Thank you for standing by, and welcome to the Yum China Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to Ms. Michelle Shen, Director of Investor Relations. Please go ahead.

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Third Quarter 2022 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. We are dialing in from different locations today. If we experience any technical difficulties during the call, please remain on the line as we reconnect. Before we get started, I'd like to remind you that our earnings call and investor 7materials 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 statements 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. Reconciliation of non-GAAP and GAAP measures is included in our earnings release. Today's call includes 3 sections. Joey will provide an update regarding our performance in the third quarter. Andy will then cover the financial performance and outlook in greater detail. Finally, we'll open the call to questions. You can find the webcast of this call and the PowerPoint presentation, which contains operational and financial information for the quarter, on our IR website. Also on the site, you can find a video we prepared that showcases our latest stores, offers and activities. Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Thank you, Michelle. Hello, everyone, and thank you for joining us today. We achieved outstanding performance in the third quarter with fantastic growth, both top line and bottom line. This demonstrates our ability to operate in an uncertain environment by learning, adapting and strengthening business fundamentals. During tougher times, our resilient business model and agility helped us manage the negative impacts. As COVID conditions were relatively calmer in July and August, we captured sales opportunities during the peak summer season. System sales recovered with 5% year-over-year growth. Operating profit surged 77% year-over-year to $316 million, even higher than 2019 levels. Great teamwork makes this possible. Key elements in our winning formula includes our in-house and tailor-made supply chain, industry-leading digital and delivery capabilities, cost restructuring and solid execution. Let's move to KFC and Pizza Hut. We have been innovating new products to satisfy customer cravings. In the past 2 years, we have established strong presence in new categories such as beef burger, whole chicken and durian pizza. This was enabled by a powerful supply chain, by securing supply at scale, streamlining production and optimizing costs. Let me share our success stories. At KFC, our extra juicy beef burgers rapidly captured meaningful market share. Since adding them to the permanent menu in May 2021, we have sold over 100 million burgers. That's about 5 beef burgers every second. For the full year, we expect to generate close to CNY 2 billion in sales from beef burgers. We cater to Chinese taste by making the patty super juicy using our specialty ovens. Customers love our burgers for their great taste and value for money. We source our Wagyu beef, [Foreign Language], locally from Northeastern China and have signed a multiyear contract to secure enterprise. Our juicy whole chicken has also quickly gained…

Thank you, Joey, and hello, everyone. Let me now go through the third quarter performance in detail. We saw sequential improvement in the third quarter. System sales returned to growth year-over-year and restaurant margin was the highest since 2018, well above our expectations. We focused on driving sales through new products and compelling value. Same-store sales recovered to the same level a year ago. From a timing perspective, the trend remains volatile impacted by frequent COVID outbreaks. In July and August, we saw a sequential recovery in same-store sales, and August exceeding the prior year. This was mainly due to lapping the Delta variant outbreak in August 2021, which heavily impacted Eastern China. However, in September, same-store sales declined mid-single digits as COVID-related health measures tightened in many areas. Around 900 stores were temporarily closed or provided limited services in September compared to around 400 stores on average in July and August. On the margin side, we continue to identify cost-saving opportunities, drive labor productivity and rebase our cost structure. Let me go through the financials and our cost control initiatives. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 6% in the quarter. Third quarter total revenues increased 5% year-over-year in reported currency to $2.68 billion due to the contribution of new units and the consolidation of Hangzhou KFC. This was partially offset by temporary store closure and foreign exchange translation. In constant currency, total revenue grew 11%. System sales grew 5%. Same-store sales were flat year-over-year. By brand, KFC same-store sales were flat with same-store traffic at 93% of prior year's level. Ticket average grew 8% due to the increase in delivery mix, which has a higher ticket average than dine-in. Abundant value campaigns, like the…

Thank you, Andy. We'll now open the call for questions. [Operator Instructions]. Ashley, please start the Q&A.

[Operator Instructions]. Your first question comes from Chen Luo with Bank of America.

Congratulations on the very strong Q3 results. Given the very fluid situation amid the COVID outbreak and restrictions in China, my question will focus on margins. We have seen very impressive margin expansion in Q3 results. And over the past 3 years, we also observed a pattern that usually, during the first few quarters of a big COVID outbreak, such as the Wuhan one or the Delta outbreak in Q3 last year and the Omicron outbreak early this year, we might see a few quarters of margin erosion. But our very agile and quick adaptation in the following quarters, we actually -- we managed to achieve margins that could be even higher than the pre-pandemic level. And let's assume that next year, we are not going to see another big wave of outbreak that would lead to massive lockdowns in our core markets such as Eastern China, is it fair to say that we can actually achieve a restaurant margin that is largely comparable to the pre-pandemic level, which is around mid-teens? So this is my question.

Chen, thank you for your questions. Obviously, our team has done a fantastic job to deliver solid margins amidst a very difficult and challenging situation. Now our margin improvement, obviously, some of these fundamental transformation, that would last going forward. Some of this is more temporary and some of these austerity measures may dial back as things return to normal. Now if you look at our margin improvement, it was largely by high productivity, right, and also for the quarter, some temporary relief and sales leveraging. Now so when we look at the initiatives that we have undertaken over the past couple of years, we have mentioned, over the past few quarters, we have taken initiatives to rebase our cost structure and also to drive efficiency gain. So you see a lot of new product innovation in terms of our assets, how we manage the pricing and also the cost inflation and commodity prices. We also -- our supply chain team continue to be our core strength in terms of managing supply and robustness of our supply chain. And also sort of mitigate partially some of those impacts from high commodity prices and allow us to continue to innovate and quickly to roll out new products that meet the consumer demand. The other one is, obviously, you look at the labor productivity. For example, we have deployed technologies. We continue to invest in technologies to automate our system processes, to help improve labor productivity. As we have mentioned probably last quarter, we're beginning to roll out a management tool for our stores. So our management team for the store can be used across multiple stores. And if you look at our rental, for example, obviously, we see some rental relief, but we also have, over the past few years, and…

I would like to just add some color in terms of our management team's thinking and also the business model, why that helps protect the margin now and in the future. Well, we do believe that this company and this team, this management team, is an anti-fragile company. Whatever stone is thrown at us, we possibly could convert these stones into our stepping stones to go further and higher. That's what we believe and then our team keeps trying to do the right thing. In terms of business model, as I mentioned in our -- in my presentation earlier, it's very important to recognize that our off-premise business right now is 60%. What does that mean? Well, if we look at it by brand, KFC is actually 65% off-premise. And that is up from last year, which was 60%. Now Pizza Hut tell an even more amazing story. Pizza Hut, the off-premise sales is 50%. Before pandemic, it was only 30%, from 30% to 50%. So our business, our off-premise business in Pizza Hut is much, much stronger and higher. Given the fluid situation and the pandemic, these are incredibly important numbers because when we are in sort of a more tougher situation, in times of , that 60% will become higher because there will be naturally some sales transfer from dine-in to additional off-premise business. So with the 60% sales to off-premise, in fluid situations, that percent will go higher. That naturally protects our business, ourselves, because it's very difficult to have a strong margin when the sales leverage is not there. So it's not only all the margin line that we prepare, as Andy has comprehensively pointed out, but on the other side, the sales side that we have also to protect. And that's a lot of hard work in the last 3 years, and the team has done a great job.

Joey and Andy, your margin management capability is really impressive. Congratulations again.

Thank you.

Thank you.

Your next question comes from Lillian Lou with Morgan Stanley.

My question is also a follow-up question on margin management but maybe from a different angle because, Joey and Andy, you mentioned about the sales leverage and also the line items, management on cost side. So maybe look at it, all the initiatives in the third quarter and also during the pandemic in these 3 years, you've been focusing on really kind of rejuvenizing the menu and the new product launch and smaller stores, a very effective promotional campaign. So when you are designing this, what's your thinking behind? Especially trying to understand that with our new stores now incrementally a higher portion of small stores, would that actually fundamentally change our margin profile going forward? And also, especially third quarter, you have more promotional campaign, but in return, actually, it didn't suffer on margin instead it's on the opposite side, you improved the margin. So I'm trying to understand a little bit further how you achieve that from these efforts.

Thank you, Lillian. I think in terms of margins, I think I want to emphasize at least in the short term, because of the COVID situations, we see fluctuations in our sales. It got impacted and high correlation with the COVID situation. So the biggest lever of deleveraging impact when things come down is actually sales, right? Higher store sales generally will drive higher restaurant margin. And we can see that, even without the pandemic, in a normal time, we'll see that margin fluctuate through the year during the first quarter, and the third quarter generally is higher sales period for us and we also see higher margins. And then in second quarter and especially the fourth quarter, generally a lower sales season for us and you'll also see lower margins. So I want to emphasize and echo what Joey had mentioned earlier, sales is very important to us in terms of driving margins and also leverage. Now in terms of our store format, our store format remains very, very healthy unit economics, probably better in the recent years. This did not just come naturally, but a lot of hard work we have put into the store format design, operations and then also the menu mix, et cetera, to make it work. Now our store format, obviously, right now are geared to our 2 areas, largely. One is on the greenfield, right? So we still have a lot of cities and townships that we can serve. And then we have a format for that. We also have formats for catering to the urban area where we're increasing density and cater to the higher mix of delivery and takeaway business. And so -- but they all have one thing in common, is that our store format in terms of upward investment…

Yes. Let me -- again, let me add some color in terms of the relation between promotion and margin management. As we mentioned earlier, we consolidate our promotion mechanism, and we focus on fewer and more impactful, such as [Foreign Language], Buy More Save More. They help drive our sales during weekends, which is quite effective. But at the same time, we are very, very careful to manage our products. For example, the whole chicken, right? The whole chicken -- I'll give you one example, you guys will get it. Sometimes it's more detail to get it. We sold 80 million whole chicken so far this year. It's roast chicken. Why not fried chicken? Well, here is the reason why. Oil this year is very expensive. So if we do roast chicken, it has 2 benefits. One, it's healthier, two, it costs less. Customers love it. So we go through every little detail, make sure that it has both great products but at good cost. And that works for not only dine-in but at-home consumption. So just a small example to give you a sense. And in terms of margin protection, I would like to share another belief which result in very good results. Back to Q2, it was a very difficult quarter. We reiterated our commitment to protect our staff's jobs, no layoffs. We looked at every single way to manage our cost structure, our margin, except layoffs. We want to protect our employees' jobs during the tough time. Everyone needs some sense of security during very fluid situations. And our staff, our 400,000-strong team, they appreciate it. And everyone, everyone go for every single innovation that we can achieve to protect our company. I'll pause here. Let's move on to next question.

Your next question comes from Xiaopo Wei with Citi.

Joey, Andy, I will also ask a question about the margin, but I will take another approach, maybe the bigger picture of what happened in the past 2 years. If we look at what happened in the past 2 years since COVID, we are seeing you open more stores. But in the third quarter, it's the first time that we are seeing amazing restaurant margin with some very short window of rebound about all the consumption, et cetera. But I can see that you greatly captured that upside of the consumption rebound. Should we say that actually the new store openings, which was the investment for the future, started working well in that situation. Looking forward, when the COVID is phasing out, actually, are new store contribution to probability would actually be more pronounced than before? Another question related to this is, if we look at the delivery sales contribution, KFC hit 37%, which is amazing, very close to Pizza Hut. I do remember years ago, when I first met Joey, I had the impression that KFC had never been that high in terms of delivery sales contribution for Pizza Hut. And now we are seeing Pizza Hut and KFC having a very close kind of delivery sales contribution. Shall we say that looking forward, KFC fundamentally has transformed and we are expecting actually higher-than-expected delivery sales contribution looking forward, approaching 40%?

So I think there's a lot of question about margin today. Obviously, we're very pleased with our margin performance in the third quarter. As we mentioned, the sales leveraging, there will come a time, we will not only able to capture not only the sales upside but also able to regain the sales leveraging. So obviously, as I mentioned before, there's a number of fundamental transformations that we have undergone, rebasing our cost structure of initiative. But I think what you are asking about is about 2 things, right? One is the new store margins and profitability. The other one is the delivery sales mix, what's the percentage going forward. Now I think when we look at the new store economics, I think -- one thing to remember is that for any new store, it generally takes a couple of years for it to ramp up sales and margins to a truly mature level. So the other part is that, obviously, we're very pleased. As you mentioned, when we look at our new store performance, they continue to be very robust, very strong. If we look at the margin front, I mentioned the ramp-up period. But even for the store that we opened this year, a large majority of them turned to restaurant breakeven or better within 3 months' time, which is tracking on par or slightly better than the historical level. And so I mean, there's a couple of things that is happening there, right? One is, as we mentioned, we have worked very hard to find the right format, not just reducing the size, the size is obviously important, but also the operations, the total offering and the menu mix. So all these worked in conjunction with that. We also -- as we mentioned, we have worked hard…

Your next question comes from Michelle Cheng with Goldman Sachs.

My question is about store expansion. So given this very strong profit margin, do you have any initial thoughts on the expansion plan into 2023? Any chance we could further accelerate expansion given we know all the smaller players are suffering. And also more specifically by brands, so aside from KFC, Pizza Hut maintaining a relatively stronger momentum on expansion, how do we think about other brands since we're actually reshuffling other brands quite aggressively in the past few quarters.

Michelle, about new store and as I mentioned, our new store performance continues to be strong. And also, as I mentioned before, I mean each year, we set a target we think what is reasonable, but ultimately, it is for the market and the fundamentals that we would try how many stores that will be opened and then also sometimes get impacted by COVID. So we will continue to maintain that disciplined and systematic approach. So when you see the economics are good, the system we're doing, you'll see that acceleration because more so we propose and more so we approve. Obviously, when the market or like the unit economics are more moderately impacted, then we see some deceleration , because it's due to the model and the assumption itself, will refresh that very regularly. So we will maintain that very disciplined approach. Obviously, we'll continue to see very strong fundamentals for store opening. We see, as I mentioned before, the greenfield. We have more KFC, we're only in a little bit more than 1,700 cities. We see probably another [indiscernible] that potentially we can enter Pizza Hut, like almost 1,000 stores that KFC already in, we don't have a Pizza Hut store. So there's a greenfield opportunity. So we feel very good about store expansion, store network expansion and opportunity there. Now in terms of -- obviously, we'll continue to have to work hard on the store format, right, because the consumer dramatically could change -- and we see obviously opportunities in these right now. Our pipeline is very strong because we will feel like very attractive right now in the restaurant industry. After 2, 3 years of pandemic, we continue to perform very well, pay our rent on time and everything. So we move them attractively even more…

Michelle, I'll just add a few comments about the store expansion. First, we certainly are opening even more smaller stores. So for Pizza Hut alone, some 5% of the new store opened this year are either smaller or satellite store, and KFC is about half. And these small stores work particularly well in lower-tier cities, and that's where we will continue our store expansion. And the result is pretty exciting and promising. So that's comment number one. Comment number two is opening new -- the smaller stores also require focus on the product and operations side, and we are giving that support to the new smaller stores. For example, chicken breast burger, [Foreign Language]. The price is very good. It's 9.9. It's brilliant. It's amazing for the lower-tier city new stores as introduction to our business. The other products like [Foreign Language], we developed these products with lower price points, specifically for lower-tier cities and specifically for the introduction of new store. And at the same time, we also continue to innovate in terms of operating process within the small stores. Well, one example, smaller stores we only can accommodate fewer number of staff, which is a great news for shareholders. But that also requires changes in terms of operating process, how to still make it work to protect our product quality, for safety. You name it. So not only just the cause are of opening new stores, but also the product and the operating process that we are focusing on.

Your next question comes from Anne Ling with Jefferies.

Regarding the cost side, we look at like -- we track the chicken price and which we saw a 20-odd percent increase. And also, at the same time, costs also increased. I understand that management has a really great way in terms of like making use of the whole chicken parts. But moving into like year 2023, when do you see this increase in terms of the cost, the chicken costs or the other commodity costs kicking into your P&L? Or maybe you can share with us what is your current agreement with your supplier.

Joey. Do you want to?

No, no, go on.

So when we look at our [Foreign Language] obviously, I think we do have to comment on how fantastic job product innovation team have done to help us manage that cost inflation. Commodity price inflation, as you mentioned, is very real and is globally and it's true also in China as well. Obvious in China, we see more moderate inflationary pressure. But still, we see the commodity price increase escalating over the past probably like a year. We see a very favorable pricing last year, 2021. We're beginning to see that commodity pricing pressure building up. And right now in China is probably, admit to get food commodity pricing increase. And as you mentioned, we all see poultry price increase -- so as I mentioned before, this will continue to be happening. And we'll continue to work hard to self-mitigate it. The other one I want to mention is that as we have mentioned before, our supply chain generally locked down most of the supply, a quarter or 2 half time. So there will be some lagging impact on the inflationary side. And obviously, because we get an inflationary environment, our supply chain also deploy long-term contracts to try to when it is possible to lock in pricing a little bit longer. For example, coffee, they have done a fantastic job at locking a longer-term pricing contract. But some of the commodity you cannot lock in for such a longer time. So we'll see some commodity pricing pressure building up in the coming quarter as well. Now as you mentioned to give up probably pricing pressure besides of the supply chain and the efficiency there is also on product innovation, as Joey has mentioned. The team has done a fantastic job developing new products, that utilize even part of the…

Anne, I'll just add one comment on that one. We do use every part of chicken accept the chicken feather. But I would also like to point out that we have our team, both the pricing team and then the product innovation team, we have been able to introduce and use different proteins; beef, pork, fish and duck. We are selling duck burger right now as we speak right now, chicken and duck burger. So we have a variety of proteins in our pipeline that we can use and we can promote, depending also on the price. I mean, the thinking is rather simple, a good share they look at what is the best in terms of quality, not only price, quality and price available in the market. And then you turn these fantastic ingredient to great food. Same for us, just at much, much bigger scale, I guess. So we have both the flexibility and the scale to deliver amazing food to our customers at very good price and very good value. Thank you, Anne.

Your next question comes from Christine Peng with UBS.

So my question is on the product side. So I supported a very interesting new product, which Joey mentioned, which is the beef burger. So I noticed that this product has been on the menu since May of 2021, which means that this is likely to be a long-standing product instead of LTO. So if that is the case, Joey, can you share with the distinction behind this product in terms of the rationale, the supply chain management and also future plan for this product going forward. Because what I'm interested to understand is that will this be a burger potentially become a very important category for KFC going forward? And what's going to be the structural impact on KFC in terms of competition, in terms of margin trends, et cetera. So anything you can share with us, that will be very much appreciated.

Thank you, Christine. Well, it's already a very important product in KFC portfolio. The speed and the support from the customer exceeds our expectation. To quantify the sales of beef burger, I mean we talk about it already. It already contributes a meaningful sales mix to our business. It's about 3% to 4% of KFC sales mix, but that is a lot already because for original recipe after all these years, it's about 6%, 7%. So it's half of our original recipe chicken sales already. So that's the number side. In terms of product side, for those who are in China, if you have a chance to try, I do strongly encourage you try it, then you can form the opinion yourself about the future of this product. I know it's rather unusual for a company selling chicken to sell beef burger, but once you try it, you will understand why. We have good range of product choice there from entry price burger, which tastes amazing still, beef burger all the way to Wagyu beef burger, Angus beef burger. And as Andy mentioned, it's hard to imagine, but it tastes amazing. Wagyu beef, you can't [indiscernible] a Wagyu beef burger. So -- and the price is still very good value. I won't say it's low price. I mean, Wagyu beef burger is fantastic value. So the choice of product is fantastic. Third is the flavor, the taste. There are plenty of customer -- customer made video comparing our burger versus other competitors. One thing very distinct about our beef burger is the burger, it's very juicy, and this is our focus. Because while some traditional beef burger lover might love the barbecue flavor, for Chinese taste, they prefer the juicy burgers. And that has been our focus. And we are uniquely positioned to do that because we have very high quality ovens in our kitchen, each of our KFC kitchen to produce the beef burger. So the beef burger is a patty, it is cooked in an oven, not on grill. So I hope that gives you some flavor of this amazing product that I love myself.

Joey, let me add a little bit here because as I'm self-proclaimed #1 fan of KFC often, and like -- but still sometimes I do need variety beside chicken and rice -- so I think the beer burger is fantastic. The beef burger does only have 1 Wagyu beef burger, but now we have a range of burgers, a beef burger that can appeal to different pricing points. I myself increase my frequency to go into the store because I have not had to yell like when I want to eat beef, I have fantastic choice for the KFC beef burger. So from a customer standpoint, I think it's fantastic because it provides greater variety like you mentioned, different proteins, different choices. And so I love it anyway.

Your next question comes from Veronica Song with Credit Suisse.

Congratulations on a very strong set of results. I have a question regarding the COFFii business. So as Joey mentioned, we're going to wind down the COFFii & JOY business and focus more on the K-Coffee and Lavazza . So could you share more color on the current situation or achievement of Lavazza, especially in terms of store expansion and any color on store economics? So how can we adopt the valuable experience we learned from COFFii & JOY and KFC to drive Lavazza's success?

Okay, so I think first of all, I think is I want to repeat it quickly, which is winding down the C&J business so that we can focus more our resources, on the common resources on [indiscernible] and give, obviously, the team more focus, more laser focus on the market. And as you mentioned, currently, our coffee strategy have 2 key brands. One is K-coffee, which serves the value and convenience segments. And for Lavazza, we will be looking on offering authentic wonderful Italian coffee and experience. So from obviously, C&J, with our homegrown brand over the past 4 years, we've learn a lot. And this is one thing that we have keep saying, we have when we enter into a new business segment. Coffee business is very different, obviously from fried chicken and Pizza Hut business. So there's lot of learning there in how to give our product, coffee, water, milk, the whole process to make good coffee. , obviously, is also very critical. And then obviously, for coffee too, the store format, I think trying to figure out what is the right format at different trade zones and economics and whatnot. And then also in terms of the Chinese customer, coffee is still a relatively new market segment. A lot of Chinese consumer are still very new to good coffee, the taste of coffee and what their preference are, also need time to spot for us to develop and learn and apply to our product development. So a lot of this learning, I think, a wonderful learning that we did with C&J would help us to obviously apply to Lavazza as we go out and expand its business. And for Lavazza, we continue to recover from, obviously, from a franchise time because a lot of store in Shanghai…

There are no further questions at this time. I will now hand back to Mr. Shen for closing remarks.

Thank you, Ashley. Thank you all for joining the call today. We look forward to speaking with you on the next earnings call. If you have further questions, please reach out through the contact information in our earnings release and on our website. Have a great day.

That does conclude our conference for today. Thank you for participating. You may now disconnect.