Yum China Holdings, Inc. quarterly report, Q2 FY2020

Yum China Holdings, Inc. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. Unless stated otherwise, financial amounts are in US$ millions. The company operates KFC, Pizza Hut and other restaurant and food-related businesses, principally in China.

Financial performance

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Total revenue	$1,902	$2,124	$3,656	$4,428
Operating profit	$128	$204	$225	$507
Net income attributable to Yum China	$132	$178	$194	$400
Diluted EPS	$0.34	$0.46	$0.50	$1.03
Restaurant profit margin	13.7%	14.7%	12.2%	16.7%
Operating cash flow	Not presented by quarter	$452	$657
Adjusted EBITDA (non-GAAP)	$261	$321	$480	$749

Q2 total revenue fell 11% reported (7% excluding foreign-exchange impact); six-month revenue fell 17% (15% excluding foreign exchange). Company sales fell 12% in Q2 and 19% year to date, or 9% and 16%, respectively, excluding foreign exchange. System sales declined 4% in Q2 and 13% year to date excluding foreign exchange; same-store sales declined 11% and 13%.

Q2 operating profit declined 38% and six-month operating profit declined 56%. KFC operating profit was $159 million in Q2 and $312 million year to date; Pizza Hut generated $15 million in Q2 and recorded a $13 million year-to-date operating loss. Restaurant margin pressure reflected lower sales, promotions and commodity inflation, partly offset by labor efficiency, government social-security contribution reductions, rent concessions and utility savings.

Cash, liquidity and obligations

• At June 30, cash and cash equivalents were $674 million and short-term investments were $1,034 million. Cash, cash equivalents and restricted cash totaled $681 million, down from $1,055 million at year-end 2019.
• Six-month operating cash flow was $452 million; investing activities used $761 million and financing activities used $59 million. Investing outflows included the Huang Ji Huang acquisition and net purchases of investments and deposits.
• Current assets were $2,303 million versus current liabilities of $1,723 million. Total liabilities were $3,676 million; the filing reports no bank borrowings outstanding at June 30. Lease liabilities totaled $2,104 million, including $2,078 million of operating lease liabilities.
• Available credit facilities were approximately $526 million; about $13 million was used for bank guarantees, reducing available facilities, with no borrowings outstanding.

Material changes, unusual items and management outlook

• COVID-19 materially disrupted results: approximately 35% of stores were closed at the outbreak peak. Management reported that more than 99% were open by the end of July, but sales and profits remained uneven and below pre-outbreak levels in some locations.
• Management expects COVID-19 to have a material adverse impact on full-year 2020 results, cash flows and financial condition. It did not provide numerical earnings or revenue guidance; the duration and extent of the impact remain uncertain.
• Results included $45 million of Q2 investment gain, principally from Meituan equity securities; the six-month gain was $37 million. The company sold part of its Meituan holding for approximately $54 million. Related U.S. tax contributed to a higher effective tax rate: 25.2% in Q2 and 27.8% year to date.
• COVID-related offsets included $25 million of year-to-date landlord rent concessions and $49 million of government social-security contribution reductions. Restaurant-level impairment charges were $24 million in Q2 and $36 million year to date, up from $11 million and $25 million in the comparable periods.
• The company acquired a 93.3% interest in Huang Ji Huang for $185 million in April. After quarter-end, it acquired another 25% of Suzhou KFC for $149 million, increasing its interest to 72% and enabling consolidation; the filing describes both acquisitions as immaterial.
• Share repurchases were temporarily suspended; none occurred in Q2. Dividends were suspended through the end of Q3 2020. The company stated that cash, operating cash flow and credit facilities should fund operations and anticipated capital expenditures for the next 12 months.

Risks and contingencies

• COVID-19 may continue to affect restaurant traffic, operations, staffing, supply chains and consumer behavior; renewed outbreaks or restrictions could worsen the impact.
• A Chinese national transfer-pricing audit concerning related-party transactions from 2006–2015 remains ongoing and focuses on the YUM franchise arrangement. The potential assessment is not reasonably estimable; additional tax, interest or penalties could be material.
• The filing describes potential Chinese indirect-transfer tax exposure related to the 2016 separation and related indemnification arrangements with YUM; any settlement could be significant.
• Most business activity and assets are in China and denominated in RMB. Management estimated that a 10% weakening of the RMB would have reduced Q2 operating profit by approximately $13 million, assuming no other changes.
• Other disclosed exposures include commodity-price volatility, competition, lease commitments, regulatory and tax uncertainty in China, and market-price volatility in the Meituan investment. Management said ordinary-course legal proceedings were not expected to have a material adverse effect.

Investor verification priorities

1. Track same-store sales, traffic and profit recovery, including the effects of any renewed COVID-19 outbreaks and regional restrictions.
2. Assess recurring restaurant profitability separately from investment gains, government support, rent concessions and impairment charges.
3. Monitor operating cash generation, investment balances, lease obligations and the adequacy and availability of credit facilities.
4. Follow developments in the Chinese transfer-pricing audit and any potential separation-related indirect-transfer tax liability.
5. Confirm the effects of the Suzhou KFC consolidation and Huang Ji Huang acquisition, and the timing of any resumption of dividends or share repurchases.