What changed in this filing

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Item 1. Legal Proceedings

2022-08-09 compared with 2022-05-06 · 37 added, 47 removed, 30 unchanged (74% of the section changed)

4 unchanged sentences

Such risks could cause our actual results to differ materially from our forward-looking statements, expectations and historical trends.

Except as set forth below, there have been no material changes from the risk factors disclosed in Part I, Item 1A.

“Risk Factors”

in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on February 28, 2022.

Except as set forth below, there have been no material changes from the risk factors disclosed in “Risk Factors”

in our Annual Report on Form 10-K for the year ended December 31, 2021 a nd Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 .

Health concerns arising from outbreaks of viruses or other illnesses may have a material adverse effect on our business.

11 unchanged sentences

Our operations and financial results of second half of 2021 were also significantly affected by multiple waves of Delta-variant outbreaks, spreading to nearly all provinces in China.

In the first quarter of 2022, the highly transmissible Omicron variant caused significant volatility in our business operations.

After a relatively stable period in January and February, the situation rapidly deteriorated in March 2022, resulting in the largest outbreak since COVID-19 first emerged in early 2020.

Compared to the first quarter of 2020, the outbreaks were more severe, in terms of case counts, duration and geographical coverage, and restrictive measures were tighter during the first quarter of 2022.

The Company incurred an operating loss in March 2022.

Looking into the second quarter of 2022, the situation has been even more challenging.

Many cities across large swaths of China have been fully or partially locked down for weeks or even months, including several economically important regions, such as Shanghai.

Drastic public health measures are being stepped up nationwide, in line with the strict enforcement of the “

dynamic zero-COVID ”

policy, resulting in further reductions of social activities, travel and consumption.

In April, over 3,000 of our stores, on average, were either temporarily closed or offered only take away and delivery service, of which approximately 50% of the stores were temporarily closed.

Same-store sales in April decreased by more than 20%.

Unless conditions significantly improve in May and June, we expect to incur an operating loss in the second quarter of 2022.

In the first quarter of 2022, the largest outbreak since COVID-19 first emerged in early 2020 caused significant volatility in our business operations.

The most severe COVID-19 outbreaks to date in China continued to significantly affect the restaurant industry and our operations in the second quarter of 2022.

During April and May, over 2,500 of our stores in China, on average, were either temporarily closed or offered only takeaway and delivery services.

Of these stores, approximately 45% were temporarily closed.

Same-store sales declined by more than 20% year over year.

We expect that our operations will continue to be impacted by the COVID-19 pandemic, including outbreaks caused by existing or new COVID-19 variants and the actions taken by governmental authorities, such as regional lockdowns, measures restricting travel and large gatherings, and recommendations against dining out.

1 unchanged sentence

Social distancing, telecommunicating and reductions in travel may become the new normal.

These conditions could fundamentally impact the way we work and the services we provide, and could have continuing adverse effects on our results of operations, cash flows and financial

condition after the pandemic subsides.

These conditions could fundamentally impact the way we work and the services we provide, and could have continuing adverse effects on our results of operations, cash flows and financial condition after the pandemic subsides.

The extent to which our operations continue to be impacted by the pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including resurgences and further spread of existing or new COVID-19 variants, the actions by the government authorities to contain the pandemic or treat its impact, the availability and effectiveness of vaccines, the economic recovery within China and globally, the impact on consumer behavior and other related factors.

7 unchanged sentences

Avian flu outbreaks could also adversely affect the price and availability of poultry, which could negatively impact our profit margins and revenues.

The audit reports included in our annual reports on Form 10-K are prepared by auditors who are not currently inspected by the Public Company Accounting Oversight Board and, as such, our stockholders are deprived of the benefits of such inspection and our common stock is subject to delisting from the New York Stock Exchange in the future.

As an auditor of companies that are publicly traded in the United States and a firm registered with the Public Company Accounting Oversight Board (“PCAOB”), our independent registered public accounting firm is required under the laws of the United States to undergo regular inspections by the PCAOB.

However, because substantially all of our operations are conducted within China, our independent registered public accounting firm’s audit documentation related to their audit reports included in our annual reports on Form 10-K is located in China.

The PCAOB is currently unable to conduct full inspections in China or review audit documentation located within China without the approval of Chinese authorities, which has not been granted.

Accordingly, the PCAOB has not inspected our independent registered public accounting firm or reviewed documentation related to the audit of our financial statements.

Inspections of other auditors conducted by the PCAOB outside of China have at times identified deficiencies in those auditors’

audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality.

The lack of PCAOB inspections of audit work undertaken in China prevents the PCAOB from evaluating our auditor’s audits and its quality control procedures.

As a result, our stockholders do not have the benefit of PCAOB inspections, and may lose confidence in our reported financial information and procedures and the quality of our financial statements.

On December 18, 2020, the Holding Foreign Companies Accountable Act (the “Act”) was signed into law.

The Act requires the SEC to prohibit the securities of any “covered issuer,”

including the Company, from being traded on any of the U.S.

securities exchanges, including the New York Stock Exchange, or traded “over-the-counter,”

if the auditor of the covered issuer’s financial statements is not subject to PCAOB inspection for three consecutive years, beginning in 2021.

On December 2, 2021, the SEC adopted final rules implementing the Act, pursuant to which the SEC will implement the trading prohibition as soon as practicable after the covered issuer has been conclusively identified as a “Commission-Identified Issuer”

for three consecutive years.

In March 2022, the Company was conclusively identified as a Commission-Identified Issuer by the SEC.

On June 22, 2021, the U.S.

Senate passed a bill which, if also passed by the U.S.

House of Representatives and signed into law, would reduce the number of consecutive non-inspection years required to trigger the trading prohibition under the Act from three years to two (the “Senate Proposed Act Amendment”).

On February 4, 2022, the U.S.

House of Representatives passed a larger bill containing provisions identical to the Senate Proposed Act Amendment which, if also passed by the U.S.

Senate and signed into law, would have the same effect (the “House Proposed Act Amendment”).

Unless the Act is amended to exclude the Company or the PCAOB is able to conduct a full inspection of our independent registered public accounting firm’s audit documentation related to their audit reports during the required timeframe, which is subject to a variety of factors outside our control including the approval of Chinese authorities, then our common stock will be delisted from the New York Stock Exchange in early 2024 or, if the House Proposed Act Amendment or Senate Proposed Act Amendment becomes law, in early 2023.

Such delisting would limit the liquidity of our common stock and our access to U.S.

capital markets, and as a result the market price of our common stock could be materially adversely affected.

On April 2, 2022, the China Securities Regulatory Commission (the “CSRC”) proposed revisions to the Provisions on Strengthening Confidentiality and Archives Administration of Overseas Securities Offering and Listing (Draft for Comments) (the “Draft Provisions”).

The Draft Provisions outline obligations of issuers listed in overseas markets with operations in China when they provide information involving state secrets or sensitive information to their securities service providers (e.g., auditors) and overseas regulators.

In addition, under the Draft Provisions, such issuers will also be required to report to the CSRC and other PRC authorities before accepting any investigation or inspection by overseas regulators.

The Draft Provisions have not yet been adopted, and it remains unclear whether any material changes will be made to the Draft Provisions before adoption, or how such measures and provisions will be enacted, interpreted or implemented and how they will affect us.

The operation of our restaurants is subject to the terms of the master license agreement which, if terminated or limited, would materially adversely affect our business, results of operations and financial condition.

Under the master license agreement with YUM, we are required to meet a Sales Growth Metric, which requires the average annual Gross Revenue (as defined in the master license agreement) for each of the KFC, Pizza Hut and Taco Bell brands for each rolling five (5) calendar year period throughout the term of the master license agreement (“Measurement Period”), beginning January 1, 2017, to exceed the annual Gross Revenue of the calendar year immediately preceding the corresponding Measurement Period (“Benchmark Year”), unless otherwise agreed by the parties.

To illustrate, the first Measurement Period was January 1, 2017 through December 31, 2021 (corresponding to the first Benchmark Year of January 1, 2016 through December 31, 2016) and the second Measurement Period is January 1, 2018 through December 31, 2022 (corresponding to the second Benchmark Year of January 1, 2017 through December 31, 2017).

The requirement regarding the Sales Growth Metric began at the end of the first Measurement Period on December 31, 2021.

Within an agreed period after the beginning of each calendar year following December 31, 2021, and during the term of the master license agreement, we are required to provide to YUM a written statement with the calculations of the Sales Growth Metric.

If our calculations indicate that any of these restaurant brands failed to meet the Sales Growth Metric (an “SGM Breach”), there is a mechanism under the master license agreement for us to explain and remediate such breach in good faith.

YUM has the right to terminate the master license agreement in the event of an SGM Breach.

In the event of two consecutive SGM Breaches for KFC, Pizza Hut or Taco Bell, YUM shall be entitled to exercise its right to eliminate or modify the exclusivity of the license granted to us and conduct and further develop the relevant restaurant brand in our licensed territory or license one or more third parties to do so.

The master license agreement may also be terminated upon the occurrence of certain events.

We do not believe there has been any material breach of the master license agreement, and we actively monitor our compliance with the terms of the master license agreement on an on-going basis.

Under the master license agreement, we have the right to cure any breach of the agreement, except for the dissolution, liquidation, insolvency or bankruptcy of the Company or upon the occurrence of an unauthorized transfer or change of control or other breach that YUM determines will not or cannot be cured.

Upon the occurrence of a non-curable breach, YUM will have the right to terminate the master license agreement (or our rights to a particular brand) on delivery of written notice.

Upon the occurrence of a curable breach, YUM will provide a notice of breach that sets forth a cure period that is reasonably tailored to the applicable breach.

If we do not cure the breach, YUM will have the right to terminate the master license agreement (or our rights to a particular brand).

The master license agreement also contemplates remedies other than termination that YUM may use as appropriate.

These remedies include:

actions for injunctive and/or declaratory relief (including specific performance) and/or damages;

limitations on our future development rights or suspension of restaurant operations pending a cure;

modification or elimination of our territorial exclusivity;

and YUM’s right to repurchase from us the business operated under an affected brand at fair market value, less YUM’s damages.

In the second quarter of 2022, we invoked the dispute resolution process pursuant to the master license agreement to resolve a disagreement with YUM over royalties charged on delivery and aggregator platform fees.

We believe, pursuant to the master license agreement, that delivery fees paid by customers for delivery services and commissions paid to third-party aggregator platforms should not be subject to royalties, and we notified YUM in April 2022 that we would stop paying royalties on such fees beginning in January 2022.

In June 2022, YUM delivered to the Company a notice of material breach of the master license agreement, demanding among other things payment of the disputed royalty amounts.

Following receipt of the notice, we paid the disputed royalty amounts under a reservation of rights, after which YUM suspended its declaration of material breaches related to payment of the disputed royalty amounts.

YUM’s notice in June 2022 also alleged, for the first time, that the Company has engaged in unauthorized use of YUM’s intellectual property under the master license agreement.

The Company believes the notice is contrary to the terms of the master license agreement and that these allegations are without merit.

The parties have submitted the dispute to mediation under the terms of the master license agreement.

If the parties are unable to resolve the dispute by mediation, then pursuant to the master license agreement, either party may submit the dispute to arbitration, while retaining all other rights and remedies, which may include the initiation of proceedings for injunctive or other equitable relief, or the exercise of contractual rights up to and including termination of the master license agreement.

If the master license agreement were terminated, or any of our license rights were limited, our business, results of operations and financial condition would be materially adversely affected.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Legal Proceedings