Ladies and gentlemen, thank you for standing by, and welcome to the Yum China 2020 First Quarter Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, to Ms. Debbie Ding. Thank you. Please go ahead.

Thank you, Operator. Hello, everyone, and thank you for joining Yum China's First Quarter 2020 Earnings Conference Call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I'd like to remind you that our earnings call and investor presentation contains 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. Reconciliations of the non-GAAP and GAAP measures should be -- is included in our earnings release. Today's call includes three sections. First, Joey will provide an update regarding recent developments in the coronavirus situation, then she will offer some highlights around our first quarter results. Andy will then cover the financial results and provide an update on our full year outlook. Finally, we'll open the call to questions. You can find the webcast of this call and a PowerPoint presentation, which contains operational and financial information for the quarter on our IR website. Now I'd like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Thank you. Thank you, Debbie. Thank you all for joining us today. I hope all of you, near and far, remain safe and healthy. Before covering our quarterly performance, I would like to update you on our actions regarding the COVID-19 situation. Throughout this crisis, we make sure that our top priority was the health and safety of our employees and customers. As stores were closed, we work with local authorities to ensure a quick implementation of health measures. We wanted to ensure 3 things: commitment to value; commitment to supply; and our commitment to quality. We wanted to make sure that in a time of crisis, KFC, Pizza Hut and our other brands will be there to provide reliable, quality meals to our customers, especially those in the front line fighting this outbreak. About 65% of our stores remain open throughout this period. Even when infection cases were rising and store closures accelerating, our employees and delivery riders continue to show up. They wore masks, observed strict hygiene and served our customers, providing a vital service in this time of need. Employees are the backbone of our business. We support them and their families by extending holiday pay even if the stores were closed. We encouraged our employees to look after each other. We strengthened medical insurance coverage for staff and more importantly, their families. We extended coverage to parents of our restaurant managers up to the age of 75. This is important as providing for parents is a key cultural duty for us in China. This is simply the right thing to do. Providing this support gave our managers the peace of mind to focus on work and contribute to our long-term success. Also, in response to the pandemic, myself, Andy, senior executives and Board members have agreed…

Thank you, Joey, and good morning, everyone. I will first address key financials and developments in the first quarter, then provide perspective on our full year outlook. Unless noted otherwise, figures mentioned refer to the first quarter of 2020. All figures are before foreign exchange rate effects, and all comparisons are year-over-year. The first quarter financial results. Total revenues declined 21% due to both temporary store closure and same-store sales declines arising from COVID-19 outbreak. Public health efforts to combat the outbreak resulted in significant store closure and reduced customer traffic. Same-store sales decline was driven by reduced dine-in sales, partly offset by delivery and takeaway growth. Temporary store closure were taken out of the same-store sales calculation and included once they reopened. KFC same-store sales decline of 11% was driven by reduced dine-in traffic. Ticket average benefited from increased mix to delivery and takeaway. Pizza Hut's same-store sales decline was 31%. Reduced dine-in traffic was also the primary driver. However, different from KFC, the increase in delivery and takeaway mix contributed to lower ticket average. January sales for both brands were strong leading into Chinese New Year but was severely impacted later in the month as news of the outbreak became widely reported and social distancing and other restrictions were implemented. As infection rate declined and same store reopened, our sales showed recovery, although we are still below preoutbreak levels. New store openings were robust in January before the Chinese New Year period. Outbreak-related traffic restrictions and construction worker supply thereafter impacted the pace of our store opening. Restaurant margin were 13.6% at KFC and 0.3% at Pizza Hut. Declines in restaurant margins across both KFC and Pizza Hut were primarily driven by sales leveraging, partly offset by our efforts to control costs. Specifically, cost of sales was 32%…

Thanks, Andy. We will now open the call for questions. [Operator Instructions]. Operator, please start the Q&A.

[Operator Instructions]. Our first question is from Xiaopo Wei from Citigroup.

First of all, thank you for hard work and social responsibility during the COVID-19 outbreak. We are seeing very resilient performance, especially KFC. So my question is, what's your observation on the consumer behavior changes during the crisis? And the automation, the new norm, and Joey mentioned a lot of innovations, what's your thinking of reinvent yourself in the business, especially for Pizza Hut? So we believe that Pizza Hut is focused on casual dining, but it would be more impacted than KFC. Is any inspiration from the crisis which will position yourself better for the recovery of Pizza Hut looking forward?

Thank you, Xiaopo. Throughout the crisis, I think the -- in terms of customer response, the first response obviously is about focus on hygiene and safety, which our business has very long traditional in this area, and we obviously are very well positioned to enhance that. And then in terms of other behavioral change, basically, the value for money and the desire for new food is still there. But most importantly is the availability of food because, right now, it's better. But back to February or last week of January, it's very important to provide the service. And our team has worked very hard to keep as many stores open as possible. On top of that, we leveraged our digital and delivery and take away business model to serve our customer while protecting our employees. So the innovation is important as well. And then going forward, is there any sort of behavioral change in the medium term, et cetera? The social distancing will linger a little bit. We continue to see that. Particularly, we can see the sales challenge still during the weekend. Because for weekday, we are okay now. We are pretty much back to last year level. But weekend is still a challenge. And holiday is still a challenge, which is quite different from past sales pattern. On top of that, the traffic hubs, because of the reduced traveling, the traffic hub business are challenged. So the weekend, the dine-in and the transportation hub. Looking forward, how do we reinvent ourselves, particularly for Pizza Hut? Let me talk about the 3 theme, and then I'll go to Pizza Hut a bit more. There are 3 focus: menu innovation, digital innovation, that's one; second, value for money; third is cost savings. It's not only about the robust business model.…

Our next telephone question is from Brian Bittner from Oppenheimer.

Do you expect any store closings from your competitors because of this crisis? Which -- what is your insights regarding the ability for all of the industry capacity in China to survive this pandemic? And then secondly, you did not change your guidance for store openings for 2020. Can you just maybe talk a little bit more about how confident you are that you can indeed achieve these store opening goals in 2020?

Thank you, Brian. It's a really good question. We believe that we have turned a corner, but I hate to just remind everyone that we're still in the middle of it. It's not over yet. We are still cautious that Q2 and Q3 will still be challenging for our industry in China. The reason -- I'll get to the competitive bit. Let me give you the context first. For the Q2, we expect May and June will be very challenging for our industry because sales is recovering, but still at preoutbreak -- still lower than preoutbreak level, as Andy mentioned earlier. And in terms of cost structure, during Q1, I think most of the industry players managed to get some help from the landlord and from the government. Or even in some situation, some companies can manage to have certain agreement with their employees in terms of flexible pay. But that -- all these sort of onetime relief that I mentioned, they are likely to go down. It's not going away by Q2. And that situation is likely to happen during May and June. So that's point 1. Point 3 -- sorry, Point 2 is, what about Q3? Will Q3 be better? Hopefully. However, in our industry, we benefit from the summer because of children's holidays, because of children's holiday that usually give us 20% to 30% uplift of sales. But this year, the summer holiday for the kids will be shortened. To what extent is still not clear across the board, but it will be shorter. So that will be challenging. So this is the context. And then come to your question, Brian, about the store closing from competitors and et cetera. We have seen some business, mainly the smaller competitors, are going such difficult times, some very famous named ones. So right now, this is the test for financial prudence, I suppose. But as I mentioned, it still will take some time to see the full impact. Come to your question about store opening, we have not changed our guidance because, while things are very tough, we are cautious, but we are also optimistic at the same time because it is the time for us to continue to build our brand, further refine our business model and also it's possible that there will be some locations or store sites that become available, particularly the high-quality ones, if they become available, our financial prudence will be helpful to allow us to still expand and invest in new stores because we are here in China market for long term. And we -- in the long term, we still believe in the market potential. And thus, our unchanged guidance on new stores. Andy, do you have anything to add?

Sure, Joey. Just a few points, right? So as we mentioned, we're investing for the long term. So our fundamental view on China have not changed. We still think there's a lot of opportunity there. So although in the first quarter, we have done roughly 180 new store opening, we're slightly below last year's schedule. And as mentioned before, it's mostly impacted by post COVID-19 outbreak, obviously traffic situation there, in terms of worker can return to work, especially on construction site. So we will try to make that up, make up the lost time in the coming quarters. And so, so far, we have not -- we targeted our 2020 new build target. So -- and same goes for other CapEx spending. So if you look at our importance, how important IT, online operations, supply chain, all these things are during the crisis, and I think, in the long term, I think those trends will continue, right? So we're seeing acceleration in -- from moving from offline to online, moving more to delivery, takeaway. So we need that infrastructure to support our long-term growth opportunities. So we will stick to $500 million to $550 million in CapEx spending this year as well. So hopefully, that helped answer your question. Thank you, Brian.

Our next telephone question is from Michelle Cheng from Goldman Sachs.

I want to follow up a little bit on the recovery path. Since, Joey, you just mentioned that industry has been -- will be quite challenging into second quarter, third quarter, but can you please share your thoughts about our recovery path for different brands? When do you think the same-store sales to recover to last year level and how to drive this improvement? And also I think in announcement, you mentioned the uneven recovery across region day part segment. And so can you share more color about this and potentially also the consumer groups like the younger generation families, et cetera?

Thank you, Michelle. For recovery path, as I mentioned earlier, the immediate focus right now is still about protecting our staff and also open as many stores as possible and also reopen the dine-in business in some stores that we were still not allowed to open. So that's immediate. And then in terms of focus, immediate is about getting the traffic back. Because for Q1, for both brands, particularly for KFC, our traffic was very heavily impacted, but we make up for the loss of sales with much higher ticket average by going to corporate catering, et cetera, et cetera, or big item ticket delivery. So right now, it's still about getting the traffic back. We are happy to see the trend improving during March and then April. Because April, right now, the same-store sales is slightly more than 10%, which is an improvement compared to March. But in the medium term, the journey continues because our traffic is not back to last year yet. As I mentioned earlier, particularly during the weekend and the transportation hub. Then the question is what to do. So when I talk about menu innovation, I probably should have elaborated a little bit more. So if for example, for both KC and Pizza Hut, we adjust our marketing calendar. I'll give you an example. Traditionally, we put a lot of this value-for-money promotion during weekdays, particularly for Pizza Hut because weekday sales is slightly lower. And in Pizza Hut's case, the weekday sales is significantly lower than weekend. So we'll put the value program during weekdays. However, now time has changed. And as I mentioned, the problem of a weekend, so we -- even for the same marketing campaign, we'll be shifting the weight of the value program to weekend and holidays to stimulate…

I just have a couple of things to add, right? So as we mentioned on our press release, our current, at least in this month, right, so far, our traffic is still down compared to the preoutbreak level. I think more than 10% same-store sales compared to last year. And then we're also constrained, as Joey mentioned, right? So we have a slight proportion of our business is in the transportation hub and tourist location. As you probably know, most airports are still -- have very limited services. Same goes for the high-speed train services. So we do see that portion of business quite depressed. So if you look at, our recovery trajectory, for example, in January, we go into the January, before the Chinese New Year, very strong. And then we were significantly impacted by the outbreak. The trough was in February. And then we're beginning to recover as the outbreak eased and people are beginning to return to work. And we've benefited quite a bit because we have kept most of our stores open during that period of time, and we're one of the few options and safe and healthy options for folks to get food, right? And as we mentioned, like in the previous update, 20% year-over-year, like same-store sales decline in March, and then now we are about like 10%, right? So -- but we're still constrained. Tourist locations, transportation hub are still restricted quite a bit in terms of traffic. And then we look forward to the recovery. I think the timing of those locations, how they will recover, I think, is still a little bit uncertain at this moment. And then also, as Joey mentioned, there's some social behavior change that are still lingering from the outbreak. Social distancing is still being practiced here in China. People, on the weekend, even when they go to a restaurant, they try to avoid congregation in large crowd, right? So I think how long that will last and how long it will take for us to go to the normal prior to the outbreak, I think is still quite a bit of uncertainty, and it's hard to predict at this time, especially given the situation globally and how that reverberates back into the Chinese economy and how that would change customer behavior, I think we still have yet to see clearly at this time.

Thank you, Andy. Michelle, I do notice that at the end of your question, you asked about the regional and tier. There is difference. East region has recovered the best. And then some region in northern part of China is still slightly behind. And in terms of city tier, our lower Tier 3s are doing slightly better than the top-tier cities for a few reasons. The main reason is Tier 1 city like Beijing, particularly Beijing, Shanghai, Guangzhou, Shenzhen -- particular Beijing, these Tier 1 cities have disproportionately higher percentage of sales from transportation hubs. And since the transportation hub business are still heavily impacted, we are talking about half of the business being impacted in transportation hub, and thus, impact the overall top-tier city business recovery. For lower-tier cities business, it has been quite resilient for other reasons as well other than the lack of transportation hubs. In lower-tier cities, during the most difficult time, it was not uncommon, and actually it was reported by some media outside China, if you go to -- if you went to a small city at that time, it was very likely that KFC was the only store that was operating. And even right now, as the country is recovering from the crisis, the competition in the lower-tier city still favor us because of our strong reputation in hygiene and food safety. And that's the difference. So thank you, Michelle.

Our next question is from Annie Ling from Jefferies.

I have two questions. First is on the cost side. Management mentions about like all these cost increase. I just want to check like whether this include all these like onetime relief in first quarter and possibly in the second quarter. And if you could like share with us what is the nature? You just talk about some of these like pension relief and all that. Would you share with us like what -- would you itemize what are this nature and on this part and whether it's included in our cost assumption and all that? And then also in terms of the commodity price increase, we understand -- it seems that based on some of the latest trends, the ticket price actually start to come down these days. So is it fair to say that we should be seeing some delay impact from last year's higher inventory costs that, first half, we might see a higher like commodity price increase and then, subsequently, it will be lower? How do we see this cost trend by half year basis? And lastly, in terms of the upcoming labor holidays, do we have any expectation? I mean, is it fair to say that this will be a good test in terms of like -- to test out how quickly the consumer can come back?

Okay. Thank you, Annie. This is Andy. And so I will try to address your question regarding the cost increases, the onetime relief in the first quarter and how does that look like in the second quarter. So as we mentioned in the prepared remarks, we did receive some relief from the government in terms of social insurance payments. There was a general reduction of that across China. We benefit from that as well. And so there's approximately $20 million of that in the cost of labor and then another, probably, a few million dollars in our SG&A. We also received rent reduction, right, so from the landlord in the quarter, it's about $15 million. So those, in total, is roughly about $40 million in onetime. Now if you look at the social insurance payment reduction program, I think that's going to expire in early second quarter. I think in April is the last month that we would probably receive that relief. Now same for rent. Most of the landlord have agreed to rent reductions during the crisis. But as the economy is initially beginning to recover, we do not expect, if there's any rent reduction, to be the same magnitude as we have received in the first quarter. Now -- and we also have about $15 million worth of government incentive that we received in the first quarter that we normally receive in the second or third quarter. So if you do that, you will notice that we will benefit in the first quarter, but year-over-year comparisons will be more difficult for us going into the second -- in the third quarter. Now I think you also have mentioned the commodity price. chicken, in particular. I think, as we mentioned, we do expect cost of sales at a single-digit…

Yes. And just for the May 1 holiday, on top of what Andy just mentioned, the transportation hub business will still be struggling. The reason is schools are opening up, particularly for the younger kids, after the May holiday. So that means that parents and kids are not encouraged to travel outside their city before the school started. So our transportation hub business in the train station are likely to continue to suffer a little bit, even during the May holiday. Thank you.

Our next telephone question is from Sara Senatore, Bernstein.

I wanted to step away from the current environment and just ask about the portfolio you're building. You -- Lavazza now and then COFFii & JOY, the recent acquisition of Huang Ji Huang -- sorry, if I butchered that -- increased equity stake and I think in investee. So just how should we think about these acquisitions in terms of contribution to growth over time? Because I think, historically, some of your smaller concepts have not performed as well as KFC or even Pizza Hut. And maybe just a trade-off between making these investments now and suspending your share buyback as we think about how you're allocating capital.

Yes. So thank you, Sara. I will try to address your questions. So in terms of our overall brand portfolio, for example, so you can think of it as sort of 3 main groupings for us, right? We have the Western food, which consists of KFC, Pizza Hut and Taco Bell. And our announcement of the equity investment in Suzhou KFC is to strengthen our control. So Suzhou KFC was a joint venture. We are able to negotiate a favorable term for us for this transaction. And so it's -- so we take that opportunity to gain control of the JV. And I think, over time, it would be incremental to our operations, okay? So -- and I think, going forward, I think we'll also look into other potential opportunity, obviously, to continue to grow our Western food portfolio in these 3 core brands. Now if we look at the Huang Ji Huang acquisitions, that is sort of complementary to our existing leadership operation. So it forms our Chinese cuisine. And as we have mentioned, it's important to gain a larger share of stomach from Chinese consumer. Chinese food remains the largest portion of the restaurant business. So we'd like to gain some expertise in that area. It's a very large and growing market. So if you think about the investment, for Huang Ji Huang, which is slightly less than $200 million, and I think that is a good investment in terms of leveraging our existing infrastructure to scale that franchise business and, I think, in the long run, would help us to build expertise in Chinese cuisine products and services. It's an important long-term growth driver for us, okay? In terms of coffee, I think coffee is mostly an organic initiative. So KFC -- so K-Coffee is sort of…

Our next question is from Christine Peng from UBS.

I think most of the questions I have, have already been addressed by the management. But if I could ask the last question I have towards Joey. So given all the changes you are seeing in the restaurant industry during the COVID-19, especially given your resilience during this crisis, should we expect an even higher than 2019 expansion pace as you look into 2021 in terms of the store opening, et cetera?

Thank you, Christine. You are familiar with our business, and we always emphasize that we still have a rough guidance of the number of new stores, but we don't really give it as sort of a target to the business. We make the store opening decision from bottom-up perspective. So if we can find enough store that meets our financial assessment and the growth assessment, we'll open the store. Because financially, if we are prudent enough, we have the capital. But if the store itself does not pass the test, we don't. So therefore, it's very difficult to sort of have a very, very specific target. But if we see the opportunity, of course, we'll take it. But we never really push our team to chase after the target. I mean, it's always good to have a bit more certainty. However, we have been doing it because we emphasize on the quality of the store more than the quantity of the store. And for us, the quality of the store is not something that we compromise. So I guess the short answer is it's possible if we find the opportunity. But if we do not find the opportunity, we won't force ourselves or push our team to do it.

Right. And this is Andy. I want to emphasize that for -- even though we provide sort of a scope and target each year, but that is just sort of like a guideline aim that help our team to aim for. We have a very internal but disciplined process to make sure that the store that we open are financially viable projects. So it's very good that our team, our development team have done a very good job over the past few years opening new store. And as you can see from our financial performance, those store have very good payback. So if you look at KFC, it's roughly 2 -- a little bit more than two years. And then if you look at Pizza Hut, it's about 3 to 4 years. So very good by industry standards, and we'll try to maintain that going forward as well. So as Joey mentioned, if they have find good targets, we encourage them to exceed whatever number. But if they don't, then they don't have to force themselves to get to that point.

As there's no more further questions, I'd like to hand the call back to the speakers. Please go ahead. Thank you.

Thank you for joining the call today. We look forward to speaking with you on the next earnings call. That concludes today's call. Thank you, and have a good day.

Thank you very much. Thank you.

Thank you, everyone.

Ladies and gentlemen, you may all disconnect, and goodbye. Thank you.