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 2022 system sales, with over 13,000 restaurants covering over 1,800 cities primarily inChina as ofMarch 31, 2023 . Our growing restaurant network consists of our flagshipKFC and Pizza Hut brands, as well as emerging brands such asTaco Bell , Lavazza, Little Sheep andHuang Ji Huang . We have the exclusive right to operate and sublicense theKFC ,Pizza Hut and, subject to achieving certain agreed-upon milestones amended inApril 2022 , Taco Bell brands inChina (excludingHong Kong ,Macau andTaiwan ), and own the intellectual property of the Little Sheep andHuang Ji Huang concepts outright. We also established a joint venture withLavazza Group , the world-renowned family-owned Italian coffee company, to explore and develop the Lavazza coffee concept inChina .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 inChina in terms of system sales. We believe that there are significant opportunities to further 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, 2023 ,KFC operated over 9,200 restaurants in over 1,800 cities across China.Pizza Hut is the leading and the largest casual dining restaurant ("CDR") brand inChina in terms of system sales and number of restaurants. As ofMarch 31, 2023 ,Pizza Hut operated over 2,900 restaurants in over 650 cities. 24
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Overview
We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including metrics that management uses to assess the Company's performance. Throughout this MD&A, we discuss the following performance metrics:
•
The Company provides certain percentage changes excluding the impact of foreign
currency translation ("F/X"). These amounts are derived by translating current
year results at prior year average exchange rates. We believe the elimination of
the F/X impact provides better year-to-year comparability without the distortion
of foreign currency fluctuations.
•
System sales growth reflects the results of all restaurants regardless of ownership, including Company-owned and franchise 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 restaurants typically generate ongoing franchise fees for the Company at an average rate of approximately 6% of system sales. Franchise 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, 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.
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 ofTaco Bell , Lavazza, Little Sheep,Huang Ji Huang , our delivery operating segment and our e-commerce business, and for 2022, also including COFFii & JOY and East Dawning, 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. 25 --------------------------------------------------------------------------------
% Change
System Sales(a) Same-Store Net New Units Operating Profit Operating Profit
Sales(a) (Reported) (Ex F/X)
KFC +17 +8 +9 +91 +105
Pizza Hut +17 +7 +11 +85 +98
All Other Segments(b) +4 +7 (4 ) +62 +59
Total +17 +8 +9 +118 +134
(a)
System sales and same-store sales percentages as shown in the table 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.
During the first quarter of 2023, sales rebounded significantly year over year
and sequentially. Our strong sales growth was driven by tremendous efforts in
seizing opportunities as the country pivoted from strict COVID-19 measures. As
compared to the first quarter of 2022, Company sales in the first quarter of
2023 increased 9%, or 17% excluding the impact of F/X. The increase in Company
sales for the quarter, excluding the impact of F/X, was driven by same-store
sales growth of 8%, net unit growth of 10% in Company-owned stores, and
significantly reduced temporary store closures.
The increase in Operating profit for the quarter, excluding the impact of F/X,
was primarily driven by the increase in Company sales, higher labor
productivity, operational efficiency, the increase in temporary relief from the
government and landlords and lower rental expenses from store portfolio
optimization, partially offset by increased value promotions, higher
performance-based compensation and wage inflation in the low single digits.
26--------------------------------------------------------------------------------
The Consolidated Results of Operations for the quarters endedMarch 31, 2023 and 2022 are presented below: Quarter Ended % B/(W) (a) 3/31/2023 3/31/2022 Reported Ex F/X Company sales$ 2,772 $ 2,548 9 17 Franchise fees and income 25 24 1 9 Revenues from transactions with franchisees 93 77 21 30 Other revenues 27 19 43 54 Total revenues$ 2,917 $ 2,668 9 18 Company restaurant expenses$ 2,209 $ 2,197 (1 ) (8 ) Operating Profit$ 416 $ 191 118 134 Interest income, net 38 12 224 232 Investment loss (17 ) (37 ) 54 54 Income tax provision (125 ) (55 ) (127 ) (141 ) Equity in net earnings (losses) from equity method investments 1 (1 ) NM NM Net Income - including noncontrolling interests 313 110 184 206 Net Income - noncontrolling interests 24 10 (136 ) (155 ) Net Income - Yum China Holdings, Inc.$ 289 $ 100 189 212 Diluted Earnings Per Common Share$ 0.68 $ 0.23 196 222 Effective tax rate 28.5 % 33.1 % Supplementary information - Non-GAAP Measures(b) Restaurant profit$ 563 $ 351 61 73 Restaurant margin % 20.3 % 13.8 % 6.5 ppts. 6.5 ppts. Adjusted Operating Profit$ 419 $ 193 Adjusted Net Income - Yum China Holdings, Inc.$ 292 $ 102 Adjusted Diluted Earnings Per Common Share$ 0.69 $ 0.24 Adjusted Effective Tax Rate 28.4 % 32.7 % Adjusted EBITDA$ 539 $ 365 NM refers to not meaningful. (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 3/31/2023
% change
System Sales Growth 8 %
System Sales Growth, excluding F/X 17 %
Same-Store Sales Growth 8 %
Unit Count 3/31/2023 3/31/2022 % Increase
Company-owned 11,374 10,385 10
Franchisees 1,806 1,732 4
13,180 12,117 9
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. 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 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
Quarter Ended 3/31/2023
Corporate
All Other and
KFC Pizza Hut Segments Unallocated Elimination Total
GAAP Operating Profit (Loss) $ 420 $ 55 $ (6 ) $ (53 ) $ - $ 416
Less:
Franchise fees and income 17 2 6 - - 25
Revenues from transactions
with franchisees 10 1 19 63 - 93
Other revenues 5 3 162 10 (153 ) 27
Add:
General and administrative
expenses 68 29 10 56 - 163
Franchise expenses 9 1 - - - 10
Expenses for transactions
with franchisees 9 1 18 63 - 91
Other operating costs and
expenses 4 3 161 8 (152 ) 24
Closures and impairment
expenses, net 1 1 1 - - 3
Other expenses (income), net 2 - - (1 ) - 1
Restaurant profit (loss) $ 481 $ 84 $ (3 ) $ - $ 1 $ 563
Company sales 2,166 591 15 - - 2,772
Restaurant margin % 22.2 % 14.2 % (21.2 )%
N/A N/A 20.3 %
28--------------------------------------------------------------------------------
Quarter Ended 3/31/2022
Corporate
All Other and
KFC Pizza Hut Segments Unallocated Elimination Total
GAAP Operating Profit (Loss) $ 220 $ 30 $ (17 ) $ (42 ) $ - $ 191
Less:
Franchise fees and income 16 2 6 - - 24
Revenues from transactions
with franchisees 8 1 11 57 - 77
Other revenues 2 2 131 10 (126 ) 19
Add:
General and administrative
expenses 65 29 13 44 - 151
Franchise expenses 9 1 - - - 10
Expenses for transactions
with franchisees 8 1 9 57 - 75
Other operating costs and
expenses 1 1 134 9 (128 ) 17
Closures and impairment
(income) expenses, net (1 ) 1 2 - - 2
Other expenses (income), net 26 - - (1 ) - 25
Restaurant profit (loss) $ 302 $ 58 $ (7 ) $ - $ (2 ) $ 351
Company sales 1,991 542 15 - - 2,548
Restaurant margin % 15.2 % 10.7 % (50.9 )% N/A N/A 13.8 %
Quarter Ended
3/31/2023 3/31/2022
Reconciliation of Reported GAAP Results to Non-GAAP
Adjusted Measures
Reconciliation of Operating Profit to Adjusted
Operating Profit
Operating Profit $ 416 $ 191
Special Items, Operating Profit (3 ) (2 ) Adjusted Operating Profit$ 419 $
193
Reconciliation of Net Income to Adjusted Net Income
Net Income -
$ 289 $
100
Special Items, Net Income - Yum China Holdings, Inc. (3 ) (2 ) Adjusted Net Income - Yum China Holdings, Inc.$ 292 $
102
Reconciliation of EPS to Adjusted EPS Basic Earnings Per Common Share$ 0.69 $
0.23
Special Items, Basic Earnings Per Common Share (0.01 ) (0.01 ) Adjusted Basic Earnings Per Common Share$ 0.70 $
0.24
Diluted Earnings Per Common Share$ 0.68 $
0.23
Special Items, Diluted Earnings Per Common Share (0.01 ) (0.01 ) Adjusted Diluted Earnings Per Common Share$ 0.69 $
0.24
Reconciliation of Effective Tax Rate to Adjusted
Effective Tax Rate
Effective tax rate (See Note 13) 28.5 % 33.1 %
Impact on effective tax rate as a result of Special
Items 0.1 % 0.4 %
Adjusted effective tax rate 28.4 % 32.7 %
29--------------------------------------------------------------------------------
Net income, along with the reconciliation to Adjusted EBITDA, is presented below.
Quarter Ended
Reconciliation of Net Income to Adjusted EBITDA3/31/2023
Net Income - Yum China Holdings, Inc. $ 289 $ 100 Net Income - noncontrolling interests 24 10 Equity in net (earnings) losses from equity method investments (1 ) 1 Income tax provision 125 55 Interest income, net (38 ) (12 ) Investment loss 17 37 Operating Profit 416 191 Special Items, Operating Profit 3 2 Adjusted Operating Profit 419 193 Depreciation and amortization 116 164 Store impairment charges 4 8 Adjusted EBITDA $ 539 $ 365
Details of Special Items are presented below:
Quarter Ended
Details of Special Items3/31/2023
Share-based compensation expense for Partner PSU Awards(1) $ (3 ) $
(2 )
Special Items, Operating Profit (3 )
(2 )
Tax effect on Special Items(2) -
-
Special Items, net income - including noncontrolling interests (3 )
(2 )
Special Items, net income - noncontrolling interests -
-
Special Items, Net Income - Yum China Holdings, Inc. $ (3 ) $
(2 )
Weighted-average diluted shares outstanding (in millions) 423
430
Special Items, Diluted Earnings Per Common Share
(0.01 ) (1) 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.
(2)
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.
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.
30
--------------------------------------------------------------------------------Segment ResultsKFC Quarter Ended % B/(W) 3/31/2023 3/31/2022 Reported Ex F/X Company sales$ 2,166 $ 1,991 9 17 Franchise fees and income 17 16 5 13 Revenues from transactions with franchisees 10 8 29 39 Other revenues 5 2 195 218 Total revenues$ 2,198 $ 2,017 9 17 Company restaurant expenses$ 1,685 $ 1,689 - (7 ) G&A expenses$ 68 $ 65 (4 ) (12 ) Franchise expenses $ 9 $ 9 4 (3 ) Expenses for transactions with franchisees $ 9 $ 8 (25 ) (34 )
Other operating costs and expenses $ 4 $ 1 (295 )
(325 )
Closures and impairment expenses
(income), net $ 1 $ (1 ) NM NM
Other expenses, net $ 2 $ 26 92 92
Operating Profit $ 420 $ 220 91 105
Restaurant profit $ 481 $ 302 60 72
Restaurant margin % 22.2 % 15.2 % 7.0 ppts. 7.0 ppts.
Quarter Ended 3/31/2023
% change
System Sales Growth 9 %
System Sales Growth, excluding F/X 17 %
Same-Store Sales Growth 8 %
Unit Count 3/31/2023 3/31/2022 % Increase
Company-owned 8,335 7,668 9
Franchisees 904 773 17
9,239 8,441 9
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2022 Actions Other F/X 3/31/2023
Company sales $ 1,991 $ 175 $ 165 $ (165 ) $ 2,166
Cost of sales (621 ) (56 ) (18 ) 49 (646 )
Cost of labor (501 ) (35 ) (15 ) 39 (512 )
Occupancy and other operating
expenses (567 ) (23 ) 23 40 (527 )
Restaurant profit $ 302 $ 61 $ 155 $ (37 ) $ 481
The increase in Company sales for the quarter, excluding the impact of F/X, was
primarily driven by same-store sales growth, net unit growth and significantly
reduced temporary store closures. The increase in Restaurant profit for the
quarter, excluding the impact of F/X, was primarily driven by the increase in
Company sales, higher labor productivity, operational efficiency, the increase
in temporary relief from the government and landlords and lower rental expenses
from store portfolio optimization, partially offset by higher performance-based
compensation, wage inflation in the low single digits and increased value
promotions.
31
--------------------------------------------------------------------------------Franchise Fees and Income/Revenues from Transactions with Franchisees
The increase in Franchise fees and income and Revenues from transactions with franchisees for the quarter, excluding the impact of F/X, was primarily driven by net unit growth and same-store sales growth.
G&A Expenses
The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by higher performance-based compensation and merit increases.
Other Expenses, net
The decrease in Other expenses, net for the quarter, excluding the impact of F/X, was primarily due to intangible assets related to reacquired franchise rights ofHangzhou KFC , Suzhou KFC andWuxi KFC being substantially amortized as ofDecember 31, 2022 . See Note 8 for detail.
Operating Profit
The increase in Operating profit for the quarter, excluding the impact of F/X, was primarily driven by the increase in Restaurant profit, and decrease in Other expenses, net, partially offset by higher G&A expenses.Pizza Hut Quarter Ended % B/(W) 3/31/2023 3/31/2022 Reported Ex F/X Company sales$ 591 $ 542 9 17 Franchise fees and income 2 2 2 10 Revenues from transactions with franchisees 1 1 7 15 Other revenues 3 2 88 103 Total revenues$ 597 $ 547 9 18 Company restaurant expenses$ 507 $ 484 (5 ) (13 ) G&A expenses$ 29 $ 29 (1 ) (9 ) Franchise expenses $ 1 $ 1 (1 ) (9 ) Expenses for transactions with franchisees $ 1 $ 1 (5 ) (13 )
Other operating costs and expenses $ 3 $ 1 (75 )
(88 )
Closures and impairment expenses,
net $ 1 $ 1 (82 ) (96 )
Operating Profit $ 55 $ 30 85 98
Restaurant profit $ 84 $ 58 44 55
Restaurant margin % 14.2 % 10.7 % 3.5 ppts. 3.5 ppts.
Quarter Ended 3/31/2023
% change
System Sales Growth 9 %
System Sales Growth, excluding F/X 17 %
Same-Store Sales Growth 7 %
Unit Count 3/31/2023 3/31/2022 % Increase
Company-owned 2,838 2,543 12
Franchisees 145 136 7
2,983 2,679 11
32--------------------------------------------------------------------------------
Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 3/31/2022 Actions Other F/X 3/31/2023
Company sales $ 542 $ 60 $ 35 $ (46 ) $ 591
Cost of sales (166 ) (19 ) (14 ) 15 (184 )
Cost of labor (157 ) (14 ) (9 ) 13 (167 )
Occupancy and other
operating expenses (161 ) (12 ) 5 12 (156 )
Restaurant profit $ 58 $ 15 $ 17 $ (6 ) $ 84
The increase in Company sales for the quarter, excluding the impact of F/X, was
primarily driven by same-store sales growth, net unit growth and significantly
reduced temporary store closures. The increase in Restaurant profit for the
quarter, excluding the impact of F/X, was primarily driven by the increase in
Company sales, higher labor productivity, operational efficiency, the increase
in temporary relief from the government and landlords and lower rental expenses
from store portfolio optimization, partially offset by increased value
promotions, higher performance-based compensation and wage inflation in the low
single digits.
G&A Expenses
The increase in G&A expenses for the quarter, excluding the impact of F/X, was primarily driven by higher performance-based compensation and merit increases.
Operating Profit
The increase in Operating profit for the quarter, excluding the impact of F/X, was primarily driven by the increase in Restaurant profit, partially offset by higher G&A expenses. All Other Segments All Other Segments reflects the results ofTaco Bell , Lavazza, Little Sheep,Huang Ji Huang , our delivery operating segment and our e-commerce business, and for 2022, also includes COFFii & JOY and East Dawning. Quarter Ended % B/(W) 3/31/2023 3/31/2022 Reported Ex F/X Company sales$ 15 $ 15 3 12 Franchise fees and income 6 6 (8 ) (1 ) Revenues from transactions with franchisees 19 11 73 86 Other revenues 162 131 23 33 Total revenues$ 202 $ 163 24 33 Company restaurant expenses$ 18 $ 22 17 10 G&A expenses$ 10 $ 13 18 12 Expenses for transactions with franchisees$ 18 $ 9 (89 ) (104 ) Other operating costs and expenses$ 161 $ 134 (21 ) (30 ) Closures and impairment expenses, net $ 1 $ 2 87 86 Operating Loss$ (6 ) $ (17 ) 62 59 Restaurant loss$ (3 ) $ (7 ) 57 54 Restaurant margin % (21.2 )% (50.9 )% 29.7 ppts. 29.7 ppts. Quarter Ended 3/31/2023 % change Same-Store Sales Growth 7 % 33
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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 as a result of rising delivery sales.
Operating Loss
The decrease in Operating loss for the quarter, excluding the impact of F/X, was
primarily driven by the decrease in Operating loss from certain emerging brands.
Corporate and Unallocated
Quarter Ended
% B/(W)
3/31/2023 3/31/2022 Reported Ex F/X
Revenues from transactions with
franchisees $ 63 $ 57 11 19
Other revenues $ 10 $ 10 (1 ) 7
Expenses for transactions with
franchisees $ 63 $ 57 (10 ) (18 )
Other operating costs and expenses $ 8 $ 9 5 (2 )
Corporate G&A expenses $ 56 $ 44 (26 ) (33 )
Other unallocated income, net $ (1 ) $ (1 ) 60 72
Interest income, net $ 38 $ 12 224 232
Investment loss $ (17 ) $ (37 ) 54 54
Income tax provision (See Note 13)
(127 ) (141 ) Equity in net earnings (losses) from equity method investments $ 1$ (1 ) NM NM Effective tax rate (See Note 13) 28.5 % 33.1 % 4.6 % 4.6 %
Revenues from Transactions with Franchisees
Revenues from transactions with franchisees 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. The increase for the quarter, excluding the impact of F/X, was mainly due to the increase in system sales for franchisees.
G&A Expenses
The increase in Corporate G&A expenses for the quarter, excluding the impact of F/X, was primarily due to higher performance-based compensation and merit increases.
Interest Income, Net
The increase in interest income, net for the quarter was primarily driven by higher interest rates and higher investment balance.
Investment Loss
The decrease in investment loss for the quarter mainly relates to the more moderate decline in the fair value of our investment in Meituan compared to the prior year period. See Note 3 for additional information.
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 of China,Hong Kong profits tax, andU.S. corporate income tax, if any. The lower effective tax rate for the quarter endedMarch 31, 2023 was primarily due to a true-up of foreign withholding tax in the quarter endedMarch 31, 2022 , a reduction in valuation allowance for certain subsidiaries, and less impact from our investment in Meituan. 34
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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 and caused significant volatility in our operations. During the first quarter of 2023, sales rebounded significantly year-over-year and sequentially. Our strong sales growth was driven by tremendous efforts in seizing opportunities as the country pivoted from strict COVID-19 measures. Margins also improved substantially, benefiting from sales leveraging, cost structure rebasing, and temporary relief from the government and landlords. However, we are still in the early stages of recovery. Sales during theChinese New Year holiday trading period were buoyed by pent-up travel demand, yet same-store sales postChinese New Year holiday in the first quarter have remained at teens level below 2019. During theLabor Day holiday period, trading was vibrant and grew on a year-over-year basis, yet same-store sales were still approximately in the mid-single digits range below the 2019 level on a pro-forma basis. We also expect inflationary pressures to be gradually built up and the benefit from temporary relief to be phased out over the coming quarters. The pace and the trajectory of the recovery remain uncertain, given the challenging macroeconomic conditions and the lingering effects of the pandemic. As such, we are staying alert with vigorous scenario planning, more flexible cost structures and operational agility to capture growth opportunities and mitigate risks when needed.
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. 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. 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. Entities that are general VAT 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 Condensed 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 ofMarch 31, 2023 , 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 ("MOF") 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 35
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assets accumulated prior to
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 ofMarch 31, 2023 , VAT assets of$95 million , VAT assets of$5 million and net VAT payable of$6 million were recorded in Prepaid expenses and other current assets, Other assets and Accounts payable and other current liabilities, respectively, on the Condensed Consolidated Balance Sheets. The Company will continue to review the classification of VAT assets at each balance sheet date, giving consideration to different local implementation practices of refunding VAT assets and the outcome of potential administrative reviews. Pursuant to Circular [2019] No. 39, Circular [2019] No. 87 and Circular [2022] No. 11 jointly issued by relevant government authorities, including the MOF and the STA, fromApril 1, 2019 toDecember 31, 2022 , general VAT taxpayers in certain industries that meet certain criteria are allowed to claim an additional 10% or 15% input VAT, which will be used to offset their output VAT and, therefore, reduce their VAT payables. Pursuant to Circular [2023] No. 1 jointly issued by the MOF and the STA inJanuary 2023 , such VAT policy was further extended toDecember 31, 2023 but the additional deduction was reduced to 5% or 10% respectively. It is uncertain whether such preferential policy will continue to be applicable upon expiration. Subsequent to the lump sum refund of VAT assets beginning onJuly 1, 2022 pursuant to Circular [2022] No. 21, the number of subsidiaries meeting required criteria for additional VAT deductions increased. Accordingly, we recognized such VAT deductions of$8 million in each of the third and fourth quarters of 2022, and$19 million in the first quarter of 2023. The VAT deductions were recorded as a reduction to the related expense item, primarily in Company restaurant expenses included in the Condensed Consolidated Statements of Income. We have been benefiting from the retail tax structure reform since it was implemented onMay 1, 2016 . However, the amount of our expected benefit from this VAT regime depends on a number of factors, some of which are outside of our control. The interpretation and application of the new VAT regime are not settled at some local governmental levels. In addition, China is in the process of enacting the prevailing VAT regulations into a national VAT law. However, the timetable for enacting the national VAT law is not clear. As a result, for the foreseeable future, the benefit of this significant and complex VAT reform has the potential to fluctuate from quarter to quarter.
Foreign Currency Exchange Rate
The reporting currency of the Company is the US$. Most of the revenues, costs,
assets and liabilities of the Company are denominated in 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$507 million in 2023 as compared to$171 million in 2022. The increase was primarily driven by the increase in net income along with working capital changes. Net cash used in investing activities was$429 million in 2023 as compared to net cash provided by investing activities of$13 million in 2022. The change was mainly due to net impact on cash flow resulting from purchases and maturities of short-term investments, long-term bank deposits and notes. Net cash used in financing activities was$99 million in 2023 as compared to$274 million in 2022. The decrease was primarily driven by the decrease in share repurchases. 36
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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 former unconsolidated affiliates. Our global offering in
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 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 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
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. During the quarters endedMarch 31, 2023 and 2022, the Company repurchased$62 million or 1.0 million shares and$232 million or 5.0 million shares of common stock, respectively, under the repurchase program.
For the quarters ended
OnMay 2, 2023 , the Board of Directors declared a cash dividend of$0.13 per share, payable onJune 20, 2023 , to stockholders of record as of the close of business onMay 30, 2023 . The total estimated cash dividend payable is approximately$54 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. 37 --------------------------------------------------------------------------------
Borrowing Capacity
As ofMarch 31, 2023 , the Company had credit facilities ofRMB4,512 million (approximately$656 million ), comprised of onshore credit facilities ofRMB3,000 million (approximately$436 million ) in aggregate and offshore credit facilities of$220 million in aggregate. The credit facilities had remaining terms ranging from less than one year to two years as ofMarch 31, 2023 . Each credit facility bears interest based on the 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 ofMarch 31, 2023 , we had outstanding bank guarantees ofRMB199 million (approximately$29 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 ofMarch 31, 2023 , which was secured by a$1-million short-term investment. The bank borrowing will be due within one year and was included in Accounts payable and other current liabilities.
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
InMarch 2023 , the FASB issued ASU 2023-01, Leases (Topic 842) - Common Control Arrangements ("ASU 2023-01"). It requires all lessees, including public business entities, to amortize leasehold improvements associated with common control leases over their useful life to the common control group and account for them as a transfer of assets between entities under common control through an adjustment to equity when the lessee no longer controls the use of the underlying asset. ASU 2023-01 is effective for the Company fromJanuary 1, 2024 , with early adoption permitted. We are currently evaluating the impact the adoption of this standard may have on our financial statements.
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 38 -------------------------------------------------------------------------------- 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 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, and (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;
•
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, which may be subject to change from time to time with little advance notice, and the risk that the PRC government may intervene or influence our operations at any time, which could result in a material change in our operations and/or the value of our securities to decline, (c) audit reports included in our annual reports prepared by auditors who are located inChina , and in the event the PCAOB is unable to inspect our auditors, our common stock will be subject to potential delisting from theNew York Stock Exchange , (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) limitation on our ability to utilize our cash balances effectively, including making funds held by our China-based subsidiaries unavailable for use outside of mainland China, due to interventions in or the imposition of restrictions and limitations by the PRC government on currency conversion and payments of foreign currency and RMB 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, (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, (s) difficulties in pursuing growth through acquisitions due to regulations regarding acquisitions, and (t) the PRC government has significant oversight and discretion to exert control over offerings of securities conducted outside of China and over foreign investment inChina -based issuers, and may limit or completely hinder our ability to offer securities to investors, or cause the value of our securities to significantly decline;
•
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 39 -------------------------------------------------------------------------------- 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; and
•
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, 2022 ) for additional information regarding factors that could affect our financial and other results. You should not place undue reliance on forward-looking statements, which speak only as of the date of the filing of this Form 10-Q. We are not undertaking to update any of these statements, except as required by law.
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