Yum China Holdings, Inc. Q2 FY2022 Earnings Call

Thank you all for standing by, and welcome to the Yum China Second Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. Please follow the operator's instructions. I'd now like to hand the conference over to Michelle Shen. Please go ahead.

Thank you, Melany. Hello, everyone and thank you for joining Yum China's second quarter 2022 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. We are dialing in from different locations today. If we experience a technical difficulty during the call, please remain on the line as we reconnect. 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 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 non-GAAP and GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding our performance in the second quarter. Andy will then cover the financial performance and outlook in greater detail. 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, Michelle. Hello everyone and thank you for joining us today. The second quarter was the most difficult quarter in the past two and a half years, with our main focus always on keeping our employees and customers safe. We also want to bring joy to our customers. We kept our morale high and came together to deliver better than expected results. I'm both glad and honored to fight the battle alongside a wonderful Yum China team. We operated with our Shanghai headquarters under lockdown for over two months and still managed to execute with extraordinary agility, quickly forming cross-functional, and cross-brand crisis management teams while we developed flexible strategies to tackle each problem as they arose. Through it all, we have stood firm and built the business stronger in so many ways. With innovative new menu offerings, delivery and digital solutions, as well as cost optimization initiatives, these solve not just the imminent problems but can serve as our learning foundation to make us more agile and resilient for the longer term. During this trying time, we continued to execute our RGM strategic framework that is resiliency, growth, and moat. Let's start with resiliency. Our resiliency shines brightest in tough situations. Let me share with you some of the measures we implemented to overcome considerable operational difficulties. During the city lockdown in Shanghai with very limited restaurant staff and riders, our goal was to sustain a minimum level of restaurant operations and serve desired food to customers. With simplified menus, we reduced the complexity of operations and inventory management. At the extreme, we just had one bucket of fried chicken on the menu, one item on the menu, and that's it. Fried chicken was perhaps one of the most desired food items in Shanghai during the lockdown and brought our customers great happiness. We launched community purchasing as early as mid-March, including packaged food products, not just for KFC and Pizza Hut but also for emerging brands like Lavazza, Taco Bell, and Little Sheep. In the Q1 earning call, I shared that with 10% to 15% of the stores open in April, Shanghai achieved 40% to 50% of pre-lockdown sales. In May, with less than half of our stores open, we reached pre-lockdown sales levels. This was a remarkable achievement. We were able to continue serving our customers, thanks to our in-house, agile supply chain management system as well as dedicated last-mile delivery riders. We obtained the necessary permits and managed the majority of Shanghai under severe mobility restrictions. Digitization also played a critical role. In just a day's time, our stellar IT team launched an AI-enabled delivery route planning tool for community purchasing in Shanghai. The tool optimized the delivery route covering a wide geography well beyond our usual store base vicinity radius. Across the country, we always faced a challenging operating environment without advertising and promotions to save costs. Some of you may remember the Psyduck Koduck and other Pokémon meal companion toys we launched around Children's Day on June 1. The Psyduck toy instantly went viral, becoming a smash hit with children and adults alike. The sensational buzz from this campaign drove almost 20% of sales in the first two days of the promotion. Who would have thought that we chose Psyduck just to accommodate our reduced advertising budget? The results were phenomenal. We were thrilled to bring joy to our customers' lives during an exceptionally hard time and to see their social media posts. We also focused on driving off-premise sales. Delivery grew 7% year-over-year and reached a record sales mix of 38% in the second quarter. Combined with take-away, off-premise sales contributed to almost two-thirds of total sales. Also excitingly, our new retail package sales reached ¥200 million in the second quarter, which is more than double the sales compared to last year. These initiatives partially offset the reduced dining services. Let's move on to growth. Even in conditions like this, we don't stop delighting our customers with innovative food and value campaigns. Our ability to innovate is an important pillar to capture growth opportunities. KFC diversified into adjacent categories to drive additional growth. With Wagyu and Angus beef burgers, as premium options we launched entry price choices at only around half of the price, which is ¥18 versus ¥33. On the weekend, we are now offering juicy whole chicken at ¥29.9 to drive sales. This juicy whole chicken is one of my personal favorites now and it's absolutely delicious. These two new categories have proven popular, accounting for mid-single digits of menu mix combined in June. Our Food Innovation Team let their creativity shine when designing new products. As you can see we launched a super abundant chicken bucket in select cities. This bucket features chicken feet, chicken wings, tips, neck and other parts traditionally favored by Chinese consumers. For some of the analysts who asked me before when we would start to sell chicken feet, we are officially selling chicken feet right now after 35 years. This follows on the heels of KFC’s launch last year of its super popular late-night snack chicken bone. In addition, the usage of all parts of the chicken provides intriguing variety to customers at a very good cost. These hot new menu offerings received amazing customer feedback and generated a boost in sales. We launched the campaign on social media and sponsored TV shows instead of using celebrities with just a third of the advertising costs. The menu achieved the same customer awareness as last year's menu. The new menu included 35 brand new or upgraded items such as stuffed crust pizza, with sausage, and meat floss real strong, while goose supreme pizza and deep-fried cereal prawn were also added to the menu. Yes, we put the cereal around a prawn, and it tastes wonderful. Taco Bell launched a rich burrito tailored with a lighter sauce and more vegetables for Chinese customers. It gained great popularity and appeal to more health-conscious customers. Value for money resonates well with customers under the current circumstances. As part of the 35th anniversary celebration in China, KFC offered its signature product at amazing prices. Original Recipe Chicken was priced at ¥19.87 and the family bucket at almost 60% off a la carte price. This campaign brought back fond memories and became a hit with customers. We rotate the offers weekly to have the flexibility to adjust according to market conditions in different regions and customer responses. Our iconic crazy first day value campaigns have won the hearts of our customers. Since we first launched it in 2018, we have been constantly spoiling our customers with very attractive offers. The campaign now inspires scores of creative social media posts. Thursdays also generate a significant sales uplift compared to regular weekdays and sometimes even weekends. At Pizza Hut, we pre-ordered all 400,000 buffet set in just 15 days with our signature buffets. We also launched a buy-more-save-more combo, offering more abundant options. The new combo successfully lifted ticket averages while lowering our costs. Let's move on to moat. Digital initiatives and supply chain infrastructure are key enablers in our strategic moat. Leveraging our dynamic digital ecosystem, we generated around 4 billion in digital sales in the first half of 2022, representing 88% of ourselves. Our loyalty program exceeds 385 million members as of the end of the second quarter. We share the latest launches and engage with members through our super apps, mini program, and social media groups. We also constantly upgrade these tools to improve our customer service. KFC's super app now features a senior-friendly interface option with simpler graphics, less promotional information, pickup forms for mature users, and streamlined ordering functions. We tailored it to the needs of our older customers. Pizza Hut also upgraded their mobile ordering manual for more flexible buy-more-save-more combos and customized product displays. Our digital capabilities were crucial to streamlining restaurant efficiency. Tools like our restaurant sales forecasting system and pocket manager gave us full visibility of the situation in each store. With these, we can rapidly adapt to changing scenarios. Our real-time inventory visibility from logistics centers to stores helps enable us to dispatch raw materials with greater precision. Restaurants could adjust orders daily based on their operating environments and share inventories across stores when fulfilling community purchasing or other large orders. As part of our ongoing effort, delivery 3.0 allows riders to share across trade zones; we now offer the same flexibility to our restaurant staff. Staff can now schedule shifts across town and even across cities. We continue to invest in building a world-class intelligent and digitized supply chain to improve operating resiliency and support business growth. Our first two greenfield logistics centers in Chengdu are now complete and operational. A week ago, we announced the start of construction on our new Supply Chain Management Center in Shanghai. This project is our largest greenfield project yet and will serve as the headquarters for our 33 logistics centers across China. It will integrate the latest state-of-the-art digital technologies and support restaurants in eastern China. 2022 has indeed been extremely challenging. We learned many lessons and now emerge as a stronger and more resilient organization. And I'm not just saying this for KFC and Pizza Hut; some of our emerging brands have also demonstrated great agility and potential during the lockdown. I'm convinced that by executing our RGM framework, we are well-positioned for sustainable, long-term growth. True to our hallmark DNA of resiliency, we are taking every action to quickly drive returning traffic to our stores by providing good food, great value, and a good customer experience. Going forward, we will continue to delight our customers and seize new opportunities to grow our business in China. With that, I'll turn the call over to Andy.

Thank you, Joey. And hello, everyone. Let me share some details regarding our second-quarter performance. The COVID situation has significantly impacted our second-quarter results. In April and May, same-store sales declined by more than 20% year-over-year. On average, more than 2,500 stores were temporarily closed or provided only limited services. The situation gradually improved in June. We were able to capitalize on that improvement, with the same-store sales decline narrowing to high single digits year-over-year, and the number of temporary store closures also reduced. We achieved an operating profit of $81 million and a restaurant margin of 12% in the second quarter. We were able to generate meaningful profit in the quarter, which exceeded our expectations, not only by capturing sales when the COVID situations improved in June, but also by taking swift and decisive actions. We adjusted offers and promotions, spent tremendous efforts in driving productivity gains, and secured one-time releases to improve our cost structure. Let me go through the financials and our cost control initiatives. Unless otherwise stated, all percentage changes are before the effects of foreign exchange. Foreign exchange had a negative impact of approximately 3% in the quarter. Second quarter total revenue decreased 13% year-over-year in reported currency to $2.1 billion due to the same-store sales decline and temporary store closures. This was partially offset by the contribution of new units and the consolidation of Hangzhou KFC. System sales were down 16%, with same-store sales at 84% of prior year’s levels. By brand, KFC same-store sales were 84% of the prior year’s level, with same-store traffic at 75%. Ticket average grew 12%, mainly due to the increase in delivery mix and the higher ticket average of community purchasing orders. Pizza Hut’s same-store sales were 85% of the prior year’s level, and same-store traffic was at 80%, while the ticket average increased by 6%. This was driven by the higher ticket average of community purchasing. The restaurant margin was 12.1%, down 370 basis points compared to last year. This was mainly due to significant sales deleveraging, cost inflation, and high delivery costs. We took actions to mitigate the impact. Let me next go to each expense line and the actions we have taken. The cost of sales was 30.9%, almost flat year-over-year. We took firm actions to reduce promotional activities and discounts to keep commodity price increases to low single digits, and to optimize the distribution frequency from warehouse to store to reduce multiple costs. The cost of labor was 27.1%, 290 basis points higher than last year, mainly due to sales deleveraging, wage inflation of 5%, and more delivery rider costs resulting from a higher delivery mix. This was partially offset by improved labor productivity due to simplified promotions and menu items, reduced operating hours as necessary, and reduced hiring. Occupancy and other costs were 29.9%, 60 basis points higher than last year. The modest increase was mainly attributable to sales deleveraging and a rise in utility prices, which was partially offset by our cost initiatives. Over the past few years, we have spent considerable efforts to reduce the fixed component of our rental expenses, shifting them to more variable components. This effort has continued to improve the flexibility of our operations. In addition, we negotiated meaningful rent relief from some landlords. Apart from that, we cut back on marketing and advertising and took on more energy-saving initiatives. General & Administrative expenses increased 6% year-over-year, mainly due to increased compensation and benefit expenses, as well as the consolidation of Hangzhou KFC, which was partially offset by lower share-based compensation expenses. Operating profit was $81 million. The net contribution from Hangzhou KFC consolidation was roughly 3% of operating profit in the quarter, including the amortization of intangible assets acquired, which is roughly $60 million per quarter and will run through the end of this year. Below the operating profit line, we incurred a $60 million mark-to-market net gain on our equity investment this quarter, which was $9 million more than the same period last year. The effective tax rate was 26.5%, 170 basis points higher than last year, mainly due to the Hangzhou KFC consolidation and lower pre-tax income. Prior to consolidations, the equity income from JVs was not subject to tax, leading to a lower tax rate. The effective tax rate in the first half of this year was 30.4%, and we expect the full-year effective tax rate to be around the low 30s. Net income was $83 million, and diluted EPS was $0.20. The mark-to-market gain positively impacted our EPS by $0.04. Despite the challenges in the second quarter, we returned $218 million to shareholders in cash dividends and share repurchases. In total, we returned $0.5 billion to shareholders in the first half of this year. We will continue to execute on our disciplined and balanced capital allocation strategy. As always, our priorities are to maintain sufficient cash for daily operations, to deal with contingencies, and to invest in capital expenditures to drive organic growth. Now, let us take a look at the third quarter outlook. We saw some gradual improvement in restaurant traffic in June, yet we remain cautious on same-store sales. The external environment remains very challenging, given that we are currently experiencing COVID outbreaks, weakening consumer sentiment, downward economic pressures, and commodity price inflation. In July, the more infectious Omicron sub-variants appeared in Shanghai, Beijing, and other cities. Nationwide, the number of cases has increased again after two months of sequential decline. Many cities, including Xi'an, Chengdu, and Lanzhou, are experiencing some degree of lockdown following the dynamic zero-COVID policy. Therefore, we expect sales recovery to take time and to be nonlinear and uneven, potentially volatile. Our focus is to drive sales recovery. We have planned a variety of new product launches and marketing promotions. We are also working to ensure great value for money to attract consumer spending. In addition, our team employs extensive scenario planning with regional focus to stay agile in this ever-changing environment. We're delighted with the better-than-planned cost savings in the second quarter. As we look into the third quarter, we're tying back some of these austerity measures to sustain long-term growth and operational excellence. For example, reduced promotions, simplified menus, shortened store operating hours, and granting leaves are temporary. In addition, the sales deleveraging impact is real, and it will continue to affect our margins. Also, we continue to face headwinds from the inflationary environment, particularly for commodities such as cooking oil and beef, as well as utilities, which have significantly weakened this year. On the labor side, we expect labor inflation to soften given the downward economic pressure. However, the increased mix in delivery sales will likely increase labor costs. Despite the challenges we face, our expansion strategy positions us well for long-term growth. In the second quarter, we slowed store openings in response to the COVID outbreaks. Nevertheless, we remain committed to opening good offline stores that will drive growth for years to come. Over the past few years, we have been innovating store models to cater to different business needs, such as delivery and take-away services to enhance store densities in high-tier cities and to extend our reach into lower-tier cities. This year, we expect more than half of our new stores to be in smaller formats. We have lowered upfront investment and streamlined restaurant operations to become more efficient. The smaller format, along with our reputation as a reliable tenant, opens up more potential sites for new store openings. Our new stores remain healthy, with the latest batch of new stores achieving payback in two years for KFC and three years for Pizza Hut. The majority of stores opened in the first quarter of this year were able to achieve breakeven in just three months. The healthy payback period reassures us of a strong pipeline and healthy new store performance, and we maintain the target of 1,000 to 1,200 net new stores for this year. In the near term, we continue to expect volatility in our business due to the resurgence of COVID outbreaks and certain economic conditions impacting consumer sentiment. Nevertheless, we continue to focus on the elements of our business that we can control. As demonstrated in the past two and a half years, we are confident that our people, our execution, and our strategy position us well to deal with this very challenging environment, perhaps better than others. Also, our investment in new stores, supply chain, and digital will create global growth opportunities and make us even more resilient. With that, I will pass it back to Michelle to start the Q&A.

Thank you, Andy. We will now open the call for questions. In order to give more people the chance to ask questions, please limit your question to one at a time. Melany, please start the Q&A.

Thank you. Your first question comes from Lillian Lou with Morgan Stanley.

Thank you, Joey and Andy, and congratulations on the solid results. My question is mainly about the margin side since every cost line was managed better than expected. I want to understand how these cost lines will trend as more stores reopen and operate normally. Andy and Joey mentioned some temporary cost-saving measures, so will same-store sales growth continue to be negative? How should we project these cost changes, particularly on the margin side, year-over-year? Thank you.

Thank you, Lillian. Let me answer your question. I think, first of all, the second quarter margins and profit exceeded our expectations. I think to make it all possible is due to the incredible efforts and dedication of our team, especially our restaurant employees, who did everything humanly possible and endured a lot of hardships during the lockdown and the pandemic to continue serving customers in need while keeping our stores open and running as normal as possible. So I think those Herculean efforts, I don't believe is possible on a sustainable basis. Obviously, the performance was dependent on some improvement in June in terms of the COVID situation and our ability to capitalize on that improvement. Our same-store sales declined to high single digits in June. But in terms of cost factors, we mentioned already that some of these initiatives are temporary. For example, we have cut back quite significantly on marketing and promotional activity. As you know, we try to drive sales by employing promotional techniques. We also mentioned that, in terms of cost inflation in the first quarter was phenomenal, but if we look at the commodity prices, they are still at elevated levels, and we expect that to continue creeping up. In terms of labor, we simplified menu items, reduced operating hours during the second quarter, and we reduced hiring. Some of these will impact us, especially as we transition back to more normal operations, and we will have to have more normal menus and operating hours. Again, going back to promoting advertising spending would also help with payback, so we're transitioning to more aggressive advertising to drive spending. We mentioned we leveraged government relief measures, which adds additional uncertainty about receiving those amounts in the third quarter. Looking into the third quarter, we maintain that the key challenge is that sales deleveraging is indeed real. We see that COVID continues to remain a significant uncertainty going forward, as we see some resurgence in cases in July nationwide, and that we see certain cities, for example Chengdu and Xi’an are under lockdown measures. This is why we say that recovery will take time and will be nonlinear and potentially volatile. We will continue to focus on cost control, set up more proactive planning, and be to adapt quickly. But we need to realize about the uncertain landscape that we face and how deleveraging will rightfully impact our margins. Thank you, Lillian.

Lillian, I want to offer some additional context regarding these numbers. Some of the methods may not persist, while others will. For those that will continue, we are sharing staff across stores. Some arrangements will not endure, such as the extreme situations we experienced in April and part of May, when stores were managed by very few employees. Typically, staff would remain in a store for one week, living there during that time. The most extreme case involved one employee staying for 33 days, while another stayed for 44 days. I recently had the pleasure of inviting some of these employees to lunch, and it truly warmed my heart to hear their stories. I am very grateful for our amazing operations team, who worked diligently to protect their jobs, serve our customers, and safeguard the company. However, these extreme arrangements cannot be sustained. If we have come this far with innovative and creative solutions, it shows that our team is even more open-minded to embracing new ideas in terms of reevaluating the cost structure. Thank you, Lillian.

Hi, Joey and Andy. Thanks for taking my question. My question is about the incremental opportunity we observed during tough times. You mentioned that there are some new businesses, like community purchasing and retail products, which are performing pretty well during difficult times. Are we going to be more aggressive in exploring these new business lines? Additionally, Joey, you earlier mentioned we have these AI-enabled routes to improve delivery efficiency, etc. How should we think about the sustainability of these opportunities we observed during tough times, and how we are going to grow these opportunities further in the future? Thank you.

Thank you, Michelle. Let me take a step back and comment on your question about the incremental opportunities. Overall, in the second quarter, we delivered substantial operating profit versus expectations. The absolute number isn't the highest for quarter 80 million; nonetheless, the quality and the effort contributed to it and the resiliency our team demonstrated is phenomenal, as you can see from the results. April was tough, May improved slightly, and June exhibited a tremendous recovery. Regarding the core of your questions in terms of what we did and how we managed to do it successfully, it returns to our strategic framework, RGM, which represents resiliency, growth, and moat. Resiliency, for example, allows us to pivot quickly as we did during community purchasing events, where we organized everything in just a couple of days. The demand for our offerings surged, including fried chicken, and with the COVID constraints, we even launched new retail measures. At the height of our new retail movement, for instance, I believe it was May, 50% of Pizza Hut's sales came from that space in Shanghai. Over time, sales have declined slightly but compared year-on-year, our new retail business doubled in the fourth quarter. In fact, in the first half of the year, we achieved sales of approximately ¥450 million from new retail and we aim for ¥1 billion by the end of the year. The scale of our supply chain gives significant leverage to this retail development, as we have our own vast network of distribution and our delivery riders help service these sales without additional delivery costs. This model will only keep growing. Our emerging brands are achieving breakthroughs in new retail. During May, Taco Bell saw sales exceed pre-lockdown levels thanks to our community purchasing initiatives. Sticking to your AI question, digital initiatives have formed a constant aspect of our operational strategy. For 35 years, we've made dedicated steps towards building a robust supply chain, increasing our focus on logistics even during the most difficult times recently. We're making investments in digital logistics to provide enhanced visibility and efficiency, so these new opportunities shall continue evolving. Despite such rare circumstances, our morale remained elevated, and our team is very proud of how we’ve protected our business and jobs. We will keep seizing every opportunity to innovate and push towards new retail excellence throughout our operating framework. Thank you for your question, Michelle.

Hi. I have one question. I would like to understand your store count increase plans in the second half. For example, how do you plan to increase store counts across different brands, such as KFC and Pizza Hut? Also, will there be a breakdown by tier of cities? Thank you.

Hi, Brian. Regarding our new store openings, as we mentioned, we have always employed a disciplined process, using methodologies to evaluate potential openings. Essentially, our approach is bottom-up, where from the market, appropriate sites are proposed, followed by financial modeling, and a review committee approves those sites after assessing overall market conditions. Thus, I don't think there's any change to our existing process. By brand, KFC will continue to account for the majority of new store openings, as it is obviously our largest brand. Pizza Hut's new store performance is also quite commendable, particularly with our lifestyle segment. For other brands like Lavazza and Taco Bell, we expect to see expansion in the second half, though the absolute numbers will remain small in comparison to KFC and Pizza Hut. For the Chinese cuisine business, openings depend on franchisees, usually ramping up before the Chinese New Year. This year, as a result of COVID, the operating landscape remains challenging, but we're carefully monitoring the situation, particularly concerning localization efforts in northwest China. Generally, we will see more opportunities in multi-city areas. We're focused on maintaining densities in tier one and tier two cities, thus that trend will remain unchanged. We have set a target of 1,000 to 1,200 net new stores for this year, and with the strong economics shown by our recent openings, we are confident in delivering good quality, profitable new stores in the long-term. Thank you, Brian. Thank you, Brian. Also, on competitive landscape, we are aware there are lower-priced alternatives in tier two and tier three cities, similar to KFC, but our strategy involves offering better value rather than simply competing on price. We focus on delivering quality food and providing a comfortable dining experience. Customers are loyal to our brand, and we've seen that through the exceptional performance of KFC, especially during the lockdown periods. We're also innovative with our product offerings and promotions, making sure we resonate with our consumer base. In terms of our competitively priced items, we strive to maintain a low cost structure, aiming to offer strong value relative to competitors. Thank you.

Regarding our approach in lower tier cities, we do have slightly differentiated menus and pricing strategies specifically targeting these regions. This allows us to tailor our offerings and run more localized promotions at the discretion of our store managers. For example, we are careful with the operating models and costs associated with our restaurants in these areas, providing opportunities for differentiation as well. Throughout our operations spanning the past 35 years, we have organized significant events such as the children’s summer events in northern China, ensuring we cater uniquely to those communities. Thank you.

Good morning, Joey and Andy, congratulations on another resilient quarter result. I realize Yum China has shown remarkable agility. My inquiry focuses on how, if China reopens fully, you can shift to an aggressive operation mode. Joey, you touched on new funding initiatives and retail opportunities. However, regarding the cooperation in KFC and Pizza Hut, how would you diverge from pre-COVID operations using lessons learned from the past two years?

Thank you, Xiaopo. Our business indeed has cultivated newfound agility. In looking at second quarter performance, our same-store sales are at 84% levels, and consequently, helps us maintain operating profits around 4%. This has allowed us to dramatically reduce our break-even point significantly, giving us excellent flexibility. Our ability to bounce back addresses your question; in quarter two our fundamentals remained intact. Even accounting for a slight stabilization in COVID regulations, we could respond rather quickly, and we hope we can continue this through future uncertainties. We believe our strategy is stable and unchanged, utilizing our RGM framework (resiliency, growth, and moat). In business models, customer-centric innovation will necessarily ramp up with growth opportunities delivering store openings and operational adaptability to improve off-prem ecosystem (currently 65% for KFC and 55% for Pizza Hut). This allocation allows growth and adaptability, ultimately helping us flourish, regardless of the challenges we face. Continually fortifying our strategic infrastructure around logistics, greenfield relays, increasing efficiencies from the ordering system, robotics for our workforce all contributes further to reinforcing resilience. We shall maintain our commitment to sustainable growth, and as we promote strategic partnerships offering unparalleled customer experiences, we are optimistic about the future. Thank you.

Thank you, Joey and Andy. Congratulations again on the strong performance. I have a follow-up question concerning margins. As you navigate through extraordinary efforts to achieve resilient performance, Andy mentioned future initiatives to maintain growth. What are long-term margin expectations, particularly moving towards a new normal? Will we maintain around 17% targets moving forward?

Thank you, CJ. As we discussed, short-term and long-term expectations differ. In the second quarter, we've executed numerous strategies that have yield results; therefore, while margins in this quarter exceed unsurprisingly our expectations, we do acknowledge fluctuating inflation and trading challenges moving forward as we seek to stabilize conditions. If we take historical precedence, there were periods during third quarter 2020 to second quarter 2021 where we saw improved operational stability yielding better margins. While historical performances aren't strictly predictive, they serve as indicative guides. We aim for a high single-digit sales increase alongside high single-digit profit growth in the long run. We are hopeful to capture even more opportunities to drive improvement in margins as stability becomes more routine. Thank you, CJ.

Thank you. Hi, management team, thank you for taking my call. I would like an update regarding the coffee business. I know it remains small, but I understand coffee is viewed as potential growth in the future. Given that store opening plans seem slower compared to peers, could you share whether we are still in the process of testing a model or have we identified a successful model to scale up? If so, what investment should we expect for coffee as we pursue this line of growth?

Anne, thank you for your question. We're quite pleased with the progress made so far. That said, our measures may not suit everyone. While progress isn't always tracked by stores alone, the metrics we do utilize indicate positive growth. We have 74 of our Lavazza stores functioning across tier-one and third-tier cities. Year-on-year performance of household sales saw more than a twofold increase. Despite the tough current environments of COVID impacting customer inflow, our wallets also expanded × our number of members quadrupling. As we strengthen our operations (like community purchasing), growth remains promising with strong partnerships in Lavazza. While we still need additional work to streamline operational efficiencies to ensure successful growth, we remain confident about our approaching experimentations that yield favorable results moving forward. Thank you.

Hi, management. Thank you for taking my question. About the key initiatives management mentioned earlier, could you provide updates on the integration of Hangzhou and business leadership? Additionally, concerning your Chinese cuisine business, could you elaborate on the extension plan and new store openings associated with it? Lastly, could management update us on the current status of franchise stores and whether there's any strengthening plan in motion after your supply chain resiliency adjustment?

Hey, Christine. Regarding Hangzhou and business leadership, our primary focus remains on recovery and improving operations, particularly in delivery. There will be considerable emphasis on franchisee collaboration to enhance the franchisee strategy and drive sales growth. While this had been challenged by the pandemic, overall management has been quite innovative, particularly in expanding health services and resources. Relatively well-managed integrations to harness newest infrastructure objectives will occur as well. We will continue monitoring and re-evaluating franchisee effectiveness as we look to achieve better synergy with a supply chain baseline.

Christine, franchise development continues being a driving force for our business moving forward. We strategically target emerging markets where franchise models offer potential for impact—tapping into strategic partnerships, highway stations for example, that will integrate our offering into their operations. Franchise strategies aren't taking center stage, but each scenario serves a unique purpose within our longer-term roadmap. We can explore this detail later on. Thank you.

Hi, Joey. Hi, Andy. Thank you for taking my question. I’d like to discuss the JV margin side. How should we evaluate plans for promotions and discounting for the second half? In particular, as we navigate both commodity headwinds and COVID uncertainty while stimulating sales, how should we best optimize our promotional activities?

Thank you, Lucy. In the second quarter, we reduced marketing and promotional activities. Looking forward to the second half, we expect to ramp up promotional activities, particularly those focused on value for money due to weakened consumer sentiment. Operating under COVID's constraints has intensified our focus on value perception while remaining cautious about price increases, which we generally structure below the inflation rate. We emphasize sales recovery with lower-cost promotion efforts, continuously evaluating outcomes based on customer response. Thank you.

Hi, Andy and Joey. Congratulations on your resilient results. My inquiry concerns member sales. Member numbers keep growing healthily, yet it seems that the percentage of member sales relative to total system sales has declined year-on-year. Could you explain this trend and whether there is concern? What are the strategies for member engagement to support growth in sales?

We estimate member sales percentage around 60 - 65%, which is fair but is not a concern, as total number of members continues to grow. The quantity and the quality of membership programs must be balanced; increasing quantity doesn't necessarily correlate with meaning. The focus now shifts toward enhancing customer experience beyond just expanding membership numbers. For instance, blending sales between KFC and Pizza Hut shows promising overlap, encouraging cross-brand engagement. We continue to focus on improving the overall member experience, ensuring that our strategies lead to robust customer retention. Thank you, Walter.

If member growth is still healthy, and member sales mix decreases—does that signify more new customers entering the segment? Are we attracting new clients?

Yes, exactly. Plus the China market overall is growing. Generally, it's reflective of both expanded member offerings as well as new customer acquisition. Andy, do you want to add any insights?

Yes, with members consistently growing and alongside new customer acquisitions, we already have a healthy membership base, and we are focused on how our strategies to enhance Colasenses improve engagement, which should lead to developing more loyalty opportunities. Thank you.

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

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