Ladies and gentlemen, thank you for standing by and welcome to today's Yum China 2018 Third Quarter Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Wednesday, the 31st of October 2018. I would now like to hand the conference over to your speaker today, Millicent Tu. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining Yum China's third quarter 2018 earnings conference call. Joining us on today's call are Ms. Joey Wat, CEO of Yum China; and Jacky Lo, CFO of the company. Before we get started, I would like to remind you that our earnings call and investor presentation contain forward-looking statements, which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our filings with the SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures and the reconciliation thereto. Today's call includes three sessions, first, Joey will cover Yum China's third quarter 2018 highlights; and Jacky will cover the financial results, we'll then open the call to questions. A webcast of this call will be available on our IR website. A PowerPoint presentation, which contains operational financial information for the quarter, is available for download. Please note that the presentation has been provided for reference, and does not correlate directly to management's prepared remarks on today's call. At this time, I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Thank you, Millicent. Good morning, good evening, everyone, and thank you for joining us today. First, I will give an overview of the quarter before providing greater detail on our operational initiatives in each of our core brands. In the third quarter, we delivered solid system sales growth in the context of soft trading conditions and greater competition. We accelerated new builds to systematically expand our footprint in both high and low tier cities. We drove traffic by launching a range of value initiatives, introducing innovative products and improving offerings in high growth dayparts. And we continue to build out our digital, data and delivery ecosystem to make it easier to dine at our core brands and create a sustainable platform for growth. KFC, our biggest brand, recorded healthy sales growth, particularly in Tier 1 cities, thanks to strong brand recognition, excellent execution and first mover advantage. While Pizza Hut sales remained under pressure during the quarter, we effectively managed the Pizza Hut restaurant margin as we optimized our investments in new products and improved labor productivity. We also made further progress on the Pizza Hut revitalization as we launched a refreshed brand identity, improved our value proposition, expanded our digital capabilities and generated greater delivery traffic through own channels. Now I will provide some more color on the performance and strategy of our key brands, starting with KFC. KFC is our primary growth engine and the number one quick service brand in China. KFC continued to perform well, with positive same-store sales growth in the third quarter on top of 10% same-store sales growth in the same quarter last year. With a two year cash payback period and the bottom line opportunities across all city tiers, expansion continues to be a key priority. During the quarter, we accelerated new…

Thank you, Joey. Good morning to those calling from Asia, and good evening to those calling from the U.S. Total revenues reached $2.2 billion in the quarter, up 6% year-over-year excluding foreign exchange translation. Total system sales grew 4% year-over-year in the third quarter of 2018, excluding foreign exchange translation, primarily due to accelerated new store openings. We have opened 195 new stores during the quarter, of which over 70% were KFC stores. In the first nine months of the year, we have opened 562 new stores, up 30% comparing to the same period last year. Our portfolio exceeded 8,300 restaurants as of the quarter end. During the quarter, KFC year-over-year system sales grew by 6% while Pizza Hut system sales declined by 2%. Yum China same-store sales declined by 1% in the third quarter of 2018, with KFC same-store sales grew by 1%, lapping a 10% same-store sales growth in the prior year; while Pizza Hut same-store sales declined by 5%, largely attributable to the impact of softer trading conditions and underperformance in the dining segment. During the quarter, KFC ticket average increased by 3% year-over-year due to continuous product innovation and upgrades, while traffic decreased by 2% year-over-year, a smaller drop comparing to the second quarter. Pizza Hut ticket average decreased by 4% year-over-year due to increased promotional activities and value campaigns. Although traffic declined by 1% year-over-year, it's an improvement as compared to the previous two quarters. While sales remained under pressure, we are starting to see a more positive traffic trend as the revitalization initiatives take effect. KFC restaurant margin was 19.2% comparing to 19.6% for the same period last year, primarily due to inflation, product investment and promotions, which were partially offset by labor productivity gains and savings in other COGS. We were pleased with…

Thank you, Jacky. So to sum up, KFC continues to perform well and is supported by strong brand recognition, excellent execution and first-mover advantage as we grow our portfolio across all city tiers. We are also encouraged by the positive feedback we are receiving around the revitalization program for Pizza Hut with a fresh new identity, new menu and store format to better connect with customers. While we expect Pizza Hut sales to remain under pressure in the fourth quarter, and it will take time to see the full impact of these reforms, we are confident that we have the right strategy in place to revitalize the brand and return it to growth. With urbanization, growing disposable income and loan penetration in lower tier cities, the long-term fundamentals of the China opportunity remains unchanged. We will continue to invest in profitable growth for our core brands to strengthen our leadership in China's restaurant industry. With that, I'll pass you back to Millicent to start the Q&A.

Thank you, Joey. We now open the call for questions. [Operator Instructions] Operator, please proceed.

Thank you so much [Operator Instructions] And our first question comes from the line of Brian Bittner. Brian, your line is now open.

Thank you. I appreciate it. Two questions, one on Pizza Hut and then one on the capital allocation strategy. On Pizza Hut, you referenced the softer trading conditions this quarter. Can you just elaborate a little bit more on what you mean by that? And how is the confidence that Pizza Hut's not facing some secular headwinds that may make it a little more difficult to turn around despite the initiatives you're putting in place?

Okay, all right. Let me - thank you, Brian. Let me share a few thoughts about the softer trading conditions. We can certainly provide some thoughts into the trend that we are observing. First is consumer. Consumers are increasingly looking for better value and better - and bigger savings. And we have seen a slowdown in foot traffic for the dine-in for Pizza Hut but at the same time, delivery continues to grow. Number two, in terms of competitor, we have also seen an increase in competition with more store openings in mid-, low-tier cities and also intensified promotions in higher-tier cities. Fortunately, we have a lot of experiences and competitive advantage compared to our peers. For Pizza Hut, we are the market leader in the western casual dining segment with excellent brand recognition. We have - also have a very good nationwide supply chain and we have a very good development team to continue the growth. In terms of whether it will be a headwind, the future of the restaurant business, both in QSR and in casual dining, is a balance of the online and offline experience for customers. So we - as we start the revitalization program last year, we have made very good progress in digital, the online experience, and we continue to make progress in there such as the tableside ordering as I mentioned earlier. But on the offline side, in the store, it's also very important to improve the store assets and the great experience. And the stores, let's not forget the stores, are the enabler for the offline business. So we see the combination of the improvement in both areas and we see long-term opportunity for the Pizza Hut business as well. I would like to make one last comment on this one before I guess, you can answer the capital question is in the long-term, we are committed to China and for KFC, we always mention that we're in 1,200 cities but we still have 1,000 cities in China that we don't have a KFC. For Pizza Hut, right now, we are only in 500 cities in China. So that means there are 1,700 cities in China that does not have Pizza Hut yet. So in the short term, obviously, we see the bumpiness. But in the long term, we believe the opportunity, the fundamentals are still very good. So maybe you can ask the capital question, Brian.

Yes. And thank you for your Pizza Hut answer, I appreciate it. It was really intriguing to see the increase in the share repurchase authorization and it sounds like you have around $1 billion left. Over what timeframe should we assume that you plan on using that authorization? If there' is any help you can give us on how to think about annual share repurchases that you're targeting, that would be super helpful.

Yes, Brian, well, obviously we are very confident in our cash generating ability, that's why we work with the board to increase the share buyback authorization. And our share buyback decision is always based on a number of quantitative and qualitative factors. And we have always been opportunistic when we execute a share buyback plan. So I mean, to put it into better perspective, so in the last 18 months, we repurchased over $400 million but over $275 million came in the last six to seven months. So I mean, we just - from our perspective, share repurchase is an ongoing commitment and just we will continue to execute the plan opportunistically. And I think the expansion of the authorization clearly shows our commitment in returning value to our shareholders. So we don't have a timeframe to put on that, but we will just continue to execute the plan as we used to.

Next question please.

Thank you.

Thank you. And our next question comes from Sara Senatore [Sanford Bernstein] Sara, your line is now open. Thank you.

Thank you. I had a quick follow-up question on sort of unit growth and then I wanted to ask about the coffee prototype. So the first is just you slowed Pizza Hut pretty dramatically but KFC has accelerated. And so year-over-year, your whole system is roughly stable in terms of growth versus last year. So I was just wondering if there's sort of a target that you have to achieve, whether it's because you want to be - you have something set out with your agreement with Yum!, or does it just kind of work out that way? Because it feels like KFC has kind of just perfectly offset the slowdown in Pizza Hut and I was trying to understand whether that's something that would persist if the Pizza Hut returns continue to be under pressure. So that's my first question, just a follow-up, and then I wanted to ask you about the coffee initiative. Obviously, we've heard about a lot of new entrants in that market and accelerated growth from some of the global brands like Starbucks or Costa. And I was just wondering maybe if you could talk about the competitive dynamics in that market, and what sort of attracted you to enter now.

Thank you, Sara. Let me start with the unit growth. We don't have a specific target for the new unit growth. We - what we want to achieve is profitable growth for the core brands. So let's start with the Pizza Hut - KFC, and then I'll talk about Pizza Hut. For KFC, we are already in 1,200 cities and it covers a range of top-tier to lower-tier cities. And the dynamic in the top-tier versus lower-tier cities is quite different. So if I could use the way to describe it, it's a one country, two strategies. So in the top-tier cities, our focus has been driving same-store sales. We are opening stores but even for Q3, we can see we drive very healthy same-store sales with the offers, the value, et cetera. And for the lower-tier cities, we are very aggressive in opening new stores because there's a lot of white space still available in both the lower tier cities we are in and in the cities where we don't even have one single KFC store. And again, we have seen the result of lower-tier cities right now is giving us very nice system sales growth. Even though the new store that we opened in imply sales transfer from the existing store to new store, but net-net, the system sales growth is what we want to see in lower-tier cities. So holistically, we believe that we are doing the right thing to drive both same-store sales in top-tier cities and system sales in lower-tier cities. And you can see in KFC, we have opened more stores for the first nine months than the entire year last year, and that is driven by the economics. When we open a store, we evaluate each store what - on each store basis,…

Thank you.

[Operator Instructions] And our next question comes from the line of Xiaopo Wei from Citigroup. Please ask your question.

I will limit my question to one. My question is for Joey. And in your statement in the press conference, you said that you will continue to build out a digital and a delivery ecosystem. And we understand that Jacky said that the company invested in Meituan IPO, and we also understand that Ant Finance is your - one of your major shareholders, while Alibaba, which is related to Ant Finance acquired Ele.me this year. So I just want to ask, do we have any closer collaboration with Ele.me or Alibaba with the changed the dynamics in the food delivering platform aggregators? Thank you.

Thank you, Xiaopo. I will share my thoughts on digital and delivery, and Jacky can mention his comments on Meituan. For digital and delivery, Xiaopo, it's really part of our holistic strategy. We do believe the future of the restaurant business is a balance of the online and offline. And for digital and delivery, we have been investing in this area since actually 2015 for KFC and then we catch up in this area for Pizza Hut since last year. We believe this is a very powerful ecosystem that we have built and will continue to build because particularly for tier 1 cities where we have a big number of stores, we see the power of data that we can learn from our customers. And we also learned from the data and then designed our marketing campaign to increase spending, to form higher visit frequency and to encourage higher participation at different categories, dayparts and even brands, even between KFC and Pizza Hut. And for our member program, our efforts include both value and experiences, so we'll continue to be committed to it. And delivery is another growth driver for both businesses right now. We have built our own channel and also, we managed a healthy mix between own channel and aggregator in terms of sourcing the traffic. And I'm happy to report that while KFC has a very healthy mix - always has a healthy mix of traffic generated by own channel, now Pizza Hut, we are also increasing of our own traffic from own channel, not to mention the 55% riders from our own - 55% orders delivered by our own riders. So we'll continue to push forward in both areas because this is strategically important, while the stores are enabler for both digital and delivery to form the total experience for our customers. So...

And Xiaopo, on your second question, I guess our delivery strategy is to work closely with our aggregator partners, both Meituan and Ele.me, just to grow our delivery sales business. So the investment in Meituan is just part of that strategy and we'll continue to invest to grow the delivery business on our own channel as well as on the aggregator platforms.

Thank you, Jacky. Next question please.

Thank you so much. And our next question comes from the line of Lillian Lou from Morgan Stanley. Please ask your question.

Hey. Morning, management. I have a question about - a little bit about the numbers because we saw quite a big savings from occupancy and other expense ratio for third quarter, over I think 130 bps. So basically, are we seeing this trend going to continue? And how much savings from, as Joey mentioned, the store efficiency improvement? How much from the rental cost? How much from other savings like advertisement, et cetera? Thank you.

Yes. Lillian, occupancy and other costs, actually it includes a few components. So advertising and marketing, utility, rental, depreciation, license fee to Yum! Brands and some other restaurant-related costs. So the improvement in this quarter mainly came from two factors. Number one, savings in advertising and marketing expenses because we are shifting from the traditional mass media to digital and targeted marketing such as member discount, which is now recorded under cost of sales. And there are also other utility savings. We have a lot of cost-saving initiatives at the store. For example, more energy-efficient appliances and processes like optimizing water and air conditioning usage. So these are the two major reasons behind the decline in occupancy costs in this quarter.

So what about the trend? Are we going to see this sustainable in the following quarters?

Yes. I think we will just - I mean, we have been doing this for many years. We will continue to optimize our cost structure, yes. It fluctuates quarter-to-quarter so - but we'll continue to do - to optimize the cost structure.

Yes, one additional point, Lillian, I would add is as we become more flexible in terms of the store format and become more sort of demanding in terms of the store size, meaning smaller store, management is becoming more efficient in our management of rental and depreciation cost, which, in the long-term is helpful to our business model.

Yes. Lillian, also keep in mind, there's seasonality to our business as well.

Sure. Thanks a lot Joey and Jack.

Thank you, Lillian.

Thank you, Lillian. And next question please,

Thank you so much. And our next question comes from the line of Matt McGinley from Evercore. Matt, your line is now open.

Thank you. My question's on the Pizza Hut margin and how well you did in managing that cost structure to offset the - how well you managed the margin decline relative to the comp. I guess as a follow-up in that, the food and paper margin, it was - you rolled over investments you began to make in food quality a year ago when the margins were still under pressure. And I understand there was a little bit of an ad shift there that would've gone from the occupancy into that. But how much of that margin decline was continued investment in food or delivery growth, which I assume is a lower ticket than dine-in and perhaps, lower margin?

Yes. Well, Matt, on the Pizza Hut margin, well, due to the softer trading condition and the more competitive environment, which have a more prominent impact on the casual dining, so Pizza Hut faced some pressure on sales this quarter. And as Joey mentioned, we are encouraged by the progress we made on the revitalization of the brand. We also effectively managed the restaurant margin as you pointed out. We accomplished that through labor efficiencies and also, optimization of our food investment. So first on the labor efficiencies, so we have been improving the labor scheduling, optimizing the management-crews matrix and also, we are utilizing the digital capabilities. For example, like the tableside ordering, to improve the crew efficiency. And also on food investment, it includes actually both product upgrade that also, the better value to our customers like member discounts. So with the step up in the value campaign this quarter, the decline in traffic has improved comparing to the previous two quarters. So China was only down 1% versus 6% in the prior quarter. So obviously, the investment in food impacted margin over the past few quarters but in Q3, we only invest about $12 million, so we are doing a more targeted investment in our food. So it was $12 million versus $15 million in the last quarter, $25 million in the first quarter. But we believe the current softness in sales may continue for the remainder of the year. But with that said, we will likely continue to invest in Pizza Hut and just step up promotion activities to drive sales. Yes, but better products and value campaigns, that will put some pressure on the margins, but we are very confident with our targeted investment in food. Supported by the four pillars of revitalization plan, Pizza Hut will gradually restore traffic and sales.

And just to add a little comment on the margin for delivery, Matt. The delivery - the food business, even with lower ticket average but with our knowledge - well, ongoing accumulation learning about customer and delivery business, we are certainly more flexible and more targeted with our marketing investment for the delivery. So the flexibility is important in the short term for - given the softer trading situation and for delivery business in particular. A - Millicent Tu Okay. next question please.

Thank you, Matt. Thank you so much. And the next question comes from the line of Michelle Cheng from Goldman Sachs. Michelle, your line is now open.

Thank you, management. My question is for Joey. Can you help us understand over consumption environment, given from second quarter, we talked about more promotional environment in terms of consumption sentiment. But how do we look for the - like, especially KFC same-store sales growth into the next few quarters? And will this impact our store expansion for next year? Understanding this year, we probably - it's very easy to reach our original target, but how about next year's store expansion target?

Thank you, Michelle. I have mentioned my thoughts on the consumption sentiments. So just really quick for KFC consumer competitor. For consumer, definitely looking for better value and bigger savings. For competitors, we can observe the increase in competition in promotion, so very aggressive promotion from our peers. How does that impact our goal in terms of store expansion? Next year, we will stay on our course. We will look at our payback, our pipeline and we will continue to push for the same-store sales in top-tier city and we'll continue to push for lower-tier city store expansion aggressively because it just makes sense. For the new store opening, although in lower-tier city, it implies sales transfer in the short term but it also builds system sales in the short term. And in the long-term, it helps our market share, it helps our brand building. Brand building and first-mover advantage is very important for KFC because it's food. The earlier we go in, that earlier we define the taste of fried chicken. And we have been doing that for 31 years successfully and we'll continue to do that. So for the store expansion next year, I will say we'll stay on the course. And for the consumption sentiment, while it's looking for better value and bigger savings, in the short term, KFC can do that. There's nothing wrong to offer something, it's a lovely term called cheap and cheerful, particularly during some slightly tougher times for customers. So thank you, Michelle.

Okay. Next question please.

And our next question comes from the line of Chen Luo from Merrill Lynch Bank of America. Your line is now open.

Thank you. I've just got one question on Pizza Hut margins. If it - looking at the details, the margin erosion in Q3 was more - was all driven by the rising food and paper costs, whereas we have achieved big savings in labor cost and occupancy and other costs. So heading to next year, actually we are going to see easy laps regarding the food and paper cost. So let's assume if same-store sales still stay at, let's say, low- to mid-single-digit decline range for next year, given all the cost-saving initiatives and easy laps for food and paper cost, are we going achieve largely stable margins for Pizza Hut? Or because of the deleverage, we are still a bit cautious on the margin outlook? Thank you.

Well, I guess, Luo Chen, we'll just continue to execute the four pillars and I mean, we are very confident in that. So that's going to first of all, restore traffic and sales and then followed by restaurant margin improvement. So - but I mean, we are just taking it one step at a time and we'll continue to execute the four pillars. And once traffic is restored, sales recovers, we'll continue to work on different initiatives to drive restaurant margin improvement.

And Luo Chen, I mean, our team has worked very, very hard to achieve the saving or to manage the margin. But I - in our terms, there's no such thing called easy lap. Nothing is really that easy, given the scale of our business. But we do plan to continue our focus on margin management and with the hope that in 2019, we can continue to focus on that and to have more positive improvements in terms of profit if our sales improve in 2019.

In interest of time, we are taking the last question. Operator?

Thank you so much. And our last question comes from the line of Anne Ling from Deutsche Bank. Anne, your line is now open.

Thank you. Hi, management team, just one, like, number regarding the same-store sales trend, our same-store sales growth in third quarter. Just want to check whether the Mid-Autumn Festival will have any impact on our sales trend. Say, like if we do not have the Mid-Autumn Festival in September, what will be our same-store sales for like, KFC or Pizza Hut? Do we have this kind or it is just not important at all? Thank you.

Anne, hi. The Festival time and weekend shift between quarters are very common and vary by brand. It's very different for KFC and Pizza Hut. We manage these shifts with our marketing campaigns, but I will add the comment that we do look at festivals as opportunities. So for KFC, we offer xiao xian rou su bing [ph]. It's a kind of moon cake for East China they love to eat to improve the customer experience. But it also helps to drive traffic and also ticket average. And for Pizza Hut, it is the first year we offered moon cake and the result of the moon cake is pleasing. So we tried something new and customer reaction was positive, and it's very likely that we'll continue to do moon cake in Pizza Hut to celebrate Mid-Autumn Festival again next year. So thank you, Anne.

Thank you.

Okay. Well, thank you all for joining today's call. This concludes Yum China's third quarter earnings presentation and this call. And we look forward to speaking with you next time. Have a great day.

Thank you, all.

Thank you so much. And that does conclude the conference for today. Thank you for participating. You may all disconnect.