Yum China Holdings (NYSE:YUMC) Q3 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to YomChina 2020 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session, at which time, if you wish to ask a question, you will need to press star and 1 on your telephone. I must advise you that this conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Debbie Ding, thank you. Please go ahead.

0:33 Thank you, operator. Hello, everyone, and thank you for joining Young China's third quarter 2020 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Wat, and our CFO, Mr. Andy Yang. Before we get started, I'd like to remind you that our earnings call and investor presentation contains forward-looking statements, which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our filings with the FCC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures.

1:21 Reconsideration of the non-GAAP and GAAP measures is included in our earnings release. Today's call includes three sections. First, Joey will provide an update regarding recent development. Then she will offer some highlights around our quarterly results. Andy will then cover the financial results and provide an update on our four-year outlook. Finally, we will open the call to questions. You can find the webcast of this call and a PowerPoint presentation which contains operational and financial information for the quarter on our IR website. Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

2:02 Thank you, Debbie. Hello, everyone, and thank you for joining us today. As I reflect on this challenging period, I want to thank our employees, our customers, our partners, and our shareholders for your continued trust in Yum China. Resilience is only proven when tested, and we certainly were tested. Following two challenging quarters, we delivered system sales growth for the third quarter. This is the result of the tireless dedication of our staff and partners, working to safely provide good food, great value and convenience for customers across our 10,000 plus stores. Hope fast, stay true. Throughout the COVID pandemic, we hold to our key operating disciplines. Food Safety, Employee Care, and Customer Focus guide our actions. In over 1,400 cities we operate, we provide employment, career progression, and a commitment to improving our local communities.

3:08 We stay true to our culture of innovation, building on our leadership in digital and delivery. All these add to the resilience of Young China. We achieved much in 2020 despite the COVID pandemic. First, we opened our 10,000th store this quarter, marking a significant milestone. Secondly, our brands demonstrated innovation and execution excellence, capturing the shift to off-premise signing early. KFC and Pizza Hut pioneered content-less delivery in late January. We engaged with over 20,000 companies regarding corporate delivery. tapping into another segment of new customers.

3:54 Pizza Hut celebrated its 30th anniversary by driving menu innovation, improving its takeaway and individual set offerings. Third, we formed a joint venture with Lavazza and opened the first flagship coffee shop in Asia. We will continue the journey together to explore the China coffee market. Fourth, we complete the acquisition of Huang Ji Huang, and formed a Chinese Dining Business Unit to tap the massive Chinese cuisine market opportunity. Last but not least, we listed on the Hong Kong Stock Exchange in September, becoming the first Delaware incorporated company to list on both NYSE and Hong Kong Exchange.

4:40 This listing, in one of the most vibrant trading markets in Asia, bring investors closer to our consumers and partners. At the same time, we maintain our strong corporate governance and discipline. The young China of the future will have a much larger footprint across China. Stores will remain new or freshly remodeled. We will continue to serve innovative food across day parts and occasions. A portfolio of brands built organically and through a disciplined M&A process will target strong growth segments. This will be supported by key infrastructure whether in supply chain, logistics or digital marketing.

5:29 We are committed to investing in this future.

5:34 A future of market leadership enabled by growth in stores, growth in our portfolio and growth in digital and membership capabilities. Let me elaborate on each of these growth initiatives. Firstly, store growth. It took us over 15 years to open the first 1,000 stores. In the last four quarters, we opened over 1,000 stores as well. We have the capability, infrastructure, and proven store models to build profitable new stores at scale. Importantly, as delivery and takeaway become more popular, We are adapting our new stores to smaller sizes and lower cap rates. Increasing store density gets us closer to our customers, serving them faster and better while capturing incremental sales and profits.

6:27 We are piloting store models, which are tailored for lower tier cities, to penetrate new markets with greater flexibility and efficiency. Localized menus. Thank you very much. and regional strategies are crucial to expansion. Enable us to develop a strong franchisee network.

7:16 Market leadership will also require investments in our infrastructure. From more logistics centers to IT solutions, we will need to strategically deploy capital for both offline and online assets. Future proving our leadership as we build the next 10,000 stores. Secondly, portfolio growth. We are proud to welcome the Huang Ji Huang and Lavazza brands to our Yum China family this year. In addition to our core Western dining brands, Chinese dining and coffee represent exciting new segments for growth. Over the past few months, we have found opportunities to collaborate between our Little Sheep and Huang Ji Huang brands in the areas of franchisee development, seasoning distribution, and supply chain. Huang Jinghuan franchise partners are already leveraging Yum China's strong delivery capabilities to improve store economics, and we are excited for further synergies.

8:16 Similarly, leveraging our coffee and joy experience, our partnership with Lavazza has seen early success. The three Lavazza stores in Shanghai are receiving great customer feedback. Yum China's capabilities in digital data and delivery are creating an ecosystem for our consumers and will drive growth across our portfolio of brands. The third growth initiative is in digital and membership. Last quarter, we shared some of our thinking around digital membership and their importance as a growth driver. We will invest in creating a customer-centric digital marketing platform. Additionally, end-to-end digitization and the application of AI technology is vital. From five to four, Our goal is to track, analyze, and automate across our value chain. From receiving of goods to real-time control of inventories and operations, investments in digitization empower us to improve operational efficiency and drive customer satisfaction.

9:22 Crucially, this will give us added confidence to accelerate working with our franchisee partners and reach further into more remote areas. Strong digital and membership programs create synergies within our portfolio of brands. This improves unit economics, in turn driving store growth. All of these growth initiatives are interdependent. Investments across all three are necessary to build on our leadership and agility. Now a few observations from this quarter. KFC sales demonstrated improvements in the third quarter, supported by our value campaigns and digital initiatives.

10:08 Domestic tourism and transportation hub volumes slowly recovered, but international travel and tourism is still weak. Pizza Hut continued to make great progress. With new offerings, refreshed restaurants, and strong execution capabilities, Pizza Hut recovered sales to 93% of prior year periods. Our actions across the pillars of revitalization continue to bear fruit as ticket average improves sequentially. Restaurant margins improved by over 5 percentage points and operating profit grew 59% year-over-year in constant currency. Value for money is important to consumers during this difficult period.

10:54 Across our brands, we ensured a strong value proposition KFC extended Crazy Thursdays to Wednesdays and Fridays. Pizza Hut brought back the hugely popular All-You-Can-Eat program in September. Apart from great value, our innovative products excite customers. At the national level, we launched the Durian Chicken Burger at KFC and a Chinese-style braised beef pizza, Dong Puerh Niu Rou, at Pizza Hut. We also trialed regional flavors in selected markets, such as Wuhan Hot Dry Noodles, Wuhan Le Gan Mian, and Late Night Delivery of Sichuan Spicy Crayfish, Sichuan Mala Xiao Long Xiang.

11:40 Delivery drove strong growth across our entire portfolio, accounting for approximately 28% of sales in the third quarter. We continued improving our takeaway menu and offers to complement deliveries. Together, off-premise signing accounted for over 55% of sales at KFC and 40% of Pizza Hut. Digital orders were 78% of sales, well above pre-COVID levels. Fueled by digital, members grew to over 285 million. During the quarter, we sold 19 million privileged memberships at KFC and Pizza Hut, covering multiple categories. Other than the signature delivery and family privileges, we sold over 8 million Chicken Lover memberships at KFC during the summer holidays. This paid membership tripled frequency and sales per member during the subscription period.

12:44 We generated meaningful profit in this quarter. Despite the pressure from South Sea leveraging, Our 320 million of operating profit, excluding special items, was the result of the strong efficiency improvement we have made. As we look forward to the end of the year and into 2021, we remain cautiously optimistic. We must continue to be vigilant and agile. I need to remind our stakeholders that China is a large, diverse market, will experience varying levels of COVID impact until the new vaccines are developed. The recovery will continue to be nonlinear and uneven, but we are well-positioned to navigate these uncertain times. With that, I will hand over the call to our CFO, Andy Yong. Andy?

13:41 Thank you, Joey. And hello, everyone. I will first address key financials and development in the third quarter, then provide some color on our outlook. Unless noted otherwise, figures mentioned refer to the third quarter of 2020. All percentage changes are before the effects of foreign exchange. Revenue was flat year over year with same-store sales recovered to 94% of the prior year period. All brands have sequential improvement in sales. This is a testament to the hard work and dedication of our employees to drive top line in the challenging environment. KFC same-store sales recovered to 94% of the prior year period, compared to 90% in the second quarter and 89% in the first quarter. Improvement was largely driven by effective value promotion and digital initiatives.

14:43 Same-store traffic recovered to 90% from 80% in the second quarter. Our transportation and tourist hub sales improved but still remain under pressure. Pizza Hut theme store sales recovered to 93% of the prior year, compared to 88% in the second quarter and 69% in the first quarter. Value Campaign, All You Can Eat, and Membership Initiative were effective in driving traffic and ticket average. died in volume to recover to over 80% of prior year for our core brands. Strong contributions from delivery and take-away continue, with over 50% of our sales being off-premise.

15:30 The consolidation of Guangjiwang contributed 3% to total system sales in the quarter. Together with the consolidation of Suzhou KFC, their contribution to total revenues was 2%. We opened 312 stores, new builds accelerated as our development team secured favorable locations with more flexible store formats also helping expansion. Despite the same-store sales decline, restaurant margins were 18.6%, up 0.9% compared to last year. Sales deleveraging was more than offset by our aggressive efforts to control costs and improve operational efficiencies. Cost of sales was 31.2%, almost flat year-over-year. This was largely driven by a 1.7% reduction at Pizza Hut as they lapped aggressive promotion May last year. KFC had a 0.7% increase in cost of sales.

16:34 The impact of more aggressive promotions and value campaigns to drive store traffic and sales was partially offset by commodity deflation of 1% at KFC. In particular, we worked closely with our major poultry suppliers to take advantage of a more benign inflation environment. Cost of labor was 21.6%, almost flat year-over-year. Rage inflation was 3%. It was subdued in many of our markets as government-mandated minimum wage increase were deferred. Labor productivity improvement has largely offset the impact of wage inflation and increase in delivery rider costs. Labor productivity improvement was accentuated by shortage of part-time workers in the quarter.

17:28 We intend to increase staffing levels in the coming months to balance service and efficiency. Compared to $40 million in the first quarter and $15 million in the second quarter, We received approximately $10 million in rent reductions and government relief. However, we expect this to phase out. G&A expenses increased 6% mainly due to a lapping of prior year's government incentives and impact of consolidating G&A expenses at Wangjiwang and Suzhou KFC. Excluding the impact of consolidation, year-to-day G&A expenses decreased 1% year-on-year. We achieved operating profit of $556 million, including a re-measurement gain of our existing equity stake in Suzhou KFC of approximately $239 million.

18:23 Excluding special items such as re-measurement gain, adjusted operating profit was $320 million, representing a year-over-year growth of 5%. Our effective tax rate was 25.6%. Net income was $439 million, and adjusted net income was $263 million. If we exclude $29 million net investment gain in late one, it would be $234 million, up 8% year on year. Diluted EPS was $1.10, and adjusted diluted EPS was $0.66. I would like to touch on our capital allocation strategy.

19:08 Following a careful review of our financial position, we will resume our cash dividends at $0.12 in the fourth quarter. Our capital allocation focuses on driving the long-term growth of Yum China while providing adequate liquidity to navigate any sudden disruption to our business. With the capital raised in our secondary listing in Hong Kong, We will focus on, one, accelerating new build and maintaining store remodeling across the YUM China portfolio. Two, stepping up investment in our digital, logistic, and delivery infrastructures to support and drive growth. Three, maintain a disciplined approach to M&A and investment while exploring opportunities to invest in brands with excellent growth opportunity, new capacities, and technology.

20:05 As this year has shown, having sufficient liquidity is paramount to operating in an uncertain environment. Our strong balance sheets provide us the capacity to deal with potential contingencies while allowing us to make targeted investments to drive growth and capture market opportunities. We believe this approach to capital planning will drive long-term shareholder returns. In terms of outlook, As we look ahead to the fourth quarter, we are encouraged by sequential quality improvement. However, we must be mindful that the pandemic is still not over yet. The remaining journey to recovery is going to be challenging. We expect our store traffic and sales continue to be impacted by, one, the lingering effect of COVID-19 on consumer behavior, two, transportation and tourist volume while recovering continue to be heavily impacted.

21:05 Three, additional precautionary measure that consumer and or government may take as we enter the colder months and as flu season approach. At the same time, we also expect margins to be impacted by sales leveraging and a continued focus on value campaigns to drive store traffic. Facing out of COVID-19, related relief. Increase staffing levels to balance services and efficiencies. And finally, stall impairment, review factoring in the impact of COVID-19.

21:50 It's important to note that the fourth quarter is not only seasonally the lowest quarter for sales, but also the biggest quarter for stall remodeling. Small changes in Operating results or investments can have a significant percentage impact on operating profits. In terms of inflation outlook for 2020, we now expect wage inflation to be low to mid-single digits, commodity inflation to be flat to low single digits, driven by lower grocery prices. In terms of store opening, including Wang Ji Wang, we now target to open more than 900 new stores.

22:35 As a reminder, following our secondary listing, we ended the third quarter with 419 million shares outstanding. As for 2021, we are operating under the new normal of reduced travel and social activity. Sales momentum will continue to be impacted until the pandemic is over. With thousands of COVID-related disruptions, different regional markets will likely experience varying performance. In October, there were regional outbreaks in Qingdao and western China, which resulted in testing for millions of people. This is a good reminder that the recovery will be nonlinear and uneven.

23:23 We continue to face cost pressures on multiple fronts, As part of our commitment to the environment, we will begin to phase out the use of plastic packaging. This is expected to materially increase our cost of sales. Rage increases have been mostly deferred or delayed in 2020. We expect this to catch up. We will also step up investment to build out our digital logistics and delivery infrastructure. Accelerating investment in these areas will be critical in maintaining our market leadership. With our digital infrastructure, solid execution, and strong balance sheet, we are prepared to capture opportunities for recovery and growth.

24:12 We will provide additional details on specific 2021 targets with our Q4 earnings release in early 2021. With that, I will pass you back to Debbie to start the Q&A. Debbie?

24:27 Thanks, Andy. We will now open the poll to propose questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A. Thank you so much. Ladies and gentlemen, we will now begin the question and answer session. As a reminder, if you wish to ask a question, You will need to press star and 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Again, it's star and 1 if you wish to ask a question. And our first question comes from the line of C.G. Lee from CICC. Your line is now open.

25:13 Hi, management. Thank you for taking my questions and congratulations on a good performance. So I can ask one question, right? My question is on Pizza Hut. Because for Q3, we see that the near 17% of restaurant margin is really a high level, even through its history. So could we know more about what happened behind this? And is it sustainable looking forward? Thank you.

25:43 Thanks. This is Andy. So I will address your question regarding margins at Pizza Hut. I think overall margins, if you look at the overall margins for the quarter, we do have very strong performance on both KFC and Pizza Hut. Overall, if you look at Pizza Hut, for example, certainly we are still impacted by sales deleveraging, roughly more than 2%. For inflation, we do see continuing are all commodity pricing pressures for the cost of good sales. But that's more than offset by the labor productivity improvement.

26:28 Now, if we look down at each cost item, if we look at, for example, cost of sales, we see that this is an improvement about almost 1.7%. You know, the main part of that is some more inflation that's offset by lapping of promotions in 2019. Now, for cost of labor, we see, you know, about 1.4% improvement. You know, despite sales leveraging, raising inflation, we see that labor productivity gain, you know, part of that, as I mentioned on the preparing mark, is exaggerated by with a shortage of part-time workers this quarter.

27:19 And also, we also benefit a little bit from the lower social insurance contributions. A big improvement here is actually on what we call O&O. And that has a lot to do with the number of cost initiatives at the restaurant level, including utilities, maintenance costs. We also got some rental relief, of course.

27:50 Okay, thank you, Andy. Thank you. Thank you so much. And your next question comes from the line of Brian Midner from Open Timer. Brian, your line is now open.

28:12 Thank you and congratulations on navigating this environment. Your unit growth outlook for 2020 continues to be very strong despite the pandemic. Are you able to give us a look into the pipeline for 2021 or give us any color on how you're starting to think about the unit growth opportunity in 2021?

28:45 Hi, Brian. This is Andy. So I will give you some power, and then Joey may want to feel free to jump in later. I think, as we mentioned, at the beginning of the year, first half this year, we certainly have low impact from COVID-19 in terms of our store opening. As we have mentioned in prior earning calls, our development teams have a lot of projects in the pipeline at the time, but obviously because of the pandemic, there was some delay in construction because they limited mobility in March, April timeframe. So they have been trying to catch up, obviously, and they have done a pretty good job this quarter.

29:36 That's why we're confident that You know, we can meet the target and raise that to, from Pearsley, we got it to about 800 to 850 stalls to now more than 900 stalls. You know, as we have mentioned, as Joey mentioned, our next milestone would be another 10,000 stall. You know, it took us quite a while to get to the first 10,000. It took us almost 33 years. We certainly think that we will do it much faster this time around. In terms of the pipeline for 2021, I think right now we're still in the planning process. It's too early to provide you that information, but we would give more details in our planning. However, if you look at our current situation right now, we do think that we still have a lot of opportunities in China for growth, for store network expansion.

30:32 If you look at the number of cities that we are in right now, it's a little bit more than 1,400 for KFC and I think 800 plus for Pizza Hut. So we're still tracking about probably close to 500,600 or more cities that we can penetrate in the future. So those are the white space. Also, in terms of increasing penetration in the top tier cities, and also lower tier cities, we think there's also a lot of opportunity as well. Looking at the soil density compared to not only to North America, but also to other Asian countries and regions, our soil density is still relatively low. So particularly with the shift to a smaller store format and also with catering more to delivery and takeaway, I think we do have a lot more opportunities in terms of increasing the penetration of our store network in the existing market that we're in right now.

31:47 Hopefully I addressed your question.

31:50 Thank you, Andy. Brian? I would just like to add three comments of your question. One is we always emphasize on the quality of stores. So we will be aggressive and open-minded about new stores if we see the opportunity of opening good stores, profitable stores, or at least breaking-even stores. So that's the bottom line we hold very, very close to our hearts. and thus, the bottom-up approach is if we find those, we'll open them. Second is, as Andy mentioned earlier, I just want to make it more specific, is at the Tier 1, Tier 2 cities, we are going for smaller stores to adjust our store portfolio strategy because the growth of delivery and takeaway and also to handle the rent and other costs as well. It's quite an efficient model to fill in the gap of the trade zone.

32:57 For the lower tier cities, we have been working on the lower tier city store models and this year we have further breakthrough in our models. Not only the investment cost for the lower tier city model is getting higher, and even lower. We find the innovations to do that. But also we have customized menus for the lower tier cities. To give you an example, we have opened a few such stores this year. We feature something called Crazy Store Manager Offer, which will feature a combo, a lunch set of 15 yuan RMB, which is a bit more than $2.

33:43 And our Normal combo for four items in Tier 1 and Tier 2 cities would be $30 to $35, etc. So you see the gap. And the products are different. We are not going to sell the same product at such big price gaps. But the lower tier cities, particularly in the western and the northern part of China, require a different understanding of our manuals. 0.3 Pizza Hut. We have been talking about the satellite store model since last year and we've been working on it because essentially what the satellite store means is huge reduction in terms of capacity investment and quite a different store operating model.

34:35 For example, our kitchen needs to move from 140 square meters to a much smaller size, cut it by half per se, and the You know, the menu is slightly different too. As of this year, we are going to have about more than 20 satellite stores, and I will be happy to say that the initial results are encouraging, and we are happy to see what we are seeing right now for both satellite stores for Pizza Hut and for the lower tier city stores for KFC. Thank you, Brian.

35:17 Thank you, Joey. Thank you, Andy. Thank you so much. And your next question comes from the line of Linda Wong from Macquarie. Linda, your line is now open.

35:31 Hi, management. I have one question regarding for the store expansion. Because I noticed that the payback period, especially for the Pizza Hut, slightly increased. Before, I think payback period is three to four years, but right now it's three to five years. So I just want to know that whether in the future we continue to expand the store, and do we worry about operational efficiency issue? And can you also share with us about Huang Ji Huang, its payback period? Thank you.

36:07 Hi there, Linda. So let me address the Wang Ji Wang, and then I'll get back to the earlier part of that. You know, for Wang Ji Wang, it's mostly a franchise model. So, you know, almost all the stores, the large majority of the stores are, you know, a franchise model. That same goes for, you know, real ships. And so, you know, the entire pay-per-view is not very meaningful, you know, for us. You know, especially, you know, the franchisees. But what we can say is that, you know, the franchisees themselves are actually massively happy, you know, with their payback. And that's why we continue to see, you know, pretty decent fill out in terms of the franchise operations over there.

36:55 Hold on one second.

37:04 It's the payback period for Pizza Hut. Linda, for the pizza payback period, I think, you know, because of the COVID-19 and the way that we calculate numbers, it's a rolling number. So, of course, during Q1, Q2, it impact our payback period a little bit. But we still overall are confident with the overall numbers. Thank you, Andy. Right, right. So, Linda, so I just want to remind folks that, you know, when we disclose the payback period, generally we are using actual number, so they

37:58 will reflect the impact on the recent months, which is, I guess, Joey mentioned, impacted by COVID-19. But overall, I think if you look at the store recovery in terms of their sales recovery, we're on, I think, the right direction. Overall, if you look at SSG, it's back to 94% for KFC and then 93% for Pizza Hut. And so So in that sense, I think we may still see that rolling average being impacted, but fundamentally, we haven't seen a material change in terms of how our stores are performing, and also in terms of long-term outlook. I think as to the recovery, even though it's going to be nonlinear and uneven, but I think eventually, The pandemic will be over. And then I think we're comfortable that we will not fundamentally change our store economics. Obviously, there were some operational changes in terms of how our store, as Joey mentioned, we would continue to experiment with different store formats.

39:15 For Pizza Hut, for example, we also have these satellite store formats that are being rolled out. So it would do with... But nonetheless, I think... The fundamental hasn't changed. Maybe more delivery, more takeaway in terms of sales, a smaller store format going forward. But I think it hasn't changed our view on the payback in the future.

39:42 Okay, got it. Thank you. Thank you so much. And your next question comes from the line of Xiao Pui from Citigroup. Your line is now open.

39:55 Good morning, Julia and Andy. Congratulations again for the strong recovery in third quarter. So we are now in fourth quarter, which is a low season. I will be more interested in upcoming 1Q next year, which is a peak season. In my view, that is Julia and team have to facing tougher choices next year of first quarter because on one hand, you have to be More proactive in terms of recovery itself further. On the other hand, you have to hedge against any risk of disruption due to any coming back of the COVID cases. So like Chinese saying, 一颗红心两手准备 So how could you balance the two with your strategy and operation in terms of innovation, value campaigns, delivery, and manual offering, et cetera? Thank you.

40:49 Thank you. Thank you, Xiaobo. That's a good way to put it. In fact, that's exactly our approach for this particular year since January, the happening of COVID-19. How are we going to do that for 2021? It's not going to be too different in terms of the general approach. We will Be prepared, we'll be agile, we'll be flexible, and we'll be cautious, but we'll also be optimistic. You know, if we look at particularly Q3 this year, all of our brands improved in terms of the SSSG, you know, the dyeing actually continued to recover, but we also worked very hard on strong value campaigns to drive traffic. for both KFC and Pizza Hut.

41:48 But at the same time, we are very well aware of the lingering effect of outbreaks and thus our repeat caution to our investors and analysts about the uncertainties of COVID-19. We just have to live with it, really. But when we come to the business, we still have to focus on each are all core pillars of the business. And we have to make sure each pillar is strong and sound and agile and flexible because we are in a very good position to manage all the challenges and actually still achieve innovations and results for our shareholders, for our customers, and for our employees. And if we just recap what, let's say, KFC and then Pizza Hut, What will happen here for Q3 or for this year so far?

42:49 As I mentioned earlier, we focus on the value promotion, LTO, the new product. And then we focus on the previous subscription, so our membership. Throughout the COVID-19, particularly during the most difficult time when we actually could not do advertisement very effectively, we actually could focus on our membership to still launch new products conduct marketing campaigns. And on top of the pillar of the membership, we work on our delivery. And our delivery improves, continues to grow with double-digit growth for Q3, Q2, and Q1. So delivery is very agile and resilient business. And Transportation Hub for Tourists is...

43:40 It's still being challenged. You know, the sales is still below pre-outbreak period. It's still about 20% less. But we continue to work on it. And then the regional differences. Regional differences also means regional opportunities, too. The eastern China is still better than northern China. The lower tier cities are still better than higher tier cities. And then the recovery in weekend and weekday, right now it's evened out. But in the past, we were doing a bit more promotion in weekdays, a bit less in weekends because our weekend traffic was quite stable, quite encouraging and vibrant. But COVID-19, the weekend traffic, the pattern changed. But it's okay. We make ourselves more agile and flexible, and we learn better how to deal with the weekend and weekday traffic recovery.

44:37 And then that's the KFC. And for the Pizza Hut, despite the COVID-19, we still fulfill our promise of sales first and profit later, which we have been talking about for a few years now. And we have seen progress in the manual, the value campaign, the perception of value, and expanding takeaway channel. And thus, by Q3, we've recovered ourselves to 93%. and driven not only due to the improvement of traffic, but ticket average. And how do we do that? Well, actually, more targeted discount marketing campaigns, increased party size and all-you-can-eat.

45:22 So all in all, with our flexibility and with our focus on each of the pillars driving the business, I think we have demonstrated our resilience for 2020, and I would like to believe Our resilience and our team's ability to deliver during a very difficult time of 2020, we shall continue to do that for 2021. Thank you, Xiaopu.

45:49 Great, thanks. Joey. Thank you so much. Andy, your next question comes from the line of Chen Li from Bank of America. Your line is now open.

46:03 Thank you, Joey and Andy, and also congratulations again on the strong Q3 results. I've got a question on Pizza Hut, which actually offers a quite big upside surprise for Q3. Typically in the past, same-store sales growth for Pizza Hut should be weaker than KFC, but this time Pizza Hut was quite close to that of KFC, and the pace of Pizza Hut recovery also seems to be faster. What's the reason behind that? Is it because of all the measures that we have taken to revitalize Pizza Hut, or it is also probably because of the assumption that maybe casual dining in China is actually recovering at a faster pace for the industry as a whole? And also with regard to margins, the food and paper cost at percentage sales declined quite dramatically for Pizza Hut. and at the same time, we are getting less promotional than last year. If that is the case, how should we reconcile that with encouraging things for Pizza Hut in Q3?

47:14 Thank you.

47:17 Let me make a comment on the sales recovery side and then Andy can address Lawton's question on margin. I would say your thoughts about the Pizza Hut recovery is due to the overall model recovery, overall business recovery is what I agree and what we believe and that's what we have been working on and we have been, as I mentioned earlier, we've been talking about our focus, our promise of sales first and profit later for Pizza Hut for a few years now. Actually, Pizza Hut pointing out In 2019, we delivered the first recovery of traffic, particularly the Danyin traffic, which was very, very critical for our business.

48:13 Because before 2019, the last time we had positive traffic growth in Pizza Hut Danyin business in particular was back to 2014. So 15, 16, 17, 18, It was hard work, and by 2019, we get our customers back, and that's the most, most important part of the improvement. And we have been also talking about a few pillars of the revitalization, the menu, food. We changed 70% of the menu, so the food is very, very different. The delivery, we rebuilt our delivery team. We took it in-house. It was painful. But we got it done without impacting the sales growth or the margin.

49:06 We work on the perception of value, food taste, service level, dining environment. I don't know whether it's clear to our stakeholders, but we actually had the commitment for Pizza Hut for not increasing the price for three years. No price increasing for free. It's a very strong commitment to bring back the value for money, which is absolutely critical for Pizza Hut's business model. And during the COVID-19, we also looked at it as a, well, of course, it's a challenge, but it's also a trigger point to do even more innovation in takeaway products.

49:51 because we were building the system before that, the mobile order system before that. And we launched in a big way, and the takeaway business took off. So that added another leg to our business. So it's not due to one or two things. It's due to many things that we have been doing. All the key pillars of the transformation are delivering the results. Thus, we are quite pleased to see the progress and I'm certainly quite proud of our team's hard work that's producing the result right now. And we do believe that the fundamental change and improvement of the business model will continue to help Pizza Hut deliver ongoing improvement. It's not done yet. We're still working on the breakfast day part, for example. because it's still an opportunity for us as well.

50:51 But that's just ongoing. With that, I'll pass the question to Andy to give some color about the margin question for Lawton.

51:01 Sure. Thanks, Joey. And actually, I want to supplement your comment a little bit. I think it's important for us to put things in perspective. I think KFC actually have improved quite well in terms of SSG. Last quarter, their SHG was about 90. And this quarter, they're about 94. If you look at Pizza Hut, last quarter, their SHG was 88. And obviously, we're pleased that they're at 93 now. So both brands have actually seen quite a bit of improvement in terms of growth recovery. And more importantly, I think, you know, If we look at the impact in the third quarter, for example, at the beginning of the third quarter, we were still having impact from the original outbreak in Beijing. And then we're also further impacted by, obviously, the children's school holiday.

52:01 So in light of that, I think we are pretty pleased with both friends' trajectory at this time. Obviously, as we mentioned before, the recovery, Pace, as we get closer and closer to full recovery, it's going to be more challenging. The reason is because we still are not out of the woods. And so if you look at transportation and tourist location, as we mentioned, it's still down quite a bit, right? More than 20% in terms of traffic over there. And those are an important part of our business, account for the high single-digit hour business. If we look further a little bit more, we still have some You can talk me to do, you know, at the dining business, right? You know, the traffic at our store right now is 90% of last year's level.

52:49 So, you know, getting people, the last group of people to feel comfortable and venture out in dining may take a bit more time. And we, so we, that's why we say, like, you know, we feel pretty good about the third quarter result, but we, you know, are cautiously optimistic in the fourth quarter. And the emphasis is in the cautiously optimism. especially as we go into the winter season and the winter flu season. So there we should expect some potentially regional outbreak or additional measure that will be taken by consumer or government as time goes by. In terms of margins, I think if we look at the overall margins, especially at Pizza Hut, I think You know, they obviously, as Joey mentioned, you know, our strategy has always been, you know, to fix the fundamentals and try to solve traffic and sales and then profitability. This is obviously a little bit unusual and extraordinary in the sense that, you know, we, at the beginning of the year, we've seen a very significant decline in sales due to COVID-19.

53:59 And we're very glad that, you know, we've seen a very quick action, you know, in terms of cost saving as well as building new products. for the situation. So when we look at cost of sales, for example, overall for Pizza Hut, as I mentioned, it was about 0.7% better. And we're still under some inflationary pressure in terms of commodity size for Pizza Hut. But obviously this year, the focus on cost savings and also targeted market promotions will benefit from the lapping of very heavy promotions in comparison to last year. So in terms of cost of labor, we still have wage inflation, but it's much more moderated this year for both brands because a lot of the minimum wage increase mandated by government have been delayed or postponed.

55:00 So it's more benign. I think if you look at wage inflation, we're probably looking at most single digits this year. But we do expect some catch-up there. The other one is that they're having some labor shortage that also accentuated the labor productivity gain. So people actually have to work a little bit extra harder. So as we mentioned on the prior remarks, We do think that in the coming months, we may have to increase the staffing levels to ensure that we have a balance of efficiency as well as service level. In terms of you mentioned O&O, I think there's a lot of improvement there. And I think, again, this is coming down to a number of things.

55:52 It's not just one initiative. There's a lot of cost initiatives. We have seen, you know, lower utility costs. We also see lower making costs and rent relief there as well. So I think, you know, in terms of the margin perspective, you know, I think the commodity inflation in certain areas is moderating a little bit, you know, compared to the early part of this year. But we still will be looking into that, especially when we go into next year, you know, in 2021. will basically be stacking up two years of inflationary pressure. For example, wage increase of the total I mentioned before, likely there could be some catch-up in some of those costs.

56:38 Some of those initiatives are sustainable. So if you look at, for example, in cost of labor, we do see productivity gains from using technology, as we have mentioned a few times. The ultimate is scheduling, the pocket store manager, You know, real-time tracking, all these would help us in the longer term for productivity improvement. But, you know, as I mentioned, you know, the labor shortage, you know, and the increasing staffing level in the coming months, it may reverse some of those gains. So, and then, you know, the subdued wage inflation this year may have some catch-up with you next year. But all in all, I think, you know, I think some of those... may need to ease up a little bit so that we don't go overboard.

57:26 In terms of commodity inflation, I think if you look at overall inflationary pressure, it's easing a little bit. Pot is still very elevated in terms of prices. It's probably 20%, 30% higher compared to last year. But for poultry, like chicken, that pressure has eased a bit. as the supply come back in. So that may help us a little bit on, you know, cause us good sell. However, as Joey mentioned, value promotions, value for money is very important proposition for consumer, you know, in this new normal. And so we may give back some of those savings in terms of grocery prices back to consumer to drive more traffic back to our store. So hopefully I addressed your question.

58:16 Yes, thanks a lot, Joey and Andy, and congratulations again. Thank you so much. And your next question comes from the line of Huizhen Li from Morgan Stanley. Your line is now open.

58:33 Thank you, Joey and Andy, and congratulations again. So I think my question on margin is well answered by Andy personally. So I think my next question is more on the development China Cuisine. So I know that the first in the expansion of units partially is from Huang Ji Huang, but I want to check what's more longer-term thoughts behind the development of this newly set up division. Thanks.

59:07 Hi, Liyuan. This is Sandy. Let me try to address your question here on the Chinese cuisine business. Obviously, you know, we We think that the Chinese cuisine is a very big market. Chinese cuisine takes a lion's share for consumers here in China in terms of dining outside. So there's a lot of opportunity for us. In terms of Chinese cuisine business, with the consolidation of Longjiwang and with our existing brand of Little Ship and East Dawning, we formed the The Chinese Cuisine Business this year, the unit is led by Ted Li. And he has been, you know, obviously responsible for, you know, the turnaround of real ships over the last couple years. You know, in terms of Chinese cuisine business, we have, you know, our goal is really try to leverage, you know, Yum China's scales, you know, our supply chain, our franchise communications, Our delivery partnerships, for example, with different aggregators, which offer a significant provincial rate for us. In terms of, we also want to take advantage of the full innovation capability. So, if you look at Low Ship, we launched a self-heating product, a similar product, and we are also looking into

1:00:39 at Little Ship, for example, growing out of the product category like barbecue, for example. And we also see a great opportunity in the seasoning and sauce business. And so we have seen Little Ship start growing that business over the past couple of years. 1G1 also have a very good sauce that they use at their store, and we've seen opportunity for them to actually leverage that up to the consumer business. So if you look at Chinese consumer business this year, I think a lot of this work would be focusing on integrations of Wang Ji Huang, making sure that we can drive that synergy, not just about cost, but also product innovations, about distribution channels, about franchisee space, opportunity there.

1:01:34 In terms of next year, I think we would like to see them moving into more growth mode, seeing more growth in the franchise space, as well as more progress on the seasoning and sauce business. So this is sort of our current view of looking at Chinese food services.

1:01:59 Thanks a lot, Andy. Thank you so much. And your next question comes from the line of Michelle Chen from Goldman Sachs. Michelle, your line is now open.

1:02:13 Hi, Joey and Andy. Congrats for the good result again. And I'm just wondering whether you can share some color about the recent trend. Since earlier you mentioned that transportation hub is still around 20% plus below the normalized level.

1:02:28 So trying to understand whether we are seeing a more significant improvement in October since we hear some relatively positive data points from other retailers and restaurants.

1:02:38 Thank you. Hi, Michelle. For the trends, I mentioned a bit earlier about KFC, the key pillars for the business recovery. The delivery is still growing. The regional difference continues, but the gap reduced. The recovery in weekend and weekdays, even now, and when it comes to the transportation hub and tourist location, the transportation hubs Business for KFC because Pizza Hut does not have much business in Transportation Hub, so it's mainly for KFC. It's still below the pre-outbreak period and we mentioned probably about minus 20%.

1:03:26 Even during the big holidays and the international traffic is still very limited due to the ongoing concern of the COVID-19. But one thing we would also like to caution our Our investors and analysts post-holiday trading is still a challenge. And that's a very interesting phenomenon because usually when customers still have the little concern of the overall economic situation, the job, etc., you tend to see pretty good trading during holidays.

1:04:12 But after the holidays, the little weakness actually shows the psychological impact. It's not only true in one country, it's generally true across different cultures, different countries. So we see a little bit of that too, which we'd just like to caution our analysts about that. But the overall trend is good. I mean, for China, we are grateful for that, you know. Thank you, Joy. Thank you so much. And your next question comes from the line of Kristen Peng from UBS. Your line is now open.

1:05:21 Thank you, Joey, Andy, for the very detailed explanation about the result as well as very positive outlook towards the future. So I have a separate question which might not be related to the quarter result, but Joey, I want to get your thoughts. So recently we read from some news reports that

1:05:41 Your company is launching Kaifeng Cai, which is a packaged food brand throughout China, starting from the KFC retail units.

1:05:54 So can you share with us your needs to long-term sorts towards this business initiative? And if you can share with us more colors in terms of the branding, pricing, Distribution Strategies. They'll be very much appreciated. Thank you, Joey.

1:06:13 Thank you, Christine. I mean, obviously, it'll be hard to serve your Wuhan Le Gan Mian because it needs to be Wuhan. It was only served in Wuhan. But hopefully, we will be able to have the opportunity for yourself to try our Kaifeng Thai products. For our... The experiment in the retail business, you know, partly is natural. Why do I say that? I'll explain it later. Partly because of the innovation that we come up with during the COVID-19. So during the COVID-19 time, obviously we have seen the trend, which is related to Michelle's question earlier, is one trend is the increase of the Home Consumption, Ren Huo Chang, the people, product, and occasion.

1:07:13 So the home occasion, the consumption is increasing, and we can see that. And Pizza Hut responded during the COVID-19 very quickly by launching the steak, the prepared steak, but it is cooked at home, and the result is very good. and Ken Tse has his own take of the home occasion opportunity. And we leverage our product innovation team, which is a fantastic team. They come up with all sorts of very yummy and great product, and they come up with a lot of these products that could be consumed at home. And so far we have launched the chicken soup, Jitan. We have launched the Law Surfer.

1:08:07 is a kind of rice noodle from Guangxi area with very strong smell. And then we have launched others like the chicken breast. So we launched a product innovation team, and right now we are testing it and selling it in mainly top tier cities, because it takes time to build up the volume because this is a volume game as well. And the result is very encouraging. And we leverage our current existing channels such as the e-commerce channel, such as our own app, such as our own current stores to sell the product. And customers can buy the product through our stores as well. So they can buy the product in the store and they can be delivered via our own in-house delivery team.

1:09:14 So you can see how we do it. We leverage the product innovation team, our distribution channel, our store team, our delivery infrastructure to expand the business. So that's where we are right now, and still early days, but we are quite excited about the progress. And the name of Kaifeng Chai, I probably mentioned it before. If I repeat it, I'm sorry. It's a name that customers in China tease KFC. This is the local version, local name for KFC, but it's more in a funny way. We just, you know, take it as a compliment. So we call ourselves Kaifeng Chai. And people got it immediately because that has been a name being used for many, many years, but never been used officially.

1:10:05 So we make it official. So that's where we are.

1:10:08 And of course, you might notice that we have also launched a coffee capsule. We call it Xiaohei Dan because it's in a little, tiny, small coffee cup. And it's an upgrade version of and Ethan Coffey with different flavors, stuff like that. And again, we try in top tier city and we are happy with the testing and the progress. So the retail business of KFC and Pizza Hut is an area that we are still learning and we are looking forward to delivering more this kind of yummy products to our customers. Thank you, Christine.

1:10:54 Thank you, Joey. Thank you so much. And your last question comes from the line of Emily from Jefferies. And your line is now open. Hi, management team. Thank you for taking my question. Just one minor thing regarding management mentioned earlier that in third quarter delivery business, one of the key driver has been like the corporate delivery. May I know, like, you know, is this corporate delivery, like, mainly from KFC or is also for Pizza Hut? And what is the growth potential over here? How much of the sales or the delivery sales is actually coming out from this corporate delivery? And I understand that we also start to, like, launch, like, delivery to park and all these, like, you know, initiatives.

1:11:44 So just want to see, like, you know, are these, like, you know, the new, like, growth driver for the delivery side? Thanks.

1:11:52 Thank you, Anne. For the corporate delivery, we have been working on the system development because all these need to be supported by a very strong IT system since last year. And originally, we targeted to expand our business to like 5,000 companies for this year. And then the COVID-19 hit. And we delivered a lot of free meals, about 170,000 free meals to over 1,450 hospitals and community centers in over 28 provinces. And suddenly we became famous for the corporate delivery due to our effort in COVID-19 by trying to do the right things.

1:12:42 because no matter how difficult the delivery, even for the food is free, we always emphasize on hot food. And that's our commitment. And so that gave us extra opportunity for company delivery because when the business recover, start to recover back to March, April, KFC and Pizza Hut are one of the few trust brands that we still have majority of our store open and people came to us trusting our brand and food quality. So we have this unique opportunity and suddenly the demand is much higher than we thought and we respond very quickly. And the benefit of corporate delivery for KFC and Pizza Hut and Yum China is we don't have to hire a new set of sales team to do that, which is something quite essential if you are a new brand of business.

1:13:40 We have all our stores. We have more than 10,000 stores right now in 1,400 cities. And our store manager and their managers, they are fantastic people and drivers behind this. So as of right now, we have worked with more than 20,000 companies on that. And not only the breakfast, but the overtime meal and the double 11 is coming. You can imagine we'll provide very strong support as well. To do that, not only it require a more customized menu, but also require system integration, the payment, because we want it to be very convenient for staff to order KFC or Pizza Hut or other brand food in their own company website or with their own payment or partly subsidized by their company, etc., etc., It could be a very complicated combination, but we would make it all easy, convenient for them. And thus, this business is growing from strength to strength. But with that said, you know, KFC and Pizza Hut in Yangtze, the base is so big. So when it comes to your question about what's the percentage of sales, it's still quite small.

1:15:00 And it's very, very hard to get big percentage of sales given our base is so big. But it's very meaningful, particularly meaningful for the stores that have the opportunity to support some companies. You can imagine the sales increase is meaningful. So that's where we are right now. We continue to expand our network of providing good food and good value for our customers. So you can imagine We have the network of over 10,000 stores right now. And between one store and another store, there are a lot of connections here. We can do more by offering corporate deliveries or working with our business partner to deliver the service required for our customers.

1:15:58 So that's where we are right now. And when it comes to smaller things like opening stores in parts or even having a small kiosk in some very convenient location. You can see it from the paradigm that we are trying to use our store as a network to further increase the connecting point with our customer by improving the convenience to the customer. And you actually will start to see Some, it's not a lot yet, but one example is in Qingdao, is the delivery box, you know, there's a wall of delivery box and customer will pick it up at a certain point, a certain spot of the office building, et cetera, et cetera.

1:16:47 So these are all the things that we are exploring, but it's all from customer's point of view, good value, good food, and convenience. Thank you, Anne. Thank you. Thank you so much. There are no further questions at this time. Speakers, you may continue. Thank you very much.

1:17:10 Thank you for joining the call today. We look forward to speaking with you on the next earnings call. This concludes today's call. Have a great day.

1:17:17 Thank you, everyone.

1:17:20 Thank you. That does conclude our conference for today. Thank you for participating in the All Now Disconnect.