Thank you for standing by, and welcome to the Yum China Third Quarter 2024 Earnings Conference Call. All participants are in listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to Florence Lip, Senior IR Director. Please go ahead.

Thank you, operator. Hello, everyone. Thank you for joining Yum China's Third Quarter 2024 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our acting CFO, Mr. Adrian Ding. I'd like to remind everyone that our earnings call and investment 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, which is available to the public through our Investor Relations website located at ir.yumchina.com. You can also find a 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. I'm proud to share that we achieved strong results again in Q3 2024. We delivered robust sales growth as well as accelerated profit growth compared to Q2. System sales grew 4% year-over-year. Same-store sales index improved sequentially and reached 97% of prior year's level. Delivery sales achieved double-digit growth as it has for 10 consecutive years. On a comparable basis, both restaurant margins and OP margin expanded year-over-year. Core operating profit grew 18% and diluted EPS increased by 32%. As we execute our RGM 2.0 strategy, we have a new focus on operational efficiency and innovation. Savings generated from improved efficiency allow us to reinvest in food innovation and our value for money offers. This broadens our addressable market. It also helped us capture more traffic, drive sales growth and expand profit margins. Meanwhile, our innovative business models KCOFFEE Cafes and Pizza Hut WOW are gaining momentum and successfully capturing new customer demand. In the first nine months, we set several new records $8.7 billion in revenue, over $1 billion in operating profit, 1,200 net new stores and over $1.2 billion returned to shareholders. We outperformed the industry in a challenging and fluid environment. Today, I will provide an update on our operations and store opening strategy. Adrian will then go through the financial performance and our latest capital return plan. I will start with operational efficiency. We are making great progress with Project Fresh Eye and Project Red Eye. We introduced these projects in quarter four of last year and quarter one of this year, respectively. These projects are to enhance operational efficiency through innovation across all aspects of our operations. Project Fresh Eye has reshaped our operations. We are evaluating processes through the Fresh Eyes of our restaurant managers, redesigning…

Thank you, Joey, and great to be with everyone today for my first earnings call. In the third quarter, we achieved strong results with major KPIs trending positively. System sales grew 4%, and same-store sales index sequentially improved to 97% of prior year level. Restaurant margin expanded 50 basis points year-over-year on a comparable basis. Core OP margin also saw a significant rise of 140 basis points. As we grew our top line, core operating profit surged by 18% and diluted EPS grew 19%, excluding the mark-to-market gain from our equity investments. As a reminder, restaurant margin on a comparable basis excludes VAT deductions as well as temporary relief from landlords and government agencies received in the prior year. Core operating profit further excludes foreign exchange impact and special items. We are immensely satisfied with this meaningful sequential improvement in our quarter three results. They demonstrate our ability to outperform the industry in both good times and bad. With our confidence in our cash-generating capabilities, we plan to step up our capital return to shareholders. First, let's take a closer look at our third quarter performance by brand, KFC system sales increased 6% year-over-year. Same-store sales were at 98% of prior year levels with 1% same-store transaction growth. Our strategy is to widen the price range and capture lower ticket average delivery orders are yielding results. Entry price combos have driven incremental traffic and delivery sales continue to grow double-digits. Our quarter three ticket average was RMB 38, 3% lower than prior year levels, an increase from RMB 37 in quarter two. More ticket items like coffee and breakfast continue to outperform. Pizza Hut system sales increased 2% year-over-year. Same-store sales were 94% of prior year levels with same-store transaction growth of 4%. Ticket average was 9% lower year-over-year. It…

Thank you, Adrian. Before we turn to Q&A, I would like just to recap the three key messages I want you to take away today. First, our quarter three results highlight our resiliency and growth strategy with our true focus on operational efficiency and innovation, we are well positioned to capture opportunities in this market. Both system sales growth and same-store sales growth are key focus for us. Second, we remain bullish on China's long-term growth opportunities. Our widened price ranges optimized delivery strategy and breakthrough business models help us broaden our addressable market. We continue to capture underserved customer segments with both equity and franchise new stores. Lastly, we maintain our due focus on sustainable growth and capital returns to shareholders. We plan to step up our three-year capital returns to $4.5 billion for 2024 to 2026. With that, I will pass it back to Florence.

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

Thank you. [Operator Instructions]. Your first question comes from Xiaopo Wei with Citigroup.

Hi, can you hear me, Joey or Adrian?

Yes, we can.

Okay, thank you. Thank you for taking my question. Congratulations on the strong third quarter. I probably want to ask a long-term question. It is a first quarter we are seeing your both your core OP margin and blending and same-store was down. As you know, the market has been focusing on same-store sales for long, but it seemed to me that it's actually as Joey said, the system sales is equally important as same-store sales. Shall we say looking forward, shall we look more into the same-store sales base of transaction volume rather than the same-store sales value because as Joey readily pointed out, you guys have innovating format, menu actually widen your pricing range. So the mix of your products or the ASP actually distort the traditional understanding of same-store sales. If that's the case, is there any other areas you will build your economy scale in terms of enlarged volume to drive your margin resilience looking forward?

Xiaopo, thank you for your long-term question. If I'm allowed to indulge my -- give a comprehensive view of our long-term strategy. Quarter three actually is a good result and illustration of how Yum China is secure RGM 2.0 strategy in the long-term. We build focuses on multiple areas. As a CEO, I mean over the questions post or decision present on either or such as either simple sales or system sales. But the fact is the only acceptable answer is to -- it's both. We want both. And then the same-store sales, obviously is composed of the transaction. So the way that we deal with it is we really are pursuing still focus, because we cannot just focus all the other. So I refer to several in my earlier remarks, but just to recap, first, we have dual focus on system sales growth and same-store sales growth. And in quarter three, obviously, we deliver 4% system sales growth for the quarter and also seven consecutive quarter of same-store transaction growth going forward, because between the TA and TC I think you can see over long-term, we focus on transaction growth, which really is the most important -- one of the most important drivers for business like ours. Not to mention the growth is also supported by 10 years of delivery growth. Second, and that's related to your margin question, we have still focus on operational efficiency and innovation. So -- and I certainly believe that any good company who want to survive need to do both. So for Q3 alone, this year, we delivered 18% core operating profit growth through multiple margin improvement projects like Project Fresh Eye, Project Red Eye and then we reinvest our savings into multiple innovations such as food innovations and then value for money…

Your next question comes from Lillian Lou with Morgan Stanley.

Hey, thank you. Good evening, Joey, and congrats again, Adrian, for your position. And also congrats for the very good result. My question is more on the near-term, because I think, Joey, you have been very clear on the long-term strategy. I think in the third quarter, I noticed that for KFC, our pricing actually recovered pretty nicely compared to the previous quarter's trend. And I just want to check the thinking behind, i.e., do we see some elevated competition that make us less pressed by on pricing? Or have we done anything to really kind of support the pricing? So related to that, any thinking about the pricing strategy in the next couple of quarters? Thank you.

Thank you, Lillian. So in terms of competition, we certainly see restaurant industry continue to grow. And then the global players are still trying to invest aggressively into China market and the current players are going deeper to lower Tier 3. And we also see some players rationalized promotional intensity in recent quarters and some aggressive players slowdown their store opening this year. For KFC pricing, we -- our strategy for KFC pricing and pizza pricing, actually, in the short to long term, relatively transparent. For KFC, we try to have stable pricing. So we -- our quarter -- this quarter is 38, I think. And then it's -- so that short term, it's slightly higher than the previous quarter. No, no, no, sorry, it's slightly lower than the slightly lower than the previous quarter, but it's higher than 2019. So it's relatively stable. For Pizza Hut pricing strategy, we are very clear from 2017 onward. We try to be a bit more mass market driven. So we have continued to lower the pricing. So that is more accessible. So in the short term, long term, that's pretty much our strategy in terms of pricing.

Thank you, Joey.

Your next question comes from Ethan Wang with CLSA.

Thank you. Hello Joey, hello Adrian. So my question is on the franchising model. I think I remember back in the Investor Day, we mentioned in the future, KFC franchisee store will be 15% to 20% of new stores. But obviously, we are now having a higher hope franchising model. So what makes this change? And if we expect more franchising model in the future, does that also mean we should expect lower CapEx spending going forward as well? Thank you.

Thank you, Ethan. I guess, firstly, on your question regarding what made the change, right? I think the key reason is we're ready. For instance, for KFC, we have the new store model, KFC small town Mini. As we communicated previously, the capital expenditure for store that model is lower than RMB 0.5 million which is roughly one third of our regular KFC store. And for instance, for the newly rolled out Pizza Hut WOW, that model could be -- have a good potential in lower-tier city as well and good for franchising. Obviously, with the recent years, the franchisee quality in China has improved meaningfully as well. So overall, the store model revenues, our QA readiness, digital capabilities and the readiness of the franchisees, enabling us to speed up the franchise opening here in China. As we mentioned during the prepared remarks, for KFC, we aim to gradually increase our net new open percentage in franchise to be 40% to 50% down the road over the next few years. For Pizza Hut, it takes a bit longer. But overall, we hope to achieve 20% to 30% of net new open for Pizza Hut being franchise model over the next few years. And speaking of franchise unit economics, obviously, we want to remind everyone here that for each $100 of system sales generated by our franchisee, we recognized $40 to $45 as our revenue, and that breakdown includes 6% to 7% of the 100 being our royalty fee collected and initial fee collected also the other $35 to $36 out of the 100 being the transaction with franchisees, the revenue from transaction with franchisees. That's mainly in the areas of COS and other services, including AMP and others. And in terms of our cost, franchise expense, 3% of license fee will need to pay to Yum brands. and our expense for transaction with franchise fees is currently in credit around our cost. But in the future, there's a potential for us to retain certain margin in the services with franchisees, because we have savings from Project Red Eye and Project Fresh Eye. And but that will lower our capital expenditure and in terms of our, I guess, ROIC, that's a real question. Over the long term, we do expect that will help enhance our ROIC, but in the near term, the impact will be immaterial because, as we mentioned, the overall pacing of step-up in franchising will be gradual over the next few years. Thank you, Ethan.

Thank you, Adrian. And congratulations on the results. Thank you.

Thank you.

Your next question comes from Michelle Cheng with Goldman Sachs.

Hi, Joey, Adrian. Thanks for having the time to ask questions. So my question is still more on the short term. I think, Adrian, you earlier mentioned that quarter-to-date, we didn't see a significant changes yet, even we are positive on stimulus. But considering last fourth quarter, the base post should be easier. So are we still seeing like incremental sequential improvement in fourth quarter trends? And also, looking ahead, when we consider both KFC and Pizza Hut, it looks that KFC the same-store sales is still much more resilient than compared with the pre-COVID levels still much closer. So when we look for same-store sales growth going forward, are we seeing that Pizza Hut's pricing trend will be gradually stabilized and KFC actually have a room to see the pricing improvement next year? Thank you.

Thank you, Michelle, for your question. As I mentioned in the prepared remarks, we are quite encouraged by the similar policies. Obviously, it will take time to influence consumer behavior and impact businesses like ours. I'd like to give some more color into quarter four performance, and especially in the top line. So entering quarter four, as I mentioned in the prepared remarks, we've not observed significant changes in consumer sentiment nor in the macro situation. In terms of the October Golden Week holiday, our SSSG slightly improved year-over-year during the Golden Week. However, the consumer spending remain cautious post-holiday. I think that's a comment that we observed for this year after a long holiday. The consumer spending returned to be cautious for a short span of time after the long holiday. Overall speaking for quarter four, we still face some top line pressure, but we are confident in our ability to outperform peers in both the good times and bad, and we are also reasonably confident that our quarter four same-store transaction index will continue to be positive for another quarter. Lastly, but importantly, we really focus on things within our control. So we continue to execute on our strategy, which has proven to be quite effective to capture incremental traffic and protect our margins. We believe we are well positioned to capture -- continue to capture consumer needs with our flagship products, stunning value, deliver strategy and breakthrough models. I think to your second part of the question relates to the difference between KFC and Pizza Hut. Obviously, given the consumers are more rationalized in their spending, Pizza Hut with their higher per-person spending currently is facing a little bit of bigger headwind compared to KFC, which is really having a super robust resilient model. However, I think…

Thank you, Adrian. I'll just add some color about the Pizza Hut same-store sales. So the Pizza Hut model, good progress, one step at a time. As Adrian mentioned, we see a very nice improvement in the dining same-store sales. And out of 150 Pizza WOW store actually one-third, 50 stores in Guangdong in the South. And because of the scale, of the Pizza WOW relative to the Guangdong total store, we see some meaningful improvement of the Guangdong same-store sales, which is exciting. But again, we have over 3,600 stores for Pizza around the country right now. So it will take some time. But the progress is good. Last but not least, the quarter four is a small quarter. So a lot of the numbers could swing either way. Thank you so much.

Thank you, Joey. Thanks for the details.

Thank you.

Your next question comes from Sijie Lin with CICC.

Thank you, Joey and Adrian. Congrats on another second quarter and general shareholder returns. I have one question. So we have seen some food safety cases overseas. So how do we balance on one hand, the cost control? And on the other hand, the quality of the product and service? Thank you.

Thank you, Sijie. Well, first of all, I presume you refer to full safety case overseas that's caused by raw Onion. First of all, we only use cook onion. So that should not have similar implication to our business. When it comes to the overall food safety versus cost control, it's always our strong philosophy and operation that we put food safety at the most important position. We are fully compliant with regulation. And also we -- is one of the few issues that if there's any issue, we reported directly to myself and then we also reported to our Board, we have a food safety committee on this one. So we absolutely treated as highest importance and priority. And it's reflected in a holistic quality assurance system and our comprehensive food safety process within our entire value chain from suppliers to logistics all the way to our stores. And last but not least, I just want to reassure you that our investment in our digital supply chain in the last many years have paid off. We have very good visibility means digital visibility of our food safety without inventory. And to the point that stock replenishment to the stores is automatic. So it's absolutely important. Last but not least, we have more than 300-plus QA employees spread across China, focusing on this important matter in addition to the technology that we have invested to monitor this particular important priority. Thank you so much.

Thank you, Joey.

Your next question comes from Anne Ling with Jefferies.

Hey, thank you. Hi, management team. Just a question on KCOFFEE. Now with 500 stores, what we hear on the ground is that it's been doing amazingly good. So I just want to check like whether you can share with us like the incremental benefit because it's a side-by-side store with your existing KFC. So maybe would you share with us what is the incremental like same-store benefit? And also, like in terms of profitability, if there's anything that you can share with us? Thank you.

Thank you, Anne. Well, long story short, the incremental sales uplift to the store, we have observed is a single-digit sales uplift, and it does produce incremental profit because of our very unique operating model. So that is the short answer. In terms of longer answer, we are indeed very excited. And today, actually, we opened our 500 stores in Shanghai right next to our headquarter and in a very prime area in Shanghai. The increase of the sales and -- or the number of cups is 30% plus roughly. And this is very exciting, especially when we take the background of the overall market in coffee as the background. And the opportunity here is a significant majority of our members of our Yum China members have yet to try a KCOFFEE. And in our side-by-side model, the cross-sell from KFC to KCOFFEE is amazing. So we are excited about it. And it took us 10 years from selling coffee to build the first KCOFFEE cafe, but we see really good progress. We have 100 stores in March. And now we have 500 stores and then by year-end, we expect to exceed 600-plus stores. And we are expanding to campus and transportation location as well. The food is good. We have very distinctive coffee, sparkling coffee, the float and then the attire or the gigantic attire. So things are looking very exciting and positive. Thank you, Anne.

Thank you.

Your next question comes from Walter Woo with CMBI.

Hi, hello, Joey and Adrian. Can you hear me?

Yes.

Yes.

Okay, thank you. Congratulations on -- to your resilient results, and thanks again for all the efforts. So my question is about the Pizza WOW store performance. So can you comment on the sales and margin performance of the Pizza WOW stores and also the midterm room for potential growth? And are they suitable for all the regions in China? And also, well, I remember the last time when I dined in the WOW stores, the menu looks really appealing and there are lots of choices and the prices are cheap. And however, when I really ordered, many of the items were just not available. So this has disappointed me a little bit. And do you think this is a problem? And how do you see the WOW store format now and going forward? And also, we are also aware of your new store format called KPRO. Are there any inflows that you're ready to share? Thank you.

Thank you. So for Pizza WOW, I mean, let's take a step back. It's only really innovation that happened only five months ago. So I think our speed of going out is very fast already. We are at about 150 stores. And the breakthrough model is very exciting. As I mentioned in the prepared remarks, the impact on the buy-in thing is very exciting. There more work to be done for the delivery side. And then in terms of the profit, we continue to work on it. Well, let me just bring back our deal focus. Innovations and operational efficiency, operational efficiency and innovation. It goes both ways. So for our core business, we achieved operational efficiency, and we take the savings and we invest in innovation. For Pizza WOW, we have the innovation first, and that is reflected in exciting sales. But the operational efficiency will come later, which I hope address your disappointment of the product because it does not happen automatically. And that's another reason why whenever we turn around business, KFC or later on Pizza Hut, we always focus on sales first, profit later one step at a time. So for Pizza WOW, go back to our framework, we have the innovation first and then operational efficiency later. So I believe that things are in good progress. And I'm very happy to see what have we achieved so far for Pizza WOW, but a lot more work to be done. It's only five months. Regarding KPRO, we have been opening a few small number of KPRO store in Hangzhou, Shanghai, Guangdong actually and it's still small right now, and obviously, target health conscious consumer with products, energy and smoothies, very healthy choices. And it's still in pilot stage, by the way. So there's still a lot to be learned. But that's one thing that we already are doing, which is sharing the learning from KCOFFEE is again, it's side-by-side. The new stores are side-by-side with the KFC coastal so that we can share, start. We can share some investment of CapEx, but still early days. Okay. Thank you.

Thank you.

Your next question comes from Linda Huang with Macquarie.

Yes, hi management. Can you hear me?

Yes.

Yes, Linda. Please.

Yes, my question is regarding for our capital allocation. We appreciate that the company step up the total return to 4.5 billion. And please correct me if I'm wrong because based on your cash flow, right? I found that every single year, our free cash flow will be around $700 million to $800 million. But if we return back to $1.5 billion, that means that probably in three years, we can use all our cash in our balance sheet. So I'm just wondering, based on this capital return, does that mean that for the three years -- next three years, we will just purely focus on the organic growth, and we never think about anything like a big M&A will happen in the next three years or we can strike the balance. If there is a big deal coming up, and we are willing to take some debt to take any M&A opportunity. So that's my question. Thank you.

Thank you, Linda. I guess there are two parts of the question. Firstly, regarding the sustainability of our capital return. Obviously, we're very confident in our ability to generate our cash. And as we mentioned, we have focus on our business growth and return to shareholders, dual focus again. So for 2024 to 2026, we plan to step up our return from $3 billion to $4.5 billion. That includes the $1.5 billion for this year 2024. And as a question regarding the longer term, right, obviously, as you correctly pointed out, we probably cannot do $1.5 billion every year forever, but I think in terms of our company's philosophy, we have always been shareholder value conscious. So we'll continue to evaluate how best to deliver long-term shareholder value. And obviously, I will not be surprised down the road, we will be able to return a meaningful portion of our free cash flow generated each year to our shareholders beyond 2026. Obviously, we have no concrete plans yet, but we'll provide some more concrete guidance down the road at the appropriate time. On your second question regarding M&A and strategic opportunities, we have been very prudent in terms of our M&A approach. Obviously, we prudently and proactively evaluate potential M&A opportunities, both historically as well as in the future and we'll only go ahead with M&A to the extent that makes sense and create value for shareholders. So obviously, for each of the M&A, as you know, we actually have a robust discussion with our board as well. To the extent, if very major M&A comes out and then to the extent, if it makes a lot of sense to Yum China, then we may or may not adjust our capital return plan. Obviously, we may or may not take on debt to fund M&A depending on size of the M&A. Again, we are very prudent in terms of our M&A approach. We'll only do M&As presentable to our shareholders. Hopefully, that will address your questions. Thank you, Linda.

Okay, thank you very much.

There are no further questions at this time. I'll now hand back to Ms. Lip for closing remarks.

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

Thank you.

Thank you.

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