Operator: Thank you all for standing by and welcome to the Yum China Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. All individuals remain in a listen-only mode. There will be a discussion followed by a question-and-answer session. I’d now like to hand the conference over to your very first speaker, Ms. Michelle Shen, IR, Director. Please go on.
Michelle Shen: Thank you, Zari. Hello everybody. Thank you for signing up with Yum China’s 4th quarter 2022 Earnings Conference Call. On today’s call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get going, I’d like to advise you that our revenues call and financier products consist of positive declarations, which undergo future occasions and unpredictabilities. Our real outcomes might vary materially from these declarations — from these positive declarations. All positive declarations ought to be thought about in combination with the cautionary declaration in our revenues release and the danger elements consisted of in our filings with the SEC. This call likewise consists of particular non-GAAP monetary steps. You ought to thoroughly think about the similar GAAP steps.
Reconciliation of non-GAAP and GAAP steps is consisted of in our revenues release. Today’s call consists of 3 areas. Joey will discuss our journey in the previous 3 years and go over 4th quarter efficiency. Andy will then cover the monetary efficiency and outlook in higher information. Finally, we will open the call to concerns. You can discover the webcast of this call and a PowerPoint discussion, which includes functional and monetary highlights on our IR website. Finally, we prepare to host our 2023 Investor Day in Shanghai through September. We eagerly anticipate sharing more information about this occasion with you in due course. Now, I wish to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?
Joey Wat: Thank you, Michelle. I wish to want everybody joining us today a happy and healthy Chinse New Year. Before taking a look at the 4th quarter and complete year, I wish to contemplate our journey these previous 3 years with COVID, a few of our essential knowings and how we have actually grown. First, I’m extremely grateful to the whole Yum China group for their dexterity, imagination, and persistence throughout this tough time. Together, we ended up being a more resistant, active business, much better placed for long-lasting development. During the previous 3 years, we rapidly rotated when purchasing traffic followed pressure. Delivery doubled from simply 20% sales mix in 2019 to 39% in 2022. Our hybrid shipment design and devoted riders allow us to record the boost in need.
Combined with takeaway, off-premise sales reached almost two-thirds in the 4th quarter of 2022. Digital buying likewise soared from 55% of sales in 2019 to now 89%. That’s over $20 billion in digital sales in 3 years. We preserved our quick development. Our store portfolio broadened by almost 40%, an overall of 3,800 net brand-new shops. KFC and Pizza Hut shops preserved a healthy repayment of 2 to 3 years, respectively. The very first year success of brand-new shops likewise enhanced. Strong brand-new store efficiency was driven by our versatile store design. We enhanced store size and protected more beneficial lease terms. For brand-new shops opened in 2022, over half remained in smaller sized formats. Such versatility permit us to continue to increase density in higher-tier cities, which is especially beneficial and useful for shipment and capture white area in lower-tier cities.
We boosted the protection and dexterity of our first-rate supply chain to assistance business development. We broaden from 29 to 33 logistics centers for much better self-sufficiency in each province. During broadened lockdowns, we include rail and sea freight to move our stock apart from our standard trucks. Our store stock presence system enables real-time sales forecasting and wise stock replenishment. These abilities help reduce extreme disturbance even throughout a lockdown and lessen waste. likewise supported item development by protecting supply at scale. Apart from our classic offerings, we launched over 500 new or upgraded menu items last year from regional offers to national launches. We invest in digital and automation to improve operating transparency and efficiency.
For example, we are rolling out smart order system, at KFC. The AI-powered system more accurately predict demand and recommend food preparation plan to minimize stock outs and wastage, and also reduce waiting time for customers. It also enhances customer experience by reducing wait time and providing real-time order update. And recently, we added a robotic service at one-third of our Pizza Hut restaurants, freeing our crews to serve customers. We remain profitable each and every quarter since the beginning of the pandemic in 2020. By rebasing cost structure and implementing austerity measures, we cushion shocks created by the volatile market situation. In the past three years, we were able to generate US$1.9 billion in free cash flow and returned over US$1 billion to shareholders.
Notably, I’m proud to say we did this while also protecting the jobs of our employees. We have had no staff layoff since the pandemic began. Looking back over this period, we see opportunities to improve our ability to operate in good times and bad times. Looking forward, our anti-fragile operations will enable us to shine and drive long-term growth in China. Now let me provide some highlights for the fourth quarter and full year. 2022 was built with unprecedented challenges. In just 12 months, we managed sporadic COVID outbreaks, entire city lockdowns, nationwide infection and the certain lifting of COVID-related restrictions. In October and November, COVID infection quickly evolved into major regional outbreaks, leading to tightened COVID-related measures.
In December, as China entered a new phase of COVID response, we face brand new challenges. With surging infection rates, a significant portion of our employees and riders became infected, resulting in a labor shortage. Thousands of our stores were temporarily closed or only provided limited services. Many residents also opt to stay home to avoid infection or recover from symptoms. Buying traffic fell sharply. During this time, as always, the health and safety of our employees and customers remain our top priority. We moved quickly and support our employees with the relief medicines and antigen test kits. We mandate daily testing for all crews and riders to minimize infections, and we organize informative health talk and a consultation hotline for our employees.
At the same time, we took immediate steps to address the labor shortage. We simplified the menu, shortened operating hours and optimized labor shifts. We reallocated crew resources among stores, prioritizing stores with stronger demand, and we adjusted delivery operations, encourage customers to pick up orders and promote packaged food products. I’m thankful for our team’s nimble actions and amazing execution. Even in this challenging quarter, we delivered substantial year-over-year restaurant margin expansion despite lower sales. This was achieved by our extensive scenario planning, operational efficiency improvement, cost rebasing initiatives and temporary relief. We were also able to open a record 538 net new stores in the fourth quarter or 1,159 net new stores in the full year.
Let’s move on to the brand. By brand, KFC and Pizza Hut continue to introduce delicious food and exciting campaigns to delight our customers. At KFC, new categories grew with solid momentum. Juicy whole chicken, and beef burger, , doubled in sales in 2022. Combined, we generate around 5% of KFC sales mix in the fourth quarter, nearly equal to our Original Recipe chicken. We continued to introduce more flavors in these categories, such as the Spicy Whole Chicken, , launched during Chinese New Year. Following the success of Pokemon Psyduck in quarter two, , our toys in the fourth quarter also generated huge social buzz. These include Fancy Chicken, , and Fluffy Chicken Popcorn, both were originally designed as pet toys or toys for your pet, but quickly became very popular with all customers and drove traffic.
At Pizza Hut, pizza sales grew nicely for the year, reaching almost 40% of sales. We sold over 100 million pizzas in 2022, that’s nearly seven pizzas per second. Apart from our signature pan-tossed and crispy pizzas, we have added stuffed-crust pizzas. Customers can choose fillings like double cheese, sausage and meat floss, Rousong. These new launches encourage the trade up and lift effective price. We continue to offer stunning value for money. Our signature value campaign at KFC, Crazy Thursday, , attract excellent traffic, generating over 50% more sales on Thursdays compared with other weekdays. Sunday, Buy More Save More continues to spur weekend sales. Customers love the option to make the math and the sizable discount. At Pizza Hut, we brought back the wildly popular two pizza for CNY 59 promotion in November.
The amazing value drove great traffic and sales uplift. New retail packaged foods provide us flexibility during lockdown and when we were short of staff. In 2022, packaged food sales grew 90% and reached nearly CNY 900 million. We continue to broaden our offerings, adding some of the classics such as our egg tart and Popcorn Chicken Now moving on to our emerging brands. We have solid management teams and strategies in place. While it will take time to fine-tune and test the business model, we are making solid — Lavazza continues to execute its four-pillar strategy, which includes brand building, menu innovation, digital and delivery, and store development. Throughout the year, we introduced new coffers flavors such as orange buffalo latte with buffalo milk.
Photo by Hanny Naibaho on Unsplash
We also introduced sweet and savory food that would pair well with coffee, such as Cube Cornetto, which is a fluffy, . Loyalty members more than double to 1 million in 2022, continue — contributing to over 40% of sales. We enhanced operational efficiency and optimize new store designs, lowering upfront investment. Although COVID disruptions have delayed store openings, Lavazza reached 85 stores by the end of quarter four. Taco Bell doubled its store count in 2022 to 91 stores. We continue to localize the menu for Chinese customers. For example, a crispy one-time taco, , use duck and a one-time wrapper in place of a tortilla. Why not? We also continue to improve the value proposition, customer experience and unit economics. Little Sheep and Huang Ji Huang were expectedly impact by COVID due to their dine-in focus.
We used 2022 to refine their business models and strengthen fundamentals from menu, marketing, store models, supply chain to digital initiatives. Huang Ji Huang also continued to generate operating profit. To wrap up, with a new chapter opening in 2023, we are excited to see positive momentum in the Chinese New Year season. We took decisive action to ensure operational efficiency and capture sales. At KFC, we broadband our signature Golden Bucket, , which is a holiday favorite. At Pizza Hut, we introduced a holiday-themed pizza with wagyu beef and seafood. It’s called , which is inspired by a popular game. It’s gratifying to see how our delicious food play an important part in our customers’ celebration during the holiday. Yet COVID remains a reality, and many challenges still lay ahead, including cautious consumer spending through the holiday.
While we anticipate the road to recovery will be gradual and uneven, I’m optimistic that brighter days are ahead. We will continue to execute our proven RGM strategy, which stand for resiliency, growth, and strategic mode, to capture the growth opportunity and deliver shareholder value. With that, I will turn the call over to Andy. Andy?
Andy Yeung: Thank you, Joey and belated Happy Chinese New Year to everyone. Let me share with you our fourth quarter performance. As Joey mentioned, we faced an extremely fluid and challenging fourth quarter as there were substantial changes in COVID conditions and related policies. In late November, due to rising infections and strict COVID-related health measures, the number of stores that were either temporarily closed or offer only takeaway and delivery services, reached a peak of over 4,300 stores. In December, we faced a different situation where most of the COVID measures were lifted. Due to labor shortage, we had to temporarily close or provide limited services at over 1,300 stores on average. In such a vital environment, we took quickly action to capture off-premise demand.
Furthermore, we controlled costs, limited wastage, and enhanced item despite lower sales. Our team did a wonderful job improving restaurant margins by almost three percentage points despite very difficult circumstances. Let us now go through the financials. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 11% in the quarter. Fourth quarter total revenue declined 9% year-over-year in reported currency to $2.1 billion. In constant currency, total revenues grew 2%. The contribution of brand-new units and the consolidation of Hangzhou KFC were partially offset by same-store sales decline and temporary store closures. System sales and same-store sales both declined 4% year-over-year.
By brand, KFC same-store sales were 97% of the prior year’s level, with same-store traffic at 84%. Ticket average grew 16% due to the rise in delivery mix, which has a higher ticket average than dine-in. Pizza Hut same-store sales were 92% of prior year level. Same-store traffic was at 98%. Ticket average was at 95%, driven by lower ticket average of delivery orders and smaller party sites due to the pandemic. Restaurant margin was 10.4%, 290 basis points higher than the prior year. The year-over-year increase was mainly driven by labor productivity, operational efficiency and temporary relief. These were partially offset by the sales leveraging impact, which includes temporary store closures, as well as higher rider costs due to high delivery volume.
We also faced inflationary headwinds in commodity and labor costs. Our team worked hard to protect margins during the fourth quarter, which is seasonally slow in terms of sales and profits. Let me go through the key products and highlight the actions we took. Cost of sales was 31.9%, 60 basis points lower than prior year. We kept commodity inflation relatively modest by strategically locking in prices and innovating the menu. We also carefully planned promotional activities and reduced wastage. Cost of labor was 28.8%, 90 basis points higher than prior year. This was mainly due to increased rider cost from higher delivery sales mix, low single-digit wage inflation and sales leveraging. This was partially offset by better labor productivities and temporary relief of $14 million.
Occupancy and other was 28.9%, 220 basis points lower than prior year despite sales deleveraging. This was mainly due to lower rental expense and other cost-saving initiatives. Rental expense, as a percentage of sales, benefited from rental relief of $12 million, strong portfolio optimization and more favorable lease terms. G&A expenses increased 2% year-over-year, mainly due to increased compensations and benefit expenses, as well as the consolidation of Hangzhou KFC. The increase was partially offset by cost control initiatives. Operating profit was $41 million compared to $633 million in year period. In the fourth quarter of 2021, we recorded a non-cash gain of $618 million from the remeasurement of our previously held equity interest in Hangzhou KFC.
By excluding the remeasurement gain, adjusted running profit increased 189% year-over-year from $60 million to $40 million. The net contribution from Hangzhou KFC’s consolidation was 12% of operating profits in the quarter. We included the last quarter of amortization of intangible assets acquired, which was roughly $15 million. Effective tax rate was 29.9%, 480 basis points higher than prior year, due to lower pre-tax income and Hangzhou KFC consolidation. Prior to consolidations, the equity income from JVs was not subject to tax, resulting in a lower tax rate. Net income was $53 million. Adjusted net income was $52 million. Excluding the $4 million mark-to-market net gain on our equity investment in Meituan in the quarter and the $9 million net loss in the prior year period, adjusted net income grew 154%.
Due to the diluted EPS and adjusted EPS were at $0.13, the mark-to-market gain in Meituan increased value EPS by $0.01. In December, we acquired an additional 20% stake in Suzhou KFC JV for approximately $115 million. This increased our total ownership in the JV from 72% to 92%. For the full year 2022, we generated free cash flow of $734 million. We returned roughly $668 million to shareholders in cash dividends and share repurchases. Cash, cash and short-term investments was $3.2 billion, down from $4 billion in the third quarter. The reduction in cash and short-term investments was mainly due to the reclassification of around $600 million from short-term investments to long-term time deposits. We invested in long-term bank deposits to benefit from better interest rates.
Let’s now turn to our outlook for 2023. In January, most of the temporary closed stores resumed normal services. Our same-store sales from the comparable Chinese New Year holiday season were up mid single-digits year-over-year, but remained below the compared level. Same-store sales benefited from pent-up need as the relaxation of COVID policy coincided with the Chinese New Year holiday. However, the real test will be the sales trajectory after the holiday, as we face more cautious customer spending and macroeconomic uncertainties. Looking ahead, we are encouraged by the new COVID policy. The future indeed looks bright. But we must keep a level head and recognize that uncertainties and challenges still lie ahead. Our country has shown that further outbreaks in the emergence of new COVID variants will pass after COVID restrictions are lifted.
We likewise face macroeconomic headwinds such as elevated commodity and wage inflation as well as softening global economic conditions. These factors may impact our operations and consumer spending in China. Now at the risk of sounding like a broken record, we continue to expect recovery to take time and be non-linear and uneven. For 2023, our top priority is to drive steps. At the same time, we will remain agile. One of the lessons we learned in the recent years is the importance of planning and preparing for a wide range of scenario, both to capitalize on growth opportunities and to mitigate risks when needed. On store development, we are targeting to open 1,100 to 1,300 new stores. We expect capital expenditure of $700 million to $900 million to support organic growth remodeling, digital, supply chain and other infrastructure development.
As always, the quality of growth is what matters to us the most, not just the quantity. So we will continue our systematic and disciplined approach to investment and growth. Finally, we remain committed to returning capital to shareholders. The Board has approved to raise the cash dividend from $0.12 per share to $0.13 per share. This is supported by our healthy balance sheet and strong cash flow. With that, I will pass you back to Michelle to start the Q&A. Michelle?
Michelle Shen: Thanks, Andy. We’ll now open the call for questions. In order to give more people to chance to ask questions, please limit your questions to one at a time. Sari, please start the Q&A.
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