百勝餐飲集團 (YUM) 2005 Q2 法說會逐字稿

Good morning.

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

At this time I'd like to welcome everyone to the second quarter 2005 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. [Operator instructions] Thank you.

Mr. Jerzyk, you may begin your conference.

Thank you, Marvin.

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

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

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

We are broadcasting the conference call via our Web site at www.yum.com.

Please be advised that if you do ask a question 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 will 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 the Safe Harbor statement included in our earnings release statement last night and may continue to be used while this call remains in the active portion of the Company's Web site, www.yum.com which will be until midnight Friday, July 29, 2005.

On our call today will you hear from David Novak, Chairman and CEO, and Rick Carucci, our CFO.

All will follow with remarks.

We will then take your questions.

Let me turn the call over to David Novak.

Okay.

Thanks, Tim, and good morning, everybody.

As you probably saw from our release last night we had a pretty good second quarter considering the short-term challenges in mainland China and overall we've had a very good start to the first half of 2005 generating 13% growth in EPS year-to-date.

We were obviously challenged in the second quarter due to the unexpected event in our China business with the seasoning ingredient but the portfolio performed well and enabled us to meet our prior EPS target.

We've said from the beginning that the strength of our Company is in the portfolio of leading brands in our tremendous geographical diversity.

The performance in 2005 has highlighted the power of having the YUM! portfolio.

In addition to that, we have some very smart people here who are always working hard to find ways to bring value to our shareholders.

In the second quarter our tax team did a great job in reducing the overall tax rate for the second quarter and full-year.

As we move to the second half we expect continued strength from our YUM!

Restaurants International division, the U.S. portfolio, and growing strength in the rebound of our China business.

Combined with improving commodity costs in the U.S. these expectations provide us with solid confidence we are on our way to another very good year at YUM!.

As a result, we raised our full-year EPS forecast reflecting 11% growth.

This will be our fourth straight year of double-digit EPS growth and achieving our at least 10% annual growth target.

The second quarter is a little more complicated than usual.

So let me summarize.

Excluding Poland, the tax rate and one-time legal charges we made $0.58, $0.02 better than what we said.

That's why we're taking our number up.

Going forward, the second half of the year has offsets from spending back Poland with facility actions.

So the second half core operating performance is unchanged from what we told you earlier, and remember we're now plus 11% versus 10%, and like always, we'll do better if we can.

Now I'll review what we are seeing in each of our businesses.

In mainland China the team has been moving very aggressively to remedy the issues affecting KFC sales.

We believe that sales will continue to improve over the near-term with the series of chicken-focused product news windows.

As you saw in the release yesterday, our expectation for period eight is solid double-digit growth in system sales and more chicken-focused product news follows the next several periods.

While our sales and profits for the year have obviously been impacted, and we're not totally out of the woods yet, our confidence is high because trends continue to improve.

As a matter of fact, we are still on track to add 375 new restaurants in the China division this year and expect similar growth in 2006.

Our development plans for new KFC restaurants continue because returns are so strong and sales are rebounding.

We also now have 180 Pizza Hut casual dining locations in China.

Clearly the leader in the category, and we're expanding units at better than a 20% rate.

System sales growth for Pizza Hut China is running solidly north of 30% year-to-date.

We have opened two additional versions of our Chinese fast-food restaurant called East Donny.

Initial customer response to the food and facility is very good and we are optimistic about its mainstream appeal.

Obviously it's early days.

We will continue to make some improvements as we build a few more restaurants over the next several months but we're very optimistic.

The team is also making good progress with the Pizza Hut home service concept to capitalize on the convenience of the delivery occasion.

We already have 18 locations and this concept is totally separate from the Pizza Hut casual dining concept.

More of these will open later this year, and we will be entering new cities with Pizza Hut home service units.

Finally, we continue to invest in China infrastructure and G&A and people capability given our unique market position and unparalleled opportunities.

You can count on us to continue to aggressively execute our number one growth strategy to build a portfolio of dominant restaurant brands in China.

Now on to our YUM!

Restaurants International division, or YRI.

We are very pleased to see strong performances across our International businesses.

We achieved 6% growth in system sales, local currency basis for Q2, and 7% year-to-date.

As a reminder our target is at least 5%.

We're exceeding the target, and as a result, we expect YRI's full-year profit growth to be at the high end of our target range of 10 to 15%.

We included further details in the release yesterday about YRI's results, and Rick will have some additional comments coming up.

I'd like to give you my perspective on the longer term outlook for this business.

The big picture, of course, on YUM!

Restaurants International is all about building new KFC and Pizza Hut restaurants around the world.

In many cases, these are markets with little or no competition in chicken, fast-food restaurants or casual dining.

For the sixth straight year, we expect to open over 700 new system restaurants in our YUM!

Restaurants International division.

The key is, we are doing this in a steady manner, expanding about 3% a year, growing same store sales, and doing it all with high returns.

Given the number of countries where we operate today, our infrastructure in place, and nearly 600 franchise partners, our confidence is high we can keep doing this for many years to come.

We opened new restaurants in over 60 countries last year.

We have significant big businesses in countries such as the U.K., Australia, Mexico, South Korea, Indonesia, Philippines, Malaysia, South Africa, and the Middle East to name quite a few.

Importantly, in addition to China, we're opening up and developing new high population emerging mega markets like India and Russia.

In India, we have over 100 Pizza Huts already opened doing well for our franchisees and we are in rapid growth mode.

We expect to have about 125 Pizza Huts in about 30 cities by year-end.

Over the past two years the KFC brand is also showing great progress and we're beginning to invest Company equity there behind the KFC brand.

We've retooled the menu to include our world famous chicken recipes and a vegetarian menu to broaden the field.

Currently, we have eight franchise KFC restaurants in India and expect to end the year with about 14 KFCs across six cities.

Interestingly, our local team and our franchisees see KFC as a bigger potential opportunity than Pizza Hut based on initial and higher volumes at KFC.

Unit level profitability is already there for both brands without the advantage of major scale.

We're excited is about continuing to expand both Pizza Hut and KFC brands in this developing mega market.

You also may have seen that we recently completed a transaction in Russia to expand KFC.

A few weeks ago I was in Russia to finalize the deal with our new partner, (Rostick’s) the leading chicken chain in Russia.

This was an excellent deal, and I'd like to give particular credit to this to Graham Allan and the YRI European team, as well as our CFO, Rick Carucci, who crafted a very creative and prudent way to enter this important developing market.

The key is, we acquired excellent local operating capability with our partner, Rostick's, and we have the opportunity to buy this business in five years if all goes well.

Importantly, we will know exactly what we're buying.

In a country that is challenging to enter for any U.S. company, we really love this deal with Rostick's, the leading chicken fast-food brand in Russia.

We think it's a breakthrough business alliance.

Rostick's brings tremendous local operating capability and will combine the KFC brand with Rostick's under one roof.

The KFC brand will be represented in nearly 100 locations in Russia as a result of this alliance.

This gives us immediate scale.

As a reference point for other developing mega markets, it took us about ten years to get to this level of scale in India and China.

What's really interesting about this alliance of KFC and Rostick's is that it's very similar to the way the Colonel originally established the KFC brand in the U.S.

KFC chicken was featured in the restaurants of our original franchisees such as Harmon's restaurants in the western U.S. and Kenny King's restaurants in Cleveland.

Now we're using the same kind of creativity and ingenuity to get started in Russia with signings that says Rostick's, featuring KFC's World-Famous Original Recipe.

Stepping back for just a moment, when you combine this opportunity in Russia with the significant business we are building in mainland China, and the investments we are making in India, YUM! has a huge opportunity to create really big businesses.

Our target is to be the leader with multiple brands in each of these emerging mega markets.

We're already there in China and on our way in India and Russia.

Another major strategic initiative we have is to develop the KFC brand in continental Europe, where there are obviously lots of people, but unfortunately at this point in time, very few KFC restaurants.

We've put Company equity in Germany, Netherlands, and France.

Our early efforts in Germany have struggled.

In the Netherlands we are in the process of testing national TV advertising which is showing early promise.

The really good news is that France is emerging as what looks to be our biggest opportunity in Western Europe.

It's early days in France for us.

We have only 30 KFC's open in France and the results look very promising.

Customer acceptance has been outstanding.

We already have some very high volumes in some of the KFC's we have opened.

Some of the highest in the world.

For example, I just met with our team in France and I visited with one of our franchisees who just opened a new KFC doing about 80,000 euros per week.

Yes, that's 80,000 euros per week.

That same franchisee has three other KFC's averaging over 50,000 euros per week in the suburbs of Paris.

Just as a reference, our KFC U.S. average volumes would be about 14 to 15,000 euros per week.

We are bullish on our business opportunity in France and are moving full steam ahead.

To put the overall European opportunity in perspective in these three big markets, McDonald's has over 2500 restaurants in Germany, Netherlands, and France.

We have only 98 KFCs, so clearly the opportunity is there.

When I was in France, I also had an opportunity to meet with many of our leaders from across Europe, the Middle East, and Pakistan, who attended my Taking People With You leadership program.

I'm pleased to report that the enthusiasm for our International opportunities is high across the board.

Hopefully, you can hear that we have never been more excited and bullish about the continued growth of YUM!

Restaurants International.

Now on to the U.S. business, where we continue to focus on improving operations and marketing innovation.

First, some perspective on Taco Bell.

In Q2 Taco Bell delivered outstanding results again with 5% same store sales growth.

Taco Bell remains one of the best, most consistent QSR brand performers over the last few years.

For those of you who haven't tried it yet, the newest creative innovation by the Taco Bell team, the Crunchwrap, is a great product for the fast-food lover.

It offers abundance, flavors, great value, and is good to go.

Clearly it drove the strong performance in period seven which we reported yesterday.

We expect continued solid performance by Taco Bell for the balance of the year.

We're especially pleased that Taco Bell's new product pipeline is full with tested programs ready to go for 2006.

In fact, the team is already working on ideas for innovation in 2007.

Importantly, the Taco Bell brand is stronger and bigger than ever.

Now on to Pizza Hut.

In total, Q2 was another good one at Pizza Hut.

Our eighth straight quarter of positive same store sales.

In fact, Pizza Hut grew same store sales 2%.

This lapped a strong year ago quarter with 5% growth.

However, we were disappointed with Pizza Hut's same store sales decline of 2% in period seven even though it lapped a strong 6% last year.

We expect roughly similar performance for the rest of the third quarter at Pizza Hut as we lap solid performance of plus 5%.

We see this as a short-term bump in the road.

We are confident that the Pizza Hut team is executing a winning long-term strategy and our leadership team is excellent.

We always have acknowledged that the pizza category is our most competitive, and frankly, our competitors are doing a better job so far this quarter.

Nevertheless, we expect to win more than we lose in this competitive category, and we look for momentum to improve at Pizza Hut with more marketing excitement coming up in the fourth quarter.

Now on to KFC in the U.S.

We are very pleased that KFC U.S. has continued to turn the corner.

We now have eight straight periods of positive same store sales growth.

There are several factors we thank for the beginning of a turnaround at KFC.

First, we are focusing on our core customers by proudly marketing and introducing our great fried chicken products.

Second, we are building new sales layers for both individual and family occasions.

The 99-cent Snacker brought us tremendous incremental individual eater occasion business and the Variety Bucket is a great way to reinvigorate our dinner business.

Importantly, we are advertising and marketing both our dinner business and individual eater products at the same time, which is building sustainability for the different eating occasions and the customer access to KFC.

Finally, we are continuing to make steady improvement in operations but believe me, we know we have much more work to do there.

The team's focus at KFC is on sustainable results, and we are already putting plans in place to overlap the obviously much improved year in 2005.

But you do see the power of the KFC brand when we do chicken right.

When you look at our entire U.S. portfolio, as you know, our blended same store sales target is to be up about at least 1 to 2%.

We were up 4% in Q1 and 5% in Q2, so we're clearly ahead of our plan and headed for another good year.

We also continue to make progress pursuing what we think is a breakthrough strategy in our industry, multibranding great brands in the U.S.

In Q2 we passed the 2800 mark in number of U.S. multibrand units, representing over 15% of the U.S. system.

For all of 2005, we continue to expect to add 550 multibrand units.

We are as bullish as ever on the prospects for multibranding and its ability to improve average unit volumes.

This past quarter we had a U.S. summit to focus on our long-term development opportunities.

Given the strength of the Taco Bell brand, and our capability to multibrand, we are confident we will be able to grow net new units in the U.S. beginning in 2007.

To put it into perspective, in the U.S. we have only 5,000 traditional Taco Bells and 5400 KFCs.

McDonald's has almost 14,000 units averaging 1.9 million in volume.

Clearly, we have the long-term opportunity to leverage our great brands.

And building same store sales and average unit volumes will be the key to future new unit development.

I'm very pleased with the progress we're making in making that happen.

Last but not least, the power of our global portfolio of leading restaurant brands makes us not your ordinary restaurant company, and a cash generating machine.

This year we will generate a record of $1.3 billion in cash from operating activities, while investing over 700 million in growing and maintaining our brands around the world.

Additionally, we are pleased to have one of the best returns on invested capital in the restaurant industry at 18%.

We've proven that we know how to invest new capital at the right returns.

At the same time, we continue to build a stronger balance sheet, buy back our own stock at record levels, and pay a meaningful dividend that we just increased by 15%.

We will continue to build value by executing the unique global growth opportunities that differentiate us from the competition and make us not your ordinary restaurant company.

Specifically, we will focus on our four key strategies.

Building dominant restaurant brands in China, driving profitable international expansion in the rest of the world, improving restaurant operations, and multibranding category leading brands.

Our ongoing goal is to increase our earnings per share at least 10% each year, and as we said, you can expect at least 11% earnings per share growth in 2005.

This will be our fourth consecutive year of solid double-digit EPS growth.

Let me now turn the call over to Rick Carucci, our CFO, for more details on Q2 and our outlook for the year.

Rick.

Thank you, David, and good morning, everyone.

I'm going to discuss several items this morning.

First, I will provide a brief second quarter review.

Second, I will share some perspective on our new higher full-year 2005 outlook and why I'm confident we will meet our forecast for 11% EPS growth.

I will also briefly review the outlook for the third quarter.

The third quarter includes additional facility action spending which we mentioned we would consider in conjunction with the Poland/Czech IPO.

Finally, I will provide a quick summary of our cash flow expectations and reiterate our plans for this cash flow.

Let me begin with the Q2 review.

We came in with EPS of $0.62 for the quarter, or 12% growth.

As you may have remembered our guidance last quarter was $0.56 for the quarter.

Our actual results were based on several factors.

First on the business side.

U.S. sales ended the quarter very strongly, as David mentioned.

Second, our International division ended up with very strong results with operating profit of 16% excluding 4X upside.

Also, our China division's Q2 profit performance was better than expected.

The China division profits declined by 10 million versus last year.

This was obviously below our target growth rate of at least 20%, but our last earnings release we expected our China division Q2 profit to be 20 to 25 million below our 25% growth target.

But when you do the math our actual performance was actually a few million dollars better than we expected.

On the financial side, three key items occurred.

The IPO of our Poland/Czech Republic franchise business was completed, our tax rate was lower than previously expected, and we incurred incremental legal charges of about $13 million, or $0.03 per share.

All in this resulted in an EPS of $0.62 for the quarter.

As David mentioned, excluding the three financial items I just discussed, EPS would have been $0.58 for the quarter.

Now let's talk a little more about U.S. and YRI performance.

For the U.S., Q2 for each of our three leading brands continued to be strong.

Strong sales in the U.S. were offset by higher facility actions expense year-over-year, and slightly higher commodity costs.

For the U.S. operating profit was up slightly versus last year, excluding the impact of the incremental facility action.

Our International division, YRI, had a very good quarter with 16% increase in operating profit prior to currency impact, and 22% in U.S. dollars.

This includes 5 million of benefit from foreign currency translation in the quarter.

Most of our International business units contributed higher profit growth.

Growth was led by our Mexico company market and our franchise-only businesses around the world.

Our franchise-only businesses represent about 40% of YRI division profit.

These businesses, which require no investment on our part, grew system sales by 5%, revenue by 13%, and profit by 20%.

This growth was led by our franchise performance in Asia, Middle East, and Southern Africa.

The only significant YRI market with profit weakness in Q2 was our Pizza Hut South Korea company equity market.

Now let's talk about the full-year.

Before I get into the details of the full-year numbers I thought I would share some personal thoughts of where we are versus this same time last year.

We are a bit stronger on the business side.

The China recovery is taking a little longer than I would have liked but from a profit standpoint, this downside is mitigated by the supplier recovery that we mentioned in the earnings release.

We had another quarter of very strong U.S. sales as well as a strong key seven.

Our International business, as I just discussed, had another great quarter.

On the financial side for the full-year, we've had a very strong Q2, which has allowed us to lower our full-year tax rate.

For the full-year this is partially offset by the legal charge of $13 million.

Overall versus this time last quarter, we are in a stronger position on the business side and the financial side, and this is why we were able to increase our full-year guidance by $0.02.

The Poland IPO does not really impact our full-year numbers.

As we have consistently stated we plan to spend back the upside from this transaction.

The transaction does impact our quarterly breakdown as the upside occurred in Q2 while the spend-back will occur during the balance of the year.

Overall, 2005 we expect to be a successful financial year for our shareholders because we expect to deliver the following.

A fourth consecutive year of double-digit EPS growth prior to special items, another record year of cash flow from operations with even more free cash available than last year, record amounts of cash returned to shareholders.

Now let's look at full-year 2005 expectations in more detail.

We currently plan to deliver at least 11% EPS growth, which is above our previous expectation.

So the question is why am I confident we will deliver another year with double-digit EPS growth.

There are four main reasons.

First, our International division is as strong as ever and we expect we'll deliver a terrific full-year profit performance at the high end of our target range.

We also expect U.S. sales to result in better profit performance in the second half with commodities no longer expected to be an issue.

As I mentioned on our last call, we are well positioned in mainland China when sales do rebound.

Well, sales are on the way back.

And fourth, for the full-year we expect our tax rate will be about one point better than previously thought.

Now let me go through these one by one.

Our first reason for confidence in the YRI sales and new unit development are as strong as ever.

Year-to-date system sales of 7% in local currency exceeded our ongoing target of at least 5%.

Unit growth is a plus 3% and same store sales are solidly positive.

We are also seeing strong growth in the majority of our markets.

Our number one market, the U.K. has been slightly disappointing performance so far this year with slightly negative same store sales in a difficult retail environment.

Mexico though, is having a very strong sales and profit growth year after struggling the past few years.

Importantly, our franchise-only markets are solidly positive in same store sales while generating good unit growth at the same time.

As mentioned earlier, we are having especially strong results in the Middle East, Southern Africa, and Asia.

We expect another strong year of new store development in International.

Overall this will be our sixth year in a row of more than 700 new restaurant openings for YRI.

Two examples of this growth.

In the U.K., although we have soft sales, we're continuing to expand at a healthy rate and expect to open more than 100 restaurants this year.

We also again plan to open over 200 franchise new units in Asia.

This includes unit growth in key countries such as Indonesia, Philippines, and Malaysia.

Importantly, we expect operating profit from our International division to be at the high end of our plus 10 to plus 15% target in 2005.

Our YRI division is simply having a very solid year.

Our second reason for confidence is we expect to deliver better U.S. profit performance in the second half of 2005 due to solid sales growth and a vastly improved commodity picture.

We are consistently growing blended U.S. same store sales above our target of plus 1 to plus 2% growth.

We lapped last year's solid Q1 and Q2 blended U.S. same store sales growth with solid performance this year plus 4% in Q1 and plus 5% in Q2.

This is our best back-to-back performance in well over five years.

We expect this continued solid sales performance to translate into stronger balance of the year profitability.

Year-over-year commodity costs are expected to be a non-factor for the balance of the year.

In fact, for the fourth quarter, we may even see some slight upside in commodity costs versus 2004.

Higher facility actions expense, balance of year, may somewhat mask the U.S. performance.

These higher facility action expenses are what we had considered as an option pending the successful completion of the Poland/Czech IPO.

These expenses would relate to closures of underperforming restaurants and refranchising restaurants not meeting our return requirements.

These actions would impact our KFC U.S. business as well as our other businesses around the world.

Now, the third reason I'm confident is that we still have an awesome China division business.

China's profit growth is largely driven by new unit growth, and that new unit growth continues.

The China division already opened 168 new units year-to-date.

We expect to build at least 375 new units for the full-year.

We are well on our way to at least 20% unit growth for the full-year 2005.

Furthermore, as noted in our release last night, we expect partial financial recovery from our mainland China seasoning supplier to cover shortfalls in profit relating to this issue.

As I mentioned earlier, my fourth reason for confidence is that our full-year tax rate will be about one full percentage point lower for the full-year.

This is a result of favorable adjustments related to the settlement of regular audit cycles.

It is important to note that this new expected lower tax rate includes about $9 million of additional tax related to the American Jobs Creation Act.

We have increased our expected repatriation of foreign earnings to about $500 million.

Over the long run, this will save our shareholders over $100 million in taxes.

Just to be clear, our upside from favorable audit resolutions have allowed us to lower our full-year tax rate despite 2005 higher costs associated with repatriated funds related to the American Jobs Creation Act.

For the full-year, for the reasons we just outlined, we are delivering a higher full-year level despite our KFC mainland China softness in Q2.

We are fortunate to have a portfolio of brands and geographic diversity which allows us to offset short-term issues.

Similar to what you have seen from YUM! in the past, in 2005 we expect to again deliver solid growth despite some challenges in parts of our business.

Now moving to the Q3 forecast.

For the third quarter, we expect EPS of $0.70 per share prior to special items.

Negative same store sales at KFC restaurants in mainland China are included in this forecast but substantially improved from Q2.

We will book about 13 million in financial recoveries from our supplier in China related to the red dye issue, and Q3, and this recovery will partially offset the below target sales performance.

We expect our International division to continue to perform well.

Additionally, we expect about 3 to $4 million in benefit from foreign currency conversion.

As discussed, we plan to invest back the gains from the successful completion of the Poland IPO in the balance of 2005.

We expect some of these actions to occur in Q3.

You'll note in the release last night that the third quarter got off to a very good start with solid period seven sales results for the U.S. portfolio plus 5%.

We expect that Taco Bell and KFC will continue to lead the U.S. performance for the third quarter.

As always, you can track our progress during the quarter as we provide you with the International division, China division, and U.S. sales updates every four-week period.

If our expectations change, you will definitely hear from us, as you have in the past.

Before I talk about our cash flow, I want to let you know we are considering whether to begin expensing options, adopting FAS 123 in either Q4 of 2005, or Q1 2006.

We'll have a final decision communicated in our Q3 earnings release scheduled for October 4th.

We estimate that expensing our stock options will have a cost of approximately $0.11 to $0.12 per share.

My last topic today is a very good news topic, which is a review of our cash flow generation.

We expect a record of 1.3 billion in net cash provided by operating activities.

We expect 720 million in capital spending, so free cash flow will be substantial again this year, nearly 600 million, a new record.

In addition, we'll generate an additional 100 million from refranchising, at least 170 million in employee stock option proceeds, and about 80 million from sales of surplus property and equipment and other items including cash from the Poland/Czech IPO.

When you add that up, that's well over 900 million in available funds.

Consistent with our previously stated approach, we expect to deliver most of this substantial cash back to our shareholders.

For 2005 you should expect at least 600 million devoted to our share repurchases.

We already have purchased 489 million year-to-date.

We have just completed our first full-year of paying regular quarterly dividends.

We have recently increased the dividend rate by 5%.

Our annual dividend rate is now $0.46 per share, which is within our planned payout range of 15 to 20%.

Over the next three years, we expect to see growing levels of cash flow.

In addition, our balance sheet continues to strengthen and our key financial ratios continue to improve.

As a quick wrap-up, we had a very solid first half with 13% EPS growth.

We have raised our full-year EPS forecast, expect to have double-digit EPS growth for the fourth year in a row.

Finally, we expect another very strong cash flow year and expect to return the bulk of this cash to shareholders.

Back to you, David.

Thank you very much, Rick.

We've had a very solid first half of the year and expect to finish up at least 11% EPS growth for the full-year.

China sales are improving and new unit openings are on track.

YRI is having an excellent year.

Our U.S. blended same store sales are ahead of target with a much better outlook on commodities in the U.S. going forward.

We're buying back stock at record levels and just increased our dividend.

And while we have our challenge, like any major company would, things are looking very good at YUM!

Brands.

So with that, we'll open it up for any questions that you may have.

[Operator instructions] Our first question comes from John Glass with CIBC.

Thanks.

Good morning.

Could you maybe talk about your reference in China this quarter to rebuild sales?

Specifically addressing issues, have you used discounting for example, and maybe how your chicken versus non-chicken mix has progressed?

I noted you used a non-chicken promotion early on and you've recently switched back to chicken.

We really haven't done any major significant discounting this last period.

We've gone back to what works best in our category and that's product news.

We introduced a Chicken Kabab product there that's doing very well, along with a new juice drink, a 9-Lives juice drink that is also driving consumption on the beverage side.

So it's more of doing what we know works best.

The mix is virtually almost all chicken.

And just to follow-up.

Is there still a geographic skew?

Is it in the cities where the contamination issue occurred that the sales are weak or is it really across the country?

Sales had dropped originally throughout the country a little stronger in what we call the second tier markets.

Not the Beijing and Shanghai markets, which were a little more sophisticated, but in those other markets.

The recovery has been pretty consistent across the board.

A little bit more in places that were down more.

Just to build on David's point about the chicken promotions.

We just were on chicken promotion, but our next several months we also plan to feature chicken as the major part of the menu, and we think that hopefully will have a positive effect.

Thank you.

Thanks, John.

Next question, please, Marvin.

Our next question comes from David Palmer with UBS.

Hi, guys.

I guess two questions here.

First, your Company ownership of your restaurants in the U.S. is higher than some chains out there.

Perhaps you can give us your view about just kind of big picture stuff here, about the right mix of Company and franchise ownership, and if it's, for instance, you know, 15% Company-owned, if that's better than 20 to 25% Company-owned, why not even go lower and maybe go to 100% franchise business model?

Maybe you can give us a conceptual overview there, you know, capital versus business.

And second, your U.K. same store sales were declining in the quarter, trends seemed to be worsening a bit there.

Perhaps you can give us some insights into that market.

Thanks very much.

Well, just talking about the franchising strategy for a second, just back me up in terms of how we look at it.

You know, when we were spun off from Pepsico, I think we had about close to 40% ownership of Company restaurants and we said that we would move towards 20% ownership.

Right now we're at about 25% Company ownership but we've had basically a two-pronged strategy.

One is that we identified the restaurants that we wanted to own that they had to earn above the cost of capital, and we've put steady pressure on our operators to earn the right to own those restaurants.

So, you know, the restaurants that we run today are earning above the cost of capital and are the best return for our shareholders.

We have no aversion whatsoever to taking that number down.

That number could be 18%, it could be 21%.

You know, we're not hung up on a specific percentage, but we are hung up on making sure that our shareholders get a good return from whatever we own.

The second thing that we really believe is, is that in large-scale markets you need to own enough of the business to lead the business.

And, you know, like in the United States, we think we need to own 20% minimally to be able to have enough, be in enough markets to control our destiny in terms of being able to have test markets, and also really understand the business deeply enough to show an empathy that our franchisees appreciate.

So we've kind of had a two-prong strategy.

Earn the right to own, make sure we deliver our shareholders great returns with what we own, and then we also, secondarily, we want to own enough of the system so that we can lead the system as we go forward.

We continually look at our ownership strategy.

And like I said before, we're not, there's nothing magic about 25% but we do think anywhere from that 15 to 25% range is right for us, and I think that will probably shift over time.

Why don't I address the U.K. question, David?

The U.K. business does have weak macros, and our sales have been soft.

With the recent bombing, our first concern, obviously, was for our employees, and we were fortunate that none of our employees were hurt.

That has impacted our central city business although that's not a huge part of either our Pizza Hut or KFC businesses.

Overall, in terms of the U.K. trends, just first of all a historical perspective.

We've been growing about 100 units a year for the last four or five years so that's been a business that we've quite a bit of unit growth when you look at KFC and Pizza Hut together.

During that period of time, while we've been growing a lot of units we've also been able to get, although it varies from year to year, as I'd say in the, you know, about 3% type of same store sales growth.

So we think in the long-term that's sort of what we'll still be targeting.

So for the balance of year, we think we have some promotions that are hopefully a little stronger than what we've had year-to-date, but our long-term perspective on that business is still very solid.

Thank you very much.

Thanks, David.

Marvin, next question, please.

Our next question comes from Joe Buckley with Bear Stearns.

Thank you.

A couple questions.

Question on the U.S. margins and profit performance in the second quarter.

Food costs actually look like they were flat year-over-year.

You did a 3% blended comp, but you had pressure on the occupancy and other operating expense line.

Just kind of curious what drove that pressure to restrain the profits there?

Okay.

In terms of, let me talk about second quarter and then sort of first half/second half type profits, Joe.

You're right, in the second quarter our profits were actually slightly down.

That was driven by several things.

One, commodities were better than the first quarter but they were still down year-over-year.

Secondly, we had increased closure of impairments of about $10 million.

And third, we had a G&A increase of $6 million, about half of which was timing and about half of which were legal costs at Pizza Hut.

If you adjusted for these items, the U.S. growth would have been about plus 5%.

If you just look at the first half and second half, that, we think, will be mostly driven by commodities.

And when you add up the commodities in the first and second half we're down in the 25 to 30 million range and the balance of the year we expect that to be flat.

So before facility actions in the back half of the year, we expect profit growth in the U.S. to be, you know, about 8%, including the 53rd week, and about 5 or 6% without it.

Joe, this is Tim Jerzyk.

Specifically on the occupancy and other, I think you mentioned, we did have some start-up costs related to WingStreet as we're expanding that pretty rapidly at Pizza Hut in the U.S.

Just a year-over-year comparison we had higher utility costs and there were some additional advertising year-over-year.

Those are the three main factors.

Okay.

How about with utilities, Tim?

Was that a big factor in that mix?

No, there was not really anything that was significant.

They were all about equal, and they were all in the 10 to 20 basis point range.

Okay.

And then a question on Pizza Hut.

Sounds like you're conceding for the rest of the quarter, and I guess I'm curious why.

I mean it seems like the pizza category is pretty strong.

Is it the product lineup this quarter that you're uncomfortable with?

And maybe while you're addressing Pizza Hut, just talk about WingStreet and whether WingStreet is still adding nicely to the average sales.

WingStreet we continue to expand and it basically adds about a point to the same store sales growth at Pizza Hut, given where we're at in the current mix of assets.

Regarding Pizza Hut, you know, our first period was soft, we're just forecasting the similar kind of performance until we get into the fourth quarter where we think we have some more exciting news.

If we do better, that will be good news.

Okay.

And then just a question on China.

David, I think you mentioned the China division expansion numbers for '06 would be about the same, about 375 units, about the same as '05.

And I guess I'm curious if that's been influenced at all by the dye-related problems or if that was kind of the game plan all along?

We thought you might go higher.

I think I said at least the same.

I think the important thing for this year is, and we haven't finalized our plans, and we have our annual operating plan will be coming up in late September, but we're moving full scale ahead, speed ahead, in terms of finding locations and laying the track, just like we have said in the past.

This year, in spite of the hiccup that we had, we're still going to open up the projected number that we saw, and the business is very strong.

So we'll do, you know, nothing has changed that would change our current outlook for new unit development in China.

Thank you.

Thanks, Joe.

Marvin, next question, please.

Our next question comes from Dan Perlo with Iridian Asset Management.

Hi, guys.

Good morning.

I'm just wondering, you made some very nice progress in terms of reducing the share base.

I mean part of that was more dollars committed to share repurchase in the second quarter and you seem to be running at even higher levels as you said, but with less, what I believe is less options dilution going forward.

Can you give us some kind of is long-term, I shouldn't say long-term target, but let's say target for the next year or two for how far you think you can reduce the share base, the fully diluted share base?

We haven't worked out our detail plans over the next couple of years but our philosophy has been that so far we think buying back shares has been our best use of our extra cash.

We generate a lot of cash.

Our debt is now at levels that we feel very comfortable with that we don't need to pay down further.

So when we've looked at it historically, we've always felt that was our best use of cash.

So I think that using 2005 as a general basis going forward wouldn't be a bad assumption but we haven't made those detailed plans yet.

But is it possible we could see over the next couple of years actual reduction on a fully diluted base?

Well, there will be a reduction this year.

So I think to Rick's point, you know, you could use for now, use some assumptions in that whole equation, but there is a reduction in '05 versus '04, and I think based on what Rick said, just use '05 as kind of a basis for going forward.

Okay.

Thanks.

Thanks, Dan.

Marvin, next question, please.

Our next question comes from Larry Miller with Prudential.

Yeah, hi, guys.

Thanks very much.

Just want to follow-up a little bit on Joe's question, maybe a different angle.

David, could you share with us your thoughts philosophically on pricing at Pizza Hut if cheese costs fall?

And then just to dimensionalize, maybe, Rick, you could dimensionalize the commodity costs outlook.

It sounds, you know, [like] Joe said it was flat this quarter, you're kind of expecting some improvement in the fourth quarter.

What are the moving parts to that business?

Cheese costs coming down, are beef costs still up?

In terms of commodities it's basically what's going away is chicken inflation in the first half, it goes from inflation to in the second half basically being flat to maybe slightly down hopefully.

Cheese will be, cheese costs will be, hopefully, deflationary in the second half.

The primary inflationary factor will be beef and a little bit of pork.

I think in terms of pizza pricing, as you know, it's a very, very competitive category.

I'm not going to give our pricing plans out on the airwaves here, but I think, you know, we take price appropriately when it makes sense.

We try to do it in a targeted fashion, and I think the name and the game in the category, if you just look at the dynamics of what's going on, is building your guest check.

Making customers feel better about spending more money at each of the respective brands.

So guest checks are actually going up, but I think customers are feeling pretty good about it because they're getting good value by getting more and more bulk pizza.

So is it fair to say that you'd be considering, along those same strategies, the premium pizzas rather than lowering check average?

We have a combination of, our big thing is product innovation.

That's our primary strategy, versus discounting.

Death in the category is discounting your core pizzas.

I mean, what you want to try to do is bundle up your meals so that you get your guest check higher so your penny profit per transaction is higher.

But just taking price reductions off your core pizza is pretty stupid.

Thanks, guys.

Thanks, Larry.

Marvin, next question.

Our next question comes from Howard Penney with Friedman, Billings, Ramsey.

The magnitude of the facility actions in the fourth quarter I thought I heard you say that you would be spending the extra week in addition to the 17 million that you got on the gain.

Can you just clarify that?

And then, how did you determine what the appropriate level of compensation was from your Chinese supplier?

Okay.

I'll probably take both of those questions.

The way I sort of think of the spend-back is we've had two big one-time upsides this year that we probably can't replicate over the next couple of years.

One is the 53rd fiscal week that you referred to, which this in 2005 we have an extra week in our fiscal calendar.

And the second was the Poland IPO proceeds, the benefit we got from those.

Together, those were $32 million of upside.

What we're doing with that money is two things.

One is, we have that to help cover the downsides we've had in China.

And then secondly, we've, you know, we're using that mostly on facility actions and other spending opportunities.

So yes, you know, in total, we're spending both of that net of what we can afford to spend from the business side.

On the supplier issue, we can't get into the discussion of exactly how that works, so we could just give guidelines.

And we gave the guideline for Q3.

What we can say is it was based on a partial recovery of the total part of the business.

So we're certainly not going to make money on this transaction, but we're trying to get back what we can.

So the, I'm just, to understand your question, answer to your question.

The $32 million, you're going to be spending all of that, and you said something at the end.

Net of, what is it net of?

Obviously all the money comes together.

The money is somewhat fungible.

We're looking at, we're going to obviously deliver on our profit commitments and then to the extent that we have the opportunity, we're going to spend-back on facility actions and other opportunities in our business.

So basically we're going to grow the core business like we said we're going to grow the core business, and we're going to strengthen our business for the long-term by spending-back appropriately.

So, again, just to hit your EPS targets is what you mean?

No.

We're going to hit our EPS target and then we're going to spend-back against the business appropriately.

We've got $32 million that we want to spend-back against the business, and we're going to hit our EPS target the way we said we're going to hit it, and already when you look at that, we're up 11% versus 10%.

We have, Howard, we have, as you noted in our release last night in the guidance for the full-year we gave you the facility actions piece for the year which said 50 to 55 million in closures and impairment.

And about the same number of refranchise gains year-over-year.

We did say, however, that subject to additional reviews that guidance could go up.

We just are not far enough along.

It's definitely a much more detailed process than you would think, maybe just looking at this thing on the surface but it involves refranchise transactions, and it's, you know, closures and impairment.

There's a lot of significant level of detail and reviews in that.

And that's why we tried to give you some indication in that guidance that just pending reviews, that number could go up.

Thank you.

Thanks, Howard.

Marvin, next question, please.

One thing I wanted to clarify, we're not looking at the facility actions or the additional dollars here to get our number, which was the inference on your comment.

Okay?

Marvin, next question, please.

Our next question comes from Steven Kron with Goldman Sachs.

Great.

Thanks.

Good morning.

I have two questions, the first one's a follow-up on the U.K. business.

Clearly it's been a unit growth story there over comps, and you're clearly committed to continuing growing units.

But can you talk a little bit about what would you need to see in that business from a comp perspective before you might pull back on unit growth and maybe allocate more resources to existing store profitability?

That's my first question.

And the second one relates to China.

Last quarter you talked about kind of the labor environment in China tightening a bit.

And while I know your supplier issue didn't change the development schedule at all, I think, David, in the past you've mentioned a risk that you see in China might be development outpacing people capabilities.

So I was wondering whether any of the negative publicity out there has disrupted your ability to attract employees?

Did you have to change any of your recruitment tactics or comp incentives at all?

We have not seen any impact on our ability to attract employees.

Our brands are big, our Company is very well respected in China.

I think frankly, the way we handled this incident has built a lot of credibility with everybody involved there.

So I think in times like these, you can go forward or backward.

We think we're going forward with more strength across the board, because of the way and the manner and the honesty and we've handled the entire issue.

So, you know, I think as for as labor goes, in terms of cost, I think over the long-term there will be some pressure on that side.

But we haven't seen anything over the last quarter that would say it's been exacerbated in any way.

And our jobs are still highly desirable, and our teams very, very motivated.

On your U.K. question, we have a very diligent process within International of reviewing new unit development.

They have quarterly reviews of what the performance is, and we have twice a year very detailed reviews where they look at the performance, not just of the overall country, but segments within that country.

Right now, we're not expecting long-term declines in our same store sales in the U.K.

So unless we change that expectation, we'd expect development to occur at roughly the pace it's been occurring.

I think the important point here, just to reiterate what Rick's saying is, we don't go forward with any country and any brand in any part of the world with a, this is the way it's always going to be, okay?

We like the fact that we have the highest return on invested capital in the industry, and we're going to spend our dollars with the shareholder in mind going forward.

So like, for example, last year, at KFC we cut back at KFC until we could get our operations in order.

We've cut back in Mexico when Mexico was soft.

So we don't have any, you know, strategic imperatives that say that we have to be developing every country at this specific rate.

Our kind of view is those kind of strategic imperatives mean you lose money and we don't want to do that.

We do have, you know, long-term strategic approaches for each part of the world that we think we'll be able to execute, but we adjust along the way.

And to David's point, we do that at a macro level but more importantly we also do it at a micro level.

So for example within the U.K., both brands, on the KFC side we had had issues a while back with growing units on high streets.

We thought that high streets could be a great unit developer.

The returns weren't there so we drastically scaled back our high street development.

Awhile back on the Pizza Hut side of the business we were struggling with Company-owned delivery units.

Because of that we shifted towards franchise delivery units and in the meantime now we've got our profitability back up in the delivery channel so we could develop again.

But we turn that on and off depending upon what the micro results are as well as the geographic result.

One other thing on this along the line of David's comments, the long-term picture for this market is, you've got KFC and Pizza Hut right around 600 restaurants and the nearest competitor of the other major brand is McDonald's with 1200.

If you look trade area by trade area, the teams there they definitely feel like they can add 3 to 400 more restaurants for each brand, but it still will be dependent upon returns, as David and Rick both just said.

Thanks.

Thanks, Steven.

Marvin, next question, please.

Our next question comes from Jeff Bernstein with Lehman Brothers.

Thank you very much.

Also had two questions.

First, in your prepared remarks I believe you mentioned KFC in Germany was struggling.

Was just wondering if could you talk about some of the issues facing your business in that market?

And second, in the release you mentioned your expectation, and I believe you mentioned it in the comments as well, an incremental 400 million in the repatriation of foreign earnings, which I believe was the upper end of your prior guidance.

Just wondering if you could talk about how you arrived at the amount and perhaps your broad intentions for this pretty significant cash flow?

Thanks.

Actually, KFC in Germany in terms of the absolute volume is doing pretty well, but in continental Europe, you've got to have very, very high volumes to make it work.

So we've got volumes that are over a million euros, but we need about a million, three million, four million euros to really make it work.

We've struggled on getting our unit volumes up high enough to cover the additional cost for, you know, real estate, facilities, and labor.

So I think, you know, it's been, it can happen over time, but we're not there yet, in Germany.

I'll handle the repatriation question.

We did about 100 million last year, and as we mentioned, we did about another 400 million in Q2.

That's actually the maximum that we're allowed to do under the law.

So we are basically repatriating the maximum amount that we're able to do under the law, which is roughly $500 million.

We don't think it will really affect our overall cash position much.

It will probably more affect the geography of our cash but we're still going through sort of final plans on that area.

The overall hit on the tax side this year from doing that, as we mentioned, was about $19 million, or $0.06 a share.

And the really good news is that we covered that, as I mentioned earlier, with our overall tax rate.

So the tax news was very strong in Q2.

Not only did we get upside, but we had upside while still covering that item.

So we felt very good about our Q2 and our full-year tax rate.

Thanks.

Marvin, next question, please.

Okay.

Our next question comes from Tom Zankel with Iridian Asset Management.

Hi.

There seems to be a lot of confusion in the marketplace today, I just wanted to clarify.

With regard to the second quarter, if you take out the impact from the Poland IPO, the lower than expected tax rate, and the legal charge, you would have earned $0.58 per share?

That is correct, Tom.

Versus the $0.56 guidance?

Yes.

And then with regard to China, down 5% in P5, flat in P6, up 5% P7, now you're saying up 12%, I believe, in period 8?

Correct.

And did I hear correctly at the beginning of the call, David, that you see the turn as accelerating there?

Yes.

Okay.

And on the fourth quarter, with the 20 million incremental facility actions, would that be about 14 million after-tax, or $0.04 to $0.05 per share?

Yes, that's a fair calculation.

So if you add that to the $0.77 you get $0.81, $0.82.

Thank you.

Thanks, Tom.

Marvin, next question, please.

Our next question comes from John Ivankoe with JP Morgan.

Hi, thanks.

I actually want to ask a question about advertising as you've seen yourself and some competitors benefit by changes in advertising, and obviously the advertising market in general is changing.

Can you, for your U.S. business, comment on how you feel about 2006 in terms of things like number of weeks, the number of promotions, mix of local, co-op, national, and whether you think it makes sense to spend more?

That's the first point.

And the second is just a quick question on the tax rate.

It's obviously been pretty volatile.

Can you just give us some sense of what you think like an '06-'07 tax rate is as we try to think about it ourselves?

Thanks.

I think the advertising dollar spend will be basically the same in terms of percent of sales next year.

The mix may shift more into national than local, given where some of the efficiencies are, John.

Okay.

Would that be something systemic, like meaningful, or slight?

I think that it depends by brand.

But I think it's more of just being smart how we spend our existing pool of dollars.

Could you remind us how the three brands are allocated between local and national now as a percent of sales?

It's basically two and two. 2% and 2% in terms of media, national, in terms of broadcast media, roughly.

Regarding your tax rate question, we gave quite a bit of guidance on 2005 and it has moved around a lot.

We have not put together a full detail plan for '06-'07.

Our general guidance is in for the long-term rate we sort of said is in the low 30s.

Is that still your best guess now?

For long- term.

What we really don't know is between now and then how long could we do better than that.

We think we'll do better than that for the next year or two, but we can't really get specific enough about that until we do the detailed plan.

Okay.

Thank you very much.

Thanks, John.

Marvin, next question, please.

Our next question comes from Paul Westra with SG Cowen.

Good morning.

Just a clarifying question on China, some of this has been asked.

I just wanted to talk about your second half outlook.

It looks like you imply for comps to be down about 8 to 10% in the second half, and, A, is that correct, and if so, it seems like that's what you're expecting for July and given your comments that you've already made pretty good progress and have some pretty good outlook, my question is, is [that] just trying to be conservative?

Well we, we're taking this sort of still one week, one month at a time, so really the only thing we gave is the period eight forecast, which was, you know, at least plus 12 system sales.

We expect, you know, a gradual recovery from there is what we're assuming as we put our numbers together.

Okay.

When you gave your full-year and you sort of back into it, is what I'm trying to get at.

I guess also following with China guidance on the margin side, sort of the same, trying to back into the second half, it looks like you're looking for down 300 or 400 basis points in margin, which is really no better than the second quarter.

Also, just a follow-up question.

Is there anything else there or are you just trying to be conservative as well?

Well, you've got to keep in mind if you, like for example, it's kind of hard to look at the fourth quarter right now.

We gave you our best estimate for the full-year, but keep in mind the third quarter, we just told you they were up 5% in local currency terms for the first period of the third quarter.

Second one would be up 12, and if you just assume same number, 12 for the last period of the third quarter, that's something like up 9 or 10% in system sales for the third quarter, our target's 22%.

So sales will still be below our target, hence the impact on margins.

And they are recovering, but you've got to keep in mind it's recovering off a low point back in period four.

They're recovering, but they're still negative comps, and they're still impacting margins, and that's what we're forecasting.

And then, it's just the last follow-up question on that.

The margin outlook that you have, is that, would you say, I mean, almost 100% because of the top line issue?

Is there anything else?

There's no other major issues in China.

It's basically mainland China, KFC, negative comps.

Great.

Thank you.

Thanks, Paul.

Marvin, next question.

Our next question comes from Rachael Rothman with Merrill Lynch.

Hi, thanks.

Two quick ones if I could.

Based on your share count guidance for the full-year, I think you guys have 295 to 300 million, it looks as though you guys may plan to repurchase about 7 million shares in the back half of the year, and I know you guys have been repurchasing a lot this year, which I commend you on.

Does that seem about right, and can you tell us where the actual shares outstanding was at the end of the quarter?

We could pull, the end of the quarter should be in the earnings release.

I think it doesn't give actual.

We can get you that.

But you've got to keep in mind what you don't see with the purchases of by quarter is the equivalency, and the timing of when we actually bought the shares.

That's why I was asking about that.

Yeah, you heard we intend to keep purchasing shares but we're not going to disclose exactly what, we just don't do that.

We did say at least 600 million for the year.

That's our guidance.

So we do have some, 111 million to do just at least to meet the guidance.

But, yeah, to try and forecast it, we've done our work through that and we still feel comfortable with that range of 295 to 300 based on what we know we've done and what we anticipate we might do.

Perfect.

And then could you just help us understand what your exposure is to your top three foreign currencies?

Maybe as an example, would percentage of your YRI operating profits come from the U.K. or some of your other largest operating profit exposure?

Are you talking about YRI or including China?

Well, if China, unless they free float the currency, it's kind of not an issue at this point, so just YRI would be great.

Our biggest one is the U.K., which is about, you know, 30%, $100 million of exposure that we have there.

There's a fairly decent drop-off to the next two.

The other two that are major would be Australia and Korea, because those are Company-owned.

That's 30% of YRI profits from the U.K.?

Yes.

Okay.

And Australia and Korea, roughly?

We can't, I'd hate to speculate.

We can give you the percentages.

We also have that, it is out on the Web site.

We presented the details of the profit by those markets in our New York book in the last December meeting.

We'll call you back and we'll get you those numbers.

Thank you so much, guys.

Thanks, Rachel.

Next question, please, Marvin.

Our next question comes from Mark Kalinowski with Buckingham.

Hi.

Just wanted to clarify if I missed it.

You had said that you expect Pizza Hut's comps to be down about, in the ballpark, at 2% during the third quarter.

Did you quantify at all and expectations for KFC and Taco Bell?

No, we didn't.

The only thing we said was our full-year guidance for U.S. comps was 3 to 4%.

So, you know, you can kind of back into what the second half is but we have not provided anything in terms of a by brand forecast.

The only thing I think Rick said in his comments was, and it certainly relates to what David said, is that KFC and Taco Bell will obviously lead the way in performance for the third quarter comps.

Thank you.

Thanks, Mark.

Marvin, next question.

Our next question comes from Kevin Collins with Fred Alger Management.

Good morning, guys.

Thanks for taking the call.

I wanted to ask you about your expectations for general and administrative spend and when we can kind of expect some leverage on that line?

In any particular segment of the business or overall?

Just overall consolidated.

I think that, well, two things.

First of all, the G&A this time was, that's where the extra legal expense resided.

So I think we got hit harder than usual on that line, and we don't expect that going forward.

I think you could expect, if you look at it by division, because, again, the reason that Tim asked the question, it's hard for us to think of it just in one big bucket, but if you look at it by major area we expect to continue to invest in China.

So the China, we don't expect to get a lot of G&A leverage.

We'll get a little bit of G&A leverage but we're still growing that business mostly by unit growth, and that's fairly G&A intensive.

In our International business, we do expect to get some leverage.

Our G&A historically, as well as going forward, we expect to be clearly less than what our sales and profit growth above that line would suggest.

And the U.S. historically we've done a pretty good job reducing our G&A.

I think the year-to-date results are a bit of an aberration because of the one-time items we talked about.

And why is it so weighted in the fourth quarter, the year-over-year growth?

In terms of G&A?

Yes.

Because the 53rd week adds something like 10 to $15 million.

It's like one percentage point growth for the whole year.

So you had that extra week of paying, you know, all the overhead dollars, all the fixed expenses.

All right.

Thank you very much.

Thank you.

Marvin, next question.

Our next question comes from Chris Brown of Banc of America Securities.

Thank you.

Just switching to the balance sheet for a minute.

The last couple of years you guys have reduced your debt pretty significantly and I know your ratings are still kind of fairly investment grade.

Do you have an update on where you stand with the agencies?

And I guess going forward, how do you look at your balance sheet and where you're kind of managing your leverage of ratings?

Well, again, first of all, the second part first.

Again, we feel pretty good about our overall debt level right now, and we don't see any real need to reduce that debt level.

Also, the way it's structured, there's a piece that's come up, about 200 million comes up in 2006 that we'll obviously take a look at, but the rest of it's not until 2009, 2011, so really, because of the way it's structured, we don't plan on doing anything on those for awhile.

Regarding the agencies, we felt good about being investment grade.

We were upgraded by Fitch to the middle of the class of that, so that was good.

We've received a positive watch from one of the other agencies.

So, you know, we feel good about the direction that we're going with the credit agencies right now.

Good enough.

Appreciate it.

Thank you, Marvin.

That's all the time we have for questions.

I'm going to turn it over to David Novak.

Thanks very much, Tim.

I think to wrap it up we've got a very solid first half of the year and expect to finish up at least 11% EPS growth for the full-year.

China sales are improving, and new unit openings are on track.

When we had the China issue, I said to our team, to our entire organization, this was a great opportunity for to us show the power of our portfolio, and that we could continue to deliver on what we said because we have such a powerful business and the diversity that we have.

Well, we've done just that, and we plan on continuing to do it.

Our YUM!

Restaurants International business is having an absolutely excellent year.

Our U.S. blended same store sales are ahead of target, with a much better outlook on commodities going forward.

And we continue to buy back at record levels and, you know, as I mentioned earlier, we've increased our dividend.

So our balance sheet is strong, and we're generating all kinds of cash and doing great things with it.

So I think this is a year, you know, last year we had the issue with commodities, which is over $60 million, I think, in unplanned costs, this year we had China.

We're dealing with that issue I think as effectively as anybody could imagine, and we're hitting our numbers and actually beating them.

So we look forward to having a good second half and talking to you next quarter.

Thanks, Marvin.

Thank you, everyone, for joining the call.

This concludes today's conference call.

You may disconnect at this time.