Sapphire Foods India Limited (SAPPHIRE) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Sapphire Foods India Limited Q2 FY '23 Earnings Conference Call. [Operator Instructions]. Please note, this conference is being recorded. I would now like to turn the conference over to Mr. Nachiket Kale from Orient Capital. Thank you, and over to you, Mr. Kale.

Good evening, everyone, and welcome to Sapphire Foods' Q2 and H1 FY '23 Earnings concall. The management today is represented by Mr. Sanjay Purohit, Group CEO and whole time Director, along with Mr. Vijay Jain, CFO. I hope everyone had a chance to go through the investor presentation and earnings press release. Before we begin, just a reminder that this call may contain some forward-looking statements, which do not guarantee future performance and involve unforeseen risks. With that, I would like to hand over to Mr. Sanjay Purohit. Please take over.

So good afternoon ladies and gentlemen. Welcome to our quarter 2 highlights. I'll talk very briefly about the numbers, and then I'll give you a color on the quarter. In the quarter, we delivered a strong performance. Our revenue was our highest ever at INR 560 crores. Our EBITDA was at INR 103 crores at 18.4%, up 350 basis points year-on-year, and our adjusted EBITDA was about INR 62 crores at 11.1%, up 490 basis points year-on-year. PAT stood at INR 27 crores, 4.8% of revenue, up 600 basis points year-on-year. Our India restaurant EBITDA grew by 40 basis points year-on-year However, due to the adverse Sri Lanka impact, consolidated restaurant EBITDA of 16.8% was actually lower by 50 basis points. And all of this, I'm looking at versus our normalized EBITDA of quarter 2 FY '22. And if you remember last year, we were painstakingly calling out that our EBITDA was actually lower than what we had received in that period because of onetime incentive that we have got on our store openings, so against the normalized EBITDA numbers, India grew by 40 basis points, but on a consolidated level, we dropped by 50 basis points. So our restaurant EBITDA. So over the quarter line, -- so at the beginning of the quarter, we thought it was going to be a challenging quarter. One KFC revenues especially for the Sapphire markets are especially impacted because of the higher festival vegetarian days that we see. And I'll say this year, the extent of drop that we see on vegetarian days has gone back to 2018, 2019 levels, so there was -- there has been quite a severe drop versus say last year, but in line with what we have seen perhaps in the earlier years. So that was one potential negative impact. The second potential negative impact was that inflation peaking. And in both the brands, we were seeing mid-teens inflation levels. Therefore, at the start of the financial year, along with Yum!, we have consciously taken a call to have price increases, not in line with inflation, but lower price increases, so as to ensure that our transaction volumes are maintained, and that has worked really well from us -- for us from a demand perspective. So we are really happy with how the quarter has gone from a demand perspective. If you look at our same-store sales growth had been really strong, our year-on-year ADS levels have been sustained in spite of 176 stores that we have added in the last 1 year. So I think the fact that SSSGs are strong, transaction growth has been maintained in spite of our price increases, I think that bodes well for [ us ]. So if you look at KFC now, we delivered a 15% same-store sales growth and a 36% increase in overall transaction. When we look at the channel level, actually dine-in was quite strong, and their transactions also grew on a year-on-year basis, but because our price increase, which we have taken in about between 9% to 10%, and like I said, inflation was in mid-teens. Our gross margins were impacted by 310 basis points. But on -- because of leverage that we got on 15% SSSG, and tighter cost management, our restaurant EBITDA was -- the drop in restaurant EBITDA went to about 80 basis points versus the normalized EBITDA level of 18.7% in quarter 2 FY '22. You would have heard both Vijay and me talk about quarter 2 being generally the lowest quarter for us from a KFC perspective, and it drops versus quarter 1. And then we hope to recover in Q3 as we go past the festival vegetarian days. So this time, we were able to [indiscernible] gross margins went down by 310 basis points. Our restaurant EBITDA margins just went down by 80 basis points. So the SSSG focus as well as the cost management focus helped us to curtail this block. On Pizza Hut, I think we have had a best-ever quarter. Our same-store sales growth grew by 23%. There was a very strong transaction growth in excess of this SSSG. And the ADS growth both over the corresponding quarter and the sequential quarter, and therefore, even when gross margins dropped by 110 basis points, our restaurant EBITDA was our highest ever at 15%, up by 440 basis points compared to a normalized restaurant EBITDA of 10.7% in quarter 2 FY '22. So here, I'm happy to say that a combination of our Omnichannel strategy, where dine-in, takeaway and delivery all 3 come, we are able to maximize revenue out of our store through all 3 channels, combined with the -- combined with all the work that we have done on cost management as well as the innovation on Pizza Hut, the same-store sales growth has been very strong at 23%. Our Sri Lanka business also had a strong quarter and we grew SSSG of -- to the tune of 37% in [indiscernible]. Now this has largely been on the back of price increases. So the transaction growth has been just about positive in this quarter. Inflation has continued to rise, and therefore, our gross margins are consequently impacted and therefore, restaurant margins also dropped to about 550 basis -- by 550 basis points to 15% versus our normalized restaurant EBITDA of 20.5% last year quarter 2. Absolute value EBITDA grew by 23% in Lankan rupee terms, but in Indian rupee terms declined by 25% with currency translation impact. Largely, if you see in quarter 1, we delivered in Indian rupees sense roughly about INR 7 crores. In this quarter also, we have delivered similar...

Roughly 10% to 11% mix of our corporate EBITDA.

Yes. We are also happy to say that our restaurant expansion pace has steadily -- has been steady. We opened 42 restaurants in quarter 2, 20 KFC, 14 Pizza Hut in India and 7 Pizza Hut and a Taco Bell in Sri Lanka. So given all the macroeconomic conditions that we are seeing many consumer product companies showing lower transaction growth, lower volume growth, our inflation being quite high, we -- the fact that we consciously took lower price increases in the hope that we will be able to maintain transaction growth. I think this quarter has been actually a very strong quarter for us. And we are quite happy at the way that it has panned out, coupled with our restaurant expansion, that means that we are in a reasonably good space. As we look at Q3, there will be some amount of -- so quarter 3 is generally better than quarter 2, and we expect some amount of -- marginal amount of gross margin improvement towards the end of quarter 3, perhaps beginning quarter 4, but inflation continues to be at the same level. So there's no drop in inflation level. So that's the overview. When I look at the page -- when I look at Page 7, the consolidated financials, you will see -- as I'm repeating myself here, INR 560 crores, up 36%. Adjusted EBITDA of INR 62 crores, up 144%, INR 62 crores translates into 11.1% adjusted EBITDA margin. EBITDA was INR 103 crores at 18.4% and PAT INR 27 crores for 4.8%. We ended the quarter with 658 stores, 301 KFC, 249 Pizza Huts in India and 106 Pizza Hut and Taco Bell Sri Lanka and 2 stores in Maldives, so totally 658 stores. I'll now quickly hand it over to Vijay, who will talk about the specific financial highlights.

Good afternoon, everyone. I'll move on to Slide #9, consolidated financial highlights. Slide #9. So we clocked sales of INR 560 crores, our highest ever revenue growth of 36%. Gross margins to drop by 310 basis points, we will decline into this at each business level. Moving on to Slide #10. Slide #10 is a bit busy. As times when you do over disclosures, it can have this kind of effect. So I will take a bit of time on this particular slide. If you look at numbers in brackets, which are given for last year, corresponding quarters, those indicate normalized restaurant EBITDA numbers, taking account -- taking aside onetime benefit, which we are receiving from Yum! on account of a COVID additional incentives, which we received, we had called out this last time as well in quarter 3 financials when we released. So on a comparison to a normalized last year, restaurant EBITDA of last year of 17.2%. We delivered 16.8% this year, a drop of 50 basis points. If you look at the note below the graph, it says India restaurant EBITDA grew by 40 basis points versus last year. So after excluding the Sri Lanka business, where we have seen a big drop on Sri Lanka, the India restaurant business grew by 40 basis points in spite of a 300 basis points drop, what we have seen at overall level. On adjusted EBITDA, at 11.1%, it was up by 750 basis points over last year, compared to a normalized EBITDA for quarter 2, which was 3.6% last year. In terms of value, we delivered INR 62.4 crores quarter 1 for us was around INR 73-odd crores. Slide #11. Overall, EBITDA of INR 103 crores, 18.4% up by 610 basis points versus last year's normalized EBITDA of 12.3% and PAT of 4.8% at INR 27 crores up by 860 basis points over last year. Last year, we were negative on PAT. On a YTD basis, if you look at, we delivered a PAT of INR 65 crores is close to 6%, up by almost 1,000 basis points versus last year. Sanjay would take over on the KFC section.

When we look at the channel contribution, you'll find that dine-in has continued to increase in overall contribution. In quarter 2, it was at 44%, whereas delivery was at about 36% and from a -- and takeaway was about 20%. We have product launches chicken peri-peri, we had chocolate lava, a lot of branding and proportions around both chicken peri-peri and chocolate lava. Our digital activation continues and the use of celebrities. Our new store -- our new store launches, we have given you some picture. Finally, we were able to launch our Colaba store. Recently in October, we launched a store near fort. And then we have launched a store in Central Mumbai also near Dadar. You can see the Faridkot, Punjab store, some of the stores in Punjab are really beautiful, big stores with full drive-through and the retail development in these -- it's an integrated retail development with a lot of food players, apparel players entertainment. So the brand does really well here. And you can see a picture of the Jalna Road, Aurangabad store.

Moving on to Slide 20 on the financials, very strong SSSG of 15% in the quarter for KFC, very healthy ADS of 134 [indiscernible] this ADS is in spite of the 82 restaurant additions, which have happened over last 1 year. So it includes all the new restaurants as well. On restaurant EBITDA, Slide 21. On gross margin, just let me cover the gross margin first. Restaurant revenue first, on restaurant revenue we clocked INR 350 crores, up by 36% additions of 20 stores, which took the count part to 300 mark for us in KFC in the last quarter. On gross margins, we dropped by 310 basis points. Two reasons over here. One prime reason that inflation picked in Q2. Quarter 1, while the inflation was there we were also carrying old inventories, with inflation peaked in quarter 2 that has a major impact, a marginal impact also on account of delivery mix relaxation compared to last year. Last year, it was 42%, now it's 36%. So a small impact also on account of delivery reduction. Our delivery prices are generally higher than our dine-in and take-away prices. However, in spite of gross margin reduction, we were able to curtail the restaurant EBITDA drop to 80 basis points if you compare to a normalized EBITDA of last year of 18.7%, we delivered 17.9%. This was possible because of healthy SSSG, which Sanjay spoke about that we were able to drive because of lower price increase than inflation, combined with the cost control, we were able to limit the drop to 80 basis points in the quarter. And overall, it is a very soft quarter -- expectedly soft quarter from a festival point of view. But from an overall demand and SSSG point of view, it was a strong quarter for us. And the cost management and healthy management that we were able to restrict the impact to 80 basis points. Going forward, Sanjay mentioned that as we move into Q3, we expect recovery and demand to pick up because the festival days -- the vegetation festival days are over. Gross margin point of view, we expect marginal recovery to happen end of quarter 3, the beginning of quarter 4. And the higher ADS or higher revenue should enable us to drive greater restaurant EBITDA margin.

From a Pizza Hut perspective, the channel sales contribution is quite similar to quarter 1, where 35% came out of dine-in and about 15%, 16% comes out of take away. So deliveries today about 49% to 50% of our total business. A lot of our branding and promotion was focused on flavour fun that we launched on in the end of July, nationally. You can see some of our new restaurant launches and we launched about 14 in the quarter. So you can see Alwal, Gandhidham, Avadi where you've got KFC and Pizza Hut in the same premise and Dighi in the Pune. And now Vijay will just talk about the numbers.

Slide 28 on Pizza Hut, our overall SSSG was 23%. And as Sanjay mentioned, that this was on back of strong transaction it was really heartening to see. In terms of ADS, we were at 64,000. This was not only a growth on sequential quarter, but as well corresponding quarter as well. And this is in spite of 61 store additions, which happened over the last 1 year in case of Pizza Hut. Restaurant revenue grew by 60% at INR 140 crores with 14 additions during the quarter in terms of the overall tally 249 restaurants. On gross margins, we dropped by 110 basis points on account of churn in our price increase generally been lower than the inflation. However, our restaurant EBITDA when compared to a normalized EBITDA of last year at 10.7%, we delivered 15.1%, which is up by 440 basis points. So this was best ever quarter for Pizza Hut in terms of revenue as well as in terms of the restaurant margins. And within 15.1%, if you guys remember last time we called out that stores which have opened from April '18 onwards over last 4 years, those are delivering mid- to high teens level of profitability, and stores prior to April '18, while they're converted to Omnichannel because of the inefficient side, they delivered low double-digit restaurant EBITDA.

Our Sri Lanka business in our economy that is still impacted, continues to do well. The highest or the greatest impact of all the disturbances came in perhaps towards the end of June, July and August. But now things are stabilizing from an operations perspective, which is easier to get fewer. There are less number of -- there are less number of electricity outages, imports and again, being allowed so we are able to -- we are able to get our important products also in time, cheese, et cetera, which is very important. So operating-wise, the business is as -- so it's at least, I would say, 85%, 90% at a normal level. Inflation, when we look at the first half would anywhere close to about 75% to 80%. We would have taken price increases in the region of about 40% and therefore, gross margins here have dropped. But ADS at a Sri Lanka level, SSSG grew by 37%. And our store openings continue. We opened 6 Pizza Huts and 1 Taco Bell...

7 Pizza Huts and 1 Taco Bell...

7 Pizza Huts and 1 Taco Bell. We are also seeing reasonably good traction on Taco Bell even though it is just 7 stores today, but potentially at some point in time, it could be another driver of growth in Sri Lanka. Our new products continue to do well. So the brand is in a strong position and when I look at October, there's been a little easing out of -- so improvement in operating conditions. However, inflation is still an issue. And given that wage inflation is not in line with general inflation, there will be pressure on consumer discretionary categories and from a transaction level, I feel that we will see pressure as we go forward. The quick financials Vijay will talk about.

Page 36, overall SSSG 37% with ADS in Lankan rupees at LKR 335,000. If we look at the Indian rupees, [indiscernible] impacted by translation of currency of almost 40% impact on depreciation. In terms of revenues, in LKR 312 crores revenue for the quarter up by 76%. In Indian rupees it is INR 67 crores, up by 2%. So still positive even though a big impact on translation of currency. At Gross margin, a drop of 1,000 basis point as we saw even in quarter 1, there was a drop of close to 900 to 950 basis points, impacted by inflation. Sanjay spoke about the price increases in the range of 40%, while the price -- while the inflation was in the range of 75% to 80%. Absolute margin still grew by 23% in LKR terms, while the percentage margin dropped by 550 basis points when you compare with normalized EBITDA of last year, so it has clocked 15% so overall things are more stable in terms of as Sanjay said operating conditions, be it for equity availability, with supply chain management, be it power and fuel, and as indicated earlier this year, we expect probably the overall year where revenue to grow by 20% to 30% in Lankan rupees. We would be happy if we are able to hold or marginally grow our EBITDA at Lankan level. In LKR terms, of course, we will have a depreciation impact of 40%, which means that the corporate EBITDA level on an annual basis would be an impact of INR 15 crores to INR 20 crores in Indian rupees. Having said that, the India business is more than able to cover for a deficit on the Lanka business, and this now comes only 10% to 11% of mix at corporate EBITDA level. That is it guys. Thank you. I'll hand it over to Vikram for the Q&A session.

[Operator Instructions] We have a first question from the line of Sameer Gupta from India Infoline.

This is Percy Panthaki here. So my question is on the margins. You mentioned there's a 300 basis points hit on gross margins. So what is the plan to counter that? Is it that you see the commodities coming down and that itself will take care of it? And if so, to what extent? And do you think any more price increases are necessary? That's the first part of the question. And second part of the question is that assuming that you recovered this 300 basis points over the next 2, 3 quarters, does that mean that your EBITDA margin also versus the 11%, 11.5% you have done this quarter, does it mean it goes up to 14% plus when that happens or it doesn't translate that way.

Yes. So Percy, if you see, I just let me take KFC example. I think we are -- we have got one balancing act to do between pricing and the impact of the pricing on consumer demand. Therefore, we've taken 9% versus inflation of mid teens been able to still hold on to very strong SSSGs and despite 310 basis points in gross margins, EBITDA margins just dropped by 80. Now, I mean we do another calculation and say, let's take mid-teens price increase. And if it leads to very poor SSSGs then the leverage impact will manage. And therefore, it can have a detrimental impact on restaurant EBITDA. So this is something that, along with Yum! we are monitoring at a close level, we are not seeing commodity prices coming down at an overall level significantly. Some places, it is coming down, for example, oil has come down. But for both the brands, inflation versus last year continues to be at this level. And now are there opportunities to take price increases, I think we'll be very cautious about some of the price increases. So I'd say gross margins perhaps we'll see some marginal improvement towards end of quarter 3, beginning of quarter 4, but would not see any dramatic improvement in the -- in gross margins. Having said that, restaurant EBITDA in quarter 3 because of better sales compared to quarter 2, we will see some leverage coming out of that, and I'm hoping that restaurant EBITDA margins improve.

And just to add to that, Percy, we have always called out that our focus is more on the restaurant EBITDA margin level, and we always try and take the impact in our stride on gross margins and still deliver a sustained and improved upon restaurant EBITDA margin. So that journey will still continue where while you do not see a full recovery on gross margins, marginal recovery, but our cost management and the SSSGs, which gives us leverage will help us move towards that restaurant EBITDA margins, the ideal margin which we are looking for.

And if the input cost comes off in future, do you think you would retain that benefit. So in one way or the other, not through MRP, but through extra promotions or something like that, a large part of that would get passed through to the consumer. What's your sense on...

If it comes down -- let's wait and watch if it comes down Percy. And it would be all combination of what SSSGs and what growth we are seeing at that point in time and which is that we will take a call Percy.

And one small question I had was on corporate expenses, the corporate expenses that I'm deriving for this quarter are about 5.6% of sales, versus in Q1, it was 5.1% of sales. So there's a 50 basis points operating deleverage on a sequential basis. So am I reading too much into this? Or do you think -- I mean, there's hope for this corporate expenses itself to be like over the next 6 to 8 quarters can be a 100 basis point driver of margins or something like that?

So for a second, we will not comment on a specific line and give a specific line guidance. Having said that quarter 2 corporate cost is also impacted by the ESOPs grant, which happened in towards latter half of quarter 1. So quarter 1 did not see probably the full impact of that. So that have probably contributed 30 basis points in this. Yes, marginal impact has also happened on account of leverage on account of lower sales. As the revenue builds up happen, our corporate cost, which is a combination of corporate cost and regional teams will definitely grow lower than the revenue growth. So you will see some leverage happening quarter-on-quarter or more logically year-on-year on corporate cost because on quarter-on-quarter seasonality also plays out. So you will see some leverage. I will not put that leverage.

And this ESOP cost of 30 basis points, does it continue into the coming quarters as well?

Quarter 2 is now representative of the ESOP cost. So it's full ESOP cost, which have got built in. In fact, what may happen is after March 23, when some ESOP gets vested, it may come down slightly, in fact.

[Operator Instructions] Next question from the line of Nihal Jham with Nuvama.

So a couple of questions. First, on the KFC part, as you're highlighting the seasonality, generally, what is the impact from Q1 to Q2 in ADS that happened because of, as you said, higher preference of vegetarian in the areas we operate?

So Nihal, very difficult to put an exact ratio because what happens is the religious festivals, the days can move between quarter 2 and quarter 3, and then last 2 years, COVID has actually played havoc with trends analysis. So very difficult to put a actual number. For example, even this quarter, you saw Navratri part of Navratri coming in September last week, where last year, the entire Navratri was in October. So very difficult to put. What I can say is that this year, the dip which we are seeing is similar to the dips which we have seen in pre-COVID times.

Having said that quarter 1, our overall ADS was in the region of 144, our overall ADS in quarter 2 was 134. So that is the extent of...

7% give or take in a way.

Give or take because new store impact from quarter-to-quarter won't be high. So that is the kind of impact we see over the full quarter, Nihal.

Understood. The only reason I asked because you highlighted inflation. So there was an exaggerated impact of footfalls or something, but I'll take the number that you are giving that this is represented.

I called out that was one worry that we had that with inflation and with vegetarian days would it impact transaction, but we are really happy with the kind of SSSG growth that we have seen because dine-in has been strong. Their transaction growth has been strong. And we have also seen it translate into SSSG growth also.

Understood. Taking two questions on Pizza Hut. First is if you could again highlight on the flavor fun which you highlighted from July been promoting. And second is if you could separately call out the margins for the new format stores, if that is the right term I will be done with?

The second question is first, we have said that the stores which are opened from April '18 onwards, and it's not a new format. It's all we operate omission of stores, whether it's old or new. The April 18 onwards are more compact ones compared to the size which we were operating earlier, which we inherited in legacy. So the compact ones are delivering anywhere from mid- to high teens.

Yes. And on flavor fun, the response has been very positive. I'm loathe to call out a specific number on flavor fun and because it's just really too early days, and while we always say that there is a seasonality impact on KFC, there is also a seasonality -- some seasonality impact that happens in Pizza Hut also. So I think we should wait for 3, 4 quarters, look at how the specific innovation goes. Undoubtedly, it is leading to transaction growth. And from an anecdotal basis, the kind of customers we are seeing coming to our stores and ordering is definitely these consumers might not have come in the past. So that value layer under INR 100 like we called out even in the last earnings call is an important future driver of growth. I hope we answered your question, Nihal.

We have next question from the line of Devanshu Bansal with Emkay Global.

Sir, wanted to check what is the typical growth trend in ADS from Q2 to Q3 because Q2 generally is a weak quarter for KFC, so if you can just help me with the historical trends, it would be helpful.

It could -- see again, ADS is also a function of how many new stores you're opening. When you look at the historical trends, we were not expanding so much. So that may not be represented the new store additions do dilute to some extent, the overall ADS. Having said that, we have seen a drop of 5% to 7% vis-a-vis quarter 1, something of that in that range. It could be anywhere between that 4% to 8%. I would not put a specific number to it, but that could be the range on quarterly 3 versus quarter 2.

Okay. And sir, for Pizza Hut, it has been a very encouraging performance with 23% SSSG. I just wanted to check if there element of low base for Pizza Hut due in the last year.

Devanshu, Sanjay here, I just want to interrupt, I think I heard Vijay said -- say a decrease in quarter 3 versus quarter 2. Actually, it is between 4% to 8% increase in quarter 3 versus quarter 2.

Yes, sir. I got that. I understood it as an increase only.

We just wanted to clarify for the benefit of everyone.

There are 260 people on the call. So there shouldn't be 260 minus Devanshu all of them freezing and saying my God this quarter we are going to be lower than quarter 2. So I just clarified for that sake. Go ahead with your question again, please, Devanshu.

Yes, sir. So I was indicating that Pizza Hut has seen a very encouraging performance with 23% SSSG this quarter. I wanted to check if there was any sort of a low base element for you last year for Pizza Hut format due to operating conditions, et cetera.

So I would say there was very marginally lower base. I would say malls that were at, say, 90% recovery last year versus what they would normally be. But I think it is minimal. So base is not the issue.

So marginally, a small impact and maybe a pocket territory like Maharashtra, where the conditions got slightly more favorable in operating from October onwards September, towards end September, but then that's a marginal impact in the base.

Got it. And lastly, sir, if you can talk about the trends in terms of SSSG for the festive season, it would be very helpful for both the formats?

Sorry, just repeat -- the festive season is over. So we have given you the SSSG numbers, the quarter numbers. Are you talking about quarter 3 or what are you talking about?

Yes, festive season in quarter 3, some outlook, if you can provide, then it will be very helpful.

We can predict our business, but we are not soothsayers here Devanshu and therefore, what Vijay just said is roughly we have seen 4% to 8% increase over quarter 2, I think that's about as much that I am able to perhaps predict.

That's for KFC, just to call out, clarify again. Pizza Hut does not get so impacted by seasonality anyway. So quarter 2 was the best ever quarter. So the ADS of Pizza Hut, which was 64,000 in quarter 2 does not have any seasonality impact. So we hope we continue on the same trajectory for Pizza Hut.

[Operator Instructions] We have the next question from the line of Kapil Jagasia with Edelweiss Broking.

First of all, congratulations for the great set of numbers. Sir, my first question is...

Kapil you are the first person who said -- who congratulated us, normally Percy is the first person who would say good set of numbers. But this time, Percy, for some reason, he was very muted, so thank you, Kapil.

Sure, sir. The store opening run rate has been very healthy in H1 so would we be eligible for the incentives from Yum! this year too, like [ ADS ] and what would be the quantum?

So just to clarify, I think you're referring to the incentives which we actually had last year. So as per our contract every year, we confused, we have been getting incentives over the last 5 years we will continue to get incentives over the next 5 years as well, that's not going to change. What we called out last year was there was some additional component on account of COVID. Because of COVID, our targets were revised and we were given some additional incentives. That's all we have called out. Those current set of numbers our representative in terms of incentive calculations, you will not see a reduction in terms of incentives, you will not see increase in terms of incentives.

Okay. That's very much there. And I just wanted to understand your take away channel, because if I just see in terms of during COVID probably people might be sitting in and taking away the pizza or KFC items, but now with nothing there, no restriction is there would it be clearly a dine-in or a delivery channel? Because I'm just trying to understand why the takeaway is still at 20% of sales, like what is like any drivers for it? Or how do you see this channel growing going forward?

So takeaway has always been a double-digit channel for us even in the past, and proximity to store enables this takeaway. In many of our mall formats stores and drive-through stores, people -- so when the drive-through format also, we say that when a person purchases in the drive-through that is under takeaway. Having said that, I think now I'll just refer to a global trend that we are seeing and perhaps that will play out in India some time. If you look at globally, delivery now -- delivery prices are substantially higher than either dine-in or takeaway prices. And apparently, there is a global trend where consumers look at these delivery prices. If they are in the vicinity of the store prefer to come and take away because it is little more economical, perhaps something like that we are seeing in India because our takeaway portions are slightly better than what has been there in the past. But again, compared to what happened during COVID, it's not better than what happened during COVID so it has reduced a little bit. So I think it's traditionally been a strong double digit contributing channel for us and the behavior that started during COVID period when takeaway increased that sort of continues even when COVID is off and neighborhood restaurants and access to a restaurant drives really takeaway.

Just to add to that, our omnichannel strategy, where all these 3 channels are available, actually puts us in a strong position that you can take advantage of 1 channel versus the other. All the 3 channels are available in Sapphire formats be it Pizza Hut, which is omnichannel, and be it KFC which is omnichannel.

Does that answer your question?

Vikram, we are Hearing some disturbance, maybe you can take it over and we can move on to the next caller.

Your next question is from the line of C. Kishore with Chola MS.

I just want to understand what is the average size of the new stores that you're opening. So that's my -- and let's say, I want to understand, going forward, would it be safe to assume that, I mean the future would be towards, let's say, smaller store sizes so that the unit economics actually work out better?

So our sizes for KFC are in the range of 1,500 to 1,600 square foot, Pizza Hut in 1,200 square foot. The reductions in sizes have happened over the last 5, 6 years that I want to call out. It's not just a COVID phenomena that we have cut down the size that happened with calculations in terms of covers, table turns, and with the advent of delivery channel, partnering with aggregators meant that we can be a more omnichannel player. So that's how the reduction has happened. While the reduction sizes happen, again, just to clarify will not impact our capacity to serve customers. So the ADS throughput can be considerably higher than what we delivered right now. And the levels where we are, we don't expect in the medium term for a dramatic or a further reduction in the sizes as we move forward because you require X amount of capacity, sitting capacity for your dine-in channel to be relevant. Any cutdowns from here on would compromise that particular channel.

We have the next question from the line of Ashish Kumar from Infinity Alternatives.

Thank you Sir and congratulations for a good set of results. Sir, on this -- when you compare a pace of store addition, while we've kind of come significantly from where we were last year. The question which I have is that when we compare to a peer growth, they seem to be opening almost double this number of stores on the KFC plus Pizza Hut India. Where did -- how do you think -- do you think that we have a path to kind of get to catch up with them in terms of the same store because from a GDP perspective, we kind of spread the GDP 50:50, right?

Yes. So I think the pace of our expansion is in line with what we have said consistently over the last 1 year that we will -- we hope to double our restaurant base of about 550 stores at the end of December '21 and that gives us roughly in the region of 130 to 160 stores. Between these numbers and all 3 businesses, Pizza Hut, KFC and Sri Lanka will be roughly be able to deliver the -- this kind of pace for expansion. Now this is what we are happy and comfortable with. I think this is a factor when you look at a pace of expansion, it is -- pace of expansion into the ADS that you are able to get out of a new store. And if you look at that, I don't think we are compromised in any way in respect to our peers.

So just to add Sanjay said double, he meant doubling in 3 to 4 years' time vis-à-vis the numbers which we had in December '21. And again, our guiding factor would not be what Pizza Hut is doing our guiding factor would be our levels, our strike rates, our paybacks that is our internal measures which we use. And that's where we feel we are comfortable with doubling the account over 3 to 4 years. On the point that you just meant that GDP wise the territory distribution is 50 -- 50:50. I would just like to clarify the territory which KFC operates in for us, they contribute 56% to India’s GDP, for Pizza Hut territories which we operate -- cover roughly 57% of India’s GDP.

Yes, which is where I was coming from. And maybe, yes, you are right that this is in line with the guidance that we have given. But given the fact that we're seeing an environment wherein the shift towards branded players like yourselves is significantly higher, if I were to say. Does it make sense to expand we have a balance sheet with a very healthy cash accrual and a healthy internal accruals. Does it make sense to kind of accelerate the pace of rollout given the fact that you have a higher footprint of the country. It is a question of -- if you don't do it is somebody like a Popeyes may come and kind of capture the space. That's it is a question of land grab?

So I don't think it's a question of land grab, Ashish. As I said, there are many things that need to be balanced. At this rate, the ADS that we get, and therefore, the new store payback that we get are healthy. I think anyone -- I think it will be -- or there will be a few players who can match this rate of expansion, deliver the kind of returns that we are looking at. So short answer is, this is the rate of expansion that we are looking at this stage.

Okay. And coming back to -- and sorry, I missed a little bit of the call when there was an issue drop on the gross margin. Do we believe that we can get back to our historical gross margin in the next couple of quarters?

So I believe you're referring to KFC in particular? So while, again, the gross margin drop of 300 basis point happened, our restaurant EBITDA dropped by only 80 basis point. So that's the way we are focusing. The idea is not to take a price increase with inflation and probably potentially impact our revenue and transaction, so we are happy with where the price increase stays right now. Yes, marginally, we expect the gross margins to come back towards the second half of quarter 3 and starting quarter 4 marginally, but could be on improving the restaurant EBITDA, which would happen with the improvement in sales, which we are anyway sitting in quarter 3 over quarter 2 because the vegetation as are now over in terms of the festivities. So the focus is more on the restaurant EBITDA margin and how do we sustain and drive restaurant EBITDA margins.

Your next question from the line of Jignesh Kamani with GMO.

Just with the gross margin front. we have seen the milk price increased by INR 3 to INR 4 last month and hence, cheese and all the other products. So do you think it's still some of the element of the gross margin and raw material still continue to rise and will have a further impact on the gross margin in the second half at least for the pizza if not for KFC?

So I mentioned this right in the beginning that there are some items where have come down, some items where as you rightly say milk prices have gone up, and therefore, potentially over the next 3, 4 months will have an impact on dairy products that we consume also. So overall, I think inflation will continue at the level that -- at the levels that we have seen in the first half. So I'm saying the deviation from this will be marginal. It's not going to go down dramatically. It's not going to go up dramatically.

Understood. Second thing on the flavor fun. Based on the initial experiments, are we seeing more down trading or new customer is taking care of any small downtrading is happening?

So like I said, it's too early to call it on flavor fun. It's just that we are getting -- I'm sure we are getting higher level of transaction growth than we have got earlier. So net-net, it is positive. We are not going into great specifics on this Jignesh, so forgive me for that.

[Operator Instructions] We have next question from the line of Heeru Tejwani with Motilal Oswal.

First of all, congratulations on the numbers we see on the process. So my question is on a very comprehensive a macro level to Sanjay. Other than India or Sri Lanka like in the QSR space, other peer groups are growing in other countries. So how -- so it's obviously from the question on increasing stores, would you look at strategically introducing any other country in the near future.

That's 2 hypothetical questions Heeru at this moment.

Having said that, Heeru, we have always called out in terms of our strategy, that apart from organic growth in terms of KFC and Pizza Hut restaurant additions -- in terms of inorganic growth, we would love to have a third brand at some point in time, if not in the short term, maybe in the medium term. And that's where we'll leave it at now whether it could be new territory or new brand in India, it's too early to hypothetical to comment.

I think largely, we should -- largely one of the considerations is that it should be able to offer similar kind of growth trajectory as India offers. So if anything that is not offering the kind of India growth trajectory -- another territory, then I think we will be very, very circumspect.

And the mantras for those identification of brand, we have listed in our annual report. So if you go to Page 35, there are 7 mantras which defines where you want to have scale and success both then that would go into our choice of the third brand. So you can refer to the Page 35 of our annual report as well.

We have next question from the line of Kalpit Narvekar with Allianz Global Investors.

Good evening and congrats on the results of the quarter. I had 2 questions. One was -- so I want to understand how this [indiscernible]. Essentially, if you've done any studies on the demand elasticity say at the young level or for product categories,like KFC and Pizza Hut, right? So if -- like how does the price -- like how does price hike affect volume growth. Let's say, in the past -- in past cycles, how if you've done the study if you have any sort of color on that?

So Kalpit, actually, we are in new territory here. And I'm just looking at my -- so we are a new territory here over the last 5 or 6 years, we've not had an inflation of this level. And hence, there is very little past data to fall back on. I'm just looking at my old consumer product experience that says that, in general, there is an impact on any discretionary income category, there is an impact when you take severe price increases. So the best way to find out actually is to experiment and say, less -- so in general, -- we feel that if we are able to restrict price increases in the region of between 60% and 70% of inflation and then find economies of scale elsewhere, it works well because the product then becomes more affordable over a period of time. I think we have used a similar kind of understanding when we have taken price increases this year also. But there is no hard and fast juristic that shows the demand elasticity. I think we've just got to do something and then see how it plays out. I think the fact that we have kept price increases to the level that we have in quarter 2 compared to the inflation and it's borne out with SSSG means that at least right now, it has worked in the quarter that has gone by.

And my second question was on the delivery fees. So how much of the delivery fees is through our own delivery system. And what is the strategy in terms of expansion of our own delivery network?

The breakup for both the brand would be different. KFC would be 90% approximately and I am giving you a very approximate numbers, 90% through aggregators and the rest delivery Pizza Hut would be 80:20 ratio. So our plans for our own delivery in terms of our systems, our app, the kind of offers which we have on our platform, they continue to be there for last 2, 3 years, and they continue to grow well. What's happening at the same time, aggregator continues to pump in money. They are growing really well. So the mix is not changing. However, our own delivery as well as aggregators, both the platforms are growing healthily.

Yes. So typically, we'd have stopped the -- our call was for an hour, but we are quite happy to continue with people on the call are also to continue. So we'll take our next call, therefore, Vikram.

We have next question from the line of Harsh Mulchandani with KRIIS PMS.

Congratulations, sir, for a good set of numbers. I just wanted to understand that do you track the set of repeat customers at your end? And how does that number look like on a quarter-to-quarter basis?

So I don't have those numbers offhand with me, I must confess Harsh so if necessarily, we can get back later, but I don't have those numbers offhand with me.

Okay. Okay. Sure, no worries. And I have another question on the prices. So I just want to understand that you operate across states. So your prices are consistent across states where you operate or they are different?

Yes, yes, yes. They are consistent in all India. There might be -- so there are...

Across India. They will be different across channels. So for example, -- so for example, delivery channel may have slightly higher prices for KFC in particular, in Pizza Hut even that's not the case. Otherwise, from state-to-state and territory-to-territory, the prices are consistent.

We also have some premium price stores -- so -- but that's about the difference. Otherwise, pricing is consistent across the country.

Got it. Got it. Fair. And just to compare it with the price which is the other operator for Pizza Hut, which operators in India. So the prices with them is also similar? Or do you have a different pricing power?

It is Pan India similar so irrespective of the stores are operated by the sister franchise or by Sapphire, the pricing strategy is consistent, not just for Pizza Hut even for KFC, across all states, and all territories.

We have next question from the line of [ Ameya Gawande with Metaverse Equity Fund ].

So sir, my question is what growth you are anticipating in within the next 3 years, particularly in Sri Lanka.

I don't think I can ensure that answer, Ameya.

So Sri Lanka as we had called out already this year, we are seeing 20% to 30% growth and the macroeconomic situation, while it has stabilized continues to remain critical so would be very full heartedly to probably try and predict 3 years from right now for Sri Lanka. We'll take a quarter at a time, let's see in the next 6 months' time, we will reach and maybe then we can have this conversation.

We have next question from the line of Pujan Shah with Congruence Advisers.

I just wanted to know what is the advertisement spend we are doing on the percentage basis?

So as per the contract with Yum!, we are required to spend 5% for a national campaign, which we contribute to Yum! and along with the sister of franchising, which is used for Pan India marketing and 1% of our local sales marketing, which we spend internally.

So total -- so as geographical-wise, our sister concern and all our companies. Do we have any segregated advertisement spend or we have collective advertisement spend on a basis of this franchise base?

So the segregation is on that 1%, where it's local sales marketing, where we spend into our territories. For the 5%, it's a national pool, which is used for pan-India marketing.

We have next question from the line of [ Dhairya Trivedi from DJT Investments ].

I have a couple of bookkeeping questions. What is the likely tax rate for this financial year?

So this financial year, it's unlikely that we will have a tax outflow because we have enough carryforward of losses. I guess we will get into the tax sale time next year maybe towards second half probably. And then going forward a year later, we'll get fall into 25% tax regime. But that's probably a couple of years away.

Okay. Got it. And another one on the royalty front, what is the royalties that we are paying to the master franchise at the current stage?

First of all, we don't pay to a master. We are a master franchise. We pay royalty to Yum!.

Yes -- so as per our agreement, it is 6.3%. But again, there would be -- we have called out there would be waivers depending upon the store opening plan. But the base number is 6.3%.

And Is it likely to go up in the next year or so?

So our royalty of 6.3% has been consistent for the last few years. In fact of Yum!, it has been consistent globally. We don't expect it to either come down or go up. That's the rate which Yum! follows globally for quite a few years across all territories.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to hand the conference back over to Mr. Sanjay Purohit for closing comments. Over to you, sir.

Yes. So first of all, thank you all for joining. We had a really good question-and-answer session. At the end of a quarter where -- which was potentially challenging, but we have been able to navigate these turbulent waters quite well. And from a demand perspective, both brands were strong in Sri Lanka also business was strong. And our old adage where we said that let's not look at gross margin, but see what is the impact of -- what is the impact of price increases on volume, and if you are able to maintain volume and therefore grow same-store sales growth, we are able to get leverage. And that's how it has played out in quarter 2, and therefore, our restaurant EBITDA margin have been quite strong. The drop versus last year quarter on KFC has been quite minimal. And the India restaurant EBITDA, both brands put together actually went up by 40 basis points. I'm quite looking forward to quarter 3 and quarter 4 and ending the year also on a strong note. Having said that, we will see you at the turn of the new year and therefore, the best wishes for the New Year in advance to all of you. Thank you.

Thank you very much, sir. Ladies and gentlemen, on behalf of Sapphire Foods India Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.