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spk01: Good day and thank you for standing by. Welcome to the Yum! China's first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. And I'd like to hand the conference over to your first speaker today, Ms. Debbie Ding. Thank you. Please go ahead.
spk10: Thank you, operator. Hello, everyone, and thank you for joining Young China's first quarter 2021 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Watt, and our CFO, Mr. Andy Yang. 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. Reconsideration of the non-GAAP and GAAP measure is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding recent development and our first quarter 2021 results. Andy will then cover the financial performance 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 Wang, CEO of YamChina. Joey?
spk06: Thank you, Debbie. Hello, everyone, and thank you for joining us today. Our first quarter results demonstrate the resilience of Yum! China. We delivered $342 million in operating profit. System sales grew 34% year-over-year as same-store sales recovered with 10% growth. We accelerated our store expansion, opening 315 new stores in a quarter. First quarter trading was adversely affected by the resurgence of COVID outbreaks and tightened public health measures. The impact was particularly pronounced in northern China where cases spike and in transportation locations due to sharply lower passenger volumes. I would like to thank our 400,000 plus employees and riders for their contributions during this difficult period. Many of them did not return to their hometown to celebrate a holiday with their families, instead serving our customers and communities. We delivered these strong results with the dedication and agility of our people. The pandemic has introduced volatility and uncertainty to our trading patterns. Our team acted and reacted nimbly to changing conditions. By planning for a variety of possible situations, and deploying resources flexibly, we overcome operational challenges. Partnering with our suppliers and through inventory and production planning, our in-house supply chain managed complexities and potential disruptions to fulfill the demand of our 10,000-plus store network. Our operations team ensured best possible level of restaurant staffing and delivery riders. Our operational effectiveness is facilitated by our digital capabilities. Amid the fluid situations, we were able to quickly adjust offers and deploy labor as demand patterns shifted. It certainly reinforces our determination to continue investment in digital technology and supply chain to fortify our competitive advantages. Let me now update you on our core brand. First, let's start with KFC. KFC delivered Operating profit of 327 million. System sales grew 24%. KFC continued to rapidly expand, opening 253 new stores in the first quarter. During Chinese New Year, we kept our operations simple to address the heavy food traffic. We focused on our signature products of fried chicken and burger. Our golden bucket, Xin Chuan Jing Tong, offered abundant value and resonate well with customers. With a variety of buckets, we captured different party sizes. In the off-peak period, we brought back KFC's signature beef wrap, and add crayfish to make it more premium and exciting. We also launched the new Chongqing chili pork burger, . As part of the offering, we ran a special promotion with the popular action role-playing game Zhenxing Impact Yuanshan, which was very well received by younger customers. Our leading digital and delivery capabilities enable us to stay agile in this fluid situation. Despite the recovery in DaYin, delivery remains popular and accounted for 28% of sales, up 10% compared to pre-COVID level in first quarter of 2019. We drove this rapid pace of growth through our hybrid delivery model. Omni-channel marketing in our own super app and aggregators drive demand, while fulfillment is done by our own dedicated riders. This allowed us to capture delivery demand with sufficient riders, which was especially crucial in ensuring the success this Chinese New Year. Delivery growth was also enabled by our continuous investment in strengthening our delivery capabilities. We started trade zone-based rider sharing in 2019. Last year, we upgraded our rider platform to improve zoning, rider routing, and monitoring. We also started testing rider sharing between KFC and Pizza Hut. This is the first time we put the platform to test during Chinese New Year peak period, and we are pleased with the progress. Leveraging our digital assets and direct connections with our over 290 million members, we were able to shorten the lead time of our marketing campaigns and modify them so that we can be more responsive to changing market conditions and consumer demand, of course. Our digital infrastructure also allowed us to deploy the appropriate supply and staffing level where needed. Digitization is essential to operating efficiently. As part of our end-to-end digitization initiatives, we pilot launched an AI-enabled restaurant inventory management tool, leveraging historical data, recent trends, and real-time inventory levels. This tool improves forecast accuracy for our limited time over. This enables us to optimize inventory and improve productivity. Now let's move on to Pizza Hut. We are encouraged by Pizza Hut's strong recovery in the first quarter. Sales grew 38% and operating profit reached $60 million. These results reflect our efforts to improve fundamentals. Let me provide an update along the four key pillars. First, our product offerings have significantly improved over the past few years. We have several successful product launches during Chinese New Year, such as serving turf platter with sea bass and steak, a flower-shaped stuffed crust pizza, a year-old holiday feast set featuring signature products. These products were great for sharing and were well-received by consumers. Pizza Hut refreshed its menu, replacing 40% of the menu with new or upgraded offerings, such as beef Wellington and roast beef tapas. We also introduced Portuguese chicken curry, a popular dish on the delivery menu to dine in. We also have been unlocking the growth potential of breakfast and afternoon tea. We strengthened the menu with new offerings, such as French toast for breakfast. and a three-layer tea set for afternoon tea time. Apart from good food, we have also been actively engaging customers both offline and online. During Chinese New Year, we celebrate the festival with consumers by bringing in some of China's intangible cultural heritage, such as shadow puppetry and paper cutting into our stores. And then on the digital front, we have been strengthening our membership program and super app to engage members and improve customer service. Our member base exceeded 90 million and contributed 55% of total sales, up 9 percentage points year-over-year. Digital ordering increased to over 80% of sales from 65% a year ago, as table-side mobile ordering became more popular. We are also applying digitization and automation in our kitchens to improve operations. As part of a multi-phase intelligent kitchen project, we started to roll out an AI-enabled tool to pace food preparation and provide real-time metrics of kitchen performance. Initial results have shown improved efficiency and customer experience. Third, Pizza Hut is strengthening its delivery takeaway and ready-to-cook offerings. Delivery accounted for 35% of sales an increase of over 10% from pre-COVID level in first quarter 2019. While growing from a small base, we are expanding our takeaway and ready-to-cook business through manual innovation and making them more convenient for consumers. Lastly, we enhanced our store portfolio through accelerated remodels and new store formats. Since 2018, we have refreshed nearly half of Pizza Hut stores to make them more relevant to our consumers. This is over 1,100 stores. As we promised in the 2019 Investor Day, average store age is now below three years. The stores look great. The new small store format, which includes the hub and spoke model, which is also mentioned in the 2019 Investor Day, is creating more opportunities for Pizza Hut's expansion, enabling us to capture the growing demand for off-premise dining. Of the 44 new units that we opened in the first quarter, over half are in small store format. I'm confident that we will unleash Pizza Hut's growth potential through this combination of much improved fundamentals, strong digital capabilities, multiple sales channels, and rejuvenated assets. In summary, we're pleased that our brands react quickly to the fluid market conditions and deliver strong operating profits despite those pressures. Most importantly, we remain optimistic about our long-term growth opportunity in China. We will continue to accelerate store expansion for our core brands, grow our emerging brands, and enhance end-to-end digitization and intelligent supply chain to build a bigger and nimble Yum! China. While we are optimistic about our future, we remain cautious about near-term conditions. Occasional COVID outbreaks, like we saw recently in Vietnam, are a constant reminder that we are not back to normal yet. Tightened public health measures continue to be a daily routine and continue to have a lingering impact on consumer behavior. Dying volume is still well below pre-COVID levels, but we are not sitting still. our nimble and innovative culture enable us to adjust marketing and operations quickly as things evolve. With that, I will turn the call over to Andy. Andy?
spk02: Thank you, Joey, and hello, everyone. Let me now provide additional details on our first quarter financials and then share perspective on this year's outlook. Unless noted otherwise, all percentage changes are before the effects of foreign exchange, Let me first cover our Q1 financial results. We experienced substantial year-over-year growth in the first quarter as we began to lap COVID-19 impact period last year. Total revenue grew 36% year-over-year, led by same-store sales growth of 10%, new unit contribution, and substantially fewer temporary store closures. Because of the volatility induced by the pandemic in 2020, the year-on-year comparisons are less representative. Looking at the two-year change gives a better sense of how we are trending back to pre-COVID levels. So we are providing performance measures here for a convenient comparison with 2019. Same-store sales recovered to approximately 94% of the first quarter of 2019, Total revenue grew roughly 7% compared to first quarter 2019, benefits from new units and consolidation of Suzhou KFC and Wangjiwa. As we discussed in the last earning call, the sales recovery was disrupted by the resurgence of regional outbreaks and significantly reduced travel. Travel volume during the 40 days Chinese New Year period was down approximately 40% year-over-year and 70% compared to 2019. These impacts were more pronounced for KFC as it has more stores in the transportation locations. On a year-over-year basis, KFC same-store sales grew 5% driven by the recovery of dine-in sales while delivery remains popular. On a two-year basis, sales recovered to approximately 94% with the same-store traffic at approximately 87%. Average ticket grew roughly 87% versus 2019 due to increase in delivery mix. The respective average ticket of delivery and buy-in remains flat. These are how same-store sales grew 38% year-over-year, driven entirely by the recovery of traffic. On a two-year basis, sales recovered to approximately 95%, led by a 2% increase in traffic. This is a true testament to the success of the brand has achieved in executing its revitalization plan. Unlike KFC, the increase in delivery and takeaway makes contributed to lower ticket average versus 2019. Restaurant margin was 18.7%, up eight points compared to last year. This was mainly driven by sales leverage, operational excellence, and favorable commodity prices. Cost of sales was 30.2%, which was 180 basis points lower than last year. Commodity prices declined by 7% year-over-year, mainly held by lower poultry prices. The impact was partially offset by investment in promotion to dry traffic. Cost of labor was 23.3%, 220 basis points lower than last year. Sales leverage and labor productivity improvement more than offset wage inflation and diminished government subsidies. Given the labor shortage that we are experiencing, we are still actively seeking to hire additional restaurant staff. Occupancy and order was 27.8%, 4.2%. lower than last year, mainly attributable to sales leverage and savings in other operating costs. We also received approximately $6 million in rental reductions and government relief. Compared to 2019, restaurant margin was radically flat. Productivity gains and cost control offset sales leverage, investment in value promotions, and increased wider costs associated with the rise in delivery volume. G&A expenses increased 24% year-over-year, mainly due to a timing shift of government incentives, gradual phase-outs of COVID-19-related relief, and the consolidation of Wang Ji Wang and Suzhou KFC. Excluding this impact, G&A increased 3% reflecting our ongoing cost controls. Offering profit was $342 million compared to $97 million last year. The increase was mainly driven by sales and restaurant margin improvement, partially offset by the increase in G&A expenses. Our effective tax rates were 29.6%. Net income was $230 million, and adjusted net income was $233 million, excluding $16 million market-to-market investment loss. It was $249 million, up 225% year-on-year. Dollar EPS increased to 53 cents. This reflects common share that were issued as part of our secondary listing in Hong Kong in September 2020. Now let's turn to the outlook. As Joey noted, we are optimistic about our growth opportunities in China, but we remain cautious about the near-term environment. While the pandemic impact is subsiding, we must be mindful that the pandemic is not over yet. The full recovery takes time with an uneven and nonlinear recovery path. We are confronting a couple of realities here. First, preventive measures will remain in effect. This will have a continuing impact on consumer behavior. Serotic outbreaks will remind consumers of the lingering risks social distancing and smaller gatherings may persist for some time. Die-in occasions are still well below pre-COVID levels. Second, consumer spending is cautious. Government data shows that despite apparent recovery in domestic travel volume during Changming holiday weekend in April, the related travel spending was still down over 40% comparing to pre-pandemic level in 2019. In fact, sales at our transportation location remain well below 2019 levels. Against this backdrop, we expect it will take time for same-store sales to fully recover to pre-COVID levels. We will focus on driving top-line growth with compelling value propositions, more marketing campaigns, product innovations, and digital engagement with consumers for both in- and off-premise applications. While necessary, this initiative will pressure our margins. Apart from that, we face other cost impediments. The tailwind of favorable commodity prices in the first quarter will likely gradually subside. At this time, we expect post-priced prices to rebound and potentially turn into inflationary pressure later this year. In addition, to replacing plastic packaging with eco-friendly materials, we will also invest packaging upgrades for delivery and takeaway. We expect labor costs to increase in the subsequent quarters. There are two components to that. First, wage inflation was 2% in the first quarter as minimum wage increases were deferred in certain markets. We expect wage inflation to pick up in the second half of the year. Four-year wage inflation should stay at mid-single digits. Second, increase hiring. In the past few quarters, we have been short of part-time workers due to COVID-related restrictions. We're working to increase restaurant staffing levels. While this will increase training hours and wage expenses, it is critical for our customer services and long-term viability. We have approximately $6 million of temporary relief from the government and landlord in the first quarter. This was partly due to a timing shift of amount previously applied in 2020. We expect this support to taper off as the year progresses. As a reminder, we are lapping over $100 million relief in 2020. In the second quarter 2020 alone, we received approximately $50 million in relief. Step-up investment in technology, end-to-end digitization, and operational infrastructure will strengthen our capability and further solidify our competitive position. But in the near term, this will pressure our margins and offering profits. Rough links up, we're working diligently to drive same-store sale recovery and accelerate store expansion. We are also committed to invest to drive accelerated growth and create value for our shareholders in the long term. With that, I will pass you back to Debbie to start the Q&A. Debbie?
spk10: Thanks, Andy. We will now open the court for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A.
spk01: Excellent. Just a reminder, if you wish to ask a question, it is Star 1. To withdraw your question, please press the pound and hash key. Once again, it is Star 1. Thank you. We have multiple questions in the queue. Our first question is from Brian Bittner from Oppenheimer. Please ask your question, Brian.
spk00: Thank you. I hope you all are doing well and staying safe. Can you help the investors in the United States just better understand who are not in China better understand what type of consumer trends you're seeing in your store base that are not located in the transportation hubs. I understand the transportation locations are challenged, given the transportation trends. But overall, you've already recovered 94% of your pre-COVID sales volume. So you're pretty close to a full recovery. So are you seeing a more clear path to pre-COVID sales levels in those markets that are outside the transportation hubs? Or is there still a lot of volatility and headwinds related to the pandemic in those more traditional markets?
spk06: Thank you, Brian. We are all staying quite safe in Shanghai. China is recovering quite smoothly despite not completely out yet. Let me give you... an overall picture about the Chinese New Year trend and then compare the KFC versus Pizza Hut and then a bit specific about the non-transportation hub. Hopefully that gives some ideas about what's going on here. So let's start with the Chinese New Year. We had a lot of uncertainties before going to Chinese New Year because the trading was a bit soft. And what our company has done is to pair have quite a few scenarios planned. So we react quickly. And as we adapt to the market condition, the trading picked up during Chinese New Year and was robust. But after the Chinese New Year, we continue to see some weaknesses in trading, particularly in transportation hub. Outside transportation hub, to answer your question, the dining volume is still well below the pre-COVID pre-COVID level. That's why we remind our investors that we are not out of the woods yet. But what can we do? We stay agile and we plan for the possible scenario. So that's point one. In terms of point two, which is, you know, a big picture of KFC versus Pizza Hut, we are happy with both brands' recovery because the QM results show the resilience and the energy of both brands. The sales was disrupted, but with the scenario planning, the year-on-year sales for KFC Pizza Hut, and I'm referring to two years, so pre-COVID-19 level, KFC was minus 6%, which is 94%, and that includes the impact of the transportation of Pizza Hut recovered to compared to 2019 Q1 without much of the transportation hubs in their store portfolio. So that gives a sense because 2020, the numbers are a bit unusual. And then when we look at the system sales, the Pizza Hut compared to 2019 is still minus two because Pizza Hut did not open that many stores last year, although we are picking up in Q1. But KFC system sales recovered to plus 6% versus 2019 because we opened a lot of stores last year. So I hope that gives a sense that, you know, it's not, with or without the transportation hub, the single sales is still having a little bit gap with this 2019. So come to a bit more specific about the trend and the trading. Andy talked about the transportation hub business is still 40% down compared to 2020, and that's the traffic. And in terms of sales, it's pretty much in line, although we do slightly better than the traffic number. And then in terms of city tier, I'm talking about KFC because KFC still covers 1,500 cities in China, over 1,500 cities in China. So that gives a better big picture of what's going on here. The lower tier cities have better sales, same-store sales, than the higher tier cities. mainly because the higher-tier city stores have the element and mix of transportation stores. And then the delivery growth is better in lower-tier cities. And the eastern part and western part of China led the recovery. Northern part and northeastern part of China, because of the regional outbreak, they have been a bit softer. And then weekday, our traffic is pretty much back to where where it needs to be or where we want it to be because we have a bit more promotion to drive the weekend traffic, which was a bit soft before, but now it's back to pretty normal. And then for the non-transportation hub stores, just single out these set of stores. It's about 2% gap versus 2019 or pre-COVID level. So, Brian, I hope that gives you a comprehensive view of the trading. From consumer behavior point of view, they're still quite value cautious, and therefore we still have to be mindful about the value that we can pass on to consumers. But that's not the only thing they want. They still want new products. So other than value, we still launch new products to make sure that we encourage the customer to come back. So I'll pause here on any... Yeah, I just have a couple of things to add there.
spk02: Brian, good evening to you. I think for the folks outside of China, I think it's important to keep in mind that we're still facing quite a bit of uncertainty and challenges related to COVID-19. So even though things seem to have calmed down a lot here, we did have a regional resurgence you know, at the end of last year and beginning of this year, right? So they have an impact on our first quarter trading. So, and then when we look around, you know, I think we still, you know, have quite a bit of health preventive measures that are still in place. So that was still, and then governments will continue to remind folks to stay alert, not to be alarmed, but stay alert, you know, on the COVID situation. And as we, you know, look, you know, outside of China, and then we have seen, you know, resurgence, in some other countries in Asia, including, you know, Japan and more recently, you know, the situation in India. So that reminds us that, you know, like, we're not out of the woods. So still a lot of challenges ahead. As Joey mentioned, you know, obviously, Transparency Hub is an important business for KFC. They account for a high percentage of the sales. So, you know, that will continue to be, you know, sort of like, you know, a challenge for them to overcome to reach that. fully recover SSG compared to the pre-COVID level. Same thing for the dining. Dining, I think, in the first quarter where traffic was still at about 87% level at the pre-COVID level. Our delivery business is doing fantastically well. It grew very strongly last year. I think this year we're still growing at mid-double-digit number. So that continues to be a bright spot for us, even compared to the COVID level, obviously, grew more than, I think, 60%, 70%. So that's sort of like the overall situation right now. Thank you.
spk00: Thank you. Thank you both for the perspective.
spk01: Next telephone question is from Chen Lau from Bofors Securities. Please ask your question, Chen.
spk11: Thank you, Joey and Andy. I've got a question on the margin side. So it seems that Pizza Hut posted pretty strong margins for Q1 this year. And in fact, if my calculation is correct, it should be the highest ever since 2018 or when we started the revitalization process. So what's our future strategy with regard to Pizza Hut in terms of balancing margins and seeing store sales growth. Is it fair to say that the future margin trend of Pizza Hut could be above the level that we saw during the past few years when we are in the process of revitalizing Pizza Hut? Thank you.
spk02: This is Andy. So let me try to address your question and then see if Joey has any follow-up. So, I think if you look at Pizza Hut, obviously, we're very pleased with the execution there. I think over the past couple of quarters, they have demonstrated that they have executed the Green Vata Student Program really well, and they are building on that resiliency. I think some of those, as we mentioned before, you know, obviously, you know, is improvement. I think, you know, if you look at the fundamentals, we continue to look at, you know, that improvement based on the fundamentals that we have laid out before, right? Store, bottling, you know, menu, the food. We also, you know, work on the digitization program, which worked out very well for us, you know, in the pandemics, right? We were able to pivot very quickly. So, and if you look at the digital number for tabletop orders, you know, it's quite incredible right now. It's almost like, you know, the extent of that. So I think they have, you know, did a really good job, you know, in revitalizing, you know, fundamental. I mean, their recovery is quite strong, but I don't think we can say, like, as a whole company, we cannot say that, you know, we're out of the woods compared to, you know, for the COVID level. So, you know, the top priority for them still is, you know, driving traffic, and we're glad that, you know, for the first quarter, In 2021, we see, you know, actually, you know, the traffic increased not only year-over-year, but also, you know, compared to the 2019 level in the first quarter. So, the next one is obviously drive that sales, sales number. And so, there's still some work there. And I think we will continue to emphasize on, you know, value for money. Value, as Joey mentioned, very important for consumer now in a as they're coming out from the impact from COVID-19. So, you know, again, you know, like, are we pleased with the progress in cost control, executions? But, you know, I think profit is still not the number one priority for us. We still, for PISA and also KFC, obviously, is, you know, to drive that store traffic, drive the consumer back to the store, and then, you know, aim for that full recovery in you know, themes of sales competitive pre-core level. But I think, you know, like if you look at Pizza Hut, some of the, you know, improvement would definitely continue. And some of that, as we mentioned before, for example, as we see the portion prices, the protein prices are going up, you know, that's in, you know, second half, like as the year progresses, we may see, you know, inflationary pressure there. Both brands are doing, you know, packaging improvement, right? You know, transitioning from plastic to eco-friendly materials, but also investing more into packaging for upgrades, for delivery, and also for takeaway products. That would also be somewhat overhanging there. Labor productivities have, you know, we have gained a lot of labor productivity improvement using technology, you know, the tool, the AI tool that we enable the restaurant operation. But some of that is, you know, sort of like due to the labor shortage that we have seen you know, in the second half last year. We have mentioned that. We continue to try to resolve that. We are looking into increasing staffing level, make sure that we continue to maintain a high level of customer services, and that's very important in the long term, I believe, right? So those are the couple of things. And then, again, you know, like if you look at the overall margin fund, you know, last year we received $100 million from, you know, government relief, right? So this year, you know, it's already phasing out. We have $6 million. in the first quarter and you expect that to continue to phase out as the year progresses. So all in all, we have some positive and then we also see some headwinds in terms of margin and cost.
spk06: Norton, I think I just want to add two comments. One is we have been very consistent with the path of recovery for Pizza Hut since the time we committed to turn around. we have always been very clear about our priority, which is sales first, profit later, and we focus on improving the fundamentals of the business in the last few years, and we are grateful that we are seeing the results. So that's point one. Point two is, what is next? The next is to focus on improving all aspects of the changes that we made in the last few years. and cement the changes made to make Pizza Hut a resilient business model. That's what we want, because that's what we have been trying hard to achieve for KFC, which is a very resilient business, and we want Pizza Hut to be a resilient business model as well. And at least in two aspects, we want to continue. One is self-first profit later. That's the path in the last few years. Next, we want both sales and profit. As I mentioned other occasions before, sales is vanity, profit is vanity, and we want a bit of both. Second, the second aspect of the Resilient Business Model, you can see we have been increasing and building our off-premise business. So now, between the delivery and takeaway, the off-premise business is over 40% of the business. And this is important because we are not relying too heavily on sign-in business. It's much better to have sign-in, delivery, and right now, takeaway or ready-to-cook product as well. You know, four pillars of the business instead of two pillars. So these are two examples of resilience that we are looking for. Thank you, Lorten.
spk11: Thanks a lot, Joey and Andy.
spk01: Our next telephone question comes from Michelle Chang from Goldman Sachs. Please ask your question, Michelle.
spk05: Hi, Joey, Andy. My question is about the occupancy and order cost. We actually noticed that this cost has been reduced. huge savings in the past few quarters. So can you give us more colors on the breakdown? And also more specifically on rental ratio, we heard from other like leading restaurant trends, they have a pretty favorable rental term post-COVID. So just wondering that compared with the pre-COVID level, are we also seeing a good rental saving and how sustainable these articles saving can be seen in the next few quarters? Thank you.
spk02: Michelle, thanks. This is Andy. So, regarding your question on O&O, I think you're right. Like, you know, we've seen, you know, quite substantial improvement, you know, coming from the O&O segment, you know, 7% year-over-year lower, and then roughly 1.4% lower than 2019 same period. I think, you know, as you can see these two numbers, O and O in a big part is driven by sales leverage. So that's the most important factor that's driving that. The other one is that if you look at utilities, there's two things that's going on there. I think over the past few years or so, the government have sort of reduced the utility cost to basically try to improve the business environment, especially during the pandemic. So that also helped. How long does it last? I think maybe end of the year or early next year. The other one is, you know, obviously over the past couple of years, we have tried to improve our kitchen automation operations. You know, we have mentioned, you know, smart utility device that we have installed in some of the store, you know, some of the procedures. So that also lowered that. And then also we mentioned that, you know, some of the savings due to rent relief, temporary relief, and some of the government relief you know, social security payments and whatnot. So that, I think, in the first quarter, we still have about $6 million. So all these combinations, you know, help us, you know, sort of improve that O2O as a percentage of our sales. But I think, you know, so I think some of those will carry forward, you know, but, you know, a big part of that would probably, you know, have to do with, you know, the sales leverage that we
spk07: Yeah, thank you, Andy.
spk01: Sure. The next telephone question is from Anne Ling from Jefferies. Please ask your question, Anne.
spk04: Hey, hi, Andy. Hi, Joey. I have a question, you know, regarding the operating the language. You know, it's a very good margin that we have experienced in the first quarter. I'm just wondering, like, you know, whether there is any, like... not one-off, but it's like, you know, a catch-up, you know, because the South has been so strong. So there are some of the investments that we need to do it, but because of the time shift that we, I mean... The question I want to ask is that what should we be expecting in terms of the operating margin in the coming couple of quarter? Is there some of the other investment that we need to play a catch up because first quarter was so good that there are some of the costs that might have left behind? So that's my question. And also a side question is on the delivery side. With this effort in terms of sharing the riders between Pizza Hut and KFC, in that case, in the past, we talked about a little bit of the margin dilution for the delivery business. With all these exercises, do you think that... At some point, our margin for delivery business will be at par to the dining-in, given the fact that the sales mix is getting higher and higher on the delivery side. Thank you.
spk02: Hi, Anne. This is Andy. Let me try to address your questions about some of the one-offs and whatnot. Obviously, I think last year we have received government subsidies and whatnot, and then, as you mentioned, So that is continuing to phase out. In the first quarter, we have a six-month down. I think that will continue to be the trend there. The other part is that, you know, for the cost of sales, for example, we were, you know, I think after a couple years of, you know, rising protein and commodity prices, beginning of second half last year, we can see that easing up. We benefited quite a bit in the first quarter. We see a 7% yield decline prices, for example. But as you have probably noticed that on the news, you know, like we see corn prices, you know, all the speeding stock that price is going up. We're already seeing, you know, like the protein prices, you know, going up both here in China, but also overseas. Our contractor locked up, you know, probably one to two quarter ahead of time. But we, as you mentioned, you know, we would see that tailwind beginning to subside as the year progress and potentially and likely potentially heading to inflationary pressure later on this year. The other one is obviously we have embarked on the facing of plastic and then as we see delivery and take away as an increasingly important part of our business, we are also investing into including the packaging for those operations. So you would probably also see the packaging costs would go up as the year progresses, as we continue to roll that out. But in terms of labor, I think part of that is obviously labor productivity. That we have been ongoing for a number of years now. The goal is really to continue to see that labor growth improvement by providing new technologies and toolkits to improve that operational operations. I think there's two issues there. One is that we did experience some labor shortage since the second half last year, as I mentioned. We tried to rectify that and then try to step up the hiring. We still are not at the level that we would like to see. So we'll continue to try that. The other one is obviously wage inflation. As the economy, as the pickup, as the pandemic impact subsides, as you mentioned, we identified some restrictions by gap in income mobility for some of the prime workers. But overall, I think the labor market will be getting tighter and tighter. And then we'd like to go to see which inflation is potentially also stepping up. And that is, you know, you have to remember that it's compounded for two years, right? So that's something that we have to work through. For delivery, I think it's not always necessary a, you know, it's more complicated story for the margins, you know, because we need to look at holistically, you know, obviously, you know, we have the delivery costs that just add up to it. But we also, you know, to see if we can improve our operation inside the restaurant, right, to improve margin. So if you look at our margin, for example, you know, before the pandemic, you know, you see that, you know, the sort of like ZOL margin relatively stable despite, you know, our delivery volume or percentage mix of sales increased from, I think, 6%, maybe... in 2016 to almost like 30% in 2019. So we are able to find a way to offset that increase in delivery costs. So we'll continue to do that as we invest, but that will likely continue to be a pressure, but we're trying to find a way to offset that. So that's overall. So I think, you know, like, I know we have to be very strong, probably, and we're very proud of our team in cost control. But you're right, going into the next few quarters, we're going to see some headwind in terms of cost and expenses.
spk06: Anne, hi. I just want to add three points to Andy's comment. In terms of cost side, we continue to work on F-cost, such as the Delivery 3.0 upgrade with rider platform upgrade, AI-enabled zoning, rider routing optimization that help. But what I really, really want to point out is point two and point three. These are the other aspects of the equation. Point two is about the sales upside during peak trading period and peak trading hour. have enough riders, we actually have more sales upside during the peak trading period. And Chinese New Year is a very good example. So it will be a bit misleading to ourselves if we just look at the cost side. So that's point two. Point three, if you think about this, when Andy said earlier it's a holistic approach, it is a holistic approach. It's not necessary That's straightforward to think that having more stores helped the delivery cost. But indeed, it was that way. When we increase the store portfolio density, then we reduce the average circle of delivery distance. For example, when we have more stores, we can reduce the delivery distance of the rider from five kilometers to three kilometers, and that reduces the cost. So it's not only just the cost. We have other quite a few aspects that we can do to both increase the sales and to manage the cost. And our number has shown that we have been able to do that in the last few years. Thank you, Anne.
spk02: And this is Andy. I want to add a little bit on Joey's comment. There's two things. One is Joey's correctly pointed out. If it's incremental sales, the profit margin is much higher. Obviously, the incremental margin should be higher. The other one is that, you know, in terms of, you know, the rider network effect. It's a very interesting thing that I think we're still looking to see how the dynamics work, right? You know, the high density network. That's enabled by the fact that we run our own delivery network. We have a hybrid model. We work with the aggregator, you know, with the traffic and our own app. But the delivery, we manage that operation outside. We have dedicated rider. So we can continue looking to improvement on the networking factor that benefits from that. So that may be a little bit different from, you know, the U.S. operational operators and some of the operational operators here in China. We want to create a unique model.
spk04: Got it. Thank you.
spk01: Thanks. Our next telephone question is from Lillian Lau from Morgan Stanley. Please ask your question, Lillian.
spk09: Hi, thanks. Hi, Andy and Joey. Yeah, I have actually one of the follow-up questions, because most of the questions were answered. That's still about the comment that Joey just made about to look at the business on the holistic approach. So compared to a couple of years ago when delivery was still a relatively smaller amount of the revenue, right now it's close to 30%. And also, the stored network in the lower tier cities, the intensity is actually higher. Compared to then, what kind of margin impact to this kind of dynamic changes? In particular, like delivery, we know that it still probably, it depends on the calculation, it probably still margin dilutive. But compared to a couple years ago, what kind of margin impact of these delivery and also lower tiers store changes to the margin? And what kind of projection we can make for the next couple of years. Will it be incrementally positive to margin? Thank you.
spk02: Okay. Thanks, Lillian. This is Andy. Let me take a crack at this, and then maybe if Julie has more additional ads, she can add a little bit more later. In terms of delivery, I think, you know, it's fair to say, you know, the delivery margin is dilutive to the overall corporation. As we mentioned before, you know, like, we generally look at the restaurant operation holistically. So we have multiple ways of delivering the product to our customer. Dine in, take away, and deliver it. Now, it's important to look at, obviously, the restaurant margin for us, because food is unlike e-commerce. E-commerce, you don't need, you just warehouse and you can distribute to the consumer. Food, you need to deliver to the consumer at a certain time to ensure quality of the food and then customer satisfaction. So having a production or restaurant location is almost a month. For us, if you look at, you know, the delivery, delivery has been growing very rapidly. I think, you know, we believe that, you know, that's incremental to our overall sales, you know. And then the other part is that, you know, if you look at overall restaurant margin, for example, you know, for, you know, Pepsi, before the, you know, pandemic, it was relatively stable, right? So, you know, it's about 18% in 2017, 18, 19. And then we are back to a similar level in the first quarter this year. So all through this period, obviously, delivery has been increasing as I mentioned before. Delivery was about 11% of our sales in 2017, and now it's about 30% plus. So we're able to maintain that margin. Obviously, it's hard work. I will go into it, but it hasn't been, you know, particular that we took to, you know. The other one is that if you look at, you know, for example, the labor cost expenditure, for example, you know, for KFC, right, for example, you know, it has been also relatively stable, despite, you know, obviously we continue to see wage inflation in China at, you know, before the pandemic to a high single digit level, right? So if you look at KFC's, you know, cost of labor, which including, you know, the wider cost there was about, you know, 20, 20, 21%. It's stable from June 18 and 19. So, logically speaking, it's probably 20, 21, 20, yeah, about 21%, right? So, and then in this year, we're at about 22%. So, overall, I think, you know, as Joey mentioned, is not, you know, necessarily diluted for us. If it's incremental sales coming in by delivery, we actually have higher margin because, you know, the marginal contribution from additional sales is actually pretty high.
spk06: Thank you, Andy. I just have one more point to add, Lillian. Actually, the shift to the delivery business actually help our rental percentage as well, just maybe bring that into equation. Why? Because if our store is relying too heavily on dying business, the location cannot be compromised too much. It has to be very, very good location. Otherwise, you don't get the business. But when we are building more and more delivery-friendly stores, relying more and more on delivery, we actually open up more opportunity for locations that are at slightly lower rent. And that's not a small deal for us. So as we expand our store portfolio, moving towards delivery, certainly it helps. Okay, thank you, Lillian.
spk09: Thanks a lot, Joey and Andy.
spk01: Our next telephone question comes from Christine Peng from UBS. Please ask your question, Christine.
spk07: Hi, management. I just have one quick question regarding the outlook provided by the management earlier. So you mentioned about there are still some uncertainties in China regarding COVID-19 situation. But having said that, we actually observed a very strong pickup in the domestic traveling activities, especially going into the Labor Day holiday. So can you maybe give us more colors in terms of the sequential trend you are observing in China in the past one or two months so that investors can get a better feeling in terms of what is the expectation we should be setting for the upcoming one or two quarters same-store sales recovery compared with pre-COVID-19 level? Thank you.
spk02: Hi, Christine. This is Andy. So I think, you know, You're correct that if you know the domestic travel volume has picked up quite a bit I think this year and especially spring festival and potentially going into the Labor Day holidays weekend. So that's the overall traffic volume side. I think that that's true. The difference is that, you know, the consumer behavior still remain cautious. So if you look at, you know, the trip that they take generally shorter trip. So you look at overall spending level is still down, you know, I think quite significantly, probably down 40% plus compared to, you know, pre-COVID level, right? So I think there's two things that we need to separate, right? You know, the trip that people take, but the type of trip that they take may be different. And also the spending level is different. And I think that is, you know, similar to what we observed before, right? Like Joey mentioned, generally when we see there's some pent-up, you know, like sort of like urge to go out when there's a holiday, right, to relax. So we see that, you know, sometimes, you know, the holiday sales will be relatively strong. But then there's, you know, post-holiday season, you know, sort of like, you know, softening. People generally, you know, still are cautious, you know, about, the COVID situations, and then also the economy, economic situations, right? So, you know, that obviously induces that with an uncertainty for folks. So that's what's going on here. Like, I think if you look at the overall situation, it is much better compared to 2020, obviously, in terms of, like, COVID situations, even compared to, you know, obviously, we... But again, as we have mentioned before, we need to stay alert, not to be alarmed, but to alert, The reason is because, you know, if we look at in China, we have a mini resurgence of the situation in the end of last year and early January. So when things come down, I think it's easy for folks to think, like, everything's back to normal, but I think the reality is that we're not. We also, you know, I think that what's happening internationally would also have an impact on the overall consumer sentiment here. We have seen, you know, the situation in India. I'll go out to the folks in India that are impacted by COVID-19. It's a constant reminder for us that we're not out of the woods. We continue to expect the recovery, the full recovery, to be nonlinear and even. It's just not a saying. I think it's our firm belief and it's how we operate and plan for different scenarios, different situations. And, you know, we encourage analysts and investors to do the same, not to extract linearly, linear extrapolation. And, you know, that's how we plan. That's why we say the full recovery of our things, our sales, takes some time. Thank you.
spk01: And our next question is from Lena Yan from HSBC. Please ask your question.
spk08: Hi, thanks management for the very detailed analysis on your performance. I have a question regarding the base effect of sales at the traffic hubs. I think you started to talk about the very negative growth at the traffic hubs from second quarter last year. So it has always been high single digits of your sales, like from second quarter last year. So would you comment that the base for traffic hub sales will become more favorable from second quarter onwards?
spk02: Thank you. Yeah, likely, right? So, you know, because, you know, we have a big impact, obviously, you know, at the, you know, the lockdown, I think, last year in the beginning, in the first quarter, and then we see a rebound in the traffic over the year. You know, but I think, you know, the volume is still significantly below, you know, the pre-COVID level. So I think on a year-over-year basis, you will see improvements, but on a, two-year period compared to pre-COVID level, I think it will take quite a bit of time for it to fully recover. And then, obviously, we're encouraged by the fact that the government is willing to allow the vaccine program. The situation here in China is possibly calm after the resurgence in December and also in January period. But I think it would be more impactful for KFC because you have more store in the transportation hub location. The other part is that the international, we don't forget we have international locations. So international travel is still pretty much immaterial right now, right? So until the country opens up border and we see international travel, that will continue to be a big overhang for the transportation hub location.
spk08: Okay, thank you very much. So I think every comparison is referred to a two-year comparison basis. Thank you.
spk01: That's right, yeah. There's no more further questions at this time. I'd like to hand the call back to the speakers for closing remarks. Please continue.
spk10: Thank you for joining the call today. We look forward to speaking with you on the next earnings call. This concludes today's call, and have a great day. Thank you.
spk01: Thank you. Bye-bye. Thank you all. You may all disconnect. Have a great day.
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