yumc-10q_20170531.htm

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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 June 29, 2017 was 383,336,203 shares.

	Quarter ended						Year to date ended
Revenues	5/31/2017			5/31/2016			5/31/2017			5/31/2016
Company sales	$	1,563		$	1,558		$	2,820		$	2,836
Franchise fees and income		31			30			58			55
Total revenues		1,594			1,588			2,878			2,891
Costs and Expenses, Net
Company restaurants
Food and paper		453			462			798			847
Payroll and employee benefits		358			342			615			587
Occupancy and other operating expenses		513			558			879			960
Company restaurant expenses		1,324			1,362			2,292			2,394
General and administrative expenses		107			104			174			170
Franchise expenses		15			17			28			31
Closures and impairment expenses, net		17			31			17			31
Refranchising gain, net		(1	)		(1	)		(2	)		(4	)
Other income, net		(11	)		(12	)		(28	)		(27	)
Total costs and expenses, net		1,451			1,501			2,481			2,595
Operating Profit		143			87			397			296
Interest income, net		5			2			7			4
Income Before Income Taxes		148			89			404			300
Income tax provision		(35	)		(16	)		(111	)		(78	)
Net income – including noncontrolling interests		113			73			293			222
Net income (loss) – noncontrolling interests		6			(4	)		11			—
Net Income – Yum China Holdings, Inc.	$	107		$	77		$	282		$	222
Basic Earnings Per Common Share	$	0.28		$	0.21		$	0.73		$	0.61
Diluted Earnings Per Common Share	$	0.27		$	0.21		$	0.71		$	0.61

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

Condensed Consolidated and Combined Statements of Comprehensive Income (Unaudited)

	Quarter ended					Year to date ended
	5/31/2017		5/31/2016			5/31/2017		5/31/2016

Net income - including noncontrolling interests	$	113	$	73		$	293	$	222
Other comprehensive income, net of tax of nil:
Foreign currency gains (losses) arising during the period		13		(7	)		35		(29	)
Comprehensive income - including noncontrolling interests		126		66			328		193
Comprehensive income (loss) - noncontrolling interests		6		(3	)		12		1
Comprehensive Income - Yum China Holdings, Inc.	$	120	$	69		$	316	$	192

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

	Year to date ended
	5/31/2017			5/31/2016
Cash Flows – Operating Activities
Net income – including noncontrolling interests	$	293		$	222
Depreciation and amortization		160			171
Closures and impairment expenses		17			31
Refranchising gain		(2	)		(4	)
Deferred income taxes		(1	)		(29	)
Equity income from investments in unconsolidated affiliates		(30	)		(26	)
Distributions of income received from unconsolidated affiliates		26			13
Share-based compensation expense		10			5
Changes in accounts receivable		3			(8	)
Changes in inventories		7			(30	)
Changes in prepaid expenses and other current assets		5			—
Changes in accounts payable and other current liabilities		7			35
Changes in income taxes payable		3			25
Other, net		(25	)		18
Net Cash Provided by Operating Activities		473			423
Cash Flows – Investing Activities
Capital spending		(177	)		(172	)
Purchases of short-term investments		(229	)		(54	)
Proceeds from refranchising of restaurants		3			13
Acquisition of business, net of cash acquired		(25	)		—
Other, net		(4	)		(1	)
Net Cash Used in Investing Activities		(432	)		(214	)
Cash Flows – Financing Activities
Net transfers to Parent		—			(118	)
Payment of capital lease obligation		(1	)		(1	)
Repurchase of shares of common stock		(30	)		—
Proceeds from exercise of stock options		4			—
Other, net		(16	)		—
Net Cash Used in Financing Activities		(43	)		(119	)
Effect of Exchange Rates on Cash and Cash Equivalents		9			(7	)
Net Increase in Cash and Cash Equivalents		7			83
Cash and Cash Equivalents - Beginning of Period		885			425
Cash and Cash Equivalents - End of Period	$	892		$	508

Supplemental Cash Flow Data
Cash paid for income tax		115			84

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

	5/31/2017			12/31/2016
ASSETS	(Unaudited)
Current Assets
Cash and cash equivalents	$	892		$	885
Short-term investments		310			79
Accounts receivable, net		74			74
Inventories, net		266			268
Prepaid expenses and other current assets		150			120
Total Current Assets		1,692			1,426
Property, plant and equipment, net		1,617			1,647
Goodwill		103			79
Intangible assets, net		105			88
Investments in unconsolidated affiliates		51			71
Other assets		287			254
Deferred income taxes		166			162
Total Assets	$	4,021		$	3,727
LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND EQUITY
Current Liabilities
Accounts payable and other current liabilities	$	966		$	971
Income taxes payable		36			33
Total Current Liabilities		1,002			1,004
Capital lease obligations		27			28
Other liabilities and deferred credits		260			252
Total Liabilities		1,289			1,284
Redeemable Noncontrolling Interest		5			—
Equity
Common stock, $0.01 par value; 1,000,000,000 shares authorized; 386,617,759.42 shares and 383,344,835.42 shares issued at May 31, 2017 and December 31, 2016, respectively; 384,760,471 shares and 383,344,835.42 shares outstanding at May 31, 2017 and December 31, 2016, respectively		4			4
Treasury stock		(59	)		(20	)
Additional paid-in capital		2,367			2,352
Retained earnings		322			40
Accumulated other comprehensive income		35			1
Total Equity – Yum China Holdings, Inc.		2,669			2,377
Noncontrolling interests		58			66
Total Equity		2,727			2,443
Total Liabilities, Redeemable Noncontrolling Interest and Equity	$	4,021		$	3,727

See accompanying Notes to Condensed Consolidated and Combined Financial Statements.

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 an ownership in entities that own and operate restaurants under the KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell 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.

During the quarter ended May 31, 2017, the Company completed the acquisition of a controlling interest in the holding company of DAOJIA.com.cn (“Daojia”), an established online food delivery service provider. The Company agreed to pay cash consideration of $36.7 million to the sellers and made a concurrent capital contribution of $25.0 million to Daojia. As of the completion of the acquisition, the Company held 90% of Daojia’s outstanding shares of common stock, or 80% of its equity interests on a fully-diluted basis. Daojia became an operating segment of the Company. The acquisition was considered immaterial.

The operations of each Concept also represent an operating se gment of the Company. In connection with the previously-announced plans to integrate the businesses of Pizza Hut Casual Dining and Pizza Hut Home Service, beginning with the quarter ended May 31, 2017, the two businesses were combined and reported together as the Pizza Hut reportable segment. As a result, the Company has two reportable segments: KFC, which remains unchanged, and Pizza Hut. Our remaining operating segments, including the operations of East Dawning, Little Sheep, Taco Bell and Daojia, are combined and referred to as All Other Segments, as those operating segments are insignificant both individually and in the aggregate. Segment financial information for prior periods has been recast to align with this change in segment reporting. There was no impact to the consolidated and combined financial statements of the Company as a result of this change.

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.

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 were 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 that 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 for the periods prior to October 31, 2016 to be reasonable. 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 May 31, 2017, and the results of our operations and comprehensive income for the quarters and years to date ended May 31, 2017 and 2016, and cash flows for the years to date ended May 31, 2017 and 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.

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 has the obligation to absorb substantially all of the profits and 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.

In July 2015, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2015-11, Inventory (Topic 330) (ASU 2015-11), which requires inventory within the scope of the standard to be measured at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for the Company in the first quarter of 2017, with early adoption permitted. We adopted ASU 2015-11 during the quarter ended February 28, 2017, and such adoption did not have a material impact on our financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718) (ASU 2016-09): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 includes provisions to simplify several aspects of accounting for share-based payment transactions, including income tax consequences, accounting for forfeitures, classification of awards as either equity or liability, and classification on the statement of cash flows. ASU 2016-09 includes a requirement that the tax effect related to the settlement of share-based awards be recorded within income tax expense or benefit in the income statement. The simplification of income tax accounting for share-based payment transactions also impacts the computation of weighted-average diluted shares outstanding under the treasury stock method. ASU 2016-09 is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU 2016-09 during the quarter ended February 28, 2017 and the impact of the adoption resulted in the following:

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.

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 and year to date ended May 31, 2016:

Prior to October 31, 2016, YUM historically performed centralized corporate functions on our behalf. Accordingly, certain YUM costs have been allocated to the Company and reflected as expenses in the Condensed Combined Financial Statements. Management considers the allocation metho dologies 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 and $6 million were allocated to the Company during the quarter and year to date ended May 31, 2016, respectively, 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.

The Condensed Combined Statements of Income include license fees that were 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. Total license fees paid during the quarter and year to date ended May 31, 2016 are reflected in the table below:

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 was historically 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.

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 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 and year to date ended May 31, 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				Year to date ended
	5/31/2017		5/31/2016		5/31/2017		5/31/2016
Net Income – Yum China Holdings, Inc.	$	107	$	77	$	282	$	222
Weighted-average common shares outstanding (for basic calculation) ^(a)		387,901,955		363,758,219		387,754,681		363,758,219
Effect of dilutive share-based employee compensation ^(a)		9,424,278		—		8,925,022		—
Weighted-average common and dilutive potential common shares outstanding (for diluted calculation)		397,326,233		363,758,219		396,679,703		363,758,219
Basic Earnings Per Share	$	0.28	$	0.21	$	0.73	$	0.61
Diluted Earnings Per Share	$	0.27	$	0.21	$	0.71	$	0.61
Employee stock options, stock appreciation rights and warrants excluded from the diluted EPS computation ^(b)		19,131,358		—		18,625,451		—

	Yum China Holdings, Inc.
									Accumulated
	Common				Additional				Other														Redeemable
	Stock				Paid-in		Retained		Comprehensive		Treasury Stock						Noncontrolling			Total			Noncontrolling
	Shares		Amount		Capital		Earnings		Income		Shares			Amount			Interests			Equity			Interest
Balance at December 31, 2016		383,344,835.42	$	4	$	2,352	$	40	$	1		(784,686.42	)	$	(20	)	$	66		$	2,443		$	—
Net Income								282										11			293
Foreign currency translation gains										34								1			35
Comprehensive income																					328			—
Dividends declared																		(22	)		(22	)
Acquisition of Daojia																		2			2			5
Repurchase of shares of common stock												(1,072,602.00	)		(39	)					(39	)
Exercise and vesting of share-based awards		3,272,924.00		—		5															5
Share-based compensation						10															10
Balance at May 31, 2017		386,617,759.42	$	4	$	2,367	$	322	$	35		(1,857,288.42	)	$	(59	)	$	58		$	2,727		$	5

On February 7, 2017, we announced that our Board of Directors authorized a $300 million share repurchase program. Under this authorization, we repurchased shares of Yum China common stock during the year to date ended May 31, 2017 as indicated below. All amounts exclude applicable transaction fees.

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.

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)

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒ (Do not check if a small reporting company)	Smaller reporting company	☐
		Emerging growth company	☐

		Page
		No.

Part I.	Financial Information

	Item 1 – Financial Statements	3

	Condensed Consolidated and Combined Statements of Income – Quarters and Years to date ended May 31, 2017 and 2016	3

	Condensed Consolidated and Combined Statements of Comprehensive Income – Quarters and Years to date ended May 31, 2017 and 2016	4

	Condensed Consolidated and Combined Statements of Cash Flows – Years to date ended May 31, 2017 and 2016	5

	Condensed Consolidated Balance Sheets – May 31, 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	17

	Item 3 – Quantitative and Qualitative Disclosures about Market Risk	31

	Item 4 – Controls and Procedures	32

Part II.	Other Information

	Item 1 – Legal Proceedings	33

	Item 1A – Risk Factors	33

	Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	33

	Item 6 – Exhibits	33

	Signatures	34