Thank you for standing by, and welcome to the Yum China Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Ms. Michelle Shen, IR Director. Please go ahead.

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Second Quarter 2023 Earnings Conference Call. 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 materials 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. Reconciliation of non-GAAP and the GAAP measures is included in our earnings release. You can find the webcast of this call and a PowerPoint presentation on our IR website. Now I would like to turn the call over to Joey Wat, CEO of Yum China. Joey?

Hello, everyone, and thank you for joining us today. I'm delighted to report outstanding performance in the second quarter, both topline and bottom line. Our results are the testament to our resilient in anti-fragile business, which allow us to capture upside in good times and protect downside in bad times. From the back office to the front lines, our teams are doing a great job. During the quarter, we reached new heights on multiple fronts. First, sales performance. Total revenue of $2.65 billion set the new record for second quarter, especially given the exchange rate. System sales grew 32% and same-store sales grew 15% year-over-year. We observed strong demand around holidays. Trading for the May 1st Labor Day holiday was vibrant. However, demand actually softened afterwards with a dip in customer traffic. We adjust nimbly with attractive campaigns and regain sales momentum in June. On June 1st Children's Day, we hit the record 8.5 million transactions that equivalent to a transaction every minute in every location across our 13,000 plus store portfolio in a single day. Thanks to our amazing operation team, robust end-to-end digitalization and agile supply chain. We flexibly handle the spike in demand during campaigns without compromising quality and customer service. The result demonstrate our brand equity and ability to connect with customers with delicious, innovative food and compelling value for money. Second, store expansion. In the first six months this year, we opened 655 net new stores, setting a new record. We continue to see vast opportunities across all regions and city tiers in China. KFC continued its aggressive expansion, hitting 9,500 stores in over 1,900 cities. Notably, Shanghai became our first city to reach 500 KFC stores. Our 500 store is in the Shanghai Library, Shanghai [indiscernible]. As part of our Book Kingdom Program for…

Thank you, Joey, and hello, everyone. Let me now share with you our second quarter performance. I'm delighted to report our robust performance in the second quarter. We achieved record revenues of $2.65 billion, representing 25% year-over-year growth. Operating profit of $257 million also reached a record level, more than tripling that of the prior year. We accelerated new store openings. We opened 542 new stores, resulting in net new store growth of 422, setting a new second quarter record. Even though same-store sales remain below 2019 levels, we saw 25% growth in revenues and 26% growth in operating profit in the second quarter compared to the pre-pandemic levels in 2019. We accomplished all this while operating in a challenging and volatile environment, an uptick of COVID infections started in late April. Consumer continue to be value conscious. Sales materially weakened after the May 1st holiday. But leveraging our multiple scenario planning, we swiftly responded by launching attractive offers to drive sales. Our sales subsequently improved in June. To provide more context, in the second quarter last year, multiple cities were under lockdown. We are lapping last year austerity measure and temporary relief. Now with that, let's go through the financials. Foreign exchange had a negative impact of approximately 6% in the quarter. Second quarter total revenue were $2.65 billion in reported currency, a 25% year-over-year increase. In constant currency, total revenue grew 32%. System sales increased 32% year-over-year in constant currency. The strong growth was mainly from same-store sales growth of 15%. The remaining growth can be roughly split equally between new unit contribution and the lapping of last year's temporary closures. Dine-in sales rebounded significantly year-over-year while delivery continued to grow. By brand, KFC same-store sales grew 15% year-over-year. Same-store traffic grew 21% and ticket average decreased 5%.…

Thank you, Andy. If you are interested in attending our Investor Day in person, please reach out to the Investor Relations team. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your question to one at a time. Ashley, please start the Q&A.

Thank you. [Operator Instructions] Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

Hi, Joey, Andy. Congrats, again for the very strong results. My question is about the promotion and the competition. So as you mentioned, the market is still very promotional and also we hear some smaller players are actually coming back. So on one side, can you discuss or share with us your observation on the competition side. And more specifically on the margin, we still see the food cost margin manage pretty well and particularly can you talk about Pizza Hut? Since, we have been working on this value position for many years, but it looks like in this quarter the food cost control is pretty decent. So can you also share with us how should we think about this pricing strategy and also further savings on the food cost? Thank you.

Michelle, thank you. I'll talk about the promotion competition. Andy will handle the margin question. Customers are very value cautious for sure, but at the same time, it's not enough if we just focus on promotion. It has to be promotion – fun, promotion and good food. And our focus is to focus on few very effective promotion platform. So what are the famous ones? Crazy Thursday is very, very fun, its user generated content these days and of course, the food there is good. So we have some new food like spring roll, not only normal spring roll, but skinny spring roll. When the spring roll is smaller, they actually taste better. You can try it with our KFC spring roll on Crazy Thursday. And then Pizza Hut is focusing on Screaming Wednesday. Again, very powerful message, very simple message, but with great food and great order from steak to pizza. And Taco Bell, focus on taco to steak. So not only just random promotion, but very focused promotion and we keep doing it again and again and again. It takes time to build to have the effect because a little do people remember Crazy Thursday start from back to 2018. So by know-how, it's a very familiar mechanism and that worked beautifully. And of course, we continue to build new promotional platform KFC, the new one will be Buy More Save More on Sunday. And that has a clear product focus called the whole chicken, during normal times the chicken sell for 39, but on Sunday weekend it sell for 29. So it's not only promotion, but grapefruit. And I think, what people – some also necessarily correlate, how we differentiate from our competitors in driving this promotion. We have the unique advantage of having our own very effective, powerful, agile and nimble supply chain. Because without the supply chain capability to source, to innovate and to deliver all these very affordable ingredients is almost impossible to support this kind of promotion on a sustainable basis. Last but not least, operation team. June 1st Children's Day, we achieved 8.5 million transactions a day. That's huge number of transactions and the fact that our operation team can handle that is amazing. Well, for people who are running the restaurant in operation, we would be able to appreciate how difficult it is to be able to handle that peak and the spike, and the IT system, it did not go down. And we can continue to push our system in terms of the stability and efficiency so that all come together. It's not just marketing promotion, it's supply chain, it's the digital, it's the operation. And while many competitors can probably replicate the marketing campaign, but the operation, the supply chain, digital, these are the real top core capability, very difficult to replicate. So I'll pause here and move on to margin question.

Okay. Thanks, Joey. So in the second quarter improvement in terms of margins, I think obviously the number one driver is the operational leverage from higher sales. And also, if you look at the overall margin improvement, it continue to benefit from our portfolio optimizations over the past few years. As I mentioned earlier, if you look at our portfolio, currently 40% of our store are open after 2019, and they're very much geared to our – working efficiently in our current operating environment. Also, we continue to benefit from the cost structure rebasing that we initiated over the past couple years. And so those are key driver for margin improvement. And I think it position us well for the long-term to operate efficiently. Certainly, if you look at particularly on cost of sales, I think, overall with lower commodity pricing in the second quarter was slightly favorable with overall commodity inflations being favorable, but the chicken price in the second quarter actually we continue to experience an upward trend. And given the stock price and also our contract, we expect that to probably extend into the third quarter. So I think for both brands, they manage their sale as very well, over the past few years, generally balancing to expand the pricing range so that we can continue to expand our addressable customer base and balancing commodity price and also the value proposition to consumer. And we generally try to return some of the savings to our consumer. So if you look at cost of labor, it also improves 70 basis point in the quarter. And again, like it's driven by the cost structure rebasing that we have. And then also as Joey mentioned, we have the store management sharing initiative that continue to help us run our store…

Thank you. Your next question comes from Brian Bittner with Oppenheimer & Company. Please go ahead.

Thank you. I just want to ask about the sales trends. Andy, you mentioned that May saw a step back in demand trends, but then you regain momentum in June. Can you just add some context here? Could you perhaps talk about where your underlying trends are verse 2019? Or anything else regarding, perhaps the consumer environment in China that you're witnessing right now, just to help us all get on the same page with modeling sales moving forward?

Okay. Brian, thanks for the questions. I think, as you mentioned, we are pretty early still in the reopening. This is the second quarter since the reopening. So we are going to – probably going to come and see some volatilities and whatnot. Obviously the decline in – or like the softening in demand in May had to do with couple of things, but when we've seen an uptick in COVID, at the end of April, starting at the end of April. And then the other one is obviously you have seen some of the economic data and indicated that the macroeconomic situation is still markedly challenging. So consumer obviously have experienced three-year COVID and would likely going to take some time to regain some of the confidence. And so that's what we are seeing right now. But as we mentioned, we have multiple scenario planning as always. So we take quick actions as we see the change in consumer behavior. We have very strong product offering and successful campaign, and that as we mentioned revitalize the sales momentum in June. And I think, again, like, I think in the near-term, it's going to be some volatility uncertainty, but I think we are well positioned to capture the opportunity when we emerge and then able to respond quickly, should the situation become a little bit more challenging.

Brian, thank you. Let me give overall picture of the business that might help understand the sales trend right now as well. Overall, I would strongly suggest our investor and analyst to really look at the business with a fresh pair of eyes because the business is a rather different business now compared to pre-pandemic. We might not be obvious enough, but 40% of our current store did not exist before pandemic. So the same-store sales really only apply to a bit more than half of our business now because 40% of the stores are new. And even for the portfolio that exists before 2019, the business is very different too because the management team has taken the opportunity in the last few years pandemic to prune the portfolio, particularly those stores with less desirable economics. So overall, the portfolio is better, but even for the store that has survived the pruning process, you bet the economics are much better with lower rent, et cetera, et cetera. And the big historical problem that we have, we used the pandemic time to sort them out as much as possible. On top of that, we have replaced the cost structure. We have completed the end-to-end digitalization and also digitalization of the entire supply chain process. So the business is more resilient, more nimble, and with better cost structure for the entire company, but also for the store economic for each store. So it's very different. Therefore, the system sales growth is quite good and same as the profitability, and that's what we wanted. Going forward, in terms of outlook, Andy talked about Q2, Q3. Obviously we're going to focus ourselves. We are going to focus on growth. We are going to focus on opening more stores and then continue to focus on…

Thank you. Your next question comes from Chen Luo with Bank of America. Please go ahead.

Thank you, Joey and Andy. My question is on margin as well. So if we combine first half this year with second half last year, and actually it would imply a four quarter, a full margin of a close to 17% at the restaurant level. So I remember many years ago, we talk about the long-term normalized restaurant margin of 70%. I know we no longer talk about long-term target. The market usually will still look at 17% as a reference. But now we are almost there. How much upside are we going to see from here? In particular, as Andy mentioned previously starting from Q3, we are going to see pretty high lapping for margins. Is it fair to say that from now on, the low hanging fruit from cost rebasing is no longer industrial and the majority of the margin expansion will come from the same-store sales or sales leveraging in the future? Thank you.

Thank you, Chen, and thank you for your questions. It's a one-off question and then it's also wonderful question as you mentioned the issue to deal with, right. Because after the reopening, after all those restructuring cost structure rebasing that we have performed over the past few years after, as Joey mentioned, our portfolio change entirely different – almost entirely different stock portfolio. We are now at obviously at multi-year, right? I think at least five years if not all time high internal margins. So we're offering very efficiently at this point. And as mentioned, even, despite the near-term volatility and challenges in the market, we are offering very efficiently. And so I think, a couple things that I want to mention. If you look at the cost structure rebasing, as we mentioned, those are very fundamental change in terms of how we operate our restaurant and also the cost structure itself. Now in terms of 17% margins, I'm glad that, when you mentioned over the past four quarter, you average hour is more there. We don't give guidance on margins, but we just do it sometimes, right? And so we did mention it over the past year or two, but I think we continue to focus on doing that. We are pretty confident in terms of our cost structure rebasing with that. We are pretty confident that our new store performance, our new store economics at multi-year, I guess the offering and investing in multi-year level. And so that give us confidence in how our portfolio moving forward as we open more stores. So we look forward to that improvement continuing. However, as we always mentioned, we generally look at cost of sales, we try to maintain that capability there. The reason why we do that is because we…

Thank you. Your next question comes from Anne Ling with Jefferies. Please go ahead.

Hi. Thank you very much for taking my call. I have – first of all the question also on the restaurant margins, Pizza Hut improving and success in the restructuring. What would be the normalized restaurant margin would be over time? Can it be like without naming like – can it be as high as like KFCs like 18% plus, and if that's the case what are the drivers? Is it more on the scale of the whole network or is it more on like driving the sales per store for further normalization? And Joey, last time mentioned that in the previous call that, you would love to see further increase in the delivery business for the Pizza Hut side. Any strategy that we can facilitate this? Thank you.

Yes. Hi, Anne. Yes. Thank you for the questions. Regarding, Pizza Hut, we are very happy to see that the revitalization program have achieved very strong result over the last two quarter already. We continue to see very strong traffic growth, continue to see strong sales growth. And as Joey mentioned, that’s fantastic product that coming out from Pizza Hut and also, Pizza Hut over the past few years as we have kept pricing stable, have continued to improve its value proposition to consumer. The value is great. And then you look at the brand, we sit resonating really well with consumer as well, and especially with some of the campaign, Genshin and other that really connect with our new customers. So I think it's wonderful that they make this transformation because I think expand the pricing range improves the value proposition. It continues to drive that addressable market, right? So now we are at 3,000 store level. Obviously, we have great opportunity to grow in more stores. And in fact, if you look at their store opening right now, it's at record level. And if you look at in the quarter alone, it probably opened more restaurant than like last couple of years combined. And so I think that's tremendous progress. And I think we continue to hope to see KFC more network expansions, especially driven by satellite store and smaller store format, and then continue to build that value positions. And then also, as they have done in the last couple of quarters – to improve their margins over time. So when you say normalize, I think, normalize, I think right now margins is even higher until 2019. I don't know, when you continue being not normalized, but I think you have the right trajectory for sure.

And the ultimate question for Pizza Hut is not necessarily only about margins. Our goal for Pizza Hut going forward after turning around is to continue to work on its resiliency and growth. Because after turning around, that's what we want the growth. But growth without resiliency is not too comfortable. Isn't it? So growth – resiliency and growth. And then of course, next step is the most strategic mode, right? We are very consistent with our thinking RGM. So the question is how to get there. What's the key to unlock to get the resiliency, to get more sales, to manage the investment and to get profit in the short-term and long-term? Well, our view of the key, which we have been working on, is the satellite store model. Overall, we look at the result of the new store payback. Pizza Hut move from four years to three years in which satellite store really deliver, these are the smaller store focus on take away and delivery, which is your second question. The satellite stores do the trick and satellite store require less investment. It requires a different menu because they may need delivery and take away-driven, and the profit is very good. And the payback is two years. So when we put the satellite store and the other store together, the overall payback is three years. So we have found the key, which is satellite store. We just need the time to build more and more and more and more from top tier city all the way to lower tier city. And the growth story of Pizza Hut is not difficult to understand. KFC only in 1,900 cities in China with 9,500 stores. And Pizza Hut, we only have 3,000 stores in 700, 800 cities in China. So that's more than a 1,000 cities in China that has Pizza Hut does not have – that has KFC, does not have Pizza Hut. So you can see why we are quite confident about the growth potential of pizza in terms of self-profit resiliency. Thank you, Anne.

Thank you. Your next question comes from Lin Sijie with CICC. Please go ahead.

Thank you, Joey and Andy. I have a follow-up question on promotion and competition. So we've seen that our insistence on value for money leads to very resilient sales recovery. But we've also seen increasing promotion and more value combos like OK San Jian Tao. So do we think this is only because people are value cautious under this economic environment or this also has relationship with more intense competition from McDonald's, from [indiscernible] and all other competitors and how this impact our ticket average and sales per store? Thank you.

Thank you. So OK San Jian Tao is new. Right now is delivering about low single-digit in terms of sales mix. The key thing here is, well, of course, customers are very cautious. It doesn't hurt to open up the price range. What does that mean? In the past, we did not have that price at 19 yen as a combo. When we introduced it, the most critical thing that we are looking for is incremental sales. In particular, incremental same-store sales, what not to like, it's fantastic. It's new business for us. And then in terms of its performance across city tier, well, people might think that it worked very well in low tier cities. Actually, not really. It works better in top tier city because this is more for what we call balance the functional consumption for the lunch. So it works better for the top tier city. But for lower tier cities actually give us insight. We still can open more stores, we can open more store in low tier city to capture that functional consumption. So we are happy with that. And again, the key to unlock this, OK San Jian Tao is ability in supply chain, whether we can solve such affordable ingredient to deliver that price point and still a reasonable profit. And our team did it. Thank you.

Your next question comes from Lillian Lou with Morgan Stanley. Please go ahead.

Thanks. Thanks, Joey and Andy for all the answers. I have a follow-up questions on same-store sales growth. So because Joey just mentioned that our store network right now is very different from pre-COVID. So when we look at the same-store sales growth compared to Pre-COVID, i.e. 2019th level, second quarter was still 10% below. But if we look at more on the holistic basis because we're adding more and more smaller stores, does that mean that actually our same-store sales growth will be below 2019th level for a longer period of time, even though our underlying operation is already kind of close to back to normal? That's more like mathematics problem question. And also in the operation perspective, what has been dragging our same-store sales growth below normal level in particular, is it still the traffic – stores or in certain area or in certain tier of cities or store format? Thanks a lot.

Lillian, so let me try to clarify this. Our system sales of 25% year-over-year, our same -store growth was 15% year-over-year. And then, if you adjust for the impact of temporary store closure last year, our system same-store sales growth lost time people use that in the industry would be about 24%. And then – sorry, our systems growth is 32%. So if you look at that in our adjusted like same-store sales growth would be close to 24% year-over-year. So I think even we mentioned some of the slowing down in the May period, in fact, our same-store sales growth were very robust and very strong. And obviously the driver for the different tiers are slightly different, as Joey mentioned. The loyalty series genuinely grow faster. And then you mentioned about the TMT space. TMT space will only very important for us, and we continue to see very robust recovery over there. And if you look at the tourist locations, I think, it's doing quite well, probably quite well. Even at the major transportation hub for domestic travel for high-tech level and for domestic flight, they are continuing to improve. I think that trajectory is [indiscernible] obviously international travel, flight travel is little softer and would probably take longer time until flight schedule got sought out. And so I think in terms of our same-store sales growth is pretty robust. So I don't know if Joey have anything to mention.

For the existing store that opened before 2019 as Andy mentioned, the transportation hub actually coming back during the May and particularly during the holidays. And by the way, that's sort of another consumer behavior right now. There's consumption during the holiday and festival is amazingly well, it's just in between, it's a bit more depressed, but we have program to manage that. But for tourist location, actually have recovered really, really well, and particularly in the tier two cities like Xi’an and whatever. So these sort of tourist destination tier two cities that are doing really well back to pre-2019 level already. But to answer your other question about the holistic same-store sales. Well, the ultimate question is how to continue to grow our same-store sales, particularly when our stores are getting smaller and smaller and smaller, particularly the newly open one, because the smaller stores require less CapEx and the payback is good. Well, it's not silly, but why not growing the same-store sales outside the store? Therefore, it's rather important to continue to drive the delivery take-away. And that goes for both KFC and Pizza Hut. And therefore, I've been emphasizing on how important it is to grow the off-premise sales and the new retail. New retail is still low single-digit compared to the entire Yum China sales. But the absolute number is not small. It provides very nice resilient sales driver, particularly during the tough time. And let me be a bit more specific about KFC. How do we do it outside the store? If you come to China have opportunity, particularly during our Investor Day, you will see more and more and more KFC store will have a window opened up so that you don't even need to – customers don't even need to go…

Your next question comes from Christine Peng with UBS. Please go ahead.

Thank you, management for the presentation as well as answering most of the questions I think investors care about. So I have a very quick question regarding the capital allocation. If you look at the first half of 2023 cash – free cash flow et cetera, so basically all the images suggest that the cash accumulation for the company has been very strong. But as we look at the cash dividends and share repurchases, it was not really suggesting a big pick up compared with the pandemic period. So I was just trying to understand what's the logic behind this and what's the future in terms of distributing more cash towards investors? Thank you.

Thank you, Christine. I think, couple things, and one is that our capital allocations as always is focusing on driving organic growth. And so it is on store opening, is on store remodeling that generally capture more than 6% of our CapEx spend. And then we also look into investing obviously new brand and also digital and supply chain to make sure that we continue to run our operations effectively, efficiently and also accurately, so that we can deal with different uncertainty. The other one is for capital allocations, obviously, we want to have a strong balance sheet to make sure that we can deal with any contingency that may come up. Occasionally, opportunistically, we look at investment, especially investment that will boost our capabilities both in the technologies, in our install operations and our supply chain. We are very committed to return capital to shareholder. If you look that in the quarter, we have returned more than $110 million to shareholder. The pace of share repurchase obviously would vary depending on the number of factors. But I think we hold very strong commitment to return excessive cash to shareholder. Dividends, as we have done so in the first quarter this year, we have raised dividends at the early part of this year by almost 8%, 9%. And so when we revisit obvious dividend policy with our board every quarter and every year. And so – but again, we are very glad in our strong operating performance generated good operating cash flow and good free cash flow in the second quarter and in the first half this year. And so we'll continue to return that excessive cash to shareholder for sure. Thanks, Christine.

Thank you. That is all the time we have for questions today. I'll now hand back to Ms. Michelle Shen for closing remarks.

Thank you for joining the call today. If you have further questions, please reach out through the contact information in our earnings release and on our website. Thank you.

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