Yum China Holdings, Inc. quarterly report, Q2 FY2022

Yum China Holdings, Inc. — Q2 2022 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2022. Financial amounts are in U.S. dollars; income statement and cash-flow figures are in millions unless noted. Yum China operates primarily in China, with KFC and Pizza Hut as its two reportable segments.

Financial performance

Metric	Q2 2022	Q2 2021	Six months 2022	Six months 2021
Total revenue	$2,128	$2,451	$4,796	$5,008
Operating profit	$81	$233	$272	$575
Net income attributable to Yum China	$83	$181	$183	$411
Diluted EPS	$0.20	$0.42	$0.43	$0.95
Operating cash flow	Not presented by quarter	$609	$773

Q2 company sales fell 9% reported (7% excluding foreign exchange); total revenue declined 13% reported (11% excluding foreign exchange). First-half company sales were approximately flat, while total revenue declined 4%.
Q2 restaurant profit was $245 million versus $354 million; restaurant margin contracted to 12.1% from 15.8%. First-half restaurant profit was $596 million versus $789 million, with margin down to 13.0% from 17.3%.
Q2 system sales and same-store sales each declined 16% excluding foreign exchange. First-half system sales declined 10% and same-store sales declined 12% on that basis.
KFC Q2 operating profit was $122 million versus $240 million; Pizza Hut was $11 million versus $39 million. First-half operating profit was $342 million for KFC and $41 million for Pizza Hut, down from $567 million and $99 million, respectively.
Adjusted EBITDA, a non-GAAP measure, was $257 million in Q2 versus $377 million; first-half adjusted EBITDA was $622 million versus $853 million.
YTD operating cash flow was $609 million. Investing activities used $52 million and financing activities used $513 million, including $400 million of share repurchases and $101 million of common dividends. Cash, cash equivalents and restricted cash ended at $1.147 billion.
At June 30, cash and cash equivalents were $1.147 billion and short-term investments were $2.506 billion. Current assets were $4.576 billion versus current liabilities of $2.153 billion. The company reported no bank borrowings; credit facilities totaled approximately $528 million, with $27 million of bank guarantees reducing availability.
Operating and finance lease liabilities totaled $2.516 billion. These are lease obligations, not reported bank borrowings.

Material changes and unusual items

COVID-19 restrictions severely affected Q2 trading: on average, more than 2,500 stores were temporarily closed or limited to takeaway and delivery during April and May. Same-store sales fell more than 20% in those months. By June, approximately 800 stores remained affected at month-end and same-store sales were down by a high-single-digit percentage year over year.
Management attributed weaker operating results to lower same-store sales and closures, commodity inflation in the low single digits, wage increases, higher utility rates, and increased delivery-rider costs. Higher productivity and landlord relief partly offset these pressures.
The store base was 12,170 at June 30, up 10% year over year. The reported company-owned unit increase includes Hangzhou KFC, consolidated following the 2021 acquisition.
Foreign-currency translation adjustments reduced Q2 comprehensive income attributable to Yum China to a loss of $156 million, despite net income of $83 million.
The company recorded a $20 million Q2 investment gain, mainly related to the fair-value change in Meituan shares; the first-half investment result was a $17 million loss. Sunner, a poultry supplier investment, had a carrying value of $235 million versus a quoted market value of $178 million.
A new VAT refund policy led to reclassification of $303 million of VAT assets to current assets. Refund timing and local implementation remain subject to review.

Outlook, risks and contingencies

No consolidated earnings or revenue guidance is provided. Management said recovery in restaurant traffic may be slow and uneven. COVID-19 cases rose again in July; the company cautioned that further outbreaks and restrictions could materially and persistently affect results, cash flows and financial condition.
The company committed to a Taco Bell network of at least 100 stores by the end of 2022 and 225 by the end of 2025, subject to the amended license arrangements and milestone conditions. YUM is to provide certain investment support.
Management believes cash on hand, operating cash flows and access to credit facilities should fund operations and anticipated capital expenditures for the next 12 months. Planned cash uses include expansion, remodeling, digitalization, automation, logistics, shareholder returns and potential acquisitions or investments.
A Chinese tax authority transfer-pricing audit covering related-party transactions from 2006–2015 remains open, with focus on the YUM franchise arrangement. Potential tax, interest and penalties cannot currently be estimated and could be material.
Yum China and YUM are in mediation over whether delivery fees and third-party aggregator commissions are subject to royalties under the master license agreement. Yum China paid disputed amounts under reservation of rights after YUM’s breach notice. YUM also alleged unauthorized use of intellectual property, which Yum China disputes. Arbitration or other remedies, potentially including license termination, remain possible if unresolved.
The filing also describes potential exposure under the China indirect-transfer tax rules relating to the 2016 separation; the amount, if imposed and allocated under the tax matters agreement, could be significant. The company says ordinary-course legal matters are not expected to have a material adverse effect; no franchisee guarantees were outstanding.

Important facts for investors to verify

Whether COVID-related restrictions and store-level sales recovered after the quarter, and how traffic, delivery mix and margins developed.
Progress and outcome of the YUM royalty and intellectual-property dispute, and continued compliance with master-license growth metrics and Taco Bell milestones.
Any developments in the transfer-pricing audit or indirect-transfer tax matter, including potential financial exposure.
Actual timing and collection of VAT refunds and whether the $303 million reclassified asset is realized as expected.
Cash generation, capital spending, lease obligations, share repurchases and dividends against the company’s stated liquidity outlook.
The effect of RMB movements and Meituan investment-value changes; a 10% RMB weakening was estimated to reduce quarterly operating profit by approximately $9 million, assuming no other changes.