Yum China Holdings, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Amounts are in U.S. dollars unless noted. Yum China operated 8,917 restaurants, primarily KFC and Pizza Hut, in mainland China.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Year to date 2019 | Year to date 2018 |
|---|---|---|---|---|
| Total revenue | $2.319B (+5% reported; +8% excluding FX) | $2.212B | $6.747B (+4% reported; +9% excluding FX) | $6.501B |
| Operating profit | $300M (+11% reported; +14% excluding FX) | $269M | $807M (-6% reported; -1% excluding FX) | $857M |
| Net income attributable to Yum China | $223M (+11%) | $203M | $623M (-2%) | $634M |
| Diluted EPS | $0.58 (+14%) | $0.51 | $1.60 (+1%) | $1.59 |
| Restaurant margin | 17.7% (+0.1 percentage point) | 17.6% | 17.0% (+0.1 percentage point) | 16.9% |
| Operating cash flow | Not reported by quarter | Not reported by quarter | $1.045B | $1.173B |
Year-to-date adjusted net income was $631M versus $560M, and adjusted diluted EPS was $1.62 versus $1.41. These non-GAAP measures exclude the 2019 $8M transition-tax adjustment and the 2018 $98M Wuxi KFC remeasurement gain, among other related tax effects. Year-to-date adjusted operating profit was $807M versus $759M.
Q3 system sales grew 8% excluding FX and same-store sales rose 2%; year-to-date system sales grew 9% excluding FX and same-store sales rose 4%. KFC Q3 same-store sales increased 3%, while Pizza Hut increased 1%. Restaurant count grew 7% year over year to 8,917.
Cash, liquidity, debt and capital allocation
- Cash and cash equivalents were $1.355B at September 30, 2019, with $364M of short-term investments. Cash, cash equivalents and restricted cash totaled $1.364B.
- Year-to-date operating cash flow was $1.045B; investing cash outflow was $553M and financing cash outflow was $368M. Capital spending was $310M. Cash flow from operations declined from 2018, primarily due to inventory-payment timing.
- No bank borrowings were outstanding. Credit facilities totaled approximately $410M, with remaining terms of one year or less; $11M of capacity supported bank guarantees.
- ASC 842 adoption brought substantial lease obligations onto the balance sheet: operating lease liabilities were $2.089B and finance lease liabilities $24M. Total lease liabilities were $2.113B; the filing says prior-year periods were not recast, limiting balance-sheet comparability.
- The company repurchased $204M of shares year to date and paid $136M in common dividends. $756M remained under the $1.4B repurchase authorization. A further $0.12-per-share dividend, estimated at $45M, was declared after quarter-end.
Changes, management commentary and outlook
- Q3 operating profit improvement reflected same-store sales and unit growth, labor efficiency and utility savings; wage and commodity inflation, promotions and product upgrades partly offset those gains. Management cited wage inflation of 5% and commodity inflation of 3% for the quarter.
- Pizza Hut Q3 restaurant profit fell to $62M from $76M and its restaurant margin declined to 11.4% from 13.8%, primarily due to higher promotion and labor costs. KFC Q3 operating profit increased 16% excluding FX.
- Year-to-date reported operating profit was lower partly because 2018 included the $98M gain on remeasurement of the previously held Wuxi KFC interest. Other pressures included inflation, promotions, and higher G&A expenses.
- Management stated existing cash and expected operating cash flow should cover operations and anticipated capital expenditures for the next 12 months. The filing provides no specific earnings or revenue guidance.
- Operating assets and most revenue are RMB-denominated. Management estimated that a 10% RMB weakening against the U.S. dollar would reduce Q3 operating profit by approximately $29M, assuming no changes in volume or local prices.
- The company had placed $9M in escrow under an agreement to acquire a controlling interest in Huang Ji Huang, with closing expected in early 2020 subject to conditions; the acquisition was described as immaterial.
Risks and contingencies
- A Chinese national transfer-pricing audit, ongoing since 2016 and covering 2006–2015 related-party transactions, focuses on the franchise arrangement with Yum! Brands. Significant developments are possible within 12 months, but the potential impact cannot be reasonably estimated; an adverse assessment could materially affect results, financial position and cash flows.
- A potential Chinese indirect-transfer tax relating to Yum! Brands’ 2016 distribution remains uncertain. Any liability and related losses would be allocated under the tax matters agreement and could be significant.
- The $232M input VAT credit asset depends on future utilization and tax interpretations; management said the benefit of the VAT regime may fluctuate and its interpretation is not settled at some local levels.
- Other disclosed exposures include RMB movements, commodity costs, food safety, labor and competition, reliance on the KFC/Pizza Hut license arrangement, China regulatory and currency restrictions, and risks in e-commerce, delivery and new concepts. The company reported no material change to the risk factors in its 2018 Form 10-K.
- Management concluded disclosure controls were effective at period-end and reported no materially affecting change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track comparable sales, unit growth and restaurant margins, particularly the recent Pizza Hut margin decline.
- Assess operating cash flow and capital spending, and distinguish the effect of inventory-payment timing from underlying cash generation.
- Monitor lease liabilities and lease costs when comparing balance-sheet and cash-flow trends across periods; lease-standard adoption changed presentation.
- Follow developments in the Chinese transfer-pricing audit and the potential indirect-transfer tax exposure; the filing does not provide a clear estimate of either potential liability.
- Separate recurring performance from the 2018 Wuxi KFC gain and the 2019 tax adjustment; review both GAAP and adjusted results.
- Verify the progress and final terms of the Huang Ji Huang acquisition and the availability of cash across China and offshore entities, given tax and currency-transfer constraints.