Ladies and gentlemen, thank you for standing by, and welcome to the Yum China 2020 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, there will be a question-and-answer session. [Operator Instructions] I will now hand the conference over to your first speaker today. Thank you, and please go ahead, Debbie.

Thank you, operator. Hello, everyone, and thank you for joining Yum China’s second 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 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 measure is included in our earnings release. Today’s call includes three sections. First, Joey will provide an update regarding recent developments, then she will offer some highlights around the quarterly 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 would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Thank you, Debbie. Hello, everyone, and thank you for joining us today. I will first update you on COVID developments, and then we’ll move on to cover performance in more detail. Throughout the COVID pandemic, we have been committed to safely providing good food, great value and convenience for our customers wherever they are. Safety is the key word here. At our stores, temperature check, face masks and frequent disinfection and cleaning protocols remain in place. A safe and healthy environment creates confidence for our customers and employees which helps drive recovery in our business. We approach this challenge with an open mind, with flexibility, speed and the courage to try new things. Our nimble marketing, enabled by our digital infrastructure, helped drive improvements at both of our core brands compared to the first quarter. KFC launched buy one get one weekend in June for the first time for members. Pizza Hut’s foot traffic was its first-ever all-you-can-eat promotion, featuring steak and baked crayfish. We focus our resources on engaging with our members, targeting specific orders and promotions. Our privilege programs drive frequency, spend and cross sells. However, we are still experiencing significant headwinds. The recovery path is non-linear and uneven. April and May sales improved sequentially, while June was impacted by delayed school holidays and more stringent social distancing due to resurge in regional infection. Our transportation and tourist locations continue to experience significant year-on-year volume declines, which impacts KFC more than Pizza Hut. Around 60 of our stores in Wuhan and Northern China remain closed for the time being. Even with short-term uncertainty, we are enthusiastic about our long-term prospects. In an incredibly challenging environment, we celebrate three important achievements. First, we opened our 10,000th store in July. This is truly an incredible achievement that would not have…

Thank you, Joey, and hello, everyone. I will first address financials and developments in the second quarter, then provide some color on our outlook. Unless noted otherwise, figures mentioned refer to the second quarter of 2020. All percentage changes are before the effect of foreign exchange. Now let me start with the second quarter results. With over 99% of stores opened, total 2Q revenues recovered to 93% of the prior year. In the first quarter, revenues were 79% the prior year level. Both of our core brands have quarter-over-quarter improvement in transaction volume. However, traffic is still below pre-COVID levels. KFC’s same-store sales recovered to 90% of prior year compared to 89% in the first quarter. We saw sequential increases in average unit volumes in April and May but a weaker June. While weaker weekday and dining recovery benefited from our promotional campaign, regional differences persist. Our transportation and tourist hub sales, which accounted for high single-digit sales mix, were still significantly and negatively impacted. The higher mix of younger school-age customers meant that the delayed and shortened school holiday had a bigger impact on KFC and Pizza Hut. Lingering effect of the outbreak on consumer behavior remained a headwind. Pizza Hut same-store sales recovered to 99% of prior year’s. This is a significant improvement from the fiscal – the first fiscal quarter. We used – segment sales were 69% of prior year. Relative to KFC, Pizza Hut has a significantly lower exposure to transportation hub locations. Our store in lower-tier cities continued to perform better than stores in the higher-tier cities, partly driven by a higher concentration of transportation hubs and tourist locations in higher tier cities. Our strong brand equity also helped market performance in the lower-tier cities. The sales recovery is nonlinear and uneven. As Joey mentioned,…

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

[Operator Instructions] Your first question comes from Chen Luo from Bank of America. Please ask your question, Chen.

So I noticed that we highlight a few risks and challenges throughout the conference call. And also in the earnings announcement, you also mentioned that these challenges which continue to impact property operations in July. Can you also help to give us a little bit more color on how we compare the July performance with June? Are we seeing any sequential improvement? And just now, Joey, you also mentioned that the summer season is likely to be challenging. And do we have any rough idea as for the trend in Q3 versus Q2? Thank you.

Hi, Chen Lou, let me take this question first, and then maybe we can add a little bit more color later. In terms of the sequential improvement in July compared to June. And as we mentioned before on our prepared remarks, right now, there’s a couple of headwinds that we see, right? So we have seen the transportation hubs as well as the tourist locations, which account for high single-digit of our sales mix being impacted quite significantly, right, by the COVID effect, down 50%, 50%, right? So I think unless there are significant changes in the situation, I think that will continue to be a headwind for us. Now we also mentioned that shopping and delayed school holiday, which should have a large impact on KFC compared to, say, Pizza Hut. As you know, normally in China, school holiday started in – generally, it would be in June. This year, because of the COVID situation, it has been delayed until mid to late July, depending on where the location and the provinces and whatnot. So I think we will still have some impact on the – in July. For the fourth quarter, we also – this year, we have a holiday shift for the mid-Autumn festival, right, which last year was in September. This year, it’s going to be in October 1, I think. So there’s also a holiday shift impact, right? So that will probably impact to front, if you look at that kind of shift. So those will remain some of this. And then, of course, in June, we have this new outbreak in Beijing that also impacted sales in, not just in Beijing, but the surrounding provinces. So the situation has improved, specifically in Beijing. However, we do see other regional outbreak, for example, in the…

Thank you, Andy. I guess, in the last earnings release, we mentioned the challenge in transportation hub and tourist location and the summer holiday delayed and shortened. And the delay – shortened two weeks in June, two weeks in July. And for this earnings release, Andy just also mentioned the regional resurgence of the COVID-19 and the little – not-so-little flooding challenges in different parts of China. So I think we are ready for next question. Thank you.

Thank you.

Your next question comes from Lillian Lou from Morgan Stanley. Please ask your question.

Thank you. I have a follow-up question on the same-store sales growth. Obviously, I think Pizza Hut did very well, actually better than that in second quarter. Well, I think Joey also mentioned in the opening remark that KFC was more affected. Just wanted to understand a little more in detail in terms of the impact to those two major banners’ recovery pace, why it’s a little bit different right now under the headwinds. And related to that is more the outlook, how we’re going to picture KFC and the Pizza Hut same-store sales growth recovery pace in second quarter or the fourth quarter? Thank you.

Thank you, Lillian. For KFC and Pizza Hut, as I mentioned in my presentation earlier, I mean part of both of the progress, Q2 has been difficult. But both brands did well in their own different way. And let me make a few comments one at a time. KFC reached to 89% same-store sales within quarter one, which is very, very quick, supported by a few weeks of strong sales before Chinese New Year and also very few trust restaurants opened during the pandemic time. So KFC rebounded very, very quickly. And Pizza Hut, because of the closure of dining business in many of our stores during Q1, so sales was more impacted. Once the dining business was allowed during Q2, the dining business for Pizza Hut bounced back quite quickly. As I can share with you that the Pizza Hut dining business recovered from 40% to 55% during Q2. So that helps. In terms of the recovery path and outlook. For both brands, that really come down to the theme that we talked about, the resilience, adaptability and innovations. And to be specific, I’m going to talk about short-term and long-term. So for the short-term initiatives, which is something that we have been doing from the very beginning of Q1 and then throughout Q2, is value, a lot of value promotions because we see that as a challenge and also opportunity. And as I mentioned in the last earnings release, the weekend was challenged. And thus, in the Q2 time, we have shifted our promotion towards more weekend and holiday, and we are seeing the results. And then second, short-term initiative, which is something that we have been doing, have been doing quite well with menu and innovations. I’m talking about the product innovations. So for KFC, we have…

Thanks a lot, Joey.

We have our next question from Michelle Cheng from Goldman Sachs. Please ask your question, Michelle.

Hi, Joey, Andy, a question about Pizza Hut. The second quarter improvement is quite encouraging, as you mentioned. We are pushing these takeaway, one-person set, and et cetera. So can you share with us what are we going to focus in second half? And given this kind of like sales mix change, so like are we going to see like some downsizing of the store or some new store format going forward? Thank you.

Thank you, Michelle. For the revitalization of Pizza Hut, I stay away from the turnaround because Pizza Hut was never so bad that need a turnaround. It has always been a very profitable business. But for the revitalization of Pizza Hut, we always have a very clear step-by-step progress. And good things do take time. In the last few years, it took us 18 months to turn the same-store sales from negative to positive, which is not slow. But let’s look at what are the key things we have done in the last few years. One is about the value for money and the quality of the product. So by last year, we managed to upgrade more than 70% of the menu. And by this year, when we launched the 30th year platinum menu, we further upgraded the menu. So that is a really good progress, and the momentum will continue because Chinese customers does want and require good food with great value for money. So – and then what are the other things that we have done? We have taken our time to rebuild our delivery infrastructure. So that’s the hard work for 2018. We took the delivery rider back to our system. We rebuild it to improve the quality of delivery. Without the quality of delivery, without ensuring pizza will reach our customer nice and warm, it’s very hard to grow sales. So we did the hard work, and you can see the impact of the delivery business growth in 2019. Now in the last two, three years, we also took the chance to rebuild our digital infrastructure, anywhere from member sales to mobile, to digital ordering, you name it. And right now, the digitalization. So now we have seen the increase of the preorder, digital order, that…

Thank you, Joey.

Your next question comes from the line of Kevin Yin from JPMorgan. Please ask your question, Kevin.

Thank you, Joey and Andy. I have two questions. The first one for – a technical question for Andy. Can you help us to understand why the operating leverage impact on Pizza Hut is not that bad as at KFC? Because if you look at the first quarter, second quarter, their margin – restaurant margin is pretty stable versus KFC’s continued declining. So that is a technical one. Second one, I’d like to know more on the impact from the flood. Can you give some vivid example or vivid case that like in some region, province, how badly the sale – the store sales are a negative impact? I mean, in some specific region, which we had some very bad flood, and how bad is the sales store – the store sales decline? Thank you.

Thank you, Kevin. So let me take your first question regarding obviously the impact on KFC and Pizza Hut and how they’re different. So I think there’s questions about the performance of the two brands. I think as we may have mentioned on the call, the SSG, which is same-store growth, was 10% decline in KFC and about 12% in Pizza Hut, which is quite an improvement, right? So in the – for KFC case, it’s improved by 1% and then most pronounced improvement at Pizza Hut, which in the last quarter was down about 31%, right? So that’s quite a lot of improvement there. But that still masks the actual improvement, right? So if you look at both brands, because the SSG calculation actually would exclude temporary store closure, right? And so if you take out – if you look at the store reopening in the second quarter, the system sales recovery actually improved by a bit on – at both brands and, on a year-over-year basis, improved from negative 20% in Q1 to about 1% in Q2. So that’s important. And obviously, we also see April and May improvement – sequential improvement in both SSG and also overall system sales improvement. As we mentioned, this got impacted by some events in the – in June and early part of July. One is that there’s a regional outbreak in Northern China. And then there’s a delayed summer holiday. And then of course, as you mentioned, there’s flooding in June and July in part of – the large, large part of China. So I think that’s very personal. And then – and as we mentioned, obviously, KFC have a very strong recovery right after the outbreak. Pizza Hut, in the first quarter, more impacted and, therefore, see a relatively better recovery. But both brands actually have recovered very well in terms of operations. In terms of the margins as well. So I think if you look at the margin on both – at both brands, it has improved. And I think this is – hopefully, will continue to be the case as sales deleveraging are beginning to ease as we move forward in the coming quarter. But obviously, KFC has been very profitable before, right? The – you see margin was about 17%, almost 18%. And then Pizza Hut revenue would impact a little bit more on that. Particularly, the reason is because if you look at transportation hub, which is a – not only account for the high single-digit of our sales but also account for low double-digit of our profitability. And that impact in that sales trend over in transportation hub and tourist location would have a disproportionate impact on KFC compared to Pizza Hut. But I think if you look at both brands, labor productivity, cost control will help us to see sequential margin improvement.

, : So why the sales in lower-tier cities hold out – still hold out fairly better despite the flooding? Because there are five reasons. One is a lot of these lower-tier cities, that means we only have a pocket – some pocket of stores being impacted, not huge scale. So where some stores, impact of that is not at the scale of Tier 1 cities so we can handle that kind of challenge. But also due to the second reason is our stores tend to recover much faster than our competitors’. So one example is the one little town, the gas got turned off by the city government, the entire town. But actually, that means more business to our store because our stores use electricity, not gas. So when the customer could not have hot food at home, they come to KFC. They could have hot food there. Not to mention, we always have free chargers for your phone and then free clean water if needed. Third reason is there’s a lack of transportation and tourist hub in the small town – city. In the small town, the transportation hub and the tourist hub, as Andy mentioned, is almost at, together, high single digit – almost double digit of our sales. And when it’s severely impacted, it does impact our overall number. But the small town, usually, the stores are less impacted by that. And fourth reason is we are one of the few trust brands in the lower tier cities. So during the difficult time, we actually benefit from it. Last but not least, delivery growth actually is even higher in the lower-tier cities than top-tier city. So I hope that gives you a better color of the dynamic of the lower-tier cities despite the flooding challenges. Thank you, Kevin.

Thank you.

Your next question comes from Anne Ling from Jefferies. Please ask your question, Anne.

Hey, hello, management. Thank you very much for taking my call, my questions. So I have a question regarding the – some of this one-off benefit. Andy, you mentioned about like the $30 million in second quarter on the social insurance payment and also like 10-year – $10 million rental relief. If we look at, like yesterday’s start-ups results, they also mentioned about like some VAT exemption, which we saw the announcement back in February that all the catering business and lodging business will have this tax reduction. That helped their same-store sales as well as their profitability. I just wonder like whether for this quarter, are you enjoying that any sort of this kind of like VAT exemption benefit? And since this benefit will last until December, may I know like how soon will you be able to get this kind of benefit? What are the procedures on this part? And is there any additional onetime benefit in this quarter and in the foreseeable future? Thank you.

Hi, Anne, I will answer your questions about it. Hi, can you hear us?

Yes, yes.

Okay. So thank you for the questions. VAT and its impact, a little bit more complicated. There’s obviously, we are aware and have looked into the VAT reductions, temporary suspension of that by the government at the beginning of the year. And generally, VAT that we collect from our sales is generally less than our VAT credit for our company services for the input cost. So there’s offsetting factors, right? So you have the sales to consumer, and we have also used product and services, and that’s offsetting. So after very careful analysis that we have done, we don’t see there’s meaningful impact on our top line or bottom line from the VAT exemption that the government have launched this year. Obviously, we’ll continue to look into it because tax is now – these are very complex issues. But in regard to VAT, would have very limited impact on our sales or our profitability. In terms of other onetimes, so we obviously received the social insurance payment reduction in both the first quarter and the second quarter. But as you know, that was because the government launched that in February and then have extended that to June. Unless there’s some new update, that may go away in the third quarter. So unless the government extend the program again, we may see that one-time relief to go away. The other one is that rental relief. We see that in the first quarter, after negotiation with the landlords. Demand is less in the second quarter compared to the first quarter. We do expect that as the recovery continues, that would also be phased out. So I think some of these one-time effects maybe lessened in the third quarter and potentially also in the fourth quarter.

Okay. And Andy, when will we know that the government might extend the social insurance payment exemption?

Yes, when they announce it, then we’d know.

There’s no like time line on that part.

No. I think in some provinces, it’s really up to the government to announce the program. Yes.

Okay, okay, got it. Thanks.

Your next question comes from the line of Christine Peng from UBS. Please ask your question, Christine.

Thank you, Andy. So I just have a question regarding the cost alignment you mentioned earlier in your presentation. So can you elaborate as regards to, number one, what magic you have been taking to do this cost alignment? And secondly, what’s going to be the margin implication, for example, in 2021, once the revenue normalized to the pre-COVID-19 level, especially for Pizza Hut? Thank you.

Okay. Christine, thank you for your questions. Yes, so obviously, as we look into the cost structure and we align that, there’s two sort of like driving goal for us. One, obviously, is to continue to make our cost structure more flexible to handle contingency, such as we have seen in COVID-19. The other part is that we’ll continue to try to drive our overall cost structure more efficiently. So that as Joey mentioned, taking advantage of the current situation where folks are more aware of the need for better cost control and better cost realignment to push through some of the initiatives that would help us to make our cost strategy, cost structure a competitive advantage for us in the longer-term. So with that in mind, so we go through sort of like each major category of our cost component. Now so if you look at our – for example, POS, obviously almost all wearable. And – but we’re also focusing on using technologies, using product innovations to sort of improve wastage in the restaurant level, to manage inventory turns better, so that can handle fluctuations in demand shift, for example. In labor, for example, as we mentioned before, over time, we have shift some of the labor component into more wearable portions with more flexible pool scheduling, et cetera. Again, give us some resiliency in terms of handling the flux in sales changes. And then also, if you look at – obviously, we benefit – sow the benefit, but in the longer term, it’s the labor productivity improvement that we use technology to drive, that really help us in the long run, to maintain that labor productivity improvement that we have seen over the past few quarters, right? So we’ll continue to focus on that, invest in technology,…

Thank you, Andy.

Thanks.

Thank you, Andy. Can I just ask the…

Sure.

Sorry. We have one last question from Xiaopo Wei from Citigroup. Please ask your question, Xiaopo.

Hi, thank you for taking my questions. I have a very quick question on Pizza Hut. If you look at the Pizza Hut recovery, actually, not only the top line but also the profit improved a lot Q-on-Q. You mentioned a lot of factors. I think it will be short-term, but let’s recall what Joey have been talking about, the revitalization effort at Pizza Hut in the past two years. Shall we say that the behavior changes of consumer post COVID may actually put Pizza Hut in a better position of revitalization post the COVID outbreak? Because we are seeing other category dining player to actually recover much slower than Pizza Hut in my observation. Could Joey you give us other color on that?

Hi Xiaopo, thank you. Well, we are certainly grateful to see the recovery in both top line and bottom line. As I mentioned, the dining recovery as well, and the bottom line recovery, of course, to a great extent, is because of the sales leverage. Our sales is back so the bottom line definitely looks better. But with that said, there are certainly a few things that happened here to help us recover better. I don’t know whether I would say COVID-19 gave us opportunity, or we just have been prepared in the last few years. And it just happened that the timing is not too bad for us. The innovation capability, the food improvement certainly helped a lot because our team right now is so innovative. And it’s something that I mentioned in the last earnings release, we are able to use whatever ingredient in our store to come up with very cost effective and efficient food for the takeaway business. One example is the [Foreign Language] the steak rice, which we use actually our pizza oven to cook. Just go through like – use the [Foreign Language] like use the pizza oven, but were very efficient and efficient in terms of cost structure as well, and it worked very well for the takeaway, for the one-set lunch – one-set meal, and thus – therefore, it worked. And that is not because COVID gave us the opportunity, because we’ve been working on the innovation capability. And then secondly, the delivery. We have our own delivery rider when we really need it. As you can imagine, if we do not have our delivery rider, even if the business is there, the – whether you have or you don’t have the delivery rider decide whether you have or don’t have the…

Thank you, Joey, and stay healthy, please.

Thank you. You too.

Okay. There are no further questions at this time. I’ll now hand the conference back to your presenters for any closing remarks.

Thank you for joining the call today. We look forward to speaking with you on the next earnings call, and that concludes today’s call. Have a great day. Thank you.

Thank you, everyone.

Thank you, thank you.

Yes, ladies and gentlemen, that will conclude today’s conference call. Again, thank you all for participating. You may now all disconnect.