Good day, and thank you for standing by. Welcome to the Yum China's Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your is speaker today Michelle Shen. Thank you. Please go ahead.

Thank you, Lyndon. Hello, everyone, and thank you for joining Yum China's third quarter 2021 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I'd like to remind you that our earnings call and investor presentations contain forward-looking statements which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statements 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 the GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding recent development and our third quarter 2021 results. Andy will then cover the financial performance in greater detail. Finally, we will open the call to questions. You can find the webcast of this call in the PowerPoint 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 Yum China. Joey?

Thank you, Michelle. Hello, everyone, and thank you for joining us today. As we shared in mid-September, we navigate a very challenging situation in the third quarter. The Delta variant outbreak that started in late July spread to 16 provinces became the most widely spread regional outbreak since the first quarter of 2020. Strict public health measures were implemented across the country. Trading was significantly impacted during the peak summer season which is traditionally a very strong quarter for our business. Same store sales declined by 7% in the quarter as demand fell for dining although this was partially offset by growth in delivery. I want to take a minute to commend our 440,000 employees for working diligently and rapidly finding solutions in this fluid situation. In response to the sharp decline in dining traffic, we quickly adjust marketing campaigns, operations and supply chain to drive demand for off-premise. Delivery sales grew 23% year-over-year or 62% on a two-year basis and contribute approximately 34% of sales in the third quarter. New retail business grew rapidly with sales in the third quarter almost equal to the first two quarters combined. Our ability to engage customers digitally with essentials during this difficult time. In the third quarter, over 60% of system sales came from members. We added about another 20 million members, ending the period with a total member count over 350 million. We sold 19 million privilege subscriptions, including the popular KFC Chicken lovers Wang Zha Ka which is a summer exclusive. Having to get important initiatives to drive sales, we saw a sequential recovery in September. For the quarter, system sales growth was positive compared to last year and to pre-COVID. New unit growth more than offset the same-store sales decline. We broke record by opening 524 new stores, ending…

Thank you, Joey, and hello everyone. Let me first review our third quarter financial performance and then discuss this year's outlook. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Let me first cover the third quarter performance. Actual results are in line with the business update we released in mid-September. Third quarter performance was disrupted by the delta variant outbreak. We are selling in same-store sales decline of 7% year-over-year. However, we still delivered positive revenue growth and system sales growth, which is led by new unit contribution. Total revenues grew 2% year-over-year and reached $2.55 billion. System sales increased 1%. Similar to prior quarters, we are providing pro forma measures here while convenience comparisons with 2019. Same-store sales were approximately 87% of the third quarter 2019 level. KFC's same-store sales were approximately 92% of the last year level, and 87% of the 2019 level with same-store traffic at approximately 82% of 2019 level. Average price ticket grew roughly 6% versus 2019, mainly due to the increase in delivery made. These same-store sales were approximately 95% of last year and 89% of 2019 level. Same-store traffic is on par with the 2019 level while average ticket decreased by about 10% driven by the increased mix in off-premise occasions, which have a lower ticket than dine-in. KFC was slightly more effective than Pizza Hut again this quarter as KFC has a higher store mix in transportations and tourist location. These locations experienced a sharp decline in sales and approximately 40% on a two year basis in the quarter. Restaurant margin was 12.2%. They are 640 basis points compared to last year. This was mainly caused by sales leveraging, more value promotion, higher wages and increased delivery costs with more delivery orders, as well as lower COVID…

Thanks, Andy. We will now open the call for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Lyndon please start the Q&A.

[Operator Instructions] Your first question comes from Michelle Cheng from Goldman Sachs. Your line is open.

Hi, Joey and Andy, thank you for taking my questions. My question is about the commodity cost inflation. So we hear many companies are starting to talk about price hike recently. So understanding the confidence that is the most very challenging. So can you share with us your pricing strategy and also compared with the previous chicken cost inflation cycle back in '18-'19 when we managed the margin pretty well, so what could be the difference now versus the past experience? Thank you.

Good morning, Michelle. Thank you for your questions. We're getting pricing as we have a long-term pricing strategy here at Yum China, we want to provide a good value for consumer and so over the years, we always have been very cautious about price increase. We do partial inflation to be invested for consumer, but mostly, we will try to find efficiencies in our operation to offset those inflationary pressure. Now, if you look back in the last few years, obviously there is commodity price fluctuation. Sometimes, it goes up, sometimes it comes down. And then over the years in China, we always have seen labor inflation right, so labor inflation generally is in the mid-single digit to high-single digit range. And I think sometimes, when there is a sudden surge or disruptions in the market, then you do see the impact on our margin. For our quarter, this quarter for example, the biggest impact obviously is our sales right, because of COVID outbreak and so you have a deleveraging impact which is ultimately impacting the margin and then, so if you think about commodity prices, we generally have a very, over time, we will have new product innovation, how to make use in our board to feel better. We would also have diversifying the different voting. So we have chicken now, we have beef, we have a variety of fish and other seafood. So that has helped us to balance the commodity price increase over time. And then obviously, we have a strong supply chain. We always work with our supplier closely to try to mitigate some of this pricing fluctuation. We generally have a sort of like place our order also in the contract, a quarter or two ahead of the quarter so that we sort of know…

Thank you Andy, that's clear.

Your next question comes from Lillian Lou from Morgan Stanley. Your line is open.

Thanks management. My question is more on the CapEx plan because we definitely increased the gross new opening quite a lot versus the previous guidance but maintained CapEx overall. So maybe a little more. I know the company talked a bit for some times in terms of the unique cap has put store with this small format model, but can you share with us a little bit more about the details of what, how they have been doing in the recent quarters in terms of the unique CapEx and the unique higher mix versus before that caused us maintaining the similar cap which was much more comfort for our stores. Thank you.

Thank you, Lillian. So obviously this quarter we did set up our CapEx for the whole year, hopefully higher than last year. I think our CapEx year-to-date is about $480 million and I think -- let me check that number here. Yes, so obviously, as we have outlined in our capital expenditure plan in our Investor Day, investment for CapEx will drive organic growth and also give you the competitive mode. So that's the multiple component to it. One is obviously the store that we're opening and we are accelerating that and as we have mentioned before, we have over the past few years, we have reduced the CapEx per store investment. So if you think about a few years back, our CapEx per store was about RMB2.5 million and then now is under RMB3 million, mostly RMB2.5 million. And as we continue to this driver for that, obviously the size of the store change. The other one is -- so overall, per store cost reduction and so our team worked very hard as one team, our brand team worked very hard to do that and make it more efficient. So I think with our new smaller store format for example, Pizza Hut, KFC, new model and more small store format catering to delivery and take away, I think we still have some opportunity to further do with use that CapEx per store going forward. Also, the other component obviously is remodeling. I think that over time, we'll continue to trend up just because we have a bigger portfolio of stock. And then the third part is, investment in supply chain and infrastructure that we have outlined before and in Investor Day is to drive efficiencies and resiliency in the supply chain, is to drive labor for the improvement through investment in technology, digitalization and et cetera. And so, I don't think there's fuel change to our plan. So hopefully, we can give you more update next quarter in terms of our full year CapEx spend. Thank you Lillian.

I think as you comment on this one, Lillian, for today we update the new store guidance for the year from last quarter, 1300 stores to 1700 stores for the year. But we did not increase the CapEx spend for the year, it's still they add $700 to $800 million range. But what happened here obviously, as you guys know us quite well, we don't chase after a blind store number. We opened good quality stores. If we can find a good quality store with additional profit and sales, then we will open it. So in terms of store economics here, I would like to give you a comment. One is, the store, the smaller store are driven by increased off-premise, means that delivery and take away. So that's more that helped that business and the smallest store helped us increase the store fantasy in the top tier city in particular. So these are the Pizza Hut store, the KFC smaller store and also, these stores with the lower investment and incremental sales and profit. They help penetrate into the smaller cities because we have variety of different business models for different locations. So number 2 comments, it is normal that these smaller stores have smaller cells per unit. But as I mentioned earlier, to drive incremental sales and profit, it demands less CapEx so as Andy mentioned earlier. Third, is the payback healthy. So that KFC payback is always about two years and Pizza Hut right now, if you notice what I said earlier is the Pizza Hut store payback is at three years now in total. That is an improvement because in the past, we always conclude that the payback for Pizza is about three to four years. So now, it has improved to three years because the small store, the Pizza Hut separate store right now, the payback is at two to three years. So in total, the improvement is at three years. So I hope that gives you a sense about why we are increasing the new store guidance for the year. Because if we look at our system sales growth number, it also tells the story for the entire Yum China versus 2020. We are driving 15% year-to-date same-store sales growth and that includes 12% year-to-date system sales growth for KFC and 20% system sales growth year-to-date for Pizza Hut. And then for KFC even compared to 2019 for year today, we are also achieving 4% system sales growth. Despite all the challenges of the outbreak and also same-store sales. So let me conclude the question here. Thank you. Lillian.

Thanks a lot. Joey and Andy. It is very detailed and helpful.

Your next question comes from Xiao Po Wei from Citi. Your line is open.

Hi, good morning, Joey and Andy. A very brief question. So your acquisition in the press release this morning, you mentioned value acquired 28% stake in Huangzhou catering services which operating a few grade logo Chinese brand. My question is, were you opening some store on standalone basis under those brands pursuing to any arrangement with the Huangzhou catering company or you are more looking at bringing those to greater [indiscernible] to your existing KFC stores or Pizza Hut to diversify your portfolio to bring more local food into the Chinese consumers. So any color would be highly appreciated. Thank you.

Thank you, Xiao Po. So we have been working with Huangzhou catering, this company for a few decades now. This is our joint venture partners of Huangzhou KFC stores and Huangzhou market is one of our best market in terms of sales and profit. And we are very grateful that we have the opportunity to invest at 28% into the Huangzhou catering and that enables us to achieve consolidation of Huangzhou KFC business which is about 700 stores with future very nice expansion opportunity ahead, so that's point one. Point two is while Huangzhou catering has other business such as the new one and old one et cetera, our focus is still on our KFC business. In terms of future cooperation, we do see cooperation in two areas. One is working with them on their central kitchen or factory whatever you call it. They have very high quality facilities and actually with this already with our Xiao Long Bao launch in Huangzhou market, they were produced by the Central Kitchen at the factory of Huangzhou catering. The second area we see, we are going to further expand our cooperation is store opening because another key shareholder of Huangzhou catering is a very successful and important player in the commercial properties in Zhejiang province. And already what we've done to open our first and the most important flagship store for Lavazza in Huangzhou, so these are the two areas that we certainly we'll see us accelerate our cooperation on top of KFC, so expansion in Zhejiang province and particularly, Huangzhou. Thank you.

Thank you very much.

Your next question comes from Chen Luo from Bank of America. Your line is open.

Thank you Joey and Andy. My question is on the marketing side. Our Q3 record margin saw over 6% year-on-year decline, I understand that it has been negatively impacted by the COVID outbreak in the quarter. However, if we look at Q2 and Q3 last year, we had a similar or even higher same-store sales decline, but our margin trends were better back then. I'm just curious to get more color on the different dynamics behind, in particular our labor cost was up 4% year-on-year, which was higher than the magnet fuel off labor cost increase in Q1 last year, which was the worst time of the COVID outbreak. Apart from the weak inflation and sales deleverage, will you actually deleverage a bit more on other regions for us to better understand the lead, the dynamic we see behind labor cost increase. In addition, our occupancy and other cost ratio have also increased normally in normal times. It is always trending down and served as a big driver to our need and margins. So do we still see further room of line item in the future barring [indiscernible] decreases last year for your clients. Thank you.

Thank you, Chen Luo your question. I think let me try to address the question here. First of all, I think before, we go into line item, I want to really emphasize that leverage increase. We went in restaurant business so when sales come down, and it would have an impact on our labor cost and on our O&O. So I don't want any those understanding. I know we have been very well over it last couple of years. And last year was also some special situation obviously. So let me address that year on example, on the cost of labor, on the sales dynamic if you look back in, for example, in 2020, right. As we have mentioned at that time, we have a very strong, strong sales trading going into the Chinese New Year period in 2020. And the period before Chinese New Year and during Chinese New Year normally is a very important, very, very good trading season for us for both sales and profitability. So we have a benefit at that time for that first month okay. Because if you recall, the outbreak was way around trying to. But there is timing difference in terms of this quarter for example in the third quarter. The outbreak happened and impacted the full quarter at the beginning to the end. So we have this full quarter impact in the sales trading situation. So that's why when you have a very profitable quarter for example, especially for us which is July and August time period before they could go back to school, that's how trading would have an impact on the sales level. The other one is commodity prices obviously. This year, we have a couple of things that is going to impact us. One is, as we have…

Thank you for the helpful color and I also look forward to having a try on the pizza next time. [indiscernible].

And many other products will [indiscernible].

Right. Thank you Chen Luo.

Thank you, Andy.

Thank you.

Your next question comes from Anne Ling from Jefferies. Your line is open.

Thank you. Hi management team. Also questions regarding your acquisition, the Huangzhou Catering Group. Does that mean that you're now owning 73% of the company? So meaning that moving forward, you will consolidate that 700 stores in terms of sales and operating profit and then you take out you at the minority line? And so if this is the case, number one, is that would there be any exceptional gain on the revaluation of your KFC investment loss of the subsidiaries in the 4Q. Second question as I like to know how should we be expecting in terms of the sales and-or the operating profit impact is it, I mean, be in Huangzhou sales will still possibly will be higher and what would be the profitability impact like? And the minor question is regarding if it is solely an associate, then I'm not sure my populations. So it seems that third quarter, it was a loss of 6 million. So I'm not sure whether it is related to the Huangzhou business or it is something else. Thank you.

Sorry, Anne. Like the last part, I didn't get it like what was a $6 million.

Oh, the 6 million a loss is the associated equity contribution the -- load operating profit line. So it's the equity contribution from your investment and in the cash flow in your...

So I didn't quite understand the question, so we may have to take that question offline, but I will try to address the first questions. I think first of all, like we did not acquire Huangzhou catering. We invest 25%, 28% in Hangzhou catering. So we have a 28% stake in that company, not acquisition of that company. The other part is that because of that and also because of some of other top of arrangement, so now we actually have no basically control of Huangzhou JV and so. So now, we will consolidate that and you're correct, similar to prior validation of our JV [indiscernible], generally, we would have a commercial and gain because obviously, it was a very successful JV. Right. So, but it is just kind of complicated accounting if we have two business combination. Right. So on the US GAAP, even though you're only acquire a portion of the stake, you're generally treated as a combination of business and then they'll treat you as a whole, what the gain of your entire or your portion of that. So it's not just the proportion to the interest that you have higher but the overall company. And so that's why normally, you would see this this proportionate measurement gain. And then eventually, it will flow into balance sheet because obviously, it is based on the allocation and so generally with the increase in goodwill as well as intangible. So and that office is similar to our treatment of that in Suzhou. And so, if you want more detail, I will refer you to our filing, that you and the 10-Q and 8-K payment, they will have more detailed explanation and technical information, kind of treatment of such a combination.

And just to be very clear, we have originally minority control of our handle joint venture of KFC with the additional 28% investment into Huangzhou catering, we will, Yum China will control and consolidate our Huangzhou KFC with approximately 60% equity interest directly and indirectly.

That's right. And yes, so, and then in terms of the impact, obviously, it will not impact themselves. It would probably increase that result, but in terms of the possibility or increase that we still assessing it, because as we mentioned, there will be some, amortization coming from this and then also the measurement of the franchise right is a lot complicated. So, we still assessing it, but we similar to as we mentioned to the impact of consolidation, like accounting impact with similar to that of Suzhou, but the offer is not as straightforward as immediately, the activity.

Okay, okay, got it. Got it. Thank you very much.

Presenters there are no further questions at this time.

Thank you for joining the call today and we look forward to speaking with you on the next earnings call. Have a great day.

Thank you, all.

Thank you, everyone.