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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2022

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to _________________

 

Commission file number 001-37762

 

 

Yum China Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

81-2421743

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

7100 Corporate Drive

Plano, Texas 75024

United States of America

 

Yum China Building

20 Tian Yao Qiao Road

Shanghai 200030

People’s Republic of China

 

(Address, Including Zip Code, of Principal Executive Offices)

(469) 980-2898

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.01 per share

YUMC

New York Stock Exchange

9987

The Stock Exchange of Hong Kong Limited

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

 

Smaller reporting company

 

 

 

 

 

 

 

 

 

 

 

 

Emerging growth company

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ☒

The number of shares outstanding of the registrant’s common stock as of May 2, 2022 was 421,430,362 shares.

 

 


 

Yum China Holdings, Inc.

INDEX

 

 

 

Page

 

 

No.

 

 

 

Part I.

Financial Information

 

 

 

 

 

Item 1 – Financial Statements

3

 

 

 

 

Condensed Consolidated Statements of Income – Quarters Ended March 31, 2022 and 2021 (Unaudited)

3

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income – Quarters Ended March 31, 2022 and 2021 (Unaudited)

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Quarters Ended March 31, 2022 and 2021 (Unaudited)

5

 

 

 

 

Condensed Consolidated Balance Sheets – March 31, 2022 (Unaudited) and December 31, 2021

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

7

 

 

 

 

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

 

 

 

 

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

40

 

 

 

 

Item 4 – Controls and Procedures

40

 

 

 

Part II.

Other Information

 

 

 

 

 

Item 1 – Legal Proceedings

41

 

 

 

 

Item 1A – Risk Factors

41

 

 

 

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

 

Item 6 – Exhibits

44

 

 

 

 

Signatures

45

 

 

 


 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Condensed Consolidated Statements of Income (Unaudited)

Yum China Holdings, Inc.

(in US$ millions, except per share data)

 

 

 

Quarter Ended

 

 

Revenues

 

3/31/2022

 

 

3/31/2021

 

 

Company sales

 

$

2,548

 

 

$

2,331

 

 

Franchise fees and income

 

 

24

 

 

 

42

 

 

Revenues from transactions with
   franchisees and unconsolidated affiliates

 

 

77

 

 

 

171

 

 

Other revenues

 

 

19

 

 

 

13

 

 

Total revenues

 

 

2,668

 

 

 

2,557

 

 

Costs and Expenses, Net

 

 

 

 

 

 

 

Company restaurants

 

 

 

 

 

 

 

Food and paper

 

 

792

 

 

 

704

 

 

Payroll and employee benefits

 

 

667

 

 

 

544

 

 

Occupancy and other operating expenses

 

 

738

 

 

 

648

 

 

Company restaurant expenses

 

 

2,197

 

 

 

1,896

 

 

General and administrative expenses

 

 

151

 

 

 

130

 

 

Franchise expenses

 

 

10

 

 

 

17

 

 

Expenses for transactions with
   franchisees and unconsolidated affiliates

 

 

75

 

 

 

169

 

 

Other operating costs and expenses

 

 

17

 

 

 

11

 

 

Closures and impairment expenses (income), net

 

 

2

 

 

 

(2

)

 

Other expenses (income), net

 

 

25

 

 

 

(6

)

 

Total costs and expenses, net

 

 

2,477

 

 

 

2,215

 

 

Operating Profit

 

 

191

 

 

 

342

 

 

Interest income, net

 

 

12

 

 

 

15

 

 

Investment loss

 

 

(37

)

 

 

(12

)

 

Income Before Income Taxes and Equity in
   Net Earnings (Losses) from Equity Method Investments

 

 

166

 

 

 

345

 

 

Income tax provision

 

 

(55

)

 

 

(102

)

 

Equity in net earnings (losses) from
   equity method investments

 

 

(1

)

 

 

 

 

Net income – including noncontrolling interests

 

 

110

 

 

 

243

 

 

Net income – noncontrolling interests

 

 

10

 

 

 

13

 

 

Net Income – Yum China Holdings, Inc.

 

$

100

 

 

$

230

 

 

Weighted-average common shares outstanding (in millions):

 

 

 

 

 

 

 

Basic

 

 

426

 

 

 

420

 

 

Diluted

 

 

430

 

 

 

434

 

 

Basic Earnings Per Common Share

 

$

0.23

 

 

$

0.55

 

 

Diluted Earnings Per Common Share

 

$

0.23

 

 

$

0.53

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3


 

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

Yum China Holdings, Inc.

(in US$ millions)

 

 

 

Quarter Ended

 

 

 

 

3/31/2022

 

 

3/31/2021

 

 

Net income – including noncontrolling interests

 

$

110

 

 

$

243

 

 

Other comprehensive income (loss), net of tax of nil:

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

13

 

 

 

(18

)

 

Comprehensive income – including noncontrolling interests

 

 

123

 

 

 

225

 

 

Comprehensive income – noncontrolling interests

 

 

12

 

 

 

12

 

 

Comprehensive Income – Yum China Holdings, Inc.

 

$

111

 

 

$

213

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4


 

Condensed Consolidated Statements of Cash Flows (Unaudited)

Yum China Holdings, Inc.

(in US$ millions)

 

 

 

Quarter Ended

 

 

 

 

3/31/2022

 

 

3/31/2021

 

 

Cash Flows – Operating Activities

 

 

 

 

 

 

 

Net income – including noncontrolling interests

 

$

110

 

 

$

243

 

 

Depreciation and amortization

 

 

164

 

 

 

128

 

 

Non-cash operating lease cost

 

 

120

 

 

 

101

 

 

Closures and impairment expenses (income)

 

 

2

 

 

 

(2

)

 

Investment loss

 

 

37

 

 

 

12

 

 

Equity income from investments in unconsolidated affiliates

 

 

 

 

 

(17

)

 

Distributions of income received from unconsolidated affiliates

 

 

 

 

 

11

 

 

Deferred income taxes

 

 

1

 

 

 

15

 

 

Share-based compensation expense

 

 

11

 

 

 

10

 

 

Changes in accounts receivable

 

 

(2

)

 

 

(3

)

 

Changes in inventories

 

 

88

 

 

 

52

 

 

Changes in prepaid expenses and other current assets

 

 

38

 

 

 

20

 

 

Changes in accounts payable and other current liabilities

 

 

(322

)

 

 

(175

)

 

Changes in income taxes payable

 

 

26

 

 

 

51

 

 

Changes in non-current operating lease liabilities

 

 

(106

)

 

 

(104

)

 

Other, net

 

 

4

 

 

 

(11

)

 

Net Cash Provided by Operating Activities

 

 

171

 

 

 

331

 

 

Cash Flows – Investing Activities

 

 

 

 

 

 

 

Capital spending

 

 

(205

)

 

 

(165

)

 

Purchases of short-term investments

 

 

(1,041

)

 

 

(1,180

)

 

Maturities of short-term investments

 

 

1,281

 

 

 

1,258

 

 

Acquisition of business, net of cash acquired

 

 

(23

)

 

 

 

 

Acquisition of equity investment

 

 

 

 

 

(261

)

 

Other, net

 

 

1

 

 

 

1

 

 

Net Cash Provided by (Used in) Investing Activities

 

 

13

 

 

 

(347

)

 

Cash Flows – Financing Activities

 

 

 

 

 

 

 

Repurchase of shares of common stock

 

 

(224

)

 

 

 

 

Cash dividends paid on common stock

 

 

(51

)

 

 

(50

)

 

Dividends paid to noncontrolling interests

 

 

(17

)

 

 

(1

)

 

Contribution from noncontrolling interests

 

 

18

 

 

 

 

 

Other, net

 

 

 

 

 

(4

)

 

Net Cash Used in Financing Activities

 

 

(274

)

 

 

(55

)

 

Effect of Exchange Rates on Cash, Cash Equivalents and Restricted Cash

 

 

1

 

 

 

(3

)

 

Net Decrease in Cash, Cash Equivalents and Restricted Cash

 

 

(89

)

 

 

(74

)

 

Cash, Cash Equivalents and Restricted Cash – Beginning of Period

 

 

1,136

 

 

 

1,158

 

 

Cash, Cash Equivalents and Restricted Cash – End of Period

 

$

1,047

 

 

$

1,084

 

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Data

 

 

 

 

 

 

 

Cash paid for income tax

 

 

23

 

 

 

40

 

 

Non-cash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures included in accounts payable and other current liabilities

 

 

182

 

 

 

151

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

5


 

Condensed Consolidated Balance Sheets

Yum China Holdings, Inc.

(in US$ millions)

 

 

 

3/31/2022

 

 

12/31/2021

 

 

 

 

(Unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,047

 

 

$

1,136

 

 

Short-term investments

 

 

2,622

 

 

 

2,860

 

 

Accounts receivable, net

 

 

70

 

 

 

67

 

 

Inventories, net

 

 

345

 

 

 

432

 

 

Prepaid expenses and other current assets

 

 

182

 

 

 

221

 

 

Total Current Assets

 

 

4,266

 

 

 

4,716

 

 

Property, plant and equipment, net

 

 

2,231

 

 

 

2,251

 

 

Operating lease right-of-use assets

 

 

2,546

 

 

 

2,612

 

 

Goodwill

 

 

2,163

 

 

 

2,142

 

 

Intangible assets, net

 

 

251

 

 

 

272

 

 

Investments in unconsolidated affiliates

 

 

305

 

 

 

292

 

 

Deferred income tax assets

 

 

96

 

 

 

106

 

 

Other assets

 

 

781

 

 

 

832

 

 

Total Assets

 

$

12,639

 

 

$

13,223

 

 

 

 

 

 

 

 

 

 

LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND EQUITY

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Accounts payable and other current liabilities

 

$

2,008

 

 

$

2,332

 

 

Income taxes payable

 

 

77

 

 

 

51

 

 

Total Current Liabilities

 

 

2,085

 

 

 

2,383

 

 

Non-current operating lease liabilities

 

 

2,214

 

 

 

2,286

 

 

Non-current finance lease liabilities

 

 

41

 

 

 

40

 

 

Deferred income tax liabilities

 

 

418

 

 

 

425

 

 

Other liabilities

 

 

173

 

 

 

167

 

 

Total Liabilities

 

 

4,931

 

 

 

5,301

 

 

 

 

 

 

 

 

 

 

Redeemable Noncontrolling Interest

 

 

14

 

 

 

14

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

Common stock, $0.01 par value; 1,000 million shares authorized; 449 million shares
  and
449 million shares issued at March 31, 2022 and December 31, 2021, respectively;
  
423 million shares and 428 million shares outstanding at March 31, 2022 and
  December 31, 2021, respectively

 

 

4

 

 

 

4

 

 

Treasury stock

 

 

(1,035

)

 

 

(803

)

 

Additional paid-in capital

 

 

4,704

 

 

 

4,695

 

 

Retained earnings

 

 

2,941

 

 

 

2,892

 

 

Accumulated other comprehensive income

 

 

279

 

 

 

268

 

 

Total Yum China Holdings, Inc. Stockholders' Equity

 

 

6,893

 

 

 

7,056

 

 

Noncontrolling interests

 

 

801

 

 

 

852

 

 

Total Equity

 

 

7,694

 

 

 

7,908

 

 

Total Liabilities, Redeemable Noncontrolling Interest and Equity

 

$

12,639

 

 

$

13,223

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

6


 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Tabular amounts in US$ millions, except as otherwise noted)

 

Note 1 – Description of Business

 

Yum China Holdings, Inc. (“Yum China” and, together with its subsidiaries, the “Company,” “we,” “us” and “our”) was incorporated in Delaware on April 1, 2016.

 

The Company owns, franchises or has ownership in entities that own and operate restaurants (also referred to as “stores” or “units”) under the KFC, Pizza Hut, Little Sheep, Huang Ji Huang, Lavazza, COFFii & JOY and Taco Bell concepts (collectively, the “concepts”). In connection with the separation of the Company in 2016 from its former parent company, YUM! Brands, Inc. (“YUM”), a master license agreement was entered into between Yum Restaurants Consulting (Shanghai) Company Limited (“YCCL”), a wholly-owned indirect subsidiary of the Company, and YUM, through YRI China Franchising LLC, a subsidiary of YUM, effective from January 1, 2020 and previously through Yum! Restaurants Asia Pte. Ltd., another subsidiary of YUM, from October 31, 2016 to December 31, 2019. Pursuant to the master license agreement, we are the exclusive licensee of KFC, Pizza Hut and, subject to achieving certain agreed-upon milestones as amended in April 2022, Taco Bell brands and their related marks and other intellectual property rights for restaurant services in the People’s Republic of China (the “PRC” or “China”), excluding Hong Kong, Macau and Taiwan. The term of the license is 50 years from October 31, 2016 for the KFC and Pizza Hut brands and, subject to achieving certain agreed-upon milestones, 50 years from April 15, 2022 for the Taco Bell brand, with automatic renewals for additional consecutive renewal terms of 50 years each, subject only to YCCL being in “good standing” and unless YCCL gives notice of its intent not to renew. In exchange, we pay a license fee to YUM equal to 3% of net system sales from both our Company and franchise restaurants. We own the intellectual property of Little Sheep, Huang Ji Huang and COFFii & JOY, and pay no license fee related to these concepts.

 

In the second quarter of 2020, the Company partnered with Luigi Lavazza S.p.A. (“Lavazza Group”), the world renowned family-owned Italian coffee company, and entered into a joint venture to explore and develop the Lavazza coffee shop concept in China. In September 2021, the Company and Lavazza Group entered into agreements for the previously formed joint venture (“Lavazza joint venture”) to accelerate the expansion of Lavazza coffee shops in China. Upon execution of these agreements, the Company controls and consolidates the joint venture with its 65% equity interest. The acquisition was considered immaterial.

 

During the fourth quarter of 2021, the Company completed its investment of a 28% equity interest in Hangzhou Catering Service Group (“Hangzhou Catering”), for cash consideration of $255 million. Upon closing, the Company directly and indirectly holds an approximately 60% equity interest in the Hangzhou KFC joint venture that operates KFC stores in and around Hangzhou, China (“Hangzhou KFC”), allowing the Company to consolidate Hangzhou KFC. The acquisition was considered immaterial.

 

As part of our strategy to drive growth from off-premise occasions, we have also developed our own retail brand operations, SoulFun, since 2018, which sells ready meals such as steak, fried rice and pasta through online and offline channels. The operating results of SoulFun are included in our e-commerce business operating segment.

 

The Company has two reportable segments: KFC and Pizza Hut. Our remaining operating segments, including the operations of Little Sheep, Huang Ji Huang, Lavazza, COFFii & JOY, Taco Bell, East Dawning, Daojia and our e-commerce business, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate. East Dawning was severely impacted by the COVID-19 pandemic. As a result, the Company decided to wind down the operations of the brand in 2021. In the first quarter of 2022, the Company closed all five remaining East Dawning units in China. Additional details on our reportable operating segments are included in Note 14.

 

The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “YUMC”. On September 10, 2020, the Company completed a secondary listing of its common stock on the Main Board of the Hong Kong Stock Exchange (“HKEX”) under the stock code “9987”, in connection with a global offering of 41,910,700 shares of its common stock. Net proceeds raised by the Company from the global offering after deducting underwriting fees and the offering expenses amounted to $2.2 billion.

7


 

 

 

Note 2 – Basis of Presentation

 

Our preparation of the accompanying Condensed Consolidated Financial Statements in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

We have prepared the Condensed Consolidated Financial Statements in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The Condensed Consolidated Financial Statements include all normal and recurring adjustments considered necessary to present fairly our financial position as of March 31, 2022, and our results of operations, comprehensive income and cash flows for the quarters ended March 31, 2022 and 2021. Our results of operations, comprehensive income and cash flows for these interim periods are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the SEC on February 28, 2022.

 

Through the acquisition of Daojia, the Company also acquired a variable interest entity (“VIE”) and subsidiaries of the VIE effectively controlled by Daojia. There exists a parent-subsidiary relationship between Daojia and its VIE as a result of certain exclusive agreements that require Daojia to consolidate its VIE and subsidiaries of the VIE because Daojia is the primary beneficiary that possesses the power to direct the activities of the VIE that most significantly impact its economic performance, and is entitled to substantially all of the profits and has the obligation to absorb all of the expected losses of the VIE. The acquired VIE and its subsidiaries were considered immaterial, both individually and in the aggregate. The results of Daojia’s operations have been included in the Company’s Condensed Consolidated Financial Statements since the acquisition date.

 

The results of the Lavazza joint venture and Hangzhou KFC’s operations have been included in the Company’s Condensed Consolidated Financial Statements since the acquisition dates.

 

Recently Adopted Accounting Pronouncements

 

In August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-06, Debt — Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40) (“ASU 2020-06”), which eliminates two of the three models in ASC 470-20 that require separate accounting for embedded conversion features and eliminates some of the conditions for equity classification in ASC 815-40 for contracts in an entity’s own equity. The guidance also requires entities to use the if-converted method for all convertible instruments in the diluted earnings per share calculation and generally requires them to include the effect of share settlement for instruments that may be settled in cash or shares. We adopted this standard on January 1, 2022, and such adoption did not have a material impact on our financial statements.

 

In May 2021, the FASB issued ASU 2021-04, Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (“ASU 2021-04”). It requires issuers to account for a modification or exchange of freestanding equity-classified written call options that remain equity-classified after the modification or exchange based on the economic substance of the modification or exchange. We adopted this standard on January 1, 2022, and such adoption did not have a material impact on our financial statements.

 

In July 2021, the FASB issued ASU 2021-05, Lessors — Certain Leases with Variable Lease (“ASU 2021-05”). It requires lessors to classify leases as operating leases if they have variable lease payments that do not depend on an index or rate and would have selling losses if they were classified as sales-type or direct financing leases. We adopted this standard on January 1, 2022, and such adoption did not have a material impact on our financial statements.

 

8


 

 

 

Note 3 – Business Acquisitions and Equity Investments

 

Consolidation of Hangzhou KFC and Equity Investment in Hangzhou Catering

 

During the fourth quarter of 2021, the Company completed its investment of a 28% equity interest in Hangzhou Catering for cash consideration of $255 million. Hangzhou Catering holds a 45% equity interest in Hangzhou KFC, of which the Company previously held a 47% equity interest. Along with the investment, the Company also obtained two additional seats on the board of directors of Hangzhou KFC. Upon completion of the transaction, the Company directly and indirectly holds an approximately 60% equity interest in Hangzhou KFC and has majority representation on its board of directors, and thus obtained control over Hangzhou KFC and started to consolidate its results from the acquisition date.

 

As a result of the acquisition of Hangzhou KFC, $66 million of the purchase price was allocated to the reacquired franchise right, which is amortized over the remaining franchise contract period of 1 year.

 

In addition to its equity interest in Hangzhou KFC, Hangzhou Catering operates approximately 60 Chinese dining restaurants under four time-honored brands and a food processing business. The Company applies the equity method of accounting to the 28% equity interest in Hangzhou Catering excluding the Hangzhou KFC business and classified this investment in Investment in unconsolidated affiliates based on its then fair value. The Company elected to report its share of Hangzhou Catering’s financial results with a one-quarter lag because its results are not available in time for the Company to record them in the concurrent period. In the first quarter of 2022, the Company's equity losses from Hangzhou Catering, net of taxes, was immaterial, which was included in Equity in net earnings (losses) from equity method investments in our Condensed Consolidated Statement of Income. As of March 31, 2022, the carrying amount of the Company’s equity method investment in Hangzhou Catering was $52 million, exceeding the Company’s interest in Hangzhou Catering’s underlying net assets by $30 million. Substantially all of this difference was attributable to its self-owned properties and impact of related deferred tax liabilities determined upon acquisition, which is being depreciated over a weighted average remaining useful life of 20 years.

 

Fujian Sunner Development Co., Ltd. (“Sunner”) Investment

 

In the first quarter of 2021, the Company acquired a 5% equity interest in Sunner, a Shenzhen Stock Exchange-listed company, for total consideration of approximately $261 million. Sunner is China’s largest white-feathered chicken producer and the Company’s largest poultry supplier.

 

The Company accounted for the equity securities at fair value based on their closing market price on each measurement date, with unrealized loss of $17 million recorded in Investment loss in our Condensed Consolidated Statements of Income for the quarter ended March 31, 2021, representing subsequent fair value changes during the quarter.

 

In May 2021, a senior executive of the Company was nominated and appointed to Sunner’s board of directors upon Sunner’s shareholder approval. Through this representation, the Company participates in Sunner’s policy making process. The representation on Sunner's board, along with the Company being Sunner’s second largest shareholder, provides the Company with the ability to exercise significant influence over the operating and financial policies of Sunner. As a result, the Company started to apply the equity method of accounting to the investment and reclassified this investment from Other assets to Investment in unconsolidated affiliates in May 2021 based on its then fair value. The Company elected to report its share of Sunner’s financial results with a one-quarter lag because Sunner’s results are not available in time for the Company to record them in the concurrent period. In the first quarter of 2022, the Company's equity income from Sunner, net of taxes, was immaterial, which was included in Equity in net earnings (losses) from equity method investments in our Condensed Consolidated Statement of Income.

 

The Company purchased inventories of $92 million from Sunner for the quarter ended March 31, 2022, and the Company’s accounts payable and other current liabilities due to Sunner were $33 and $56 million as of March 31, 2022 and December 31, 2021, respectively.

 

As of March 31, 2022, the carrying amount of the Company’s investment in Sunner was $250 million, exceeding the Company’s interest in Sunner’s underlying net assets by $172 million. Of this basis difference, $20 million was related to finite-lived intangible assets determined upon acquisition, which are being amortized over estimated useful life of 20 years. The remaining differences were related to goodwill and indefinite-lived intangible assets, which are not subject to amortization, as well as deferred tax liabilities impact. As of March 31, 2022, the market value of the Company’s investment in Sunner was $195 million based on its quoted closing price.

 

 

9


 

 

Meituan Dianping (“Meituan”) Investment

 

In the third quarter of 2018, the Company subscribed for 8.4 million, or less than 1%, of the ordinary shares of Meituan, an e-commerce platform for services in China, for total consideration of approximately $74 million, when it launched its initial public offering on the HKEX in September 2018. In the second quarter of 2020, the Company sold 4.2 million of the ordinary shares of Meituan.

 

The Company accounts for the equity securities at fair value with subsequent fair value changes recorded in our Condensed Consolidated Statements of Income. The fair value of the investment in Meituan is determined based on the closing market price for the shares at the end of each reporting period. The fair value change, to the extent the closing market price of shares of Meituan as of the end of reporting period is higher than our cost, is subject to U.S. tax.

 

A summary of pre-tax gains or losses on investment in equity securities of Meituan recognized, which was included in Investment loss in our Condensed Consolidated Statements of Income, is as follows:

 

 

 

Quarter Ended

 

 

 

 

3/31/2022

 

 

3/31/2021

 

 

Unrealized (losses) gains recorded on equity securities still held
   as of the end of the period

 

$

(38

)

 

$

1

 

 

(Losses) gains recorded on equity securities

 

$

(38

)

 

$

1

 

 

 

 

Note 4 – Revenue Recognition

 

The Company’s revenues primarily include Company sales, Franchise fees and income and Revenues from transactions with franchisees and unconsolidated affiliates.

 

Company Sales

 

Revenues from Company-owned restaurants are recognized when a customer takes possession of the food and tenders payment, which is when our obligation to perform is satisfied. The Company presents sales net of sales-related taxes. We also offer our customers delivery through both our own mobile applications and third-party aggregators’ platforms. For delivery orders placed through our mobile applications, we use our dedicated riders, while for orders placed through third-party aggregators’ platforms, we either used our dedicated riders or third-party aggregators’ delivery staff in the past. With respect to delivery orders delivered by our dedicated riders, we control and determine the price for the delivery service and generally recognize revenue, including delivery fees, when a customer takes possession of the food. When orders are fulfilled by the delivery staff of third-party aggregators, who control and determine the price for the delivery service, we recognize revenue, excluding delivery fees, when control of the food is transferred to the third-party aggregators’ delivery staff. The payment terms with respect to these sales are short-term in nature. Starting in 2019, we use our own dedicated riders to deliver orders placed through aggregators’ platforms to customers of KFC and Pizza Hut stores.

 

We recognize revenues from prepaid stored-value products, including gift cards and product vouchers, when they are redeemed by the customer. Prepaid gift cards sold at any given point generally expire over the next 36 months, and product vouchers generally expire over a period of up to 12 months. We recognize breakage revenue, which is the amount of prepaid stored-value products that is not expected to be redeemed, either (1) proportionally in earnings as redemptions occur, in situations where the Company expects to be entitled to a breakage amount, or (2) when the likelihood of redemption is remote, in situations where the Company does not expect to be entitled to breakage, provided that there is no requirement for remitting balances to government agencies under unclaimed property laws. The Company reviews its breakage estimates at least annually based upon the latest available information regarding redemption and expiration patterns.

 

Our privilege membership programs offer privilege members rights to multiple benefits, such as free delivery and discounts on certain products. For certain KFC and Pizza Hut privilege membership programs offering a pre-defined amount of benefits that can be redeemed ratably over the membership period, revenue is ratably recognized over the period based on the elapse of time. With respect to the KFC and Pizza Hut family privilege membership program offering members a mix of distinct benefits, including a welcome gift and assorted discount coupons with pre-defined quantities, consideration collected is allocated to the benefits provided based on their relative standalone selling price and revenue is recognized when food or services are delivered or the benefits expire. In determining the relative standalone selling price of the benefits, the Company considers likelihood of future redemption based on historical redemption pattern and reviews such estimates periodically based upon the latest available information regarding redemption and expiration patterns.

 

10


 

Franchise Fees and Income

 

Franchise fees and income primarily include upfront franchise fees, such as initial fees and renewal fees, and continuing fees. We have determined that the services we provide in exchange for upfront franchise fees and continuing fees are highly interrelated with the franchise right. We recognize upfront franchise fees received from a franchisee as revenue over the term of the franchise agreement or the renewal agreement because the franchise rights are accounted for as rights to access our symbolic intellectual property. The franchise agreement term is generally 10 years for KFC and Pizza Hut, five or 10 years for Little Sheep and three or 10 years for Huang Ji Huang. We recognize continuing fees, which are based upon a percentage of franchisee sales, as those sales occur.

 

Revenues from Transactions with Franchisees and Unconsolidated Affiliates

 

Revenues from transactions with franchisees and unconsolidated affiliates consist primarily of sales of food and paper products, advertising services and other services provided to franchisees and unconsolidated affiliates that operate our concepts.

 

The Company centrally purchases substantially all food and paper products from suppliers for substantially all of our restaurants, including franchisees and unconsolidated affiliates that operate our concepts, and then sells and delivers them to the restaurants. In addition, the Company owns seasoning facilities for its Chinese dining business unit, which manufacture and sell seasoning products to Huang Ji Huang and Little Sheep franchisees. The performance obligation arising from such transactions is considered distinct from the franchise agreement as it is not highly dependent on the franchise agreement and the customer can benefit from the procurement service on its own. We consider ourselves the principal in this arrangement as we have the ability to control a promised good or service before transferring that good or service to the franchisees and unconsolidated affiliates that operate our concepts. Revenue is recognized upon transfer of control over ordered items, generally upon delivery to the franchisees and unconsolidated affiliates.

 

For advertising services, the Company often engages third parties to provide services and acts as a principal in the transaction based on our responsibilities of defining the nature of the services and administering and directing all marketing and advertising programs in accordance with the provisions of our franchise agreements. The Company collects advertising contributions, which are generally based on certain percentage of sales from substantially all of our restaurants, including franchisees and unconsolidated affiliates. Other services provided to franchisees and unconsolidated affiliates consist primarily of customer and technology support services. Advertising services and other services provided are highly interrelated to franchise right, and are not considered individually distinct. We recognize revenue when the related sales occur.

 

Loyalty Programs

 

Each of the Company’s KFC and Pizza Hut reportable segments operates a loyalty program that allows registered members to earn points for each qualifying purchase. Points, which generally expire 18 months after being earned, may be redeemed for future purchases of KFC or Pizza Hut branded products or other products for free or at a discounted price. Points cannot be redeemed or exchanged for cash. The estimated value of points earned by the loyalty program members is recorded as a reduction of revenue at the time the points are earned, based on the percentage of points that are projected to be redeemed, with a corresponding deferred revenue liability included in Accounts payable and other current liabilities on the Condensed Consolidated Balance Sheets and subsequently recognized into revenue when the points are redeemed or expire. The Company estimates the value of the future redemption obligations based on the estimated value of the product for which points are expected to be redeemed and historical redemption patterns and reviews such estimates periodically based upon the latest available information regarding redemption and expiration patterns.

11


 

 

Disaggregation of Revenue

 

The following table presents revenue disaggregated by types of arrangements and segments:

 

 

 

Quarter Ended 3/31/2022

 

 

Revenues

 

KFC

 

 

Pizza Hut

 

 

All Other Segments

 

 

Corporate and Unallocated

 

 

Combined

 

 

Elimination

 

 

Consolidated

 

 

Company sales

 

$

1,991

 

 

$

542

 

 

$

15

 

 

$

 

 

$

2,548

 

 

$

 

 

$

2,548

 

 

Franchise fees and income

 

 

16

 

 

 

2

 

 

 

6

 

 

 

 

 

 

24

 

 

 

 

 

 

24

 

 

Revenues from transactions
   with franchisees and
   unconsolidated affiliates

 

 

8

 

 

 

1

 

 

 

11

 

 

 

57

 

 

 

77

 

 

 

 

 

 

77

 

 

Other revenues

 

 

2

 

 

 

2

 

 

 

131

 

 

 

10

 

 

 

145

 

 

 

(126

)

 

 

19

 

 

Total revenues

 

$

2,017

 

 

$

547

 

 

$

163

 

 

$

67

 

 

$

2,794

 

 

$

(126

)

 

$

2,668

 

 

 

 

 

Quarter Ended 3/31/2021

 

 

Revenues

 

KFC

 

 

Pizza Hut

 

 

All Other Segments