UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2017

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _________________

Commission file number 001-37762

Yum China Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	81-2421743
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)
7100 Corporate Drive Plano, Texas 75024 United States of America	16/F Two Grand Gateway 3 Hong Qiao Road Shanghai  200030 People’s Republic of China
(Address, Including Zip Code, of Principal Executive Offices) (469) 980-2898
(Registrant’s Telephone Number, Including Area Code)
Not Applicable (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ☐ Accelerated filer  ☐ 

Non-accelerated filer  ☒(Do not check if a smaller reporting company) Smaller reporting company  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐ No ☒

The number of shares outstanding of the registrant’s common stock as of March 30, 2017 was 384,334,841 shares.

Yum China Holdings, Inc.

INDEX

		Page
		No.
Part I.	Financial Information
	Item 1 – Financial Statements	3
	Condensed Consolidated and Combined Statements of Income – Quarters ended February 28, 2017 and February 29, 2016	3
	Condensed Consolidated and Combined Statements of Comprehensive Income – Quarters ended February 28, 2017 and February 29, 2016	4
	Condensed Consolidated and Combined Statements of Cash Flows – Quarters ended February 28, 2017 and February 29, 2016	5
	Condensed Consolidated Balance Sheets – February 28, 2017 and December 31, 2016	6
	Notes to Condensed Consolidated and Combined Financial Statements	7
	Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
	Item 3 – Quantitative and Qualitative Disclosures about Market Risk	27
	Item 4 – Controls and Procedures	27
Part II.	Other Information
	Item 1 – Legal Proceedings	29
	Item 1A – Risk Factors	29
	Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	29
	Item 6 – Exhibits	29
	Signatures	30

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated and Combined Statements of Income (Unaudited)

Yum China Holdings, Inc.

(in US$ millions, except for per share data)

	Quarter ended
Revenues	2/28/2017			2/29/2016
Company sales	$	1,257		$	1,278
Franchise fees and income		27			25
Total revenues		1,284			1,303
Costs and Expenses, Net
Company restaurants
Food and paper		345			385
Payroll and employee benefits		257			245
Occupancy and other operating expenses		366			402
Company restaurant expenses		968			1,032
General and administrative expenses		67			66
Franchise expenses		13			14
Refranchising gain, net		(1	)		(3	)
Other income, net		(17	)		(15	)
Total costs and expenses, net		1,030			1,094
Operating Profit		254			209
Interest income, net		2			2
Income Before Income Taxes		256			211
Income tax provision		(76	)		(62	)
Net income – including noncontrolling interests		180			149
Net income – noncontrolling interests		5			4
Net Income – Yum China Holdings, Inc.	$	175		$	145
Basic Earnings Per Common Share	$	0.45		$	0.40
Diluted Earnings Per Common Share	$	0.44		$	0.40

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

3

Condensed Consolidated and Combined Statements of Comprehensive Income (Unaudited)

Yum China Holdings, Inc.

(in US$ millions)

	Quarter ended
	2/28/2017		2/29/2016
Net income - including noncontrolling interests	$	180	$	149
Other comprehensive income, net of tax of nil:
Foreign currency gains (losses) arising during the period		22		(22	)
Comprehensive income - including noncontrolling interests		202		127
Comprehensive income - noncontrolling interests		6		4
Comprehensive Income - Yum China Holdings, Inc.	$	196	$	123

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

4

CondensedConsolidated and Combined Statements of Cash Flows (Unaudited)

Yum China Holdings, Inc.

(in US$ millions)

	Quarter ended
	2/28/2017			2/29/2016
Cash Flows – Operating Activities
Net income – including noncontrolling interests	$	180		$	149
Depreciation and amortization		64			68
Refranchising gain		(1	)		(3	)
Deferred income taxes		(1	)		(19	)
Equity income from investments in unconsolidated affiliates		(17	)		(16	)
Share-based compensation expense		3			3
Changes in accounts receivable		8			(8	)
Changes in inventories		40			17
Changes in prepaid expenses and other current assets		5			7
Changes in accounts payable and other current liabilities		31			113
Changes in income taxes payable		51			56
Other, net		(6	)		6
Net Cash Provided by Operating Activities		357			373
Cash Flows – Investing Activities
Capital spending		(74	)		(80	)
Purchases of short-term investments		(100	)		(54	)
Proceeds from refranchising of restaurants		2			7
Other, net		(1	)		(1	)
Net Cash Used in Investing Activities		(173	)		(128	)
Cash Flows – Financing Activities
Net transfers from Parent		—			7
Payment of capital lease obligation		(1	)		—
Net Cash (Used in) Provided by Financing Activities		(1	)		7
Effect of Exchange Rates on Cash and Cash Equivalents		6			(5	)
Net Increase in Cash and Cash Equivalents		189			247
Cash and Cash Equivalents - Beginning of Period		885			425
Cash and Cash Equivalents - End of Period	$	1,074		$	672
Supplemental Cash Flow Data
Cash paid for income tax		25			23

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

5

CondensedConsolidated Balance Sheets

Yum China Holdings, Inc.

(in US$ millions, except for number of shares)

	2/28/2017			12/31/2016
ASSETS	(Unaudited)
Current Assets
Cash and cash equivalents	$	1,074		$	885
Short-term investments		180			79
Accounts receivable, net		68			74
Inventories, net		231			268
Prepaid expenses and other current assets		169			120
Total Current Assets		1,722			1,426
Property, plant and equipment, net		1,627			1,647
Goodwill		80			79
Intangible assets, net		87			88
Investments in unconsolidated affiliates		37			71
Other assets		261			254
Deferred income taxes		163			162
Total Assets	$	3,977		$	3,727
LIABILITIES AND EQUITY
Current Liabilities
Accounts payable and other current liabilities	$	984		$	971
Income taxes payable		84			33
Total Current Liabilities		1,068			1,004
Capital lease obligations		28			28
Other liabilities and deferred credits		251			252
Total Liabilities		1,347			1,284
Equity
Common stock,  $0.01 par value; 1,000,000,000 shares authorized; 384,311,143 shares    and 383,344,835.42 shares issued and outstanding at February 28, 2017    and December 31, 2016, respectively		4			4
Treasury Stock		(20	)		(20	)
Additional paid-in capital		2,359			2,352
Retained earnings		215			40
Accumulated other comprehensive income		22			1
Total Equity – Yum China Holdings, Inc.		2,580			2,377
Noncontrolling interests		50			66
Total Equity		2,630			2,443
Total Liabilities and Equity	$	3,977		$	3,727

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

6

Notes to CondensedConsolidated and Combined Financial Statements (Unaudited)

(Tabular amounts in US$ millions)

Note 1 – Description of the 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 separated from Yum! Brands, Inc. (“YUM” or the “Parent”) on October 31, 2016 (the “separation”), becoming an independent publicly traded company as a result of a pro rata distribution (the “distribution”) of all outstanding shares of Yum China common stock to shareholders of YUM. On October 31, 2016, YUM’s shareholders of record as of 5:00 p.m. Eastern Time on October 19, 2016 received one share of Yum China common stock for every one share of YUM common stock held as of the record date. Yum China’s common stock began trading “regular way” under the ticker symbol “YUMC” on the New York Stock Exchange on November 1, 2016.

The Company owns, franchises or has ownership in entities that own and operate restaurants under the KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, Taco Bell, East Dawning and Little Sheep concepts (collectively, the “Concepts”). In connection with the separation of the Company from 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 Yum China, 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 sub-license 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 excluding Hong Kong, Taiwan and Macau (the “PRC” or “China”). 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 East Dawning and Little Sheep intellectual property and pay no license fee related to these concepts.

The operations of each Concept represent an operating segment of the Company. We have two reportable segments: KFC and Pizza Hut Casual Dining. Our remaining operating segments, including the operations of Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate.  

Note 2 – Basis of Presentation

In connection with our separation from YUM, the direct and indirect equity interests of all of our operating subsidiaries and intermediate holding companies were transferred from YUM to Yum China, when Yum China was still one of YUM’s subsidiaries, through a series of transactions, which were completed in August 2016. The Company separated from YUM on October 31, 2016, becoming an independent publicly traded company as a result of a pro rata distribution of all outstanding shares of Yum China common stock to shareholders of YUM.

The financial statements presented herein represent (i) for periods prior to October 31, 2016, the combined financial statements of YUM’s China businesses and operations when Yum China was a wholly owned subsidiary of YUM (referred to as “Condensed Combined Financial Statements”) and (ii) for periods subsequent to October 31, 2016, the consolidated financial statements of the Company as a separate publicly traded company following its separation from YUM (referred to as “Condensed Consolidated Financial Statements” and, together with the Condensed Combined Financial Statements, referred to as the “Condensed Consolidated and Combined Financial Statements”).

Our preparation of the accompanying Condensed Consolidated and Combined 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.

7

The accompanying Condensed Combined Financial Statements have been prepared on a standalone basis and are derived from YUM’s consolidated financial statements and underlying accounting records. Transactions between the Company and YUM that were not cash settled were considered to be effectively settled at the time the transactions are recorded. The Condensed Combined Financial Statements include all revenues, costs, assets and liabilities directly attributable to the Company either through specific identification or allocation. The Condensed Combined Statements of Income include allocations for certain of YUM’s Corporate functions which provided a direct benefit to the Company. These costs have been allocated based on Company system sales relative to YUM’s global system sales. System sales includes the sales results of all restaurants regardless of ownership. All allocated costs have been deemed to have been paid to YUM in the period in which the costs were recorded. The Company considers the cost allocation methodology and results to be reasonable for the periods prior to October 31, 2016. However, the allocations may not be indicative of the actual expense that would have been incurred had the Company operated as an independent, publicly traded company for the periods prior to October 31, 2016. Upon the separation, Parent Company Investment was adjusted as a result of settlement of certain assets and liabilities with YUM and formed the Company’s common stock and additional paid-in capital. See Note 3 for further discussion.

We have prepared the Condensed Consolidated and Combined 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 and Combined Financial Statements include all normal and recurring adjustments considered necessary to present fairly our financial position as of February 28, 2017, and the results of our operations, comprehensive income and cash flows for the quarters ended February 28, 2017 and February 29, 2016. 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 and Combined Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the SEC on March 8, 2017.

Certain comparative items in the Condensed Consolidated and Combined Financial Statements have been reclassified to conform to the current period’s presentation to facilitate comparison.

Our fiscal year ends on December 31. The Company operates on a fiscal monthly calendar, with two months in the first quarter, three months in the second and third quarters and four months in the fourth quarter.

Note 3 – Transactions with YUM

Prior to the separation, there existed a parent-subsidiary relationship between YUM and the Company. We had the following transactions with YUM for the quarter ended February 29, 2016:

Allocation of Corporate Expenses

YUM historically performed centralized corporate functions on our behalf prior to October 31, 2016. Accordingly, certain YUM costs have been allocated to the Company and reflected as expenses in the Condensed Combined Financial Statements. Management considers the allocation methodologies used to be reasonable and appropriate reflections of the historical expenses attributable to the Company. The expenses reflected in the Condensed Combined Financial Statements may not be indicative of the actual expenses that would have been incurred during the periods presented if we had operated as a separate, standalone entity.

Corporate expense allocations primarily relate to centralized corporate functions, including finance, accounting, treasury, tax, legal, internal audit and risk management functions. In addition, corporate expense allocations include, among other costs, IT maintenance, professional fees for legal services and expenses related to litigation, investigations or similar matters. Corporate allocations of $3 million were allocated to the Company during the quarter ended February 29, 2016, and have been included in general and administrative (“G&A”) expenses in the Condensed Combined Statements of Income. All of the corporate allocations of costs are deemed to have been incurred and settled through Parent Company Investment in the Condensed Combined Balance Sheets in the period where the costs were recorded. Following the separation from YUM, we perform these functions using our own resources or purchased services.

8

License Fee

The Condensed Combined Statements of Income include a fee that was historically paid to YUM comprised of initial fees and continuing fees equal to 3% of our Company and franchise sales prior to October 31, 2016. License fees due to YUM for our Company-owned stores are included within restaurant margin in Occupancy and other operating expenses in the Condensed Consolidated and Combined Statements of Income.  License fees due to YUM on franchise sales are included in Franchise expenses. Total license fees paid during the quarter ended February 29, 2016 are reflected in the table below:

	Quarter ended
	2/29/2016
Initial fees - Company	$	2
Initial fees - Franchise		—
Continuing Fees - Company		38
Continuing Fees - Franchise		10
Total	$	50

Cash Management and Treasury

The Company funds its operations through cash generated from the operation of its Company-owned stores, franchise operations and dividend payments from unconsolidated affiliates. Prior to October 31, 2016, excess cash has historically been repatriated to YUM through intercompany loans or dividends. Transfers of cash both to and from YUM are included within Parent Company Investment in the Condensed Combined Balance Sheets. YUM has issued debt for general corporate purposes but in no case has any such debt been guaranteed or assumed by the Company or otherwise secured by the assets of the Company. As YUM’s debt and related interest is not directly attributable to the Company, no such amounts have been allocated to the Condensed Combined Financial Statements.

Note 4 – Earnings Per Common Share (“EPS”)

On October 31, 2016, YUM’s shareholders of record as of October 19, 2016 received one share of Yum China common stock for every one share of YUM’s common stock held as of the record date. For periods ended October 31, 2016 and prior, basic and diluted earnings per share were computed using the number of shares of Yum China common stock outstanding as of October 31, 2016, the date on which Yum China common stock was distributed to YUM’s shareholders. The same number of shares was used to calculate basic and diluted earnings per share for the quarter ended February 29, 2016 since there were no dilutive securities until after the separation.

The following table summarizes the components of basic and diluted earnings per share:

	Quarter ended
	2/28/2017		2/29/2016
Net Income – Yum China Holdings, Inc.	$	175	$	145
Weighted-average common shares outstanding (for basic calculation)(a)		387,525,034		363,758,219
Effect of dilutive share-based employee compensation(a)		7,821,987		—
Weighted-average common and dilutive potential common shares outstanding    (for diluted calculation)		395,347,021		363,758,219
Basic Earnings Per Share	$	0.45	$	0.40
Diluted Earnings Per Share	$	0.44	$	0.40
Employee stock options, stock appreciation rights and warrants excluded from the    diluted EPS computation(b)		18,448,360		—

(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 on shares of common stock 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 outstanding equity awards are included in the computation of diluted EPS, if there is dilutive effect.

9

(b) These unexercised employee stock options, stock appreciation rights and warrants were not included in the computation of diluted EPS because to do so would have been antidilutive for the quarters presented.

Note 5 – Accumulated Other Comprehensive Income (“AOCI”)

The Company’s other comprehensive income for the quarters ended February 28, 2017 and February 29, 2016 and AOCI balances as of February 28, 2017 and December 31, 2016 were comprised solely of foreign currency translation adjustments. We recognized other comprehensive income of $22 million and other comprehensive loss of $22 million for the quarters ended February 28, 2017 and February 29, 2016, respectively. The accumulated balances reported in AOCI on the Condensed Consolidated Balance Sheets for currency translation adjustments were $22 million and $1 million as of February 28, 2017 and December 31, 2016, respectively. There was no tax effect related to the components of other comprehensive income for all periods presented.

Note 6 – Items Affecting Comparability of Net Income and Cash Flows

Refranchising Gain, net

The Refranchising gain, net by reportable segment and All Other Segments is presented below. We do not allocate such gains and losses to our segments for performance reporting purposes.

	Quarter ended
	2/28/2017		2/29/2016
KFC	$	1	$	3
Pizza Hut Casual Dining		—		—
All Other Segments		—		—
Total Company	$	1	$	3

Store Closure and Impairment Activity

Store closure income and Store impairment charges by reportable segment and All Other Segments are presented below:

	Quarter ended
	2/28/2017
	Total Company			KFC			Pizza Hut Casual Dining		All Other Segments
Store closure income (a)	$	2		$	1		$	1	$	—
Store impairment charges		(2	)		(2	)		—		—
Closure and impairment expenses	$	—		$	(1	)	$	1	$	—

	Quarter ended
	2/29/2016
	Total Company			KFC			Pizza Hut Casual Dining		All Other Segments
Store closure income(a)	$	2		$	2		$	—	$	—
Store impairment charges		(2	)		(2	)		—		—
Closure and impairment expenses	$	—		$	—		$	—	$	—

(a) Store closure income include proceeds from forced store closures, lease reserves established when we cease using a property under an operating lease and subsequent adjustments to those reserves and other facility-related expenses from previously closed stores. Remaining lease obligations for closed stores were not material at February 28, 2017 or December 31, 2016.

10

Note 7 – Other Income, net

	Quarter ended
	2/28/2017		2/29/2016
Equity income from investments in unconsolidated affiliates	$	17	$	16
Foreign exchange net loss and other		—		(1	)
Other income, net	$	17	$	15

Note 8 – Supplemental Balance Sheet Information

Accounts Receivable, net	2/28/2017			12/31/2016
Accounts receivable, gross	$	70		$	76
Allowance for doubtful accounts		(2	)		(2	)
Accounts receivable, net	$	68		$	74

Prepaid Expenses and Other Current Assets	2/28/2017		12/31/2016
Prepaid rent	$	40	$	39
Other prepaid expenses and current assets(a)		129		81
Prepaid expenses and other current assets	$	169	$	120

(a) Includes receivables of $8 million and $16 million due from payment processors or aggregators as of February 28, 2017 and December 31, 2016, respectively.

Property, Plant and Equipment	2/28/2017			12/31/2016
Buildings and improvements	$	2,072		$	2,029
Capital leases, primarily buildings		30			29
Machinery and equipment		1,075			1,081
Property, plant and equipment, gross		3,177			3,139
Accumulated depreciation and amortization		(1,550	)		(1,492	)
Property, plant and equipment, net	$	1,627		$	1,647

Accounts Payable and Other Current Liabilities	2/28/2017		12/31/2016
Accounts payable	$	509		480
Accrued capital expenditures		99		132
Accrued compensation and benefits		156		191
Accrued taxes, other than income taxes		24		14
Dividends payable		22		—
Other current liabilities		174		154
Accounts payable and other current liabilities	$	984	$	971

Other Liabilities and Deferred Credits	2/28/2017		12/31/2016
Deferred escalating minimum rent	$	155	$	153
Other noncurrent liabilities and deferred credits		96		99
Other liabilities and deferred credits	$	251	$	252

11

Noncontrolling Interests

Noncontrolling interests represent the ownership interests of minority shareholders of the entities that operate KFC restaurants in Beijing and Shanghai, China. A reconciliation of the beginning and ending carrying amount of the equity attributable to noncontrolling interests is as follows:

	Noncontrolling Interests
Balance at December 31, 2016	$	66
Net income – noncontrolling interests		5
Dividends declared		(22	)
Currency translation adjustments		1
Balance at February 28, 2017	$	50

Note 9 – Fair Value Measurements

As of February 28, 2017, the carrying values of cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximated their fair values because of the short-term nature of these instruments.

In addition, certain of the Company’s assets, such as property, plant and equipment, goodwill and intangible assets, are measured at fair value on a non-recurring basis, if determined to be impaired.

During the quarter ended February 28, 2017, we recorded restaurant-level impairment (Level 3) of $2 million. The remaining net book value of the assets measured at fair value as of February 28, 2017, subsequent to these impairments, was not significant.

Note 10 – Income Taxes

	Quarter ended
	2/28/2017			2/29/2016
Income tax provision	$	76		$	62
Effective tax rate		29.9	%		29.5	%

Our effective tax rate is generally lower than the U.S. federal statutory rate of 35% due to the majority of our income being earned in China where the tax rate is lower than the U.S. rate. The slightly higher effective tax rate for the first quarter of 2017 was due to non-deductibility of certain expense items.

Note 11 – Reportable Operating Segments

We have two reportable operating segments: KFC and Pizza Hut Casual Dining. We also have four non-reportable operating segments, Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell, which are combined and referred to as All Other Segments, as these operating segments are insignificant both individually and in the aggregate. The following tables summarize Revenues and Operating Profit for each of our reportable operating segments:

	Quarter ended
Revenues	2/28/2017		2/29/2016
KFC	$	896	$	921
Pizza Hut Casual Dining		339		328
All Other Segments		49		54
Total	$	1,284	$	1,303

12

	Quarter ended
Operating Profit	2/28/2017			2/29/2016
KFC(a)	$	207		$	191
Pizza Hut Casual Dining		65			39
All Other Segments		4			—
Unallocated and corporate expenses(b)		(23	)		(24	)
Unallocated Refranchising gain(b)		1			3
Operating Profit	$	254		$	209
Interest income, net(b)		2			2
Income Before Income Taxes	$	256		$	211

(a) Includes equity income from investments in unconsolidated affiliates of $17 million and $16 million for the quarters ended February 28, 2017 and February 29, 2016, respectively.

(b) Amounts have not been allocated to any segment for performance reporting purposes.

Note 12 – Contingencies

Indemnification of China Tax on Indirect Transfers of Assets

In February 2015, the Chinese State Administration of Taxation (“SAT”) 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 distribution. However, given how recently Bulletin 7 was promulgated, 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 tax could be significant.

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 thirty 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.

Unconsolidated Affiliates Guarantees

From time to time we have guaranteed certain lines of credit and loans of unconsolidated affiliates. As of February 28, 2017, there were no guarantees outstanding for unconsolidated affiliates. Our unconsolidated affiliates had total revenues of approximately $222 million and $250 million for the quarters ended February 28, 2017 and February 29, 2016, respectively, and assets and liabilities of approximately $320 million and $242 million, respectively, at February 28, 2017.

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 and Combined Financial Statements, is not likely to have a material adverse effect on the Company’s annual 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.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

References to the Company throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (this “MD&A”) are made using the first person notations of “we,” “us” or “our.” This MD&A contains forward-looking statements, including statements with respect to the retail tax structure reform and the potential effects thereof, our evaluation of the effects of the integration of Pizza Hut Casual Dining and Pizza Hut Home Service on our reportable segments, future capital resources to fund our operations and anticipated capital expenditures and our ability to pay dividends. See “Cautionary Note Regarding Forward-Looking Statements” at the end of this Item 2 for information regarding forward-looking statements.

Introduction

Yum China Holdings, Inc. is the largest restaurant company in China, with over 7,600 restaurants as of February 28, 2017. Our growing restaurant base consists of China’s leading restaurant brands, including KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell. Following our separation from YUM, we have the exclusive right to operate and sub-license the KFC, Pizza Hut and, subject to achieving certain agreed-upon milestones, Taco Bell brands in China, excluding Hong Kong, Taiwan and Macau, and we own the East Dawning and Little Sheep marks outright. We were the first major global restaurant brand to enter China in 1987 and we have developed deep operating experience in the market. We have since grown to become one of China’s largest retail developers covering over 1,100 cities and opening an average of approximately two new restaurants per day over the past five years.

KFC is the leading Quick-Service Restaurant (“QSR”) brand in the PRC in terms of system sales and number of restaurants. As of February 28, 2017, KFC operates over 5,200 restaurants in over 1,100 cities across China.  Measured by number of restaurants, we believe KFC has a two-to-one lead over the nearest Western QSR competitor in China and KFC has continued to grow in both large and small cities. Similarly, Pizza Hut Casual Dining is the leading Casual Dining Restaurant (“CDR”) brand in China as measured by system sales and number of restaurants. We believe Pizza Hut Casual Dining, with over 1,700 restaurants in over 400 cities, has an approximately six-to-one lead in terms of number of restaurants over its nearest Western CDR competitor in China.

The operations of each of the Concepts represent an operating segment of the Company within the Condensed Consolidated and Combined Financial Statements. We have two reportable segments: KFC and Pizza Hut Casual Dining. Our remaining operating segments, including the operations of Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate.

In the first quarter of 2017, we started discussions on integrating the management and business approach for Pizza Hut Casual Dining and Pizza Hut Home Service, which would allow us to create a network of approximately 2,000 stores for pizza delivery. As we make progress on implementing changes, we will continue to evaluate the potential impact on reportable segments.

Separation from YUM

The Company separated from YUM on October 31, 2016, becoming an independent publicly traded company as a result of a pro rata distribution of all outstanding shares of Yum China common stock to shareholders of YUM. On October 31, 2016, YUM’s shareholders of record as of 5:00 p.m. Eastern Time on October 19, 2016 received one share of Yum China common stock for every one share of YUM common stock held as of the record date. Yum China’s common stock began trading “regular way” under the ticker symbol “YUMC” on the New York Stock Exchange on November 1, 2016.  

Basis of Presentation

The financial statements presented in this Form 10-Q represent (i) for periods prior to October 31, 2016, the Condensed Combined Financial Statements of YUM’s China businesses and operations when Yum China was a wholly owned subsidiary of YUM and (ii) for periods subsequent to October 31, 2016, the Condensed Consolidated Financial Statements of the Company as a separate publicly traded company following its separation from YUM. Throughout this Form 10-Q, when we refer to the “financial statements,” we are referring to the “Condensed Consolidated and Combined Financial Statements,” unless the context indicates otherwise.

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The Condensed Combined Financial Statements have been prepared on a standalone basis and are derived from YUM’s consolidated financial statements andunderlying accounting records. Transactions between the Company and YUM that were not cash settled were considered to be effectively settled at thetime the transactions are recorded. The Condensed Combined Financial Statements include all revenues, costs, assets and liabilities directly attributable to theCompany either through specific identification or allocation. The Condensed Combined Statements of Income include allocations for certain of YUM’s Corporatefunctions which provide a direct benefit to the Company. These costs have been allocated based on Company system sales relative to YUM’s globalsystem sales. All allocated costs have been deemed to have been paid to YUM in the period in which the costs were recorded. The Company considers thecost allocation methodology and results to be reasonable for the periods prior to October 31, 2016. However, the allocations may not be indicative of theactual expense that the Company would have experienced had the Company operated as an independent, publicly traded company for the periods prior toOctober 31, 2016. Upon the separation from YUM, Parent Company Investment was adjusted as a result of settlement of certain assets and liabilities withYUM and formed Yum China’s common stock and additional paid-in capital.

Overview

We intend for this MD&A to provide the reader with information that will assist in understanding our results of operations, including metrics that management uses to assess the Company's performance.  Throughout this MD&A, we discuss the following performance metrics:

• The Company provides certain percentage changes excluding the impact of foreign currency translation (“F/X”).  These amounts are derived by translating current year results at prior year average exchange rates.  We believe the elimination of the F/X impact provides better year-to-year comparability without the distortion of foreign currency fluctuations.

• System sales growth reflects the results of all restaurants regardless of ownership, including Company-owned, franchise and unconsolidated affiliate restaurants that operate our Concepts, except for non-Company-owned restaurants for which we do not receive a sales-based royalty.  Sales of franchise and unconsolidated affiliate restaurants typically generate ongoing franchise fees for the Company at a rate of approximately 6% of system sales.  Franchise and unconsolidated affiliate restaurant sales are not included in Company sales on the Condensed Consolidated and Combined Statements of Income; however, the franchise fees are included in the Company’s revenues.  We believe system sales growth is useful to investors as a significant indicator of the overall strength of our business as it incorporates all of our revenue drivers, Company and franchise same-store sales as well as net unit growth.

• Same-store sales growth is the estimated percentage change in sales of all restaurants that have been open and in the Company system one year or more.

• Company Restaurant profit (“Restaurant profit”) is defined as Company sales less expenses incurred directly by our Company-owned restaurants in generating Company sales.  Company restaurant margin percentage is defined as Restaurant profit divided by Company sales.  Within the Company Sales and Restaurant Profit analysis, Store Portfolio Actions represent the net impact of new unit openings, acquisitions, refranchising and store closures, and Other primarily represents the impact of same-store sales as well as the impact of changes in restaurant operating costs such as inflation/deflation.

• In addition to the results provided in accordance with GAAP throughout this MD&A, the Company provides Adjusted EBITDA, which we define as net income including noncontrolling interests adjusted for income tax, interest income, depreciation, amortization and other items. This non-GAAP measure is not intended to replace the presentation of our financial results in accordance with GAAP. Rather, the Company believes that the presentation of this non-GAAP measure provides additional information to investors to facilitate the comparison of past and present results.

All Note references in this MD&A refer to the Notes to the Condensed Consolidated and Combined Financial Statements. Tabular amounts are displayed in millions of U.S. dollars except percentages and per share and unit count amounts, or as otherwise specifically identified. Percentages may not recompute due to rounding. References to quarters are references to the Company’s fiscal quarters. The Company’s first fiscal quarter of 2017 and 2016 consist of the two months ended February 28, 2017 and February 29, 2016, respectively.

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Quarters ended February 28, 2017 and February 29, 2016

Results of Operations

Summary

Quarterly highlights:
	% Change
	System Sales(a)			Same-Store Sales(a)			Net New Units	Operating Profit
KFC	+3			+1			+5	+9
Pizza Hut Casual Dining	+9			+2			+9	+67
All Other Segments		(5	)		(3	)	+10	NM
Total	+4			+1			+6	+22

(a) System Sales and Same-Store Sales percentages as shown in tables exclude the impact of F/X.

The Company has over 7,600 units, predominately KFC and Pizza Hut Casual Dining restaurants, which are the leading quick service and casual dining restaurant brands, respectively, in mainland China. Given our strong competitive position, a growing economy and a population of approximately 1.4 billion in mainland China, the Company has rapidly added KFC, Pizza Hut Casual Dining and Pizza Hut Home Service restaurants.  

Company sales in the first quarter of 2017 decreased by 2%, but increased by 3% excluding the impact of F/X. The increase in Company sales during the quarter, excluding the impact of F/X, was driven by net new unit growth and same-store sales growth. The increase in Restaurant profit was primarily aided by the impact of the retail tax structure reform implemented on May 1, 2016. The benefit from the retail tax structure reform was most visible and impactful on food and paper costs while other items such as utility cost and rental expense also benefited from it.  

The Consolidated and Combined Results of Operations for the quarters ended February 28, 2017 and February 29, 2016 are presented below:

	Quarter Ended						% B/(W)(a)
	2/28/2017			2/29/2016			Reported
Company sales	$	1,257		$	1,278			(2	)
Franchise fees and income		27			25			5
Total revenues	$	1,284		$	1,303			(2	)
Restaurant profit	$	289		$	246			17
Restaurant Margin %		23.0	%		19.3	%		3.7		ppts.
Operating Profit	$	254		$	209			22
Interest income, net		2			2			47
Income tax provision		(76	)		(62	)		(23	)
Net Income - including    noncontrolling interests		180			149			21
Net Income - noncontrolling interests		5			4			10
Net Income - Yum China Holdings, Inc.	$	175