Notes to Condensed Consolidated Financial Statements (Unaudited)
(Tabular amounts in US$ millions)
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, COFFii & JOY, East Dawning 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”), Yum! Restaurants Asia Pte. Ltd., a wholly-owned indirect subsidiary of YUM, and Yum Restaurants Consulting (Shanghai) Company Limited (“YCCL”), a wholly-owned indirect subsidiary of the Company, entered into a 50-year master license agreement 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, for the exclusive right to use and sublicense the use of intellectual property owned by YUM and its subsidiaries for the development and operation of the KFC, Pizza Hut and, subject to achieving certain agreed-upon milestones, 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, Taiwan and Macau. 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, COFFii & JOY and East Dawning, and pay no license fee related to these concepts.
The Company also owns a controlling interest in the holding company of DAOJIA.com.cn (“Daojia”), an established online food delivery service provider in China.
In addition, the Company started a new e-commerce business in 2017, offering a wide selection of products including electronics, home and kitchen accessories, fresh groceries, and other general merchandise to customers directly through the Company’s e-commerce platform.
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, 2020 and our results of operations, comprehensive income and cash flows for the quarters ended March 31, 2020 and 2019. 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 defined and included in the Company’s Annual Report on Form 10-K as filed with the SEC on February 27, 2020.
7
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.
Recently Adopted Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires measurement and recognition of expected versus incurred credit losses for financial assets held. The FASB subsequently issued amendments to clarify the implementation guidance. We adopted these standards on January 1, 2020 using the modified retrospective method. The adoption of this standard resulted in a change of our provision policy primarily for accounts receivable, but such adoption did not have a material impact on our financial statements. See Note 3 for additional information related to our accounts receivable provision policy.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework –changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amends the fair value measurement guidance by modifying disclosure requirements. We adopted the standard on January 1, 2020, and such adoption did not have a material impact on our financial statements. See Note 11 for additional disclosure on fair value measurement.
In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other-Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”), which aligns the requirements for capitalizing implementation costs in a cloud computing arrangement service contract with those for an internal-use software license. We adopted this standard on January 1, 2020, and such adoption did not have a material impact on our financial statements.
In November 2018, the FASB issued ASU 2018-18, Collaborative Arrangements (Topic 808), Clarifying the Interaction between Topic 808 and Topic 606 (“ASU 2018-18”), which clarifies that transactions in a collaborative arrangement should be accounted for under ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”) when the counterparty is a customer for a distinct good or service. The amendment also precludes an entity from presenting consideration from a transaction in a collaborative arrangement as revenue if the counterparty is not a customer for that transaction. We adopted the standard on January 1, 2020, and such adoption did not have a material impact on our financial statements.
Note 3 – Revenue Recognition
The Company’s revenues primarily include Company sales, Franchise fees and income and Revenues from transactions with franchisees and unconsolidated affiliates.
8
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, in the past, third-party aggregators’ delivery staff. 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 were fulfilled by the delivery staff of third-party aggregators, who control and determine the price for the delivery service, we recognized revenue, excluding delivery fees, when control of the food was transferred to the third-party aggregators’ delivery staff. The payment terms with respect to those sales were 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 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.
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 in accordance with ASC 606. The franchise agreement term is generally 10 years for KFC and Pizza Hut, and five or 10 years for Little Sheep. 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.
9
The Company centrally purchases substantially all food and paper products from suppliers for substantially all of our restaurants, including franchisees and unconsolidated affiliates, and then sells and delivers them to the restaurants. 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. 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 a 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 the 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.
Disaggregation of Revenue
The following table presents revenue disaggregated by types of arrangements and segments:
|
|
Quarter Ended 3/31/2020
|
|
Revenues
|
|
KFC
|
|
|
Pizza Hut
|
|
|
All Other
Segments
|
|
|
Corporate and
Unallocated
|
|
|
Combined
|
|
|
Elimination
|
|
|
Consolidated
|
|
Company sales
|
|
$
|
1,220
|
|
|
$
|
322
|
|
|
$
|
6
|
|
|
$
|
—
|
|
|
$
|
1,548
|
|
|
$
|
—
|
|
|
$
|
1,548
|
|
Franchise fees and income
|
|
|
33
|
|
|
|
1
|
|
|
|
1
|
|
|
|
—
|
|
|
|
35
|
|
|
|
—
|
|
|
|
35
|
|
Revenues from transactions
with franchisees and
unconsolidated affiliates
|
|
|
16
|
|
|
|
1
|
|
|
|
5
|
|
|
|
139
|
|
|
|
161
|
|
|
|
—
|
|
|
|
161
|
|
Other revenues
|
|
|
—
|
|
|
|
—
|
|
|
|
16
|
|
|
|
1
|
|
|
|
17
|
|
|
|
(7
|
)
|
|
|
10
|
|
Total revenues
|
|
$
|
1,269
|
|
|
$
|
324
|
|
|
$
|
28
|
|
|
$
|
140
|
|
|
$
|
1,761
|
|
|
$
|
(7
|
)
|
|
$
|
1,754
|
|
10
|
|
Quarter Ended 3/31/2019
|
|
Revenues
|
|
KFC
|
|
|
Pizza Hut
|
|
|
All OtherSegments
|
|
|
Corporate and
Unallocated
|
|
|
Combined
|
|
|
Elimination
|
|
|
Consolidated
|
|
Company sales
|
|
$
|
1,539
|
|
|
$
|
541
|
|
|
$
|
9
|
|
|
$
|
—
|
|
|
$
|
2,089
|
|
|
$
|
—
|
|
|
$
|
2,089
|
|
Franchise fees and income
|
|
|
36
|
|
|
|
1
|
|
|
|
2
|
|
|
|
—
|
|
|
|
39
|
|
|
|
—
|
|
|
|
39
|
|
Revenues from transactions
with franchisees and
unconsolidated affiliates
|
|
|
17
|
|
|
|
1
|
|
|
|
7
|
|
|
|
145
|
|
|
|
170
|
|
|
|
—
|
|
|
|
170
|
|
Other revenues
|
|
|
—
|
|
|
|
—
|
|
|
|
14
|
|
|
|
1
|
|
|
|
15
|
|
|
|
(9
|
)
|
|
|
6
|
|
Total revenues
|
|
$
|
1,592
|
|
|
$
|
543
|
|
|
$
|
32
|
|
|
$
|
146
|
|
|
$
|
2,313
|
|
|
$
|
(9
|
)
|
|
$
|
2,304
|
|
Accounts Receivable
Accounts receivable consist of trade receivables and royalties from franchisees and unconsolidated affiliates, and are generally due within 30 days of the period in which the corresponding sales occur and are classified as Accounts receivable on the Condensed Consolidated Balance Sheets. Prior to the adoption of ASC 326, our provision for uncollectible receivable balances was based upon pre-defined aging criteria or upon the occurrence of other events that indicated that we may not collect the balance due. Upon adoption of ASC 326 starting from January 1, 2020, our provision of credit losses for accounts receivable is based upon the current expected credit losses (“CECL”) model. The CECL model requires an estimate of the credit losses expected over the life of accounts receivable since initial recognition, and accounts receivable with similar risk characteristics are grouped together when estimating CECL. In assessing the CECL, the Company considers both quantitative and qualitative information that is reasonable and supportable, including historical credit loss experience, adjusted for relevant factors impacting collectability and forward-looking information indicative of external market conditions. While we use the best information available in making our determination, the ultimate recovery of recorded receivables is also dependent upon future economic events and other conditions that may be beyond our control. Trade receivables that are ultimately deemed to be uncollectible, and for which collection efforts have been exhausted, are written off against the allowance for doubtful accounts. As of March 31, 2020 and December 31, 2019, the ending balances of provision for accounts receivable were both $1 million, and amounts of accounts receivable past due were immaterial. Receivables due from unconsolidated affiliates including trade receivables and dividend receivables were $43 million and $58 million as of March 31, 2020 and December 31, 2019, respectively.
11
Costs to Obtain Contracts
Costs to obtain contracts consist of upfront franchise fees that we paid to YUM prior to the separation in relation to initial fees or renewal fees we received from franchisees and unconsolidated affiliates, as well as license fees that are payable to YUM in relation to our deferred revenue of prepaid stored-value products, privilege membership programs and customer loyalty programs. They meet the requirements to be capitalized as they are incremental costs of obtaining contracts with customers and the Company expects to generate future economic benefits from such costs incurred. Such costs to obtain contracts are included in Other assets on the Condensed Consolidated Balance Sheets and are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the assets relate. Subsequent to the separation, we are no longer required to pay YUM initial or renewal fees that we receive from franchisees and unconsolidated affiliates. The Company did not incur any impairment losses related to costs to obtain contracts during any of the periods presented. Costs to obtain contracts were $9 million at both March 31, 2020 and December 31, 2019.
Contract Liabilities
Contract liabilities at March 31, 2020 and December 31, 2019 were as follows:
Contract liabilities
|
|
3/31/2020
|
|
|
12/31/2019
|
|
- Deferred revenue related to prepaid stored-value products
|
|
$
|
81
|
|
|
$
|
86
|
|
- Deferred revenue related to upfront franchise fees
|
|
|
39
|
|
|
|
39
|
|
- Deferred revenue related to customer loyalty programs
|
|
|
27
|
|
|
|
24
|
|
- Deferred revenue related to privilege membership programs
|
|
|
15
|
|
|
|
16
|
|
- Others
|
|
|
3
|
|
|
|
3
|
|
Total
|
|
$
|
165
|
|
|
$
|
168
|
|
Contract liabilities primarily consist of deferred revenue related to prepaid stored-value products, privilege membership programs, customer loyalty programs and upfront franchise fees. Deferred revenue related to prepaid stored-value products, privilege membership programs, and customer loyalty programs is included in Accounts payable and other current liabilities on the Condensed Consolidated Balance Sheets. Deferred revenue related to upfront franchise fees that we expect to recognize as revenue in the next 12 months is included in Accounts payable and other current liabilities, and the remaining balance is included in Other liabilities on the Condensed Consolidated Balance Sheets. Revenue recognized that was included in the contract liability balance at the beginning of each period amounted to $38 million and $33 million for the quarters ended March 31, 2020 and 2019, respectively. Changes in contract liability balances were not materially impacted by business acquisition, change in estimate of transaction price or any other factors during any of the periods presented.
The Company has elected, as a practical expedient, not to disclose the value of remaining performance obligations associated with sales-based royalty promised to franchisees in exchange for the franchise right and other related services. The remaining duration of the performance obligation is the remaining contractual term of each franchise agreement. We recognize continuing franchisee fees and revenues from advertising services and other services provided to franchisees and unconsolidated affiliates based on a certain percentage of sales, as those sales occur.
12
Note 4 – Earnings Per Common Share (“EPS”)
The following table summarizes the components of basic and diluted EPS (in millions, except per share data):
|
|
Quarter Ended
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
Net Income – Yum China Holdings, Inc.
|
|
$
|
62
|
|
|
$
|
222
|
|
Weighted-average common shares outstanding (for basic calculation)(a)
|
|
|
376
|
|
|
|
379
|
|
Effect of dilutive share-based awards(a)
|
|
|
6
|
|
|
|
7
|
|
Effect of dilutive warrants(b)
|
|
|
4
|
|
|
|
2
|
|
Weighted-average common and dilutive potential common shares outstanding
(for diluted calculation)
|
|
|
386
|
|
|
|
388
|
|
Basic Earnings Per Common Share
|
|
$
|
0.16
|
|
|
$
|
0.59
|
|
Diluted Earnings Per Common Share
|
|
$
|
0.16
|
|
|
$
|
0.57
|
|
Share-based awards excluded from the diluted EPS computation(c)
|
|
|
3
|
|
|
|
2
|
|
(a)
|
As a result of the separation, shares of Yum China common stock were distributed to YUM’s shareholders of record as of October 19, 2016 and included in the calculated weighted-average common shares outstanding. Holders of outstanding YUM equity awards generally received both adjusted YUM awards and Yum China awards, or adjusted awards of either YUM or Yum China in their entirety. Any subsequent exercise of these awards, whether held by the Company’s employees or YUM’s employees, would increase the number of common shares outstanding. The incremental shares arising from outstanding equity awards are included in the computation of diluted EPS, if there is dilutive effect.
|
(b)
|
Pursuant to the investment agreements dated September 1, 2016, Yum China issued to strategic investors two tranches of warrants on January 9, 2017, with each tranche initially providing the right to purchase 8,200,405 shares of Yum China common stock, at an initial exercise price of $31.40 and $39.25 per share, respectively, subject to customary anti-dilution adjustments. The warrants may be exercised at any time through October 31, 2021. The incremental shares arising from outstanding warrants are included in the computation of diluted EPS, if there is dilutive effect when the average market price of Yum China common stock for the period exceeds the applicable exercise price of the warrants.
|
(c)
|
The Company excluded 2 million outstanding stock appreciation rights (“SARs”) and restricted stock units (“RSUs”) from the computation of diluted EPS because to do so would have been antidilutive for the quarters presented, and 1 million performance stock units (“PSUs”) because they are contingently issuable based on the achievement of performance and market conditions, which have not been met as of March 31, 2020.
|
13
Note 5 – Equity
Changes in Equity and Redeemable Noncontrolling Interest (in millions)
|
|
Yum China Holdings, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
Additional
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable
|
|
|
|
Stock
|
|
|
Paid-in
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
Treasury Stock
|
|
|
Noncontrolling
|
|
|
Total
|
|
|
Noncontrolling
|
|
|
|
Shares*
|
|
|
Amount
|
|
|
Capital
|
|
|
Earnings
|
|
|
Loss
|
|
|
Shares*
|
|
|
Amount
|
|
|
Interests
|
|
|
Equity
|
|
|
Interest
|
|
Balance at December 31, 2019
|
|
|
395
|
|
|
$
|
4
|
|
|
$
|
2,427
|
|
|
$
|
1,416
|
|
|
$
|
(49
|
)
|
|
|
(19
|
)
|
|
$
|
(721
|
)
|
|
$
|
98
|
|
|
$
|
3,175
|
|
|
$
|
—
|
|
Net Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
66
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(40
|
)
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
(42
|
)
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
|
|
|
Cash dividends declared
($0.12 per common share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(45
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(45
|
)
|
|
|
|
|
Repurchase of shares of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
Exercise and vesting of share-based awards
|
|
|
1
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
|
|
Share-based compensation
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
Balance at March 31, 2020
|
|
|
396
|
|
|
$
|
4
|
|
|
$
|
2,434
|
|
|
$
|
1,433
|
|
|
$
|
(89
|
)
|
|
|
(20
|
)
|
|
$
|
(728
|
)
|
|
$
|
100
|
|
|
$
|
3,154
|
|
|
$
|
—
|
|
|
|
Yum China Holdings, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
Additional
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable
|
|
|
|
Stock
|
|
|
Paid-in
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
Treasury Stock
|
|
|
Noncontrolling
|
|
|
Total
|
|
|
Noncontrolling
|
|
|
|
Shares*
|
|
|
Amount
|
|
|
Capital
|
|
|
Earnings
|
|
|
(Loss) Income
|
|
|
Shares*
|
|
|
Amount
|
|
|
Interests
|
|
|
Equity
|
|
|
Interest
|
|
Balance at December 31, 2018
|
|
|
392
|
|
|
$
|
4
|
|
|
$
|
2,402
|
|
|
$
|
944
|
|
|
$
|
(17
|
)
|
|
|
(13
|
)
|
|
$
|
(460
|
)
|
|
$
|
103
|
|
|
$
|
2,976
|
|
|
$
|
1
|
|
Net Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
222
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
229
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
59
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
288
|
|
|
|
|
|
Cash dividends declared
($0.12 per common share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(46
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(46
|
)
|
|
|
|
|
Dividends declared
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(34
|
)
|
|
|
(34
|
)
|
|
|
|
|
Repurchase of shares of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
(65
|
)
|
|
|
|
|
|
|
(65
|
)
|
|
|
|
|
Exercise and vesting of share-based awards
|
|
|
2
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
|
|
Share-based compensation
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
Cumulative effect of accounting change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(60
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
|
|
(63
|
)
|
|
|
|
|
Balance at March 31, 2019
|
|
|
394
|
|
|
$
|
4
|
|
|
$
|
2,408
|
|
|
$
|
1,060
|
|
|
$
|
39
|
|
|
|
(15
|
)
|
|
$
|
(525
|
)
|
|
$
|
76
|
|
|
$
|
3,062
|
|
|
$
|
1
|
|
*: Shares may not to add due to rounding.
Share Repurchase Program
Our Board of Directors has authorized an aggregate of $1.4 billion for our share repurchase program. The Company repurchased 0.2 million and 1.7 million shares of Yum China common stock at a total cost of $7 million and $65 million for the quarters ended March 31, 2020 and 2019, respectively. The total cost includes $2 million settled subsequent to March 31, 2019, for shares repurchased with trade dates on or prior to March 31, 2019. As of March 31, 2020, $692 million remained available for future share repurchases under the authorization.
Note 6 – Items Affecting Comparability of Net Income and Cash Flows
Impact of COVID-19 Pandemic
The COVID-19 pandemic has significantly impacted the Company’s operations in the first quarter of 2020. The decrease in Operating profit for the quarter was mainly driven by same-store sales declines and temporary store closures resulting from the COVID-19 pandemic, and offset by one-time rent concessions of $14 million from landlords and a one-time government subsidy in the form of a reduction in social security contributions of $20 million. Operating profit for the quarter ended March 31, 2020 was $97 million, a decrease of 68% from the first quarter ended March 31, 2019.
14
Restaurant-level Impairment
In the first quarter of 2020, we considered the adverse economic effects of the COVID-19 pandemic an impairment indicator, and performed an additional impairment evaluation for long-lived assets of restaurants. As a result of the evaluation, we recorded a restaurant-level impairment charge of $9 million. In the first quarter of 2019, we also performed an additional impairment evaluation as a result of adopting ASC 842 and recorded a restaurant-level impairment charge of $12 million. See Note 11 for additional information.
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 Hong Kong Stock Exchange in September 2018. The Company accounted 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 related unrealized loss of $8 million and unrealized gain of $10 million was included in Investment gain or loss in our Condensed Consolidated Statements of Income for the quarters ended March 31, 2020 and 2019, respectively.
Transition Tax
The U.S. Treasury Department and Internal Revenue Service (“IRS”) released the final transition tax regulations in the first quarter of 2019. We completed the evaluation of the impact on our transition tax computation based on the final regulations released in the first quarter of 2019 and recorded an additional amount of $8 million for the transition tax accordingly. See Note 12 for additional information.
Partner PSU Awards
In February 2020, the Company’s Board of Directors approved new grants of SARs, RSUs and PSUs to employees under the Yum China Holdings, Inc. Long Term Incentive Plan (the “2016 Plan”). The awards will be earned based on their respective vesting terms, with PSUs subject to market conditions or performance conditions. A special award of PSUs (“Partner PSU Awards”) was granted to select employees who were deemed critical to the Company’s execution of its strategic operating plan. These Partner PSU Awards will only vest if threshold performance goals are achieved over a four-year performance period, with the payout ranging from 0% to 200% of the target number of shares. Partner PSU Awards were granted to address increased competition for executive talent, motivate transformational performance and encourage management retention. Given the unique nature of these grants, the Compensation Committee of the Board does not intend to grant similar, special grants to the same employees during the performance period. The impact from these special awards is excluded from metrics that management uses to assess the Company’s performance. The Company recognized a share-based compensation cost associated with the Partner PSU Awards of $1 million for the quarter ended March 31, 2020.
Note 7 – Other Income, net
|
|
Quarter Ended
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
Equity income from investments in unconsolidated affiliates
|
|
$
|
20
|
|
|
$
|
23
|
|
Foreign exchange impact and other
|
|
|
(4
|
)
|
|
|
(4
|
)
|
Other income, net
|
|
$
|
16
|
|
|
$
|
19
|
|
15
Note 8 – Supplemental Balance Sheet Information
Accounts Receivable, net
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Accounts receivable, gross
|
|
$
|
79
|
|
|
$
|
89
|
|
Allowance for doubtful accounts
|
|
|
(1
|
)
|
|
|
(1
|
)
|
Accounts receivable, net
|
|
$
|
78
|
|
|
$
|
88
|
|
Prepaid Expenses and Other Current Assets
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Receivables from payment processors and aggregators
|
|
$
|
20
|
|
|
$
|
41
|
|
Prepaid rent
|
|
|
1
|
|
|
|
2
|
|
Dividends receivable from unconsolidated affiliates
|
|
|
—
|
|
|
|
8
|
|
Other prepaid expenses and current assets
|
|
|
91
|
|
|
|
83
|
|
Prepaid expenses and other current assets
|
|
$
|
112
|
|
|
$
|
134
|
|
Property, Plant and Equipment
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Buildings and improvements
|
|
$
|
2,174
|
|
|
$
|
2,159
|
|
Finance leases, primarily buildings
|
|
|
30
|
|
|
|
30
|
|
Machinery and equipment, and construction in progress
|
|
|
1,211
|
|
|
|
1,282
|
|
Property, plant and equipment, gross
|
|
|
3,415
|
|
|
|
3,471
|
|
Accumulated depreciation
|
|
|
(1,915
|
)
|
|
|
(1,877
|
)
|
Property, plant and equipment, net
|
|
$
|
1,500
|
|
|
$
|
1,594
|
|
Other Assets
|
|
3/31/2020
|
|
|
12/31/2019
|
|
VAT assets
|
|
$
|
241
|
|
|
$
|
243
|
|
Land use right
|
|
|
129
|
|
|
|
133
|
|
Investment in equity securities
|
|
|
102
|
|
|
|
110
|
|
Long-term deposits
|
|
|
73
|
|
|
|
71
|
|
Prepayment for investment(a)
|
|
|
27
|
|
|
|
—
|
|
Restricted cash(a)
|
|
|
9
|
|
|
|
9
|
|
Costs to obtain contracts
|
|
|
9
|
|
|
|
9
|
|
Others
|
|
|
5
|
|
|
|
5
|
|
Other Assets
|
|
$
|
595
|
|
|
$
|
580
|
|
Accounts Payable and Other Current Liabilities
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Accounts payable
|
|
$
|
466
|
|
|
$
|
623
|
|
Operating leases liabilities
|
|
|
403
|
|
|
|
382
|
|
Accrued compensation and benefits
|
|
|
142
|
|
|
|
223
|
|
Contract liabilities
|
|
|
133
|
|
|
|
135
|
|
Accrued capital expenditures
|
|
|
111
|
|
|
|
150
|
|
Accrued marketing expenses
|
|
|
79
|
|
|
|
64
|
|
Other current liabilities
|
|
|
100
|
|
|
|
114
|
|
Accounts payable and other current liabilities
|
|
$
|
1,434
|
|
|
$
|
1,691
|
|
Other Liabilities
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Accrued income tax payable
|
|
$
|
70
|
|
|
$
|
69
|
|
Deferred income tax liabilities
|
|
|
66
|
|
|
|
67
|
|
Contract liabilities
|
|
|
32
|
|
|
|
33
|
|
Other non-current liabilities
|
|
|
43
|
|
|
|
41
|
|
Other liabilities
|
|
$
|
211
|
|
|
$
|
210
|
|
16
Reconciliation of Cash, Cash equivalents, and Restricted Cash for Condensed Consolidated Statements of Cash Flows
|
|
3/31/2020
|
|
|
12/31/2019
|
|
Cash and cash equivalents as presented in Condensed Consolidated Balance Sheets
|
|
$
|
1,048
|
|
|
$
|
1,046
|
|
Restricted cash included in Other assets(a)
|
|
|
9
|
|
|
|
9
|
|
Cash, Cash Equivalents and Restricted Cash as presented in Condensed Consolidated Statements of Cash Flows
|
|
$
|
1,057
|
|
|
$
|
1,055
|
|
(a)
|
Restricted cash included in Other assets within our Condensed Consolidated Balance Sheet represents amounts deposited into an escrow account pursuant to a definitive agreement entered into in August 2019 to acquire a controlling interest in the Huang Ji Huang group, a leading Chinese-style casual dining franchise business. In addition, the Company made a prepayment of $27 million during the first quarter of 2020 when certain closing conditions were met, and it was included in Other assets within our Condensed Consolidated Balance Sheet as of March 31, 2020. The acquisition was completed in April 2020. See Note 15 for additional information.
|
Note 9 – Goodwill and Intangible Assets
The changes in the carrying amount of goodwill are as follows:
|
|
Total
Company
|
|
|
KFC
|
|
|
Pizza Hut
|
|
|
All Other
Segments
|
|
Balance as of December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill, gross
|
|
$
|
645
|
|
|
$
|
235
|
|
|
$
|
19
|
|
|
$
|
391
|
|
Accumulated impairment losses(a)
|
|
|
(391
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(391
|
)
|
Goodwill, net
|
|
|
254
|
|
|
|
235
|
|
|
|
19
|
|
|
|
—
|
|
Effect of currency translation adjustment
|
|
|
(4
|
)
|
|
|
(4
|
)
|
|
|
—
|
|
|
|
—
|
|
Balance as of March 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill, gross
|
|
|
641
|
|
|
|
231
|
|
|
|
19
|
|
|
|
391
|
|
Accumulated impairment losses(a)
|
|
|
(391
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(391
|
)
|
Goodwill, net
|
|
$
|
250
|
|
|
$
|
231
|
|
|
$
|
19
|
|
|
$
|
—
|
|
(a)
|
Accumulated impairment losses represent goodwill impairment attributable to the Little Sheep and Daojia reporting unit.
|
Intangible assets, net as of March 31, 2020 and December 31, 2019 are as follows:
|
|
3/31/2020
|
|
|
12/31/2019
|
|
|
|
Gross Carrying
Amount(a)
|
|
|
Accumulated
Amortization
|
|
|
Accumulated
Impairment
Losses(b)
|
|
|
Net
Carrying
Amount
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Accumulated
Impairment
Losses(b)
|
|
|
Net
Carrying
Amount
|
|
Finite-lived intangible
assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reacquired franchise
rights
|
|
$
|
147
|
|
|
$
|
(115
|
)
|
|
$
|
—
|
|
|
$
|
32
|
|
|
$
|
148
|
|
|
$
|
(113
|
)
|
|
$
|
—
|
|
|
$
|
35
|
|
Daojia platform
|
|
|
16
|
|
|
|
(4
|
)
|
|
|
(12
|
)
|
|
|
—
|
|
|
|
16
|
|
|
|
(4
|
)
|
|
|
(12
|
)
|
|
|
—
|
|
Customer-related assets
|
|
|
12
|
|
|
|
(9
|
)
|
|
|
(2
|
)
|
|
|
1
|
|
|
|
12
|
|
|
|
(8
|
)
|
|
|
(2
|
)
|
|
|
2
|
|
Others
|
|
|
9
|
|
|
|
(4
|
)
|
|
|
—
|
|
|
|
5
|
|
|
|
9
|
|
|
|
(4
|
)
|
|
|
—
|
|
|
|
5
|
|
|
|
$
|
184
|
|
|
$
|
(132
|
)
|
|
$
|
(14
|
)
|
|
$
|
38
|
|
|
$
|
185
|
|
|
$
|
(129
|
)
|
|
$
|
(14
|
)
|
|
$
|
42
|
|
Indefinite-lived intangible
assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Little Sheep trademark
|
|
$
|
51
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
51
|
|
|
$
|
52
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
235
|
|
|
$
|
(132
|
)
|
|
$
|
(14
|
)
|
|
$
|
89
|
|
|
$
|
237
|
|
|
$
|
(129
|
)
|
|
$
|
(14
|
)
|
|
$
|
94
|
|
(a)
|
Changes in gross carrying amount include effect of currency translation adjustment.
|
(b)
|
Accumulated impairment losses represent impairment charges on intangible assets acquired from Daojia primarily attributable to the Daojia platform.
|
17
Amortization expense of finite-lived intangible assets was $3 million and $6 million for the quarters ended March 31, 2020 and 2019, respectively. As of March 31, 2020, expected amortization expense for the unamortized definite-lived intangible assets is approximately $9 million for the remainder of 2020, $12 million in 2021, $12 million in 2022, $2 million in 2023 and $1 million in 2024.
Note 10 – Leases
As of March 31, 2020, we operated over 7,400 Company-owned restaurants, leasing the underlying land and/or building. We generally enter into lease agreements for our restaurants with initial terms of 10 to 20 years. Most of our lease agreements contain termination options that permit us to terminate the lease agreement early if the restaurant’s unit contribution is negative for a specified period of time. We generally do not have renewal options for our leases. Such options are accounted for only when it is reasonably certain that we will exercise the options. The rent under the majority of our current restaurant lease agreements is generally payable in one of three ways: (i) fixed rent; (ii) the higher of a fixed base rent or a percentage of the restaurant’s sales; or (iii) a percentage of the restaurant’s sales. Most leases require us to pay common area maintenance fees for the leased property. In addition to restaurants leases, we also lease office spaces, logistics centers and equipment. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
In limited cases, we sub-lease certain restaurants to franchisees in connection with refranchising transactions or lease our properties to other third parties. The lease payments under these leases are generally based on the higher of a fixed base rent or a percentage of the restaurant’s annual sales. Income from sub-lease agreements with franchisees or lease agreements with other third parties are included in Franchise fees and income and Other revenue, respectively, within our Condensed Consolidated Statements of Income. The financial impact of our accounting as a lessor was not significant.
Supplemental Balance Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
3/31/2020
|
|
|
12/31/2019
|
|
|
Account Classification
|
Assets
|
|
|
|
|
|
|
|
|
|
|
Operating lease right-of-use assets
|
|
$
|
1,899
|
|
|
$
|
1,985
|
|
|
Operating lease right-of-use assets
|
Finance lease right-of-use assets
|
|
|
17
|
|
|
|
18
|
|
|
Property, plant and equipment, net
|
Total leased assets
|
|
$
|
1,916
|
|
|
$
|
2,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
|
|
Operating lease liabilities
|
|
$
|
403
|
|
|
$
|
382
|
|
|
Accounts payable and other current liabilities
|
Finance lease liabilities
|
|
|
2
|
|
|
|
2
|
|
|
Accounts payable and other current liabilities
|
Non-current
|
|
|
|
|
|
|
|
|
|
|
Operating lease liabilities
|
|
|
1,704
|
|
|
|
1,803
|
|
|
Non-current operating lease liabilities
|
Finance lease liabilities
|
|
|
25
|
|
|
|
26
|
|
|
Non-current finance lease liabilities
|
Total lease liabilities
|
|
$
|
2,134
|
|
|
$
|
2,213
|
|
|
|
18
Summary of Lease Cost
|
|
Quarter Ended
|
|
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
|
Account Classification
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease cost
|
|
$
|
121
|
|
|
$
|
117
|
|
|
Occupancy and other operating expenses, G&A or Franchise expenses
|
Finance lease cost
|
|
|
|
|
|
|
|
|
|
|
Amortization of leased assets
|
|
|
1
|
|
|
|
—
|
|
|
Occupancy and other operating expenses
|
Variable lease cost (a)
|
|
|
49
|
|
|
|
91
|
|
|
Occupancy and other operating expenses or Franchise expenses
|
Short-term lease cost
|
|
|
3
|
|
|
|
3
|
|
|
Occupancy and other operating expenses or G&A
|
Sub-lease income
|
|
|
(6
|
)
|
|
|
(7
|
)
|
|
Franchise fees and income or Other revenues
|
Total lease cost
|
|
$
|
168
|
|
|
$
|
204
|
|
|
|
(a)
|
In the first quarter of 2020, the Company was granted $14 million in lease concessions from landlords related to the effects of the COVID-19 pandemic. The lease concessions were primarily in the form of rent reduction over the period of time when the Company’s restaurant business was adversely impacted. The Company applied the interpretive guidance in a FASB staff Q&A document issued in April 2020 and elected: (1) not to evaluate whether a concession received in response to the COVID-19 pandemic is a lease modification and (2) to assume such concession was contemplated as part of the existing lease contract with no contract modification. Such concession was recognized as negative variable lease cost in the period the concession was granted.
|
Supplemental Cash Flow Information
|
|
Quarter Ended
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
|
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
107
|
|
|
$
|
127
|
|
Financing cash flows from finance leases
|
|
|
1
|
|
|
|
—
|
|
Right-of-use assets obtained in exchange for new lease liabilities(b):
|
|
|
|
|
|
|
|
|
Operating leases
|
|
$
|
32
|
|
|
$
|
57
|
|
Finance leases
|
|
|
—
|
|
|
|
(1
|
)
|
(b)
|
This supplemental non-cash disclosure for right-of-use (“ROU”) assets obtained in exchange for new lease liabilities also includes non-cash transactions resulting in adjustments to the lease liability or ROU asset due to modification or other reassessment events.
|
|
|
Quarter Ended
|
|
Lease Term and Discount Rate
|
|
3/31/2020
|
|
|
3/31/2019
|
|
Weighted-average remaining lease term (years)
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
6.9
|
|
|
|
7.3
|
|
Finance leases
|
|
|
11.3
|
|
|
|
12.0
|
|
|
|
|
|
|
|
|
|
|
Weighted-average discount rate
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
6.0
|
%
|
|
|
6.1
|
%
|
Finance leases
|
|
|
5.9
|
%
|
|
|
5.7
|
%
|
19
Summary of Future Lease Payments and Lease Liabilities
Maturities of lease liabilities as of March 31, 2020 were as follows:
|
|
Amount of
Operating Leases
|
|
|
Amount of
Finance Leases
|
|
|
Total
|
|
Remainder of 2020
|
|
$
|
397
|
|
|
$
|
3
|
|
|
$
|
400
|
|
2021
|
|
|
447
|
|
|
|
4
|
|
|
|
451
|
|
2022
|
|
|
388
|
|
|
|
3
|
|
|
|
391
|
|
2023
|
|
|
325
|
|
|
|
3
|
|
|
|
328
|
|
2024
|
|
|
261
|
|
|
|
3
|
|
|
|
264
|
|
Thereafter
|
|
|
771
|
|
|
|
21
|
|
|
|
792
|
|
Total lease payment
|
|
|
2,589
|
|
|
|
37
|
|
|
|
2,626
|
|
Less: imputed undiscounted interest(c)
|
|
|
482
|
|
|
|
10
|
|
|
|
492
|
|
Present value of lease liabilities
|
|
$
|
2,107
|
|
|
$
|
27
|
|
|
$
|
2,134
|
|
(c)
|
As the rate implicit in the lease cannot be readily determined, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the imputed interest and present value of lease payments. We used the incremental borrowing rate on January 1, 2019 for operating leases that commenced prior to that date.
|
As of March 31, 2020, we have additional lease agreements that have been signed but not yet commenced, with total undiscounted minimum lease payments of $109 million. These leases will commence between the second quarter of 2020 and 2023 with lease terms of 1 year to 20 years.
Note 11 – Fair Value Measurements and Disclosures
The Company’s financial assets and liabilities primarily consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and lease liabilities, and the carrying values of these assets and liabilities approximate their fair value in general.
The Company accounts for its investment in the equity securities of Meituan at fair value, which is determined based on the closing market price for the shares at the end of each reporting period, with subsequent fair value changes recorded in our Condensed Consolidated Statements of Income.
20
The following table is a summary of our financial assets measured on a recurring basis or disclosed at fair value and the level within the fair value hierarchy in which the measurement falls. The Company classifies its cash equivalents, short-term investments and investment in equity securities within Level 1 or Level 2 in the fair value hierarchy because it uses quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value, respectively. No transfers among the levels within the fair value hierarchy occurred during the quarters ended March 31, 2020 and 2019.
|
|
|
|
|
|
Fair Value Measurement or Disclosure
at March 31, 2020
|
|
|
|
|
Balance at
March 31, 2020
|
|
|
Level 1
|
|
|
|
|
Level 2
|
|
|
|
|
Level 3
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time deposits
|
|
$
|
440
|
|
|
$
|
—
|
|
|
|
|
$
|
440
|
|
|
|
|
$
|
—
|
|
|
Money market funds
|
|
|
182
|
|
|
|
182
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash equivalents
|
|
|
622
|
|
|
|
182
|
|
|
|
|
|
440
|
|
|
|
|
|
—
|
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time deposits
|
|
|
440
|
|
|
|
|
|
|
|
|
|
440
|
|
|
|
|
|
|
|
|
Fixed rate debt securities(a)
|
|
|
50
|
|
|
|
|
|
|
|
|
|
50
|
|
|
|
|
|
|
|
|
Total short-term investments
|
|
|
490
|
|
|
|
—
|
|
|
|
|
|
490
|
|
|
|
|
|
—
|
|
|
Other assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in equity securities
|
|
|
102
|
|
|
|
102
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,214
|
|
|
$
|
284
|
|
|
|
|
$
|
930
|
|
|
|
|
$
|
—
|
|
|
(a)
|
Classified as held-to-maturity investments and measured at amortized cost.
|
|
|
|
|
|
|
Fair Value Measurement or Disclosure
at December 31, 2019
|
|
|
|
|
Balance at
December 31, 2019
|
|
|
Level 1
|
|
|
|
|
Level 2
|
|
|
|
|
Level 3
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time deposits
|
|
$
|
407
|
|
|
|
|
|
|
|
|
$
|
407
|
|
|
|
|
|
|
|
|
Money market funds
|
|
|
331
|
|
|
|
331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash equivalents
|
|
|
738
|
|
|
|
331
|
|
|
|
|
|
407
|
|
|
|
|
|
—
|
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time deposits
|
|
|
611
|
|
|
|
|
|
|
|
|
|
611
|
|
|
|
|
|
|
|
|
Total short-term investments
|
|
|
611
|
|
|
|
|
|
|
|
|
|
611
|
|
|
|
|
|
|
|
|
Other assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in equity securities
|
|
|
110
|
|
|
|
110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,459
|
|
|
$
|
441
|
|
|
|
|
$
|
1,018
|
|
|
|
|
$
|
—
|
|
|
Non-Recurring Fair Value Measurements
In addition, certain of the Company’s restaurant-level assets (including operating lease ROU assets, property, plant and equipment), goodwill and intangible assets, are measured at fair value based on unobservable inputs (Level 3) on a non-recurring basis, if determined to be impaired.
21
In determining the fair value of restaurant-level assets, the Company considered the highest and best use of the assets from market participants’ perspective, which is represented by the higher of the forecasted discounted cash flows from operating restaurants and the price market participants would pay to sub-lease the ROU assets and acquire remaining restaurants assets, even if that use differs from the current use by the Company. The after-tax cash flows incorporate reasonable assumptions we believe a franchisee would make, such as sales growth, and include a deduction for royalties we would receive under a franchise agreement with terms substantially at market. The discount rate used in the fair value calculation is our estimate of the required rate-of-return that a franchisee would expect to receive when purchasing a similar restaurant and the related long-lived assets. In situations where the highest and best use of restaurant-level assets are represented by sub-leasing the operating lease ROU assets and acquiring remaining restaurant assets, the Company continues to use these assets in operating its restaurant business, which is consistent with its long-term strategy of growing revenue through operating restaurant concepts.
As a result of adopting ASU 2018-13 in the first quarter of 2020, the following disclosure was included in relation to significant unobservable inputs used in the fair value measurement. As of March 31, 2020, the fair value of restaurant-level assets, if determined to be impaired, are primarily represented by the price market participant would pay to sub-lease the operating lease ROU assets and acquire remaining restaurants assets, which reflects the highest and best use of the assets. Significant unobservable inputs used in the fair value measurement include market rental prices, which were valued by an independent valuation specialist. The direct comparison approach is used as the valuation technique by assuming sub-lease of each of these properties in its existing state with vacant possession. By making reference to lease transactions as available in the relevant market, comparable properties in close proximity have been selected and adjustments have been made to account for the difference in factors such as location and property size.
The following table presents amounts recognized from all non-recurring fair value measurements based on unobservable inputs (Level 3) during the quarters ended March 31, 2020 and 2019. These amounts exclude fair value measurements made for restaurants that were subsequently closed or refranchised prior to those respective period-end dates.
|
Quarter Ended
|
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
|
Account Classification
|
Restaurant-level impairment(a)
|
$
|
9
|
|
|
$
|
12
|
|
|
Closure and impairment expenses, net
|
ROU impairment prior to the adoption of ASC 842(b)
|
|
—
|
|
|
|
82
|
|
|
Retained Earnings
|
Total
|
$
|
9
|
|
|
$
|
94
|
|
|
|
(a)
|
Restaurant-level impairment charges are recorded in Closure and impairment expenses, net and resulted from our impairment evaluation of long-lived assets of individual restaurants that were being operated at the time of impairment and had not been offered for refranchising. We performed an additional impairment evaluation in the first quarter of 2020, considering the adverse economic effects of the COVID-19 pandemic an impairment indicator. We also performed an additional impairment evaluation upon adoption of ASC 842 in the first quarter of 2019. The remaining net book value of assets measured at fair value for the quarter ended March 31, 2020 was $29 million and the remaining net book value of assets measured at fair value for the quarter ended March 31, 2019 was insignificant.
|
(b)
|
ROU impairment prior to the adoption of ASC 842 represents an impairment charge on operating lease ROU assets arising from existing operating leases as of January 1, 2019. After netting with the related impact on deferred taxes of $19 million and the impact on noncontrolling interests of $3 million, we recorded a cumulative adjustment of $60 million to retained earnings in accordance with the transition guidance for the new lease standard. For those restaurants under operating leases with full impairment on their long-lived assets (primarily property, plant and equipment) before January 1, 2019, an additional impairment charge would have been recorded before January 1, 2019 had the operating lease ROU assets been recognized at the time of impairment.
|
22
Note 12 – Income Taxes
|
|
Quarter Ended
|
|
|
|
3/31/2020
|
|
|
3/31/2019
|
|
Income tax provision
|
|
$
|
32
|
|
|
$
|
93
|
|
Effective tax rate
|
|
|
32.7
|
%
|
|
|
28.9
|
%
|
The higher effective tax rate for the quarter ended March 31, 2020 was primarily due to a non-deductible loss in the first quarter of 2020, while non-taxable gain in the first quarter of 2019 related to our investment in equity securities of Meituan.
In December 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Tax Act”), which included a broad range of tax reforms. The U.S. Treasury Department and IRS released the final transition tax regulations in the first quarter of 2019. We completed the evaluation of the impact on our transition tax computation based on the final regulations released in the first quarter of 2019 and recorded an additional amount of $8 million for the transition tax accordingly.
The Tax Act requires a U.S. shareholder to be subject to tax on Global Intangible Low Taxed Income ("GILTI") earned by certain foreign subsidiaries. We have elected the option to account for current year GILTI tax as a period cost as incurred, and therefore included it in estimating the annual effective tax rate.
In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was enacted on March 27, 2020 in the U.S., includes measures to assist companies, including temporary changes to income and non-income-based tax laws. For the quarter ended March 31, 2020, the CARES Act had no material tax impact on our Condensed Consolidated Financial Statements. We continue to monitor additional guidance issued by the U.S. Treasury Department, the IRS and others.
We are subject to reviews, examinations and audits by Chinese tax authorities, the IRS and other taxing authorities with respect to income and non-income based taxes. Since 2016, we have been under a national audit on transfer pricing by the Chinese State Taxation Administration (“STA”) in China regarding our related party transactions for the period from 2006 to 2015. The information currently exchanged with the tax authorities focuses on our franchise arrangement with YUM. We have submitted information to the extent it is available to the Company. It is reasonably possible that there could be significant developments, including expert review and assessment by the STA, within the next 12 months. The ultimate assessment will depend upon further review of the information provided and ongoing technical and other discussions with the STA and in-charge local tax authorities, and therefore it is not possible to reasonably estimate the potential impact. We will continue to defend our transfer pricing position. However, if the STA prevails in the assessment of additional tax due based on its ruling, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations and cash flows.
23
Note 13 –Segment Reporting
We have two reportable segments: KFC and Pizza Hut. Our remaining six non-reportable operating segments, including the operations of Little Sheep, COFFii & JOY, East Dawning, Taco Bell, Daojia, and our e-commerce business, are combined and referred to as All Other Segments, as these operating segments are insignificant both individually and in aggregate.
|
|
Quarter Ended 3/31/2020
|
|
Revenues
|
|
KFC
|
|
|
Pizza Hut
|
|
|
All Other
Segments
|
|
|
Corporate
and
Unallocated(a)
|
|
|
Combined
|
|
|
Elimination
|
|
|
Consolidated
|
|
Revenue from external
customers
|
|
$
|
1,269
|
|
|
$
|
324
|
|
|
$
|
21
|
|
|
$
|
140
|
|
|
|
1,754
|
|
|
$
|
—
|
|
|
$
|
1,754
|
|
Inter-segment revenue
|
|
|
—
|
|
|
|
—
|
|
|
|
7
|
|
|
|
—
|
|
|
|
7
|
|
|
|
(7
|
)
|
|
|
—
|
|
Total
|
|
$
|
1,269
|
|
|
$
|
324
|
|
|
$
|
28
|
|
|
$
|
140
|
|
|
$
|
1,761
|
|
|
$
|
(7
|
)
|
|
$
|
1,754
|
|
|
|
Quarter Ended 3/31/2019
|
|
Revenues
|
|
KFC
|
|
|
Pizza Hut
|
|
|
All Other
Segments
|
|
|
Corporate
and
Unallocated(a)
|
|
|
Combined
|
|
|
Elimination
|
|
|
Consolidated
|
|
Revenue from external
customers
|
|
$
|
1,592
|
|
|
$
|
543
|
|
|
$
|
23
|
|
|
$
|
146
|
|
|
|
2,304
|
|
|
$
|
—
|
|
|
$
|
2,304
|
|
Inter-segment revenue
|
|
|
—
|
|
|
|
—
|
|
|
|
9
|
|
|
|
—
|
|
|
|
9
|
|
|
|
(9
|
)
|
|
|
—
|
|
Total
|
|
$
|
1,592
|
|
|
$
|
543
|
|
|
$
|
32
|
|
|
$
|
146
|
|
|
$
|
2,313
|
|
|
$
|
(9
|
)
|
|
$
|
2,304
|
|
|
|
Quarter Ended
|
|
Operating Profit (Loss)
|
|
3/31/2020
|
|
|
3/31/2019
|
|
KFC(b)
|
|
$
|
153
|
|
|
$
|
288
|
|
Pizza Hut
|
|
|
(28
|
)
|
|
|
50
|
|
All Other Segments
|
|
|
(10
|
)
|
|
|
(5
|
)
|
Unallocated revenues from transactions with
franchisees and unconsolidated affiliates(c)
|
|
|
139
|
|
|
|
145
|
|
Unallocated Other revenues
|
|
|
1
|
|
|
|
1
|
|
Unallocated expenses from transactions with
franchisees and unconsolidated affiliates(c)
|
|
|
(135
|
)
|
|
|
(143
|
)
|
Unallocated Other operating costs and expenses
|
|
|
(1
|
)
|
|
|
(1
|
)
|
Unallocated and corporate G&A expenses
|
|
|
(21
|
)
|
|
|
(33
|
)
|
Unallocated Other (loss) income
|
|
|
(1
|
)
|
|
|
1
|
|
Operating Profit
|
|
$
|
97
|
|
|
$
|
303
|
|
Interest income, net(a)
|
|
|
9
|
|
|
|
9
|
|
Investment (loss) gain(a)
|
|
|
(8
|
)
|
|
|
10
|
|
Income Before Income Taxes
|
|
$
|
98
|
|
|
$
|
322
|
|
|
|
Quarter Ended
|
|
Impairment Charges
|
|
3/31/2020
|
|
|
3/31/2019
|
|
KFC(d)
|
|
$
|
4
|
|
|
$
|
8
|
|
Pizza Hut(d)
|
|
|
6
|
|
|
|
5
|
|
All Other Segments(d)
|
|
|
2
|
|
|
$
|
1
|
|
|
|
$
|
12
|
|
|
$
|
14
|
|
24
|
|
Total Assets
|
|
|
|
3/31/2020
|
|
|
12/31/2019
|
|
KFC(e)
|
|
$
|
3,034
|
|
|
$
|
3,160
|
|
Pizza Hut
|
|
|
887
|
|
|
|
950
|
|
All Other Segments
|
|
|
158
|
|
|
|
166
|
|
Corporate and Unallocated(f)
|
|
|
2,498
|
|
|
|
2,674
|
|
|
|
$
|
6,577
|
|
|
$
|
6,950
|
|
(a)
|
Amounts have not been allocated to any segment for performance reporting purposes.
|
(b)
|
Includes equity income from investments in unconsolidated affiliates of $20 million and $23 million for the quarters ended March 31, 2020 and 2019, respectively.
|
(c)
|
Primarily includes revenues and associated expenses of transactions with franchisee and unconsolidated affiliates derived from the Company’s central procurement model whereby the Company centrally purchases substantially all food and paper products from suppliers and then sells and delivers to restaurants, including franchisees and unconsolidated affiliates. Amounts have not been allocated to any segment for purposes of making operating decisions or assessing financial performance as the transactions are deemed corporate revenues and expenses in nature.
|
(d)
|
Primarily includes store closure impairment charges, restaurant-level impairment charges resulting from our additional impairment evaluation performed in the first quarter of 2020 in response to adverse impact from the COVID-19 pandemic, and additional impairment evaluation performed in the first quarter of 2019 as a result of adopting ASC 842 (See Note 11).
|
(e)
|
Includes investments in unconsolidated affiliates.
|
(f)
|
Primarily includes cash and cash equivalents, short-term investments, investment in equity securities, and inventories that are centrally managed.
|
Note 14 – Contingencies
Indemnification of China Tax on Indirect Transfers of Assets
In February 2015, the STA issued Bulletin 7 on Income arising from Indirect Transfers of Assets by Non-Resident Enterprises. Pursuant to Bulletin 7, an “indirect transfer” of Chinese taxable assets, including equity interests in a Chinese resident enterprise, by a non-resident enterprise, may be recharacterized and treated as a direct transfer of Chinese taxable assets, if such arrangement does not have reasonable commercial purpose and the transferor has avoided payment of Chinese enterprise income tax. As a result, gains derived from such an indirect transfer may be subject to Chinese enterprise income tax at a rate of 10%.
YUM concluded and we concurred that it is more likely than not that YUM will not be subject to this tax with respect to the pro rata distribution of all outstanding shares of Yum China common stock to shareholders of YUM in connection with the separation (the “distribution”). However, there are significant uncertainties regarding what constitutes a reasonable commercial purpose, how the safe harbor provisions for group restructurings are to be interpreted and how the taxing authorities will ultimately view the distribution. As a result, YUM’s position could be challenged by Chinese tax authorities resulting in a 10% tax assessed on the difference between the fair market value and the tax basis of the separated China business. As YUM’s tax basis in the China business is minimal, the amount of such a tax could be significant.
25
Any tax liability arising from the application of Bulletin 7 to the distribution is expected to be settled in accordance with the tax matters agreement between the Company and YUM. Pursuant to the tax matters agreement, to the extent any Chinese indirect transfer tax pursuant to Bulletin 7 is imposed, such tax and related losses will be allocated between YUM and the Company in proportion to their respective share of the combined market capitalization of YUM and the Company during the 30 trading days after the separation. Such a settlement could be significant and have a material adverse effect on our results of operations and our financial condition. At the inception of the tax indemnity being provided to YUM, the fair value of the non-contingent obligation to stand ready to perform was insignificant and the liability for the contingent obligation to make payment was not probable or estimable.
Guarantees for Franchisees and Unconsolidated Affiliates
From time to time we have guaranteed certain lines of credit and loans of franchisees and unconsolidated affiliates. As of March 31, 2020, guarantees on behalf of franchisees were immaterial and no guarantees were outstanding for unconsolidated affiliates.
Legal Proceedings
The Company is subject to various lawsuits covering a variety of allegations from time to time. The Company believes that the ultimate liability, if any, in excess of amounts already provided for these matters in the Condensed Consolidated Financial Statements, is not likely to have a material adverse effect on the Company’s results of operations, financial condition or cash flows. Matters faced by the Company from time to time include, but are not limited to, claims from landlords, employees, customers and others related to operational, contractual or employment issues.
Note 15 – Subsequent Events
Acquisition of a Controlling Interest in Huang Ji Huang
In April 2020, the Company completed the acquisition of a controlling interest in the Huang Ji Huang group, a leading Chinese-style casual dining franchise business, for cash consideration of approximately $185 million. Upon completion of the acquisition, the Company held a 93.3% interest in Huang Ji Huang group. Founded in 2004 and headquartered in Beijing, Huang Ji Huang has over 640 restaurants in China and internationally. The acquisition was considered immaterial. As of the date of this filing, the Company has not yet completed the fair value assessment on the determination of identifiable assets acquired and the liabilities assumed in the acquisition.
Acquisition of Additional Interest in Unconsolidated Affiliate
In April 2020, the Company entered into a definitive agreement to acquire an additional 25% equity interest in an unconsolidated affiliate that operates KFC stores in and around Suzhou, China (“Suzhou KFC”), for cash consideration of approximately $149 million. Upon closing of the acquisition in the second half of the year, subject to the satisfaction of closing conditions, the Company is expected to increase its equity interest to 72%, allowing the Company to consolidate Suzhou KFC. The acquisition was considered immaterial.
26