Luckin Coffee(US:LKNCY)2021-09-20 16:00PART I ITEM 3. KEY INFORMATION This section presents selected financial data for fiscal years 2018, 2019, and 2020, including significant net losses and negative operating cash flows, alongside detailed risk factors related to fabricated transactions, legal proceedings, and regulatory environments 3.A. Selected Financial Data The company's total net revenues grew from RMB 3.02 billion in 2019 to RMB 4.03 billion in 2020, yet net loss attributable to shareholders widened to RMB 5.59 billion, driven by approximately RMB 2.4 billion in provisions for SEC and equity litigant settlements, with operating cash flow remaining negative Selected Consolidated Statements of Comprehensive Loss (2018-2020) | Indicator | 2018 (RMB thousands) | 2019 (RMB thousands) | 2020 (RMB thousands) | | :--- | :--- | :--- | :--- | | Total net revenues | 840,695 | 3,024,934 | 4,033,418 | | Operating loss | (1,598,006) | (3,212,115) | (2,587,268) | | Net loss | (1,619,152) | (3,160,507) | (5,602,990) | | Net loss attributable to shareholders | (3,190,334) | (3,712,596) | (5,589,105) | Selected Consolidated Balance Sheet Data (as of Dec 31) | Indicator | 2019 (RMB thousands) | 2020 (RMB thousands) | | :--- | :--- | :--- | | Total assets | 9,762,261 | 9,322,399 | | Total liabilities | 4,619,734 | 6,597,515 | | Cash and cash equivalents | 4,865,824 | 4,806,023 | Selected Consolidated Cash Flow Data (2018-2020) | Indicator | 2018 (RMB thousands) | 2019 (RMB thousands) | 2020 (RMB thousands) | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | (1,310,694) | (2,166,970) | (2,376,832) | | Net cash used in investing activities | (1,283,218) | (1,815,890) | (1,712,333) | | Net cash generated from financing activities | 3,988,402 | 7,240,746 | 4,029,070 | - The company provides non-GAAP financial measures, such as adjusted operating loss and adjusted net loss, to exclude items like share-based compensation, impairment losses, and provisions for settlements, which management uses to evaluate operating performance4951 3.D. Risk Factors The company faces substantial risks stemming from its 2019 fabricated transactions, including numerous legal proceedings, Nasdaq delisting, and a material weakness in internal controls, alongside operational, structural, and significant regulatory risks in China and the U.S - The previously disclosed Fabricated Transactions have led to numerous legal proceedings, significant expenses, and adverse impacts on the company's reputation, operations, and ability to raise capital5557 - A material weakness in internal control over financial reporting was identified as of December 31, 2020, specifically a lack of sufficient entity-level control policies and procedures, including failures in demonstrating integrity and proper segregation of duties6465 - The company is undergoing an offshore restructuring of its indebtedness under the supervision of Joint Provisional Liquidators (JPLs) appointed by a Cayman court, with no absolute assurance of its successful completion7374 - Trading in the company's ADSs may be prohibited under the Holding Foreign Companies Accountable Act (HFCA Act) if the PCAOB is unable to inspect its auditor located in China197201 - Recent PRC government actions to strengthen supervision over U.S.-listed China-based companies, particularly concerning data security and overseas listings, may require CSRC approval for future offerings and could materially impact the company202206207 ITEM 4. INFORMATION ON THE COMPANY This section details Luckin Coffee's history, including its 2019 IPO, 2020 Nasdaq delisting, and subsequent restructuring efforts, along with a business overview of its technology-driven new retail model, store network, product offerings, organizational structure, and the complex regulatory landscape in China 4.A. History and Development of the Company Founded in 2017, Luckin Coffee Inc. rapidly grew, completing its IPO in May 2019, but was delisted from NASDAQ in July 2020 following a financial fabrication scandal, leading to the appointment of Joint Provisional Liquidators and subsequent restructuring agreements with bondholders and investors - The company was delisted from Nasdaq on July 1, 2020, and its ADSs have since been quoted on the OTC Pink market under the symbol 'LKNCY'271 - In July 2020, 'light-touch' Joint Provisional Liquidators (JPLs) were appointed by a Cayman court to supervise the company's operations and oversee a restructuring of its financial obligations272 - In March 2021, the company entered into a Restructuring Support Agreement (RSA) with a majority of its convertible note holders, aiming for a recovery of 91%-96% of par value for them273 - In April 2021, the company secured an investment agreement for approximately $250 million from Centurium Capital and Joy Capital, with proceeds intended to facilitate the restructuring and fulfill obligations under the SEC settlement275 4.B. Business Overview Luckin Coffee operates one of China's largest coffee networks, pioneering a technology-driven model focused on high quality, convenience, and affordability through mobile apps and a network of primarily small-format pick-up stores, supplemented by a retail partnership model, while being subject to extensive PRC regulations - The company's business model is built on mobile apps for a cashier-less environment and a store network focused on pick-up stores (96.5% of total self-operated stores as of Dec 31, 2020) to ensure convenience and low operating costs282293 - As of July 31, 2021, the company had 4,030 self-operated stores, 1,293 partnership stores, and 752 Luckin Coffee EXPRESS machines, with over 78.4 million cumulative transacting customers286 - Technology is central to the business, used for customer engagement, simplifying store operations, inventory management, and supply chain optimization284348 - The company launched a retail partnership model in September 2019 to expand its footprint, particularly in lower-tier cities, with 874 partnership stores in operation by the end of 2020310311 - The business is subject to a wide range of PRC regulations, including the recently effective Data Security Law and the upcoming Personal Information Protection Law, which govern data collection, use, and security354402403 4.C. Organizational Structure Luckin Coffee Inc., a Cayman Islands holding company, operates in China through its PRC subsidiaries and a Variable Interest Entity (VIE), Beijing Luckin Coffee Technology Ltd., controlled via contractual arrangements to hold foreign-restricted licenses and manage economic benefits - The company uses a VIE structure to hold certain foreign-restricted licenses, such as the ICP license, which may be needed for future operations436 - Control over the VIE is maintained through a series of contractual agreements, including a Proxy Agreement, Share Pledge Agreement, Master Exclusive Service Agreement, and Exclusive Option Agreement441444445447 - The nominal shareholders of the VIE as of the report date were Ms. Jenny Zhiya Qian and Mr. Min Chen, both of whom were terminated from the company, and the company is in the process of replacing them439848 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section provides management's discussion and analysis of the company's financial condition and results of operations, highlighting a 33.3% increase in net revenues to RMB 4.03 billion in 2020, driven by higher average selling prices and customer growth, despite a significant widening of net loss to RMB 5.60 billion due to large provisions for legal settlements 5.A. Operating Results In 2020, net revenues increased by 33.3% to RMB 4.03 billion, primarily due to higher average selling prices and customer growth, with significant revenue growth from partnership stores, though operating expenses rose to RMB 6.62 billion, and net loss widened to RMB 5.60 billion due to substantial provisions for legal settlements and impairment of trust investments Key Operating Data (Q4 2019 vs Q4 2020) | Indicator | Q4 2019 | Q4 2020 | | :--- | :--- | :--- | | Total self-operated stores | 4,507 | 3,929 | | Total partnership stores | 282 | 874 | | Cumulative transacting customers (thousands) | 40,608.9 | 64,915.6 | | Avg. monthly items sold in self-op stores (thousands) | 33,273.4 | 31,632.2 | | Avg. monthly items sold in partnership stores (thousands) | 594.7 | 6,068.7 | - Net revenues grew 33.3% year-over-year to RMB 4,033.4 million in 2020, driven by increased average selling prices, growth in transacting customers, and a significant increase in revenue from partnership stores487492 - Operating expenses in 2020 included RMB 475.3 million in losses and expenses related to the Fabricated Transactions and restructuring, covering legal fees, investigation costs, and regulatory penalties505 - The company recorded significant one-time provisions in 2020: RMB 1,177.1 million for the SEC settlement, RMB 1,226.1 million for equity litigants settlement, and RMB 1,140.0 million for the impairment of trust investments510511512 5.B. Liquidity and Capital Resources The company's primary liquidity source has been cash from historical equity and debt financings, with cash, cash equivalents, and restricted cash totaling RMB 4.94 billion as of December 31, 2020, despite net cash used in operating activities of RMB 2.38 billion and net cash used in investing activities of RMB 1.71 billion, offset by RMB 4.03 billion from financing activities Summary of Cash Flows (2019 vs 2020) | Indicator | 2019 (RMB thousands) | 2020 (RMB thousands) | | :--- | :--- | :--- | | Net cash used in operating activities | (2,166,970) | (2,376,832) | | Net cash used in investing activities | (1,815,890) | (1,712,333) | | Net cash generated from financing activities | 7,240,746 | 4,029,070) | | Cash and restricted cash at end of year | 4,981,429 | 4,939,045 | - The company believes its current cash and anticipated cash flow will be sufficient to meet its working capital and capital expenditure needs for at least the next 12 months553 - Capital expenditures decreased to RMB 822.3 million in 2020 from RMB 1,614.2 million in 2019, primarily for property and equipment558 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section outlines significant leadership changes following the 2020 financial scandal, with Dr. Jinyi Guo appointed Chairman and CEO, details the Board's composition and committees, executive compensation, equity incentive plans, employee headcount, and the dual-class share ownership structure, where Centurium Capital holds 43.5% of total voting power 6.A. Directors and Senior Management Following the financial fabrication scandal, the company reformed its leadership, terminating former CEO Jenny Zhiya Qian and COO Jian Liu, and removing former Chairman Charles Zhengyao Lu, with Dr. Jinyi Guo now serving as Chairman and CEO, leading a new senior management team and a Board comprising three other executives and four independent directors - The company underwent a significant leadership overhaul in July 2020, terminating the former CEO and COO and removing the former Chairman due to their involvement in the Fabricated Transactions570 - Dr. Jinyi Guo, a co-founder, was appointed Chairman of the Board and CEO in July 2020571 6.B. Compensation In 2020, aggregate cash compensation for executive officers was RMB 26.6 million and for non-executive directors was RMB 3.1 million, with the company adopting a new 2021 Equity Incentive Plan authorizing up to 222.8 million Class A ordinary shares for issuance, under which 4.2 million restricted share units have been granted - In 2020, the company paid RMB 26.6 million in cash to its executive officers and RMB 3.1 million to its non-executive directors582 - The company adopted a new 2021 Equity Incentive Plan in January 2021, authorizing up to 222,769,232 Class A ordinary shares for awards597 6.C. Board Practices The Board of Directors consists of seven members, including four independent directors, and has established an Audit Committee, a Compensation Committee, and a Nominating and Corporate Governance Committee, each with specific charters and responsibilities, with the Audit Committee composed entirely of independent directors, and Mr. Sean Shao designated as an 'audit committee financial expert' - The Board consists of seven directors, four of whom are independent610 - The company has three key board committees: Audit, Compensation, and Nominating and Corporate Governance612 - The Audit Committee is comprised of four independent directors, and Mr. Sean Shao is designated as the 'audit committee financial expert'613 6.D. Employees As of December 31, 2020, Luckin Coffee had 8,590 full-time and 12,718 part-time employees, all based in China, representing a decrease from year-end 2019, with the majority of full-time staff involved in store operations Employee Headcount (as of Dec 31) | Employee Type | 2019 | 2020 | | :--- | :--- | :--- | | Full-time | 12,007 | 8,590 | | Part-time | 18,114 | 12,718 | 6.E. Share Ownership As of July 31, 2021, the company had a dual-class share structure with 1.88 billion Class A shares and 144.8 million Class B shares outstanding, with Centurium Capital beneficially owning 100% of the Class B shares, granting it 43.5% of the aggregate voting power, while other major shareholders included entities in liquidation and Joy Capital - The company has a dual-class share structure where Class A shares have one vote and Class B shares have ten votes239690 - As of July 31, 2021, Centurium Capital beneficially owned 100% of the outstanding Class B ordinary shares, representing 43.5% of the company's total voting power628632 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section details transactions with related parties, primarily entities affiliated with former chairman Mr. Charles Zhengyao Lu, including services received from UCAR Inc. and QWOM, guarantees provided by former management for credit facilities, and notably, two fully impaired trust investments totaling RMB 1.14 billion made in March 2020 that benefited Mr. Lu's affiliated entities - The company engaged in transactions with entities controlled by former chairman Mr. Charles Zhengyao Lu, including renting office space from UCAR Inc. and receiving advertising services from QWOM641643 - In March 2020, under the direction of former management, the company made two trust investments totaling RMB 1.14 billion (US$174.7 million) into entities affiliated with Mr. Lu, which have been fully impaired645649 - Former chairman Mr. Charles Zhengyao Lu and former CEO Ms. Jenny Zhiya Qian provided personal guarantees for several credit facilities, all of which were terminated by June 2020 after the underlying borrowings were settled635638 ITEM 8. FINANCIAL INFORMATION This section focuses on legal proceedings arising from the financial fabrication scandal, including a US$180 million SEC settlement in December 2020, ongoing investigations by the U.S. Department of Justice and China's Ministry of Finance, multiple U.S. securities class action lawsuits with a binding term sheet for a US$187.5 million settlement in one federal case, and a RMB 61.0 million fine from China's SAMR - The company settled with the SEC in December 2020, agreeing to a US$180 million civil penalty for the Fabricated Transactions, which can be offset by payments made to security holders through the Cayman restructuring process6541063 - The company remains under investigation by the U.S. Department of Justice (DOJ) and China's Ministry of Finance regarding the Fabricated Transactions657661 - Multiple securities class action lawsuits were filed, with a binding term sheet entered into on September 20, 2021, to settle the primary federal class action for a global amount of US$187.5 million, subject to court approvals6626631075 - China's State Administration for Market Regulation (SAMR) imposed an aggregate fine of RMB 61.0 million on two of the company's entities and other third parties for violating anti-unfair competition laws658 ITEM 10. ADDITIONAL INFORMATION This section details the company's corporate governance and share structure, including its dual-class share system that grants disproportionate voting power to Class B shareholders, and outlines material tax consequences for investors in the Cayman Islands, PRC, and the U.S., highlighting a significant risk of being classified as a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes - The company has a dual-class share structure where each Class A ordinary share has one vote and each Class B ordinary share has ten votes, concentrating control with holders of Class B shares690 - There is a significant risk that the company will be classified as a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes, which could result in adverse tax consequences for U.S. investors260725 - If the company is deemed a PRC resident enterprise for tax purposes, it could be subject to a 25% tax on its worldwide income, and dividends paid to non-PRC shareholders could be subject to a 10% withholding tax716 ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to several market risks, primarily foreign currency exchange rate risk as revenues and most costs are in Renminbi (RMB) while some cash is held in U.S. dollars, currency convertibility risk due to PRC government controls, and interest rate risk on its interest-bearing assets and liabilities - The company faces foreign currency exchange rate risk as its revenues are in RMB but it holds some cash in USD and may need to convert currencies for dividends or debt service748749 - Currency convertibility risk exists due to PRC government controls on the remittance of RMB out of China750 PART II ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES The company defaulted on its US$460 million convertible senior notes due 2025, as the appointment of 'light-touch' Joint Provisional Liquidators (JPLs) on July 15, 2020, constituted an event of default, causing the entire principal and accrued interest to become immediately due and payable, with the company currently negotiating a restructuring of this debt with noteholders - The appointment of Joint Provisional Liquidators (JPLs) on July 15, 2020, triggered an event of default on the US$460 million convertible senior notes due 2025, making the full principal and interest immediately due762 - The company is negotiating a restructuring of the defaulted notes under a Restructuring Support Agreement (RSA) with a majority of the noteholders763 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS This section confirms no material modifications to security holders' rights and details the full utilization of net proceeds from the May 2019 IPO and January 2020 follow-on public offering for general corporate purposes - The net proceeds from the May 2019 IPO (approx. US$607.2 million) and the January 2020 follow-on offering (approx. US$419.5 million) have been fully utilized for general corporate purposes766767769770 ITEM 15. CONTROLS AND PROCEDURES Management concluded that as of December 31, 2020, the company's disclosure controls and procedures were ineffective due to a material weakness in internal control over financial reporting, specifically a lack of sufficient entity-level controls and proper segregation of duties, for which a comprehensive remediation plan is underway - Management concluded that disclosure controls and procedures were ineffective as of December 31, 2020, due to a material weakness in internal control over financial reporting772 - The identified material weakness is a 'Lack of sufficient entity level control policies and procedures, including failure to demonstrate commitment to integrity and ethical values and lack of appropriate segregation of functions and duties and approval'774 - A comprehensive remediation plan is underway, including strengthening payment and contract controls, enhancing IT security, establishing internal audit and compliance functions, and hiring key finance personnel with U.S. GAAP experience775777778780 PART III ITEM 18. FINANCIAL STATEMENTS This section contains the company's audited consolidated financial statements for fiscal years 2018, 2019, and 2020, including balance sheets, statements of comprehensive loss, shareholders' equity, and cash flows, along with detailed notes covering financial fabrication, accounting policies, legal contingencies, related party transactions, and subsequent events Consolidated Balance Sheet Highlights (As of Dec 31, 2020) | Account | Amount (RMB thousands) | Amount (US$ thousands) | | :--- | :--- | :--- | | Total Assets | 9,322,399 | 1,428,720 | | Cash and cash equivalents | 4,806,023 | 736,555 | | Total Liabilities | 6,597,515 | 1,011,113 | | Convertible senior notes | 3,001,500 | 460,000 | | Payable for SEC settlement | 1,174,500 | 180,000 | | Payable for equity litigants settlement | 1,223,438 | 187,500 | | Total Shareholders' Equity | 2,724,884 | 417,607 | Consolidated Statement of Comprehensive Loss Highlights (FY 2020) | Account | Amount (RMB thousands) | Amount (US$ thousands) | | :--- | :--- | :--- | | Total net revenues | 4,033,418 | 618,147 | | Operating loss | (2,587,268) | (396,519) | | Provision for SEC settlement | (1,177,074) | (180,394) | | Provision for equity litigants settlement | (1,226,119) | (187,911) | | Impairment of trust investments | (1,140,000) | (174,713) | | Net loss | (5,602,990) | (858,699) |