Yum China Holdings, Inc. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Yum China 2020 First Quarter Earnings Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, to Ms. Debbie Ding. Thank you. Please go ahead.

Thank you, Operator. Hello, everyone, and thank you for joining Yum China's First Quarter 2020 Earnings Conference Call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. 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 SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliations of the non-GAAP and GAAP measures should be included in our earnings release. Today's call includes three sections. First, Joey will provide an update regarding recent developments in the coronavirus situation, then she will offer some highlights around our first quarter results. Andy will then cover the financial results and provide an update on our full year outlook. Finally, we'll 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'd like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Thank you. Thank you, Debbie. Thank you all for joining us today. I hope all of you, near and far, remain safe and healthy. Before covering our quarterly performance, I would like to update you on our actions regarding the COVID-19 situation. Throughout this crisis, we made sure that our top priority was the health and safety of our employees and customers. As stores were closed, we worked with local authorities to ensure a quick implementation of health measures. We wanted to ensure three things: commitment to value; commitment to supply; and our commitment to quality. We wanted to make sure that in a time of crisis, KFC, Pizza Hut, and our other brands would be there to provide reliable, quality meals to our customers, especially those on the front line fighting this outbreak. About 65% of our stores remained open throughout this period. Even when infection cases were rising and store closures were accelerating, our employees and delivery riders continued to show up. They wore masks, observed strict hygiene, and served our customers, providing a vital service in this time of need. Employees are the backbone of our business. We support them and their families by extending holiday pay even if the stores were closed. We encouraged our employees to look after each other. We strengthened medical insurance coverage for staff and, more importantly, their families. We extended coverage to parents of our restaurant managers up to the age of 75. This is important as providing for parents is a key cultural duty for us in China. This is simply the right thing to do. Providing this support gave our managers the peace of mind to focus on work and contribute to our long-term success. Also, in response to the pandemic, myself, Andy, senior executives, and Board members have agreed to forgo 10% of our salaries for the rest of this year as contributions to fund additional assistance for frontline employees and their families impacted by COVID-19. Since all this started, I have been humbled and impressed by the dedication, resilience, and creativity of our employees. Even as Wuhan was in lockdown and our stores closed, our people helped with the delivery of meals to frontline medical staff. We provided over 170,000 meals at no cost to over 1,450 hospitals and health centers in 28 provinces. On Women's Day on the 8th of March, a day we usually drive holiday sales, we made a decision to close all stores that day in Wuhan that had just opened or reopened. We instead dedicated these stores to serving thousands of free meals to medical workers that have come from all over China to support Wuhan. With our reputation for quality, safety, and value built over 30 years in China, our brands resonate well with consumers. This trust is a key enabler of success in our pivot to delivery and takeaway programs during this quarter. Importantly, we live our mission to be the world's most innovative pioneer in the restaurant industry. We pioneered contactless delivery and takeaway. Pizza Hut increased its takeaway offerings and started delivery of ready-to-cook steak. We adapt quickly to changes in consumer needs, relying on our solid execution and market-leading digital capabilities. Recently, the situation appears to have turned the corner. Approximately 99% of our stores are open, with some stores offering delivery and takeaway only or operating with shortened hours. Our Wuhan stores are mostly back in business. We look forward to, again, giving our customers what they expect from Yum China, good food, great value, pleasant dining, and the convenience of our digital experience. Nevertheless, the recovery is not guaranteed nor linear. Volume has not yet returned to pre-outbreak levels. There remain differences across regions and brands as the country gets back to work. Social distancing, telecommuting, and reductions in travel may become the new normal. This could fundamentally impact the way we work and the services we provide. 2020 will be a very challenging year. I'm grateful to lead the dedicated team at Yum China. Our culture of innovation, our strong operational excellence, and our leadership in digital and delivery in our industry position us to thrive. This crisis also offers us opportunities to grow, to create, and to build a stronger Yum China. Now let's move to our first quarter performance. System sales were down 20%. Approximately 35% of our store base was closed during the peak of the outbreak. Stores that operated suffered outbreak-related declines in sales. We opened 179 new stores, mostly at KFC. Nearly all of our new builds were completed in January, with store openings gradually resuming in late March. Same-store sales declined 15%. Sales declines were particularly pronounced at our tourism and transportation locations with regional and tier differences. We mitigated sales declines with menu innovation and a shift to delivery and takeaway. Our business model proved resilient. With the dedication of our employees across dine-in, delivery, and takeaway and a strong digital platform, we were quick to adapt. From inventory management to rental relief, we tackled every opportunity. With help from suppliers and landlords as well as support from government authorities, we achieved $97 million in operating profit in Q1. We were diligent and flexible in managing inventory issues while maintaining our strict food safety protocols. For example, we used the excess premium ice cream inventory from Hokkaido as raw material for our egg tarts and milk tea. This created a high-quality product for customers and prevented unnecessary waste. Delivery and takeaway made an important contribution to operations during the crisis. Delivery was crucial in driving online orders to our stores, while takeaway offered a safe alternative as dine-in services were limited or closed. Delivery sales grew 40%, and the delivery sales mix grew to 35% compared to a 19% mix last year. In late January, we rolled out contactless delivery on our Super App at both KFC and Pizza Hut. Contactless delivery's emphasis on safety is both popular and responsible. Over 60% of all own channel orders at KFC and Pizza Hut selected the contactless option with adoption peaking at over 80%. Having dedicated riders was crucial in supporting our business during this time. Our commitments around value, supply, and quality would not have been possible without amazing riders. This emphasis on safety and rider supply drove our own channel growth above that of aggregators during the quarter. Successful takeaway requires digital pre-order capability, a suitable menu and packaging, and most importantly, a strong value proposition. KFC and Pizza Hut have all these things. I'm very proud of our Pizza Hut brand, which more than doubled its takeaway contribution in the quarter, establishing a clear third option on top of dine-in and delivery, showcasing the resilience of this brand. Turning to digital, communicating with our customers quickly and transparently was important to building trust and engagement during the outbreak. We leveraged our vast member platform to provide information on our safety protocols and store operations. Our membership program continued to grow, with over 250 million members at the end of the quarter. Member sales exceeded 60% at KFC due to the increased shift to online sales. Digital orders account for over 84% of KFC sales and 65% at Pizza Hut. Mobile pre-orders rose as consumers increased usage of takeaway services. We continue to drive menu innovation and value even during the crisis. During the quarter, our primary focus was safety and providing safe food. We emphasized our core products and deferred some new innovations. We continued to delight and surprise with several new products, such as tea-infused hard-boiled eggs and a traditional Chinese side item, very popular particularly in the eastern and southern parts of China. At KFC, we also introduced special items during the Qingming festival. In Pizza Hut, we launched crayfish mozzarella pasta. We also continue to provide smart abundant value, which was important in an environment of economic stress. Our signature Crazy Thursday campaign at KFC and RMB 25 one-person set meal at Pizza Hut, known as the discount meal in Chinese, were all well received. In late April, we launched a test for our plant-based chicken nugget in some of our Tier 1 stores. We are excited about this new innovation in meat alternatives. Shanghai presell coupons for this test sold out in just one hour. Now let me make a few brand-specific observations. First, KFC showed its resilience again. Our digital delivery and takeaway offerings provide a strong basis of support for the business even during the crisis. Our flexible workforce and variable rent structure across most of our stores allowed us to quickly adjust to sales fluctuations. With this focus on casual and family dining, Pizza Hut was more impacted by the outbreak as consumers congregated less and practiced social distancing. We will continue to focus on building a Yum family-friendly dining environment while strengthening our offerings for individuals and takeaway. Throughout the crisis, we continued to develop our new and emerging brands. We formed a joint venture with Lavazza and opened the first Lavazza Asia flagship store in Shanghai. This store showcases the premium and authentic Italian coffee experiences Lavazza has developed over its 125-year history. We combined this with Yum China's scale, operational capabilities, and in-depth knowledge of the China market. On April 8, we completed the acquisition of Huang Ji Huang, a pioneer of Chinese simmer pot casual dining. It has over 640 mostly franchised stores, both in China and internationally. In addition to this acquisition, we established a Chinese dine-in business unit, comprised of our three core Chinese dine-in brands, Little Sheep, East Dawning, and Huang Ji Huang. I'm confident that the Chinese and Western brands in our portfolio will synergize to delight consumers with delicious food and a superior digital customer experience.

Thank you, Joey, and good morning, everyone. I will first address key financials and developments in the first quarter, then provide perspective on our full year outlook. Unless noted otherwise, figures mentioned refer to the first quarter of 2020. All figures are before foreign exchange rate effects, and all comparisons are year-over-year. The first quarter financial results: Total revenues declined 21% due to both temporary store closure and same-store sales declines arising from the COVID-19 outbreak. Public health efforts to combat the outbreak resulted in significant store closures and reduced customer traffic. Same-store sales decline was driven by reduced dine-in sales, partly offset by delivery and takeaway growth. Temporary store closures were taken out of the same-store sales calculation and included once they reopened. KFC same-store sales declined 11%, driven by reduced dine-in traffic. Ticket average benefited from increased mix to delivery and takeaway. Pizza Hut's same-store sales decline was 31%. Reduced dine-in traffic was also the primary driver. However, different from KFC, the increase in delivery and takeaway mix contributed to lower ticket average. January sales for both brands were strong leading into Chinese New Year but were severely impacted later in the month as news of the outbreak became widely reported and social distancing and other restrictions were implemented. As infection rates declined and same stores reopened, our sales showed recovery, although we are still below pre-outbreak levels. New store openings were robust in January before the Chinese New Year period. Outbreak-related traffic restrictions and construction worker supply thereafter impacted the pace of our store opening. Restaurant margins were 13.6% at KFC and 0.3% at Pizza Hut. Declines in restaurant margins across both KFC and Pizza Hut were primarily driven by sales leveraging, partly offset by our efforts to control costs. Specifically, cost of sales was 32% and a 1.5% year-over-year increase. Commodity inflation for the quarter was 3%. Through decisive actions at the store level and working proactively with our suppliers, we were able to manage down inventory write-offs and store-level waste, normally associated with store closures and sales fluctuations. Cost of labor was 25.5%, a 3% year-over-year increase. Year-on-year wage inflation was 4%. Increased portion of delivery sales contributed to higher labor cost percentages. Employees received extra holiday pay with additional labor hours for increased safety protocols at our stores. We managed our cost of labor by quickly adjusting schedules. Our digital scheduling tools and Pocket Manager, a real-time app, were instrumental in sustaining high levels of productivity across both brands. Lastly, temporary relief from social insurance payments provided by the government was approximately $20 million. In terms of rental expenses, over the past few years, we made a concerted effort to increase the variable components and lower the fixed components of our rental expenses to improve the resiliency and flexibility of our operations. In general, approximately 40% of our rental expenses are tied to revenues, which declined proportionally to lower sales in the quarter. In addition, we negotiated approximately $50 million in rental reduction. G&A costs were lower by 11% year-over-year, benefiting from cost control as well as certain onetime government relief programs, including temporary reductions in social insurance payments and accelerated payments of certain government incentives that we received in the first quarter, which would usually have been received in the second or third quarter. We recorded an impairment charge of $9 million. Bottom line, we achieved operating profit of $97 million. We are incredibly proud to have achieved profitability in such difficult circumstances. The effective tax rate was 32.7%, higher than usual, primarily due to the mark-to-market loss from our equity investment in Meituan that is not taxable but reduced our pretax income. Net income was $62 million, driven by the operating profit just mentioned and the $8 million mark-to-market loss from our investment in Meituan. Diluted EPS and adjusted diluted EPS were both $0.16 in the first quarter. Next, let me cover our balance sheet and capital allocation. Cash and short-term investments remained strong at $1.54 billion. The COVID-19 outbreak has a significant impact on our operations and results in the first quarter. While the situation in China was discretionally stabilizing, we remain cautious as our restaurant traffic is still below pre-outbreak levels. We expect an extended recovery period, and the pace will be uneven across regions, day parts, and segments. We will continue to implement aggressive measures to control our costs. On the other hand, global infections continue to rise. It remains difficult to predict the full impact of the pandemic on the broader economy and how consumer behavior may change. The outbreak has highlighted the importance of having a prudent financial position. With a challenging year ahead, we need to proactively maintain a strong balance sheet while positioning ourselves to take advantage of growth opportunities. Therefore, despite having a strong balance sheet, we will temporarily suspend our share purchases and for the next two quarters dividends. We have taken this action out of an abundance of caution as we navigate through these challenging times. We believe the strength of our balance sheet and capital structure will offer us flexibility to respond to contingencies if needed and to continue investments in long-term value-creating opportunities where appropriate. Now I will turn to our outlook for 2020. The situation continues to evolve. Our resilience and adaptability helped avoid operating losses for the quarter. Results were supported by strong performance and added onetime relief that are likely to reduce, if not terminate, in early Q2. We continue to experience significant disruption to our business from the outbreak. Some stores are still closed or operating under limited hours or services. The traffic at restaurants is below pre-outbreak levels as people avoid going out and practice social distancing. The recovery of weekend leisure volumes has been weaker than weekday volumes. Traffic at transportation hubs and tourist locations has also been extremely soft. The recovery trend is gradual and choppy. We'll be taking decisive actions with regard to cost management. Sales deleveraging will continue to pressure margins. At the current sales run rate since the outbreak, and excluding onetime relief, we have not reached levels required for sustained profitability. Our store opening program previously interrupted is restarting. We are not revising our target of 800 to 850 new stores for the year. However, we will reevaluate conditions as the year goes on. The outbreak highlights the importance of online-to-offline integration. Our investment in digital, technology, and supply chain will continue. Together with investments in new stores and remodeling, our 2020 CapEx plan is unchanged in the range of $500 million to $550 million. We expect wage inflation to stay at mid- to high single digits this year. Commodity inflation is still a challenge. Despite volatility across most commodities, protein supply in China remains tight. Our best estimate of 2020 commodity inflation now is for low to mid-single digits. We expect 2020 to be difficult. A new normal characterized by reduced travel and social activity may persist. As we look forward to recovery, we will continue to focus on serving our employees, our customers, and the community in which we operate. At Yum China, we're here for the long run. Now before I turn the call to Debbie for the Q&A session, I will update you on some investments we have made. In addition to the acquisition of Huang Ji Huang that Joey mentioned, we have entered into an agreement to purchase an additional 25% equity stake in Suzhou KFC for approximately $149 million. We expect to close the transaction in the second half of this year, subject to relevant closing conditions. Upon closing, Yum China will hold a consolidating 72% equity stake in the entity.

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

Our first question is from Xiaopo Wei from Citigroup.

First of all, thank you for hard work and social responsibility during the COVID-19 outbreak. We are seeing very resilient performance, especially KFC. So my question is, what's your observation on the consumer behavior changes during the crisis? And the automation, the new norm, and Joey mentioned a lot of innovations, what's your thinking of reinventing yourself in the business, especially for Pizza Hut? So we believe that Pizza Hut is focused on casual dining, but it would be more impacted than KFC. Is there any inspiration from the crisis that would position yourself better for the recovery of Pizza Hut looking forward?

Thank you, Xiaopo. Throughout the crisis, I think the first response obviously is about focus on hygiene and safety, which our business has a very long tradition in this area, and we obviously are very well positioned to enhance that. And then in terms of other behavioral changes, basically, the value for money and the desire for new food is still there. But most importantly, the availability of food is critical; right now, it's better. But back to February or last week of January, it was very important to provide the service. Our team has worked very hard to keep as many stores open as possible. On top of that, we leveraged our digital and delivery and takeaway business model to serve our customers while protecting our employees. The innovation is important as well. And then going forward, is there any sort of behavioral change in the medium term, et cetera? The social distancing will linger a little bit. We continue to see that. Particularly, we can see the sales challenge still occurring during the weekend. During the weekdays, we are okay now. We are pretty much back to last year's level. But the weekend is still a challenge. The holiday is still a challenge, which is quite different from past sales patterns. On top of that, the traffic hubs, because of the reduced traveling, the traffic hub business is challenged. So the weekend, dine-in, and transportation hub are experiencing difficulty. Looking forward, how do we reinvent ourselves, particularly for Pizza Hut? Let me talk about three themes, and then I'll go into Pizza Hut a bit more. There are three focus areas: menu innovation, digital innovation; second, value for money; and third, cost savings. It's not only about having a robust business model. Cost-saving is also about we save every bit we can and pass on the savings back to the customer to further improve the value for money. So in the long term, while we are, in the short term, focusing on menu innovation, value for money, and cost-saving, we are also building an even more agile and robust business model. When it comes to Pizza Hut, as I mentioned earlier—in my presentation—I am very proud of Pizza Hut during this crisis because the Pizza Hut business has a higher percentage of dine-in business. So naturally, it was more impacted because, at the worst time, even if we managed to open the store, the dine-in business was not allowed to operate. KFC, because it is QSR, had a higher percentage of takeaway sales; during the worst time, it was slightly less impacted. However, building the takeaway business for Pizza Hut has always been a strategic initiative. We actually started in 2019 during Chinese New Year, trying to push for the takeaway business, and it achieved certain traction. So we got to about 5% of sales coming from takeaway. Before the 2020 Chinese New Year, we had planned and prepared to take advantage of the Chinese New Year to accelerate the takeaway business. And then COVID-19 hit. It actually gave Pizza Hut the opportunity to accelerate the takeaway business even more. So for Q1, the takeaway business for Pizza Hut was roughly double what it was before, about 10% to 11% on average. During the worst time of the crisis, the percentage was even higher. To do takeaway business, it’s not only just asking the customer to do the takeaway business; it requires several things. One, it requires digital order capability, mobile order capability, and we had that ready right before the Chinese New Year. It also requires very strong value for money because that’s what customers want for takeaway business. Lastly, it requires a flexible menu that is somewhat simpler. During the crisis, because of certain store closures, we faced inventory challenges. But instead of just facing the challenge, we took advantage of this opportunity to create some new items using the inventory we had, which then made it into a takeaway menu. So, the innovation agility happened right there. And with that, the takeaway business is now a meaningful part of our business, which is fantastic. And this is something I believe I shared with our investment community before. We want the delivery business, which is a dominant part of Pizza Hut business already. We also want takeaway business because it does not require the delivery challenge while we aim to strengthen the dine-in business. So I hope that gives you a sense of the challenges and changes in customer behavior and our focus on rebuilding ourselves, with a bit of color on Pizza Hut's business.

Our next telephone question is from Brian Bittner from Oppenheimer.

Do you expect any store closings from your competitors because of this crisis? What is your insight regarding the ability of all industry capacity in China to survive this pandemic? Secondly, you did not change your guidance for store openings for 2020. Can you just maybe talk a little bit more about how confident you are that you can indeed achieve these store opening goals?

Thank you, Brian. It's a really good question. We believe that we have turned a corner, but I hate to remind everyone that we're still in the middle of it. We are still cautious that Q2 and Q3 will be challenging for our industry in China. The reason I'll get to the competitive bit; let me give you the context first. For Q2, we expect May and June will be very challenging for our industry because sales are recovering but still below pre-outbreak levels, as Andy mentioned earlier. In terms of cost structure, during Q1, I think most industry players managed to get some help from landlords and from the government or even manage to have certain agreements with their employees in terms of flexible pay. All these sort of onetime relief are likely to go down; they are not going away by Q2. That situation is likely to happen during May and June. What about Q3? Will Q3 be better? Hopefully. However, in our industry, we benefit from the summer because of children's holidays, which usually gives us a 20% to 30% uplift of sales. But this year, we don’t know how long the summer holiday for kids will be; it will be shorter. To what extent is still not clear across the board, but it will be challenging. Regarding your question about store closings from competitors, we have seen some businesses, mainly smaller competitors, struggling through these difficult times, including some very famous names. So right now, this is a test for financial prudence, I suppose. But, as I mentioned, it still will take some time to see the full impact. On store openings, we have not changed our guidance because while things are very tough, we are cautious, but we are also optimistic at the same time because it is the time for us to continue to build our brand, further refine our business model, and also it's possible that there will be some locations or store sites that become available, particularly the high-quality ones, and if they become available, our financial prudence will help us continue to expand and invest in new stores because we are committed to the long-term potential of the China market.

Sure, Joey. Just a few points, right? As we mentioned, we're investing for the long term. Our fundamental view on China has not changed. We still think there's a lot of opportunity there. Although in the first quarter, we did roughly 180 new store openings, we were slightly below last year's schedule. As mentioned before, this was mostly impacted by post COVID-19 outbreak traffic situations and worker availability, especially for construction. So we aim to make up the lost time in the coming quarters. So far, we have not changed our target for new builds in 2020. The same goes for other CapEx spending; if you look at the importance of IT, online operations, and supply chain, all these elements became prominent during the crisis. I believe that, in the long term, those trends will continue. We see acceleration from moving offline to online and more towards delivery and takeaway. We need that infrastructure to support our long-term growth opportunities. We will stick to our CapEx plan for this year, which is $500 million to $550 million.

Our next telephone question is from Michelle Cheng from Goldman Sachs.

I want to follow up a little bit on the recovery path. Since Joey you just mentioned that the industry will be quite challenging into the second quarter and third quarter, can you please share your thoughts about the recovery path for different brands? When do you think the same-store sales will recover to last year's levels, and how will you drive this improvement? Additionally, in the announcement, you mentioned the uneven recovery across regions and tiers. Can you share more details about this, and potentially also the consumer groups like the younger generation and families?

Thank you, Michelle. For the recovery path, as I mentioned earlier, the immediate focus right now is still about protecting our staff and also opening as many stores as possible, and reopening the dine-in business in some stores that we are still not allowed to open. From here, it is essential to focus on getting the traffic back. For Q1, both brands, particularly KFC, experienced a significant impact on traffic, but we made up for the loss of sales with a much higher ticket average through corporate catering, and other large item deliveries overall. We were happy to see the trend improving in March and now April, where same-store sales are slightly more than 10%, which is an improvement compared to March. Nevertheless, traffic is not back to last year's levels. As I mentioned earlier, particularly during weekends and at transportation hubs. Now the question is what we can do. When I talk about menu innovation, I should have elaborated a little bit more. For example, for both KFC and Pizza Hut, we adjusted our marketing calendar. Traditionally, we put a lot of value-for-money promotions during weekdays, particularly for Pizza Hut which sees slightly lower sales during the week. In contrast, the weekend is typically stronger. However, now the time has changed, and especially facing challenges during weekends, hence, we'll shift the weight of our value program to weekends and holidays to stimulate traffic. It seems like a small change, but it’s incredibly important. Additionally, with respect to menu and innovation, our foods, exciting foods, in Chinese, we call it small fortune, small happiness. We've launched traditional items, such as tea eggs during difficult times, which brought surprise and delight to our customers. They were happy to see our ability to launch new products during a crisis. This month, we test-launched the plant-based chicken nugget, which was extremely popular, selling out within an hour. This week, we've also launched a sweet tofu dish with various flavor options across China. Good food continues to put smiles on people's faces, even in difficult times. Furthermore, value for money is crucial. In these uncertain times, customers are more cautious with spending. We did not raise our prices; our traditional dish remains at RMB 7, which is approximately $1. Our commitment to price will continue, and we will achieve this through cost structure examination and ensuring we pass savings back to the customer. This is a commitment from our entire company.

I just have a few things to add. As we mentioned in our press release, our current traffic is still down compared to pre-outbreak levels. More than 10% same-store sales are down compared to last year. We're also constrained; as Joey mentioned, some of our business is located in transportation hubs and tourist locations. As you probably know, most airports still have very limited services. The high-speed train services are also very restricted, which has affected that portion of our business. Our recovery trajectory has been gradual. In January, we had a robust performance before the Chinese New Year; then we were significantly impacted by the outbreak. The trough was in February. We began to recover as the outbreak eased and people started to return to work. We maintained most of our stores open during that period and provided safe, healthy options for consumers. In March, same-store sales declined 20% year-over-year, and now we are at about 10%. However, the tourist locations and transportation hubs remain significantly depressed. The timing of how these areas will recover is still uncertain. Social behavior changes linger from the outbreak; social distancing is still practiced here in China. People, even when they visit a restaurant, try to avoid large gatherings. How long this situation will last and how long it will take for us to return to pre-outbreak normalcy is hard to predict at this time given the global situation.

Thank you, Andy. I do notice that at the end of your question, you asked about regional and tier differences. The differences are notable. The East region has recovered the best, while some regions in the northern part of China are still lagging behind. In terms of city tier, our lower Tier 3 cities are doing slightly better than the top-tier cities. The main reason is that Tier 1 cities like Beijing, particularly Beijing, and also Shanghai, Guangzhou, and Shenzhen, have a significantly higher percentage of sales from transportation hubs, and since the transportation hub business is still heavily impacted, this greatly affects the overall recovery for the Tier 1 cities. In contrast, lower-tier cities maintained stronger performance during tough times due to a lack of transportation hubs. Reports have shown that during the toughest times, KFC often was seen as the only operational store within many smaller cities. Now, as the country recovers from the crisis, competition in lower-tier cities still favors us because of our long-standing reputation for hygiene and food safety. Thank you, Michelle.

Our next question is from Annie Ling from Jefferies.

I have two questions. First is on the cost side. Management mentioned all these cost increases; I just want to check if this includes all these onetime relief in the first quarter and possibly in the second quarter. If you could share with us the nature of these reliefs—pension relief and all that? Could you itemize that and whether it's included in your cost assumption? And then also in terms of commodity price increases, we understand that it seems that based on some of the latest trends, ticket prices actually start to come down these days. Is it fair to say that we should expect some delay impact from last year's higher inventory costs over the first half, and then subsequently lower prices? How do we see this cost trend on a half-year basis? Lastly, regarding the upcoming labor holidays, do we have any expectations? Is it fair to say that this will serve as a good test for how quickly consumers will return?

Okay. Thank you, Annie. This is Andy. I will address your questions regarding cost increases and onetime relief in the first quarter and how this looks going into the second quarter. As we mentioned in our prepared remarks, we did receive some relief from the government in terms of social insurance payments. There was a general reduction of that across China, and we benefited from it, which amounts to approximately $20 million in both labor costs and an additional few million dollars in SG&A. We also received around $15 million in rental reductions from the landlords in the quarter, amounting in total to roughly $40 million in onetime relief. In relation to the social insurance payment reduction program, this is anticipated to end in early Q2, particularly in April, which will be the last month we would likely receive that relief. Likewise for rent, while most landlords agreed to rent reductions during the crisis, as the economy recovers, we expect that any rent reductions from landlords will not be of the same magnitude as the first quarter. Furthermore, we received approximately $15 million in government incentives during Q1 that would typically be received in Q2 or Q3. As a result, we benefited in Q1, but year-over-year comparisons could become more challenging in Q2 and Q3. Regarding commodity prices, particularly for chicken, we predict sales costs at a single-digit level. You're correct in noting that demand declines and logistic issues from COVID-19 have created a temporary glut of poultry supply, causing prices to drop slightly. However, overall, commodity prices remain elevated due to ongoing tightness in protein products in China, with pork prices more than double year-over-year. Overall protein supply remains tight despite the crisis, triggered by transportation and international transportation issues caused by COVID-19. That may also lead to future impacts on pricing. Our contracts generally are set at least a quarter in advance, so we'll see how this pans out, but we expect protein prices—such as chicken and pork—to remain elevated in the near term. With respect to upcoming labor holidays, we have the May 1 Labor Day weekend coming up. This situation is tricky; while people are eager to go out after being cooped up, the government is also concerned about large gatherings. Some cities in China have implemented staggered schedules for school children during the holiday period to alleviate congestion during holiday outings. So, it will be interesting to see how consumer behavior plays out during this long weekend. Overall, we also need to consider other holidays and shifts, as they will impact our business. This year, many schools have reopened, but there are announcements regarding shortened or delayed summer vacations, significantly impacting our business. Historically, summer vacations, when kids are free, have typically been peak seasons for us due to increased travel.

Yes. Regarding the May 1 holiday, in addition to what Andy mentioned, our transportation hub business is likely to continue facing challenges. Given that schools are reopening for younger kids after May holiday, parents and children are discouraged from traveling outside their cities before school starts. As a result, the transportation hub business in train stations will likely continue to struggle during the May holiday. Thank you.

Our next telephone question is from Sara Senatore from Bernstein.

I wanted to step away from the current environment and just ask about the portfolio you're building. You have Lavazza now and then COFFii & JOY, the recent acquisition of Huang Ji Huang—sorry if I butchered that—an increased equity stake I think in an investee. How should we think about these acquisitions in terms of contributions to growth over time? Because I think, historically, some of your smaller concepts have not performed as well as KFC or even Pizza Hut. Is there a trade-off between making these investments now and suspending your share buyback as we think about capital allocation?

Yes. Thank you, Sara. I will try to address your questions. In terms of our overall brand portfolio, you can think of it in three main groupings. We have Western food, which includes KFC, Pizza Hut, and Taco Bell. Our announcement of the equity investment in Suzhou KFC is to strengthen our control over this venture. We negotiated favorable terms for this transaction. Thus, it would incrementally benefit our operations going forward. We also hope to continue exploring other potential growth opportunities in our Western food portfolio comprising these three core brands. Now regarding the acquisition of Huang Ji Huang, this is complementary to our existing leadership operations. It helps us capture a larger share of the Chinese food market, a large and growing sector. The investment of slightly less than $200 million in Huang Ji Huang is prudent as it allows us to leverage our existing infrastructure to scale that franchise business, and I think in the long haul, it will help us build expertise in Chinese cuisine offerings. Now, regarding coffee, I believe the coffee business is primarily an organic initiative. K-Coffee, which is a brand within KFC, has rolled out across our restaurants and has been quite successful, with 137 million cups of coffee sold, making us one of the largest coffee sellers in China. The C&J concept is still in the developmental phase, and while it may not be feasible to expect profit in the first year or two, we remain disciplined. Our location numbers have been on point, and we have taken time to experiment with product offerings and store formats. Once the right formula is identified, we will scale it quickly based on our capacity to build stores and infrastructure. As for Lavazza, we’ve established a joint venture with them, and our flagship store has been well received since our soft launch. Regarding capital allocation, our #1 priority, as always, is organic growth. We will continue investing in store openings and remodeling. Second, we will invest in growth initiatives, including coffee and Chinese cuisine. Lastly, we're committed to returning any excess cash to our shareholders. Over the past two years, we initiated a $1.5 billion share repurchase program, of which approximately $800 million has been repurchased. We still have about $600 million remaining in the program. Once the situation stabilizes, and it becomes clear, we will continue our commitment to return cash to shareholders but only when it is appropriate and prudent. During this crisis, a strong balance sheet is imperative for a restaurant operator.

Our next question is from Christine Peng from UBS.

I think most of the questions I have have already been addressed by the management. But if I could ask the last question to you, Joey. Given all the changes you are seeing in the restaurant industry during COVID-19, especially given your resilience during this crisis, should we expect an even higher than 2019 expansion pace as you look into 2021 in terms of store openings?

Thank you, Christine. You are familiar with our business, and we always emphasize we still maintain a rough guidance for the number of new stores, but we don't designate it as a strict target. We make store opening decisions from a bottom-up perspective. If we can find enough stores that meet our financial assessments and growth outlook, we will proceed to open new stores. However, if the opportunity does not pass our tests, we won’t push ourselves. Therefore, it’s difficult to offer a precise target. But if we identify opportunities, of course, we will seize them. We've never pushed our team to chase targets. It's good to have some certainty, but we focus more on quality than on quantity. The quality of our stores is not something we compromise on.

Right. And this is Andy. I want to emphasize that while we provide scope and target each year, that is simply a guideline that helps our team aim for success. We have a disciplined internal process to ensure the stores we open are financially sound projects. Our development team has done an exceptional job opening new stores over the past few years. Our financial performance shows that these stores are yielding a good payback. For KFC, it’s slightly more than two years, and for Pizza Hut, around three to four years, which is competitive by industry standards. We will maintain that strategy going forward, and as Joey mentioned, if they find good targets, we encourage them to exceed goals; if not, there is no need to force progress.

As there are no more further questions, I'd like to hand the call back to the speakers. Please go ahead. Thank you.

Thank you for joining the call today. We look forward to speaking with you on the next earnings call. That concludes today's call. Thank you, and have a good day.

Thank you very much. Thank you.

Thank you, everyone.

Ladies and gentlemen, you may all disconnect, and goodbye. Thank you.