Yum China Holdings, Inc.

Thank you all for standing by and welcome to the Yum! China first quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question at that time, you'll need to press star 1 on your telephone. I'd now like to hand the conference over to your first speaker, Florence Lipp, Senior Director, Investor Relations of Yum! China. Thank you. Please go ahead.

Thank you, Tara. Hello, everyone. Thank you for joining Young China's first quarter 2022 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Watt, and our CFO, Mr. Andy Yeung. Due to the current COVID restrictions in Shanghai, we are dialing in from different locations today. If we experience a technical difficulty during the call, please remain on the line as we reconnect. Before we get started, I'd like to remind you that our earnings call and investor 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 a cautionary statement in our earnings release and the risk factors included in our filings with the SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding our performance in first quarter. Andy will then cover the financial performance and outlook in greater detail. Finally, we will open the call to questions. You can find the webcast of this call and a PowerPoint presentation which contain operational and financial information for the quarter on our IR website. Now, I would like to turn the call over to Joey Watt, CEO of Yelp China.

Joey? Thank you, Florence. Hello, everyone, and thank you for joining us today. We are battling the most severe outbreak since COVID-19 first emerged two years ago. The challenges we face are unprecedented. The case counts, duration, geographical coverage, and restrictive measures are far more extensive than previous outbreaks. Shanghai, Tianjin, Jilin, and Guangdong were among the places to experience extended periods of lockdown. Shanghai, one of the most impacted cities, has been locked down for more than a month now. Our operational headquarters in Shanghai are all working remotely. Hundreds of millions of people across China are currently under some level of restrictions. Even regions with few cases have tightened containment measures in line with the dynamic zero COVID policy. Compared to 2020, it's far more complex to keep our stores open, get our employees to work, and obtain necessary approvals. Our store operations, delivery, and supply chain have been heavily impacted due to ever-changing restrictions. I want to thank our frontline employees at restaurants and logistics centers, our delivery riders, and our staff at the back office for working tirelessly during this difficult time. I'm extremely proud to see how quickly we adapted to each new challenge and how teams from across the company support one another. From procurement, logistics, IT, HR, to public affairs, we work as one team. Our mission is to serve the community and customers in need to the best of our abilities. hundreds of our back office staff rising to the occasion. They volunteered to serve at the front line, supporting our restaurants. They performed health checks at restaurants, delivered food using their own carts, and served as customer service representatives. Soon after the lockdown in Shanghai started, where most business activities have come to a halt, we became one of the few and first authorized food suppliers to serve the community. While we can only offer limited services, we are prioritizing food and drinks to frontline workers, volunteers, and makeshift hospitals. We also provide ready-to-eat products to the elderly living alone and cancel children's books to kids in quarantine centers. During the lockdown, the demand for KFC and Pizza Hut products surged. Many of our customers got on social media like WeChat and Douyin, the equivalent of TikTok in China, expressing their longing for our signature products. Many of them also shared their happy moments on social media when they enjoyed KFC fried chicken or Pizza Hut pizzas. I'm glad we could bring some comfort and joy to our customers in trying times like this. It also gives us energy and a renewed sense of purpose. Health and wellness of our employees is always our top priority. We delivered over 10,000 food packages to closed off employees. We also provide packages with essential supplies and upgrade medical plan for those who are infected. Our ability to adapt to the dynamic operating environment is at the core of our resiliency. With valuable learning from prior outbreaks, we have developed extensive scenario planning and toolkits to deal with different situations. Nationwide, we quickly adjusted marketing campaigns and simplified manual to streamline operations. Our hybrid delivery model with dedicated riders allowed us to maintain adequate rider capacity and continue operations in most places. Delivery grew at double digits and reached 36% of company sales. Seizing the demand for at-home consumption, we promoted new retail package products such as steak, pasta, and fried rice. New retail sales in the first quarter more than doubled over the prior year period. The surge of Omicron cases and the ensuing lockdown have turned everything upside down for us in Shanghai. Despite the city-wide lockdown, we were able to keep about 10% to 15% of our stores open for delivery or takeaway in April, to serve as many communities as possible when mobility is heavily restricted we introduced community purchasing across all brands as early as mid-March. This is a new way to group orders among residents to maximize efficiency with focus on key menu categories, offering only a few preset combos. We also promoted new retail packaged food, which are perfect items ready to eat and easy to store under this circumstance. New retail sales mixing in April surged to over 15% in Shanghai. By swiftly implementing these initiatives, we were able to generate 40% to 50% of pre-lockdown level of sales in Shanghai, despite having very limited stores offering off-premises services only. In other words, 10% to 15% of our stores generated 40% to 50% of our pre-lockdown sales in Shanghai. Community purchase created new business opportunities for our brand. KFC optimized its community purchasing menu to just one item, the fried chicken combo, as it is one of the most desired options food items during lockdown. Our customers share their appreciation on social media, quoting that having KFC fried chicken is the happiest moment in the last month, and our fried chicken is a comfort food and nourishment of the soul. People are craving for KFC, and we are working our best to fulfill them. We also look forward to serving customers at our restaurant when they come to satisfy their craving after the lockdown. Pizza Hut was one of the few places to order hot pizza during lockdown. To meet the demand, we simplified the menu to combos with two pizzas, dry rice and ready-to-cook steak and pasta. Our customers were so excited to receive high-quality, well-packaged and safe products during lockdown. Community purchasing presented fantastic cross-selling opportunities and increased brand awareness for our emerging brands. These brands captured a significant portion of sales compared to the level before lockdown with signature products and packaged food offerings, even when only a few stores were open in Shanghai. For example, Lavazza offered packaged cheese and ham in addition to its famous coffee and pastries. Taco Bell served hot quesadilla, fried chicken, and breakfast DIY package. Little Sheep offered takeaway hot pot with meat and fresh vegetables, highly sought-after items during lockdown. Let's move on to supply chain and digital. Our industry-leading supply chain and digital capabilities are critical business enablers to fulfill ever-changing demands. Our in-house supply chain team work wonders in difficult situations like this. We quickly introduced strategic redundancy in our supply chain with backups in different logistics centers to lessen the impact of supply chain disruptions and to allow us to continue operations. We immediately designed a 200-kilometer detour route to ensure supply to logistics centers in eastern China. Instead of just using trucks, we moved inventories by rail and sea freight as well. In just a few days, we set up a temporary drop-off and pick-up site not far from Shanghai to support the region under lockdown. We also repurposed ingredients from one product to another and reallocate inventory across restaurants and even brands to fully utilize our resources and minimize wastage. Digital enabled us to put innovative ideas into action. Since March, we cut back on advertising. We leveraged our membership program and our own channels to digitally engage our customers We rapidly launched a digital mini program to make community purchasing easier. Our digital infrastructure provides real-time visibility to store inventory, allowing us to precisely forecast the material demand, manage supply chain routes, and minimize food wastage.

Ladies and gentlemen, it appears that Joey has dropped from the call. Please stand by while she reconnects the line.

Hello. The line just dropped, and I just called back. Can you hear me?

Yes, Joey. Please go ahead.

Yeah. I hope by now you have a better picture of the challenges that we face, and even in situations like this, how we find ways to serve our customers and communities. This is the third year for the COVID pandemic, so it is understandable that pandemic fatigue may be settling in. I'm very proud of our team members. They have been courageous and continue to maintain a positive attitude in face of adversity. The pandemic will surely pass and our business will recover. As we look ahead, I'm confident that as long as we focus on new opportunities, remain innovative, be bold with our initiatives, Be agile in our actions and control our cost structure. We can get through this challenging time and become even stronger. We remain confident in the long-term prospects in China. We will continue to invest and focus on our GM strategy so we can fortify our market leadership and capture the significant growth opportunities across our brand. Before I pass to Andy, let me say a few words about changes in our leadership teams. I'm pleased that Johnson Huan, previously the general manager of KFC, is now our first chief customer officer. This strategic move will better integrate customer centricity into our brand-driven culture. Johnson will focus on building capabilities to better understand and serve customers. He will spearhead cross-functional initiatives, including cross-brand customer loyalty program and delivery initiatives. He will also oversee Coffee & Joy, LaVasa, and Taco Bell. With Johnson's strong technology background and deep understanding of the organization, I'm confident that he's the best leader for this role. Walton. Walton Wang, our chief development officer, succeeded Johnson as the new KFC GM. Walton joined KFC as an operations management trainee 24 years ago and worked his way up. He led various initiatives to improve KFC's business operations. In a way, so formats and business models. I believe that Walton's strong leadership and deep operations experience will bring KFC to new heights. Walton's achievement as a homegrown leader will also inspire our entire frontline employees. With that, I will turn the call over to Andy. Andy?

Thank you, Zoe, and hello, everyone. Now, let me share some color of our first quarter performance. Compared to a relatively stable January and February, the COVID situation in March rapidly deteriorated. March same-store sales declined by more than 20%. As Joey mentioned, our team put in tremendous efforts to sustain operations, mobilize and fully utilize available resources to drive sales and proactively manage costs. we achieved a profitable quarter, demonstrating the resiliency of the business. We continued to grow by opening 329 net new stores and ending the quarter with over 12,000 units. First quarter total revenue grew 4% in reported currency to $2.7 billion. The contribution of new units and the consolidation of Hangzhou KFC was partially offset by the same-store sales decline and temporary store closures. System sales were down 4% in constant currency. Same-store sales were 92% of prior year's level. By brand, KFC same-store sales were 91% of prior year's level, with same-store traffic at 86%. Average ticket grew 6%, mainly due to the increase in delivery mix. which has a higher average ticket than dining. These are same-store sales for 95% of prior years level. Same-store traffic was at 97%, while average ticket was down by 2%. This was driven by the increased mix of delivery, which has a lower average ticket than dining. Restaurant margin was 13.8%, down 490 basis points, compared to last year. This was mainly due to higher commodity prices and raised inflation, as well as higher delivery costs due to increasing delivery volume. Now, let me go through each expense line item. Cost of sales was 31.1 percent, 90 basis points higher than last year. This was mainly due to commodity inflation. We also incur high logistic costs and rate stage due to the regional outbreaks. Cost of labor was 26.2%, 90 basis points higher than last year. This is due to sales leveraging, rate inflation of 5%, and higher delivery rider costs from higher delivery mix. Occupancy and others was 28.9%, 110 basis points higher than last year, mainly actually revolved to the sales leveraging impact and 10% increase in utility prices. The impact was partially mitigated by proactive savings in advertising expenses. G&A expenses increased 14% year-over-year in constant currency, mainly due to consolidation of Hangzhou KFC and Labasa, as well as increased compensation and benefit expenses. Offering profit was $191 million. Solid performance in January and February enabled us to achieve a profitable quarter. The net contribution from Hangzhou KFC's consolidation was 5% of offering profit in the quarter. It also includes The amortization of intangible assets acquired roughly $16 million per quarter that went through the end of this year. Below the operating profit line, we incur a $30 million mark-to-market net loss on our equity investment this quarter. It was $14 million more than the same period last year. Our effective tax rate was 33.1%. The high tax rate is mainly due to lower pre-tax income and the Hangzhou KFC consolidation. Prior to consolidation, the aggregate income from JVs was not subject to tax, resulting in a lower tax rate. These factors will likely continue to impact the effective tax rate for the rest of the year. Therefore, we expect four-year effective tax rates to be low to mid-30s. Net income was $100 million. Valued EPS was $0.23. The mark-to-market loss in Meituan negatively impacted valued EPS by $0.07. Let's now turn our attention to the outlook for the second quarter of 2022. As the COVID situation deteriorates, we face even stronger headwinds in the second quarter. Eastern China the most economically vibrant regions in China, is severely impacted this time. Eastern China is also our most important market, accounting for around 30 to 40% of our store mix and sales mix. Apart from Shanghai, many large cities such as Guangzhou, Suzhou, Tianjin, Changchun, and Xi'an were also partially locked down in April. strict preventive measures are in place nationwide, significantly limiting social activities and mobility. For example, during the Labor Day holidays in Beijing, restaurants provided only off-premises services. Residents are required to provide proof of a negative PCR test to enter public venues. Consumer spending has also been weak. Non-manufacturing PMI dropped from 48 in March to 42 in April, according to government statistics. This was the lowest and steepest reduction since February 2020. In April, our same-store sales declined more than 20 percent. In addition, around 3,000 stores were temporarily closed or provided only delivery or takeaway services. significantly more than March. Around half was temporary closures. As a reminder, store-providing-only delivery and takeaway services are included in our same-store sales calculations. Temporary closures are excluded from the same-store sales calculations during the closure period, but would negatively impact system sales and revenue. Margins are expected to be pressured further in the second quarter. Significant sales decline is expected due to the worsening COVID outbreak. Sales leveraging impact will be more pronounced, too, as sales and margins are seasonally lower in the second quarter. Furthermore, we continue to face several cost headwinds, including the surge in commodity prices, wages, and utility prices. The increase in delivery sales makes will also increase wider costs. The current situation is very challenging. We incur loss in March. Barring a significant improvement in external conditions in May and June, we expect to operate at a loss in the second quarter. We are taking actions to lessen the short-term impact. In addition to what Joey mentioned, We are adjusting our marketing events and promotional activities, temporarily postponing small remodels, negotiating rent relief, optimizing raw material cost structure, and implementing G&A austerity. We quickly deployed various initiatives across the country while staying flexible depending on local conditions. Now looking past the very tough business environment in the near term, our efforts will have a long-term positive impact. We have strengthened our brand equities and bonded with our customers. We have also gained valuable experience and developed two kits to help us navigate different situations. Our business model is even more agile and resilient than before. We have made important breakthroughs in community purchase and new retail. We will continue to make constructive and strategic changes to seize market opportunity as they arise. We're here in China for the long run. Powered by healthy store economics, we are confident to further expand our store network. KFC and Pizza Hut new store linking healthy store payback at two years and three years respectively. The majority of stores opened in 2021 also achieved monthly breakeven within the first three months. While we expect a slower pace of store openings in the second quarter due to COVID, we still intend to achieve our four-year target of 1,000 to 1,200 net new units. We'll continue with our systematic and disciplined approach and prudently evaluate the situation. Also, I'm pleased to share that we have entered into an agreement with Yum! Brand to join a step-up investment in accelerating Taco Bell's store growth in China. We are committed to expanding the Taco Bell store network to at least 100 stores by the end of this year and at least 225 stores by the end of 2025. In turn, Yum China will have the exclusive right to operate a brand in China for 50 years. I'm confident in Taco Bell's long-term potential in China. Now turning to capital allocation, the board of directors expanded the authorization of share repurchases by $1 billion in March to an aggregate of $2.4 billion. At the end of the first quarter, Our remaining authorization was approximately $1.4 billion. We returned over $280 million to shareholders in cash, dividends, and share buybacks in the first quarter. We continue to employ a disciplined and balanced capital allocation strategy. As I mentioned before, our priority is to have sufficient cash for daily operations and to deal with contingencies. We will continue to make significant capex investment in digital supply chain infrastructure and our store network expansions. We are confident that this investment will widen our strategic mode, drive sustainable growth, and capture attractive long-term opportunities in China. With that, I will pass you back to Fong to start the Q&A.

Thanks, Andy. We will now open the call for questions. Operator, could you please start the Q&A?

Thank you, Florence. Ladies and gentlemen, we will now begin the question and answer session. If you'd like to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you need to cancel your request, please press the pound or hash key. Our first question comes from at CICC. Please go ahead.

Thank you, Jory and Andy. Thank you for your great efforts in now certain environments. So I have two questions. The first is, so the multiple waves of COVID outbreak, especially the Omicron this year, it's a very difficult situation for market players in whole restaurant industry. So regarding the impact on industry supply, what's your observation? If there were many closures of mom and pop during the last two years, are we seeing more small and medium-sized chains facing difficulties this year? And my second question is, could you please give us more color on the promotion strategy at the current stage? What's the difference compared to the last two years considering the evolving situation? Thank you.

Thank you, Shijie. Let me share some thoughts here. First of all, we are very grateful with our own business model. You know, this is Young China, particularly KFC and Pizza Hut, a fantastic business model that we can do well when the time is good, but it's also proven again and again during challenging times this is a very resilient business model. So we are very grateful and we still can capture, you know, 40 to 50% of sales in Shanghai with 10 to 15% of store. In terms of competitive landscape, it's still a bit difficult to tell, particularly in Shanghai or lockdown cities because we are still going through it Um, but, uh, I think this is, uh, this is definitely the time, uh, that, that, that differentiate, um, the company with, uh, with solid operating capability, um, and also, um, prudent financial, um, uh, arrangement, uh, versus the others. Uh, so fortunately, I think for, for young China, uh, both our operation and digital, and also our prudent financial philosophy help us through the difficult times. In terms of promotion strategies, we have multiple scenarios. So while for nationwide, the sales is under pressure, but for the country, for the cities, And the problems that are still going on, you know, with our normal business operation, the business still as usual. We still pursue good products with fantastic values, with promotion. And recently, we just launched the entry-level beef burger priced at 19 yuan RMB. And for Pizza Hut, we just launched a new menu for the year which is again 40% improvement of the menu item on the menu. So this is still going on and we still have like our very famous Crazy Thursday for KFC and Screaming Wednesday for Pizza Hut as value program. But for For cities that are in lockdown, such as Shanghai or Guangzhou or Shenzhen, we put back the promotion because the focus is about maximizing our limited resources to meet the customer's unmet needs. Here, we really have the unmet needs. because a rather small percentage of our stores can open. And we also put back our menu. As I mentioned earlier, in KFC case, we only offer one combo, which is fried chicken. We don't have burger. We don't have fries, just fried chicken with some Pepsi cola. And then for Pizza Hut, there are two pizzas, the very famous,

Sorry, ladies and gentlemen, it looks like Joey's line has jumped once again. Please stand by. Thank you, Joey. You're now free back on the call. Please continue.

Okay. We can take the next question.

Certainly. Our next question will come from Lillian Lu at Morgan Stanley. Please go ahead, Lillian.

Hi, Joey. Hope all is well. Given all the challenges the operation are facing, could you give us a bit of update about the trends in eastern and southern area close to the end of April or May, i.e. the latest trend, especially I think in southern China seems like the situation is better than eastern region. If we talk about the economic importance, both regions are very important. So just to give a little bit color of if the lockdown, you kind of relieve what the impact could be. And following on that, also, because you mentioned that there's a simplified menu, and also in the normal areas, we also offer the normal menus. So I want to understand a little bit further of, under such a complicated situation, how do we manage the logistics and also procurement, especially I understand that the... transportation disruption bottleneck is still there. Thank you.

Thank you. You know, Andy has mentioned earlier about his thoughts and our thoughts about the Q2 and the early May trading. So I'm going to comment on the trading pattern. Let me take Cassie as example to help sort of understand the overall big picture. The dying cells definitely dropped very significantly. The delivery has come up, and, you know, we can understand that. Nationwide, we drove growth through our hybrid delivery model with our own rider. As I mentioned earlier, in Shanghai's case, you know, when we don't have enough rider or our rider being quarantined, our own back office staff volunteer to deliver whenever we could. if we can get the license or approval to go out and deliver. So that's the dying versus delivery. And then the transportation hub, as you can imagine, really suffer. The transportation hub, like the train station, et cetera, the trade right now is about 50% below the pre-COVID level, which is compared to 2020. You know, non-transportation location also declined because the decline is nationwide. And then in terms of weekend versus weekday, weekend is doing slightly better because it's a bit more functional. Sorry, weekday is a bit more better because it's functional. Weekend, you know, it's slightly a bit weaker, relatively speaking. And then lower tier cities are doing slightly better and because they are less impacted by the transportation hub. And then the higher tier cities are more impacted by the regional outbreaks. And then system cells in lower tier cities are also better because of the new store opening there. And by region, interestingly, despite the outbreaks in the southern part of China and eastern part of China, eastern part of China is still doing better in terms of things of growth. It's a very resilient part of the country. And we are very focused on eastern part of China, so this is not a bad news. So beyond that pattern of trading, I mean, the similar pattern kind of, you know, sort of applies to Pingsha He as well. In terms of the logistics and procurement, as I mentioned earlier, I think our team is just absolutely amazing. And not to mention, this is our own in-house logistics supply chain, and they work days and nights. Our team have come up with alternative arrangements very quickly. We traditionally use trucks to move goods around, and you probably know that it has become a bit challenging to move goods around across province. So we use rail mainly to take the goods to the west, and then use sea freight. sea freight, we can put our goods into sea freight and send it to Tianjin to cover the northern part of China and send to Guangzhou to cover the southern part of China. And then our logistics center in Shanghai and Kunshan, we have both. They are working, our team is working in sort of closed loop arrangement to keep our, you know, logistics, you know, running. without major disruptions. And also because this is our own in-house team, so we can move the supply between the stores and between the brands and to also minimize the wastage. Again, you know, it has proven our investment in supply chain and also in digital capability a very important strategic mode because now we have digital visibility of a real-time stock so that we know exactly where stocks are, what's their expiry date. With the visibility, we can be a lot more efficient to keep up the supply as much as we could and also minimize the food wastage, particularly when food is a challenge for Shanghai. So this is incredibly important. So that's where we are. It's not easy. There are a lot of dramas. a lot of challenges, but we seem to be able to adapt really quickly and be as agile as ever. I mean, I'm sure some of these innovations will help us in the long term as well. And then, not to mention, other than logistics and procurement, all these things, what really helps is externally our innovations in new retail we have been we have been incubating the new retail business for few years now the brand called so fun we've been doing it for few years now and and by by second week of March we can see you know, the potential opportunity in new retail when Shanghai was in sort of soft lockdown. And literally within a few days, a few days, we come up with the initiative of community purchasing across all the brands. Not only KFC, but Lavazza and Taco Bell and all the brands. And we do it together and original community purchasing is only a hotline. Later on, we have the When I say later on, I mean a few days later. We have the mini app, and then we have the ready-to-eat, ready-to-heat, ready-to-cook product. And the packaged food also allows us to be more efficient with the logistic process because the new retail packaged foods These are much better food to store and to move around in bulk. So, of course, where we are with this challenge comes opportunity because, you know, Yum! China is very well positioned to capitalize with extensive store network, our membership, our online channel, and already established, you know, channels via third parties such as Jingdong or Tmall for the new retail as well. So I'll pause here and save some time for the next question. Okay. Thank you, Lilia. Thanks a lot, Joey.

Thank you. And just before we continue, we'll ask the participants to limit to one question. Thank you. Our next question will come from Anne Ling at Jefferies. Please go ahead.

Hi, thank you very much for taking my call. Just to follow up regarding the same-sex house comment that Joey just mentioned, that the same-sex house was better in the eastern part of China despite all these strange lockdowns. So meaning that for the rest of the nation, we are seeing a much weaker same-sex house trend. I just want to check with management, what is your take on this? It doesn't mean that there's more fundamental issues regarding consumer sentiment or some underlying structural issues, which we should continue to worry about even when the COVID situation starts to subside on that. And we're also seeing the membership cells. as a percentage of sales, you know, was lowered, you know, on a quarter-on-quarter basis. So does it mean that, you know, during this period, you know, we have more new customers? If that's the case, you know, how are we able to capture this and turn it into our members? And if it is not the case, you know, how are we going to remedy that? Thanks.

This is Andy. I think I will take the question. I think the first question is about the regional differences between, you know, even China and the rest of the country. I think, you know, there's a couple of things. One is obviously we're referring to, you know, the overall eastern part of China, you know, not impacted by, well, not significantly impacted by, you know, the COVID situation. For example, Shanghai, obviously, you know, because of the lockdowns, is significantly below the national average. But I think what we're referring to is overall the situation in eastern China outside of Shanghai is probably still performing quite robustly. So I think it probably has to do with the overall economic vibrancy here in eastern China. As you know, eastern China is the most vibrant, economically speaking, regions in the country. You know, account for a big part of GDP, a very strong growth rate. And we see that, you know, the wealth distribution is also, you know, quite evenly distributed. So that's why we continue to see eastern China as a very important and a very good growth market for us. Now, obviously, there's some regional differences. You know, for example, north-eastern part of China this year and over, you know, the last couple of years, had been hit by wave after wave of COVID. And so I think overall, economically speaking, the northeastern part of China is also less vibrant compared to, for example, eastern China. So I think that's generally some regional differences. And obviously, our strategy, our store network expansion would also factor that in as we open new stores. Now, you know, I think, you know, the other question is about, you know, the sales decline. I think, you know, it's very important to keep in mind, you know, the sales decline or same-source sales decline in recent months are driven by COVID surge, omnicom surge, which resulting in, you know, very strict preventive measure and health measures. that I had to say, you know, as I mentioned on my pre-prepare remark, have an impact on the restaurant industry, but also on, you know, obviously the non-manufacturing sector, service sectors in China as well, and also the manufacturing sectors. So I think, you know, it's worth keeping in mind the temporary or the short-term nature of this. If you look at, we're competent, you know, we're doing a lot of things, obviously, to try to address the short-term challenges, you know, both in terms of, you know, how to use our existing resources. One, obviously, is to, you know, continue to provide service to our customer, to manage costs, to provide positions, and also meet the demand in the impacted regions. And then we also have cost control, as we mentioned. It's not only for short-term, but also, you know, looking into cost structure in the long-term, how we can emerge better. And we're confident, you know, if you look at In China, we have a strong opportunity. There's a lot of white space still, so we can expand and grow. If you look at between the second half of 2020 and the first half of 2021, when things become relatively more stable, we were able to capitalize on the rebound, the recovery, and also, you know, the opportunity they have to present in terms of both sales and also margins. So I think it's fairly, you know, fair to say, you know, there's a short-term piece and then there's an intermediate, longer-term, and then longer-term, we're much, you know, more confident about the market opportunity. So, Anne, hopefully that answers your questions.

Right, right. So what I'm also referring to is on the membership sales as a percentage to system sales. where it's gone from like 64% to 62%?

I think, you know, like the membership sales is not always higher the better. You have to understand, you know, like we, you know, our membership continues to grow. And, you know, obviously, you know, in this period of time, you know, like, you know, maybe it may not be impacted. But, you know, we continue to need to have, you know, attract new customers, right? If we have 100% member sales, then that would be problematic for us in the long term because that means we're not attracting new customers to purchase at our store. So I think it's a healthy mix. In 60-some percent in membership, it's already a very high number. We don't particularly pursue a number for membership sales, and we don't particularly think that having higher membership sales would necessarily be better. I think, you know, this is a healthy level where we have a good mix of, you know, our member sales and then also a good mix of new customers coming to our store.

Okay, cool.

Thank you, Andy.

Thank you.

Our next question comes from Veronica Song at Credit Suisse. Please go ahead.

Thanks for taking that question, and thanks to Joy and Andy for sharing. This is Veronica from Credit Suisse. I have a quick question on the store expansion. So the expansion today is very well on track, and I understand that management maintains the annual expansion target for now. But may we ask, in what market condition or at what stage will the management consider to lift or cut the annual expansion target? Thanks.

Okay, Joey, let me adjust this question for Veronica. In terms of our store network expansions, I think it's worthy to keep in mind that we employ a very disciplined strategy for store network expansion. We continue to see good opportunities. That's why we continue to expand our network. And our store economics, our payback period, reflect that disciplined approach and also, you know, the strong economics. So if you look at, you know, KFC, for example, you know, the payback period for those new stores were, you know, two years. And for Pizza Hut, it's about, you know, three years. So it's very strong economics and, you know, because we apply a consistent discipline approach, you know, we sell a lot to be consistent. And that can happen, you know, I think a lot of people ask questions, why you know, it seems like we have some COVID challenge. How come your economic and payback is still very strong? That's because in over the past few years, we continue to innovate in our store model. We lower the capex, make us more flexible. And so we just see more opportunities, more sites available that meet our internal requirements. Now, on the other hand, I think, you know, obviously COVID and the new soil is not immune to COVID. But, you know, I think, you know, if we look at, you know, the situations, if it is a prolonged situation, obviously longer term, you will see that, that impact reflected, you know, you know, in our payback period, our payback period is based on, you know, a, a, a sort of like historical, sort of 12 to 24 months performance. So, so, when you have a sharp impact in the short term, you may not show that up in the near term. Now, what will change in our long-term expansion? As we have mentioned, obviously, in the first quarter, we're going to slow the store expansion because of the COVID situation right now. Some of these are practical reasons. We also are suspending sort of like store remodeling at this time temporarily. Our store remodeling is in very good shape. On average, you look at our store portfolio, the store either new or have been remodeled over five years. So 80% of that is like that. So we think we can also slow that a little bit. Unless, obviously, as I mentioned, these public situations have been very prolonged, and then we impact our store in economics. then we may go back and devalue it. So the important thing for us matrix that we look after is obviously the return on our investment, uh, the heat rate, success rate of our new store. Uh, and then obviously, you know, uh, going forward, you know, how close we, uh, you know, the market is trending to our expectations. And so all of these would help us to revise, you know, our model input. So hopefully, you know, you know, um, when we look at the longer-term strategy, there's no change to it. I think, you know, the stock economic is still very healthy. You know, as I mentioned before, 2021's new stock opening, you know, they were able to reach even within three months. So, you know, that's very healthy, and the payback period is very healthy. So not much, you know, in the long-term changed, you know, our view on stock network expansion. And we see a lot of space, you know, in the low-tier cities as well as, you know, potentially improving our soil density in the urban area for off-premise consumptions. Thank you, Monica.

Thank you. Our next question comes from Lena Yang at HSBC. Please go ahead.

Hi, management. Thanks very much for taking my question. I think there are lots of uncertainty in the short term, so I actually want to ask a question about the longer term. So if I look at KFC per store sales per year, in 2019 it was close to RMB 8 million per store. That's lower number in 2020 and even lower number in 2021, probably because we open more stores in lower tier cities. So I think if we consider a longer term, considering the mix of new store opening, Do management have an estimate of where is the ideal like the per store sales for KFC can settle at like in the absence of COVID situation? And also considering the opportunity from retail, like Joey just shared, the retail has like grow very fast. Like capacity wise, like theoretically, what kind of retail revenue we could expect in 2022 and what is more like a medium-term target. So that's my question. Thank you.

Thank you. Let me share some thoughts with you in this particular area. One is about the store average sales and the other one is the new retail. So for store average sales, I would like to take a step back and share that KFC and Pizza Hut both have a range of store models. There are some big stores that have more seating and there are some smaller stores that are more off-premise driven. And this is incredibly important because if we keep chasing the average store size, then we miss the big opportunity in terms of the convenience. The reason why this is so important because if you can see our mix of off-premises business is growing and growing and off-premises is really driven by the store network. And as Andy just mentioned earlier in our new store opening strategy, the store density within our current top tier cities is incredibly important. Um, and then of course we are opening a store in the lower tier city as well, as you mentioned. And you know, if you just think theoretically within the same five kilometer, if I have more store there, then the convenience and the speed of delivery is much higher and more efficient. So, so we will continue to pursue a range of business model or store models within the business. And let's say Pizza Hut, for the new store that we opened this year, 70 to 80 of the stores are smaller stores. We're talking about 100 square meters or 150 square meters or below. That is the smaller store we're pursuing. When it comes to retail, new retail, it's still early days. Last year for 2021, our sales was about give and take about 80 million U.S. dollars. And that doubled the sales the year before because we have been incubating this business for a few years now. And as of quarter one this year, we further doubled that compared to the previous year. So for the quarter one, we are talking about close to 40 million U.S. dollars new retail sales. I mean, when we put it in the entire business, you know, we have a pretty big base. So you're talking about 1% to 2%. But then if we only look at the lockdown cities such as Shanghai, we can be talking about 10%, 20%, or even in smaller business, 50% for the emerging brands. So how big it is in the future is a bit too early to tell. But as I mentioned just earlier, we are in a very good position to do that because we have the product, we have the store network, and we have our online channel, and we have our own logistics and delivery capability. And so for new retail business, even though it's still relatively small, it's profitable, which is very, very difficult to achieve. So that's where we are, and it's proven to be particularly important in difficult times like this, and we are so glad for the flexibility and agility of the new retail that brought us in the middle of the pandemic. Thank you.

Thank you so much for sharing the store sales and different formats, Joey. If I observe correctly, I actually also observed your personal number of employees declined by around 30% in between 2021 to 2019. So if I assume things are back to normal one day, actually there is hope for a labor cost productivity gain to show. in your financial results? I'm not sure if that's within your expectations.

Labor productivity is an ongoing challenge.

Back to 2015, 2016, we have 7,000 plus stores.

We have about 400,000 20 or 440,000 staff right now we have 12,000. So we still only have 420,000 staff. So that gives you a sense about it. And then during the pandemic during the lockdown of Shanghai, some store operating at five to 10 people, but this is not sustainable. That means our staff really putting every ounce of their energy. But there will be some innovation coming out of this because we are pushing our thinking into sharing management across the store, which is something that we learn from ourselves in our deliveries, rather sharing among few stores. So some innovations will stay, but to what extent, we are still in the process. Thank you. Thank you. Let's take the next question. Yes.

Thank you. Just once again, if you can ask one question at a time. Thank you. Our next question will come from Xiaopo Wei at Citi. Please go ahead.

Morning, Joey. My question is about the new business. I mean, we appreciate the great effort, you know, top-time in 1Q, and we know that you're sophisticated. supply chain, very agile digital capability impressed us again in the top time. So you did mention your prepared remarks about a group purchase, which is a very new model in Shanghai. Do you think this is going to be a valid model to expanding to other parts of China, even if the COVID situation improves? That is the first question. The second question is, For the market consolidation, usually we are seeing the top time like COVID situation, always a good opportunity to consult the market. We still remember that in second quarter 2020, post the first wave of COVID, you guys consulted market immediately. So presumably the casual dining segment can be more consolidated post the COVID waves than the QSR. So this week, referring to the Pizza Hut where the investors have been focused a lot. Shall we say that your Pizza Hut business could be even more enjoying more advantage of market consolidation post this wave or Omicron wave versus previous one? So there's two questions. Thank you.

Thank you, Xiaopu. The first question, community purchasing, we

Unfortunately, it looks like Joey's line has dropped once again.

Please stand by while we reconnect. While we connect, Joey, let me address the second question, which is about the consolidation opportunities in the marketplace. I think, as we have mentioned on our capital acquisition strategies, obviously we have put a lot of emphasis on investing in CapEx to drive you know, organic growth, and then also, you know, to build our strategic mode. So, you know, our preference, you know, for consolidation in the marketplace is really, you know, through the expansions, you know, of, you know, our store network across all the brands. You know, we have, you know, the KFC, you know, quick service restaurant business. We also have, you know, Pizza Hut in the restaurant and casual dining business. We also have coffee and joint and Labaster in the coffee business. And then we also have the Chinese goods business. So I think we already have a number of opportunities. As we mentioned, you know, today, we also, you know, have a joint, sort of like a new announcement arrangement with Young Brand to join a step-up investment to accelerate, you know, store network expansions here in China for Taco Bell. So I think we already have a lot of wonderful opportunities, you know, coffees and taco, and as well as the growing opportunities here with KFC and Pizza Hut. So I think the main focus, the main drive for us, you know, for consolidating the market is really through the expansions and the growth of our own organic brand. I see, you know, like Joey is already back online. So Joey, would you do just the first question? Yeah.

So the community purchasing, Xiaopu, we of course share the best practice within the company. So we get the scenario plan for whatever cities and province. If it's going to lockdown or soft lockdown, we'll keep the options open. Right now, community purchasing in Shanghai, as the shoppings, become slightly easier, we can see the demand come down a little bit, which is a pretty good thing, actually. But, you know, at the worst time, we have 10 to 15 stores open in Shanghai. But as of right now, we have about 40% of our stores open. So we can still serve customers. better with more stores open than just relying on community purchasing. But, you know, it is sort of an example of agility and adaptability of our business model and our team. So thank you.

Our next question comes from Jack Chen at CLSA. Please go ahead. Sorry, looks like Jack's dropped from the call. Our next question will come from Christine Peng at UBS. Please go ahead.

Thank you, management, for answering the questions. So I have a quick question regarding the cost-cutting measures. So given this prolonged and fluid situation about COVID restrictions and lockdown in China, so I'm just wondering what kind of cost-cutting measures you know, management has put in place or considered putting into place to deal with this, you know, situation. And also, I remember back in 2020, there are quite a few government grants given to Yang China during the COVID, you know, period. So are there any government grants similar to 2020 that will be given to Yang China for the remaining of the year? Thank you.

Christine, so let me, you know, address your questions regarding, you know, obviously cost control and cost reassuring. I think, you know, obviously we're looking at, you know, from a COS side, pretty strong inflationary pressure globally. And so, you know, we'll continue to work with our supply chain, our long-term supply chain partner to manage that. That will be including, you know, potentially longer-term contracts We, as you mentioned before, you know, our contract usually lock in, you know, in a quarter or two ahead of time. We may flexibly deal with that, you know, given the inflationary pressure. For example, for coffee beans, you know, we have locked up, you know, supply that contract that would last us to, you know, 2023. And that would help us to mitigate that. Obviously, you know, not everything can be done automatically. like that, but I think we have a very smart, logical, and supply chain folks here that have a lot of experience, and historically deal with different inflationary environments. Now, the other one is obviously the energy cost. Energy cost in China and globally also gone up, as we mentioned, to the prices of 10%. start then, you know, we are also implementing, that's why we invest in technology. We have and we continue to invest in technologies that would help us to reduce energy consumption. You know, so hopefully, you know, that will pay off in the long term. And the other one is, you know, we will continue to deploy technologies across our supply chain to make sure that we you know, both have the flexibility to deal with, you know, different potential scenarios, but also make them more efficient. I think it's paying off as we see, you know, in the current situations, we're able to very flexibly to redesign, you know, the supply chain network, you know, the routings, and using both rail and sea freight to flexibly manage our logistics operations. um they also you know we see uh technology being employed in you know store operations in the back office uh so you know the labor productivity improvement long one should be held by you know our investment in technology now all in all obviously uh is you know in terms of margins or cause um the biggest driver is actually sales and so you know um you know we will continue to focus on you know obviously um our CRM program, digital program, and then, you know, size marketing, drive sales. And then, finally, we will continue to look at our innovations in product design, you know, and how to best utilize, you know, the resources that we have, for example, whole chicken versus, you know, some of the pot. So those are the sort of like, you know, the way we look at the cost space. And then and then also in the longer term, obviously, we're looking at, you know, see potentially restructure some of the cost base, including rent and rental relief, as you mentioned, in 2022, in the first quarter, the you know, there's, you know, the government have launched, you know, some relief program for COVID. But mostly, mostly is addressed to small, medium enterprises. And so So we will continue to work with the government and see if we can qualify for some of those programs. But I think for the most part, those programs are aimed at small to medium enterprises. For rent relief, I will continue to work with the landlord, not only for rental relief, but also in the longer term, as you mentioned. We don't target a particular growth number for our store. but we'd like to have a quality store open. And so we would continue to work with the landlord to make sure that our rental cost structure is competitive in the long run. And that's most important. So thank you, Christine.

Thank you, Andy. So I just want to make sure the previous guidance about the commodity cost and labor cost increase for 2022 will not change despite all the volatility we have seen in the past two to three months globally.

Well, I think, you know, there will be some changes, but I think the biggest driver for obvious margin, as I mentioned, is sales leveraging and deleveraging. Then the other part is obviously, you know, the inflationary pressures. You know, some of these commodity prices have been more stable, some are in line with our expectation, but some of this is actually very stable. jumping very high right now. So if you look at, you know, for example, poultry and pork, they're relatively in line with our expectation. But, you know, if you look at beef, you look at, you know, other commodities, they have surged quite a bit. And then also if you look at energy costs also go up. And so for example, cooking oil and all that can be impacted. All in all, I think, you know, like I mentioned, you know, those are the small factors, but the self-leveraging is the biggest factor.

Thank you, Andy.

Sure.

Our next question comes from Brian Wang at China Merchant Security. Please go ahead.

Hi, Joey. Hi, Joey. So basically, I want to understand, within your P&L, how much of your... and also the restaurant costs, you know, are fixed, and how much is still variable. Because, you know, when I see your PML, so I can see that the run currently accounts for around 30%, and then I wonder that, you know, when you run a contract, how much is actually based on a share of the store sales? Thank you so much.

Brian, you know, I think your line was coming in and out, but I guess your question is about, you know, costs, and particularly wearable costs versus, you know, fixed costs. Okay. So I think, as I mentioned before, you know, obviously the key cost structure for us is You know, COS is largely variable cost. You know, it's the wall input and paper and packaging for our products. And then COL, you know, we have a hybrid model. Obviously, we have the full-time workers, and then we also have a large part-time workforce that, you know, on a more flexible scheduling basis. In terms of O&O, as you mentioned, the rent, a large percentage of the rent, 80% of that have a wearable component to it. And in terms of dollar sign, it's probably depending on the sales, obviously, because it's wearable. So normal times, maybe 40%, 50% of that, about 50% or so at this time. but it's wearable for rent. And then we also have, you know, obviously market expenditure and all that, you know, we can flex around that. So your overall cost structure, I think it's fair to say that, you know, majority of our costs are flexible, wearable, but we also have a very large portion of them is fixed, including, you know, our journey expenses, for example, salary for our headquarter staff, most operations, and then, you know, the fixed costs in the rentals. So, you know, self-leveraging is real for our business. And, you know, and as we have mentioned over and over again. So, but we, as we mentioned before, we're doing a lot of things to control costs in the near term, but also looking into a longer term structure. For example, you know, like G&A and, you know, in the short term may be impacted by, you know, self-leveraging, deleveraging. And then, but in the long term, our goal is really to keep G&A growth to be below, you know, sales growth, for example. So that's overall, you know, our things. Same for ZOL. You know, we'll use technology and improve our process and store format, et cetera, to make sure that, you know, in the long haul, you know, our labor productivity, you know, in a good trend. So thank you. Thank you. Bye. Thank you.

Our final question comes from Jack Chen at CLSA. Please go ahead.

Thanks, Joy and Andy, for taking my questions. I'm sorry that my line just didn't work. My question is regarding Taco Bell brand strategy because this brand has entered China market for years but still in small size. So as we are planning to have over 100 Taco Bell stores by this year, So could you please share us more about how we're going to develop this brand to benchmark with KFC and Pizza Hut? And since the COVID hit several big cities in China, so if this trend continues, we want to know how it will impact our store opening, such as maybe we can only find store locations in low-tier cities and less impacted regions.

Thank you. Thank you, Jack. We look at this Taco Bell opportunity over a very long time. If we look at, let's say, Pizza Hut, we are already in 700 cities and only in 700 cities out of 2,700 cities, and KFC is in 1,700 cities. So if we, in the coming few years, want to open at least 225 stores, and honestly, it's not that... Joey has dropped off the line.

So I would just, you know, supplement what Joey is mentioning. So obviously, we have looked into the Taco Bell business for a number of years. But, you know, as you mentioned, we still have a lot of opportunities, not only for, you know, our existing brand, KFC Pizza Hut to enter, but obviously for Taco Bell, too. You know, 225 new stores by 2025, you know, is an ambitious target, but it's not an overstretching target. If we look at, you know, the reason why we're confident about, you know, stepping it up, obviously, you know, We have experimented with the brand quite a bit with the format, different format and whatnot. And then I think some of the pilot testing that we have earlier, you know, to make us more efficient and flexible, you know, are showing some very, you know, encouraging signs, especially for the newer, smaller format, you know, which is about 100 square meters and with, you know, lower capital expenditure. and with a simplified manual. I think if you look at the store performance, that gives us quite a bit of encouragement in terms of expanding the store network there. Again, obviously, it's really important for us with any store opening is the discipline process. So we do supply discipline process with a small store format and a new format for technical as well. And so in terms of all Taco Bell, I think we've seen that in the urban top tier cities, they're popular with younger generations. They are more open to trying out new good food. And then if you look at during the lockdown period, the brand also did quite well with the pot offering as well as the delivery coverage. You know, we're excited. We're excited with the Taco initiative. You know, over the next few years, you should see more growth in that brand. And then we would, you know, obviously separate investment with Taco Bell International to drive that startup growth. Thank you.

Thank you, Eddie.

Thank you for joining the call today. We look forward to speaking with you on the next earnings call. And sorry about the... Have a great day.

Thank you so much. This does conclude the call today. Thank you all for joining. You may now disconnect.