Yum China Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Yum China 2020 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, there will be a question and answer session. To ask a question today, you will just need to press star 1 on your telephone. But I will now hand the conference over to your first speaker today. Thank you and please go ahead, Debbie.

Thank you, Operator. Hello, everyone, and thank you for joining Young China's second quarter 2020 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Wat, and our CFO, Mr. Andy Yang. Before we get started, I'd like to remind you that our earnings call and investor presentation contains forward-looking statements, which are subject to future events and uncertainties. Our results 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. Consideration of the non-GAAP and GAAP measure is included in our earnings release. Today's call includes three sections. First, Joey will provide an update regarding recent developments. Then she will offer some highlights around the quarterly results. Andy will then cover the financial results and provide an update on our four-year outlook. Finally, we will open the call to questions. You can find the webcast of this call and a platform presentation which contains operational and financial information for the quarter on our IR website. Now I would like to turn the call over to Ms. Joey Wat, CEO of Young China. Joey? Thank you, Debbie. Hello, everyone. and thank you for joining us today. I will first update you on COVID developments and then we'll move on to cover performance in more detail. Throughout the COVID pandemic, we have been committed to safely providing good food, great value and convenience for our customers wherever they are. Safety is the key word here. At our stores, temperature checks, face masks, and frequent disinfection and cleaning protocols remain in place. A safe and healthy environment creates confidence for customers and employees, which helps drive recovery in our business. We approach this challenge with an open mind, with flexibility, speed and the courage to try new things. Our nimble marketing, enabled by our digital infrastructure, helped drive improvements at both of our core brands compared to the first quarter. KFC launched Buy One Get One Weekend in June for the first time for our members. Pizza Hut drove traffic with its first ever all-you-can-eat promotion, featuring steak and baked crayfish. We focused our resources on engaging with our members, targeting specific specific offers and promotions. Our privileged programs drive frequency, span, and cross sales. However, we are still experiencing significant headwinds. The recovery path is nonlinear and uneven. April and May sales improved sequentially, while June was impacted by delayed school holidays and more stringent social distancing due to resurging regional infections. Our transportation and tourist locations continue to experience significant year-on-year volume declines, which impacts KFC more than Pizza Hut. Around 60 of our stores in Wuhan and northern China remain closed for the time being. Even with short-term uncertainty, we are enthusiastic about our long-term prospects In an incredibly challenging environment, we celebrate three important achievements. First, we opened our 10,000th store in July. This is truly an incredible achievement that would not have been possible without our exceptional employees. We are seizing this opportunity to expand our footprint. Second, Pizza Hut has now been serving our Chinese consumers for 30 years. Beginning in June, we kicked off our 30th anniversary celebration with an all-new menu and all-you-can-eat promotion. We saw long queues and new customers. We are now a proud food service sponsor of the 2022 Olympic and Paralympic Winter Games in Beijing. We are honored to work with the Olympic Committee to promote Olympic values of excellence respect and friendship here in China to our millions of members and customers. These achievements show how Yum! China has become deeply ingrained in the lives and memories of millions of Chinese people. From the first taste of KFC in 1987 in Beijing to trying something new at Pizza Hut, we are proud to be the largest and still growing restaurant company in China. With the combined effort of our team, we continue our sales recovery and, importantly, remain profitable in this quarter. This profitability is a reflection of our resilience, our adaptability, and the strong, dedicated execution of our team. As we enter the third quarter, I look forward to continuing our innovation journey. We are cautiously optimistic. The recent regional outbreaks highlight that the recovery is nonlinear and uneven. While the summer season will be challenging, I'm grateful to be leading a dedicated team to ensure that we are building a strong and stronger Yang China. So let's talk about digital strategy. Benefits of our digital strategy were particularly evident over the past few months. I would like to take some time to talk about how our member program and digital ecosystem have built our resilience, both for the short and long term. Our over 265 million members provide a strong base for engagement. We interact with members within a digital ecosystem supported by our super app, strategic partnerships with online platform and in-store digitization, Whether letting our customers know about our contactless delivery model or promoting weekend-specific offers, we reach our members faster, with greater flexibility, and at lower cost. Member sales account for over 60% in the second quarter. While overall sales declined during the outbreak, our year-on-year member sales grew by double-digits. We acquire new members in innovative ways. Using popular social media apps and websites, we convert online traffic into in-store sales. We also engage at the corporate level. Over 10,000 corporations have signed up to our corporate delivery program, bringing entirely new groups of customers to Yum! China. Once members are acquired, we are able to design more targeted promotions, We improved the stickiness of our members as they use our super app or mini program, eventually upselling members into our privileged program. We have sold close to 10 million privileged subscriptions this year. Frequency and spending of these loyal users is more than double pre-subscription levels. Overall, we doubled the average revenue per active member over the past few years. Our members are increasingly loyal to our brand. Engagement is crucial for our member retention. Over years of consumer insight, we have developed award-winning games, marathon clubs, and even one of the largest online children's bookstores on our KFC app. Whether through short-term promotions or long-term member engagements, Our digital strategy extends across brands and channels, from dine-in delivery to takeaway. With this solid digital foundation, we are well positioned to capture future growth opportunities. Off-premise dining remains a key pillar of growth. Delivery sales accounted for 29% of sales in a quarter, a 36% year-on-year growth. Our delivery business is top of mind with our consumers. Its consistency rates highly in taste, convenience, and value. Our dedicated delivery riders once more support growth during this time. At Pizza Hut, digital engagement drove incremental takeaway growth. With redesigned menu and packaging suitable for takeaway, we used our digital channels to communicate the value and convenience of our one-person set meals. Over half of all takeaway orders were done through mobile. I'm proud of our achievements thus far, but there's much more we are targeting. From ready-to-cook, corporate, and late-night deliveries, we have the scale, the resources, and the vision to capture those future opportunities. Now let's move on to menu innovation and value promotion. Our digital initiatives rely on an enticing innovative menu to get customers excited. Pizza Hut launched its new platinum menu in conjunction with its 30th anniversary celebration kickoff. Learning from successful limited time offers, this menu is substantially fresher, extending our appeal to young and family-oriented customers. We showcase our pizza innovation with our Pizza Air series, Bo Cui Bing Di Xie Lie, thin crust pizzas that appeal to smaller appetites. We extend our leadership in the steak category with Thicker Anger Steak, and importantly, make steak available for delivery. Our Monet Afternoon Tea Set, with virtual reality effects of Monet paintings in select stores that appealed to our young social media savvy customers. Many menu items also got an upgrade. Our baked crayfish with cheese got high marks on value and our lasagna was appreciated by young and old alike. I'm really excited about all the innovation in our 30th anniversary menu. The look and feel show our pizza and our Pizza Hut positioning, which is always something new. So I hope you will try it soon. Cassie brought back favorites, Beef Wraps and Taco Jr. during the quarter, with crayfish in the taco to showcase abundance and premium. We extended drinks, desserts, and late-night delivery lines. Our breakfast tofu pudding, which is Xin Dian Feng Wei Dou Hua, quickly became a crowd favorite, and we showcased festival innovations with exciting products such as scallops, salty egg yolk, rice dumplings. In Chinese, that's 干贝咸蛋黄八宝粽子. To drive traffic, KFC also launched value campaigns throughout the quarter. A plant-based protein pilot was successful, introduced across KFC, Pizza Hut, and Taco Bell. They sold out quickly. Once the domestic production may be scaled, this has great potential to bring our brand to new and discerning consumers. Now, let me wrap up with a few brand-specific observations. First, KFC. KFC continued to demonstrate its resilience and operational excellence. Second quarter transactions substantially improved compared to the first quarter. Compared to the rest of our portfolio, KFC has a higher concentration of stores located in transportation and tourist hubs. And they are impacted by the downturn in business and holiday travel. Delayed and shortened school holidays, together with lingering effects of the outbreak on consumer behavior, will continue to pressure sales. We will work on providing value and occasion to draw customers in, but recovery is likely to take an extended period of time. Next, Pizza Hut. Our 30th anniversary All-You-Can-Eat campaign went viral with over 80 million views and comments on social media, driving long queues and obstacles. We have seen encouraging signs of transaction recovery, However, the delayed and shortened summer holidays will impact our business as well. We will strengthen our offerings for individuals and for delivery and takeaway while family dining volumes recover. Third, Taco Bell has now expanded beyond Shanghai. We opened our first flagship store in Shenzhen and will be opening soon in Beijing. We are excited to bring this new cuisine to more of China. and we are working hard to create an appropriate business model just right for Chinese customers. Finally, integration of our Chinese dining unit is on track. Our Little Sheep and Huan Ji Huan store sales are recovering and we are leveraging the Yangtze network in areas of delivery, retail and logistics to further Huan Ji Huan's capabilities. I will hand over the call to our servo, Andy Yang. Andy, please.

Thank you, Joey, and hello, everyone. I will first address financials and developments in the second quarter, then provide some color on our outlook. Unless noted otherwise, figures mentioned refer to the second quarter of 2020. All percentage changes are before the effect of foreign exchange. Now, let me start with the second quarter results. With over 99% of stores open, Total Q2 revenues recovered to 93% of the prior year. In the first quarter, revenues were 79% of the prior year level. Both of our core brands have quarter-over-quarter improvement in transaction volume. However, traffic is still below pre-COVID levels. KFC's theme store sales recovered to 90% of prior year, compared to 89% in the first quarter. We saw sequential increases in average unit volumes in April and May, but a weaker June, while weaker weekday and dine-in recovery benefited from our promotional campaign, regional differences persist. Our transportation and tourist hub sales, which accounted for high single-digit sales mix, were still significantly and negatively impacted. The higher mix of younger school-age customers meant that the delayed and shortened school holidays had a bigger impact on KFC than Pizza Hut. Lingering effects of the outbreak on consumer behavior remain a headwind. Pizza Hut seems to have sales recovered to 88% of prior years. This is a significant improvement from the first fiscal quarter when sales were 69% of prior years. Relative to KFC, Pizza Hut has a significantly lower exposure to transportation hub locations. Our store in lower tier cities continues to perform better than stores in the higher tier cities, partly driven by a higher concentration of transportation hubs and tourist locations in higher tier cities. Our strong brand equity also helps relative performance in the lower tier cities. The sales recovery is nonlinear and Anivin. As Joey mentioned, growth momentum was slowed by the resurgence of regional infections, delayed and shortened summer holidays, and continued anemic sales at major transportation and tourist locations. We opened 169 stores, mostly at KFC. Construction activities have mostly normalized, and the pace of the new build is on track. The threshold margins were 13.7% compared to 14.7% last year, mainly due to sales leveraging, which was partially offset by our efforts to control costs and runoff benefits. Cost of sales was 32.9%, a 1.4% year-over-year increase. While protein supply eased in the second quarter, our contracts are generally signed three to six months in advance. Commodity inflation for the quarter was 3%. Value promotions are key to drive traffic into our stores, which will also impact our margins. Cost of labor was 22.7%, a 0.7% year-over-year decrease. Productivity improvement and temporary relief more than offset the impact of sales leveraging and wage inflation. Within this figure, Wage inflation was 3%. This was used in many of our markets as government-mandated increases in minimum wage were deferred. And increased proportions of delivery sales contributed to higher labor cost percentages. These factors were mitigated by digital scheduling tools and pocket manager real-time monitoring, which drive improvements in productivity. Lastly, Reductions in social insurance payments were roughly $30 million. We negotiated approximately $10 million in rental relief in this quarter. We implemented cost realignment measures and benefited from reduced social insurance payments. However, due to timing of government incentive receipts, G&A costs increased by 8% year-over-year, excluding the impact of timing shifts of government and other one-time expenses G&A would have decreased slightly year-over-year. We recorded impairment charges of $24 million. We achieved offering profits of $128 million, bolstered by cost realignment and one-time relief. Looking below the line, our gain from equity investment in May 2020 was $45 million, which is before $14 million in U.S. income tax, relative to gains recognized during the second quarter and prior period. Our effective tax rate was 25.2%. Net income was $132 million. Diluted EPS was $0.34, and adjusted diluted EPS was $0.35. Now, I will turn to our outlook for 2020. The situation is still evolving. However, resilience, adaptability, and innovation are key strengths as we Navigate an Unprecedented Environment. Our outlook is based on certain key realities. One, transportation and tourist volumes continue to be unlimited. Two, the delay and shortened school holidays will impact sales momentum. Three, the COVID situation is unpredictable with its lingering effects and regional outbreaks. We expect the recovery to remain nonlinear and uneven. Four, will continue to pressure margins, especially as one-time government and rental leave are face-up. In response to this reality, we need to be patient and vigilant in rebuilding ourselves' momentum, focusing on our strength in manual and digital innovation. Successfully leveraging our member base and digital ecosystem to drive frequency and spend will be key. Our promotions are adaptable, and we have seen some successes in building weekend recovery through greater value offering. Lastly, we are taking decisive actions to realign our core structure. As we look ahead, we continue to target 800 to 850 new stores for this year. Investment in digital technology and supply chain continues. Our 2020 CapEx plan is unchanged in the range of 500 to 550 million dollars. We expect wage inflation to stay at mid-single digits this year, as minimum wage increases have been delayed in many provinces. Finally, while protein supply in China appears to be loosening, our best estimate of 2020 commodity inflation is for low single digits. Risks to your global supply chain remain, which may have potential implications to our domestically sourced products. As previously announced, we will increase our stake in the Suzhou KFC Joy Venture. The transaction is expected to close in August, subject to satisfaction of closing conditions. We see the new normal of reduced travel, social activities with bouts of disruption as secondary regional outbreaks occur and are contained. The lingering effect of COVID will impact consumer behavior. That being said, With our digital infrastructure, solid execution, and strong balance sheets, we are prepared to capture opportunities for recovery and growth. With that, I will pass you back to Debbie to start the Q&A. Debbie?