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. IntroductionYum China Holdings, Inc. is the largest restaurant company inChina in terms of system sales, with over 9,900 restaurants as ofJune 30, 2020 . Our growing restaurant base consists of our flagshipKFC and Pizza Hut brands, as well as emerging brands such as Little Sheep,Huang Ji Huang , COFFii & JOY, East Dawning andTaco Bell . We have the exclusive right to operate and sublicense theKFC ,Pizza Hut and, subject to achieving certain agreed-upon milestones, Taco Bell brands inChina , excludingHong Kong ,Taiwan andMacau (the "PRC" or "China"), and own the intellectual property of the Little Sheep,Huang Ji Huang , COFFii & JOY and East Dawning concepts outright. We were the first major global restaurant brand to enter China in 1987 and with over 30 years of operations, we have developed deep operating experience in the China market. We have since grown to become one of China's largest restaurant developers with locations in over 1,400 cities as ofJune 30, 2020 . We believe that there is significant opportunity to expand within China, and we intend to focus our efforts on increasing our geographic footprint in both existing and new cities.KFC is the leading and the largest quick-service restaurant ("QSR") brand inChina in terms of system sales. As ofJune 30, 2020 ,KFC operated over 6,700 restaurants in over 1,400 cities across China.
Overview We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including metrics that management uses to assess the Company's performance. Throughout this MD&A, we discuss the following performance metrics:
• The Company provides certain percentage changes excluding the impact of
foreign currency translation ("F/X"). These amounts are derived by
translating current year results at prior year average exchange rates. We
believe the elimination of the F/X impact provides better year-to-year
comparability without the distortion of foreign currency fluctuations.
• System sales growth reflects the results of all restaurants regardless of
ownership, including Company-owned, franchise and unconsolidated affiliate
restaurants that operate our concepts, except for sales from
non-Company-owned restaurants for which we do not receive a sales-based
royalty. Sales of franchise and unconsolidated affiliate restaurants
typically generate ongoing franchise fees for the Company at a rate of
approximately 6% of system sales. Franchise and unconsolidated affiliate
restaurant sales are not included in Company sales in the Condensed
Consolidated Statements of Income; however, the franchise fees are
included in the Company's revenues. We believe system sales growth isuseful to investors as a significant indicator of the overall strength of
our business as it incorporates all of our revenue drivers, Company and
franchise same-store sales as well as net unit growth.
31
-------------------------------------------------------------------------------- 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.
•
sales less expenses incurred directly by our Company-owned restaurants in
generating Company sales. Company restaurant margin percentage is defined
as Restaurant profit divided by Company sales. Within the Company sales
and Restaurant profit analysis, Store Portfolio Actions represent the net
impact of new-unit openings, acquisitions, refranchising and store
closures, and Other primarily represents the impact of same-store sales as
well as the impact of changes in restaurant operating costs such as
inflation/deflation.
• 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, Adjusted Effective Tax Rate and
Adjusted EBITDA, which we define as net income including noncontrolling
interests adjusted for income tax, interest income, net, investment gain
or loss, depreciation and amortization, and other items, including storeimpairment charges and Special Items. The Special Items for the year to
date ended
related to Daojia and share-based compensation cost recognized for a
special award of performance stock units ("Partner PSU Awards") granted to
select employees. The Special Item for the year to date ended
2019 represents impact from the Tax Cuts and Jobs Act (the "Tax Act"). The
Company excludes impact from Special Items for the purpose of evaluating
performance internally. Special Items are not included in any of our
segment results. In addition, the Company provides Adjusted EBITDA because
we believe that investors and analysts may find it useful in measuring
operating performance without regard to items such as income tax, interest
income, net, investment gain or loss, depreciation and amortization, and
other items, including store impairment charges and Special Items. These
adjusted measures are not intended to replace the presentation of ourfinancial results in accordance with GAAP. Rather, the Company believes
that the presentation of these adjusted measures provides additional
information to investors to facilitate the comparison of past and present
results, excluding those items that the Company does not believe are
indicative of our ongoing operations due to their nature.
All Note references in this MD&A refer to the Notes to the Condensed
Consolidated Financial Statements. Tabular amounts are displayed in millions of
32
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Quarters and Years to Date Ended
Results of Operations Summary The Company has two reportable segments:KFC andPizza Hut . Our remaining operating segments, including the operations of Little Sheep,Huang Ji Huang , East Dawning,Taco Bell , Daojia, COFFii & JOY and our e-commerce business, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate. Additional details on our reportable operating segments are included in Note 13. Quarterly highlights: % Change System Sales(a) Same-Store Net New Units Operating Profit Operating Profit Sales(a) (Reported) (Ex F/X) KFC (6 ) (10 ) +9 (22 ) (19 ) Pizza Hut (12 ) (12 ) - (48 ) (45 ) All Other Segments(b) NM (27 ) NM 35 35 Total (4 ) (11 ) +14 (38 ) (35 ) Year to date highlights: % Change System Sales(a) Same-Store Net New Units Operating Profit Operating Profit Sales(a) (Reported) (Ex F/X) KFC (10 ) (11 ) +9 (37 ) (34 ) Pizza Hut (25 ) (22 ) - NM NM All Other Segments(b) 69 (29 ) NM (31 ) (33 ) Total (13 ) (13 ) +14 (56 ) (54 )
NM refers to changes over 100%, from negative to positive amounts or from zero to an amount.
(a) System sales and same-store sales percentages as shown in tables exclude the
impact of F/X. Effective
normalized in the same-store sales calculation by excluding the period during
which stores are temporarily closed.
(b) Sales from non-Company-owned restaurants, for which we do not receive a
sales-based royalty, are excluded from system sales and same-store sales.
As ofJune 30, 2020 , the Company operated over 9,900 units, predominatelyKFC andPizza Hut restaurants, which are the leading and largest QSR and CDR brands, respectively, in mainland China in terms of system sales. We believe that there is significant opportunity to expand within China, and we intend to focus our efforts on increasing our geographic footprint in both existing and new cities. 33
-------------------------------------------------------------------------------- Starting in lateJanuary 2020 , the COVID-19 pandemic has significantly impacted the Company's operations. The first three weeks of January were strong, but then the pandemic led to subsequent same-store sales declines of 40-50% compared to the comparableChinese New Year holiday period in 2019. Approximately 35% of stores were closed by mid-February at the peak of the outbreak, with significant regional differences. For restaurants that remained open, same-store sales declined due to shortened operating hours and reduced traffic, with a significant portion of stores providing only delivery and takeaway services. As the first quarter progressed, sales performance recovered gradually, with same-store sales down approximately 20% in late March. Second quarter operations improved since the COVID-19 outbreak. More than 99% of stores inChina were open at the end ofJuly 2020 , with sales and profits trending unevenly. Sales improved sequentially in April and May but softened in June. Sales were primarily impacted by significantly reduced traffic at transportation and tourist locations, delayed and shortened school holidays and resurging regional infections. As compared to the second quarter of 2019, Company sales in the second quarter of 2020 decreased 12%, or 9% excluding the impact of F/X. Company sales for the year to date endedJune 30, 2020 decreased 19%, or 16% excluding the impact of F/X. The quarter and year to date decreases in Company sales, excluding the impact of F/X, were 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 Operating profit for the quarter, excluding the impact of F/X, was primarily driven by same-store sales declines, higher promotion costs, commodity inflation, higher store impairment charges and timing shift of government incentives received, partially offset by labor efficiency, one-time reductions in social security contributions and lease concessions, realignment of cost structure to lower G&A expenses and utilities savings. The year to date decrease in Operating profit, excluding the impact of F/X, was primarily driven by same-store sales declines, temporary store closures, commodity inflation and higher store impairment charges, partially offset by labor efficiency, one-time reductions in social security contributions and lease concessions, and utilities savings. 34 --------------------------------------------------------------------------------
The Consolidated Results of Operations for the quarters and years to date ended
Quarter Ended % B/(W) (a) Year to Date Ended % B/(W) (a)
6/30/2020 6/30/2019 Reported Ex F/X 6/30/2020 6/30/2019 Reported Ex F/X Company sales$ 1,692 $ 1,926 (12 ) (9 )$ 3,240 $ 4,015 (19 ) (16 ) Franchise fees and income 37 36 2 6 72 75 (4 ) (1 ) Revenues from transactions with franchisees and unconsolidated affiliates 157 154 1 5 318 324 (2 ) 1 Other revenues 16 8 97 106 26 14 86 94 Total revenues$ 1,902 $ 2,124 (11 ) (7 )$ 3,656 $ 4,428 (17 ) (15 ) Restaurant profit$ 231 $ 283 (18 ) (15 )$ 396 $ 669 (41 ) (39 ) Restaurant Margin % 13.7 % 14.7 % (1.0 ) ppts. (1.0 ) ppts. 12.2 % 16.7 % (4.5 ) ppts. (4.5 ) ppts. Operating Profit$ 128 $ 204 (38 ) (35 )$ 225 $ 507 (56 ) (54 ) Interest income, net 8 10 (8 ) (5 ) 17 19 (8 ) (4 ) Investment gain 45 17 NM NM 37 27 40 40 Income tax provision (45 ) (46 ) 1 (1 ) (77 ) (139 ) 44 43 Net Income - including noncontrolling interests 136 185 (27 ) (24 ) 202 414 (51 ) (49 ) Net Income - noncontrolling interests 4 7 50 49 8 14 44 42 Net Income -Yum China Holdings , Inc.$ 132 $ 178 (26 ) (23 )$ 194 $ 400 (52 ) (50 ) Diluted Earnings Per Common Share$ 0.34 $ 0.46 (26 ) (24 )$ 0.50 $ 1.03 (51 ) (50 ) Effective tax rate 25.2 % 20.0 % 27.8 % 25.2 % Adjusted Operating Profit$ 132 $ 204 $ 230 $ 507 Adjusted Net Income -Yum China Holdings , Inc.$ 136 $ 178 $ 199 $ 408 Adjusted Diluted Earnings Per Common Share$ 0.35 $ 0.46 $ 0.51 $ 1.05 Adjusted Effective Tax Rate 24.6 % 20.0 % 27.3 % 23.8 % Adjusted EBITDA$ 261 $ 321 $ 480 $ 749
(a) Represents the period-over-period change in percentage.
Performance Metrics
Quarter Ended Year to Date Ended
6/30/2020 6/30/2019 6/30/2020 6/30/2019
System Sales (Decline) Growth (8 )% 3 % (16 )% 3 %
System Sales (Decline) Growth, excluding F/X (4 )% 10 % (13 )% 10 %
Same-Store Sales (Decline) Growth (11 )% 4 % (13 )% 4 %
Unit Count 6/30/2020 6/30/2019 % Increase
Company-owned 7,479 7,049 6
Unconsolidated affiliates 947 853 11
Franchisees 1,527 849 80
Other(a) 1 - NM
9,954 8,751 14
(a) This unit represents the first Lavazza restaurant.
35
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Non-GAAP Measures
Special Items, along with the reconciliation of the most directly comparable
GAAP financial measures to the non-GAAP adjusted financial measures, are
presented below.
Quarter Ended Year to Date Ended
Detail of Special Items 6/30/2020 6/30/2019 6/30/2020 6/30/2019
Derecognition of indemnification assets
related to Daojia(a) $ (3 ) $ - $ (3 ) $ -
Share-based compensation expense for
Partner PSU Awards(b) (1 ) - (2 ) -
Special Items, Operating Profit (4 ) - (5 ) -
Tax Expenses on Special Items(c) - - - -
Impact from the Tax Act(d) - - - (8 )
Special items, net income - including
noncontrolling interests (4 ) - (5 ) (8 )
Special items, net income -
noncontrolling interests - - - -
Special Items, Net income - Yum China
Holdings, Inc. $ (4 ) $ - $ (5 ) $ (8 )
Weighted-average diluted shares
outstanding (in millions) 388 389 387 389
Special Items, Diluted Earnings Per
Common Share $ (0.01 ) $ - Non-GAAP Reconciliations Reconciliation of Operating Profit to Adjusted Operating Profit Operating Profit$ 128 $ 204 $ 225 $ 507 Special Items, Operating Profit (4 ) - (5 ) - Adjusted Operating Profit$ 132 $ 204 $ 230 $ 507 Reconciliation of Net Income to Adjusted Net Income Net Income - Yum China Holdings, Inc.$ 132 $ 178 $ 194 $ 400 Special Items, Net Income - Yum China Holdings, Inc. (4 ) - (5 ) (8 ) Adjusted Net Income - Yum China Holdings, Inc.$ 136 $ 178 $ 199 $ 408 Reconciliation of EPS to Adjusted EPS Basic Earnings Per Common Share$ 0.35 $ 0.47 $ 0.51 $ 1.06 Special Items, Basic Earnings Per Common Share (0.01 ) - (0.02 ) (0.02 ) Adjusted Basic Earnings Per Common Share$ 0.36 $ 0.47 $ 0.53 $ 1.08
Diluted Earnings Per Common Share
$ 0.50 $ 1.03 Special Items, Diluted Earnings Per Common Share (0.01 ) - (0.01 ) (0.02 ) Adjusted Diluted Earnings Per Common Share$ 0.35 $ 0.46 $ 0.51 $ 1.05 Reconciliation of Effective Tax Rate to Adjusted Effective Tax Rate Effective tax rate (See Note 12) 25.2 % 20.0 % 27.8 % 25.2 % Impact on effective tax rate as a result of Special Items(c)(d) 0.6 % - % 0.5 % 1.4 % Adjusted effective tax rate 24.6 % 20.0 % 27.3 % 23.8 %
(a) In the quarter ended
indemnification asset previously recorded for the Daojia acquisition as the
indemnification right pursuant to the purchase agreement expired. The
expense was included in Other income, net, but was not allocated to any
segment for performance reporting purposes.
(b) In
who were deemed critical to the Company's execution of its strategic
operating plan. These PSU awards will only vest if threshold performance
goals are achieved over a four-year performance period, with the payout
ranging from 0% to 200% of the target number of shares subject to the PSU
awards. Partner PSU Awards were granted to address increased competition for
executive talent, motivate transformational performance and encourage
management retention. Given the unique nature of these grants, the
Compensation Committee does not intend to grant
36
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similar, special grants to the same employees during the performance period.
The impact from these special awards is excluded from metrics that
management uses to assess the Company's performance. The Company recognized
share-based compensation cost of
the Partner PSU Awards for the quarter and year to date ended
respectively.
(c) The tax expense was determined based upon the nature, as well as the
jurisdiction, of each Special Item at the applicable tax rate.
(d) We completed the evaluation of the impact on our transition tax computation
based on the final regulations released by the
the
additional amount of $8 million for the transition tax accordingly.
Adjusted EBITDA
Net income, along with the reconciliation to Adjusted EBITDA, is presented
below.
Quarter Ended Year to Date Ended
Reconciliation of Net Income to Adjusted EBITDA
$ 132 $ 178 $ 194 $ 400 Net Income - noncontrolling interests 4 7 8 14 Income tax provision 45 46 77 139 Interest income, net (8 ) (10 ) (17 ) (19 ) Investment gain (45 ) (17 ) (37 ) (27 ) Operating Profit 128 204 225 507 Special Items, Operating Profit 4 - 5 - Adjusted Operating Profit 132 204 230 507 Depreciation and amortization 105 106 214 217 Store impairment charges 24 11 36 25 Adjusted EBITDA$ 261 $ 321 $ 480 $ 749 37
-------------------------------------------------------------------------------- Segment ResultsKFC Quarter Ended Year to Date Ended % B/(W) % B/(W) 6/30/2020 6/30/2019 Reported Ex F/X 6/30/2020 6/30/2019 Reported Ex F/X Company sales$ 1,260 $ 1,410 (11 ) (7 )$ 2,480 $ 2,949 (16 ) (13 ) Franchise fees and income 32 33 (5 ) (2 ) 65 69 (7 ) (3 ) Revenues from transactions with franchisees and unconsolidated affiliates 15 15 1 5 31 32 (1 ) 2 Total revenues$ 1,307 $ 1,458 (10 ) (7 )$ 2,576 $ 3,050 (16 ) (13 ) Restaurant profit$ 183 $ 225 (19 ) (16 )$ 349 $ 534 (35 ) (32 ) Restaurant margin % 14.6 % 16.1 % (1.5 ) ppts. (1.5 ) ppts. 14.1 % 18.1 % (4.0 ) ppts. (4.0 ) ppts. G&A expenses$ 42 $ 49 15 12$ 88 $ 98 10 7 Franchise expenses$ 16 $ 16 8 5$ 32 $ 35 11 7
Expenses for transactions
with franchisees and
unconsolidated affiliates
(4 ) $ 31 $ 32 1 (2 )
Closures and impairment
expenses, net $ 10 $ - NM NM $ 11 $ 7 (64 ) (73 )
Other income, net $ (12 ) $ (12 ) 8 12 $ (29 ) $ (30 ) - 3
Operating Profit $ 159 $ 205 (22 ) (19 ) $ 312 $ 493 (37 ) (34 )
Quarter Ended Year to Date Ended
6/30/2020 6/30/2019 6/30/2020 6/30/2019
System Sales (Decline) Growth (9 )% 4 % (14 )% 5 %
System Sales (Decline) Growth, excluding F/X (6 )% 12 % (10 )% 12 %
Same-Store Sales (Decline) Growth (10 )% 5 % (11 )% 5 %
Unit Count 6/30/2020 6/30/2019 % Increase
Company-owned 5,231 4,811 9
Unconsolidated affiliates 947 853 11
Franchisees 571 515 11
6,749 6,179 9
38
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Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 6/30/2019 Actions Other F/X 6/30/2020
Company sales $ 1,410 $ 56 $ (158 ) $ (48 ) $ 1,260
Cost of sales (450 ) (19 ) 34 16 (419 )
Cost of labor (311 ) (13 ) 42 11 (271 )
Occupancy and other
operating expenses (424 ) (22 ) 44 15 (387 )
Restaurant profit $ 225 $ 2 $ (38 ) $ (6 ) $ 183
Year to Date Ended
Store
Portfolio
Income (Expense) 6/30/2019 Actions Other F/X 6/30/2020
Company sales $ 2,949 $ (54 ) $ (327 ) $ (88 ) $ 2,480
Cost of sales (926 ) 12 74 29 (811 )
Cost of labor (631 ) (15 ) 68 20 (558 )
Occupancy and other
operating expenses (858 ) (24 ) 93 27 (762 )
Restaurant profit $ 534 $ (81 ) $ (92 ) $ (12 ) $ 349
The decrease in Company sales and Restaurant profit for the quarter, excluding
the impact of F/X, was primarily driven by the same-store sales decline due to
the impact of the COVID-19 pandemic, higher promotion costs and commodity
inflation of 2%, partially offset by labor efficiency, one-time reductions in
social security contributions and lease concessions, and utilities savings.
The year to date decrease in Company sales and Restaurant profit, excluding the impact of F/X, was primarily driven by the same-store sales decline and temporary store closures due to the impact of the COVID-19 pandemic, higher promotion costs and commodity inflation of 2%, partially offset by labor efficiency, one-time reductions in social security contributions and lease concessions, and utilities savings.
Franchise Fees and Income
The decrease in Franchise fees and income for the quarter, excluding the impact
of F/X, was primarily driven by same-store sales decline of restaurants operated
by unconsolidated affiliates and franchisees due to the impact of the COVID-19
pandemic, partially offset by the net unit growth.
The year to date decrease in Franchise fees and income, excluding the impact of
F/X, was primarily driven by same-store sales decline and temporary closure of
restaurants operated by unconsolidated affiliates and franchisees due to the
impact of the COVID-19 pandemic, partially offset by the net unit growth.
G&A Expenses
The quarter and year to date decrease in G&A expenses, excluding the impact of
F/X, was primarily driven by one-time reductions in social security
contributions, realignment of cost structure and higher government incentives
received, partially offset by merit increase.
39
--------------------------------------------------------------------------------Operating Profit The quarter and year to date decrease in Operating profit, excluding the impact of F/X, was primarily driven by the decrease in Restaurant profit and higher store impairment charges, partially offset by lower G&A expenses.Pizza Hut Quarter Ended Year to Date Ended % B/(W) % B/(W) 6/30/2020 6/30/2019 Reported Ex F/X 6/30/2020 6/30/2019 Reported Ex F/X Company sales$ 422 $ 507 (17 ) (13 )$ 744 $ 1,048 (29 ) (26 ) Franchise fees and income 1 1 28 33 2 2 14 18 Revenues from transactions with franchisees and unconsolidated affiliates 1 1 12 17 2 2 8 11 Other revenues - 1 (32 ) (30 ) - 1 (25 ) (23 ) Total revenues$ 424 $ 510 (17 ) (13 )$ 748 $ 1,053 (29 ) (26 ) Restaurant profit$ 47 $ 58 (18 ) (14 )$ 48 $ 135 (64 ) (63 ) Restaurant margin % 11.2 % 11.3 % (0.1 ) ppts. (0.1 ) ppts. 6.4 % 12.9 % (6.5 ) ppts. (6.5 ) ppts. G&A expenses$ 23 $ 27 13 10$ 47 $ 51 8 5 Franchise expenses $ - $ - (8 ) (12 )$ 1 $ 1 (3 ) (6 ) Expenses for transactions with franchisees and
unconsolidated affiliates $ 1 $ 1 (16 )
(21 ) $ 2 $ 2 (20 ) (24 )
Closures and impairment
expenses, net $ 10 $ 3 NM NM $ 15 $ 6 NM NM
Operating Profit (Loss) $ 15 $ 29 (48 ) (45 ) $ (13 ) $ 79 NM NM
Quarter Ended Year to Date Ended
6/30/2020 6/30/2019 6/30/2020 6/30/2019
System Sales Decline (16 )% (3 )% (28 )% (3 )%
System Sales (Decline) Growth, excluding F/X (12 )% 4 % (25 )% 3 %
Same-Store Sales (Decline) Growth (12 )% 1 % (22 )% 1 %
Unit Count 6/30/2020 6/30/2019 % Increase (Decrease)
Company-owned 2,150 2,178 (1 )
Franchisees 108 74 46
2,258 2,252 -
40
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Company Sales and Restaurant Profit
The changes in Company sales and Restaurant profit were as follows:
Quarter Ended
Store
Portfolio
Income (Expense) 6/30/2019 Actions Other F/X 6/30/2020
Company sales $ 507 $ (8 ) $ (60 ) $ (17 ) $ 422
Cost of sales (155 ) 2 13 6 (134 )
Cost of labor (137 ) 3 20 3 (111 )
Occupancy and other
operating expenses (157 ) 4 18 5 (130 )
Restaurant profit $ 58 $ 1 $ (9 ) $ (3 ) $ 47
Year to Date Ended
Store
Portfolio
Income (Expense) 6/30/2019 Actions Other F/X 6/30/2020
Company sales $ 1,048 $ (76 ) $ (201 ) $ (27 ) $ 744
Cost of sales (314 ) 22 47 9 (236 )
Cost of labor (280 ) 14 44 7 (215 )
Occupancy and other
operating expenses (319 ) 14 51 9 (245 )
Restaurant profit $ 135 $ (26 ) $ (59 ) $ (2 ) $ 48
The decrease in Company sales and Restaurant profit for the quarter, excluding
the impact of F/X, was primarily driven by same-store sales decline due to the
impact of the COVID-19 pandemic, commodity inflation of 5% and higher promotion
costs, partially offset by one-time reductions in social security contributions,
labor efficiency, lease concessions, and savings in utilities and other
restaurant operating costs.
The year to date decrease in Company sales and Restaurant 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, and commodity
inflation of 4%, partially offset by labor efficiency, one-time reductions in
social security contributions and lease concessions, and utility savings.
G&A Expenses
The quarter and year to date decrease in G&A expenses, excluding the impact of F/X, was primarily driven by one-time reductions in social security contributions and the realignment of cost structure.
Operating Profit (Loss)
The quarter to date decrease in Operating profit and year to date Operating loss, excluding the impact of F/X, was primarily driven by the decrease in Restaurant profit mainly due to the impact of the COVID-19 pandemic and higher store impairment charges, partially offset by lower G&A expenses.
41
--------------------------------------------------------------------------------All Other Segments
All Other Segments reflects the results of Little Sheep,
Quarter Ended Year to Date Ended
% B/(W) % B/(W)
6/30/2020 6/30/2019 Reported Ex F/X 6/30/2020 6/30/2019 Reported Ex F/X
Company sales $ 10 $ 9 5 9 $ 16 $ 18 (13 ) (10 )
Franchise fees and income 4 2 NM NM 5 4 27 32
Revenues from transactions
with franchisees and
unconsolidated affiliates 11 5 NM NM 16 12 22 27
Other revenues 25 16 55 60 41 30 37 42
Total revenues $ 50 $ 32 53 59 $ 78 $ 64 20 24
Restaurant profit $ - $ - NM NM $ (3 ) $ (1 ) (72 ) (64 )
Restaurant margin % 2.5 % (9.9 )% 12.4 ppts. 12.4 ppts. (15.5 )% (7.8 )% (7.7 ) ppts. (7.7 ) ppts.
G&A expenses $ 11 $ 8 (47 ) (53 ) $ 19 $ 16 (19 ) (23 )
Expenses for transactions
with franchisees and
unconsolidated affiliates $ 9 $ 5 (98 ) NM $ 13 $ 11 (14 ) (18 )
Other operating costs
and expenses $ 21 $ 14 (51 ) (56 ) $ 36 $ 26 (41 ) (46 )
Closures and impairment
expenses, net $ 1 $ 1 (22 ) (26 ) $ 3 $ 2 (53 ) (59 )
Operating Loss $ (2 ) $ (5 ) 35 35 $ (12 ) $ (10 ) (31 ) (33 )
Quarter Ended Year to Date Ended
6/30/2020 6/30/2019 6/30/2020 6/30/2019
Same-Store Sales Decline (27 )% (7 )% (29 )% (12 )%
Total Revenues
The quarter and year to date increase in Total revenues, excluding the impact of
F/X, was primarily driven by the consolidation of Huang Ji Huang and the
increase in demand of online orders of certain product categories (mainly fresh
grocery products) from our e-commerce business, partially offset by the
same-store sales decline due to the impact of the COVID-19 pandemic.
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--------------------------------------------------------------------------------G&A Expenses
The quarter and year to date increase in G&A expenses, excluding the impact of
F/X, was primarily driven by the consolidation of
Operating Loss The decrease in Operating loss for the quarter, excluding the impact of F/X, was primarily driven by the improvement in Restaurant profit and operating profit generated byHuang Ji Huang . The year to date increase in Operating loss, excluding the impact of F/X, was primarily driven by the increase in Restaurant loss and higher store impairment charges, partially offset by the operating profit generated byHuang Ji Huang . Corporate and Unallocated Quarter Ended Year to Date Ended % B/(W) % B/(W) 6/30/2020 6/30/2019 Reported Ex F/X 6/30/2020 6/30/2019 Reported Ex F/X Revenues from transactions with franchisees and unconsolidated affiliates$ 130 $ 133 (3 ) 1$ 269 $ 278 (3 ) - Other revenue 1 1 17 22 2 2 (6 ) (2 ) Expenses for transactions with franchisees and unconsolidated affiliates 135 133 (1 ) (5 ) 270 276 3 (1 ) Other operating costs and expenses 1 1 37 35 2 2 17 14 Corporate G&A expenses 37 25 (47 ) (51 ) 58 58 1 (2 ) Other unallocated (loss) income (2 ) - NM NM (3) 1 NM NM Interest income, net 8 10 (8 ) (5 ) 17 19 (8 ) (4 ) Investment gain 45 17 NM NM 37 27 40 40 Income tax provision (See Note 12) (45 ) (46 ) 1 (1) (77 ) (139 ) 44 43 Effective tax rate (See Note 12) 25.2 % 20.0 % (5.2) % (5.2) % 27.8 % 25.2 % (2.6) % (2.6) %
Revenues from Transactions with Franchisees and Unconsolidated Affiliates
Revenues from transactions with franchisees and unconsolidated affiliates primarily include revenues derived from the Company's central procurement model whereby food and paper products are centrally purchased and then mainly sold toKFC andPizza Hut franchisees and unconsolidated affiliates. The quarter and year to date change excluding the impact of F/X, was in line with the change in system sales of related franchisees and unconsolidated affiliates. G&A Expenses The same government incentives received in the second quarter of 2019 were received in the first quarter of 2020. Excluding the impact from timing shift of government incentives received and the impact of F/X, corporate G&A expenses decreased in the second quarter of 2020 mainly due to the realignment of cost structure.
The year to date increase in Corporate G&A expenses, excluding the impact of F/X, was primarily driven by merit increase, partially offset by one-time reductions in social security contributions and the realignment of cost structure.
43
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Investment Gain
The Investment gain relates to our investment in equity securities of Meituan Dianping ("Meituan"). See Note 6.
Income Tax Provision
Our income tax provision includes tax on our earnings at the Chinese statutory tax rate of 25%, withholding tax on repatriation of earnings outside of China andU.S. corporate income tax, if any. The higher effective tax rates for the quarter and year to date endedJune 30, 2020 were primarily due to theU.S. tax related to gain recognized on investment in equity securities of Meituan during the second quarter and prior periods and, as for the quarter endedJune 30, 2020 , higher other residualU.S. tax. See Note 6 for additional information.
Significant Known Events, Trends or Uncertainties Expected to Impact Future Results
Impact of COVID-19 Pandemic Starting in lateJanuary 2020 , the COVID-19 pandemic has significantly impacted the Company's operations. The pace of recovery is uneven with recent sales and traffic still below pre-outbreak levels as people continue to avoid going out and practice social distancing. More than 99% of stores inChina were open at the end ofJuly 2020 , with sales and profits trending unevenly. Sales were primarily impacted by significantly reduced traffic at transportation and tourist locations, delayed and shortened school holidays and resurging regional infections. These factors and the lingering effect of COVID-19 continued to impact operations in July. Management cannot ascertain the extent to which our operations will continue to be impacted by the COVID-19 pandemic, which depends largely on future developments that are highly uncertain and cannot be accurately predicted, including the possible reemergence and further spread of COVID-19 and the actions by government authorities to contain or treat its impact, the economic recovery within China and globally, the impact on consumer behavior and other related factors. The Company expects that COVID-19 will have a material adverse impact on the Company's results of operations, cash flows and financial condition for the full year 2020. For further information on the risks associated with the COVID-19 pandemic, see "Item 1A. Risk Factors."
Tax Examination on Transfer Pricing
We are subject to reviews, examinations and audits by Chinese tax authorities, theIRS and other taxing authorities with respect to income and non-income based taxes. Since 2016, we have been under a national audit on transfer pricing by the STA inChina regarding our related party transactions for the period from 2006 to 2015. The information currently exchanged with the tax authorities focuses on our franchise arrangement with YUM. We have submitted information to the extent it is available to the Company. It is reasonably possible that there could be significant developments, including expert review and assessment by the STA, within the next 12 months. The ultimate assessment will depend upon further review of the information provided and ongoing technical and other discussions with the STA and in-charge local tax authorities, and therefore it is not possible to reasonably estimate the potential impact. We will continue to defend our transfer pricing position. However, if the STA prevails in the assessment of additional tax due based on its ruling, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations and cash flows. PRC Value-Added Tax ("VAT") EffectiveMay 1, 2016 , a 6% output VAT replaced the 5% business tax ("BT") previously applied to certain restaurant sales. Input VAT would be creditable to the aforementioned 6% output VAT. The latest VAT rates imposed on our purchase of materials and services included 13%, 9% and 6%, which were gradually changed from 17%, 13%, 11% and 6% since 2017. These rate changes impact our input VAT on all materials and certain services, 44 --------------------------------------------------------------------------------
mainly including construction, transportation and leasing. However, the impact on our operating results is not expected to be significant.
Entities that are VAT general taxpayers are permitted to offset qualified input VAT paid to suppliers against their output VAT upon receipt of appropriate supplier VAT invoices on an entity-by-entity basis. When the output VAT exceeds the input VAT, the difference is remitted to tax authorities, usually on a monthly basis; whereas when the input VAT exceeds the output VAT, the difference is treated as an input VAT credit asset which can be carried forward indefinitely to offset future net VAT payables. VAT related to purchases and sales which have not been settled at the balance sheet date is disclosed separately as an asset and liability, respectively, on the Consolidated Balance Sheets. At each balance sheet date, the Company reviews the outstanding balance of any input VAT credit asset for recoverability, giving consideration to the indefinite life of the input VAT credit assets as well as its forecasted operating results and capital spending, which inherently includes significant assumptions that are subject to change. As ofJune 30, 2020 , an input VAT credit asset of$237 million and payable of$6 million were recorded in Other assets and Accounts payable and other current liabilities, respectively, on the Consolidated Balance Sheets. The Company has not made an allowance for the recoverability of the input VAT credit asset, as the balance is expected to be utilized to offset against VAT payables more than one year fromJune 30, 2020 . Any input VAT credit asset would be classified as Prepaid expenses and other current assets if the Company expected to use the credit within one year. We have been benefiting from the retail tax structure reform since it was implemented onMay 1, 2016 . However, the amount of our expected benefit from this VAT regime depends on a number of factors, some of which are outside of our control. The interpretation and application of the new VAT regime are not settled at some local governmental levels. In addition, the timetable for enacting the prevailing VAT regulations into national VAT law, including ultimate enacted VAT rates, is not clear. As a result, for the foreseeable future, the benefit of this significant and complex VAT reform has the potential to fluctuate from quarter to quarter.
Foreign Currency Exchange Rate
The reporting currency of the Company is the US$. Most of the revenues, costs,
assets and liabilities of the Company are denominated in Chinese Renminbi
("RMB"). Any significant change in the exchange rate between US$ and RMB may
materially affect the Company's business, results of operations, cash flows and
financial condition, depending on the weakening or strengthening of RMB against
the US$. See "Item 3. Quantitative and Qualitative Disclosures About Market
Risk" for a further discussion.
Consolidated Cash Flows
Our cash flows for the years to date ended
Net cash provided by operating activities was$452 million in 2020 as compared to$657 million in 2019. The decrease was primarily driven by the net income decrease. Net cash used in investing activities was$761 million in 2020 as compared to$368 million in 2019. The increase is mainly due to cash consideration paid for the acquisition ofHuang Ji Huang , and the net impact on cash flow resulting from purchases and maturities of short-term investments and long-term time deposits, partially offset by cash proceeds from the partial disposal of our investment in equity securities of Meituan. 45 -------------------------------------------------------------------------------- Net cash used in financing activities was$59 million in 2020 as compared to$259 million in 2019. The decrease was primarily driven by a decrease in the number of shares repurchased due to the temporary suspension of our share repurchase program and a decrease in the amount of dividends paid due to the temporary suspension of dividends through the end of the third quarter of 2020.
Liquidity and Capital Resources
Historically we have funded our operations through cash generated from the operation of our Company-owned stores and from our franchise operations and dividend payments from our unconsolidated affiliates.
Our ability to fund our future operations and capital needs will depend on our ongoing ability to generate cash from operations. We believe our principal uses of cash in the future will be primarily to fund our operations and to make capital expenditures, distributions to our stockholders and share repurchases as well as any acquisition or investment we may make. As a result of the COVID-19 pandemic, we have taken, and continue to take, certain actions to provide additional liquidity and flexibility, which include temporarily suspending our share repurchase program and, through the end of the third quarter of 2020, dividends, partial disposal of our investment in Meituan equity securities, as well as increasing our credit facilities. We believe that our future cash from operations, together with our access to funds on hand and capital markets, will provide adequate resources to fund these uses of cash and that our existing cash, net cash from operations and credit facilities will be sufficient to fund our operations and anticipated capital expenditures for the next 12 months.
If our cash flows from operations are less than we require, we may need to access the capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future or at all will be impacted by many factors, including, but not limited to:
• our financial performance; • our credit ratings; • the liquidity of the overall capital markets; and
• the state of the Chinese,
between the Chinese and U.S. governments.
There can be no assurance that we will have access to the capital markets on terms acceptable to us or at all.
Generally our income is subject to the Chinese statutory tax rate of 25%. However, to the extent our cash flows from operations exceed our China cash requirements, the excess cash may be subject to an additional 10% withholding tax levied by the Chinese tax authority, subject to any reduction or exemption set forth in relevant tax treaties or tax arrangements.
Share Repurchases and Dividends
Our Board of Directors has authorized an aggregate of$1.4 billion for our share repurchase program.Yum China may repurchase shares under this program from time to time in open market or privately negotiated transactions, including block trades, accelerated share repurchase transactions and the use of Rule 10b5-1 trading plans. During the years to date endedJune 30, 2020 and 2019, the Company repurchased$7 million or 0.2 million shares and$140 million or 3.5 million shares of common stock, respectively, under the repurchase program.
For the quarter ended
46
--------------------------------------------------------------------------------Due to the unprecedented effects of the COVID-19 pandemic and associated economic uncertainty, the Company temporarily suspended its share repurchases and, through the end of the third quarter of 2020, dividend payments.
Our ability to declare and pay any dividends on our stock may be restricted by earnings available for distribution under applicable Chinese laws. The laws, rules and regulations applicable to our Chinese subsidiaries permit payments of dividends only out of their accumulated profits, if any, determined in accordance with applicable Chinese accounting standards and regulations. Under Chinese law, an enterprise incorporated inChina is required to set aside at least 10% of its after-tax profits each year, after making up previous years' accumulated losses, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of its registered capital. As a result, our Chinese subsidiaries are restricted in their ability to transfer a portion of their net assets to us in the form of dividends. At the discretion of the Board of Directors, as an enterprise incorporated inChina , each of our Chinese subsidiaries may allocate a portion of its after-tax profits based on Chinese accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. Borrowing Capacity As ofJune 30, 2020 , the Company had credit facilities ofRMB3,713 million (approximately$526 million ), comprised of onshore credit facilities ofRMB2,300 million (approximately$326 million ) in aggregate and offshore credit facilities of$200 million in aggregate. The credit facilities had remaining terms ranging from less than one year to three years as ofJune 30, 2020 . Each credit facility bears interest based on the prevailing rate stipulated by thePeople's Bank of China , Loan Prime Rate ("LPR") published by the National Interbank Funding Centre of the PRC orLondon Interbank Offered Rate ("LIBOR") administered by theICE Benchmark Administration . Each credit facility contains a cross-default provision whereby our failure to make any payment on a principal amount from any credit facility will constitute a default on other credit facilities. Some of the credit facilities contain covenants limiting, among other things, certain additional indebtedness and liens, and certain other transactions specified in the respective agreement. Some of the onshore credit facilities contain sublimits for overdrafts, non-financial bonding, standby letters of credit and guarantees. As ofJune 30, 2020 , we had outstanding bank guarantees ofRMB 89 million (approximately$13 million ) to secure our lease payment to landlords for certain Company-owned restaurants. The credit facilities were therefore reduced by the same amount, while there were no borrowings outstanding as ofJune 30, 2020 .
Off-Balance Sheet Arrangements
See the Guarantees section of Note 14 for discussion of our off-balance sheet arrangements.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
See Note 2 for details of recently adopted accounting pronouncements.
New Accounting Pronouncements Not Yet Adopted
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In December 2019 , the FASB issued ASU 2019-12, Income Tax (Topic 740),
Simplifying the Accounting for Income Taxes ("ASU 2019-12"), which simplifies
the accounting for income taxes by eliminating certain exceptions to the
guidance in Topic 740 related to the approach for intraperiod tax allocation,
the methodology for calculating income taxes in an interim period and the
recognition of deferred tax liabilities for outside basis differences. The
guidance also simplifies the accounting for franchise taxes and enacted changes
in tax laws or rates and clarifies the accounting for transactions that result
in a step-up in the tax basis of goodwill. ASU 2019-12 is effective for the
Company from January 1, 2021 , with early adoption permitted. We are currently
evaluating the impact the adoption of this standard will have on our financial
statements.
In January 2020 , the FASB issued ASU 2020-01, Investments-Equity Securities
(Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and
Derivatives and Hedging (Topic 815) ("ASU 2020-01"), which clarifies the
interaction for equity securities under Topic 321 and investments accounted for
under the equity method of accounting in Topic 323 and the accounting for
certain forward contracts and purchased options accounted for under Topic 815.
ASU 2020-01 is effective for the Company from January 1, 2021 , with early
adoption permitted. We are currently evaluating the impact the adoption of this
standard will 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," "predict," "likely," "should," "forecast," "outlook," "model," "continue," "ongoing" or other similar terminology. Forward-looking statements are based on our expectations, estimates, assumptions or projections concerning future results or events as of the date of the filing of this Form 10-Q. Forward -looking statements are neither predictions nor guarantees of future events, circumstances or performance and are inherently subject to known and unknown risks, uncertainties and assumptions that could cause our actual results and events to differ materially from those indicated by those statements. We cannot assure you that any of our assumptions are correct or any of our expectations, estimates or projections will be achieved. Numerous factors could cause our actual results to differ materially from those expressed or implied by forward-looking statements, including, without limitation, the following:
• Risks related to our business and industry, such as (a) food safety and
food-borne illness concerns, (b) significant failure to maintain effective
quality control systems for our restaurants, (c) significant liability
claims, food contamination complaints from our customers or reports of
incidents of food tampering, (d) health concerns arising from outbreaks of
viruses or other illnesses, including the COVID-19 pandemic, (e) the fact
that we derive substantially all of our revenue from our operations in
China, (f) the fact that the operation of our restaurants is subject to
the terms of the master license agreement with YUM, (g) the fact that our
success is tied to the success of YUM's brand strength, marketing
campaigns and product innovation, (h) shortages or interruptions in the
availability and delivery of food products and other supplies, (i)
fluctuation of raw materials prices, (j) our inability to attain ourtarget development goals and the potential cannibalization of existing
sales by aggressive development, (k) risks associated with leasing real
estate, (l) inability to obtain desirable restaurant locations on
commercially reasonable terms, (m) labor shortages or increases in labor
costs, (n) the fact that our success depends substantially on our
corporate reputation and on the value and perception of our brands, (o)
the occurrence of security breaches and cyber-attacks, (p) failure toprotect the integrity and security of our customer or employee personal,
financial or other data or our proprietary or confidential information
that is stored in our information systems or by third parties on our
behalf, (q) failures or interruptions of service or security breaches in
our information technology systems, (r) the fact that our business depends
on the performance of, and our long-term relationships with, third-party
mobile payment processors, internet infrastructure operators, internet
service providers and delivery aggregators, (s) failure to provide timely
and reliable delivery services by our restaurants, (t) our growth strategy
with respect to COFFii & JOY may not be successful, (u) challenges and
risks related to our e-commerce business, (v) the anticipated benefits of
the acquisition of Daojia may not be realized in a timely manner or at
all, (w) the Chinese government may determine that the VIE structure of
Daojia does not comply with Chinese laws on foreign investment in
restricted industries, (x)
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our inability or failure to recognize, respond to and effectively manage
the impact of social media, (y) litigation and failure to comply with
anti-bribery or anti-corruption laws, (z)
changes in tax rates, disagreements with tax authorities (including with
respect to the transfer pricing audit) and imposition of new taxes, (aa)
changes in consumer discretionary spending and general economic
conditions, (bb) competition in the retail food industry, (cc) loss or
failure to obtain or renew any or all of the approvals, licenses andpermits to operate our business, (dd) our inability to adequately protect
the intellectual property we own or have the right to use, (ee) YUM's
failure to protect its intellectual property, (ff) seasonality and certain
major events in
instances of fraud or other misconduct committed by our employees,
customers or other third parties, (hh) changes in accounting standards and
subjective assumptions, estimates and judgments by management related to
complex accounting matters, (ii) failure of our insurance policies to
provide adequate coverage for claims associated with our business
operations, (jj) unforeseeable business interruptions, (kk) failure by usto maintain effective disclosure controls and procedures and internal
control over financial reporting in accordance with the rules of the
(ll) 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, (mm) our investment in technology and
innovation may not generate the expected level of returns, and (nn) our
strategic investments or acquisitions may be unsuccessful;
• Risks related to doing business in
political policies and economic and social policies or conditions, (b)
uncertainties with respect to the interpretation and enforcement of
Chinese laws, rules and regulations, (c) changes in trade relations
between
higher taxes on goods imported from
the value of the Chinese Renminbi, (e) limitations on our ability to
utilize our cash balances effectively due to governmental control ofcurrency conversion and payments of foreign currency, (f) changes in laws
and regulations, (g) reliance on distributions by our operating
subsidiaries in
unfavorable tax consequences resulting from our classification as a China
resident enterprise for Chinese enterprise income tax purposes, (i)
uncertainty regarding indirect transfers of equity interests and enhanced
scrutiny by Chinese tax authorities, (j) difficulties in effecting service
of legal process, enforcing foreign judgments or bringing original actions
in
by non-registration of lease agreements related to certain properties, (l)
risk in relation to unexpected land acquisitions, building closures or
demolitions, (m) potential fines for failure to comply with law, (n)
restrictions on our ability to make loans or additional capital
contributions to our Chinese subsidiaries due to Chinese regulation ofloans to, and direct investment in, Chinese entities by offshore holding
companies and governmental control of currency conversion and (o)
difficulties in pursuing growth through acquisitions due to regulations
regarding acquisitions;
• Risks related to the separation and related transactions, such as (a)incurring significant tax liabilities if the distribution does not qualify
as a transaction that is generally tax-free for
purposes and the Company could be required to indemnify YUM for material
taxes and other related amounts pursuant to indemnification obligations
under the tax matters agreement, (b) being obligated to indemnify YUM for
material taxes and related amounts pursuant to indemnification obligations
under the tax matters agreement if YUM is subject to Chinese indirect
transfer tax with respect to the distribution, (c) potential
indemnification liabilities owing to YUM pursuant to the separation and
distribution agreement and there being no assurance that the indemnity
provided by YUM with respect to certain liabilities in connection with the
separation will be sufficient to insure us against the full amount of such
liabilities, (d) the possibility that a court would require that we assume
responsibility for obligations allocated to YUM under the separation and
distribution agreement and (e) potential liabilities due to fraudulent
transfer considerations.
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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 theSecurities and Exchange Commission (including the information set forth under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 and this Form 10-Q) for additional information regarding factors that could affect our financial and other results. You should not place undue reliance on forward-looking statements, which speak only as of the date of the filing of this Form 10-Q. We are not undertaking to update any of these statements, except as required by law.
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