Yum China : 3Q 2022 Earnings Conference Call Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

Q3 2022 Yum China Holdings Inc Earnings Call

EVENT DATE/TIME: NOVEMBER 02, 2022 / 12:00AM GMT

REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us

1

©2022 Refinitiv. All rights reserved. Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies.

NOVEMBER 02, 2022 / 12:00AM GMT, Q3 2022 Yum China Holdings Inc Earnings Call

CORPORATE PARTICIPANTS

Joey Wat Yum China Holdings, Inc. - CEO & Director

Ka Wai Yeung Yum China Holdings, Inc. - CFO

Michelle Shen Yum China Holdings, Inc. - IR Director

CONFERENCE CALL PARTICIPANTS

Chen Luo BofA Securities, Research Division - MD

Lillian Lou Morgan Stanley, Research Division - Executive Director

Xiaopo Wei Citigroup Inc. Exchange Research - Research Analyst

Michelle Cheng Goldman Sachs Group, Inc., Research Division - Executive Director Kin Shun Ling Jefferies LLC, Research Division - Equity Analyst

Yan Peng UBS Investment Bank, Research Division - Executive Director and China Consumer Staples Sector Analyst Veronica Song Crédit Suisse AG, Research Division - Research Analyst

PRESENTATION

Operator

Thank you for standing by, and welcome to the Yum China Third Quarter 2022 Earnings Conference Call. (Operator Instructions)

I would now like to hand the conference over to Ms. Michelle Shen, Director of Investor Relations. Please go ahead.

Michelle Shen Yum China Holdings, Inc. - IR Director

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Third Quarter 2022 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. We are dialling in from different locations today. If we experience any technical difficulties 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 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 statements in our earnings release and the risk factors included in our filings with the SEC.

This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and GAAP measures is included in our earnings release.

Today's call includes 3 sections. Joey will provide an update regarding our performance in the third quarter. Andy will then cover the financial performance and outlook in greater detail. Finally, we'll open the call to questions. You can find the webcast of this call and the PowerPoint presentation, which contains operational and financial information for the quarter, on our IR website. Also on the site, you can find a video we prepared that showcases our latest stores, offers and activities.

Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Joey Wat Yum China Holdings, Inc. - CEO & Director

Thank you, Michelle. Hello, everyone, and thank you for joining us today. We achieved outstanding performance in the third quarter with fantastic growth, both top line and bottom line. This demonstrates our ability to operate in an uncertain environment by learning, adapting and strengthening business fundamentals. During tougher times, our resilient business model and agility helped us manage the negative impacts.

As COVID conditions were relatively calmer in July and August, we captured sales opportunities during the peak summer season. System sales recovered with 5% year-over-year growth. Operating profit surged 77% year-over-year to $316 million, even higher than 2019 level. Great teamwork made this possible. Key elements in our winning formula include our in-house and tailor-made supply chain, industry-leading digital and delivery capabilities, cost restructuring and solid execution.

REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us

2

©2022 Refinitiv. All rights reserved. Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies.

NOVEMBER 02, 2022 / 12:00AM GMT, Q3 2022 Yum China Holdings Inc Earnings Call

Let's move to KFC and Pizza Hut. We have been innovating new products to satisfy customer cravings. In the past 2 years, we have established strong presence in new categories such as beef burger, whole chicken and durian pizza. This was enabled by our powerful supply chain, by securing supply at scale, streamlining production and optimizing costs.

Let me share our success stories. At KFC, our extra juicy beef burgers rapidly captured meaningful market share. Since adding them to the permanent menu in May 2021, we have sold over 100 million burgers. That's about 5 beef burgers every second. For the full year, we expect to generate close to CNY 2 billion in sales from beef burgers. We cater to Chinese tastes by making the patty super juicy using our specialty ovens. Customers love our burgers for their great taste and value for money. We source our Wagyu beef, (Long jiang he niu), locally from Northeastern China and have signed a multi year contract to secure price and supply.

Our juicy whole chicken has also quickly gained popularity since its launch late last year. Year-to-date, we have sold over 18 million whole chickens. Whole chicken is a versatile product, good for both dine-in and take-home consumption. We use a different breed of smaller chicken with better cost that is the perfect size for an individual meal and particularly juicy. And it's good for sharing on the dining table at home as well.

At Pizza Hut, durian pizza has become a customer favorite. In fact, during Q3 promotion, every 4th pizza we sold was a durian pizza. Our limited-time durian trio pizza, (Liu lian san jing ling), with 3 types of durian was especially popular with durian lovers. Customers are increasingly value-conscious, yet we do not compromise on quality.

Last quarter, we shared about KFC's widely popular Crazy Thursday campaign, (Feng kuang xing qi si). Since 2018, we have been offering delicious food, including the latest innovations at amazing value. The campaign continues to be a phenomenal event, generating a significant boost in sales every Thursday. Our customers create witty and playful social media content using the Crazy Thursday theme. Many of these postings have gone viral, creating huge hype for us.

Now to drive weekend traffic for families and kids, we have introduced a Sunday Buy More Save More, (Zhou ri feng kuang pin), campaign in July. Customers can get a bigger discount when they buy more, up to 50% off for 8 items. This new promotion platform has built wonderful momentum with good value perception while protecting our ticket average.

Apart from abundant value, we also launched a golden SPA chicken breast burger, (Huang jin SPA ji pai bao). This is our first successful chicken breast burger. We added an extra step in the preparation process to make the breast meat super juicy and tender. This entry-price burger widens our choices for customers and is a great product for lower-tier cities.

We strive to keep our brands appealing to youthful customers. In September, we transformed select Pizza Hut stores into social hubs for gamers, partnering with the popular RPG game, Genshin Impact, (Yuan shen). We decorated stores, outfitted restaurant crews and offered exclusive gifts. The campaign generated extraordinary social buzz. In just 3 minutes, we sold over 300,000 themed combo meals. And our Super APP recorded its highest activity ever. I'm looking forward to more successful events with this partnership.

Let's move to digital and delivery. We have been enhancing our delivery and digital ecosystem to make our business fundamentally stronger. Customers love convenience. Delivery sales are growing fast. Empowered by our dedicated delivery riders and leading digital capabilities, delivery grew 19% year-over-year and reached 38% of sales mix in quarter 3.

Together with takeaway, off-premise sales were over 60%. Our ability to capture off-premise demand not only enables us to effectively serve customers but also cushions store closure impact due to COVID conditions. This 60% off-premise sales is so fundamental to our business model because it really protects our downside in both sales and profit despite the fluid situation.

We have been maximizing delivery coverage and flexibility using AI technology. Most recently, we launched Smart Delivery, (Tan xing shang quan), to dynamically adjust delivery coverage for each store by daypart, taking into account the operating hours of nearby stores. The upgraded system helps us serve more customers more efficiently.

Our digital capabilities serve as key touch points with customers. In quarter 3, we reached 2 milestones in our digital ecosystem: one, our

REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us

3

©2022 Refinitiv. All rights reserved. Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies.

NOVEMBER 02, 2022 / 12:00AM GMT, Q3 2022 Yum China Holdings Inc Earnings Call

loyalty programs reached 400 million members; and two, cumulatively, since 2018, KFC sold over 100 million privilege subscriptions. Our privilege subscriptions offer great value for money, and have been an effective tool, in driving frequency and spending.

Our digital capabilities are also crucial to streamlining restaurant efficiency. Digital orders optimize in-store labor efficiency and accounted for more than 90% of sales in the quarter. Pizza Hut's table-side mobile ordering sales have grown exponentially from just 2% at its launch in 2018 to 45% in quarter 3 2022. This helps mitigate rising wage inflation and frees up crew members to enhance customer service.

To improve digital experience, we introduced intelligent order sequencing at KFC, (Zhi neng ding dan jiao fu), in the third quarter. This system automatically arranges orders to shorten customer wait time.

Now let's move on to coffee, our third growth engine. Lavazza is making solid progress along its clear 4-pillar strategy. The pillars include brand building, menu upgrades, expanded digital and delivery capabilities and store development. Here's how we build these out.

Branding. Lavazza has a century-long reputation for coffee expertise. We will continue to accentuate its brand positioning as the leading Italian coffee brand, offering an authentic Italian experience.

Menu upgrade. We are broadening food and drink offerings with more unique Italian products, including KAFA premium single-origin beans and Tigelle, which is an Italian flatbread with meat or egg stuffing, something like our Chinese (Rou jia mo). We also launched localized products such as coconut latte, buffalo milk latte, and even osmanthus latte. Osmanthus, (Gui hua), is a very lovely, fragrant flower used in many Chinese desserts. These new products capture the latest coffee trend and have been well received by our customers.

Digital and delivery. We are building our membership program and digital fundamentals to improve customer experience and attract online traffic. Delivery reached almost 40% of sales mix in quarter 3.

Store development. Now with 78 stores, we have further refined our store models, paving the way for growth.

We have made great progress so far, but work remains. Good things do take time. We want to grow this brand right, with every step at the right time. In close partnership with Lavazza Group, we are confident to build a successful Lavazza business in China.

We decided to wind down our COFFii & Joy operation. From branding to site selection to operations and more, we learned a lot with COFFii & Joy. This invaluable learning experience will help us capture growing opportunities in the coffee market.

Going forward, we will grow our coffee business with 2 distinct market positioning: K-COFFEE, focused on value and convenience; and Lavazza, focused on authentic Italian coffee.

To summarize, our innovations and hard work in the pandemic years have made our business fundamentally stronger. We are confident in our team's ability to find opportunities in adversity and unlock further potential in China. We will continue to execute our RGM, which stands for resiliency, growth and moat, framework to strengthen our competitive position and capture long-term growth.

With that, I will turn the call over to Andy. Andy?

Ka Wai Yeung Yum China Holdings, Inc. - CFO

Thank you, Joey, and hello, everyone. Let me now go through the third quarter performance in detail. We saw sequential improvement in the third quarter. System sales returned to growth year-over-year and restaurant margin was the highest since 2018, well above our expectations. We focused on driving sales through new products and compelling value. Same-store sales recovered to the same level a year ago. From a timing perspective, the trend remains volatile impacted by frequent COVID outbreaks.

In July and August, we saw a sequential recovery in same-store sales, and August exceeding the prior year. This was mainly due to

REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us

4

©2022 Refinitiv. All rights reserved. Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies.

NOVEMBER 02, 2022 / 12:00AM GMT, Q3 2022 Yum China Holdings Inc Earnings Call

lapping the Delta variant outbreak in August 2021, which heavily impacted Eastern China. However, in September, same-store sales declined mid-single digits as COVID-related health measures tightened in many areas. Around 900 stores were temporarily closed or provided limited services in September compared to around 400 stores on average in July and August. On the margin side, we continued to identify cost-saving opportunities, drive labor productivity and rebase our cost structure.

Let me go through the financials and our cost control initiatives. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 6% in the quarter. Third quarter total revenues increased 5% year-over-year in reported currency to $2.68 billion due to the contribution of new units and the consolidation of Hangzhou KFC. This was partially offset by temporary store closures and foreign exchange translation. In constant currency, total revenue grew 11%. System sales grew 5%. Same-store sales were flat year-over-year.

By brand, KFC same-store sales were flat with same-store traffic at 93% of prior year's level. Ticket average grew 8% due to the increase in delivery mix, which has a higher ticket average than dine-in. Abundant value campaigns, like the Family Bucket and Buy More Save More, also strongly contributed to higher ticket.

Pizza Hut same-store sales grew 2% year-over-year.Same-store traffic grew by 2%, while ticket average was flat. Higher delivery mix, which has a lower ticket average than dine-in was offset by discount management.

Restaurant margin was 18.8%, 660 basis points higher than last year. The year-over-year increase was mainly due to higher productivity, temporary relief and sales leveraging. These were partially offset by inflation in commodity, wage and utility costs. Rider cost also increased due to higher delivery volume.

Our team worked diligently to improve our cost structure, so let me next go through each expense line item and the actions we have taken. Cost of sales was 30.7%, 150 basis points lower than last year. We focused on the most effective campaigns to drive traffic. That allowed us to be more cost efficient while ensuring great value for money. We also managed commodity price inflation to low single digits.

Cost of labor was 23.5%, 210 basis points lower than last year. This was mainly due to improvement in labor productivity and relief recognized in the third quarter of $17 million. These were partially offset by increasing rider costs from higher delivery sales mix and wage inflation of 2%. We improved labor productivity by, one, optimizing staff scheduling and hiring; two, sharing restaurant management teams across stores; and three, leveraging digital tools to automate processes, such as digital ordering and inventory management. There was also a lapping impact due to higher staffing levels in 2021 caused by the sudden Delta variant outbreak.

Occupancy and others was 27%, 300 basis points lower than last year. This was mainly due to our cost-saving initiatives and lower rental expense as a percentage of sales. In addition, we pulled back on marketing and advertising.

Rental expenses were lower in the quarter due to, one, rental relief of $13 million; two, smaller store format with lower upfront investment and better store economics; and three, negotiating more rental relief with variable components.

G&A expenses increased 16% year-over-year, mainly due to increased compensation and benefit expenses, consolidation of Hangzhou KFC and incremental expenses from emerging brands. There were also onetime expenses associated with primary listing conversions in Hong Kong.

Operating profit was $316 million, a 77% increase year-over-year. The net contribution from Hangzhou KFC consolidation was 6% of total operating profit in the quarter. It includes amortization of intangible assets acquired, which was roughly $16 million per quarter. This will run through the end of this year.

Below the operating line, we incurred a [$12 million](corrected by company after the call) mark-to-market net loss on our equity investment in Meituan in the quarter. It was lower than the $32 million net loss in the same period last year. The effective tax rate was 29.9%, 160 basis points higher than last year due to Hangzhou KFC consolidation. Prior to consolidation, the equity income from JVs was

REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us

5

©2022 Refinitiv. All rights reserved. Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies.