Yum China Holdings, Inc.

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 a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. 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. Jo Yuat, and our CFO, Mr. Andy Yoon. 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. Actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with a cautionary statement in our earnings release and the risk factors included in our findings with FDC. 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 a webcast of this call in the PowerPoint presentation on our IR website. Now I would like to turn the call over to Joey Wang, CEO of Young China. Joey?

Hello, everyone, and thank you for joining us today. I'm delighted to report outstanding performance in the second quarter, both top only and bottom line. Our results are the testament to our resilient and 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 line, our teams are doing a great job. During the quarter, we reached new heights on multiple fronts. Third, 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 holidays was vibrant. However, demand actually softened afterwards with a dip in customer traffic. We adjusted limply with attractive campaigns and we gained sales momentum in June. On June 1st, Children's Day, we hit the record 8.5 million transactions. That's 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 results 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 next-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 500th store is in the Shanghai Library. As part of our Book Kingdom program for kids, It features a dedicated reading area to promote the love of reading to children. It's also one of our 36 angel restaurants of KFC China. The restaurant offers a warm, inclusive space for employees and customers with special needs. It showcases our commitment to positive social impact in the communities we serve. Pizza Hut opened a record 169 net new stores in the first half of the year. Supported by strengthened fundamentals through the revitalization program, healthy new store payback give us confidence for accelerated growth. In addition, Pizza Hut reached 3,000 stores in China, a milestone that few casual dining restaurant chains can claim. Our 3,000 store is in Qinghuandao, a popular holiday destination in northern China. This resort-themed store boasts a beautiful patio with stunning sea view. In addition, it was built with eco-friendly materials and an intelligent energy management system. Third is profitability. Our operating profit for the first half of 2023 has already exceeded the entire year of 2022. This achievement reflects our ability to capture sales and rebate our cost structure. Our rent for the first half was below 9%. This is the best ratio in the past decade. Now, let's talk about KFC. Our value platform generated Amazing sales results. First, crazy Thursday, the famous crazy Thursday, 瘋狂星期四, continue to be a tremendous draw, driving 50% more sales than other weekdays. Second, Sunday, buy more, save more, 週日瘋狂拼, energize Sunday sales. We captured at-home consumption with our juicy whole chicken, 蜜汁全雞, We sold 22 million of this product in the first half, and more than doubled itself year over year. Third, our weekday value combos, OK San Jian Tao, are gaining popularity. We added a new sizzling roasted chicken fried burger, Zhi Zhi Kao Zhi Cui Bao, to enrich our entry price point offerings. For just US $3, Customers love the new weekday value combos. Delicious and innovative food continues to delight our customer KFC. In the second quarter, we introduced the quesa, a creative twist on pizza that utilized our existing ingredients. We used the wrap from our dragon twister, Lao Bei Jin Ji Rou Ji, to make the thin crust and popcorn chicken, Ji Mi Hua, as the topping. This fun, innovative, limited-time-over-generated strong sale receives great potential for more taser variations in the future. K-coffee sales grew 50% with 47 million cups sold in the second quarter. Our Ice Sparkling Americano with Sexy Lemon is the perfect drink to beat the summer heat. We use our soda fountain machine to make this sparkling drink without additional investment in the store. It has become K-Coffee's best ever limited time offering. Now, let's talk about our marketing campaign. Connecting with families and children is an important part of strengthening our brand affinity. Around Children's Day, we partnered with Sanrio, Sanrio, and sold nearly 3 million meal sets with adorable toys such as Hello Kitty. This campaign contributes to our overwhelming success on Children's Day. Of course, these popular toys also work very well for adults as well. Pizza Hut. Let's move to Pizza Hut. We continuously innovate to offer better products at great value. Our new menu launched in May has been a big success and strong sales driver. Over half of the menu items are either new or upgraded from a year ago. Pizza is our biggest category, accounting for over one-third of sales. We continue to fortify our pizza expert image by upgrading existing products and introducing new toppings. apart from our signature Super Supreme, and durian, durian pizza. We introduced a new pizza, like bolognese pizza with beef, pizza. It's a familiar taste because of spaghetti, and it has become a customer favorite, especially among children. Of course, we use quite a bit existing ingredients to simplify the store operation and to keep the ingredients fresh as well. In addition, many customers are trading up to stuffed crust pizza, which accounts for nearly 40% of pizza sales. Most recently, we launched pineapple and cream stuffed crust to complement our other stuffed crust choices of cheese and sausage. Pizza Hut has been sharpening its value proposition and customer engagement. Our value platform Screen Wednesday successfully drove sales and traffic growth. Every Wednesday, we offer different meal choices from pizza, steak, rice, and pasta, to appetizers at an attractive price of $3 to $5 US dollars. There are choices for one-person meals and for social gatherings. We continue our collaboration with Jensen Impact, Jensen, for the second year. This campaign significantly boosts sales and attracts many young customers. We sold more than two million meal sets with themed accessories, tripling last year's numbers. This wildly popular campaign helped us recruit over one million new members. Lavazza, let's switch gears to Lavazza. Lavazza continues to make good strides forward. In July, we crossed the 100-store milestone. In addition to the coffee shop business, we sell Lavazza coffee beans and capsules to premium hotels, restaurants, and other channels. Recently, Lavazza also starts supplying coffee beans to Pizza Hut to upgrade the coffee at Pizza Hut. I'm happy with the progress we have made and excited about the growth opportunity. Digital. On to digital. Our digital ecosystem plays a crucial role in recruiting and engaging members, driving their activities and unlocking sales performance and potential for us. Our loyalty programs now exceed 445 million members. Member sales increased to 66%, setting a new record. Our super app had a major update earlier this year, offering our customers a better digital experience. We introduced interesting member-exclusive perks to tickle our customers, such as app-exclusive new product pre-sales and lucky draws utilizing member points. In addition, we have been working with third-party online platforms to expand our reach. For example, prepaid discount vouchers, Yifu Chips, have been gaining popularity on short video platforms. By offering geographically specific deals, we effectively attract new members and increase spending of existing customers. Our end-to-end digitization unleashed great potential of our restaurant general manager, our GM. Our store management team sharing initiative It is progressing well at KFC and Pizza Hut. Selected RGM, for the first time in our history, can now manage multiple stores. Our AI-enabled systems have streamlined administrative work to help relieve our RGMs of repetitive tasks. By further integrating our store management system, we enhance the visibility of store operations and cross-store data analytics. These digital tools empower our RGM to manage multiple stores more effectively while upholding operating standards. This will be a driver for future store costs and also address our bottleneck of new store opening. So we are looking for more progress going forward. Summer peak season, as we speak, we have entered our summer peak trading season. We are ready to capture summer holiday traffic with eye-catching menu items backed up by rock solid operations. we have brought back our crowd-pleasing fried chicken taco with a new ingredient, blue frog . It does not translate well, but is a delicacy for a customer in China. At Pizza Hut, we have extended our popular durian pizza with a new product, durian coconut lava pizza, , durian pizza. To handle increased demand in the summer peak season, we are ramping up crew resources, securing supplies, and staying vigilant with multiple scenario planning. With that, I'll turn the call over to Andy.

Thank you, Joey. And hello, everyone. Let me now share with you our second quarter performance. I'm delighted to report a robust performance in the second quarter. we achieved record revenues of $2.65 billion, representing 25% year-over-year growth. Opening 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 remained below 2019 levels, we saw 25% growth in revenues and 26% growth in operating profits 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. Consumers 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 of dairy measures and temporary relief. Now with that, let's go through the financials. Foreign exchange had a negative impact of possibly 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. Dining 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%. It was driven by successful traffic-driving promotions the lapping of large community purchasing orders, and the decrease in delivery mix. Delivery has higher ticket average than dining in. Pizza Hut same-store sales grew 13% year-over-year. Same-store traffic grew 27%, and ticket average decreased 11%. It was driven by successful promotional activities and the lapping of community purchasing orders. Lower mix-up delivery, which has a lower ticket average than dine-in at Pizza Hut, partially offset the ticket average decrease. Restaurant margin was 16.1%, 400 basis points higher than the prior year. Occupancy and order improved significantly year over year. This was primarily due to offering leverage derived from higher sales. and ongoing benefit of cost structure rebasing efforts. These were partially offset by lapping last year's outstanding measures, increased promotional activities, and wage inflation. Let me now go through the key items. Cost of sales was 30.7 percent, 20 basis points lower than the prior year. We kept our cost of sales low despite increased promotional activities to drive traffic. Our supply chain team's hard work and innovative use of affordable ingredients contributed to the favorable commodity pricing. Cost of labor was 26.4%, 70 basis points lower than the prior year. This was driven by operating leverage from sales growth lower rider costs due to low delivery sales mix, and benefit from store management sharing initiatives. This more than offset wage inflation, the lapping of austerity measures, and temporary relief last year. Occupancy and order was 26.8%, 310 basis points lower than the prior year. Rental expense and depreciation improved year-over-year. Operating leverage from higher sales, store portfolio optimization, and more favorable new store rental terms all contributed to the improvement. This was offset by lacking of standard measures and higher rental relief last year. G&A expenses increased 15% year-over-year in constant currency mainly from high-performance-based incentives of coronavirus and merit increases. Operating profit was $257 million, more than triple year-over-year. Our effective tax rate was 24.7%. We continue to expect our full-year effective tax rate to be around 30%. That income was $197 million, increasing 138% in reported currency. Diluted EPS was 47 cents, increasing 135% in reported currency. We generated $417 million in operating cash flows and $264 million in free cash flows. we returned $116 million to shareholders in cash dividends and share repurchases. At the end of the second quarter, we had around $3 billion in cash and short-term investment and another $1.2 billion in long-term bank deposits and notes to benefit from better interest rates. Now, let's turn to our outlook for the third quarter. Driving sales remain our top priority. As Joey mentioned earlier, we are stepping up promotional activities and have planned attractive offers with great food at compelling values. We are also lining up exciting marketing campaigns and resources to support those initiatives to capture peak summer holiday sales. In terms of store opening, With healthy store economics and a robust store pipeline, we are confident to achieve 1,100 to 1,300 net new stores in the four years. Our team has put tremendous effort into developing multiple store formats, lowering capex, and securing more favorable lead terms. We opened 655 net new stores in the first half of 2023, Our new store has maintained a healthy payback of two years for KFC and three years for Pizza Hut. This gives us confidence to expand across different city tiers and regions. Regarding margins, our store network expansion and our cost structure rebasing efforts over the past few years position us well to capture both sales and drive operational leverage since the reopening. With 40% of our current store open after 2019, we are opening an average of one new store every five hours. Our store portfolio is well-suited to operating efficiently in the evolving market conditions. We expect our efforts on efficiency improvement and cost structure rebasing to continue to benefit possibly in the long term. And we note that last year's record third quarter restaurant margin set a relatively high benchmark due to austerity measure and $30 million of temporary relief in the prior year. We also expect summer hiring to normalize inflation of low to mid single digits in the second half. Now, despite macro uncertainty and volatility in the near term, our multiple scenario planning capabilities and agility position us well to capture opportunities in good times and manage the downside in bad times. We continue to focus on driving sales, improving operational efficiency, and investing in digital and supply chain for long-term growth. Before I conclude, I would like to highlight our upcoming Yum China Investor Day to be held in September in Xi'an, China. Joey, myself, along with our leadership team, including KFC and Pizza Hut brand managers, will share updates on our strategic priorities. We have also planned food tasting during visits to our restaurants, logistics center, and digital center. Now, through these events, Investors and analysts can gain first-hand insights into the market and our business, so we look forward to hosting you in Xi'an. With that, I will pass you back to Michelle. Michelle?

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 questions to one at a time. Ashley, please start a Q&A.

Thank you. If you wish to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star 2. If you're on a speakerphone, please pick up the handset to ask your question. 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. As you mentioned, the market is still very promotional, and also we hear some smaller players are actually coming back. On the 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 full cost margin managed pretty well. And particularly, can you talk about Pizza Hut? Since we have been working on this value reposition for many years, but it looks like in this quarter the full 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 full cost? Thank you.

Michelle, thank you. I'll talk about the promotion competition and 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 focused on field very effective promotion platform. So what are the famous ones? Crazy Thursday is very, very fun. It's 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, you know, very powerful message, very simple message, but with great food and great offer from steak to pizza. And Taco Bell focused on Taco Tuesday. 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 Little do people remember, Crazy Thursday started from back to 2018. So by now, it's a very familiar mechanism and that works beautifully. And of course, we continue to build new promotional platforms. You can see 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 chickens sell for $39. But on Sunday weekend, it sells for $29. So it's not only promotion, but great food. And I think what people don't 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 surprising capability to source, to innovate, and to deliver all these very affordable ingredients, it's 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 8.8%. 8.5 million transactions a day. That's a huge number of transactions. And the fact that our operation team can handle that is amazing. For people who are running the restaurant in operation, we will be able to appreciate how difficult it is to be able to handle the peak and the spike. And the IT system, it did not go down. We can continue to push our in terms of the stability and efficiency. So that all come together. It's not just marketing promotion. It's the pricing, it's the digital, it's the operation. And while many competitors can probably replicate the marketing campaign, but the operation, the suppression, digital, these are the real top core capability, very difficult to replicate. So I'll pause here and move on to margin questions.

Okay, thanks, Joey. So in the second quarter improvement in terms of margins, I think obviously the number one driver is, you know, the operational leverage from higher sales. And also, if you look at, you know, the overall margin improvement, it continues to benefit, you know, from our portfolio optimizations over the past few years. As I mentioned earlier, you know, if you look at our portfolio, currently, you know, 40% of our stock are open after 2019, and they're very much geared toward 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 drivers for margin improvement. And I think we position as well for the long term to operate efficiently. If you look at, you know, particularly on, you know, cost of sales, I think overall, you know, commodity pricing in the second quarter was, you know, slightly favorable with, you know, overall commodity inflations being favorable. But, you know, the chicken price in the second quarter actually continued to experience an upward trend. And, you know, given, you know, the spot price and also our contract, we expect that, you expand into the third quarter. So I think for both brands, you know, they managed their sales very well over the past two years, genuinely balancing to expand, you know, the pricing range so that we can, you know, continue to expand our addressable customer base and balancing, you know, commodity price and also the value proposition to consume. And we genuinely try to return some of the savings to our consumer, you know, So if you look at cost of labor, it also improves Sandy Basin's point in the quarter. And again, it's driven by the cost structure rebasing that we have. And then also, as Joey mentioned, we have the stall management sharing initiative that can help us run our stall efficiently. And that's more than offset the low single digits labor inflation in the second quarter we experienced. And then, you know, if you look at O&O, as you mentioned, you know, biggest improvement over the past few years, we continue to structurally change, you know, our rental contract. Not only we have more wearable components of that rental term, but also overall lease or rent as a percentage of revenue at, you know, decade levels, right, best in the decade. And so I think the structural change will continue to benefit us and also in terms of depreciations and also as we work down our capital investment per store, that's also very sustainable, I think. And then look at our initiative in energy savings and also we benefit from our investment in technology so that our AMP also is seeing some leverage. And so all that contributes to O&O improvement. So I think that's how we look at it. In terms of like the outlook, I think, as I mentioned, commodity prices generally are favorable, with exception perhaps with chicken price in the next quarter. In terms of labor costs, inflation, I think we're looking at low to mid single digit, you know, in the second half this year. Again, like, you know, But one thing I want to, again, emphasize a little bit is that last year it was a special situation. Obviously, we received about $30 million of one-time relief due to the COVID situation last year. And then we also have some off-the-air programs. So that's it. Thanks.

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 regained momentum in June. Can you just add some context here? Could you perhaps talk about where your underlying trends are versus 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, you know, as you mentioned, you know, we're pretty early still in the, you know, reopening. You know, this is second quarter since the reopening. So we're going to probably going to come in here and see some volatility and whatnot. Obviously, in the decline in the softening in demand, in May had to do with a couple of things. One, we've seen an uptake 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 it indicated that the macroeconomic situation is still markedly challenging. So consumer obviously have experienced three-year COVID and and would likely want to take some time to regain some of the confidence. And so that's what we're 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, revitalized the sales momentum in June. And I think... Again, I think in the near term there's going to be some volatility and uncertainty, but I think we are well positioned to capture the opportunity when it emerges and then able to respond quickly should the situation become a little bit more challenging.

Brian, thank you. Let me give an overall picture of the business that might help understand the sales trend right now as well. Overall, I would strongly suggest our investor and analysts 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 too 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 existed before 2019, the business is very different too because the management team has taken the opportunity in the last few years of pandemic to prune the portfolio. particularly those stores with less desirable economics. So overall, the portfolio is better. But even for the stores that have 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 use the pandemic time to sort them out as much as possible. On top of that, we have refaced the cost structure. We have completed end-to-end digitization and also digitization 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, Q2, Q3. Obviously, we're going to focus on sales. We're going to focus on growth. We're going to focus on opening more stores and then continue to focus on delicious and innovative food that really works for customers. But in the longer term, the macro in the short term, you know, it's hard to predict from month to month basis. But, you know, China GDP has slowed down to growing probably twice as fast as other developed countries. It's not too bad, isn't it? And then it's an amazing big market. And we do serve 2 billion customers a year. And certain regional growth, like in the middle of China, it's very nice. The growth is very good, and therefore we are able to open stores very fast, particularly in these what we call new bread baskets. So what does that mean to KFC Pizza Hut? KFC, you can see from our speed of store opening in the last few years, we are opening a lot of stores. And we are reaching 9,500 stores in China alone for KFC. And Shanghai alone is 500 cities. And we are not only just opening stores in lower tier cities, we are actually opening stores in all tier cities. We are utilizing franchising. We are utilizing different channels such as some channels are newly found opportunities such as university and hospital and high-speed rail service station. And it worked. And then Pizza Hut is really ready to accelerate the growth after a few years of turnaround. The margin is good and it surpassed 3,000 store mark for casual dining, which is quite difficult to get to in terms of scale, in terms of casual dining. So, you know, the smaller brands are also developing and, you know, Lavazza just reached a 100 store milestone. and also start to sell coffee beans in retail. So going forward, we are committed, we are optimistic, and therefore you can see our net new store opening this year is still at the rate that is the record for our business in the last 36 years. Thank you, Brian.

Thank you. Your next question comes from Chen Liu 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 that would imply a full quarter margin of close to 17% at the restaurant level. So I remember many years ago, we talked about the long-term normalized restaurant margin of 70%. I know we no longer talk about long-term target, but 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 that strong, and the majority of the margin expansion will come from the same-store sales or sales leveraging in the future? Thank you.

Thanks, Lu Chen. And thank you for the questions. It's a wonderful question, and then it's also a wonderful question as you mentioned, an issue to deal with, right? Because after the reopening, after all this restructuring, cost structure rebasing that we have performed over the past few years, after, you know, as Julie mentioned, you know, our portfolio changed, entirely different, almost entirely different stock portfolio. We are now, you know, at obviously at multi-year, right, you know, I think at least five years, if not all-time high in terms of margins. So we're operating very efficiently at this point. And as mentioned, even despite the near-term volatility and challenges in the market, we are operating very efficiently. And so I think a couple of things that I want to mention. If you look at the cost structure we're basing, as we mentioned, those are very fundamental change in terms of how we operate our restaurant and also you know, the cost structure itself. Now, in terms of, you know, 17% and margins, I'm glad that, you know, when you mentioned, you know, over the past four quarters, you averaged out it's more there. We don't give guidance on margins, but we just do it sometimes, right? So we did mention it over the past, you know, year two, but, you know, I think we continue to focus on doing that. We're pretty confident in terms of you know, our cost, you know, structurally basing with NAS. We're pretty confident that, you know, our new store performance, new store economics at multi-year, I guess, you know, offering the best in multi-year level. And so that gives us confidence in how our portfolio moving forward as we open more store. So we look forward to that, you know, improvement continuing. However, as we always mentioned, You know, we generally, you know, look at cost of sales. We try to maintain that stability there. The reason why we do that is because, you know, we obviously have a very innovative team that can help us to mitigate some of the vulnerabilities, you know, in commodity prices. We also use efficiently our product that we have over the years. So, fully utilizing the resources like pulled chicken, you know, beef. And then also our supply chain is tremendous. I believe to actually lock in long-term contracts. For example, coffee bean over the last couple of years was very volatile. We were able to lock down a three-year contract. However, we always, you know, being very cautious about pricing and pricing increase. And because the reason is that we want to make sure that our consumer continue to benefit from cost-saving and also enjoy quick value from our food. So we generally try to keep COS market stable And then CLL, you know, I think we have initiative continue to improve labor productivity improvement. As you mentioned, we have the, you know, the stock management sharing initiative. We continue to invest in technology to enable our team member to work more efficiently in the restaurant. But we have got to also look at, you know, the ongoing labor inflation is a fight in our industry, right? We always have to due to labor costs and inflation over time. So we generally also try to keep that stable. Now, as mentioned, O&O has improved over the years, and not only the last couple of years, but even over the past five years, ten years. And so, as we mentioned, we're at a pretty efficient level, but we see continuing room for improvement. So that's generally how we look at the global margin. Obviously, the next quarter or so, there was some anomaly on a year-over-year basis because of last year's temporary leave and austerity program. But overall, I think our trajectory is the right trajectory. Thanks for watching.

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

Thank you very much for taking my call. I have a personal question also on the restaurant margins. With Pizza Hut improving, um and success in the restructuring what would be the normalized restaurant margin would be over time uh can it be like you know without like you know they mean like figure can it be as high as like you know kfc is like you know 18 plus you know um and if that's the case you know what are the drivers uh is it more on the scale of the whole network or is it more on like you know driving the sales per store uh for further normalization And, Joey, last time mentioned that, you know, in the previous call that you would love to see further increase in the delivery or takeaway business for the Pizza Hut side. Any strategy that we can facilitate this? Thank you.

Yeah, hi, Anne. Yeah, thank you for the questions. You know, regarding Pizza Hut, we're very happy to see that, you know, the realization program have achieved very strong results over the last two quarters already. We continue to see very strong traffic growth. We continue to see strong sales growth. And as Joey mentioned, there's fantastic products that are coming out from Pizza Hut. And also Pizza, over the past few years, as we have kept pricing stable, have continued to improve its value proposition to consumers. The value is great. And then you look at the brand, we see it resonating really well with consumers as well, especially with some of the campaigns, Jensen and others, that really connect with our new customers. So I think it's wonderful that they make this transformation because I think you know, expand the pricing range, improve the value proposition, you know, it continues to drive, you know, that addressable market, right? So now we're at 3,000 store level. You know, obviously it has great opportunity to grow into more store. And in fact, if you look at, you know, their store opening, their store opening right now is, you know, at record level. And if you look at, you know, in the quarter alone, it probably opened more restaurants than, you know, like the last couple of years combined. And so I think that's tremendous progress. And I think, you know, we continue to hope to see, you know, KFC, more network expansion, especially driven by satellite store and, you know, smaller store format, and then continue to build, you know, that value position. And then also, you know, as they have done in the last quarter, continue to improve, you know, their margins over time. But when you say normalized, I think, you know, normalized, you know, I think right now the margins are even higher than 2019. I don't know when we would consider being not normalized. But I think you have a right to reject, for sure.

I think, 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 strategic mode, right? We are very consistent with our thinking, our GM. The question is how to get there. What's the key to unlock, to get the resiliency, to get more cells, to manage the investment and to get profit in the short 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 moved from four years to three years in which satellite stores really deliver These are the smaller stores focused on takeaway and delivery, which is your second question. The satellite stores do the trick, and satellite stores require less investment. It requires a different menu because they mainly delivery and takeaway 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 are 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 there's more than 1,000 cities in China that have Pizza Hut, does not have, have KFC, does not have Pizza Hut. So you can see why we are quite confident about the growth potential of Pizza Hut in terms of sales, profit, resiliency. Thank you, Anne.

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

Thank you, Joe 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 a very resilient sales recovery, but we've also seen increasing promotion and more value combos like OK San Dian Tao. So do we think this is only because people are value cultures under this economic environment, or this also has a relationship with more intense competition from McDonald's, from Pasutin, and or other competitors? And how will this impact our ticket average and sales per store? Thank you.

Thank you. The OK content now is new. Right now it's 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 19.9 yuan 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. In terms of its performance across city-tier, well, people might think that it works very well in low-tier cities. Actually, not really. It works better in top-tier cities because this is more for what we call Gan Xu, the functional consumption for the lunch. So it works better for the top tier cities. But for lower tier cities, it actually gives us insight. We still can open more stores. We can open more stores in lower tier cities to capture that functional consumption. So we are happy with that. And again, the key to unlock this OK Sanjian Tao, the WeJay Campbell, is ability in supply chain. whether we can solve such affordable ingredient to deliver that price point and still have reasonable profit. Our team did it.

Thank you. Your next question comes from Lillian Lu with Morgan Stanley. Please go ahead.

Thank you, Joey and Andy, for all the answers. I have a follow-up question on same-style sales growth. Joey just mentioned that Our store network right now is very different from pre-COVID. So when we look at the same-style sales growth compared to pre-COVID, i.e. 2019 level, in the second quarter, we're 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-style sales growth will be below 2019 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 thin-style sales growth below normal level in particular? Is it still the traffic hub stores or in certain area or in certain tier of cities or store format? Thanks a lot.

Brilliant. So let me try to clarify this. Our system sales was 25% year-over-year. Our same-salt growth was 15% year-over-year. And then if you adjust for the impact of temporary salt closure last year, our system same-salt sales growth, a lot of times people use that in the industry, would be about 24%. And, you know, and then, sorry, our systems growth is 32%. So, if you look at that, you know, our adjusted, you know, like, same-source sales growth would be close to 24% year-over-year. So, I think, you know, even, you know, we mentioned some of the slowing down in the May period. In fact, you know, our same-source sales growth are very robust and very strong. And, you know, and obviously, you know, the driver for, you know, the different tiers, different slightly different, you know, from the China we mentioned. The royalty city is genuinely, you know, growing faster. And then, you know, and you mentioned about, you know, the T&T space. T&T space will continue to be very important for us, and we continue to see, you know, pretty robust recovery over there. You know, and if you look at tourist locations, I think, you know, it's doing, you know, it's quite well, probably quite well. Even at the major transportation hub for domestic travel for tourists, high-speed railroad and for domestic flights, they continue to improve. I think that trajectory is going pretty strong. Obviously, international travel, flight travel is a little softer, and then it would probably take a longer time until flight schedules got shut out. And so I think, you know, in terms of our sales growth, it's pretty robust. So I don't know if Joey has 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 amazingly well. It's just in between. It's a bit more depressed, but we have programs to manage that. But for tourist locations, actually, it has recovered really, really well, and particularly in the Tier 2 cities, you know, like Xi'an and whatever. So these sort of tourist destinations, Tier 2 cities, are doing really well, you know, back to pre-2019 level already. But to answer your other question about the holistic same process, Well, here 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 opened one, because the smaller stores require less capital and the paper is good. Well, it sounds silly, but why not growing the same-store sales outside the store then? 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 young China sales, but the absolute number is not small, and it provides very nice resilience self-driver, particularly during the tough times. 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 MSA day, you will see more and more and more our KFC store will have a window opened up so that you don't even need to, customers don't even need to go inside the store to get your coffee or ice cream. or whatever snack or meal. And that improved convenience helps, and you bet we are doing it at scale whenever we could. And then you will see more coffee trucks or stand-alone coffee. Well, the system does grow this nicely, but if we look at capacity coffee compared to last year, it only increased by 50%, which is not too bad, isn't it? And the coffee truck investment is low. It's lovely. It's so cute in any tourist location or anywhere without a fixed location. It's okay. So we only have about, you know, 200 right now, but you bet we're going to have more. And then during the holiday and festival, there are pop-up stores. Well, actually, it's not something new. We just don't talk enough about it. We do a lot of the pop-up stores during Chinese New Year. And right now it works for holiday and festival too. So it doesn't matter, well, to a certain it matters, but we don't want the size of the store to limit our things for growth because we can go outside. You will see more and more and more breakfast kiosks around the store these days. It works both for KFC and Pizza Hut. You know, even though it's already very convenient to pick up breakfast from our store, we further improve the convenience by bringing the breakfast to the subway station, et cetera, et cetera. So I hope that gives you a sense about how do we drive the holistic thing for those, despite our stores are getting smaller.

Thank you. Your next question comes from Christine Ping 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, you know, 2023 cash, free cash flow, So basically, all the measures suggest that the cash accumulation for the company has been very strong. But as we look at the cash dividends and share with purchases, it was not really suggesting a big, you know, pickup compared with the pandemic period. So I was just trying to understand what's the logic, you know, behind this and what's the future salt in terms of distributing more, you know, cash towards investors. Thank you.

Thank you, Christine. I think, you know, a couple things. One is that, you know, our capital allocation, as always, is focusing on driving organic growth. And so, you know, it's on store opening. It's on store remodeling. that genuinely capture more than 6% of our cap expanding. And then we also look into investing, obviously, in our 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 uncertainties. The other one is, you know, for cash allocations, obviously, you know, we want to have a strong balance sheet to make sure that we can deal with any contingency that may come up. You know, occasionally, opportunistically, we look at investment, especially investment that would boost our capabilities, both in the technologies, you know, install operations, and our supply chain. We're very committed to returning, you know, capital to shareholders. If you look at in the quarter, we have returned more than $110 million to shareholders. The pace of share repurchase obviously will vary depending on the number of factors, but I think we hold a strong commitment to return excessive cash to shareholders. Dividends, as we have done so in the first quarter this year, we have raised dividends in the early part of this year. by almost 8-9%. And so we will revisit, you know, obvious dividend policy with our board every quarter and every year. And so, but, you know, again, we're very glad, you know, our strong operating performance generate good operating cash flow and good free cash flow in the second quarter and the first half this year. And so, We'll continue to turn 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 Shin 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 our website. Thank you.

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