Yum China Holdings, Inc. Q2 FY2023 Earnings Call

Thank you for standing by, and welcome to the Yum China Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. I would now like to hand the conference over to Ms. Michelle Shen, IR Director. Please go ahead.

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Second Quarter 2023 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I'd like to remind you that our earnings call and investor materials contain forward-looking statements, which are subject to future events and uncertainties. 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 the GAAP measures is included in our earnings release. You can find the webcast of this call and a PowerPoint presentation on our IR website. Now I would like to turn the call over to Joey Wat, CEO of Yum China. Joey?

Hello, everyone, and thank you for joining us today. I'm delighted to report outstanding performance in the second quarter, both topline and bottom line. Our results are a testament to our resilient and anti-fragile business, which allows us to capture upside in good times and protect downside in bad times. From the back office to the front lines, our teams are doing a great job. During the quarter, we reached new heights on multiple fronts. First, sales performance. Total revenue of $2.65 billion set a new record for the second quarter, especially given the exchange rate. System sales grew 32% and same-store sales grew 15% year-over-year. We observed strong demand around holidays. Trading for the May 1st Labor Day holiday was vibrant. However, demand actually softened afterward with a dip in customer traffic. We adjusted nimbly with attractive campaigns and regained sales momentum in June. On June 1st Children's Day, we hit a record of 8.5 million transactions, equivalent to a transaction every minute in every location across our 13,000-plus store portfolio in a single day. Thanks to our amazing operations team, robust end-to-end digitalization, and agile supply chain, we flexibly handled the spike in demand during campaigns without compromising quality and customer service. The results demonstrate our brand equity and our ability to connect with customers with delicious, innovative food and compelling value for money. Second, store expansion. In the first six months of this year, we opened 655 net new stores, setting a new record. We continue to see vast opportunities across all regions and city tiers in China. KFC continued its aggressive expansion, hitting 9,500 stores in over 1,900 cities. Notably, Shanghai became our first city to reach 500 KFC stores. Our 500th store is in the Shanghai Library, as part of our Book Kingdom Program for kids, featuring a dedicated reading area to promote the love of reading to children. It's also one of our 36 Angel Restaurants of KFC China. The restaurant offers a warm, inclusive space for employees and customers with special needs, showcasing our commitments to positive social impact in the communities we serve. Pizza Hut opened a record 169 net new stores in the first half of the year, supported by strengthened fundamentals through the revitalization program. Healthy new store payback gives us confidence for accelerated growth. In addition, Pizza Hut reached 3,000 stores in China, a milestone that few casual dining restaurant chains can claim. Our 3,000th store is in Qinhuangdao, a popular holiday destination in Northern China. This resort features both a beautiful patio with stunning sea view and was built with eco-friendly materials and an intelligent energy management system. Third is profitability. Our operating profit for the first half of 2023 has already exceeded the entire year of 2022. This achievement reflects our ability to capture sales and rebase our cost structure. Our operating margin for the first half was below 9%. This is the best ratio in the past decade. Now let's talk about KFC. Our value platform generated amazing sales results. First, Crazy Thursday, the famous Crazy Thursday promotion continues to be a tremendous draw, driving 50% more sales than other weekdays. Second, Sunday Buy More Save More energized Sunday sales. We captured home consumption with our Juicy Whole Chicken; we sold 22 million of this product in the first half and more than doubled its sales year-over-year. Third, our weekday value combos are gaining popularity. We added a new sizzling roasted chicken fried burger to enrich our entry price point offerings for just $3. Customers love the new weekday value combos. Delicious and innovative food continues to delight our customers at KFC. In the second quarter, we introduced K-zza, a creative twist on pizza that utilized our existing ingredients. We used the wrap from our Dragon Twister to make the thin-crust and popcorn chicken as the topping. This fun, innovative, limited-time offer generated strong sales. We see great potential for more K-zza variations in the future. K-Coffee sales grew 50% with 47 million cups sold in the second quarter. Our Iced Sparkling Americano with Zesty Lemon is the perfect drink to beat the summer heat. We use our soda fountain machines to make this sparkling drink without additional investment in the store. It has become K-Coffee's best-ever limited-time offering. Now let's talk about our marketing campaign. Connecting with families and children is an important part of strengthening our brand affinity. Around Children's Day, we partnered with Sanrio and sold nearly 3 million meal sets with adorable toys such as Hello Kitty. This campaign contributed to our overwhelming success on Children's Day. Of course, this popular toy also works very well for adults as well. Let's move to Pizza Hut. We continuously innovate to offer better products at great value. Our new launch in May has been a big success and strong sales driver. Over half of the menu items are either new or upgraded from a year ago. Pizza is our biggest category, accounting for over one-third of sales. We continue to fortify our pizza expert image by upgrading existing products and introducing new toppings. Apart from our Signature Super Supreme and Durian Pizza, we introduced a new Bolognese pizza with beef that has become a customer favorite, especially among children. We use quite a bit of existing ingredients to simplify the store operation and to keep the ingredients fresh as well. Many customers are trading up to stuffed crust pizza, which accounts for nearly 40% of pizza sales. Most recently, we launched pineapple and cream stuffed crust to complement our other stuffed crust choices of cheese and sausage. Pizza Hut has been sharpening its value proposition and customer engagement. Our value platform, Scream Wednesday, successfully drove sales and traffic growth. Every Wednesday, we offer different meal choices from pizza, steak, rice, and pasta to appetizers at attractive prices of $3 to $5. There are choices for one-person meals and for social gatherings. We continue our collaboration with Genshin Impact for the second year. This campaign significantly boosted sales and attracted many young customers. We saw more than 2 million meal sets with themed accessories, tripling last year's numbers. This popular campaign helped us recruit over 1 million new members. Now, let's switch gears to Lavazza. Lavazza continues to make good strides forward. In July, we crossed the 100-store milestone. In addition to the coffee shop business, we sell Lavazza coffee beans and capsules to premium hotels, restaurants, and other channels. Recently, Lavazza also started supplying coffee beans to Pizza Hut to upgrade the coffee at Pizza Hut. I'm happy with the progress we have made and excited about the growth opportunity. On to Digital. Our digital ecosystem plays a crucial role in recruiting and engaging members, driving their activities, and unlocking sales performance and potential for us. Our loyalty programs now exceed 445 million members. Member sales increased to 66%, setting a new record. Our Super-Apps had a major update earlier this year, offering our customers a better digital experience. We introduced interesting member exclusive perks to entice our customers, such as app-exclusive new product pre-sales and lucky draws utilizing member points. We have also been working with third-party online platforms to expand our reach. For example, prepaid discount vouchers have been gaining popularity on short video platforms. By offering geographically specific deals, we effectively attract new members and increase spending of existing customers. Our end-to-end digitization unleashes great potential for our Restaurant General Manager, RGM. Our store management team sharing initiative is progressing well at KFC and Pizza Hut. Selected RGMs can now manage multiple stores for the first time in our history. Our AI-enabled systems have streamlined administrative work to help relieve our RGMs of repetitive tasks. By further integrating our store management system, we enhance the visibility of store operations and cross-store data analytics. This digital tool empowers our RGMs to manage multiple stores more effectively while upholding operating standards. This will be a driver for future store cost management and also address our bottleneck of new store opening. So we are looking for more progress going forward. We have entered our summer peak trading season. We are ready to capture summer holiday traffic with eye-catching menu items backed up by solid operations. At KFC, we have brought back our crowd-pleasing fried chicken tacos with a new ingredient. At Pizza Hut, we have extended our popular Durian Pizza with a new product, Durian Coconut Lava Pizza. To handle increased demand in the summer peak season, we are ramping up crew resources, securing supplies, and staying vigilant with multiple scenario planning. With that, I'll turn the call over to Andy.

Thank you, Joey, and hello, everyone. Let me now share with you our second quarter performance. I'm delighted to report our robust performance in the second quarter. We achieved record revenues of $2.65 billion, representing 25% year-over-year growth. Operating profit of $257 million also reached a record level, more than tripling that of the prior year. We accelerated new store openings. We opened 542 new stores, resulting in net new store growth of 422, setting a new second-quarter record. Even though same-store sales remain below 2019 levels, we saw 25% growth in revenues and 26% growth in operating profit in the second quarter compared to the pre-pandemic levels in 2019. We accomplished all this while operating in a challenging and volatile environment, with an uptick in COVID infections starting in late April. Consumers continue to be value-conscious. Sales materially weakened after the May 1st holiday. But leveraging our multiple scenario planning, we swiftly responded by launching attractive offers to drive sales. Our sales subsequently improved in June. To provide more context, in the second quarter last year, multiple cities were under lockdown. We are lapping last year's austerity measures and temporary relief. Now with that, let's go through the financials. Foreign exchange had a negative impact of approximately 6% in the quarter. Second quarter total revenue were $2.65 billion in reported currency, a 25% year-over-year increase. In constant currency, total revenue grew 32%. System sales increased 32% year-over-year in constant currency. The strong growth was mainly from same-store sales growth of 15%. The remaining growth can be roughly split equally between new unit contribution and the lapping of last year's temporary closures. Dine-in sales rebounded significantly year-over-year while delivery continued to grow. By brand, KFC same-store sales grew 15% year-over-year. Same-store traffic grew 21% and ticket average decreased 5%. It was driven by successful traffic-driving promotions, the lapping of large community purchasing orders, and the decrease in delivery mix. Delivery has a higher ticket average than dine-in. Pizza Hut same-store sales grew 13% year-over-year, same-store traffic grew 27%, and ticket average decreased 11%. It was driven by successful promotional activities and the lapping of community purchasing orders. Lower mix of delivery, which has a lower ticket average than dine-in at Pizza Hut, partially offset the ticket average decrease. Restaurant margin was 16.1%, 400 basis points higher than the prior year. Occupancy and other improved significantly year-over-year. This was primarily due to offering leverage derived from higher sales and ongoing benefit from cost structure rebasing efforts. This was partially offset by lapping last year's austerity measures, increased promotional activities, and wage inflation. Let me now go through the key items. Cost of sales was 30.7%, 20 basis points lower than the prior year. We kept our cost of sales low despite increased promotional activities to drive traffic. Our supply chain team's hard work and innovative use of affordable ingredients contributed to the favorable commodity pricing. Cost of labor was 26.4%, 70 basis points lower than the prior year. This was driven by operating leverage from sales growth, lower rider costs due to low delivery sales mix, and benefits from small management sharing initiatives. This more than offset wage inflation, the lapping of austerity measures, and temporary relief last year. Occupancy and other was 26.8%, 310 basis points lower than the prior year. Rental expenses and depreciation improved year-over-year. Operating leverage from higher sales, store portfolio optimization, and more favorable new store rental terms all contributed to the improvement. This was offset by lapping austerity measures and higher rental relief last year. G&A expenses increased 15% year-over-year in constant currency, mainly from higher performance-based incentive accruals and merit increases. Operating profit was $257 million, more than tripled year-over-year. Our effective tax rate was 24.7%. We continue to expect our full-year effective tax rate to be around 30%. Net income was $197 million, increasing 138% in reported currency. Diluted EPS was $0.47, increasing 135% in reported currency. We generated $417 million in operating cash flow and $264 million in free cash flow. We returned $160 million to shareholders in cash dividends and share repurchases. At the end of the second quarter, we had around $3 billion in cash and short-term investments and another $1.2 billion in long-term bank deposits and notes to benefit from better interest rates. Now let's turn to our outlook for the third quarter. Driving sales remain our top priority. As Joey mentioned earlier, we are stepping up promotional activities and have planned attractive offers with great food at compelling values. We are also lining up exciting marketing campaigns and resources to support those initiatives to capture peak summer holiday sales. In terms of store opening, with healthy store economics and a robust store pipeline, we are confident to achieve 1,100 to 1,300 net new stores in the full year. Our team has put tremendous effort into developing multiple store formats, lowering CapEx, and securing more favorable lease terms. We opened 655 net new stores in the first half of 2023. Our new stores have maintained a healthy payback of two years for KFC and three years for Pizza Hut. This gives us confidence to expand across different city tiers and regions. Regarding margin, our store network expansion and our cost structure rebasing efforts over the past few years positioned us well to capture both sales and drive operational leverage since the reopening. With 40% of our current stores opened after 2019, we are opening an average of one new store every five hours. Our store portfolio is well suited to operate efficiently in the evolving market condition. We expect our efforts on efficiency improvement and cost structure rebasing to continue to benefit profitability in the long-term. We look at last year's record third-quarter restaurant margins set a relatively high benchmark due to our austerity measures and $30 million of temporary relief in the prior year. We also expect some hiring to normalize and measure inflation of low-to-mid single-digit in the second half. Despite macro uncertainty and volatilities in the near-term, our multiple scenario planning capabilities and agility position us well to capture opportunities in good times and manage the downside in bad times. We continue to focus on driving sales, improving operational efficiency, and investing in digital and supply chain for long-term growth. Before I conclude, I would like to highlight our upcoming Yum China Investor Day to be held in September in Xi'an, China. Joey, myself, along with our leadership team, including KFC and Pizza Hut brand managers, will share updates on our strategic priorities. We have also planned food tasting during visits to our restaurant, logistics center, and digital center. Through this event, investors and analysts can gain firsthand insights into the market and our business, so we look forward to hosting you in Xi'an. With that, I'll pass you back to Michelle.

Thank you, Andy. If you are interested in attending our Investor Day in person, please reach out to the Investor Relations team. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your question to one at a time. Ashley, please start the Q&A.

Thank you. Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

Hi, Joey, Andy. Congrats, again for the very strong results. My question is about the promotion and the competition. So as you mentioned, the market is still very promotional and also we hear some smaller players are actually coming back. So on one side, can you discuss or share with us your observation on the competition side? And more specifically on the margin, we still see the food cost margin manage pretty well and particularly can you talk about Pizza Hut? Since we have been working on this value position for many years, but it looks like in this quarter the food cost control is pretty decent. So can you also share with us how should we think about this pricing strategy and also further savings on the food cost? Thank you.

Michelle, thank you. I'll talk about the promotion competition. Andy will handle the margin question. Customers are very value-cautious for sure, but at the same time, it’s not enough if we just focus on promotion. It has to be promotion – fun promotion and good food. Our focus is on a few very effective promotion platforms. What are the famous ones? Crazy Thursday is very, very fun; its user generated content these days and, of course, the food there is good. We have some new food like spring rolls, not only normal spring rolls, but skinny spring rolls. When the spring roll is smaller, they actually taste better; you can try it with our KFC spring roll on Crazy Thursday. And then Pizza Hut is focusing on Screaming Wednesday. Again, a very powerful message, very simple message, but with great food and great variety from steak to pizza. So not only just random promotion, but very focused promotion and we keep doing it again and again and again. It takes time to build to have the effect because a little do people remember Crazy Thursday started back in 2018. So, by now, it’s a very familiar mechanism and that works beautifully. And, of course, we continue to build new promotional platforms like KFC, the new one will be Buy More Save More on Sunday. That has a clear product focus called the whole chicken; during normal times the chicken sells for $39, but on Sundays it sells for $29. So it's not only promotion, but great food. And I think what people sometimes don't necessarily correlate, how we differentiate from our competitors in driving this promotion, we have the unique advantage of having our own very effective, powerful, agile, and nimble supply chain. Because without the supply chain capability to source, to innovate and to deliver all these very affordable ingredients, it is almost impossible to support this kind of promotion on a sustainable basis. Last but not least, the operations team. On June 1st Children's Day, we achieved 8.5 million transactions a day. That's a huge number of transactions and the fact that our operations team can handle that is amazing. Those running the restaurant in operation would appreciate how difficult it is to be able to handle that peak and the spike, and the IT system did not go down. We can continue to push our system in terms of the stability and efficiency, so that all come together. It’s not just marketing promotion – it's supply chain, it's digital, it's operations. And while many competitors can probably replicate the marketing campaign, but the operation, the supply chain, and digital – these are the real core capabilities, very difficult to replicate. So I’ll pause here and move on to the margin question.

Okay. Thanks, Joey. So in the second quarter, the improvement in terms of margins, I think obviously the number one driver is the operational leverage from higher sales. If you look at the overall margin improvement, it continues to benefit from our portfolio optimizations over the past few years. As I mentioned earlier, 40% of our stores are now open after 2019 and they're much geared to operate efficiently in our current environment. We continue to benefit from the cost structure rebasing that we initiated over the past couple of years. Those are key drivers for margin improvement and position us well for the long-term to operate efficiently. If you look particularly at the cost of sales, I think overall with lower commodity pricing in the second quarter was slightly favorable with overall commodity inflation but the chicken price in the second quarter has continued to experience an upward trend. Given the stock price and our contracts, we expect that to probably extend into the third quarter. For both brands, they have managed their sales very well over the past few years, generally balancing the pricing range so that we can continue to expand our addressable customer base by balancing commodity price and the value proposition to consumers. We generally try to return some of the savings to our consumers. If you look at the cost of labor, it also improved 70 basis points in the quarter. This was driven by the cost structure rebasing that we have done. Also, as Joey mentioned, we have the store management sharing initiative that continues to help us run our store efficiently and more than offset the low single-digit labor inflation in the second quarter we experienced. If you look at occupancy and other expenses, as we mentioned, the biggest improvement over the past few years has come from our structural changes to rental contracts. Not only do we have more variable components to that rental term, but overall leases have improved to best in a decade. These structural changes will continue to benefit us. Our initiatives in energy savings and the ongoing benefit from our investment in technology have allowed our advertising and promotion expenses to also see some leverage. All of that contributes to the improvement in occupancy and other expenses. I think that's how we look at it. In terms of outlook, commodities generally appear favorable with the exception of potential chicken price increases in the next quarter. We are looking at labor cost inflation to normalize to low to mid-single-digit in the second half of this year. One thing I wanted to emphasize is that last year was a special situation where we received about $30 million of one-time relief due to COVID situations last year, and we also had some alternate program. Thank you.

Thank you. Your next question comes from Brian Bittner with Oppenheimer & Company. Please go ahead.

Thank you. I just want to ask about the sales trends. Andy, you mentioned that May saw a step back in demand trends, but then you regained momentum in June. Can you just add some context here? Could you talk about where your underlying trends are versus 2019? Or anything else regarding the consumer environment in China that you're witnessing right now, just to help us all get on the same page with modeling sales moving forward?

Okay. Brian, thanks for the question. I think, as you mentioned, we are still early in the reopening. This is the second quarter since the reopening, so we are likely to experience some volatility. Obviously, the decline in demand in May had to do with a couple of things, including an uptick in COVID infections at the end of April. The other point is, as you have seen some of the economic data, the macroeconomic situation remains markedly challenging. Consumers have experienced three years of COVID and likely will take some time to regain their confidence. That's what we are seeing right now. But as we mentioned, we have multiple scenario planning in place as always, so we take quick actions as we see changes in consumer behavior. We have very strong product offerings and successful campaigns, and as we mentioned, revitalized the sales momentum in June. I think, again, in the near term, we will encounter some volatility and uncertainty, but we are well positioned to capture opportunities to adapt when situations become more challenging.

Brian, thank you. Let me provide an overall picture of the business that might help you understand the sales trend right now. Overall, I would strongly suggest our investors and analysts view the business with fresh eyes because it is a very different business now compared to pre-pandemic. It might not be obvious enough, but 40% of our current stores did not exist before the pandemic. So the same-store sales only applies to a bit more than half of our business now, because 40% of the stores are new. For the portfolio that existed before 2019, the business is also quite different because the management team has taken the opportunity in the last few years to prune the portfolio, particularly those stores with less desirable economics. Overall, the portfolio is better, and for the surviving stores, the economics are much improved with lower rents, etc. We used the pandemic time to sort this out as much as possible. On top of this, we have replaced the cost structure. We have completed end-to-end digitalization and the digitalization of the entire supply chain process. The business is more resilient, more nimble, with a better cost structure for the entire company as well as each store. System sales growth is strong, and the same applies to profitability, which is what we wanted. Going forward, in terms of outlook, Andy discussed Q2 and Q3. We are going to focus on growth. We are committed to opening more stores and continuing to focus on delicious and innovative foods that truly appeal to customers. But in the longer term, while short-term macro conditions are hard to predict, China’s GDP has slowed down, growing at twice the rate of developed countries. It’s not too bad. Isn't it? It’s still an amazing market, and we serve around 2 billion customers a year. Certain regions, like the central parts of China, are showing good growth. Therefore, we are able to open stores very fast, particularly in these what we call new basket categories. For KFC and Pizza Hut, you can see from our opening speed in recent years that we are opening many stores, now reaching 9,500 stores in China alone for KFC. In Shanghai, we have already reached 503 stores. We are not just opening stores in lower-tier cities; we are also penetrating all tier cities using franchising and exploring newly found opportunities like universities, hospitals, and high-speed rail service stations, and they are effective. Pizza Hut is ready to accelerate growth after a few years of turnaround. The margin is good, and we have surpassed the 3,000-store mark, a considerable challenge for casual dining in terms of scale. The smaller brands are also developing quickly. Lavazza just reached the 100-store milestone and started to sell coffee beans in retail. We are optimistic about future growth potential, so you can see our record pace of new store openings this year. Thank you, Brian.

Thank you. Your next question comes from Chen Luo with Bank of America. Please go ahead.

Thank you, Joey and Andy. My question is on margin as well. If we combine the first half of this year with the second half of last year, it would imply a full-year margin of close to 17% at the restaurant level. Many years ago, we discussed the long-term normalized restaurant margin of about 17%. I know we no longer provide long-term targets, but the market usually looks at 17% as a reference. Now we are almost there. How much upside do we see from here? In particular, as Andy mentioned, starting from Q3, we are going to see pretty high lapping for margins. Is it fair to say that from now on, the low-hanging fruit from cost rebasing is no longer available and the majority of margin expansion will come from same-store sales or sales leveraging in the future? Thank you.

Thank you, Chen, and thank you for your questions. That’s a wonderful question to deal with, right? After the reopening and all those restructuring and cost structure rebasing we have performed over the past few years, after, as Joey mentioned, our portfolio is almost entirely different – we are now at multiyear or at least five-year highs in terms of internal margins. So we're offering very efficiently at this point. A couple of things I want to mention. If you look at the cost structure rebasing, as we mentioned, those are very fundamental changes in how we operate our restaurants and the cost structure. Now in terms of 17% margins, I’m glad that when you mention over the past four quarters, we are there; it’s more than that. We don’t give guidance on margins, but we continue to focus on doing that. We’re pretty confident in terms of our cost structure rebasing with that. We have confidence in how our portfolio operates as we open more stores. However, as we always mentioned, we generally look at the cost of sales, and we try to maintain that capability. We have a very innovative team that mitigates some volatilities in commodity prices. We efficiently utilize our product resources over the years. We also leverage the capabilities of our supply chain and lock in long-term contracts, for example, coffee beans over the last couple of years. However, we are always cautious about pricing increases to ensure consumers benefit from cost savings and enjoy our food's value. We also continue to pursue labor productivity improvement. As mentioned, we invest in technologies and enable our team members to work more efficiently in the restaurant. Lastly, as mentioned, occupancy and other factors have improved over the years, not just in the last couple of years but even over the past 5 to 10 years. We are quite efficient now, but there is continued room for improvement. So that’s how we look at the overall margin. Obviously, the next quarter will appear distinct due to last year’s temporary relief and austerity program, but our trajectory remains solid. Thanks, Chen Luo.

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

Hi. Thank you very much for taking my call. I have a first question on the restaurant margins for Pizza Hut improving and the success of the restructuring. What would the normalized restaurant margin be over time? Can it be as high as KFC’s at 18% or more? If so, what are the drivers? Is it more about the scale of the whole network or is it more about driving sales per store for further normalization? Joey last time mentioned that you would love to see a further increase in the delivery business for the Pizza Hut side. Any strategies that we can facilitate this? Thank you.

Hi, Anne. Yes, thank you for the questions. Regarding Pizza Hut, we are very happy to see that the revitalization program has achieved very strong results over the last two quarters. We continue to observe very strong traffic and sales growth. As Joey mentioned, Pizza Hut has continued to improve its value proposition, yielding great results. The brand resonates well with consumers, especially with campaigns like Genshin that have connected with our younger customers. The transformation has expanded the pricing range, enhancing the value proposition and continuing to drive the addressable market. We have reached the level of 3,000 stores, providing significant opportunities for growth. If you analyze the current store opening rate, it’s at record levels—more new restaurants opened in this quarter than in the last couple of years combined. I think this progress is encouraging. We continue to hope to see KFC expand its network, especially driven by the satellite store and smaller format strategies to improve margins over time. When normalizing margins, we are already witnessing improvements that surpass even those of 2019.

The ultimate goal for Pizza Hut is not solely about margins. Our focus after the turnaround is on continued growth and resilience. Achieving growth without resilience is uncomfortable. So both are important. We see satellite store models as the key to achieving this. Looking at new store payback, Pizza Hut has improved from four years to three years, particularly with satellite stores focusing on delivery and takeaway. The profitability from these stores is very encouraging. With that combined store payback of three years, we found a way to grow. We just need time to build more of these from top-tier to lower-tier cities. The growth story of Pizza Hut is straightforward; KFC operates in 1,900 cities with 9,500 stores, while Pizza Hut has only 3,000 stores in 700 to 800 cities in China. So there are over 1,000 cities in China that have KFC stores but not Pizza Hut stores. This explains our confidence about future growth potential in terms of profit resilience.

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

Thank you, Joey and Andy. I have a follow-up question on promotion and competition. So we have seen that our insistence on value-for-money leads to very resilient sales recovery. But we have also seen increasing promotion and more value combos like OK San Jian Tao. Do we think this is only because people are value cautious under this economic environment, or does it also relate to more intense competition from other players? How does this impact our ticket averages and sales per store? Thank you.

Thank you. The OK San Jian Tao is new and currently delivering about low single-digit in terms of sales mix. The key thing here is that while customers are very value-conscious, opening up the price range doesn't hurt. In the past, we did not have that price point at 19 yuan as a combo. When we introduced it, the most critical thing we are looking for is incremental sales, particularly incremental same-store sales; and that’s fantastic. It represents new business for us. As for its performance across city tiers, people might think it only works in low-tier cities, but actually, it works better in top-tier cities because it provides a more balanced functional consumption for lunch. Indeed, it gives us insights that we can still open more stores, particularly in low-tier cities, to capture that functional consumption. We’re happy with that. The key to unlocking OK San Jian Tao’s success is our capability in supply chain. This flexibility allows us to deliver affordable ingredients at a reasonable profit. And our team has effectively executed that. Thank you.

Your next question comes from Lillian Lou with Morgan Stanley. Please go ahead.

Thanks. Thanks, Joey and Andy for all the answers. I have a follow-up question on same-store sales growth. Joey previously mentioned that our store network is very different from pre-COVID. Looking at the same-store sales growth compared to pre-COVID, the second quarter was still 10% below. If we look at the holistic picture because we're adding more smaller stores, does that mean that our same-store sales growth will be below 2019 levels for a longer period, even though our underlying operation is almost back to normal? Also, from an operational perspective, what has been dragging our same-store sales growth below normal levels? Is it still the traffic of stores in certain areas or certain tiers of cities or store formats? Thanks a lot.

Lillian, let me clarify this. Our system sales were up 25% year-over-year and our same-store growth was up 15% year-over-year. If you adjust for the impact of temporary store closures last year, like many people in the industry use, our system same-store sales growth would be about 24%. Sorry, our system sales growth is 32%. So if you look at that in an adjusted manner, same-store sales growth would be close to 24% year-over-year. Even with the slowing in May, our same-store sales growth remains robust. The drivers across tiers differ slightly. The loyalty series would likely grow faster. The TMT space is important for us, and we continue to see a strong recovery there. Tourist locations are also performing quite well, especially in major transportation hubs in domestic travel for high-speed trains and domestic flights, which continue to improve. While international travel remains softer, it may take longer to adjust. Overall, our same-store sales growth is solid. Joey, do you have anything to add?

For existing stores that opened before 2019, as Andy mentioned, transportation hubs have been recovering well. Consumer behavior reflects remarkable consumption during holidays and festivals, though it may dip during quieter periods. We have programs to manage that. For tourist locations, particularly tier two cities like Xi’an, they are performing exceptionally well, already back to pre-2019 levels. To answer your question about the holistic same-store sales: the ultimate goal is to grow our same-store sales, especially when our stores are getting smaller, particularly with newly opened ones, since these smaller stores require less CapEx and have good payback. It’s critical for us to continue driving delivery and takeaway sales. This strategy applies to both KFC and Pizza Hut: we must not allow store size to restrict our same-store growth, and we have several initiatives in place. You can expect to see more KFC stores with windows opening up to facilitate pickup, enhancing convenience for our customers. We also plan to expand coffee trucks and standalone coffee stations for strategic locations. We currently have around 200 coffee trucks, but we plan to add more. During holidays, we conduct pop-up stores, which are not new; we simply don't talk about them enough. We often utilize these for festivals and regular promotions throughout the year. So, we don’t want the size of stores to limit our same-store growth, as we can pursue success externally. You will indeed see more breakfast kiosks that facilitate both KFC and Pizza Hut, further expanding convenience. I hope this clarifies how we will drive our holistic performance despite smaller store sizes. Thank you.

Your next question comes from Christine Peng with UBS. Please go ahead.

Thank you, management, for the presentation as well as answering most of the questions I think investors care about. So I have a very quick question regarding capital allocation. If you look at the first half of 2023 cash flow details, the metrics suggest a strong cash accumulation for the company. However, as we assess cash dividends and share repurchases, they do not indicate a significant increase compared with the pandemic period. I am trying to understand the logic behind this and what the future holds for distributing more cash toward investors. Thank you.

Thank you, Christine. A couple of points. Our capital allocations have focused on driving organic growth. It's on store openings and remodeling, which typically capture more than 6% of our CapEx spend. We also invest in new brands, digital ventures, and supply chain improvements to ensure effective and efficient operations amidst uncertainties. We aim for a strong balance sheet to manage potential contingencies. Occasionally, we look for opportunistic investments that enhance our capabilities in technology and operations. We remain committed to returning capital to shareholders. In the quarter, we returned over $110 million to shareholders. The pace of share repurchases can vary based on many factors, but we remain focused on returning excess cash to shareholders. Dividends, as done in the first quarter of this year, increased nearly 8-9%. We regularly review our dividend policy with our board every quarter and year. We’re pleased that strong operating performance yields good operating and free cash flow in the first half of this year, and we will continue returning that excess cash to shareholders. Thanks, Christine.

Thank you for joining the call today. If you have further questions, please reach out through the contact information in our earnings release and on our website. Thank you.

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