Yum China Holdings, Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to Yum China’s 2020 Third Quarter Earnings Conference Call. At this time, all participants will be in a listen-only mode. There will be a presentation, followed by a question-and-answer session. I must advise you that this conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Debbie Ding. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining Yum China's third quarter 2020 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 presentation contains 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 statement in our earnings release and the risk factors included in our filings with the SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of the non-GAAP and GAAP measure is included in our earnings release. Today's call includes three sections. First, Joey will provide an update regarding recent developments, then she will offer some highlights around our quarterly results. Andy will then cover the financial results and provide an update on our full-year outlook. Finally, we will open the call to questions. You can find the webcast of this call and a 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, Debbie. Hello, everyone, and thank you for joining us today. As I reflect on this challenging period, I want to thank our employees, our customers, our partners, and our shareholders for your continued trust in Yum China. Resilience is only proven when tested, and we certainly will be tested. Following two challenging quarters, we delivered system sales growth for the third quarter. This is the result of the tireless dedication of our staff and partners, working to safely provide good food, great value, and convenience for our customers across our 10,000 plus stores. Helping us stay true throughout the COVID pandemic, we held to our key operating disciplines: food safety, employee care, and customer focus. In the over 1,400 cities we operate, we provide employment, career progression, and a commitment to improving our local communities. We stay true to our culture of innovation, building on our leadership in digital and delivery. All these factors contribute to the resilience of Yum China. We achieved much in 2020, despite the COVID challenges. First, we opened our 10,000th store this quarter, marking a significant milestone. Second, our brand demonstrated innovation and execution excellence, capturing the shift to off-premise dining early. KFC and Pizza Hut pioneered contactless delivery in late January. We engaged with over 20,000 companies regarding corporate delivery, tapping into a new segment of customers. Pizza Hut celebrated its 30th anniversary by driving menu innovation and improving its takeaway and individual set offering. Third, we formed a joint venture with Lavazza and opened the first flagship coffee shop in Asia, continuing our journey to explore the Chinese coffee market. Fourth, we completed the acquisition of Huang Ji Huang and formed a Chinese dining business unit to tap into the massive Chinese cuisine market opportunity. Last but not least, we were listed on the Hong Kong Stock Exchange in September, becoming the first Delaware incorporated company to list on both NYSE and Hong Kong Exchange. This listing in one of the most vibrant trading markets in Asia brings investors closer to our consumers and partners. At the same time, we maintain our strong corporate governance and discipline. The Yum China of the future will have a much larger footprint across China. Stores will remain new or freshly remodeled. We will continue to serve innovative food across day parts and occasions. Our portfolio of brands, built organically and through a disciplined M&A process, will target strong growth segments. This will be supported by key infrastructure, whether in supply chain logistics or digital marketing. We are committed to investing in this future—a future of market leadership enabled by growing stores, growth in our portfolio, and growth in digital and membership capabilities. Let me elaborate on each of these growth initiatives. Firstly, store growth. It took us over 15 years to open the first 1,000 stores. In the last four quarters, we opened over 1,000 stores as well. We have the capability and infrastructure improvement store models to build profitable new stores at scale. Importantly, as delivery and takeaway become more popular, we are adapting our new stores to smaller sizes and lower capital expenditures. Increasing store density gets us closer to our customers, serving them faster and better while capturing incremental sales and profits. We are piloting store models tailored for lower-tier cities to penetrate new markets with greater flexibility and efficiency. Localized menus, store layouts, and operating models enable us to serve a more value-conscious customer. China is a large, diverse market with regional differences, economic environment, and policy. We will adopt region-specific strategies to create the flexibility needed to pursue saturated growth trends regionally. Multiple channels, different models, and regional strategies are crucial to expansion, enabling us to develop a strong franchisee network. Market leadership will also require investments in our infrastructure, from more logistics centers to IT solutions. We will need to strategically deploy capital for both offline and online assets, future-proofing our leadership as we build the next 10,000 stores. Secondly, portfolio growth—we are proud to welcome the Huang Ji Huang and Lavazza brands to our Yum China family this year. In addition to our core western dining brands, Chinese dining and coffee represent exciting new segments for growth. Over the past few months, we have found opportunities to collaborate between our Little Sheep and Huang Ji Huang brands in the areas of franchisee environment, seasoning distribution, and supply chain. Huang Ji Huang franchise partners are already leveraging Yum China’s strong delivery capabilities to improve store economics, and we are excited for further synergies. Similarly, leveraging our COFFii & JOY experience, our partnership with Lavazza has seen early success. The three Lavazza stores in Shanghai are receiving great customer feedback. Yum China's capabilities in digital data and delivery are creating an ecosystem for consumers and will drive growth across our portfolio of brands. The third growth initiative is in digital and membership. Last quarter, we shared some of our thinking around digital memberships and their importance as a growth driver. We will invest in creating a customer-centric digital marketing platform. Additionally, end-to-end digitization and the application of AI technologies will enhance tools from farm to fork. Our goal is to track, analyze, and automate across our value chain, from the receipt of goods to real-time control of inventories and operations. Investments in digitalization empower us to improve operational efficiency and drive customer satisfaction. Crucially, this will give us the confidence to work with our franchisee partners and reach further into more remote areas. Strong digital and membership programs create synergies within our portfolio of brands. This improves unit economics, in turn driving store growth. All of these growth initiatives are interdependent. Investments across all three are necessary to build on our leadership and agility. Now, a few observations from this quarter: KFC sales demonstrated improvements in the third quarter, supported by our value campaigns and digital initiatives. Domestic tourist and transportation hub volumes slowly recovered, but international travel and tourism are still weak. Pizza Hut continued to make great progress with new offerings, fresh restaurants, and strong execution capability. Pizza Hut recovered sales to 93% of the prior year period. Our actions across the pillars of revitalization continue to bear fruit, as ticket average improved sequentially. Restaurant margins improved by over five percentage points and operating profit grew 59% year-over-year in constant currency. Value for money is important to consumers during this difficult period. Across our brands, we ensured a strong value proposition; KFC extended Crazy Thursdays to Wednesdays and Fridays. Pizza Hut brought back its hugely popular all-you-can-eat program in September. Apart from great value, our innovative products attract customers. At the national level, we launched the Durian Chicken Burger at KFC and a Chinese-style braised beef pizza, Dongpo new row, at Pizza Hut. We also identified regional flavors in Latin markets, such as Wuhan Hot-Dry Noodles, Wuhan Re Gan Mian, and late-night delivery of seasoned spicy crayfish and seasoned nacho chips. Delivery drove strong growth across our entire portfolio, accounting for approximately 28% of sales in the third quarter. We continued improving our takeaway menu and offerings to complement delivery. Together, off-premise menu accounted for over 55% of sales at KFC and 40% of Pizza Hut. Digital orders were 78% of sales, approaching pre-COVID levels. Cumulative digital members grew to over 285 million. During the quarter, we sold 19 million privilege memberships at KFC and Pizza Hut covering multiple categories. Besides the signature delivery and family privileges, we sold over eight million Chicken Lovers memberships during the summer holidays. This paid membership tripled frequency and sales per member during the subscription period. We generated meaningful progress in this quarter. Despite the pressure from sales deleveraging, our $320 million of operating profit, excluding special items, was the result of the strong efficiency improvements we have made. As we look forward to the end of the year and into 2021, we remain cautiously optimistic. We must continue to be vigilant and agile. I need to remind our stakeholders that China is a large, diverse market, and regions will experience varying levels of COVID impact until new vaccines are developed. The recovery will continue to be non-linear and uneven, so we are well positioned to navigate these uncertain times. With that, I’ll hand over the call to our CFO, Andy Yeung. Andy?

Thank you, Joey. And hello, everyone. I will first address key financials and developments in the third quarter, then provide some color on our outlook. Unless noted otherwise, figures mentioned refer to the third quarter of 2020. All percentage changes are before the effects of foreign exchange. Revenue was flat year-over-year, with same-store sales recovering to 94% of the prior year period. All brands saw sequential improvement in sales. This is a testament to the hard work and dedication of our employees to drive topline in a challenging environment. KFC’s same-store sales recovered to 94% of the prior year period, compared to 90% in the second quarter and 89% in the first quarter. Improvements were largely driven by effective value promotion and digital initiatives. Same-store traffic recovered to 90% from 80% in the second quarter. Our transportation and tourist hub sales improved but still remain under pressure. Pizza Hut's same-store sales recovered to 93% of the prior year period, compared to 88% in the second quarter and 69% in the first quarter. Value campaigns, all-you-can-eat, and membership initiatives were effective in driving traffic and ticket average. Overall, dine-in volume recovered to over 80%, driving higher yield for our core brands. Strong contributions from delivery and takeaway continued, with over 50% of our sales being off-premise. The consolidation of Huang Ji Huang contributed 3% to total system sales in the quarter. Together with the consolidation of Suzhou KFC, the contribution to total revenues was 2%. We opened 312 stores—new builds accelerated as our development team secured favorable locations with more flexible store formats, also helping expansion. Despite the same-store sales decline, restaurant margins were 18.6%, up 0.9% compared to last year. Sales deleveraging was more than offset by our aggressive efforts to control costs and improve operational efficiencies. Cost of sales was 31.2%, almost flat year-over-year. This was largely driven by a 1.7% reductions at Pizza Hut as they lacked aggressive promotion year-over-year. KFC experienced a 0.7% increase in cost of sales. The impact of more aggressive promotions and value campaigns to drive store traffic and sales was partially offset by commodity inflation of 1% at KFC. We worked closely with our major poultry suppliers to take advantage of a more benign inflation environment. The cost of labor was 21.6%, almost flat year-over-year. Rate inflation was 3%. It was subdued in many of our markets as government-mandated minimum wage increases varied. Labor productivity improvements have largely offset the impact of wage inflation and increases in delivery write-off costs. We intend to increase staffing levels in coming months to balance service and efficiency. Compared to $40 million in the first quarter and $50 million in the second quarter, we received approximately $10 million in rent reductions and government relief; however, we expect this to phase out. G&A expenses increased by 6%, mainly due to a lapping of prior year's government incentives and the impact of consolidating G&A expenses at Huang Ji Huang and Suzhou KFC. Excluding the impact of consolidation, year-to-date G&A expenses decreased by 1% year-on-year. We achieved an operating profit of $556 million, including a re-measurement gain of our existing equity stake in Suzhou KFC of approximately $239 million. Excluding special items such as re-measurement gains, adjusted operating profit was $320 million, representing a year-over-year growth of 5%. Our effective tax rate was 25.6%. Net income was $439 million, and adjusted net income was $263 million. If we exclude a $29 million net investment gain in Meituan, it would be $234 million, up 8% year-on-year. Diluted EPS was $1.10, and adjusted, diluted EPS was $0.66. I would like to touch on our capital allocation strategy. Following a capital review of our financial position, we will resume our cash dividends at $0.12 in the fourth quarter. Our capital allocation focuses on driving long-term growth for Yum China while providing adequate liquidity to navigate any sudden disruption to our business. With the capital raised in our secondary listing in Hong Kong, we will focus on: first, accelerating new builds and maintaining store remodeling costs for the Yum China portfolio; second, stepping up investment in our digital, logistics, and delivery infrastructures to support and drive growth; third, maintaining a disciplined approach to M&A and investment while exploring opportunities to invest in brands with excellent growth opportunities, new capacities, and technologies. As this year has shown, having sufficient liquidity is paramount to operate in an uncertain environment. Our strong balance sheet provides us the capacity to deal with potential contingencies while allowing us to make targeted investments to drive growth and capture market opportunities. We believe this approach to capital planning will drive long-term shareholder returns. In terms of outlook, as we look ahead to the fourth quarter, we are encouraged by sequential quality improvement. However, we must be mindful that the pandemic is not over yet. The remaining journey to recovery is going to be challenging. We expect our store traffic and sales to continue to be impacted by: first, the lingering effects of COVID-19 on consumer behavior; second, transportation and tourist volumes, while recovering, continue to be heavily impacted; third, additional precautionary measures that consumers and/or companies may take as we enter the colder months and as flu season approaches. At the same time, we also expect margins to be impacted by sales deleveraging and a continued focus on value campaigns to drive store traffic, factoring in increased staffing levels to balance services and efficiencies. It’s important to note that the fourth quarter is seasonally the lowest quarter for sales but also the biggest quarter for store remodeling. Small changes in operating results or investments can have a significant percentage impact on operating profit. In terms of inflation outlook for 2020, we now expect wage inflation to be low to mid-single digits, commodity inflation to be flat to low single digits driven by lower quoted prices. In terms of store openings, including Huang Ji Huang, we now target to open more than 900 new stores. As a reminder, following our secondary listing, we ended the third quarter with 419 million shares outstanding. As for 2021, we are operating under the new normal of reduced travel and social activity. Sales momentum will continue to be impacted until the pandemic is over; with the balance of COVID-related disruptions, the market will likely experience varying performance. In October, there were regional outbreaks in Qingdao and Western China, which we started testing millions of people. This is a good reminder that recovery will be non-linear and uneven. We continue to face cost pressures on multiple fronts; as part of our commitment to the environment, we will begin to phase out the use of plastic packaging. This is expected to materially increase our cost of sales. Rate increases have mostly been deferred or delayed in 2020. We expect these to catch up. We will also step up investment to build out our digital logistics and delivery infrastructure; accelerating these investments is critical for maintaining our market leadership. With additional infrastructure, solid execution, and a strong balance sheet, we are prepared to capture opportunities while recovering and growing. We will provide additional details on specific 2021 targets with our Q4 earnings release in early 2021. With that, I will pass you back to Debbie to start the Q&A. Debbie?

Thanks, Andy. We’ll now open the floor to polling questions. In order to get as many people as possible the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A.

Thank you so much. Ladies and gentlemen, we will now begin the question-and-answer session. And our first question comes from the line of Sijie Lin from CICC. Your line is now open.

Hi management, thank you for taking my questions, and congratulations on the good performance. So, I can ask one question, right? My question is about Pizza Hut; because for Q3, we see that the near 17% restaurant margin is really a high level even through its history. So could we know more about what happened behind this and is it sustainable looking forward? Thank you.

Thanks. This is Andy. So I will address your question regarding margins at Pizza Hut. I think overall margins, if you look at the overall margin for the quarter, we do have strong performance on both KFC and Pizza Hut. Overall, if you look at Pizza Hut, for example, certainly we still impacted by healthy leveraging, roughly more than 2%. For inflations, we do see continuing commodity pressures—pricing pressures—for the cost of goods, but that’s more than offset by the labor productivity improvement. Now, if we look at each class items, if we look at, for example, cost of sales, we see that these improvements dropped by almost a quarter, like 1.7%. The main part of that is commodity inflation that’s offset by lower promotions from last year. Now, for cost of labor, we see about a 1.4% improvement despite sales leveraging wage inflation; we see that labor productivity gains offset as I mentioned on the prepared remarks, accentuated by a shortage of part-time workers in the quarter. And we also benefited a little bit from the lower social insurance contributions. The significant improvement here is actually on what we call O&O, and that has a lot to do with the number of part initiatives at the restaurant level, including utilities and maintenance costs.

Okay. Thank you, Andy.

Thank you so much. And your next question comes from the line of Brian Bittner from Oppenheimer. Brian, your line is now open.

Thank you, and congratulations on navigating this environment. Your unit growth outlook for 2020 continues to be very strong despite the pandemic. Are you able to give us a look into the pipeline for 2021 or give us any color on how you’re starting to think about the unit growth opportunity in 2021?

Hi Brian, this is Andy. So I would give you some color, and then Joey may want to feel free to jump in later. I think as we mentioned at the beginning of the year, in the first half of this year, we suddenly had little impact from COVID-19 on the opening of our stores. As we have mentioned in our prior earnings call, our development teams have a lot of projects in the pipeline at the time; however, due to the pandemic, there was some delay in infrastructure, as stores were limited from March to April. So they have been trying to catch up, and they have done a pretty good job this quarter. That’s why we are confident that we can meet the target and raise the guidance from 800 to 850 stores to now more than 900 stores. As we have mentioned, our next milestone would be another 10,000 stores. It took us quite a while to get to the first 10,000. We believe that we will do it much faster this time around. In terms of the pipeline for 2021, we are now in the planning process; it’s too early to provide you that information, but we will give more details during our planning. However, if you look at our current situation right now, we do think that we still have a lot of opportunities in China to grow our store network. If you look at the number of cities that we are currently in, a little bit more than 1,400 for KFC and about 800 plus for Pizza Hut, we feel there are probably close to 500 to 600 or more cities that we can penetrate in the future. There are many opportunities within existing markets for increasing penetration in top-tier cities, as well as in lower-tier cities. I think there’s a lot of opportunities as well. If you look at the small density compared to North America and other Asian countries, our small density is still quite below the norm. So I think the shift towards smaller store formats and catering more to delivery and takeaway will provide us with opportunities for increasing penetration.

Thank you, Andy. Brian, I would just try to add three comments to your question. One is, we always emphasize the quality of stores. We will be aggressive and open-minded about new stores, if we see the opportunity to open good, profitable stores or at least breaking-even stores. That’s the bottom line. We hold very closely to our commitment to that bottom line, and we will open them as we find them. Second, as Andy mentioned earlier, we are targeting smaller stores for Tier 1 and Tier 2 cities to adjust our store portfolio strategy because of the growth of delivery and takeaway, as well as to manage rent and other costs. Our model is quite efficient to fill the gap of the needs in these areas. For lower-tier cities, we have been working on our lower-tier city store models. This year, we have achieved further breakthroughs in our models. Not only has our cost for the lower-tier city model decreased, but we have also modified our menus for those locations. To give you an example, we have opened a few such stores this year featuring a lunch combo priced at RMB 15 (a bit more than $2), while our normal combo in Tier 1 and Tier 2 cities typically ranges from RMB 30 to 35. We are not going to sell the same products at such large price gaps. We aim to tailor our offerings for the lower-tier cities. Point three, regarding Pizza Hut, we have discussed our satellite store models since last year, and we’ve been working on that. Essentially, these satellite stores represent a significant reduction in CapEx compared to traditional models. For example, we’ve reduced the kitchen size from 140 square meters to about half of that. The menu style has also been adapted accordingly. This year, we plan to have over 20 satellite stores, and I am happy to report that the initial results are encouraging. We are pleased with the outcomes so far for both satellite stores for Pizza Hut and our lower-tier city stores for KFC.

Thank you, Joey. Thank you, Andy.

Thank you so much. And your next question comes from the line of Linda Huang from Macquarie. Linda, your line is now open.

Hi management. I have one question regarding store expansion. Because I noticed that the payback period, especially for Pizza Hut, slightly increased. Before, I think the payback period was three to four years, but right now it's around five years. So I just want to know whether we will continue to expand our stores in the future and if we need to worry about operational efficiency issues. Can you also share with us about Huang Ji Huang’s payback period? Thank you.

Hi, Linda. So let me address the question you asked, and then I will get back to the question on payback periods. For Huang Ji Huang, it’s primarily a franchise model with a large majority of stores being franchised, so the payback period is not very meaningful for us, especially since we can't control that directly. However, franchisees do seem quite happy with that payback. In terms of the payback period for Pizza Hut, I think because of COVID-19, the way we calculate payback has been affected. During Q1 and Q2, we experienced impacts that extended the payback period a bit, but we are still confident in the overall trend for Pizza Hut's payback period, particularly with innovations related to satellite stores. We are pleased with what we are seeing right now with Pizza Hut.

In summary, Linda, I want to remind everyone that the payback period is a rolling number and reflects the recent months that have been impacted by COVID-19. Despite that, overall, we see recovery in our sales, with same-store sales growth back to 94% for KFC and 93% for Pizza Hut. Although the payback period has been affected, we have not seen a material change in how stores are performing.

Okay. Got it. Thank you.

Thank you so much. And your next question comes from the line of Xiaopo Wei from Citi Group. Your line is now open.

Good morning, Joey and Andy. Congratulations again for the strong recovery in the fourth quarter. So, we are now in the fourth quarter, which is a low season. I am more interested in the upcoming 1Q next year, which is a peak season. In my view, Joey and your team have to face tougher choices next year in the first quarter because, on one hand, you have to be more proactive in terms of recovering sales further. On the other hand, you have to hedge against any risks of disruption due to any resurgence of COVID cases. How could you balance the two with your strategy and operation in terms of innovations, value campaigns, delivery, and menu offerings, etc. Thank you.

Thank you, Xiaopo. That’s a good way to put it. In fact, that’s exactly our approach for this particular year since generally the happening of COVID-19. How are we going to do that for 2021? It’s not going to be too different in terms of the general approach. We will be prepared, we’ll be agile, we’ll be flexible, and we’ll be cautious, but we’ll also be optimistic. Looking at particularly Q3, all of our brands improved in terms of same-store sales growth, continuing to recover. However, we are still focusing on strong value campaigns to drive traffic for both KFC and Pizza Hut. At the same time, we are fully aware of the lingering effects of outbreaks and have reminded our investors and analysts about the uncertainties of COVID-19. We have to address this reality. Yet, we still need to focus on the core pillars of our business; we must ensure each pillar is strong, agile, and flexible, which puts us in a good position to manage all the challenges and still innovate for our shareholders, customers, and employees. Recapping what has occurred so far for KFC and Pizza Hut this year, as I mentioned earlier, we focused on value promotions, introduction of new products, and strengthening our membership programs. Throughout the COVID-19 tough times, even when we could not advertise very effectively, we leaned on our membership base to launch new product campaigns as well. Delivery has proven to be a resilient business as it continues to see double-digit growth. Tourist traffic is still being challenged; sales remain below pre-pandemic levels, which is about 20% less. We are continuously working on this as well. We also note regional differences, which means regional opportunities; Eastern China is performing better than Northern China, and lower-tier cities are doing better than higher-tier cities. The recovery patterns on weekends and weekdays have shifted. In the past, we were doing a bit more promotions on weekdays; now we see the weekend traffic is stable and vibrant. We are also adjusting our marketing strategies accordingly. Despite the challenges posed by COVID-19, we have maintained our promise of prioritizing sales first and profit later. We have seen significant progress in menu innovations, particularly in improving perceptions of value as we expand our takeaway channels. Overall, we have demonstrated our resilience through 2020, and I want to believe we will continue to do so in 2021.

Great. Thanks, Joey.

Thank you so much. And your next question comes from the line of Chen Luo from Bank of America. Your line is now open.

Thank you, Joey and Andy, and also congratulations again on the strong Q3 results. So, I have a question on Pizza Hut, which actually offers quite a big surprise for Q3. Typically in the past, same-store sales growth for Pizza Hut should be weaker than KFC, but at this time, Pizza Hut was quite close to that of KFC. The pace of Pizza Hut's recovery also seems to be faster. What’s the reason behind that? Is it because of all the measures that we have taken to revitalize Pizza Hut, or is it also partly due to the assumption that casual dining in China is recovering faster for the industry as a whole? Additionally, regarding margin, how do we reconcile the higher food and paper costs alongside the encouraging same-store growth trends for Pizza Hut in Q3?

Let me address the sales recovery side, and then Andy can provide insights on margin. I agree with your assessment that Pizza Hut's recovery reflects overall market conditions, and that’s what we believe. We’ve been timely in making adjustments; since 2019, we focused on revitalizing traffic, which is critical for our growth. Pizza Hut’s traffic had seen notably positive dynamics since 2019. Last year, we revamped 50% of our menu and improved our delivery system. Combined with strong value messages and maintaining price stability, we successfully attracted customers back. As our innovative concepts evolve, especially during the pandemic, this has triggered further developments. While customer trust in our brand and food quality remained, we adapted quickly to meet market demands—especially with takeout options. Overall, our revitalization measures across Pizza Hut have contributed positively to our performance. Now, I will pass it over to Andy for insights on margins.

Sure, thanks, Joey. I want to put things in perspective first. KFC has improved significantly in SSG, from about 90 last quarter to 94 this quarter. Similarly, Pizza Hut’s SSG showed progress from 88 to 93. Both brands are recovering well, despite challenges still present. It's important to keep in mind that as we approach a full recovery, some official and temporary impacts are likely. On the margins for Pizza Hut, we were able to maintain a healthy margin that reflects our focus on operational initiatives, including addressing the cost of goods sold and labor. We experienced some commodity pressures on total sales, but fortunately, we also benefited from cost-saving initiatives, including specific promotions. During the early part of this quarter, we were still contending with impacts stemming from prior outbreaks. Now, we are quite satisfied with the ongoing upward trajectory across both brands.

Yes. Thanks a lot, Joey, Andy, and congratulations again.

Thank you so much. And your next question comes from the line of Lillian Lou from Morgan Stanley. Your line is now open.

Thank you, Joey and Andy, and congratulations again. So I think my question on margin is well answered by Andy personally. So I think my next question is more on the development of Chinese cuisine. I know that the fast expansion of units partially comes from Huang Ji Huang, but I want to check what’s the longer-term strategy behind the development of this newly set-up division.

Hi, Lillian. This is Andy. Let me address your question about the Chinese cuisine business. We think that the Chinese cuisine market is very influential; it holds the largest share for out-of-home dining in China, presenting abundant opportunities. With the consolidation of Huang Ji Huang and our existing leadership, we are forming the Chinese cuisine business this year, led by Ben Lee, who has been responsible for the turnaround at Little Sheep. Our objective in this division is to leverage Yum China’s scale, supply chain, and franchises, establishing partnerships with delivery service aggregators that offer us preferential rates. Additionally, we are looking to infuse innovation into our offerings; for instance, we’re enhancing our menu selections while expanding flavors and concepts. Our ambition is to launch auxiliary products, like significant breakthroughs in sauces and seasonings, as these areas are gaining traction. We plan to integrate operations and refine the synergies between Huang Ji Huang and our existing brands. Overall, we are eager to expand our footprint in Chinese dining as we look ahead.

Thanks a lot, Andy.

Thank you so much. And your next question comes from the line of Michelle Cheng from Goldman Sachs. Michelle, your line is now open.

Hi, Joey and Andy. Congrats on the good result again. I just want to ask if you can share some color about the recent trends. I think earlier you mentioned that transportation hubs are around 20% below the normal level. So I’m trying to understand whether we are seeing more significant improvement in October, as we've seen relatively positive data points from other retailers and restaurants. Thank you.

Hi, Michelle. Regarding trends I mentioned earlier, we have observed improvements in KFC's core performance, as I highlighted previously. Delivery is continuing to grow, although regional differences persist. We note the transportation hubs and tourist locations still sit below pre-pandemic levels, marked at approximately 20% less. Even during holidays, international traffic remains limited due to the ongoing COVID-19 situation. We advise caution regarding post-holiday trading, as it can be challenging due to consumer sentiment. When customers are concerned about economic conditions, weekend days may see better trading; however, after holidays, there could be a noticeable dip in sentiments. Nevertheless, the broader outlook in China remains positive and life is returning to normal compared to other regions. We appreciate that ongoing recovery thus far continues to progress.

Thank you, Joey.

Thank you so much. And your next question comes from the line of Christine Peng from UBS. Your line is now open.

Thank you, Joey, Andy, for the very detailed explanation of the results, as well as a very positive outlook. I have a separate question that might not be related to the quarterly results. Joey, I want to get your thoughts on the launch of COFFii & JOY, which is a packaged food brand throughout China, starting from KFC retail units. Can you share with us the long-term vision for this business initiative? If you can provide us with more insights in terms of branding, pricing, distribution strategies, that would be much appreciated. Thank you.

Thank you, Christine. The initiative for retail is largely driven by opportunities identified through COVID-19. More consumers are expected to engage in home consumption, prompting additional insights. During COVID-19, we swiftly launched products like the prepare-at-home steak, which was well-received. We've had many offerings related to how consumers can enjoy KFC at home. We’re utilizing our innovative product teams to create delicious items such as chicken soup and rice noodles from the southern region of China. We test these products mainly in top-tier cities due to demand, and we are excited as the results show promise. We are tapping into various e-commerce channels, as well as KFC stores, facilitating integrated distribution, leveraging both the online and offline networks. Through our infrastructure, we've begun rolling out COFFii & JOY as a way to cater to consumers' needs while playing upon the connection they already have with the KFC brand. We regard this as a wise move to explore new avenues for growth amidst the changing food retail landscape, and we believe there are more opportunities here.

Thank you, Joey.

Thank you so much. Your last question comes from the line of Anne Ling from Jefferies. Anne, your line is now open.

Hi management team. Thank you for taking my question. One minor point, regarding the management mention earlier that in the third quarter delivery business one of the key drivers has been the corporate delivery. May I know, is this corporate delivery mainly from KFC, or is it also for Pizza Hut? What is the growth potential in this area? How much of the delivery sales have actually come from this corporate delivery? And I understand that we also started to launch delivery to parks and other initiatives. So I just wanted to see the new growth strategies for the delivery side. Thanks.

Thank you. For corporate delivery, we have developed a robust system, which we began targeting early last year, with the ambition to provide food to professional organizations. During the pandemic, we delivered over 107,000 free meals to many hospitals and community centers across 28 provinces. This effort and our readiness during the post-recovery period garnered us a strong reputation for corporate delivery, so many prefer us when making purchasing choices. We have continued to grow our connections with over 20,000 companies, and as of now, we don't need to hire a new sales team to manage this area, which expands our potential without increasing costs. The delivery under this initiative is small volume wise, accounting for only about 6%, but it is meaningful in the stores that support corporate partnerships. We’re also experimenting new models like delivery to parks and are keen on innovating to ensure convenience for our consumers. With our strong infrastructure, we definitely see growth potential, and we will continue to prioritize excellent service and great food for everyone.

Thank you.

Thank you so much. There are no further questions at this time. Speakers, you may continue.

Thank you very much.

Thank you for joining the call today. We look forward to speaking with you on the next earnings call. This concludes today's call. Have a great day.

Thank you, everyone.

Thank you.

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