Yum China Holdings, Inc.

Good day, everyone, and thank you for standing by. Welcome to Yum China's second quarter 2026 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question, you will need to press star 1-1 on your telephone. You will then hear a message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. Now it's my pleasure to hand the conference to Florence Lip, Senior Director of Investor Relations. Please proceed.

Thank you, operator. Hello, everyone, and welcome to YUM China's second quarter 2026 earnings conference call. With me on the call are our CEO, Ms. Joey Wat, and our CFO, Mr. Adrian Ding. Before we begin, I will remind everyone that our remarks and investment materials contain four looking statements. These are subject to future events and uncertainties, and actual results may differ materially. Please refer to these four looking statements together with the cautionary statement in our earnings release and the risk factors included in our SEC filings. We'll also be talking about non-GAAP financial measures. We encourage you to review the comparable GAAP measures along with the reconciliation of non-GAAP and GAAP measures provided in our earnings release, which is available on our investor relations website at ir.yamchina.com. You can also find both the webcast replay and a PowerPoint presentation on our IR website. Please note that all year-over-year growth rates discussed today exclude the impact of foreign currency unless we mention otherwise. With that, I'll now turn the call over to Joey Wat, CEO of YamChina. Joey? Hello, everyone, and thank you for joining us. We delivered strong second quarter results. For the ninth consecutive quarter, we achieved system sales growth, operating profit growth, and OP margin expansion at the same time. I would like to thank our team again for making this possible. Revenue grew 13%. Operating profits increased 14% and diluted EPS rose 21% year-over-year, partially supported by favorable foreign exchange impact. Excluding foreign exchange impact, system sales grew 6% in Q2. up from 4% in Q1 and continued to outperform the catering industry. Same-store sales growth also improved sequentially to 1%, driven by the 14th consecutive quarter of same-store transaction growth. We opened 560 net new stores with expansion accelerating year-over-year across both equity and franchise stores. With our dual focus on innovation and operational efficiency, Q2 restaurant margins and OP margins stayed resilient despite significant cost pressure from a higher delivery mix. Our breakthrough side-by-side modules are scaling rapidly, especially in higher tier cities. KFC's K-Coffee Cafe and K-Pro are effectively capturing new customer occasions. Pizza Hut's new burger bar was well-received by our customers. At the same time, KFC's small-time model and Pizza Hut's wow are helping us penetrate lower-tier cities quickly. Together with innovation in our core menus, These initiatives are unlocking new opportunities for us. Let me start with Pizza Hut, which makes significant progress in Q2. Pizza Hut's same-store sales growth returned to positive at 1%, while new store openings accelerated almost double what we did in Q2 last year. This brings net new store openings to 381 in the first half, nearly matching our 2025 total. In April, we launched Fuhitas and Shashukas on the spring menu to enrich Pizza Hut's protein platform and enhance the dining experience. In May, we extended our pizza category into lighter meal occasions with a new multigrain crust and new protein and vegetable toppings. The pizza's colorful look, nutrient-packed profile, and grain-rich texture make it our best-selling crust since launch in June. We also introduced an individual-sized multigrain pizza with less than 500 calories, helping us attract more solo and light meal diners. Beyond pizza, we are taking Pizza Hut's burger category to the next level with a new side-by-side module, Pizza Hut's Burger Bar. In just six months, it has expanded to more than 200 locations, contributing double-digit incremental sales and meaningful profit to parent stores. Pizza Hut's Burger Bar features a tight menu centered on make-to-order burgers from an open kitchen. Our buns are baked fresh in store every day, xian kao mian bao, and our patties come straight off the griddle, releasing a rich, savory aroma. Great-tasting burgers, amazing value for money, and a quick-service model have proved very appealing to young consumers and solo diners. With light investment and by utilizing space in existing stores, we believe Pizza Hut's burger bar can unlock significant growth opportunities for Pizza Hut. We plan to accelerate the rollout in the second half, reaching 500 to 600 locations by the end of 2026. That will represent around 10% of Pizza Hut's nearly 5,000 store portfolio. and we are about to reach a major breakthrough by becoming the owner of the Pizza Hut brand in mainland China after operating the brand in the market for 36 years. In the near term, the savings in license fees will enhance store economics and make Pizza Hut's restaurant margin closer to KFCs. This will enable more potential new stores to meet our payback requirement of two to three years. Over the longer term, brand ownership will give us greater strategic flexibility and allow us to respond more nimbly to market opportunities and consumer needs. While we are still reviewing our growth plan, our initial assessment points to accelerated store openings beginning next year. In 2027 and 2028, we now expect net new openings to exceed 800 per year, up from our original target of over 600. As we step up our efforts at Pizza Hut, KFC continues to be our number one growth driver, delivering strong results. In quarter two, both system sales and core operating profits grew 7% year-over-year. Same-store sales grew 1%. In the first half, KFC opened nearly 800 net new stores, around 200 more than in the first half last year. KFC's hero products and their extensions continued to drive strong sales and repeat purchases. Whole Chicken has become a major platform for at-home consumption, generating over 2 billion yuan in sales last year. This category has delivered double-digit growth every year since its launch in 2021 and remains on track for double-digit growth in 2026. In April, we add the aromatic paper-wrapped roast chicken, Xiang Ju Zi Bao Jin, to the permanent menu. It's super juicy and high in protein, appealing to consumers seeking lighter meals. Zinger is another top-selling platform for KFC. In quarter two, we introduced the limited-time offer, more fragrant, spicier Zinger. The extra spicy chicken thigh, secret sauce, and toasted sesame aroma attracted younger customers. Sales were especially strong in spicy-loving provinces such as Jiangxi and Sichuan. With more regional flavors to come, we see strong potential for the Zinger category to exceed 5 billion yuan in sales by the end of 2026. KFC's side-by-side modules, K-Coffee Cafe and K-Pro, continue to gain momentum and deliver incremental sales and profits. K-Coffee Cafe grew to more than 3,300 locations, and we are on track to reach 5,000 locations by the end of 2027. In addition to coffee offerings, K-Coffee Cafe is broadening its tea and food options, including more egg tart flavors and Breakfast Pairings to expand its addressable market. K-Pro has expanded to over 450 locations and has proven more promising than we expected. Earlier this year, we raised our year-end rollout target from 400 to 600 locations, and we now expect to reach around 800 locations. Following its success in higher tier cities, we are expanding K-Pro into select lower tier cities. Beyond increasing its footprint, we are capturing the growing demand for lighter meals through manual innovation. In addition to our signature energy bowls, we recently launched sandwiches featuring whole wheat buns and chia seeds. and High Protein Ingredients. The sandwiches became an instant hit with good repeat purchases. In fact, more than 80% of K-Pro sales came from KFC members, showing the power of cross-selling and membership. Combined with our trusted food quality standards and strong value for money, K-Pro is well positioned to become a leading player in China's light meal business. Aside from new modules, KFC is also rolling out car-side pickup service to improve convenience for customers who drive. More than 8,000 KFC stores now offer either drive-through or car-side pickup, where our restaurant staff bring orders to designated pull-up areas. While customer awareness and habits are still in the early stage, the service is gaining traction, supported by strong repeat purchases. Over 7 million members have used this service this year, yet that still represents only 3% of our active member base, leaving significant room for growth. Let me now turn the call over to Adrian.

Thank you, Joey. Let me update key highlights by brand, starting with KFC. In quarter two, both KFC's same-store sales growth and system sales growth improved sequentially. System sales grew 7%, up from 5% in quarter one. Same-store sales grew 1%, the fifth consecutive quarter of growth. Same-store transactions grew 4%, more than offset the ticket average decrease of 3%. Ticket average was 36 yuan, lower year on year, mainly due to incremental smaller orders from new customer segments and locations, such as K-Coffee and K-Pro. Despite significant rider cost headwind, KFC's restaurant margin expanded 20 basis points to 17.1% in quarter two, OP margin also expanded by 20 basis points, once again demonstrating KFC's strong execution and nimble operations at scale. KFC's side-by-side modules continue to drive incremental sales and profit while improving store economics through model iteration. K-Coffee Cafe delivered around mid-single-digit sales uplift to its parent stores while K-Pro delivered around 20%. CapEx for both K-Coffee Cafe and K-Pro has come down by around half from earlier modules last year, and both are showing solid margin improvements. Now, moving on to Pizza Hut. In quarter two, system sales grew 6% year over year, accelerating from 4% in quarter one proven by the sequential improvement in same-store sales growth to 1%. Same-store transactions grew strongly by 13% in quarter two, marking the 14th consecutive quarter of growth, offsetting an 11% ticket average decrease. Ticket average was 68 yuan, moving closer to our target range of 60 to 70 yuan in line with our mass market strategy. mainly driven by better value for money and incremental smaller orders, including those from solo diners and burger bars. Pizza Hut restaurant margin was down 40 basis points, mainly due to the increased costs associated with the higher delivery sales mix, better value for money, and expenses related to the launch of the Pizza Hut burger bar. The new initiative successfully drove incremental sales and profit with a modest margin investment. In the first half, restaurant margin was up 10 basis points year over year. OP margin expanded by 60 basis points, mainly driven by lower closure and impairment expenses, reflecting improved store performance. In the second half, we expect greater year-on-year improvement versus the first half in Pizza Hut's restaurant margin, as efficiency continued to improve and rider cost headwinds softened. Moving on to store opening. We opened around 1,200 annual stores in the first half, about double the pace of the same period last year, and entered more than 200 new cities. Both equity and franchise store openings accelerated year over year. In the higher tier cities, We continue to densify our network, primarily through equity stores, to sustain our powerful brand momentum and operational mode. At the same time, franchisees, which accounted for 40% of total annual opening in the first half, are unlocking incremental opportunities for us. They provide additional resources to help us expand into lower tier cities, remote areas, and strategic locations. with franchise stores accounting for only 18% of total stores of Yum China were confident there were significant opportunities ahead. Let me now go through our quarter two PML. System sales grew 6% year on year. Same store sales grew 1%, sequentially improved from quarter one. Our restaurant margin was 16.1%. in line with the prior year level. Improvements in occupancy and other costs offset growth in cost of sales and cost of labor. Cost of sales was 31.5%, 50 basis points higher year over year, mainly due to better value for many offerings, increased packaging costs due to a higher delivery sales mix, and Pizza Hut's new menu items, which have higher COS and are still being optimized. Commodity prices remain favorable, though the benefit was smaller than before. We also improved our procurement efficiency through menu innovation and dynamic price management. Cost of labor was 27.6%, 40 basis points higher year-on-year. Rider costs continued to increase year-on-year in quarter two, driven by the strong growth in delivery sales mix. which rose from 45% last year to 54% this year. The margin impact from rider cost was 140 basis points, slightly lower than in quarter one, and we offset most of that through enhanced store operations. Occupancy and other was 24.8%, 90 basis points forward year over year. The rent ratio improved through lease renegotiations and more favorable rent in lower tier cities. We also implemented other initiatives to enhance operational efficiency. Our OP margin was 11.1%, 20 basis points higher year over year, achieving the ninth consecutive quarter of OP margin expansion. Savings in GNN expenses help improve OP margins. Operating profit was $348 million, a second quarter record, growing 7% year on year. Net income was $244 million, up 6% year on year. Excluding our investment in Meituan, net income grew 3% year on year. Our investment in Meituan had a negative impact of $6 million in quarter two, compared to a negative impact of $14 million in quarter two last year, As a reminder, we recognize $13 million less in interest income in Q2 this year due to a low cash balance resulting from the cash we return to shareholders and lower interest rates. Diluted EPS was $0.70, 14% higher year-on-year, or up 10%, excluding our investment in Meituan. Now, moving on to our 2026 outlook, let me start with sales. Since June, we have been lapping a higher delivery sales base, and that tougher sales comparison will continue through the second half. That said, given our disciplined execution last year and multiple growth drivers, we remain confident in our ability to lead the catering industry in China. July tracks broadly in line with our expectations. were working hard to maintain positive same-store sales growth in quarter three and deliver the 15th consecutive quarter of positive same-store transaction growth. Moving on to margins. Before considering the impact of the Pizza Hut deal, we expect quarter three restaurant margin to be stable to slightly positive year on year. Relative to the first half, Incremental rider cost pressure is expected to moderate slightly, as delivery sales mix already increased to 51% in Q3 last year. Our continued efforts to improve operational efficiency and optimize store costs, including rent, labor productivity, and capex, are expected to support margins, giving us room to reinvest in growth. We expect OP margins to be roughly in line with Q3 last year, There was a positive margin impact of about 20 basis points from some ad hoc government subsidies in Q3 2025 that are not expected to repeat in Q3 this year. Some similar subsidies were already recognized in the first half this year, though in smaller amounts. For the full year, without considering the impact of the Pizza Hut deal, we're confident in meeting our 2026 targets. which are consistent with the range we shared at our investor day last year and in February. These include same-store sales index of 100 to 102, mid to high single-digit system sales growth, high single-digit operating profit growth, double-digit EPS growth, and a slight improvement in restaurant and OP margins for Yum China. Additionally, We remain on track to reach 20,000 stores by year end. Now, let's turn to the Pizza Hut deal, which is on track to close in August. We plan to fund this transaction primarily with debt. We expect to borrow an offshore bridge loan of around $1.2 billion equivalent for up to 12 months. For longer term financing, all options remain on the table. will proceed in the best interest of our shareholders and execute financing when market conditions are appropriate. We'll provide an update once our financing plan is finalized. The savings in the 3% licensee payments to Yum! Brands are expected to add 2.8% to Pizza Hut's restaurant OP margins after taking VAT into account. This translates to approximately 60 basis points for Yum! China overall. For quarter three, We expect around 30 to 40 basis points positive impact to both Yum! China's restaurant and OP margins, and for the 2026 full year, around 20 to 30 basis points. After accounting for due related costs, financing interest expense, tax, and without considering the potential higher growth of Pizza Hut, we expect the due to be accretive to dilute EPS, slightly accretive in 2026, and made single-digit accreted in 2027 and 2028. In terms of capital returns to shareholders, we remain on track to return $1.5 billion to shareholders in 2026, equivalent to around 10% of our current market cap. In the first half, we returned $718 million, including $515 million through share repurchases and $203 million through quarterly cash dividends. We stepped up share repurchases in quarter two, reflecting what we believe was a relatively attractive share price. From 2027 onward, we remain committed to returning around 100% of annual free cash flow after subsidiaries dividend payment to non-controlling interests. This translates to an average of $900 million to $1 billion plus in 2027 and 2028 and exceed $1 billion in 2028 and beyond. With ownership of Pizza Hut brand supporting faster growth, we also see potential upside to our future free cash flow. With that, let me hand it back to Joey for her closing remarks.