Yum China Holdings, Inc.

Q3 2021 Earnings Conference Call

10/28/2021

spk01: Good day and thank you for standing by. Welcome to the Yom China 3rd 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 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to our speaker today, Michelle Shen. Thank you. Please go ahead.
spk02: Thank you, Lyndon. Hello, everyone, and thank you for joining YamChina's Third Quarter 2021 Earnings Conference Call. Joining us on today's call are our CEO, Ms. Joey Watt, and our CFO, Ms. Andy Yon. 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 SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. reconciliation of non-GAAP and GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding recent development and our third 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 in the 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. Zhouyi Wang, CEO of Yum China. Zhouyi?
spk05: Thank you, Michelle. Hello, everyone, and thank you for joining us today. As we shared in mid-September, we navigate a very challenging situation in the third quarter. The Delta variant outbreak that started in late July spread to 16 provinces. became the most widely spread regional outbreak since the first quarter of 2020. Strict public health measures were implemented across the country. Trading was significantly impacted during the peak summer season, which is traditionally a very strong quarter for our business. Simple sales declined by 7% in the quarter as demand fell for dyeing, although this was partially offset by growth in delivery. I want to take a minute to thank our 440,000 employees for working diligently and rapidly finding solutions in this fluid situation. In response to the sharp decline in dying traffic, we quickly adjusted marketing campaigns, operations, and supply chains to drive demand for all segments. Delivery sales grew 23% year over year, or 62% on a two-year basis, and counter-built approximately 34% of sales in the third quarter. New retail business grew rapidly, with sales in the third quarter almost equal to the first two quarters combined. Our ability to engage customers digitally was essential during this difficult time. In the third quarter, over 60% of system sales came from members. We add about another 20 million members, ending the period with a total member count of over 350 million. We sold 19 million privileged subscriptions, including the popular KFC chicken lover's car, ,, which is a summer exclusive. Having taken important initiatives to drive sales, we saw a sequential recovery in September. For the quarter, system sales growth was positive compared to last year and to pre-COVID. New unit growth more than offset the same-store sales decline. We broke records by opening 524 new stores, ending the quarter with 11,415 stores. However, we do not compromise quality for quantity. We have prudent new store approval process and carefully track the performance of each new store. New store payback remains healthy at around two years at KFC and three years at Pizza Hut. Our smaller store format enable us to increase store density in higher tier cities and further penetrate into lower tier cities with lower cap and rent. provide some color on our key brands. First, KFC. We set up value and promotional campaigns to drive traffic, and we introduced great food items. Juicy whole chicken was sold out within a week. Our meat sauce Wagyu or Angus beef burger also proved popular. Our premium beef burgers have been very successful since becoming permanent menu items. We are building a beef burger platform covering different price points. We're taking menu innovation and localization to the next level following the success of hot fried noodles, Le Gan Mian, in Wuhan. We rolled that out nationwide in September. In a week of launching, we sold over 1 million bowls. It's the best performing limited time over breakfast item in the past three years. We also introduced steamed dumplings, xiaolongbao, to more stores in eastern China. More recently, we launched hot pepper soup, the very famous hu la chan in Henan. All of these are very well received by our customers. KFC has added nearly 1,000 stores and entered 150 new cities over the past 12 months. As we mentioned during the investor day, we are now tracking 1,200 potential cities that we could enter in the future with multiple store formats. Next, let's talk about Pizza Hut. Years of transformation has improved Pizza Hut's fundamentals and resilience. In the third quarter, Pizza Hut opened 103 stores The highest number of store openings in a quarter since 2016. Satellite stores and other smaller formats accounted for over 70% of the new stores and enabled us to capture the strong demand for delivery with higher store density. We upgrade our buy one, get one pizza promotion. For the free second pizza, customers were given more flexibility to choose when, where, and what pizza they would like to have. This mechanism was a breakthrough for us, enabled by our upgraded digital platform. The promotion was exciting for customers and created sales uplift for us. During this 10-day campaign, we sold approximately 1 million buy-one-get-one pizza sets. For a limited time, we also offered new pizza flavors modeled on popular Chinese dishes, such as sea bass pizza with pickled vegetables, suan cai hai lu yu, and spicy stir-fried pork pizza, ma la xiang gu. These innovative products where pizza has taken on localization and positioned us to attract young consumers who love to try new things. Moving on to coffee, our third growth engine. We are very excited about our different partnership with Lavazza. This 126-year-old Italian brand offers a truly authentic Italian experience. Our Italian coffee exclusively uses high-quality Lavazza beans roasted in Torino, Italy. In addition to coffee, customers love the delicious food. Popular items like Emiliano which is toast sandwich, and mini croissants with ham and cheese are made fresh in our fully equipped kitchen. The high proportion of food, which is 25%, contributes to a higher ticket average. At the end of September, we have 26 Lavazza stores in four top-tier cities. We expand beyond Shanghai to Hanzhou, Beijing, and Guangzhou, where our stores receive great customer feedback. Our first Beijing store is already ranked the most popular cafe in Taoyuan District. Encouraged by the positive results, we expect to enter into more top tier cities and more than double our current store base in the fourth quarter. Despite recent challenges, our commitment to China's long-term growth remains unshaken. We are always planning for the future. and have been executing on the strategies outlined during our September investor day. Despite the difficulties posed by the outbreak, we worked diligently to build our store pipeline. We now expect to open over 1,700 growth new stores in 2021, up from 1,300. I'm also excited about our investment in Hangzhou Catering Service Group This will allow us to accelerate growth across our brand in Zhejiang province. Lastly, we continue to enhance capabilities in supply chain and digital. These are our core enablers for sustainable growth in the long term. Last week, we opened our digital R&D center with three sites in Shanghai, Nanjing, and Xi'an. The center is a key part of our strategy to build a dynamic digital ecosystem. The R&D center will consolidate and expand dedicated resources to develop solutions and services to optimize customer experience and operating efficiency. We plan to invest $100 to $200 million and to employ up to 500 staff over the next five years for this particular initiative. As for supply chain, in addition to the logistics center in Chengdu, we have another one under construction in Huai'an, which is in Jiangsu Province. There are also several sites in the pipeline. As we mentioned during the investor day, we plan to operate about 45 to 50 logistics centers and consolidation centers over the next several years to support our expansion and to further increase efficiency. With that, I will turn the call over to Andy.
spk09: Thank you, Joey, and hello, everyone. Let me first review our third quarter financial performance and then discuss this year's outlook. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Let me first cover the third quarter performance. Actual results are in line with the business update we released in mid-September. Third quarter performance was disrupted by the Delta Variance outbreak, resulting in same-store sales decline of 7% year-over-year. However, we still deliver positive revenue growth and system sales growth, which is led by new unit contribution. Total revenues moved 2% year-over-year and reached $2.55 billion. System sales increased 1%. Similar to prior quarters, we are providing performer measures here for convenience comparison with 2019. Same-store sales were approximately 87% of the third quarter 2019 level. KFC's same-store sales were approximately 92% of the last year level. and 87% of the 2019 level, with same-store traffic at approximately 82% of 2019 level. Average ticket price grew roughly 6% versus 2019, mainly due to the increase in delivery mix. These same-store sales were approximately 95% of last year and 89% of 2019 level. Theme store set traffic is on par with the 2019 level, while average ticket decreased by about 10%, driven by the increased mix in off-premise locations, which have a lower ticket than sign-in. KFC was likely more affected than Pizza Hut again this quarter, as KFC has a higher store mix in transportation and tourist locations. These locations experienced a sharp decline in sales, down approximately 40% on a two-year basis in the quarter. Restaurant margin was 12.2%, down 640 basis points compared to last year. This was mainly caused by sales deleveraging, more value promotions, higher wages, and increased delivery costs associated with more delivery orders, as well as lower COVID-related relief this year. Cost of sales was 32.2%, 100 basis points higher than last year. Modest decline in commodity prices year-over-year partially offset the step-up value promotions to drive customer traffic and phasing out of plastic packaging and other packaging upgrades. Cost of labor was 25.6%, 400 basis points higher than last year. This is due to a few factors. First, wage inflation was 6% in the quarter, notably higher than previous quarters. Second, increased delivery volume contributed to higher labor cost percentages. Third, additional labor hours were scheduled going into the third quarter, which is typically a seasonally strong trading period for us. We also scheduled more labor hours for increased safety protocols during the outbreak. We were quick to adjust labor scheduling to mitigate the sales leverage and impact. Occupancy and order was 30%, 140 basis points higher than last year, mainly attributable to the sales leverage and impact. We received $10 million COVID-related one-time relief in the third quarter last year, while the amount was only $2 million this year. G&A expenses increased 6% year-over-year, mainly due to high compensation costs and increased headcounts. We were profitable in the quarter with offering profits of $178 million, excluding a non-cash measurement gain of our existing equity interest in Labasa Joy Venture of $10 million adjusted operating profit was $168 million, a 52% decrease year-over-year or a 48% decrease compared to 2019. Our effective tax rate is 28.3%. We maintain the full-year effective tax rate outlook at 27% to 29%. Net income was $104 million, and adjusted net income was $96 million. Excluding $32 million net investment loss of May 1, it was $128 million, down 50% year-over-year. Diluted EPS was 24 cents. Market-to-market loss in May 1 negatively impacted our diluted EPS by 7 cents. In a quarter, we returned $85 million to shareholders in the form of cash dividends and shared repurchases. As we look ahead to the fourth quarter, we remain cautious. Strict public health measures are still in effect. Consumers are cautious about spending and are traveling less. According to government statistics, for the seven-day National Day holiday starting October 1st, The number of travelers was down 2% compared to the same period last year and down 30% versus 2019. Related travel spending was down 40% compared to 2019. While we are seeing a slight sequential recovery, same-store sales still remain below prior year and pre-COVID-19 level. Die-in volume and traffic at transportation hubs are still significantly impacted. We expect the recovery of same-store sales to take time with a nonlinear and uneven path. Recently, we have seen a resurgence of cases across 12 provinces and municipalities, including Inner Mongolia, Gansu, and Beijing. We will continue to monitor the development and stay agile. In addition, the fourth quarter is seasonally the smallest quarter for sales and profit margin. Based on what we are seeing so far, we expect the margin and offering profit in the fourth quarter to be significantly impacted by, one, sales deleveraging, as same-store sales remain below prior year and pre-COVID levels. Rising commodity prices. Since the fourth quarter of 2020, we have benefited from a deflationary environment which will very likely end in a false order. Cost of sales will also pressure by aggressive campaigns as we continue to drive traffic through attractive promotions. Three, wage inflation, which is expected to be in the mid-single-digit range. Wider costs are likely to continue to increase as delivery trends further upward. Please note that the fourth quarter last year included several one-time items, including one COVID and other one-time relief from government and landlords, almost $13 million. Two, lower staffing level due to shortage of part-time workers. These are unlikely to repeat this year. Now, despite the near-term challenges, we remain committed to driving long-term growth In the short term, we will focus on keeping our operation agile and resilient in the face of considerable disruptions and uncertainty caused by the pandemic. For the long run, we will focus on fortifying our competitive mode and growing our business and making continuous improvements in our business model and store operation. We have a strong track record of managing our cost structure and growing our business profitably over the years. we'll continue to focus on product innovation and leveraging the strength in our supply chain to mitigate the impact of commodity price swing. On the COL fund, we'll continue to invest in technology, automation, and digital infrastructure to improve labor productivity. On the other hand, the near-term challenges while tough for the restaurant industry as a whole also create favorable conditions for us to expand our store network and capture growth opportunities. As Joey mentioned, we now expect to open 1,700 new units in 2021, almost five stores per day. We're maintaining our previous capital expenditure target of $700 to $800 million, which benefited from our ongoing efforts to reduce capex spending per new stock. Looking ahead, we will continue to invest in accelerating growth and fortifying our resiliency, as highlighted at the investor day in September. We will provide you details on 2020 targets during our fourth quarter earnings release in early 2020. With that, I will pass you back to Michelle to start the Q&A. Michelle?
spk02: Thanks, Andy. We'll now open the call for questions. In order to give us as many people as possible the chance to ask questions, please limit your questions to one at a time. Lyndon, please start the Q&A.
spk01: As a reminder, to ask a question, you will need to press star 1 on your telephone. Your first question comes from Michelle Chang from Goldman Sachs. Your line is open.
spk03: Thank you for taking my question. My question is about the commodity cost inflation. So we hear many companies starting to talk about price hike recently. So understanding the consumption sentiment is still very challenging. So can you share with us your pricing strategy and also compare with the previous chicken cost inflation cycle back in 18, 19? when we manage the margin pretty well. So what could be the difference now versus the past experience? Thank you.
spk09: Good morning, Michelle. Thank you for your question. Regarding pricing, you know, we have a long-term pricing strategy here at Yum! China. We want to provide good food at, you know, good value for consumers. And so, you know, over the years, we always have, you know, be very cautious about price increase. We do pass through partial inflation to investors for consumers, but mostly we will try to find efficiency in our operations to offset those inflationary pressures. Now, if you look back in the last few years, obviously there's commodity price fluctuations. Sometimes it goes up, sometimes it comes down. And then, you know, over the years in China, we always have seen, you know, labor inflation, right? So, you know, labor inflation generally is in the mid single digit to, you know, high single digit range. And I think, you know, sometime, you know, when there's a sudden surge or disruptions in the market, you know, then you do see you know, the impact on our margin. You know, for our quarter, this quarter, for example, the biggest impact, obviously, is our sales, right, because of COVID outbreak. And so you have a deleveraging impact, which is, you know, disproportionately, you know, impacting the margin. And then, you know, so if you think about commodity prices, we generally have a very, you know, over time, we will have new product innovations, how to make use of our material better. We would also, you know, have diversifying, you know, the different proteins, right? So we have chicken now. We have, you know, bees. We have duck and, you know, a variety of fish and other seafood. So, you know, that also helps us to, you know, balance, you know, the commodity price increase over time. And then, obviously, we have a very strong supply chain. We always work with our supplier closely to try to mitigate some of this pricing fluctuation. we generally have a place our order or sign a contract a quarter or two ahead of the quarter so that we sort of know how to manage that cost increase over time. And then we also work with our supplier, obviously, to when good time, the price go up, they they just have to earn a little less. When time is bad, we also have to try to support them. Over time, we have a stable supply chain situation for them and for us as well. That's generally how we deal with it. In terms of labor inflations, over the years, you have seen that we have invested quite a bit in digital automations and technology in our infrastructure. Overall, it's trying to improve labor productivity. As we have outlined it in the investor day, you have seen LELER have presented how technology helped us improve labor productivity. A few years ago, we had 400,000 plus employees. Today, we have a similar number of employees, but we have a significantly higher number of staff. So our labor productivity has improved. So if you look at our UC margin, or if you look at our restaurant margin, it has remained relatively stable. So I think in 2016, it was roughly 15% range. And then in 2019, it was about 16%. And then last year, it was about 15%. All in all, over time, we're able to manage all these different cost components, the cost structure, quite well, maintaining that margin. Thank you.
spk03: Thank you, Yandy. That's clear.
spk01: Your next question comes from from Morgan Stanley. Your line is open.
spk04: Thanks, management. My question is more on the the CapEx plan because we definitely increased the gross new opening quite a lot versus the previous guidance, but maintain the CapEx overall. So maybe a little more detail. I know that company talked about this for some time in terms of the unique CapEx per store with this small format model, but can you share with us a little bit more about details of What have we been doing in the recent quarters in terms of the unique CapEx and the unique economics versus before that caused us maintaining the similar CapEx with much more kinds of stores? Thank you.
spk09: Thank you, Lillian. So obviously this quarter we did set up our CapEx. For the whole year, it's probably higher than last year. I think our CapEx year-to-date is about $480 million. And I think... I'll just check that number here. Yeah. So, you know, obviously, as we have outlined in our capital expenditure plan in our investor day, investment for CapEx is to drive organic growth and also to build competitive models. So that's multiple components to it. So one is obviously store network opening. And we are accelerating that. And as we have mentioned before, over the past few years, we have reduced the CapEx per store uptime investment. So if you think about a few years back, our CapEx per store was about 2.5 million RMB. and then now is under 3 million RMB, close to 2.5 million RMB. And as we continue to, there's two drivers for that. One is obviously the size of the store changed. The other one is the overall per store footage cost reduction. And so our team worked very hard, our run team, our brand team worked very hard to do that, make it more efficient. So, I think, you know, with our new smaller store format, for example, Pizza Hut, we have the new time models and more small, you know, store format catering to our delivery and takeaway. I think we still have some opportunity to further reduce that traffic, first of all, going forward. Also, you know, the other component, obviously, is, you know, remodeling. Over time, we'll continue to trend up just because we have a bigger portfolio of stock. And then the third part is investment in supply chain and infrastructure, as we have outlined before and invested, is to drive efficiencies, resiliency in our supply chain, is to drive labor productivity improvement through investment in technology, digitalization, and et cetera. And so I don't think there's material change to our plan. So hopefully... you know, we can give you more update next quarter in terms of our four-year cap expense. Thank you, Lillian.
spk05: I just ask you comment on this one, Lillian. For today, we update the new store guidance for the year from last quarter 1300 store to 1700 store for the year, but we did not increase the cap expense for the year. It's still say at 700 to 800 million range. So what happened here? What happened here, obviously, as you guys know us quite well, we don't chase after a blind store number. We open good quality stores. If we can find a good quality store with additional profit and sales, then we will open it. So in terms of store economics here, I would like to give you three comments. One is the smaller stores are driven by increased off-premise means of delivery and takeaway. So the smaller stores help that business, and the smaller stores help us increase the store density in the top tier cities in particular. So these are the KFC smaller stores. And also these stores with the lower investment and incremental sales and profit, it helps penetrate into the smaller cities because we have a variety of different business models for different locations. So number two comment, it's normal that these smaller stores have smaller sales per unit, but as I mentioned earlier, it drives incremental sales and profit, and it demands less capex per store, as Andy mentioned earlier. Third is the payback is healthy. So you know that capex payback is always about two years, and piece of heart right now, if you notice what I said earlier, is the Pizza Hub, the store payback is at three years now in total. That is an improvement because in the past, we always concluded the payback for Pizza Hub is about three to four years. So now it has improved to three years because the small store, the pizza satellite store right now, the payback is at two to three years. So in total, the improvement is at three years. So I hope that gives you a sense about why we are increasing the new store guidance for the year. Because if we look at our system sales growth number, it also tells a story. For the entire Yum! China versus 2020, we are driving 15% year-to-date same-store sales growth. And that includes 12% year-to-date system sales growth for KFC and 20% system sales growth year-to-date for Pizza Hut. And then for KFC, even compared to 2019, for year-to-date, we are also achieving 4% system sales growth, despite all the challenges of the outbreak and all the things ourselves. So let me conclude the question here. Thank you, Lillian.
spk04: Thanks a lot, Joey and Andy. That's very detailed and helpful.
spk01: Your next question comes from Xiaopo Wei from CT. Your line is open.
spk07: Hi, good morning, Joey and Andy. I have a very brief question on your acquisition. In the press release this morning, you mentioned that you acquired 28% stake in Hangzhou Catering Services, which is operating a few great local Chinese brands. My question is, will you open some store on a standalone basis under those brands, pursuant to any arrangement with the Hangzhou Catering Company? Or you are more looking at bringing those great local cuisines like a Jiuwei Guan and etc. to your existing KFC stores or Pizza Hut to diversify your portfolio to bring more great local food to the Chinese consumers? So any color would be highly appreciated. Thank you.
spk05: Thank you, Xiaopu. So we have been working with Hangzhou Catering, this company, for two decades now. This is our joint venture partner of Hangzhou KFC stores. And Hangzhou market is one of our best market in terms of sales and profits. And we are very grateful that we have the opportunity to invest 28% into the Hangzhou catering. And that enabled us to achieve consolidation of Hangzhou KFC business, which is about 700 stores with future very nice expansion opportunity ahead. So that's point one. The point two is, While Hangzhou Catering has other businesses such as Siwei Guan and Puyong Guan, et cetera, our focus is still on our KFC business. In terms of future cooperation, we do see cooperation in two areas. One is working with them on their central kitchen or factory, whatever you call it, They have very high-quality facilities in there. Actually, we did already work with them. Our Xiaolongbao launched in Hangzhou market, Ziwei Guan Xiaolongbao. Guess what? They were produced by the Central Kitchen or the factory of Hangzhou Catering. The second area, we see we are going to further expand our cooperation is so opening because another key shareholder of Hangzhou Catering is a very successful and important player in the commercial properties in Zhejiang Province. And we already work with them to open our first and the most important flagship store for Lavazza in Hangzhou. So these are the two areas that we certainly will see accelerate our cooperation on top of KFC expansion in such a process, and particularly Hangzhou. Thank you.
spk07: Thank you very much.
spk01: Your next question comes from Chang Lu from Bank of America. Your line is open.
spk08: Thank you, Joey and Andy. My question is on the margin side. Our Q3 restaurant margin saw over 60% young year decline. I understand that it has been massively impacted by the COVID outbreak in the quarter. However, if we look at Q2 and Q3 last year, we had a similar or even higher change for sales growth decline, but our margin trends were better back then. I'm just curious to get more color on the different dynamics behind. In particular, our labor cost ratio was up 4% year-on-year, which was higher than the magnitude of labor cost increase in Q1 last year, which was the worst time of the COVID outbreak. Apart from the wage inflation and sales delivery, can you actually elaborate a bit more on other reasons for us to better understand the dynamic behind the labor cost increase. In addition, our occupancy and other cost ratios have also increased. Normally, in normal times, it is always trending down and serves as a big driver to our median margin. So do we still see further room of cost savings on this line item in the future, barring extraordinary future reasons like future years' time? Thank you.
spk09: Thank you for your questions. Let me try to address the questions here. First of all, I think before we go into each online item, I want to really emphasize that sales leveraging is real. We run a restaurant business, so when sales come down, it would have impact on our labor costs and on our O&O. So, you know, I don't want any misunderstanding. I know we have done very well over the last couple of years. And last year was also some special situation, obviously. So let me address that here on, for example, on the cost of labor or on the sales dynamic. You know, if you look back in, you know, for example, in 2020, right, you know, we, as we have mentioned at that time, we have a very strong sales trading going into the Chinese New Year period in 2020. And the period before Chinese New Year and during Chinese New Year normally is a very important, very good trading season for us, for both in terms of sales and profitability. So we have a benefit at that time for that first month. So because if you recall, the outbreak was way around Chinese New Year period. So it's timing difference. In terms of, for example, this quarter, for example, in the third quarter, the outbreak happened and impacted the full quarter at the beginning to the end. So we have this full quarter impact in the same trading situation there. So that's why when you have a very profitable quarter, for example, you know, especially for us, you know, which is August and July and August time period before they go back to school. You know, that sales trading would have an impact on the sales leverage. The other one is commodity prices, obviously. You know, this year we have a couple of things that is going to impact us. One is, you know, as we have mentioned before, we're phasing out plastic in our packaging. We have mentioned that last year that's going to have an impact on us, you know, and then When we look at the other part of sales leveraging, obviously we have all this infrastructure to deliver product to our restaurant. So when sales leveraging happens, it's going to impact the cost per package, for example, that they deliver to the restaurant. And then if you look at labor, for example, labor this year, as we have mentioned in last quarter, we raised our staff wage in June and July. That's after, you know, sort of like holding it back and trying to control the cost for their, you know, first half of the year. You know, so at that time, you know, our labor inflation was about 2%, 3%. In the third quarter, it's about 6%, 7% increase. So it's higher. And then, you know, another thing that's very important to notice is that we, as I mentioned on our prepared remarks, It is a peak trading season, so we have planned some of the labor scheduling ahead of time. The other part is that during the outbreak, we also had to step up staffing to make sure that we have even tightened up our follow-up, that tightening up health protocol. So, to measure temperature, to check CO2, to do more frequent table cleaning, etc., etc. So, that's the COO impact there. And then, you know, obviously, we have some wearable costs, but, you know, whenever you open a restaurant, you're going to have utility costs. You're going to have, you know, some of the rent, right? Rent is some of the stakes and some of it is wearable. So, again, you're going back to that, you know, sales revenue impact on the margin. I think in the long run, I think, you know, we have been able to manage the cost structure quite well. We have seen, obviously, as mentioned before, commodity price fluctuations, labor cost increase. Again, going back to what we do best, working with our team, our food innovation team, to introduce good products at great value for consumers. One example that we have recently done is we have a fried chicken bone as a snack, the whole case. So that's a good way to utilize obviously part of the chicken that we have not used previously. We also use that for, for example, soup. So product innovation is very important for us and we continue to do that. Working with supply chain is very important. I think a couple years ago when, again, it was searching or coming down, we have mentioned consistently that we work with our supplier for the long term So we help each other in good time and bad time. And so in that case, it will help us to mitigate, not completely eliminate the impact, but we'll try to mitigate. So we'll continue to do that working with our supply chain on COS. And COS, obviously, is very important. You notice that delivery costs volume go up in pandemic it's going to have an impact on cos that's not col but we're able to manage that long term but you know sometimes some of the structure terms change in the you know delivery and sign in mix would also have an impact so again we're going to invest in you know technology infrastructure automation including you know investment in our delivery and make it more efficient right the production queuing for food production, you know, the route, you know, optimization for our rider, you know, trace zone, you know, how we design the trace zone and all that. So we're trying to continue to make the operation more efficient.
spk08: Thank you, Shane. Thank you for the helpful comment, Andy. I also look forward to having a try on the Yangtze Gap when I'm in China next time. Is it just a nationwide launch or just offered in Northeastern China?
spk05: And many other products. All of these are fantastic.
spk08: Right. Thank you. Okay. Thank you, Andy.
spk04: Thank you.
spk01: Your next question comes from Anne Ling from Jefferies. Your line is open.
spk06: Hey, thank you. Hi, management team. Also, questions regarding your acquisition, the Hangzhou Catering Group. Does it mean that you're now owning 73% of the company? So meaning that, you know, moving forward, you consolidate that 700 store in terms of sales and operating profit, and then you take out your minority at the minority line. So if this is the case, number one is that, you know, would there be any exceptional gain on the revaluation of your KFC, like, you know, investment or subsidiary in the 4Q. Second question is like you know how should we be expecting in terms of the sales and or the operating profit impact is that I mean being in Guangzhou in Hangzhou their sales per store possibly will be higher so and what would be the profitability impact like and the minor question is regarding If it is probably an associate, then I'm not sure my calculation is correct. It seems that third quarter, it was a loss of $6 million. So I'm not sure whether it is related to the Hangzhou business or it is something else. Thank you.
spk09: Sorry, Anne, like the last part, I didn't get it. Like what was the $6 million related to?
spk06: Oh, the $6 million loss is the associated equity contributions below the operating profit line. So it's the equity contribution from your investment.
spk09: It's in the cash flow in your... Okay, so I didn't quite understand the question, so we may have to take that question offline. But I will try to address the first questions. I think, first of all, we did not acquire... Hangzhou Catering, we invest 28% in Hangzhou Catering. So we have a 28% stake in that company, not acquisition of that company. The other part is that because of that and also because of some of other corporate government arrangements, so now we actually have basically control of the Hangzhou JV. And so now we will consolidate that. And you're correct, similar to prior consolidation of our JV at Wuxi and Suzhou. Generally, we would have a remershment gain, because obviously those are very successful JV. But it is kind of complicated accounting is where to business combination right so he's under US GAAP even though you only acquire a portion of the state you know you genuinely treat it as a you know combinations of business and then you treat as a whole you know you know what's the game of your entire you know, consolidation, your portion of that. So it's not just a proportion, you know, to the interest that you acquire, but, you know, the overall company. And so that's why normally you would see this disproportionate, you know, measurement gain. And then eventually it would flow into the balance sheet, you know, because, you know, obviously it's based on, you know, the accession or accommodation allocation. And so generally you would see an increase in goodwill as well as, you know, intangible. So, you know, and that process is similar to our treatment of that in Suzhou and Wuxi. Okay. And so I, you know, if you want more detail, I would refer, you know, you to our filing, you know, that you and the PEN-Q, the PEN-K statement. It will have more detailed explanation and a technical explanation, you know, of the kind of treatment of such a combination.
spk05: And just to be very clear, We have originally a minority control of our own Hangzhou joint venture of KFC. With the additional 28% investment into Hangzhou Catering, we will, YUM China, will control and consolidate Hangzhou KFC with approximately 60% equity interest directly and indirectly.
spk09: That's right. And, yeah, so in terms of the impact, you know, obviously, you know, it would not impact the system cells. You know, it would probably, you know, increase that result. But in terms of, you know, the probability or will that increase that, we're still assessing it because, as we mentioned, you know, there would be some, you know, amortization coming from this and then also the measurement of, you know, the franchise rate. It's a lot of complicated, so we're still assessing it. But we're similar to, as we mentioned, to the impact of consolidation of the accounting impact. We're similar to that of Suzhou. But in terms of it, it's not as straightforward as it would immediately be. Okay, got it, got it.
spk06: Thank you very much.
spk01: There are no further questions at this time.
spk02: Thank you for joining the call today. We look forward to speaking with you on the next earnings call. Have a great day. Thank you all.
spk00: Thank you.
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