Thank you for standing by. Welcome to the Yum China Second Quarter 2024 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to Ms. Florence Lip. Please go ahead.

Thank you, operator. Hello, everyone. Thank you for joining Yum China's Second Quarter 2024 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. I'd like to remind everyone that our earnings call and investor materials contain forward-looking statements, which are subject to future events and uncertainties. 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 GAAP measures is included in our earnings release. You can find the webcast of this call and a PowerPoint presentation on our IR website. Please note that during today's call, all year-over-year growth results exclude the impact of foreign currency, unless otherwise noted. 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, Yum China reported record levels of revenue, operating profit and EPS for the second quarter. System sales grew 4% on top of 32% growth in the same period last year. Core operating profit grew 12% to USD 275 million. EPS increased 19%. I would like to thank our colleagues for their hard work and innovative spirit. We are navigating a complex and dynamic environment. Yes, but we see the many challenges more as opportunities. With our industry-leading capabilities and our scale, we are turning these situations to our competitive advantage. We have taken aggressive steps to drive revenue and profitability. I would like to highlight 3 of them. First, we took a fresh look at every key process and cost elements in our businesses. We make counters innovations to improve our operational efficiency, enhance profitability and increase resiliency. We are already seeing results. We are achieving major cost savings and reinvesting them into food and value. Second, we broadened our addressable market and held market share with our sharp focus on value for money and innovative products. Our transactions and delivery sales both grew by double digits in the second quarter. We will continue to innovate across our menu to address customer needs. Third, our breakthrough business models, K-Coffee, and Pizza Hut WOW achieved encouraging initial results. These stores delivered incremental same-store sales and incremental profit. They are showing great future potential. These strategies are working well. Q2 was our most profitable second quarter since our spin-off. Restaurant margins stabilized. OP margin expanded to 9.9%. Let me first talk about our initiatives to drive operational efficiency. These initiatives cover all aspects of our organization. First, Project Fresh Eye launched in Quarter 4 last year, helped improve OP margins this quarter. We…

Thank you, Joey, and hello, everyone. As this will be my last earnings call with Yum China, I want to express my sincere gratitude to Joey, my colleagues and shareholders and our analysts. Over the past 5 years, it has been a rewarding experience working closely with such a talented and dedicated leadership team. I'm proud of the accomplishment that we have achieved together, navigating the challenges posed by the pandemic and its aftermath. Yum China emerged from the pandemic, more resilient and ready to accelerate growth. I'm confident in the company's continued success under the capable leadership of the existing management team. Now let's turn to our financial results. In the second quarter, we delivered a solid performance and set numerous new records, including revenue of $2.68 billion, operating profit of $266 million, operating margins of 9.9% and diluted EPS of $0.55. That's for sure impressive given the current market condition. As Joey shared earlier, the initiative that we launched beginning in the fourth quarter of last year to drive sustainable growth and protect margins are beginning to pay off. While top lapping and current market conditions impacted same-store sales, our margins stabilized. Our sales growth was led by healthy traffic. Total transactions grew 13% and same-store transactions grew 4% year-over-year in the second quarter. It's a testament to how well our brand, product, marketing and promotions, resonating well with consumers. We attract new customers and capture more occasions from existing customers by broadening our price range and offering delicious food at affordable price cost. Despite a lower ticket average, restaurant margin was markedly flattish year-over-year. on a comparable basis. Core operating margin actually improved year-over-year, setting a new quality record for operating margin, thanks to our economy of scale and cost measures. Taking a longer view, our system…

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

[Operator Instructions] Your first question comes from Michelle Cheng with Goldman Sachs.

Joey and Andy, congrats for the very strong and resilient numbers and Andy, all the best. So my question is about this new business format and store concept. And it's really impressive that we have a very aggressive opening year-to-date. And thank you, Joey, also sharing the target by end of year but can you please give us more color about the economics and also the contributions at K-Coffee side-by-side stores in sector sales for those stores, we already have these openings in the past few months. And given it's still more value position. So shall we -- when we think about the economics, should we see that these full cost ratio will be higher, but this will be offset by like more simplified cost structure in O&O payroll and to net net from the margin perspective, structurally, we will see more upside from this new model? And also, are we going to see more new concepts in addition to the K-Coffee and WOW in the next few quarters?

Thank you, Michelle. It's truly amazing for our team to have this breakthrough and we are very excited about it. And I will answer your last question first is we are going to focus on these 2 breakthrough model out of KFC and Pizza Hut. And I think the initial result is very encouraging, and we'll focus on that for the rest of the year and going forward. Come back to the content of the new concept, first of all, the easiest way is 12%. I encourage all our analysts. Just across the border, I recently visited the one in Ivanta UniCentr, I think, is a pizza valve. And then we have a few other coffee side by side. And you can see the menu of the operation, and you have a very good feel about it. So for K-Coffee, it has its own menu. The menu is very simple. And then in terms of the product, we have some winning product, the Sparkling Coffee is a fantastic product and food is also important. And that comes to the next characteristic of K-Coffee is we share the kitchen and the operation with the normal KFC store. So the kitchen is shared. Operation team is shared, but it has its own distinct area. And then for the customer, the value for money is amazing, and I will highlight one particular offer, which I mentioned in my remarks, is the -- in the campus. Campus takeout K-Coffee store, we actually offer sparkling coffee with a hotdog at 9.9. You might naturally ask the question how does it work for the margin. Well, think about this way, for many years already, we offer our breakfast at 9.9. We offer the food and the coffee comes for free. In K-Coffee is the reverse. We…

Your next question comes from Lillian Lou with Morgan Stanley.

My question is about the recent trend on the same-store sales and also, again, congratulations on giving such a good result and even under a bit challenged environment. So I want to understand getting into the quarter, fourth quarter when the top comp kind of alleviated a bit. And with all this cost efficiency put in place, how we should look at the operation on a holistic basis? And have you seen different trends in different tier of markets in terms of the demand and the cost management like high-tier city and low-tier cities?

Thank you, Lillian. Let me share a little bit learning from the Quarter 1 trading pattern and then make a few comments about the Quarter 2. By region, the Eastern Power China is still the most resilient one, but lower tier city recover faster than higher-tier city both year-on-year and versus longer term like pre-pandemic 2019. By location, the residential locations are more resilient and shopping centers are almost back to 2019 levels. And moving on to the business environment, there's been a lot of attention to the business environment and consumer sentiment in China. We are not seeing significant change in market conditions and consumer sentiment going to Quarter 2. With that said, Quarter 3, sorry. My -- with that said, my management team and I share one particular philosophy on that. Yes, business is tough right now, but much like life, right? It's always tough. In business as in life, we always expect the unexpected. We don't whine about it. We accept whatever comes our way and we adapt and do the right thing. Often in doing so, we are able to turn the disruptions to our competitor advantage by deploying our scale and our capabilities. In terms of how to do it, et cetera, I have covered them in my remarks regarding the specific actions. But the 3 key points bear repeating in summary. First of all, to answer your question about the cost efficiency, we have turned every process and cost element to drive operational efficiency, make our store managers work low lighter and reinvest into our value for money offerings and support our margins. Second, we have innovate creative new products, which have lovely picture in the PowerPoint deck, and we widened our price points to broaden our addressable market and drive traffic. Third, we innovate breakthrough store model, such as the K-Coffee cafe and mini store for small times for KFC and the fast casual model called Pizza Hava, which I just described, to power future growth of KFC and Pizza Hut. Like all 3 strategies are showing strong initial results. As a result, for Quarter 2 this year, we see robust growth or actually double-digit growth in transaction and delivery sales. Our restaurant margins stabilized and core OP grew by 12%. We see the most profitable Quarter 2 since spinoff despite the industry dynamic. Thank you, Lillian.

The next question comes from Chen Luo with Bank of America Merrill Lynch.

Joey, Andy, this is Chen. And congrats again on the strong result and also my best wishes to Andy. I'd like to take a deeper look at margins, definitely, our Q2 margin speed expectation. And when you're looking into the details, I noticed, first of all, the food and paper cost as percent of sales edged down by 60 bps on a Q-on-Q basis despite the fact that our promotion seems to be very intense in Q2. So what is driving that? Is this because of the falling commodity cost? Or it's because of our smart value or the supply chain initiatives? And secondly, if you look at the cost of labor, it has declined big time on a year-on-year basis for Pizza Hut, and also for the group is largely flattish versus the usual upward trend. So what is also driving all these changes? And lastly, I noticed that our first half restaurant margin is actually pretty much on par with first half of 2019, which is usually regarded by the market as a normalized comparison base. Is it fair to say that going forward, our margins can be largely comparable for 2019 for the rest of the year?

Thank you, Chen for your question. And -- in terms of short term, I think, obviously, we are narrating some pretty dynamic, pretty complex operating environment in the short term. And consumer remain very value conscious. And so that's an important thing to keep in mind. So from our perspective, if you look at third quarter last year, was not particularly low base. If you think about last year, we see the consumer data softened in late September. So that's something that we keep in mind. So in the short term, obviously, sales would be an important driver for margins as we have mentioned on the call. But nevertheless, as we have mentioned in our prepared remarks, we have taken very decisive actions to adjust our cost structure. And so that -- and then also, we have a very decisive action to change some of our business model to embrace the market change. And so as a result, we're able to see stabilized margins. And then also, we see expansions in our operating margin to change that is the best thing to spin off. Now if you look at our initiative, those initiatives are not a short-term measure. They are long-term structural change in the way how not only the cost structure, but also how we operate our business, make it more efficient. In the short term, I think like if you think about the bond price in the short term, some of the commodity prices more favorable. But at the same time, we, again, have mentioned over and over again, that is important for us to invest in value, invest and embrace the consumer changes. And so -- and still add some time in fact, as we have mentioned before. We always -- in the long term target 31%…

I'll just give two concrete examples for you, Luo Chen. For example, COS, right, we -- in select caterinow, we go straight to the farmer and producer. We get really good ingredient at better price, you can totally imagine. We'll continue to do that. In the COL, what are the specific things that you can see in our kitchen? 80% of our Pizza Hut store right now have automatic fry rise machine. It's pretty cool. You might consider to have one in your house. It's actually very small. So it really solve the labor shortage or labor problem, particularly during the peak time. And then 50% of our Pizza Hut store right now have robotic server. Not all the store can do it because so small store cannot benefit from it. [Foreign Language]. So this definitely a structural change to the COL. And then we have -- as I mentioned in my prepared remarks, we have fewer SKUs at select daypart. What does that mean? It means that we take out some tail for selected daypart. Not throughout whole day, but just throughout certain time of the day, so that it has less wastage, spend better, right? Less wastage, therefore, less COS, less COL that all makes sense. And these are the specific examples.

Look forward to that automatic rider machine if it is available on shelf. And also that's my best wishes to Andy again.

Your next question comes from Anne Ling with Jefferies.

So I have a small one. The new format again. So moving forward, for example, for Pizza Hut WOW, does it mean that in the future on the store opening that because currently, you're mainly doing a conversion on the store. So moving forward for your new opening, will that also mean that some of the new opening will also be strict on Pizza Hut WOW. And based on your current network. How many of them do you think that currently you can be -- you can make this kind of shift and how quickly you can do that? Or like at what point you make a decision in terms of accelerating this rollout? And then for the K-Coffee store, the same question is that under your current store network, how many stores are actually visible for this kind of like adjacent store format?

Thank you, Anne. For Pizza Hut WOW model, is one of the models. For both K-Coffee and Pizza Hut, we actually have multiple store model for multiple locations and formats and city, et cetera, et cetera. Currently, for Pizza Hut WOW, we are testing this model in different part of the country, and also top tier city, low-tier city you can imagine. So we will be a bit more clear later on in the year about how many of the existing stores that have the potential to be converted. And you can imagine some of the new store is suitable for this model. We will open Pizza Hut WOW as a new store as well. Similar story for K-Coffee, but not so similar. K-Coffee is not so much a conversion. K-Coffee Cafe is a bit like identify existing store, and we kind of have a side-by-side and on sort of a distinct store to the existing KFC store. But again, we are testing it in different parts of China right now and the most remote part is in Chigata, right, Stan, Tibet. And in tourist location and then [Foreign Language], the Handle high-speed railway station you can imagine. So different locations, different city tier, we are testing it. And then we are building our food and also the drink of the K-Coffee as well. So we have a bit more aggressive number of K-Coffee, which is by the end of the year, 500, 600 -- 500 to 600 stores, but this is what we have in our mind, and we'll continue to learn and then we adjust and adapt and we accelerate the speed if we need to and we'll continue to learn. Thank you, Anne.

Your next question comes from Brian Bittner with Oppenheimer & Co.

Thank you. Andy, it's been a pleasure working with you. Thanks for all the help over the years, and I wish you the best. I was hoping you guys could put some guardrails on how to think about the second half of the year for same-store sales. Of course, if we look at last year, the comparison gets a lot easier in the third and fourth quarter. But given the operating environment, I'm not sure how relevant comparisons are. So is there, in fact, an opportunity for same-store sales to show some improvement in the second half, first to first half? Or is the message from you that we analysts should remain pretty conservative and maybe expect more of a similar second half as what we saw in the first half?

Brian, thank you so much for your time, work and then also thank you for your question. I think in macro, I think there's a lot of news on the macro side. I think some of the complexities and potentially challenges in the Chinese consumer space or economy as well discussed. What we try to mention on this call is that as a company, we continue to be able to take decisive actions to want to drive sales and the other one is to control costs. Those two are actually hand in hand, right? So something -- some of this initiative, we would be able to take more control and then we sell quickly. And so as a result, you can see, our cost structure has improved quite significantly. And I think the strategy is working. On the other hand, we also pass along the savings to consumers, especially in the market where consumers are more value conscious. And so we'll continue to do that and channel some of the savings to invest in value campaign, some promotional activities to drive traffic. And I think we also have some results that were pretty encouraging. If you look at our traffic growth, we achieved same-store traffic growth of low single digit this quarter. And then if you look at our overall profit growth for our franchise overall, like the brand, we're seeing double-digit growth in our store traffic. And that is very important for our restaurant industry because traffic growth is what sustained long-term growth and profitability for our business. And so in terms of the macro outlook, I think, as Joey mentioned earlier, we don't see significant change going into the third quarter. And we might focus that last year, third quarter was not particularly easy as you put it, because we're only beginning to see some softening in the consumer space in late September last year. And so you can -- if you go back to last year, the trend and what we have come in at that time. And so -- but good news is we have a lot of initiative and to try that. We have some breakthrough in our business model with Pizza Hut WOW model with KFC, K-Coffee Cafe model. And obviously, we also have a lot of initiatives on food innovation as a restaurant industry leading player. We're very proud of our innovative capabilities. And that is very important to drive consumer to the store. And so we'll continue to do that, but as we caution people be overly optimistic in the second half. We're not pessimistic, but it shouldn't be overly optimistic.

Thank you, Brian. Maybe I'll just add a few comments here. I mean, obviously, nobody has the crystal ball here. And I just want to emphasize that Yum China is a growing company in a growing market called China. It seems quite fashionable these days to be bearish on China. But I just want to add that even at current growth rate, China still accounts for almost 1/3 of the world's annual growth. And particularly, the shift of growth to lower tier city kind of reminds me of the push into the frontier in the U.S. and part of yesterday's Wild West become today's Silicon Valley. And something like that has already happened in Shenzen. So I'm confident that it will happen elsewhere in China as well. Therefore, system sales is equally important compared to systems same-store sales. And we will try to focus on both system sales and same-store sales to have the balanced approach. And you will appreciate that we are also opening a lot of new stores, and that will have certain sales transfer in terms of same-store sales. However, even with that, we are taking a balanced approach as well because 30% of our new stores actually are more on the strategic location or a small tier city where the sales transfer can be managed better, and more than half of our new store in lower-tier cities these days. And last but not least, the K-Coffee, Pizza Hut WOW actually are very focused on growing the same-store sales. So we try to focus and have a balanced approach. Last but not least, it's not reported in media. But last year alone, China actually opened 400 shopping malls in mostly in Tier 2 and below. I think about how many countries in the world these days open 400 shopping malls. And for this year alone, 2024, we are expecting another 300 shopping malls to be opened in China. So when new shopping mall opened like that, we shall open new stores. Even though it might imply sales transfer from the traditional high street to the new shopping mall because that's how economy evolves and low-tier cities develop. So just try to put some content into the background macro here. Thank you, Brian.

And I do appreciate the system sales side of the equation, but that the unit growth is what's known and the same-store sales is kind of what's unknown. And that was the essence of my question.

The next question comes from Sijie Lin with CICC.

Congrats for the high operational efficiency and strong bottom line, and best wishes to Andy. So I want to better understand our pricing strategy in the coming quarters especially KFC because for Pizza Hut, we want to introduce entry-level pizza and lower the ticket average. But for Pizza Hut, the TA is relatively stable over a longer period. although we are expanding price range. So recently, we observed that some other restaurant companies may hope to keep relatively stable CA this year after TA cuts last year. So how about our pricing strategy, especially for KFC, will we keep it relatively stable? Or we may further increase promotion because elasticity is still high and to pass savings to the consumer.

Thank you, Sijie. So the question is about the TA basically. And I presume the TA hidden question is about the margin. So the TA trend for both KFC and Pizza Hut is consistent with our strategy to drive traffic. Driving traffic is the most important thing in our business, and we see robust same-store transaction growth at both KFC and Pizza Hut. And we see 13% total transaction growth for the business. And that represents the health of our business, by the way, Point 2 is even with the lower TA Q2 stabilized restaurant margins and improve operating margin because we take proactive steps to improve the operational efficiency as well. So for KFC in the long term, we will take a balanced approach to maintain a steady TA. TA fluctuate quarter-by-quarter and particularly compared to pandemic. However, if we take a long-term view, Quarter 2 TA actually is RMB 37 and it's still higher than the Quarter 2 TA of 2019. That's pre-pandemic, and that's 35. So in the long term, KFC, we have a very balanced approach. But in the short term, we will have sharp focused value, widen the price range because that worked well and that drove traffic as we can see. However, with that said, we also will continue to offer higher ticket items with strong value for money such as whole chicken, family bucket because they continue to do well, and they balance out the TA as well. For Pizza Hut, TA come down by design since 2017. Every year, we want to take the TA down a bit. For Quarter 2, it's probably a bit more than we expected but it's okay. And let me add the Pizza Hut actually, April, the same-store sales TA suffer because of outsized promotion campaign last year, April. And by May and June, actually, it recovered the particular same-store cells, recover pretty close to KFC. The Pizza Hut will continue to tap into more value-cautious consumer and solo diner segments with entry price pizzas, burgers and 1 person meal, et cetera. And then, of course, the K-Coffee WOW. By the way, the entry price pizza, which is below RMB 50, which we talked about it in the last earnings release. This particular price point pizza is growing at double digit for us. It's very nice because it's expanding our market share in this particular segment. Thank you, Sijie.

The last question comes from Xiaopo Wei with Citigroup.

Yes. Xiaopo Wei with Citigroup. Yes. A lot of things have been discussed in the prepared remarks and the prior Q&A I just want to understand that given this environment, a lot of things have been done by Joey and the team on the efficiency improvement. Have you thought about any disposal of a small business in this environment because the small business in the past was intended for expansion of the business, but given all the environment and focus on efficiency, the small business may be a distraction of the resources. I just want to seek Joey's thinking on this perspective.

Thank you, Xiaopo. I mean your thinking is completely along the line of our thinking. We constantly review our portfolio of the smaller business. And then if I would like to make a few comments here is -- for example, the new retail, I mean some packaged food, that smaller business served us well during the pandemic. When we could not open any stores in certain markets. However, now business are sort of more back to normal and we can see the historic mission of the packaged food is probably accomplished. So we are going to probably reduce our move and netted by bit very soon. So that's one example. And then for other smaller business, we always have a very disciplined approach, which Andy has shared in previous interactions with our shareholders and analysts. We only invest a very small percentage of our profit on the small business. While it gives us the opportunity, the smaller business give us opportunity to learn, to train our staff and to fail. It's not set up to fail but smaller business is very challenging. So we'll continue to review our portfolio. Lavazza actually is making really good progress. We have more -- significantly more breakeven sold this year than last year, we are happy about it. The retail beam business of Lavazza is actually turning profitable in Quarter 2 of 2024, and we expect meaningful sales growth this year. And for Lavazza, we actually are moving coffee bean production from Italy to China so that we have fresh bean, more nimble innovation, lower cost, et cetera. So Lavazza will continue, and it's -- it takes time to build a good business, but it's really building step by step. And then the Huang Ji Huang a very resilient business. We are adding 15 new stores in the first half, bringing our total to over 800 stores globally. And little ship, we have this new model is to convert part of the store, sometimes the new store to serve one person and has achieved initial success, and we are building more stores this year. And then Taco Bell is having a bit of a harder time because -- it is indeed a bit more soft foreign concept to Chinese consumer. So we need a bit more time, and we are starting out the portfolio to further improve the business model. And that's where we are but, Xiaopo, we are constantly reviewing the health of the smaller business.

Yes. Sure, Xiaopo. I will add a little bit more there. As any capital deployment in our company, we're very disciplined about it. Store model albeit the brand. I think we have demonstrated in the past, and we'll continue to do that, which is when we see something that have potential, we'll continue to invest in that. And we don't have a -- we don't have a requirement to say well you need and need to be profitable for a smaller brand. For example, building a coffee brand in China will take time, right? But we see great progress, and we'll continue to invest in that. We also so we have closed some brands like C&J, right, like when you thing we need to consolidate our resources focusing on the core business on Lavazza and now K-Coffee at the lower end functional end of the coffee business. And so yes, so like capital deployment, including for the brand, for the store, the overall portfolio will continue to remain very disciplined about it to make sure that capital deployed efficiently for our shareholders. Thank you, Xiaopo.

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

Thank you.

Thank you so much, guys.