百勝餐飲集團 (YUM) 2003 Q2 法說會逐字稿

Good morning.

My name is Laura and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the YUM!

Brands 2003 second quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press "1" on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you.

I would now like to turn the call over to Mr. Tim Jerzyk, vice president of investor relations.

Thank you, Laura.

Good morning, everyone, and thanks for joining us on the call.

Before we begin, I'd like to go through a few necessary things.

This call is being recorded and will be available for playback.

We are broadcasting this conference call via our Web site at www.Yum.com.

Please be advised that if you do ask a question later on, it will be included in both our live conference and in any future use of the recording.

I would also like to advise that this conference call may include forward-looking statements that reflect management's expectations based on currently available data.

However, actual results are subject to future events and uncertainties.

The information in this conference call related to projections or other forward-looking statements may be relied on subject to our safe harbor statement, which is included in the earnings release from last night, and may continue to be used while this call remains in the active portion of the company's Web site, which will be until midnight August 1st, 2003.

On our call today, we have David Novak, Chairman and CEO, Dave Deno, our CFO, and Aylwin Lewis, our President, Chief Multibranding and Operating Officer.

Each will follow with remarks and we will then take your questions.

Now I'd like to turn the call over to David Novak.

Thank you, Tim, and good morning, everybody.

I'm pleased to say that we met our earnings commitment once again and remain absolutely on target for full year earnings and cash flow commitments.

Importantly for the second quarter, we had profit growth in both our U.S. and international businesses, in what is obviously a difficult operating environment.

Dave Deno, our CFO, will talk more about the second quarter results shortly.

And let me say that sales and margins were tough, but we made it happen through continued success at Taco Bell, significant progress at Pizza Hut with same-store sales now positive, and good old-fashioned cost control.

We expect a stronger second half and to deliver on our commitment of at least $2 of share as we go forward.

Strategically, we remain focused on executing our three key strategies - profitable international growth, multi-brand expansion, and improving restaurant operations and making our core brands even stronger.

We continue to make progress on each of these strategies this quarter.

Let me now talk a little bit more about where we are with each of these key strategies.

First, international restaurant expansion is absolutely on track.

This is the most important contributor to the YUM! earnings growth model.

We expect to grow our international restaurant base by 6% again this year.

The company and its franchise partners will open more than 1,000 new international traditional restaurants this year.

Our annual target rate for net restaurant expansion continues to be 5% to 6%.

Right now it looks like growth for 2003 will be at the high end of our target rake range.

We expect our franchise partners will open 60% to 70% of our new KFC and Pizza Hut international restaurants.

As I have said in the past, we remain very disciplined in how we invest and allocate our international capital.

Obviously the strong returns we achieve on company new restaurant investments are strengthened by new franchise restaurant openings, which are clearly high return.

The vast majority of our company international capital investment continues to be focused on four markets--China, the UK, Korea, and Mexico.

All signs today are green and go in China, the UK and Mexico.

We have pulled back development somewhat in Korea with Pizza Hut because of recent sales performance in macro issues.

That's in line with our stated goal to deliver profitable growth, not just growth.

Importantly, I just returned from store tours with our key business leaders in Europe.

We are investing in Germany, France and Holland to develop additional growth markets to contribute to our international growth equations three to five years from now.

Unit economics look promising in France and the Netherlands.

However, Germany is more challenging given the tough economy and higher level of government social costs.

To drive higher volume, we just opened our first KFC A&W multibrand restaurant in Germany.

Beef is still the number one protein choice in Germany, and we're hopeful the variety of burgers and KFC chicken will drive higher average unit sales that we'll need in that marketplace to be successful.

We'll post you on our progress as we go down the road.

Developing a big business in continental Europe is our number one opportunity internationally, but it's also our biggest challenge.

We're making progress and we'll take our time to get it right.

We do not want to invest ahead of our capability.

As I said earlier, one of our key markets for international restaurant expansion, China, is as strong as ever.

The market was briefly impacted by SARS in terms of lower sales and delays in new unit openings, but its performance is back to where it was pre-SARS and has terrific momentum.

Sam Su, our General Manager for China, and his team did an absolutely fantastic job of doing everything they could to provide customers with easy access to our brands during the SARS outbreak.

As a result, the impact of SARS to our business was very short-lived.

Importantly, sales growth for both KFC and Pizza Hut brands in China have rebounded quickly and soundly, which is a testament to the strength of each brand in this key market.

There's no doubt in our mind that China is going to be a global economic powerhouse for the longer term.

YUM!'s leadership position in China gives us a major growth driver for years to come.

In fact, we want to be the dominant QSR leader in every major category in China, and we have the infrastructure to do it.

All in all, we continue to be confident YUM!'s international growth engine is on track, and we expect to see international system sales back in the range of at least 7% growth constant currency terms by Q4.

Number two, we continue to add more multibrand restaurants in the U.S. with our franchise partners during the second quarter.

Key accomplishments this year will be the addition of about 400 multibrand restaurants in the U.S., and most importantly, setting the stage for continuing steady expansion over the next five years.

We have really focused on determining the best brand combinations as well as really making these new restaurants much more attractive and appealing to the QSR consumer.

Our customers are telling us they love our new facilities, and the branded choice they are offering.

Our franchise partners continue to develop about half of our multibrand restaurants.

This past week, we held a business summit in Louisville with 60 franchise leaders from each of our brands around the United States.

We established operating criteria with our franchise partners for being growth-ready for multibrand expansion.

Clearly, we want to expand multibranding in the best way possible and with the look of a leader.

We believe our growth-ready standards will do just that by helping us drive sound, strong execution.

We also talked with our franchise partners about the key things we're working on to make multibranding even better, which include the things we've talked about in prior calls, such as optimizing the kitchen integration of two brands, increasing labor productivity, and improving people readiness and selection.

We've made very good progress in these areas, and expect to continue to get better and better.

Frankly, the only way we could blow this big idea is going too fast and having lousy execution.

Importantly, we now have multibrand opportunities for all of our U.S. brands.

This is a huge opportunity for us to enhance our growth potential in a competitive U.S. market, and we know that outstanding execution is key and we are focused on executing in an outstanding fashion.

Third, we continue to make progress in improving our restaurant operations.

Aylwin Lewis is on this call and will give you a complete mid year operations update so you can get a sense of our progress.

We know we are in the bottom to middle tier in operations versus our competition, and we see this as a key business opportunity.

So, we remain very focused on improving key operational measures and setting the stage for a more trusted consistently positive customer experience in our restaurants.

Our goal is to drive more consistent same-store sales growth, and we believe operations is critical to achieving that goal.

Hopefully, I've given you a better sense of what to expect from us in 2003, our progress as well as our challenges.

We are as focused as ever on executing against these three key strategies and getting better and better every day.

As we look at our U.S. business for the rest of 2003, we're confident sales performance will be stronger than the first half.

With our portfolio of category-leading brands, the innovation we have planned for the balance of the year, continued improvement in system-wide operations, combined with the expansion of multibranding, we expect to produce at least 2% growth in the U.S. company same-store sales for the balance of 2003, at each of our three core brands.

Later on in the Q and A session, I'll answer any questions you may have on our individual brands.

International restaurant growth, multibranding and continually improving operations and difficult differentiating our category-leading brands, these are the three building blocks that give us a great opportunity for growth in our industry.

With that, let me turn it over to Dave Deno to take you through the details of the quarter and for 2003, how we will deliver at least 10% earnings growth, strong cash flow, continued growth in franchise fees, higher returns, and an even stronger balance sheet.

Dave?

Thank you, David, and good morning, everybody.

Before I turn to our Q2 results, let me update you briefly on the full-year picture for YUM!.

We remain on track for our full-year commitment of at least $2 per share in earnings for the full year prior to any special items.

For the second half, we expect to continue to show balance profit growth from our international and U.S. businesses with at least 2% growth in company same-store sales at each of our three founding brands--Taco Bell, Pizza Hut, and KFC.

Importantly, from a YUM! earnings growth perspective, the pipeline for new international restaurant openings is healthy and on target.

While some restaurant development was delayed in China at the height of the SARS crisis in certain regions of that country, we expect to open more than 1,000 new international restaurants again this year.

And as our shareholders know, international is our fastest-growing and largest division and is the biggest piece of the YUM! growth equation.

Obviously these 1,000 new units will be a big contributor to next year's profit.

Now I'll talk about Q2.

As you already know from last night's release and previous communications, we did take a charge in Q2 for a legal judgment against Taco Bell.

We will, however, vigorously pursue the appeal process.

If unsuccessful upon appeal, we will pursue reimbursement from appropriate parties.

That was an unexpected and unfortunate event that we are dealing with.

Now on to business performance.

Overall, before special item charges, we came in at 48 cents per share, which was 2 cents ahead of our prior expectation.

As you saw from our second quarter earnings release, with the exception of blended U.S. same-store sales, most of our results in the quarter came in about as expected.

The second quarter EPS side, as David mentioned, was due to good cost control, especially favorable G&A costs and continued impact from our financial strategies, in this case, share repurchases.

Our full-year forecast remains unchanged, at least $2 per share excluding special items.

Looking at quarter 3, we are comfortable with the consensus at 52 cents a share before special items.

For the second quarter, most of the businesses came in pretty much as we expected in our last release.

International system wide sales growth was right in line, as were favorable foreign currency benefits.

U.S. blended same-store sales growth for company restaurants was up about 1%, which was slightly below our expectation of plus 2%.

On the cost side, our restaurant margin was somewhat lower than expected primarily as a result of declining same-store sales growth in some of our markets.

There were no significant surprises in commodities.

Second quarter G&A costs, which were better than expected, were below last year by about $7 million.

Additionally, store closure costs were slightly favorable versus expectations.

However, our tax rate before special items of 32.3% was slightly higher than the range of 31% to 32% we expected.

This does not change our previous full-year expectations for tax rate in the range of 31% to 32%.

This is the range we outlined to you last December.

Overall, the second quarter with 12% growth earnings per share prior to special items was a good quarter considering the challenges we faced in some markets.

Importantly, both our international and U.S. businesses contributed to profit growth.

This was a very good quarter for cash flow.

We were able to reduce debt by $153 million, buy back $34 million of our stock, and invest $131 million of capital into the business.

We continue to allocate our capital in a very disciplined manner, and any assets on the balance sheet must earn the right to own to remain on the balance sheet.

You should expect to see continued modest re-franchising the balance of the year.

We expect $75 million to $100 million of cash proceeds from re-franchisings for the full year.

Now let's take a look at the balance for the year 2003.

Beginning with the third quarter, we have now fully lapsed the long jumps over AMW acquisition impact.

So, you will see normalized year-on-year earning comparisons going forward.

As I mentioned earlier, for the third quarter, we are comfortable with the consensus of 52 cents per share, 13% growth compared to last year, prior to any special items.

Importantly, our U.S. business, we expect the balance of the year from period 8, through the end of the year, to show 2% to 3% blended same-store sales growth, a marked improvement over the first half.

On the international side, we'll have a slow beginning to the third quarter as the impact of SARS in China in May flows through our period 7 results, the first full week period of Q3 consistent with what we previously communicated.

After period 7, you should see steady improvement in international system sales growth, and we expect fourth quarter will be back in line with our normal expectations of 7% growth in local currency terms.

Importantly, as David said, China was impacted by SARS, and has experienced a pronounced and rapid rebound in sales.

Sales are now back to pre-SARS levels and are growing nicely.

Since this was such a concern on our last call, it is nice to have sales bounce back so quickly.

We provided you with all the other necessary details related to our expectations for the third quarter in our earnings release last night.

Please refer to that for further details if you missed it.

As always, you can track our progress during the quarter as we provide you with both international and U.S. sales results for every four-week period.

Now let's briefly look at our U.S. brand portfolio for Q3 and the balance of the year.

We continue to expect improved blended same-store sales growth for the balance of the year for period 8 forward.

This is based on continued solid execution at Taco Bell and improved execution at both KFC and Pizza Hut.

Easier comparisons at KFC especially and at Pizza Hut in Q3 helps this outlook.

Taco Bell continues on a path for a good year with steady growth, lapping very strong growth a year ago.

Taco Bell's performance continues to be among the very best in the restaurant business.

Expect no major changes for the Bell's 2003 with continued focus on better execution on restaurant operations, brand positioning, and relevant product news, like Chicken Cesar grilled stuffed Burrito, to keep the consumer excited about Taco Bell.

In addition, we have just done a product review at Taco Bell and the pipeline is full.

Expect more product news from Taco Bell in the months ahead.

We expect Taco Bell to deliver at least 2% same-store sales growth for the balance of the year and for 2003.

Just a reminder, Taco Bell is lapping a plus 7 same store same-store sales growth in 2002.

At KFC, the comparisons beginning in period of period 8 are definitely easier, in fact, about 5 points easier, and we expect improved execution in terms of speed of service.

We will also feature relevant product news, like boneless wings, for the on the go QSR consumer looking for chicken innovation.

Additionally, the KFC team is working on a new advertising campaign.

This will be introduced in the fourth quarter.

Overall, from period 8 through the end of the year, we expect to see about 2% same-store sales growth at KFC.

The numbers will be better while they are (inaudible) more impactful concept news in 2004.

For the full year, KFC will be about even with 2002 and represents our biggest single brand challenge.

We have much to do, and we will have positive sales performance as our overlaps get easier.

On to Pizza Hut.

As I said in our last call, the new team was working extremely hard to improve brand performance, and our expectations were for progress to begin to show in the second half.

So far we are happy to say that we're on target.

Sales results for both period 6 and period 7 were good, with well differentiated offers.

First with the Pizzone (ph)promotion in period 6, followed by the DVD offer in period 7.

Additionally, a new brand positioning and ad campaign was launched with the pizza and DVD offer for period 7.

Pizza Hut is implementing a definite shift targeting families, with the positioning gathering around the good stuff, coupled with differentiated relevant value offers to the time star family looking for a home meal replacement solution.

Expect continued better execution along these lines, better operations execution especially around improved customer access, and, of course, continued product news and innovation.

Company same-store sales growth at Pizza Hut for the balance of the year should also be in the plus 2% range and for the full year, about even with last year.

We are very pleased with the progress Pizza Hut is making.

For the U.S. business, this means blended same-store sales growth for 2003 will likely be closer to plus 1% versus our target of plus 2%.

This gap will utilize about half our plan contingency.

We have had our challenges, but we believe that each of the brands will finish 2003 and enter 2004 with improved levels of differentiation with stronger brand positioning and product offerings.

In addition, we expect our operations to get better and better, especially regarding customer service and speed.

Turning to our cash flow targets for 2003, we remain confident in our full-year target.

We will generate over $1 billion dollars of cash flow from operations, plan to spend $750 to $800 million in capital including franchise acquisitions, pay down $200 million of debt, and buy-back at least $100 million of stock.

We expect to end the year with a strengthened balance sheet and even better financial ratios.

On our last call, I finished my update by saying let me reiterate we expect another good year for YUM! brands in a very challenging environment, and we believe we will deliver at least 10% growth in EPS prior to any special items.

This view has not changed.

The challenges have come, and we have been meeting our targets.

As a result, we continue to expect at least 10% growth in EPS prior to special items for 2003.

We expect to meet our commitment to shareholders as detailed last December

For the balance of the year and beyond, our key focus remains improved operations.

We have made progress, but this is a long-term journey to the top spot in number one position.

Importantly, all of our key initiatives and efforts in this regard are fully resourced and funded for 2003, and will be again for 2004.

Now let me turn the call over to Aylwin Lewis, President, Chief Multibranding Officer, to provide a mid year update on our operating progress.

Thank you, Dave.

Good morning, everyone.

I'd like to take this opportunity to provide you an update on the solid progress we are making against our key operating metrics, which I spoke with you in December of last year.

We're still focused on YUM!'s global operating platform, which has been in place since 2001 around key areas of Customer Mania mind-set and behavior, people capability, high visibility coaching and leadership, discipline around the P&L and balance score card.

Last year was our second full year of operating with this platform around the world, and as I reported to you last December in New York, we made good progress in 2002, and we are targeted to have continued progress in 2003 and beyond.

This is a multiple-year journey to our ultimate spot to be great operators and have number one position with our consumer metrics.

So at mid year, let me go through each of the platforms briefly and give you our progress.

First, Customer Mania mindset and behavior.

We complete customer Mania training at our team member level once a quarter in every restaurant around the globe.

This is our second year of completing this progress.

We have learned that by engaging our (inaudible) team members in our business, teaching them about our objectives and challenges, and more importantly, empowering them with the skills and ability to solve customer issues on the spot, we will ultimately deliver a better customer experience.

Since we introduced our menu training, we have seen our customer complaints to our 1-800-lines that exist in all of our domestic brands drop by about 10%.

We’re down to a level of five calls per 10,000 transactions.

More importantly, we've seen an increase in our customer compliments overall of about 30% since 2001.

A specific example of the improvement is that at Taco Bell, our compliments are up about 70%.

We feel very good about this progress.

What is more interesting is that 85% of these compliments are about our people.

We believe this is a real testament to the impact of Customer Mania training, which focuses on our people in the restaurants and their interactions with our customers.

The key to creating and sustaining a customer menu mindset and culture is to continue to reinforce its principles regularly every year with all our team members.

In fact, we're doing it four times a year in every restaurant.

We've done this now for the past two years, and we will continue.

Our training is very focused on each and every time around core Customer Mania principles.

Meetings activities are modified modestly each quarter.

We celebrate folks that are doing a great job, and more importantly, we engage the team members in a very active way in every session in every restaurant.

Second, people capability.

We put in place our one best way restaurant management tools that we're utilizing across all of our brands.

One example of this is our high impact coaching class.

We train our coach levels, which are our above-restaurant leaders, on effective techniques to motivate our restaurant management teams to enable them to drive, sustain and have great performance.

This is a two-day class, and this class is now implemented all across YUM! around the world.

As we frequently committed to you, the key measures we focus on for our people capability section are team member turnover, our GM turnover, and management stability.

We're making significant progress in reducing team member turnover at each one of our brands.

Our short-term goal is to have this number down to about 100%.

Currently, we are down to 108%, which is 20 basis points better than where we ended in 2002 at 128%.

Two of the brands, Taco Bell and Pizza Hut, are below 100%.

We feel very good about this accomplishment.

The overall YUM! average of 108 includes Long John Silver's, which has been part of this process, and have been on an operating platform just since the beginning of 2003.

Their turnover is currently well above our YUM! average at 150%.

But what is noteworthy is that this is down by over 100% from when we acquired them last May.

We believe team member turnover is a very important measure.

It's a leading indicator of whether the capability to improve restaurant operations is in place.

Obviously, we are encouraged by these trends, which in the people capability area I had shared with you last quarter, we have developed a promising tool that will help us identify those restaurant managers that have the skills that can run a multibrand restaurant successfully.

We believe this tool is a breakthrough.

We shared this tool last week at our US franchise summit, and our franchisees were very encouraged by what they say and we expect to see our franchisees start using this tool very soon, before the end of the year.

Third, high visibility, leadership and coaching.

For this section update, I'd like to focus on how we're really trying to build capability with our leaders and coaches.

One of the significant initiatives that we developed last year was the establishment of Ops College.

This is a one-week course where we bring in our operators to teach them about running great restaurants, and get them very involved in our ops platform.

This is the second year of the college.

We've just completed this past month our second college of the year.

We have great attendance by franchisees.

In fact, over 90% of the attendants are our franchisees.

Our last college had over 85 people.

We've augmented the week-long session with shorter classes of two-day durations.

For instance, multibranding--we've held that session twice this year and have had over 40 attendants.

We will add courses continually to our college around subjects of coaching, restaurant financials, and conflict resolution.

Fourth, Champs execution.

As most of you know -- most of you are aware of our Champs check, which measure our ability to execute cleanliness, hospitality, order accuracy, maintenance of our restaurants, product quality, and speed of service.

Our scores are based on mystery shoppers at Taco Bell and KFC.

In the case of Pizza Hut and Long John Silver, we use customer surveys from actual customers.

Last year, we finished 2002 with a Champ score of 91.

We're currently averaging 92.

This is right on target with our two-point commitment of 93 for the balance of the year.

We will finish at 93 before the end of the year.

We also have put into place a measure to look at percent of champs check at 100%.

We believe this is a very important measure for us, and for quarter to date, our percent of 100% champs checks are at 40.

This is versus a number of 34% last year

Finally, our Champs excellent review, which is our CDR, this is the comprehensive multi-hour unannounced audit that we do at each restaurant at least twice a year--front of house and back of the house.

This has been launched since 2002.

We've committed to an average of between 82% and 85% for this year.

We're currently averaging 85%.

This is a 2% improvement from where we were at the end of 2002.

We believe this is very good progress considering that these are completely unannounced.

Finally, a balanced score card.

This is a foundational tool that we use in all our restaurants across the globe.

It measures people, customers, sales and profits.

It's a great alignment tool.

We put a lot of degree of discipline and process around the balance score card.

Our commitment is to be at a grade point average of 3.25 by the end of this year.

Currently we're at an average of 3.05.

The gap is because of sales shortfall.

We're confident the back half of the year, we will achieve our target.

Before I wrap up, just one specific area of performance I'd like to give you an update on, primarily, it's what we're doing with KFC around speed of service, which is a key objective for that brand.

During the first half of 2003, KFC launched its comprehensive speed of service initiative at our national convention.

We conducted team member training and we put timers in all the company-owned restaurants.

Before the end of the year, we expect to have the majority of our franchisees follow suit.

As a direct result of this initiative, we have seen our order to delivery time improve by over 60 seconds since the beginning year at the company-owned KFC restaurants.

Overall, this target of order to delivery at KFC is still much higher than our overall goal.

We're confident we will continue to make progress against this goal.

This is the same comprehensive approach we implemented at Taco Bell about two years ago, and we've seen dramatic improvement at Taco Bell.

In fact, they continue to use the program to decrease their speed of service.

While we're happy with this progress at KFC, we recognize it's only one part of solving the brand challenge.

We will continue to push operational improvement across all categories at KFC down for the year.

Lastly, in addition to the five areas that we talk about internally, we're very honed in on our external measures.

And we recognize our internal measures are still middle to bottom tier.

We're not pleased with these rankings, but they provide us tremendous motivation to continue on our journey towards excellence.

As you can see, we've made solid progress this year.

We're on target to hit most and nearly all of our committed targets for our operational platform.

We will report to you by the end of this year.

This is a multi-year journey.

We're moving hard to get our operations at a level where they will drive sales.

Thank you, and I'll turn it back over to Dave.

Thanks, Aylwin.

Just in summary here, you know, we made our earnings commitment once again.

We're absolutely on target for our full-year earnings and cash flow commitments.

We're making progress up against our strategic initiatives, and we expect to have a stronger second half of the year.

So with that, let me turn it over to you for any questions that you have and we'll give you our best answers.

At this time, I would like to remind everyone, in order to ask a question, please press "1" on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Our first question comes from John Glass of CIBC World Markets.

Thanks.

Good morning.

I'm still trying to reconcile the earnings out performance versus your initial guidance, 2 cents of (ph) performance is I think about $9 million pretax, and understanding that your margins fell more than you expected and comps are a little below, which would roughly equate to $18 million to $20 million shortfall, where else did you improve performance besides G&A?

Or was it perhaps a case of relying on the contingency?

Hi, John.

What it was overhead.

We did have a little bit of favorability in our closed store expenses, if you look at that line item.

And we did have a share repurchase program underway to lay that through.

And as David did say, we did have very strong performance at Taco Bell and improved performance at Pizza Hut, so that helps us also.

But primarily on the cost side we talked about earlier, overhead, some closed stores, and also some repurchase of shares over time.

OK.

So in other words, more than just in the G&A line, there's been cost savings somewhere else on the P&L?

We didn't have quite as much closed store expenses as we expected, and then as we repurchase shares, obviously that helps our EPS some, and those are the three areas that really helped us out.

OK.

And then just you didn't take up your annual guidance, you confirmed a third quarter estimate.

Are you less optimistic about the fourth quarter now on a sales basis, are you being more conservative?

First of all, it's a long year, 2 cents is $10 million, on almost a billion dollar business.

We want to beat the $2 per share.

Given it's the halfway point, we want to stick with at least $2 a share, John.

And if we beat it, we'll slow it through, and if we don't, we'll hit at least $2.

We're confident about that.

But it's halfway through, we've got a long fourth quarter ahead of us, so we're continuing with our at least $2 per share guidance.

Thank you.

Our next question comes from Mitchell Speiser of Lehman Brothers.

Thanks very much.

Good morning.

You have a 3% comps target U.S. blended in the third quarter, yet it looks like your U.S. margin target is down anywhere from 75 to 90 basis points, and can you please comment or reconcile that and that and included in that, if you can give your commodity cost outlook?

Thank you.

Sure.

Thanks, Mitch.

First of all, to be specific, our U.S. blended same-store guidance is 2.7%, so we're rounding up to 3%.

Secondly, as I mentioned in my remarks, KFC has a 5 percentage point change in trend versus last year, so their lap gets far easier in periods 8 and 9, and you've seen the results at Taco Bell, and Pizza Hut.

On the margin side, what we're seeing are two or three things that are causing us some downfall in margin.

First of all, we do have a bit of an uptick in commodity costs around cheese.

We are hedged about a third of our costs in cheese, but we are seeing some increase in cheese.

Two, some of our promotions do cost us on the margin side.

I'd specifically point to our DVD promotion, Mitch, that does cost us a little bit on margins, and three, we are making investments against this business to grow sales for the long term, specifically some of our asset upgrades and also we've invested behind some of our uniforms at Taco Bell.

So we are seeing -- we do expect a stronger back half of the quarter in same-store sales growth.

We do see some margin hazards there which I talked about, which is some of the commodity costs, and also some of the investments that we are making.

We try to incorporate that in our guidance for Q3.

The other commodity costs for the most part are in pretty good shape.

Thanks, Mitch.

Next question, please.

Our next question comes from Andrew Barish of Bank of America Securities.

A question on the international guidance for the third quarter still kind of at 4 to 5.

I understand the slower start here in period 7, but is there still some reporting lag that works into that number, or are you seeing a little bit of weakness in some other areas given that China has bounced back?

Yes.

Good morning, Andrew.

What we have seen is we do have a reporting lag in our numbers, and P7 reflected some of the issues we had in China with SARS.

We do expect an uptick in international sales to get us to that 5% level, until we started out at 3 in a constant currency, you should see a nice uptick.

Having said that, we do have some markets that we're working on.

David talked about Korea, that we've got to work on.

We've got to work on our business in Thailand some.

And we've got to work on our Pizza Hut business in Australia.

So we do have some challenges that we've got to go up against, Andrew, but at the same time, I think you will see, given that we started relatively slow because of SARS, you will see an uptick back half the quarter and balance of the year.

Thanks.

Thanks, Andy.

Next question, please.

Our next question comes from Janice Meyer of Credit Suisse First Boston.

Hi.

Thank you.

I was wondering on Taco Bell, if you could flesh out a little the trends in the core business versus new products, so we can get a comfort level that the same-store sales growth is not just product-driven, but actually more sustainable?

Sure.

Janice, Taco Bell has been in the very happy position of getting nice new product upside, but also the core business has continued to perform well, transactions are up, guest check is up modestly.

And you can really see that, Janice, when we go back and we advertise against some of our core long-term products like steak tacos or other things like that.

So we're getting both the core gains and new product gains and also we're doing a good job in keeping our value ratings.

So both sides of the business are doing well.

Great.

Most of the product news on Taco Bell comes from just extensions off of our existing operating platform too, so we're really driving core products with these.

OK, thank you.

Thank you Janice.

Next question please.

Our next question comes from Coralie Witter of Goldman Sachs.

Hi, two questions, the first one is a follow-up to Andy's earlier question on international.

Could you re-quantify the SARS impact that you had from China?

Obviously it was a lot shorter in duration than your initial scenario.

So if you could talk about that on a per-share basis.

And then secondly, on KFC and Pizza Hut, if you could talk a little bit more about how much of what you're struggling with there is execution versus category because, of course, some of your competitors in both categories have not been producing the best sales numbers during this past year.

OK, first on the China scene, what we saw in China and in Asia with the SARS business was about two to three weeks of impact where sales were down somewhere between 20%, 25%, maybe 30%.

That was consistent with what we've been talking about and seeing in prior calls.

So I can't do the math in my head right now.

Maybe a point or two in overall system sales growth.

But we saw 20 to 30% down for two or three weeks in China, and in other markets too.

Regarding the category performance at Pizza Hut and KFC, I'll answer it for a second and maybe turn it over to David.

As we mentioned, we we're very happy with how Pizza Hut is doing when you look at how the results are doing at Pizza Hut, the last couple months versus our competitors and the industry, so we're quite pleased with some of the things that they have going on.

Coralie, could you mind repeating your question so I understand a little bit more what you're trying to get at?

Sure.

When you've analyzed the challenges over the past year, you've identified some execution areas, for example, KFC, you've put in the timers to improve speed of service and that's started to work.

And you've identified new product pipeline as something that you need to refill, which is also on the agenda.

But when you look at the competitive landscape, it appears that your competition both on the chicken and the pizza category, have had a very difficult year as well, and how much of that do you think is -- things that you can control versus difficulties that are just present in the category and are those difficulties more economic or is there a bigger issue with those categories?

This has always been debatable, but in the pizza category, one of the things we've always said is the biggest issue we have facing us, from a category perspective, is just consumer confidence.

It's a product category that the analysis we've done is tied very closely on how people are feeling about life.

So as that picks up, we think that will help the overall category dynamics.

But frankly, we think we had a lot of fixing to do at Pizza Hut, and I think we're starting to reap the benefits of that, and we're outperforming our competition because of it.

We now are playing much more significantly in the value game, but we're doing it on our terms.

We did it with Pizzone, bringing back to Pizzone for example is the second pizza, so you get your core pizza quality that you want and then you can get a specialty pizzas from Pizza Hut, a pizza that nobody else has, at a good price.

That was very effective for us and worked.

The DVD promotion is another way for us to do added value.

We've launched a new advertising campaign called "gather around the good stuff," which is very focused on mom being the primary purchase influencer.

We think executionally, we were focused too directly on the echo boomer versus really going up against the primary decision-maker for the pizza purchase.

So we think these things are coming into play.

We continue to make progress operationally at Pizza Hut.

Not as much as we'd like, but we're steadily moving the ball forward in terms of our measures there, and I think that's paying off.

So we feel good about where we're at on Pizza Hut.

We think we're out performing competition right now because we've fixed some of our executional weaknesses, and we expect to see continued good performance at Pizza Hut for the balance of the year.

When you look at KFC, the category has been soft recently.

There have been a lot of challenges for all of our competition.

We think our competition in many cases has grown too fast, okay, and they're having some problems with that.

But in markets like, let's say, New York, where we know competition is increased its penetration very aggressively, we have suffered a bit from just the competitive inroads that have been made there, and that's a big company market, which affects our sales.

Chicken continues to be a growth category, a protein -- the protein is popular.

People love chicken.

We don't think there's anything inherently wrong with the chicken category.

We do think that our execution has been poor.

We're not pleased with the way we have executed the brand the last six months, and we've got to get a lot better.

As we look at the balance of the year we know that KFC is our biggest challenge where we have the most work to do.

Fortunately, we have the benefit of an easy overlap.

So even as you see, you know, positive same-store sales at KFC, I don't want you thinking that we think we're satisfied with the way we have the brand positioned—where our value proposition is, where we're at with new products.

What we are doing, though, is aggressively getting after each one of those areas because we frankly think execution is a big problem at KFC.

We haven't had the advertising campaign that we ought to have, we haven't moved as quickly on the value proposition as we need to move, and while we have a lot of exciting things in test market, we think we got behind the 8 ball, and we're now trying to move forward and get a lot of testing so we can make 2004 a good year for us.

We expect the team to make progress.

We expect to get this business moving forward because we know we have the category leading brands and category that ought to grow and we expect a lot more out of KFC as we go in the future.

Our next question comes from Joe Buckley of Bear, Stearns & Company.

Thank you.

I have a couple of questions.

First on same-store sales, the guidance for the third quarter blended company comp is 3%, I think you said 2.7% to be more precise, but given a flat period 7, that kind of implies up 4 to 5 in period 8 through 9.

You're kind of talking plus 2ish or better each brand.

Just want to kind of verify the math there, I guess, on the 4 to 5 for periods 8 and 9.

The biggest thing is, I think we'll need about plus 4 the last two periods.

The biggest thing is the five-point change in trend, look at your P7, P8, P9 numbers for KFC.

That's a big part of it.

And then look at the P7 overlap versus the P8 overlap and the P9 overlap, and then look at what we are trending on Pizza Hut and Taco Bell, and that's how we get to our forecast.

You mentioned your new advertising of both Pizza Hut and KFC.

Curious what your advertising spend has been like year over year.

I know 02 was up quite a bit on the company side (inaudible) your P&L?

Just kind of curious how it's --?

We spend about the same as last year, maybe a little bit more, Joe.

We haven't done a huge uptick in advertising spend, nor have we cut back anything, so it's kind of a normal year, shall we say.

OK.

And last I think you mentioned the check at Taco Bell was up a little bit.

Just curious what you're seeing check wise at KFC and Pizza Hut?

Pizza Hut check was up some.

Taco Bell - or excuse me KFC check was up some, and then we had some transaction losses or negative transactions at KFC and Pizza Hut during the quarter.

OK.

Thank you.

Thanks, Joe.

Next question, please?

Our next question comes from Jonathan Waite of McDonald Investments.

Good morning.

Wondering on your labor initiatives, if you could give us an update on your initiative of taking a point out of the labor line?

Well, we continue to target productivity improvements in our margins.

The single biggest thing -- and if I miss anything, I'll turn it over to Aylwin too -- but the single biggest thing we focus on is our outliers, so we ask our restaurants to run their business to our labor standards where we try to get better and better and better on our outlier performance, i.e., people aren't performing up to their labor standards, each and every period.

That's where we really make significant progress.

I think the point of labor improvement was relative to the multibrand restaurants, and we're making significant progress on that target, mainly through IT efforts, outlier efforts, and we have a very renewed focus on the outlier approach in our multibrand restaurants.

So we feel like we're going to achieve that target over time.

And we also are working on the labor deployment in our multibrand restaurants too.

What's your timeline for that?

Probably by the end of this year.

We really want to set the thing up for 2004.

OK.

And then internationally, is the 150 basis points in the third quarter, is that just basically due to P7 and SARS, or is there -

There's the P7 outlook, but also I highlighted earlier some of the countries that we're trying to work through--Korea, Thailand, and our Pizza Hut business in Australia.

And not to be too defensive on margins because we're not happy where we're at, but I just want to remind everybody that in the U.S., we were up 15.8 margins, I believe, which is pretty good still when you look at versus our competition.

So I just want to highlight that also.

But that doesn't mean that we're happy with it.

We're trying to get after it, but it's the combination internationally of some of the SARS impact you're seeing in P7, but also some of the countries that we have to work on.

Thank you.

Thanks, Jonathan.

Next question, please?

Our next question comes from John Ivankoe of J.P.

Morgan Securities

Hi, thanks.

Actually, I have two questions on cost of goods sold related to both the domestic and international piece.

First, could you go through the increase in cost of goods sold in the domestic business, just kind of lay that on top of the commodity environment that you saw in the quarter and what we should expect going forward?

And secondly, in the international business, there have been four quarters of very big cost of goods sold declines.

Is that something you expect to go, going forward, and are there any mix issues there that we should be aware of?

Thanks.

First of all, on the U.S. business, John, on the cost of goods sold, they're really two or three things.

One, we did have some increases in commodities.

Two, we did have some things that we did on the marketing side that did hurt our margins, specifically, the cake promotion at KFC in period 5.

So the mix change in our business did impact margins, John, in the quarter.

Now, going forward, I did highlight the chief issue we have, which is in our forecast based on what we know today, and also we do have some higher cost product that we're considering rolling out in some of our restaurants the balance of the year.

So we will continue to see some food cost challenges in our business regarding somewhat on commodities, but also some of our marketing programs that we are doing.

Having said that, margins as a huge important part of our business and something we're managing very tightly.

Now on the international side, could you just repeat the question, John?

Yes, sure.

You've had four quarters in a row of fairly big cost of goods sold declines in your international business.

Is that something we should be concerned of lapping?

Is there continuing to be any purchasing initiatives driving that?

Yeah, we did some big structural benefits, especially regarding the supply chain in China.

I mean, when countries join the WTO, and markets open up and those kinds of things, we do get supply chain benefits because we are -- there's more competition in the marketplace and we're taking advantage of that.

So it is a leverage point for us.

We have a very big business there, and supply chain initiatives are paying off.

We think it's a structural opportunity going long term.

So that's something that continues year over year over year.

It's nothing that we need to be concerned of lapping?

No, that is not a one-timer, John.

That is something that is a long-term supply chain benefit.

Thank you.

Thanks, John.

Next question, please.

Our next question comes from Jeff Omohundro of Wachovia Capital.

Good morning.

My question relates to Taco Bell and in particular, some of your recent promotions seemed to have served to broaden the appeal of the concept, I think, to a wider audience.

I'm thinking of the chicken Cesar grilled stuffed burrito for example most recently, the product and the media supporting it.

I'm just curious what your market testing suggests on that and whether you see further opportunities?

Yeah, I think one of the things that we've really been excited about on Taco Bell is that if you think back, two and a half years ago, there was real concern that we could sell a product over 99 cents.

We still have that core value equity that is very important, but we've been able to take up the quality of our products and the price points to over $3 and have seen very, very good success.

And we think because of the power of the drive through window, the market share advantage that Taco Bell has, we're going to keep testing the bounds on how much we can take up our pricing.

We think we want to be as close to quick casual quality food as we can be, and as long as we're giving people products that they feel terrific about the overall value when you think quality plus price, I think we're moving in the right direction there.

So we see -- we're testing a lot of ways to really improve the overall product offerings at Taco Bell and the quality at Taco Bell with higher-priced items.

So it's a good 1-2 punch that we don't think we've maxed out on at this point.

Great.

Thanks.

Our next question comes from Karen Lamark of Merrill Lynch.

Good morning.

I'd like to go back to your opening remarks and get some clarity on your geographic expansion priorities.

It sounded like Europe has become of greater interest, and unless I'm mistaken, this is a change.

I wonder if you could talk about that.

Thank you.

You know, it's not a greater interest in terms of the reality of the business.

Our geographic priorities continue to be China, the UK, Mexico, and Korea.

Those are the four equity markets that we're investing in.

We have a tremendous Asian business, and that's where most of our franchise development is coming from.

As we go forward down the road, Europe is one of those areas where we hope to build a business that we can really be proud of three to five years down out.

And that's more of a longer-term issue, and I was just giving you an update of the market tour that I just recently went on.

So we have identified Holland, France, and Germany as places where we're making strategic company investments right now to build a base of company stores that will allow us to franchise down the road, and we're very early on in the process, we've been at it for a little over two and a half years, we've had some success, some failures, you know, but we're on our way to building a business there and we think it will get done.

Right now we're more optimistic about France and Holland than we are on Germany, but we'll see.

So, we've made a lot of progress, and we expect to make it happen, but our overall international priorities are the same as we've identified in the past.

Thank you.

Thanks, Karen.

Next question, please.

Our next question comes from Chuck Grieg of Atlas Capital.

Morning, guys.

Just a couple of quick questions.

On the labor front, given the lower turnover that you're experiencing, shouldn't that in some way help to offset any waiver inflation that you may encounter as we move through the balance of this year and into next year?

Secondly, guidance on fully diluted shares outstanding, and finally, when do you expect to include the Yorkshire restaurants in the comp data?

Let me try and make sure I answer all these and if I miss anything, I'll come back to you.

Basically on the labor, with turnover improving, it ends up with a higher wage base employee because we have more tenure, but there is significant savings in training, and obviously we're going to get better customer service as a result of a longer-term employee.

So I think we're going to continue to see the benefits of that pretty much on the training side that we're going to be saving.

So that's the first piece in labor there.

On the shares, we think somewhere between 304 and 308 shares.

It depends on our share price and all that kind of good stuff.

We think it's still pretty valid.

So we're okay there.

And then on the third part of the question, can you help me out again?

I missed the third one.

When do you include the Yorkshire restaurants in the comp data?

Yeah, our plan is not to include the Yorkshire restaurants in the comp data.

It's going to be primarily a multibranding place.

It's a very, very small part of our business.

Having said that, the trends in Yorkshire in the Long John Silver's restaurant have been positive.

They've been positive since we bought the business and we're very happy with it, and as Aylwin and David mentioned, we're making very good progress in multibranding especially the Long John Silver's business.

So going back to the labor, do you think you can get some leverage with the comp store sales improvement expectation?

Oh, yeah.

If we get positive same-store sales growth 2, 3 points, we will get labor leverage, there's no doubt about that.

Thanks a lot.

Very good quarter.

Thank you.

Chuck.

Next question will be our last question, please.

Our next question comes from Reza Wahab (ph) from Lehman Brothers.

Hi.

It's Bob Buttenhall (ph).

Good morning.

Could you talk a little bit about the competitive landscape and how much discounting activity you're expecting in the second half of the year?

I think the competitive landscape is competitive, ok?

I mean, we're in very competitive categories.

It's an intense category that everybody knows a lot about.

You read about it, see it every day, see it on the reader boards up and down the streets as you go home.

So, you know, we think that the discounting and price wars has been a part of this business for the last 10 years and will be a part of the next 10 years.

We don't see anything different in the second half than we see in the first half.

Thank you.

Let me kind of wrap this up and we'll close out the call.

As you look at YUM!, you think about YUM!, the commitment we made to our shareholders -- we're going to grow each year at least 10% in operating earnings per share growth.

This year, we're confident of achieving at least 10%, that 10% number, and in fact, we're ahead of it year-to-date in terms of what our forecasts were, and if we are able as David says to beat our 10% target, we'll let it flow through and we'll have an even better year, but we think if we can just keep growing this business at least 10% every year, we're going to have a hell of a company, and naturally what our goal is, and that's what we're really trying to get done.

This year, you're seeing the power of our portfolio.

Taco Bell is having a strong performance overlapping a very good year.

Pizza Hut is starting to pick up speed, and is being turned around and starting to gain strength.

And frankly, we've identified some things that we feel very good about Pizza Hut as we go on into the future that we feel strong about that brand.

KFC is our biggest single issue right now, and we're struggling at KFC, and we're on top of it, but the fact is, is we've got some work to do there.

And the good news is, we do have an easy overlap as we go into the second half of the year

When you look at our international business, we weathered a very tough first half.

We've weathered SARS, we weathered the mid-east issue, and we're still hanging in there.

We're still building the business.

We are fully on track to add 1,000 new international units this year, which is what our commitment is.

Our pipeline is good, and recall international development, 1,000 new units a year adds up to about half of our growth equation as we go into 2004.

As we go forward, the thing that we are focused on, the thing we're building this business around is executional excellence.

That's what we think is the key to our success.

We are getting tighter and tighter around our processes.

We've been at this now for over five years.

We've got the processes in place, we know how to grow this business.

The real key challenge for us is execution.

And we just had our second global management meeting, and that was the title of the event, ok, and we spent two and a half days really honing in on our processes and how we execute and really build a great restaurant company.

So we're on track to deliver everything that we said that we would deliver to our shareholders.

It's been a very challenging year for the industry.

We look for better results in the second half.

It's going to be tough, but we think we will continue to deliver and hit that 10% number.

So with that, I'll sign off, and we'll talk to you in New York and wherever we happen to see you.

OK.

Thanks.

Thanks, everyone, for joining our call.

This concludes today's YUM!

Brands conference call.

You may now disconnect.