Yum China Holdings, Inc. — Form 10-Q Summary
Business context and reporting period
The filing reports unaudited combined results for the quarter and year to date ended August 31, 2016, with comparisons to the corresponding 2015 periods. Amounts are in U.S. dollars; financial statement amounts are in millions. Yum China operated KFC, Pizza Hut and other restaurant concepts in China. The statements reflect the business as part of Yum! Brands, including allocated corporate costs, and may not represent costs as an independent company.
Yum China separated from Yum! Brands on October 31, 2016, after the reporting period, and began trading as YUMC on November 1. It reported 7,330 restaurants at August 31, up 7% year over year.
Key financial and operating metrics
| Metric | Quarter ended Aug. 31, 2016 | Quarter ended Aug. 31, 2015 | YTD 2016 | YTD 2015 |
|---|---|---|---|---|
| Total revenues | $1,883 | $1,969 | $4,774 | $4,861 |
| Operating profit | $286 | $255 | $582 | $483 |
| Net income, including noncontrolling interests | $202 | $192 | $424 | $357 |
| Net income attributable to Yum China | $192 | $187 | $414 | $352 |
| Restaurant margin | 19.2% | 16.5% | 17.0% | 14.6% |
| Effective tax rate | 29.8% | 25.2% | 28.0% | 26.5% |
- Quarterly company sales declined 4% as reported; total system sales grew 3% excluding foreign exchange, while same-store sales declined 1%. YTD system sales grew 5% excluding foreign exchange and same-store sales grew 1%.
- Quarterly operating profit increased 12% and YTD operating profit increased 21% as reported. YTD operating profit before special items was $580 million, versus $483 million in 2015.
- Quarterly operating cash flow was not separately presented; YTD cash provided by operating activities was $822 million, down from $918 million. Investing used $232 million, compared with $345 million, and financing used $247 million, compared with $193 million.
- Cash and cash equivalents were $750 million at August 31, up from $425 million at December 31, 2015. Current assets were $1,158 million and current liabilities $1,092 million. No borrowings were outstanding under the credit facilities as of the report’s issuance. Capital lease obligations were $29 million.
- YTD capital spending was $268 million, compared with $357 million. Net transfers to Yum! Brands were $243 million, versus $194 million.
Material changes versus the prior comparable period
- Quarterly revenues fell 4% as reported, while operating profit rose 12% and Yum China net income rose 3%. YTD revenues fell 2%, while operating profit increased 21% and attributable net income increased 18%.
- Restaurant margins improved 2.7 percentage points for the quarter and 2.4 points YTD. Management attributed the improvement mainly to lower restaurant costs, including the benefit of China’s business-tax-to-VAT reform, and, YTD, same-store sales growth at KFC and higher equity income from affiliates.
- KFC’s quarterly same-store sales declined 1%; Pizza Hut Casual Dining declined 4%. YTD, KFC same-store sales grew 4%, while Pizza Hut declined 9%. Pizza Hut quarterly operating profit rose to $78 million from $64 million, but YTD profit declined to $130 million from $146 million.
- The effective tax rate increased, primarily because of deferred tax asset write-offs after a change in the company’s decision about certain deductions and increased costs of repatriating current-year foreign earnings.
Outlook, management commentary, risks and unusual items
- Management expected approximately 525 gross new units and nearly 800 remodels in 2016. It expected the VAT reform to benefit margins, but cautioned that the benefit could fluctuate as the rules and input-credit process develop.
- Management estimated that protests and consumer boycotts following a July 2016 South China Sea ruling reduced quarterly same-store sales by approximately 400 to 500 basis points.
- The company recorded restaurant impairment charges of $35 million YTD, including $30 million in KFC and $11 million in Pizza Hut Casual Dining, partly offset by store-closure income. A $3 million quarterly reversal of a prior aircraft-sale loss was a special item. The Little Sheep founding shareholders’ redemption generated an $8 million loss attributable to noncontrolling interests YTD.
- A potential Chinese tax under Bulletin 7 concerning the indirect transfer of Chinese assets in the spin-off could be significant. Any liability is to be allocated under the Tax Matters Agreement between Yum China and Yum! Brands and could materially affect results and financial condition. The company said ordinary-course legal matters were not expected to have a material adverse effect.
- Subsequent to period-end, Primavera and Ant Financial invested a combined $460 million for approximately 5% of the company, subject to adjustment, plus warrants for approximately 4% additional ownership. New revolving credit facilities totaling approximately $180 million were also established; none was drawn as of the report’s issuance.
- Foreign-exchange exposure is material: management estimated that a 10% weakening of the RMB against the U.S. dollar would have reduced operating profit by approximately $26 million for the quarter and $73 million YTD, assuming no volume or local-price changes. Management also cited commodity-price exposure and uncertainty over future access to capital markets as a newly independent company without a credit rating.
Important facts for investors to verify
- Whether VAT input credits are realized as expected and how the evolving VAT rules affect restaurant margins.
- Whether the estimated boycott impact was temporary and how same-store sales trend by brand, particularly at Pizza Hut Casual Dining.
- The final ownership and dilution effects of the strategic investment and warrants, and the implications of the spin-off agreements and ongoing Yum! Brands license fees.
- The exposure, allocation and possible financial impact of any Bulletin 7 tax assessment related to the separation.
- Standalone expenses and cash-flow needs after separation: historical corporate allocations may not reflect actual independent-company costs.
- The trend in restaurant impairment charges, labor and commodity costs, and currency sensitivity.