and
KFC Pizza Hut Segments Unallocated Elimination Total
GAAP Operating Profit (Loss) $ 827 $ 111 $ (29 ) $ 477 $ - $ 1,386
Less:
Franchise fees and income 120 8 25 - - 153
Revenues from transactions
with
franchisees and
unconsolidated affiliates 59 6 98 500 - 663
Other revenues 8 3 297 20 (252 ) 76
Add:
General and administrative
expenses 240 111 42 171 - 564
Franchise expenses 59 4 1 - - 64
Expenses for transactions
with
franchisees and
unconsolidated affiliates 58 6 88 497 - 649
Other operating costs and
expenses 4 2 294 17 (252 ) 65
Closures and impairment
expenses, net 20 7 7 - - 34
Other (income) expenses, net (8 ) - 7 (642 ) - (643 )
Restaurant profit (loss)
$ - $ -$ 1,227 Company sales 6,816 2,092 53 - - 8,961 Restaurant margin % 14.9 % 10.7 % (20.8 )% N/A N/A 13.7 %
Reconciliation of Reported GAAP Results to Non-GAAP Adjusted Measures
2022 2021
Reconciliation of Operating Profit to Adjusted Operating Profit Operating Profit$ 629 $
1,386
Special Items, Operating Profit (4 )
620
Adjusted Operating Profit$ 633 $
766
Reconciliation of Net Income to Adjusted Net Income
Net Income -
$ 442 $
990
Special Items, Net Income -Yum China Holdings, Inc. (4 )
465
Adjusted Net Income -
525
Reconciliation of EPS to Adjusted EPS Basic Earnings Per Common Share$ 1.05 $
2.34
Special Items, Basic Earnings Per Common Share (0.01 )
1.10
Adjusted Basic Earnings Per Common Share$ 1.06 $
1.24
Diluted Earnings Per Common Share$ 1.04 $
2.28
Special Items, Diluted Earnings Per Common Share (0.01 )
1.07
Adjusted Diluted Earnings Per Common Share$ 1.05 $
1.21
Reconciliation of Effective Tax Rate to Adjusted
Effective Tax Rate
Effective tax rate (See Note 17) 30.1 % 26.5 %
Impact on effective tax rate as a result of Special
Items 0.2 % (1.3 )%
Adjusted effective tax rate 29.9 % 27.8 %
68
2022 Form 10-K--------------------------------------------------------------------------------
Net income, along with the reconciliation to Adjusted EBITDA, is presented below:
2022 2021
Reconciliation of Net Income to Adjusted EBITDA
Net Income - Yum China Holdings, Inc. $ 442 $ 990
Net income - noncontrolling interests 36 33
Equity in net (earnings) losses from
equity method investments 2 - Income tax provision 207 369 Interest income, net (84 ) (60 ) Investment loss 26 54 Operating Profit 629 1,386 Special Items, Operating Profit 4 (620 ) Adjusted Operating Profit 633 766 Depreciation and amortization 602 516 Store impairment charges 51 48 Adjusted EBITDA$ 1,286 $ 1,330
Details of Special Items are presented below:
Details of Special Items 2022
2021
Share-based compensation expense for Partner PSU Awards(a)
$ (8 ) Gain from re-measurement of equity interest upon acquisition(b) -
628
Special Items, Operating Profit (4 )
620
Tax effect on Special Items(c) - (155 ) Special Items, net income - including noncontrolling interests (4 )
465
Special Items, net income - noncontrolling interests -
-
Special Items, Net Income - Yum China Holdings, Inc.$ (4 ) $ 465 Weighted-Average Diluted Shares Outstanding (in millions) 425
434
Special Items, Diluted Earnings Per Common Share$ (0.01 )
(a)
InFebruary 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.
(b)
In the fourth and third quarters of 2021, as a result of the consolidation ofHangzhou KFC and the Lavazza joint venture, the Company recognized a gain of$618 million and$10 million , respectively, from the re-measurement of our previously held equity interest at fair value. The re-measurement gains were not allocated to any segment for performance reporting purposes. (See Note 3 for additional information.)
(c)
Tax effect 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 equity in net earnings (losses) from
equity method investments, 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.
69
2022 Form 10-K
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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.
Segment Results
KFC delivered a resilient performance in 2022 by accelerating store expansion with attractive returns and maintaining solid profitability.KFC continued to focus on innovative products, creating abundant value for our customers, as well as on upgrading ingredients to meet Chinese consumers' needs.KFC also continued its digital and delivery initiatives to enhance the customer experience.KFC's loyalty program members exceeded 380 million at year-end 2022 and contributed approximately 62% of system sales atKFC in 2022. Delivery sales accounted for approximately 38% of Company sales atKFC in 2022 with store and city coverage of 89% and 98%, respectively, at the end of 2022. % B/(W) 2022 2021 Reported Ex F/X Company sales$ 7,120 $ 6,816 4 9 Franchise fees and income 56 120 (53 ) (51 )
Revenues from transactions with
franchisees and unconsolidated affiliates 33 59 (45 ) (43 ) Other revenues 10 8 26 33 Total revenues$ 7,219 $ 7,003 3 7 Company restaurant expenses$ 5,999 $ 5,803 (3 ) (8 ) G&A expenses$ 254 $ 240 (6 ) (10 ) Franchise expenses$ 29 $ 59 50 48
Expenses for transactions with
franchisees and unconsolidated affiliates$ 30 $ 58 49 46
Other operating costs and expenses
(68 )
Closure and impairment expenses,
net $ 16 $ 20 19 13
Other expenses (income), net $ 97 $ (8 ) NM NM
Operating Profit $ 787 $ 827 (5 ) (1 )
Restaurant profit $ 1,121 $ 1,013 11 15
Restaurant margin % 15.7 % 14.9 % 0.8 ppts. 0.8 ppts.
2022
% Change
System Sales Decline (8 )%
System Sales Decline, excluding F/X (4 )%
Same-Store Sales Decline (7 )%
Unit Count 2022 2021 % Increase
Company-owned 8,214 7,437 10
Franchisees 880 731 20
9,094 8,168 11
70
2022 Form 10-K--------------------------------------------------------------------------------
2021 New Builds Acquired Closures Refranchised 2022
Company-owned 7,437 1,060 5 (283 ) (5 ) 8,214
Franchisees 731 169 (5 ) (20 ) 5 880
Total 8,168 1,229 - (303 ) - 9,094
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Store Portfolio
Income (Expense) 2021 Actions Other F/X 2022
Company sales $ 6,816 $ 1,052 $ (456 ) $ (292 ) $ 7,120
Cost of sales (2,158 ) (317 ) 176 91 (2,208 )
Cost of labor (1,642 ) (284 ) 53 76 (1,797 )
Occupancy and other operating expenses (2,003 ) (276 ) 204 81 (1,994 )
Restaurant profit $ 1,013 $ 175 In 2022, the increase in Company sales, excluding the impact of F/X, was primarily driven by net unit growth and 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 increase in Restaurant profit, excluding the impact of F/X, was primarily driven by the increase in Company sales, higher labor productivity, operational efficiency and temporary relief, partially offset by inflation in commodities and wages in the low single digits, as well as increased rider cost associated with a rise of approximately seven percentage points in delivery sales mix from the prior year partially due to more severe outbreaks. Franchise Fees and Income
In 2022, the decrease in Franchise fees and income, excluding the impact of F/X,
was primarily driven by the acquisition of
G&A Expenses
In 2022, the increase in G&A expenses, excluding the impact of F/X, was
primarily driven by the acquisition of
Operating Profit In 2022, the decrease in Operating profit, 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 restaurant margin improvement, net unit growth and an increase in Operating profit contributed by theHangzhou KFC acquisition. 71 2022 Form 10-K
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During 2022, we continued to focus on strengtheningPizza Hut's fundamentals, including investments in products, strengthening our digital capabilities, developing delivery and other channels and enhancing our asset portfolio to drive growth.Pizza Hut's loyalty program members exceeded 130 million at year-end 2022 and contributed approximately 62% of system sales atPizza Hut in 2022. Delivery sales accounted for approximately 43% of Company sales atPizza Hut in 2022 with store and city coverage of 96% and 98%, respectively, at the end of 2022. % B/(W) 2022 2021 Reported Ex F/X Company sales$ 1,939 $ 2,092 (7 ) (4 ) Franchise fees and income 7 8 (6 ) (3 ) Revenues from transactions with franchisees and unconsolidated affiliates 4 6 (30 ) (27 ) Other revenue 10 3 256 280 Total revenues$ 1,960 $ 2,109 (7 ) (3 ) Company restaurant expenses$ 1,761 $ 1,868 6 2 G&A expenses$ 110 $ 111 - (4 ) Franchise expenses $ 4 $ 4 9 5
Expenses for transactions with
franchisees and unconsolidated affiliates $ 3 $ 6 28 25 Other operating costs and expenses $ 8 $ 2 (301 ) (328 ) Closure and impairment expenses, net $ 4 $ 7 58 54 Operating Profit$ 70 $ 111 (36 ) (36 ) Restaurant profit$ 178 $ 224 (20 ) (18 ) Restaurant margin % 9.2 % 10.7 % (1.5 ) ppts. (1.5 ) ppts. 2022 % Change System Sales Decline (7 )% System Sales Decline, excluding F/X (3 )% Same-Store Sales Decline (6 )% Unit Count 2022 2021 % Increase Company-owned 2,760 2,452 13 Franchisees 143 138 4 2,903 2,590 12 2021 New Builds Closures Acquired 2022 Company-owned 2,452 401 (98 ) 5 2,760 Franchisees 138 16 (6 ) (5 ) 143 Total 2,590 417 (104 ) - 2,903
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Store Portfolio
Income (Expense) 2021 Actions Other F/X 2022
Company sales $ 2,092 $ 39 $ (113 ) $ (79 ) $ 1,939
Cost of sales (637 ) (14 ) 14 25 (612 )
Cost of labor (598 ) (24 ) 25 25 (572 )
Occupancy and other operating expenses (633 ) (19 ) 51 24 (577 )
Restaurant profit $ 224 $ (18 ) $ (23 ) $ (5 ) $ 178
72
2022 Form 10-K-------------------------------------------------------------------------------- In 2022, the decrease in Company sales, 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, excluding the impact of F/X, was primarily driven by the decrease in Company sales, inflation in commodities and wages in the low single digits, as well as increased rider cost associated with a rise of approximately seven percentage points in delivery sales mix from the prior year partially due to more severe outbreaks, partially offset by higher labor productivity, operational efficiency and temporary relief.
G&A Expenses
In 2022, the increase in G&A expenses, excluding the impact of F/X, was primarily driven by merit increases.
Operating Profit
In 2022, the decrease in Operating profit, excluding the impact of F/X, was primarily driven by the decrease in Restaurant profit and higher G&A expenses.
All Other Segments
All Other Segments reflects the results ofTaco Bell , Lavazza, Little Sheep,Huang Ji Huang , COFFii & JOY, East Dawning, our delivery operating segment and our e-commerce business. % B/(W) 2022 2021 Reported Ex F/X Company sales$ 51 $ 53 (3 ) 1 Franchise fees and income 18 25 (29 ) (27 )
Revenues from transactions with
franchisees and unconsolidated affiliates 39 98 (60 ) (58 ) Other revenues 563 297 90 99 Total revenues$ 671 $ 473 42 49 Company restaurant expenses$ 70 $ 63 (10 ) (15 ) G&A expenses$ 46 $ 42 (7 ) (11 ) Franchise expenses$ 1 $ 1 (158 ) (170 )
Expenses for transactions with
franchisees and unconsolidated affiliates$ 35 $ 88 60 59 Other operating costs and expenses$ 557 $ 294 (90 ) (99 ) Closure and impairment expenses, net$ 12 $ 7 (100 ) (112 ) Other loss, net $ -$ 7 NM NM Operating Loss$ (50 ) $ (29 ) (75 ) (82 ) Restaurant loss$ (19 ) $ (10 ) (75 ) (83 ) Restaurant margin % (37.6 )% (20.8 )% (16.8 ) ppts. (16.8 ) ppts. Total Revenues In 2022, the increase in Total revenues, 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 mainly as a result of rising delivery sales and the contribution of sales from the Lavazza joint venture, partially offset by the decrease in Revenues from transactions with franchisees and unconsolidated affiliates primarily driven by the acquisition ofHangzhou KFC , same-store sales declines and temporary store closures due to the impact of the COVID-19 pandemic. Operating Loss In 2022, the increase in Operating loss, excluding the impact of F/X, was primarily driven by the loss incurred by the Lavazza joint venture, as well as an increase of Operating loss from certain emerging brands due to the impact of the COVID-19 pandemic. 73 2022 Form 10-K
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Corporate & Unallocated
% B/(W)
2022 2021 Reported Ex F/XRevenues from transactions with
franchisees and unconsolidated affiliates(a)$ 211 $ 500 (58 ) (56 ) Other revenues$ 42 $ 20 102 111
Expenses for transactions with
franchisees and unconsolidated affiliates(a)$ 211 $ 497 58 56 Other operating costs and expenses$ 39 $ 17 (119 ) (130 ) Corporate G&A expenses$ 184 $ 171 (8 ) (11 ) Other unallocated income$ 3 $ 642 (100 ) (100 ) Interest income, net$ 84 $ 60 40 43 Investment loss$ (26 ) $ (54 ) 51 51 Income tax provision (See Note 17)$ (207 ) $ (369 ) 44 42 Equity in net earnings (losses) from equity method investments$ (2 ) $ - NM NM
Effective tax rate (See Note 17) 30.1 % 26.5 % (3.6 ) ppts (3.6 ) ppts
(a)
Primarily includes revenues and associated expenses of transactions with franchisees and unconsolidated affiliates 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. Amounts have not been allocated to any segment for purposes of making operating decisions or assessing financial performance as the transactions are corporate revenues and expenses in nature.
Revenues from Transactions with Franchisees and Unconsolidated Affiliates
In 2022, the decrease in Revenues from transactions with franchisees and
unconsolidated affiliates, excluding the impact of F/X, was mainly due to the
acquisition of
Other Revenues/Operating Costs and Expenses
In 2022, the increase in Other revenues/operating costs and expenses was mainly driven by logistics and warehousing services provided to third parties.
Corporate G&A Expenses
In 2022, the increase in Corporate G&A expenses, excluding the impact of F/X, was primarily driven by higher compensation costs.
Other Unallocated Income
Other unallocated income primarily includes a gain of$618 million and$10 million in 2021 recognized from the re-measurement of our previously held equity interest in connection with the consolidation ofHangzhou KFC and the Lavazza joint venture, respectively. See Note 3 for additional information.
Interest Income, Net
The increase in interest income, net for 2022 was primarily driven by higher interest rates.
Investment Loss The decrease in investment loss primarily relates to a lower decrease in the fair value of our investment inMeituan Dianping ("Meituan") in 2022, as well as lapping our unrealized investment loss in Fujian Sunner Development Co., Ltd. ("Sunner") before the equity method of accounting was applied in 2021. See Note 3 for additional information. 74 2022 Form 10-K
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Income Tax Provision
Our income tax provision primarily includes tax on our earnings at the Chinese statutory tax rate of 25%, withholding tax on planned or actual repatriation of earnings outside ofChina ,Hong Kong profits tax, andU.S. corporate income tax, if any. Our effective tax rate was 30.1% and 26.5% in 2022 and 2021, respectively. The higher effective tax rate in 2022 compared with that in 2021 was due to lapping prior year tax benefits from equity income from investments in unconsolidated affiliates and impact of lower pre-tax income.
Significant Known Events, Trends or Uncertainties Expected to Impact Future Results
Impact of COVID-19 Pandemic
Starting in lateJanuary 2020 and throughout 2021 and 2022, the COVID-19 pandemic significantly impacted the Company's operations and financial results. InDecember 2022 , the government issued a series of new COVID-19 response guidelines that significantly changed its COVID-19 policies, including removing mass testing and central quarantine requirements as well as lifting travel restrictions. A massive wave of infections quickly surged in the country, spreading to nearly all provinces inChina . Sales in January improved sequentially, driven by the resumption of normal services at our restaurants and an earlierChinese New Year holiday season, which coincided with the pivot in COVID policies. Many people traveled during the holiday for the first time since COVID-19 began. According to government statistics, the number of domestic travelers and related tourism spending during the 7-dayChinese New Year holiday increased year over year, but still remained below the 2019 level. Our same-store sales for the comparableChinese New Year holiday also increased mid-single digits year over year, but remained below the 2019 level. As the country enters the new phase of COVID response, we are cautiously optimistic. The overall business environment and consumer sentiment have improved but near-term uncertainties remain. Consumers tend to be more careful with spending after holidays. Experiences in other countries also suggest that further outbreaks following relaxation of COVID restrictions and emergence of different COVID variants may happen. A portion of the population may remain cautious about going out in public, while macroeconomic factors such as an inflationary environment and softening global economic conditions may weigh on consumer spending. As such, we are staying alert in this fluid situation and planning for multiple scenarios to capture growth opportunities and mitigate risks when needed. For further information on the risks associated with the COVID-19 pandemic, see "Item 1A. Risk Factors-Risks Related to Our Business andIndustry-Health concerns arising from outbreaks of viruses or other illnesses may have a material adverse effect on our business. The COVID-19 pandemic has had, and may continue to have, adverse effects on our results of operations, cash flows and financial condition."
Tax Examination on Transfer Pricing
We are subject to reviews, examinations and audits by Chinese tax authorities, theIRS 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.
PRC Value-Added Tax
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. Our new retail business is generally subject to VAT rates at 9% or 13%. 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. 75 2022 Form 10-K
-------------------------------------------------------------------------------- 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 a VAT 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 VAT asset for recoverability, giving consideration to the indefinite life of VAT assets as well as its forecasted operating results and capital spending, which inherently includes significant assumptions that are subject to change. As ofDecember 31, 2022 and 2021, the Company has not made an allowance for the recoverability of VAT assets, as the balance is expected to be utilized to offset against VAT payables or be refunded in the future. OnJune 7, 2022 , theChinese Ministry of Finance and the STA jointly issued Circular [2022] No. 21, to extend full VAT credit refunds to more sectors and increase the frequency for accepting taxpayers' applications with an aim to support business recovery. Beginning onJuly 1, 2022 , entities engaged in providing catering services inChina are allowed to apply for a lump sum refund of VAT assets accumulated prior toMarch 31, 2019 . In addition, VAT assets accumulated afterMarch 31, 2019 can be refunded on a monthly basis. As the benefits of certain VAT assets are expected to be realized within one year pursuant to Circular [2022] No. 21,$303 million of VAT assets as ofJune 30, 2022 were reclassified from Other assets to Prepaid expenses and other current assets. As ofDecember 31, 2022 , VAT assets of$88 million , VAT assets of$5 million and a net VAT payable of$7 million were recorded in Prepaid expenses and other current assets, Other assets and Accounts payable and other current liabilities, respectively, on the Consolidated Balance Sheets. The Company will continue to review the classification of VAT assets at each balance sheet date, giving consideration to the different local implementation practice of refunding the VAT assets and results of the potential administrative review. We have been benefiting from the retail tax structure reform since it was implemented onMay 1, 2016 . However, the amount of our expected benefit from this VAT regime depends on a number of factors, some of which are outside of our control. The interpretation and application of the new VAT regime are not settled at some local governmental levels. In addition,China is in the process of enacting the prevailing VAT regulations into VAT law. However, the timetable for enacting the VAT law is not clear. As a result, for the foreseeable future, the benefit of this significant and complex VAT reform has the potential to fluctuate from quarter to quarter.
Foreign Currency Exchange Rate
The reporting currency of the Company is the US$. Most of the revenues, costs, assets and liabilities of the Company are denominated in 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 7A. Quantitative and Qualitative Disclosures About Market Risk" for a further discussion. Consolidated Cash Flows Net cash provided by operating activities was$1,413 million in 2022 as compared to$1,131 million in 2021. The increase was primarily driven by refunds of VAT assets. See Note 8. Net cash used in investing activities was$522 million in 2022 as compared to$855 million in 2021. The decrease was mainly due to lapping the impact of cash consideration paid for the acquisition ofHangzhou KFC and equity investment in Sunner in 2021. Net cash used in financing activities was$844 million in 2022 as compared to$313 million in 2021. The increase was primarily due to the resumption of share repurchases starting in the third quarter of 2021 and the cash consideration paid for the acquisition of an additional 20% equity interest in Suzhou KFC.
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 global offering in
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2022 Form 10-K
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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, step up investments in digitalization, automation and logistics
infrastructure, provide returns to our stockholders, as well as 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 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. We currently expect our fiscal year
2023 capital expenditures will be in the range of approximately $700 million to
$900 million .
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 our access to the
•
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 ourChina 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.
Dividends and Share Repurchases
OnMarch 17, 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 the open market or, subject to applicable regulatory requirements, through privately negotiated transactions, 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 years endedDecember 31, 2022 and 2021, the Company repurchased$466 million or 10.5 million shares and$75 million or 1.3 million shares of common stock, respectively, under the repurchase program.
The Company paid a cash dividend of
On
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. 77 2022 Form 10-K
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Borrowing Capacity
As ofDecember 31, 2022 , the Company had credit facilities ofRMB4,518 million (approximately$655 million ), comprised of onshore credit facilities ofRMB3,000 million (approximately$435 million ) in the aggregate and offshore credit facilities of$220 million in the aggregate. The credit facilities had remaining terms ranging from less than one year to two years as ofDecember 31, 2022 . 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,London Interbank Offered Rate ("LIBOR") administered by theICE Benchmark Administration , or Secured Overnight Financing Rate ("SOFR") published by theFederal Reserve Bank of New York . 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. Interest on any outstanding borrowings is due at least monthly. Some of the onshore credit facilities contain sub-limits for overdrafts, non-financial bonding, standby letters of credit and guarantees. As ofDecember 31, 2022 , we had outstanding bank guarantees ofRMB209 million (approximately$30 million ) mainly to secure our lease payments to landlords for certain Company-owned restaurants. The credit facilities were therefore reduced by the same amount. There was a$2-million bank borrowing outstanding as ofDecember 31, 2022 , which was secured by a$1-million short-term investment. The bank borrowing was due within one year and included in Accounts payable and other current liabilities.
Material Cash Requirements
Our material short-term and long-term cash requirements as ofDecember 31, 2022 included: Less than More than Total 1 Year 1-3 Years 3-5 Years 5 Years Finance Leases(a)$ 62 $ 7$ 12 $ 11 $ 32 Operating Leases(a) 2,814 552 837 617 808 Purchase Obligations(b) 478 148 108 181 41 Transition Tax(c) 34 7 27 - - Total$ 3,388 $ 714 $ 984 $ 809 $ 881 (a)
These obligations, which are shown on a nominal basis, relate primarily to approximately 11,000 Company-owned restaurants. See Note 12 for additional information.
(b)
Purchase obligations relate primarily to capital expenditure commitment for infrastructure, as well as supply and service agreements. We have excluded agreements that are cancelable without penalty or have a remaining term not in excess of one year. Such commitments are generally near term in nature, will be funded from operating cash flows, and are not significant to the Company's overall financial position.
(c)
This amount represents transition tax payable on the deemed repatriation of accumulated undistributed foreign earnings after utilizing existing qualified foreign tax credits, which is to be paid over a maximum of eight years beginning in 2018. We have not included in the table above approximately$25 million of liabilities for unrecognized tax benefits related to the uncertainty with regard to the deductibility of certain business expenses incurred as well as related accrued interest and penalties. These liabilities may increase or decrease over time as a result of tax examinations, and given the status of the examinations, we cannot reliably estimate the period of any cash settlement with the respective taxing authorities. These liabilities exclude amounts that are temporary in nature and for which we anticipate that over time there will be no net cash outflow. In addition to the material cash requirements listed above, the Company andLavazza Group have committed to contributing$100 million to the Lavazza joint venture, in proportion to their respective equity interest of 65% and 35%, respectively, by the end of the first quarter of 2023. The cash will be used to further develop the Lavazza coffee concept inChina .
We had no material contingent obligations as of
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2022 Form 10-K
--------------------------------------------------------------------------------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 , theFinancial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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. We will adopt this standard in the first quarter of 2023, 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. We will adopt this standard in the first quarter of 2023, and do not expect the adoption of this standard will have a material impact on our financial statements. InMarch 2022 , the FASB issued ASU 2022-02 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. We will adopt this standard in the first quarter of 2023, and do not expect the adoption of this standard will have a material impact on our financial statements. InJune 2022 , the FASB issued ASU 2022-03 Fair Value Measurement-Fair Value Measurement of Equity Securities Subject to Contractual Sale Restriction ("ASU 2022-03"), clarifying that a contractual restriction on the sales of an equity security is not considered part of the unit of account of the equity security, and therefore, is not considered when measuring fair value. The guidance also clarifies that a contractual sales restriction should not be recognized as a separate unit of account. We will adopt this standard in the first quarter of 2023, and do not expect the adoption of this standard will have a material impact on our financial statements. InSeptember 2022 , the FASB issued ASU 2022-04 Liabilities-Disclosure of Supplier Finance Program Obligations ("ASU 2022-04"), requiring entities that use supplier finance programs in connection with the purchase of goods and services to disclose the key terms of the programs and information about their obligations outstanding at the end of the reporting period. We will adopt this standard in the first quarter of 2023, and do not expect the adoption of this standard will have a material impact on our financial statements.
Critical Accounting Policies and Estimates
Our reported results are impacted by the application of certain accounting
policies that require us to make subjective or complex judgments. These
judgments involve estimations of the effect of matters that are inherently
uncertain and may significantly impact our quarterly or annual results of
operations or financial condition. Changes in the estimates and judgments could
significantly affect our results of operations, financial condition and cash
flows in future years. A description of what we consider to be our most
significant critical accounting policies and estimates follows.
79
2022 Form 10-K
--------------------------------------------------------------------------------Loyalty Programs
Each of the Company'sKFC andPizza Hut reportable segments operates a loyalty program that allows registered members to earn points for each qualifying purchase. Points, which generally expire 18 months after being earned, may be redeemed for future purchases ofKFC orPizza Hut branded products or other products for free or at a discounted price. Points cannot be redeemed or exchanged for cash. The estimated value of points earned by the loyalty program members is recorded as a reduction of revenue at the time the points are earned, based on the percentage of points that are projected to be redeemed, with a corresponding deferred revenue liability included in Accounts payable and other current liabilities in the Consolidated Balance Sheets and subsequently recognized into revenue when the points are redeemed or expire. The Company estimates the value of the future redemption obligations based on the estimated value of the product for which points are expected to be redeemed and historical redemption patterns and reviews such estimates periodically based upon the latest available information regarding redemption and expiration patterns.
Breakage Revenue
We recognize revenues from prepaid stored-value products, including gift cards and product vouchers, when they are redeemed by the customer. Prepaid gift cards sold at any given point generally expire over the next 36 months, and product vouchers generally expire over a period of up to 12 months. We recognize breakage revenue, which is the amount of prepaid stored-value products that is not expected to be redeemed, either (1) proportionally in earnings as redemptions occur, in situations where the Company expects to be entitled to a breakage amount, or (2) when the likelihood of redemption is remote, in situations where the Company does not expect to be entitled to breakage, provided that there is no requirement for remitting balances to government agencies under unclaimed property laws. The Company reviews its breakage estimates at least annually based upon the latest available information regarding redemption and expiration patterns.
Impairment or Disposal of Long-Lived Assets
We review long-lived assets of restaurants (primarily operating lease
right-of-use assets and property, plant and equipment ("PP&E")) semi-annually
for impairment, or whenever events or changes in circumstances indicate that the
carrying amount of a restaurant may not be recoverable. We evaluate
recoverability based on the restaurant's forecasted undiscounted cash flows,
which are based on our entity-specific assumptions, to the carrying value of
such assets. The forecasted undiscounted cash flows incorporate our best
estimate of sales growth based upon our operation plans for the unit and actual
results at comparable restaurants. For restaurant assets that are deemed not to
be recoverable, we write down the impaired restaurant to its estimated fair
value. In determining the fair value of restaurant-level assets, we consider the
highest and best use of the assets from market participants' perspective, which
is represented by the higher of the forecasted discounted cash flows of
operating restaurants and the price market participants would pay to sub-lease
the operating lease right-of-use assets and acquire remaining restaurant assets,
even if that use differs from the current use by the Company. Key assumptions in
the determination of fair value include reasonable sales growth assumption in
generating after-tax cashflows that would be used by a franchisee in the
determination of a purchase price for the restaurant, and market rental
assumption for estimating the price market participants would pay to sub-lease
the operating lease right-of-use assets. Estimates of forecasted cash flows of
operating restaurants are highly subjective judgments and can be significantly
impacted by changes in the business or economic conditions. Estimates of the
price market participants would pay to sub-lease the operating lease
right-of-use assets are based on comparable market rental information that could
be reasonably obtained for the property. In situations where the highest and
best use of the restaurant-level assets from market participants' perspective is
represented by sub-leasing the operating lease right-of-use assets and acquiring
the remaining restaurant assets, the Company continues to use these assets in
operating its restaurant business, which is consistent with its long-term
strategy of growing revenue through operating restaurant concepts.
When we believe it is more likely than not a restaurant or groups of restaurants
will be refranchised for a price less than their carrying value, but do not
believe the restaurant(s) have met the criteria to be classified as held for
sale, we review the restaurants for impairment. Expected net sales proceeds are
generally based on actual bids from the buyer.
The discount rate used in the fair value calculations is our estimate of the
required rate-of-return that a franchisee would expect to receive when
purchasing a similar restaurant or groups of restaurants and the related
long-lived assets. The discount rate incorporates rates of returns for
historical refranchising market transactions and is commensurate with the risks
and uncertainty inherent in the forecasted cash flows.
80
2022 Form 10-K
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We evaluate indefinite-lived intangible assets for impairment on an annual basis
or more often if an event occurs or circumstances change that indicates
impairment might exist. We perform our annual test for impairment of our
indefinite-lived intangible assets at the beginning of our fourth quarter. When
we evaluate these assets for impairment, we have the option to first perform a
qualitative assessment to determine whether an intangible asset group is
impaired. If we believe, as a result of the qualitative assessment, that it is
more likely than not that the fair value of the intangible asset group is less
than its carrying amount, we will then perform a quantitative assessment. Fair
value is an estimate of the price a willing buyer would pay for the intangible
asset and is generally estimated by discounting the expected future after-tax
cash flows associated with the intangible asset. The discount rate is our
estimate of the required rate-of-return that a third-party buyer would expect to
receive. These estimates are highly subjective, and our ability to achieve the
forecasted cash is affected by factors such as changes in our operating
performance and business strategies and changes in economic conditions. Our
indefinite-lived intangible assets had a book value of $130 million and $141
million as of December 31, 2022 and 2021, respectively, representing two
material indefinite-lived intangible assets, which are our Little Sheep and
Huang Ji Huang trademarks.
In the year ended December 31, 2022 , considering the continuing adverse effects
of the COVID-19 pandemic, we performed quantitative impairment assessments for
the Little Sheep and Huang Ji Huang trademarks and the fair value estimate
exceeded their carrying amount. Fair value of the Little Sheep and Huang Ji
Huang trademarks was determined using a relief-from-royalty valuation approach
that was based on unobservable inputs, including estimated future revenues as
well as the selection of an appropriate discount rate based on weighted-average
cost of capital which includes company-specific risk premium, which are
considered Level 3 inputs. No impairment charges on trademarks related to Little
Sheep and Huang Ji Huang were recorded in 2022 and 2021.
Our finite-lived intangible assets that are not allocated to an individual
restaurant are evaluated for impairment whenever events or changes in
circumstances indicate that the carrying amount of the intangible asset may not
be recoverable. An intangible asset that is deemed not recoverable on a
undiscounted basis is written down to its estimated fair value, which is our
estimate of the price a willing buyer would pay for the intangible asset based
on discounted expected future after-tax cash flows. For purposes of our
impairment analysis, we update the cash flows that were initially used to value
the finite-lived intangible asset to reflect our current estimates and
assumptions over the asset's future remaining life.
Impairment of
We evaluate goodwill for impairment on an annual basis as of the beginning of
our fourth quarter or more often if an event occurs or circumstances change that
indicates impairment might exist. When we evaluate goodwill for impairment, we
have the option to first perform a qualitative assessment to determine whether
it is more likely than not the fair value of a reporting unit is less than its
carrying amount. If we believe, as a result of the qualitative assessment, that
it is more likely than not that the fair value of the reporting unit is less
than its carrying amount, we will then perform a quantitative assessment. Our
reporting units are our individual operating segments. Fair value is the price a
willing buyer would pay for the reporting unit, and is generally estimated using
discounted expected future after-tax cash flows from the business operation of
the reporting unit.
Future cash flow estimates and the discount rate are the key assumptions when
estimating the fair value of a reporting unit. Future cash flows are based on
growth expectations relative to recent historical performance and incorporate
sales growth and margin improvement assumptions that we believe a third-party
buyer would assume when determining a purchase price for the reporting unit. The
sales growth and margin improvement assumptions that factor into the discounted
cash flows are highly correlated as cash flow growth can be achieved through
various interrelated strategies such as product pricing and restaurant
productivity initiatives. The discount rate is our estimate of the required
rate-of-return that a third-party buyer would expect to receive when purchasing
a business from us that constitutes a reporting unit. We believe the discount
rate is commensurate with the risks and uncertainty inherent in the forecasted
cash flows. These estimates are highly subjective, and our ability to achieve
the forecasted cash is affected by factors such as changes in our operating
performance and business strategies and changes in economic conditions.
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2022 Form 10-K
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Our goodwill of $1,988 million as of December 31, 2022 was related to the KFC ,
Pizza Hut , Huang Ji Huang and Lavazza reporting units. In the year ended
December 31, 2022 , considering the continuing adverse effects of the COVID-19
pandemic, we performed quantitative impairment assessments for goodwill related
to Huang Ji Huang and the fair value estimate exceeded its carrying amount. The
fair value of Huang Ji Huang reporting unit was based on the estimated price a
willing buyer would pay, and was determined using an income approach with future
cash flow estimates supported by estimated future sales, margin, as well as the
selection of an appropriate discount rate based on weighted-average cost of
capital which includes company-specific risk premium. We elected to perform a
qualitative impairment assessment for each of our individual reporting units of
KFC , Pizza Hut and Lavazza in 2022. Based on our qualitative assessment, the
Company concluded that no changes in events or circumstances have occurred that
indicated impairment may exist and it was more likely than not that the fair
value of the reporting units exceeds their carrying amount and therefore no
quantitative assessment was required. No impairment charge on goodwill was
recorded in 2022 and 2021.
If we record goodwill upon acquisition of a restaurant(s) from a franchisee and
such restaurant(s) is then sold within two years of acquisition, the goodwill
associated with the acquired restaurant(s) is written off in its entirety. If
the restaurant is refranchised two years or more subsequent to its acquisition,
we include goodwill in the carrying amount of the restaurants disposed of based
on the relative fair values of the portion of the reporting unit disposed of in
the refranchising and the portion of the reporting unit that will be retained.
Share-Based Compensation
We account for share awards issued to employees in accordance with Accounting
Standards Codification Topic 718 ("ASC 718"), Compensation-Stock Compensation.
Share-based compensation cost is measured at the grant date based on the fair
value of the award and is recognized as an expense, net of estimated
forfeitures, over the requisite service period, which is generally the vesting
period. We recognize share-based compensation expense for awards granted to
employees and non-employee directors using the straight-line method.
We estimated the fair value of stock options and SARs at the grant date using
the Black-Scholes option-pricing model ("the BS model"). It should be noted that
the option-pricing model requires the input of highly subjective assumptions.
Changes in the subjective input assumptions can materially affect the fair value
estimate and, as a result, our operating profit and net income. PSUs have market
conditions that are based on the closing price of Yum China's stock or relative
total shareholder return against the MSCI China Index measured over the
performance period. The fair values of PSUs have been determined based on the
outcome of a Monte-Carlo Simulation model (the "MCS model").
Under the BS and MCS models, we made a number of assumptions regarding the fair value of the share-based awards, including:
•
the expected future volatility of the price of shares of
•
the risk-free interest rate;
•
the expected dividend yield; and
•
the expected term.
We estimated the expected future volatility of the price of shares ofYum China common stock based on the historical price volatility of the publicly traded shares of common stock of comparable companies in the same business asYum China as well as the historical volatility of the Company's common stock. The risk-free interest rate was based on theU.S. Treasury zero-coupon yield in effect with maturity terms equal to the expected term or performance measurement period of the awards. The dividend yield was estimated based on the Company's dividend policy. We use historical turnover data to estimate the expected forfeiture rate. 82 2022 Form 10-K
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Income Taxes
Uncertain Tax Positions
We are subject to reviews, examinations and audits by Chinese tax authorities, theIRS and other tax authorities with respect to income and non-income based taxes. We recognize the benefit of positions taken or expected to be taken in our tax returns when it is more likely than not that the position would be sustained upon examination by these tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. AtDecember 31, 2022 and 2021, we had$21 million and$20 million , respectively, of unrecognized tax benefits related to the uncertainty with regard to the deductibility of certain business expenses incurred. We evaluate unrecognized tax benefits, including interest thereon, on a quarterly basis to ensure that they have been appropriately adjusted for events, including audit settlements, which may impact our ultimate payment for such exposures. 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.
Unremitted Earnings of Foreign Subsidiaries
We have investments in our foreign subsidiaries where the carrying values for financial reporting exceed the tax basis. Except for the planned but yet to be distributed earnings, we have not provided deferred tax on the portion of the excess that we believe is indefinitely reinvested, as we have the ability and intent to indefinitely postpone the basis differences from reversing with a tax consequence. The Company's separation from YUM was intended to qualify as a tax-free reorganization forU.S. income tax purposes resulting in the excess of financial reporting basis over tax basis in our investment in theChina business continuing to be indefinitely reinvested. The excess of financial reporting basis over tax basis as ofDecember 31, 2017 was subject to the one-time transition tax under the Tax Act as a deemed repatriation of accumulated undistributed earnings from the foreign subsidiaries. However, we continue to believe that the portion of the excess of financial reporting basis over tax basis (including earnings and profits subject to the one-time transition tax) is indefinitely reinvested in our foreign subsidiaries for foreign withholding tax purposes. We estimate that our total temporary difference for which we have not provided foreign withholding taxes is approximately$3 billion atDecember 31, 2022 . The foreign withholding tax rate on this amount is 5% or 10% depending on the manner of repatriation and the applicable tax treaties or tax arrangements. See Note 17 of the Consolidated Financial Statements for a further discussion of our income taxes. 83 2022 Form 10-K
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