百勝餐飲集團 (YUM) 2006 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would like to introduce Mr. Tim Jerzyk, Vice President of Investor Relations.

Sir, you may begin your conference.

Thank you and thank you for joining us on the call today.

I just want to give you a reminder before we start into the normal part of our call, it is time to make plans to attend our 2006 annual conference for investors and analysts.

The meeting will take place Tuesday December 5, from approximately 8:00 a.m. to about 2:00 a.m.

Eastern time at the St. Regis hotel in New York.

Online registration is required before 5:00 p.m.

Eastern time Friday, December 1.

Please register at www.yum.com, click on register now beside this event under upcoming analyst and investor event.

If you have any questions, please do call us at Yum!

Brands Investor Relations, 888-298-6986.

With that, let's get into the regular session of the call.

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

We are broadcasting the conference call via our website, www.yum!.com.

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

I would also like to advise that this conference call does include forward-looking statements that reflect management's expectations based on currently available data; however, actual events are subject to future events and uncertainties.

The information in the conference call related to projections or other forward-looking statements may be relied on subject to our Safe Harbor statement, which is included in our earnings release last night and may continue to be used while this call remains in the active portion of our company's website, which will be until about 5:00 p.m.

Eastern time Friday October 20, 2006.

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

Following remarks from both we will take your questions.

Now I'll turn the call over to David Novak.

Thank you, Tim, and good afternoon, everybody.

As you may have seen from our third quarter release last night, we reported outstanding results for the quarter with 11% worldwide operating profit growth and 20% EPS growth.

Importantly, each of our businesses contributed to operating profit growth and margin expansion to this performance.

Our growth this quarter was led by our high return international divisions, with across the board strong growth in new restaurants, same-store sales, and profits.

China's division profits increased by 26% and YRI by 22%.

Better news yet, we expect China operating profit to be up 35 to 40% for 2006.

Based on this strong performance, I am pleased to report we have raised our forecasted EPS for 2006 by $0.06 to $2.89 or 14% growth.

We believe the growth opportunities for our portfolio of brands around the world is second to none.

Consider this, China and YRI each already make more profits than companies like Wendy's, Applebees, or Ruby Tuesdays.

Yum!

China will generate nearly $300 million in profit, and as I said, growing by at least 35 to 40% this year.

YRI will generate about $400 million in profit this year and grow by at least 10% once again.

And unlike the U.S., which is extremely penetrated, we have just begun to capture the huge new unit opportunities in our international businesses.

And also unlike the U.S., we have very little competition.

This is how we very simply think about our growth opportunities outside the U.S.

We have over 18,000 traditional restaurants in the United States, where there are about 300 million people.

We have about 2,000 restaurants in mainland China with 1.3 billion people.

YRI has about 12,000 restaurants for over 4 billion people.

We think that provides us with major opportunities for expansion of our brand portfolio.

In addition to what we believe is the most powerful and proven international opportunity in our category is our tremendous cash flow generation led by our U.S. portfolio.

Consistently over $1 billion every year in terms of EBITDA.

Additionally, our already substantial annual cash flows are enhanced by our refranchise program.

This has enabled us to produce strong shareholder payouts.

In fact, we expect to return over $1 billion to shareholders this year which is a repeat of last year.

Our substantial stock buybacks will continue to be impactful, reducing our share count this year by 6% after a 2% reduction last year.

Additionally, we'll pay a dividend that will return another 1% to shareholders in 2006.

We fully expect to return similar total amounts to shareholders for the foreseeable future.

Finally, our global portfolio enables consistency of performance.

This will be our fifth straight year of at least 13% EPS growth and exceeding our annual target of at least 10% growth.

In addition, the free cash flow generation from every segment of our portfolio will enable us to pay out another $1 billion plus to shareholders in 2006.

Now let's look at each of our businesses.

Let's look at China first.

In our China division, as I said last quarter, we're back and booming once again.

With KFC, we are moving at an aggressive pace in mainland China with development growth of nearly 20%.

We now have nearly 1700 KFCs.

Returns remain very strong, are very best in the world, and we continue to expand in more cities.

We will likely be in about 400 cities by year-end building a great base for the KFC brand everywhere in China.

The summary for KFC is we're the dominant leader and we're moving full steam ahead.

You also need to recognize that our Pizza Hut casual dining business in mainland China is now a major business as well.

We've now reached major scale levels with over 225 casual dining restaurants and development is strong with excellent returns similar to KFC.

We're excited that because Pizza Hut casual dining is growing units at a 20% rate versus last year with solid same-store sales growth.

We're in over 50 cities and clearly the undisputed leader in casual -- in the casual dining category.

Now let's talk about the third brand we have been working on, developing for full-scale expansion, Pizza Hut home service.

We have 33 units currently in five cities and the overall economic models for this delivery business looks very promising.

We're excited as we just completed a TV test in Shanghai with our first ad campaign to drive this business.

The results were very good and we're ready to roll to more cities.

There is no doubt the home service market is emerging in mainland China and we will be there to capitalize on the opportunity.

To summarize, our China business had a great third quarter with profit growth of 26% and we're up 38% year-to-date, so clearly our two-year trends are excellent.

Importantly, we are opening over 400 new restaurants and achieving record restaurant margins even while rapidly developing and building new brands like Pizza Hut home service and East Awning, our fast food Chinese restaurant concept.

We continue to believe that KFC ultimately has the potential for 14,000 locations, similar to the level of development by McDonalds in the United States and that we ultimately have the potential for about 2,000 Pizza Hut casual dining locations, similar to Applebees in the United States.

That's 16,000 restaurants before you would consider the potential of Pizza Hut home service and East Awning.

Our belief is that ultimately we'll have at least 20,000 restaurants in China.

Now on to our Yum!

Restaurants international division, or what we call YRI.

We are very pleased to see strong performance from our YRI portfolio.

For Q3, we achieved 9% growth in system sales, local currency base us well ahead of our target of at least 5% growth.

YRI opened 176 new restaurants in the third quarter and virtually all of our 452 restaurant -- new restaurant openings this year or 94% of them were by our franchise and joint venture partners.

Most significantly, franchise fees grew by 15% in the third quarter to a new record and our overall operating margin improved versus last year to another record for the third quarter.

YRI generates solid, consistent growth that is geographically diverse with high returns.

Importantly, we are not sitting on our success.

We are just starting to develop in India, continental Europe with KFC, and now Russia.

And we are in the early stages of developing these megamarkets, which we believe will become increasingly important to YRI.

Most importantly for YRI, our new unit pipeline looks very good and we now expect at least 770 new openings for 2006 ahead of our original plan for 750 new openings.

The fact is, YRI continues to build one heck of a track record.

It will be seven straight years of opening over 700 new restaurants.

Now let's talk about where our growth outside the United States is taking us.

This year we expect that YRI will represent nearly 30% of overall Yum! profit and Yum!

China will represent 20%.

So nearly 50% of our profit today is coming from international divisions with at least 75% of our profit growth as well from these businesses.

We think we'll easily be at 60% international profits in the next five years with Yum!

China and YRI each being at about 30%.

Now on to our U.S. businesses.

Before I get into the details, let me give you our view of the U.S. business.

First, for the full year, we expect our profit to be up 3 to 5%, which historically stacks up well versus our 1% long-term trend.

Our blended U.S. same-store sales is expected to be flat for the year with our third quarter results down 2%, driven by poor performance at Pizza Hut, which was down 5%.

We are working aggressively to turn around Pizza Hut.

Importantly, Pizza Hut has the strongest brand equity in the pizza category, which gives us confidence.

Looking at both Taco Bell and KFC, we are confident in our market positions.

When you look at the two-year growth rates for both of these brands, they are comparable to other big names in the category.

For example, Taco Bell and KFC are averaging 2 to 3% growth over the past two years.

McDonalds is averaging 3 to 5% and Wendy's is about flat.

So Taco Bell and KFC are definitely in the game.

We expect Taco Bell and KFC to be up for the full year and Pizza Hut to be down 3%.

Having said all that, rest assured that no one is satisfied and we are absolutely focused on getting back on track.

In fact, I can tell you for certain we are obsessed with it and we are also very confident that we will deliver.

In fact, we believe it's very realistic to target plus 2 to 3% same-store sales growth for our U.S. business again next year based on the aggressive plans that our dedicated teams are putting in place.

Our target is also to grow our profit 5%.

We realize that the proof is in the pudding, so you will have to see.

Now let's look in detail by brand.

First, some perspective on Taco Bell, our biggest U.S. business.

For Q3, Taco Bell experienced a 2% decline in same store sales, lapping a strong 8% a year ago.

Or two year growth of 3%.

For the remainder of the year, we do expect sales results to be in a similar pattern as we have experienced recently.

We are making some adjustments to products and promotions to help regain our momentum against the difficult comparisons.

Looking a Look ahead to 2007, we remain confident in every aspect of the Taco Bell brand.

The fundamentals are solid, ramp positioning, our TV ads, our new product pipelines, and our improving operations.

We also have major new product news planned for 2007, and we have adjusted our marketing plan that reinforces Taco Bell's compelling value in what is obviously a tougher competitive environment.

Taco Bell has been one of the leaders in growth for the past several years, with 2% same-store sales growth expected for 2006 after years of plus 7, plus 5, plus 2, and plus 7.

That's a track record and we're confident we will once again be in the plus 2 to 3% range at Taco Bell in 2007.

Now on to KFC.

KFC delivered flat same-store sales growth in Q3 lapping 6% growth last year or two-year average growth of 3%.

We're up 2% year-to-date lapping 6% growth a year ago.

As with Taco Bell, we believe KFC performance also stacks up fairly well within our category in terms of two-year growth rates.

Looking at all aspects of the brand fundamentals, we are confident of the positioning and our TV ads.

Operations are improving from a low base, but are steadily making progress.

We remain very focused on execution against building sales layers around our four new concepts of variety bucket, snacker, flavor station, and our famous bowls.

You will see continued news in support of these concepts for the balance of the year, including famous bowls, which was a very successful new product introduction, which will be coming up in two weeks.

Additionally, for our 2007 calendar, we have pulled forward into the second half of 2007 what we thought was our most compelling new product ideas targeted for 2008.

We have an outstanding pipeline of product news at KFC.

Now on to Pizza Hut.

The picture has changed somewhat as we have begun to lap weaker performance versus a year ago.

Our sales results have improved, but are still not where we need to be and transactions remain down for the category overall.

I can assure you we're putting a full court press on at Pizza Hut.

The good news is the team has been working through a problem detection analysis and other category and brand research to develop a road map to a turnaround plan.

As we go forward, we will begin to implement our turnaround plan and we believe you will begin to see improved results in 2007 off of this year's poor performance.

Our turnaround plan will be comprehensive in terms of marketing and operating plans.

At this time, with a very tough category trend and two major national competitors, I cannot be more specific.

I can tell you we are all over this business and we are putting every Yum! resource to bear that will help us turn this business around.

We have turned around each of our brands at one point in time and will do it again, and we'll do it with Pizza Hut.

All I can say is to trust our track record that it will happen again.

To summarize on the U.S. business, we do not see any significant change for the balance of year in terms of same-store sales growth when looking at likely results in terms of two-year growth rates.

We have this factored into our forecast.

We are confident that Taco Bell and KFC each has the right plan in place for the balance of the year and 2007.

For Pizza Hut, we will be lapping weak numbers next year and are in the process of making changes, as I mentioned.

Based on our Taco Bell and KFC market positions and the progress we expect to make at Pizza Hut, we remain confident of reaching our plus 2 to 3% same-store sales target for the U.S. in 2007.

Beyond the U.S. base business, we're excited to see that new restaurant development is beginning to ramp up at Taco Bell, and with Taco Bell/KFC multibrands, which will provide with us with a new source of profit growth in the U.S.

Our franchisees are excited about our new bold choice Taco Bell restaurant design and so are our customers.

You should expect to see many more across the U.S. over the next several years.

Taco Bell U.S. will expand by about 1.5% new units net of closures in 2006.

And finally, we expect to make continued progress in upgrading KFC U.S. and Pizza Hut U.S. system restaurants during 2007.

For KFC, we expect 600 to 700 upgrade projects to be completed in 2007, most of these by our franchisees.

At Pizza Hut, we expect 200 to 300 upgrade projects to be completed, again, mostly by our franchisees.

All told, there will be significant capital invested by our franchisees next year for image upgrades at KFC and Pizza Hut U.S. as well as Taco Bell for new restaurant growth.

To summarize, the power of our global portfolio and international scale and growth makes us not your ordinary restaurant company and a cash-generating machine.

Importantly, we will continue to invest substantial company capital in mainland China, which provides high-growth, high returns, and ultimately, we believe, significant scale for Yum!.

Over the long-term, we expect to continue to grow our earnings per share at least 10%, pay out substantial cash to shareholders, and build value by executing against our unique international growth opportunities with high returns that differentiate us from other global consumer companies.

Specifically, we'll focus on our four key strategies, Building dominant restaurant brands in China, driving profitable international expansion, steadily improving our U.S. brands and operations, and multibranding category leading brands.

Now I'll turn it over to Rick Carucci, our CFO, who will take you through the numbers.

Rick?

Thank you, David, and good afternoon, everyone.

I'm going to review five items today.

First, Yum!'s third quarter results; second, Yum!'s year-to-date results; third, our full-year 2006 outlook; fourth, a brief update of our refranchising program; and fifth an update of our full-year cash flow expectations.

Let's now talk about our third quarter, which was another high-quality quarter.

Worldwide operating profit growth was up 11% and operating margins in all three businesses also improved nicely.

Let's look at Q3 by business segment.

China's division restaurant margin was up over 3 points versus a year ago.

Year-to-date margins are well over 21%, which is an all-time record.

We are very encouraged by this performance.

Needless to say our China division had an even better quarter than we had expected, with 10% same-store sales growth, record margins, and 26% profit growth.

Both the KFC and Pizza Hut casual dining brands had strong sales growth in quarter three.

This quarter also demonstrated the power of development-based growth.

Our two-year profit growth in the China division was 66%.

Our two-year development growth in mainland China was 55%.

Because we continued to build units when our sales did bounce back, we knew we would be in a great position regarding profit performance.

Yum!

Restaurants international also had a very strong third quarter with 22% operating profit growth.

While we had expected strong growth in quarter three, we are obviously very pleased with this result.

Importantly, margin performance was strong with over 20% operating margin, an increase of nearly 3 points from last year.

Same-store sales and company markets increased by 4% after being flat in the first half of the year.

This resulted in an increase in restaurant margin of 0.8%.

YRI franchise fees were up 13% in local currency.

This was led by a 6% increase in franchise restaurants and by 4% growth in same-store sales.

The strongest-performing markets were in our franchise-only areas of the world, South America, Caribbean Latin America, Middle East, and Asia.

These franchise results led to the strong 2.7 point increase in operating margin.

In overall, U.K. business showed improved performance versus the first half of the year.

Total third quarter U.K. profits were up 4% in local currency versus prior year driven by strong same-store sales growth for KFC.

Our Pizza Hut U.K. business struggled during Q3 as we were in the late stages of completing the acquisition of Whitbread's 50% interest in our former joint venture.

We expect stronger sales performance for this business in the balance of the year.

Turning to the U.S., we had disappointing sales in the third quarter.

We did benefit from substantially lower commodity costs following two extremely tough years of commodity inflation.

The commodity favorability in the third quarter was $10 million.

In addition, closures and impairment expense dropped $13 million versus last year.

This largely explains why profits were up slightly, about 1% versus last year, despite system same-store sales being down 2%.

To summarize, the third quarter was a again a high-quality quarter driven by 11% growth in worldwide operating profit.

This outstanding quarterly performance was led by strong growth from our China and YRI divisions, each with profit growth exceeding 20%.

In the financial area, we saw a slightly lower tax rate of about 26% versus last year's rate of about 27%.

The lower tax rate offset a $6 million increase in interest expense.

The increase was driven primarily from higher rates on the variable rate portion of our debt and it also reflects slightly higher debt levels this year versus last year.

And finally, we continue to make very good progress at reducing our share count, now down to 255 million shares at quarter end and a 7% reduction average diluted shares year-over-year.

All this resulted in an EPS growth of 20% against the third quarter last year.

That wraps up Q3.

Now I want to review our year-to-date business performance as we look ahead to 2007.

Year-to-date, our worldwide operating profit increased by 14%, led by across the board strength in each of our businesses.

China was up 38% year-to-date, well above our long-term 20% target.

YRI was up 9% year-to-date, close to our long-term 10% target.

The U.S. was up 8% year-to-date, above our long-term 5% target.

All in all, this represents high quality and strong performance from our global portfolio.

Overall year-to-date, we are up $113 million in operating profit.

China's year-to-date results have driven 53% of that growth and YRI, 20% of that growth.

That's nearly 75% of our year-to-date operating growth from our two international divisions.

That has been the picture over the last eight years and we expect that story line to continue into the foreseeable future.

Year-to-date, earnings per share was up 18% ahead of our operating profit growth.

Our significant reduction in share count more than offset a higher year-to-date tax rate and higher year-to-date interest expense.

Now let's turn to our full-year outlook.

As we look ahead to the fourth quarter, please keep in mind that our reported growth rates will be negatively impacted by the laps of the 53rd week last year.

This impacts YRI, the U.S. business, and Yum! overall.

Our China division will not be affected.

Let's look first at our U.S. business.

In this environment and with the tough lapse at both Taco Bell and KFC balance of year, Q4 is a little hard to read.

However, we believe in the U.S. we'll finish with between 3 and 5% profit growth overall for 2006 prior to lapping last year's 53rd week.

We have factored this into our overall outlook.

We are not particularly bullish on Q4 domestic sales.

We do, however, expect favorable commodity costs versus last year, but with lower gains year-over-year within the first three quarters.

While we are working very hard to turn around our U.S. business, we feel great about Yum!'s overall business.

We are confident in our brands, we know our U.S. sales will bounce back, and we strongly believe our results will improve over time.

Also, we are especially confident about the outlook for China and YRI during the balance of this year.

We expect China division operating profit to be up 35 to 40% for the year driven by another great year of new unit expansion.

We will likely open more than 400 new restaurants.

Same-store sales will be solid for the year and restaurant margins will be up over 20% for the full year.

At YRI, we expect operating profit to be up at least 10% for the year, excluding last year's 53rd week benefit.

YRI will have a strong fourth quarter with over 10% profit growth on a like for like basis.

For the year overall, the really good news is that we expect solid margin growth in all three businesses.

Our growth model is very productive this year and looks very strong for the future.

Based on the operating profit strength we discussed, our full-year EPS guidance increases to $2.89 or 14% growth.

With our global portfolio, we have a track record of consistently achieving about 10% EPS growth despite soft results in any quarter two from any of our businesses.

Specifically for 2006, we are demonstrating that we can absorb a tough stretch of U.S. sales and yet have our global portfolio deliver solid double digit EPS growth.

Now I'd like to provide you with an update of our refranchising progress.

At YRI, we are continuing to refranchise our company units in some smaller scale businesses, namely Pizza Hut businesses in Canada, France, and Australia.

We continue to make progress on this front and we have refranchised 157 YRI company restaurants over the past four quarters.

With the recent acquisition of our 50% ownership of the Pizza Hut U.K. joint venture, our company ownership is now at 16% at YRI.

We will be refranchising in the U.K. over the next two to three years to bring our YRI ownership down to similar levels as before the acquisition.

As a result, you should expect us to continue some refranchising at YRI over the next three years.

We continue to like our current franchise dominant business model for YRI.

Where we do invest our own equity and run company restaurants, we generally look for three things.

First, potential for significant scale; second, strong growth potential in the market; and third, strong returns.

We'll sometimes compromise on one of the first two points, but not on the third, the high returns.

In the U.S., we continue to make progress against our two-year plan of refranchising at least 1,000 company-owned restaurants.

We have refranchised about 200 U.S. company-owned restaurants year-to-date with at least a similar amount for Q4.

As we previously stated, our target at the end of 2007 is to reach 20% blended company ownership in the U.S. from about 26% at the beginning of this year.

We expect to reduce our U.S. company-owned restaurant count from about 4700 at the end of 2005 to less than 3700 by year-end 2007.

The good news is our two-year U.S. program is progressing well and is currently expected to be completed on time with a large pool of capable franchise buyers.

We expect to meet our financial targets of, A, a 50% basis point improvement in U.S. restaurant margin;

B, no impact to operating profit dollars; and C, a 75 basis point improvement in ROIC.

We also expect to receive cash of $250 million in 2006, which is above our original $150 million estimate.

Now let's talk about cash flow.

We continue to expect to end this year with another record of about $1.3 billion in net cash provided by operating activities.

We'll invest about 625 million on capital spending during the year, which will result in about $700 million of traditional free cash flow.

We are fortunate that even after we invest capital for growth our China, YRI, and U.S. businesses each generate free cash flow.

We expect additional cash flow of over 250 million from refranchising proceeds, another 150 million in employee stock option proceeds, and 40 million from sales of surplus property and equipment and other items.

When you add it all up, that's over 1.1 billion in available cash.

Consistent with our recent past, our stated approach is to give our share back to our shareholders in the form of share buybacks and a dividend.

We believe we received an especially great value in our stock buybacks this year.

During the third quarter alone, we bought back $337 million of stock at an average price of $47.52.

Our year-to-date purchases stand at 853 million.

For the full year, we expect our diluted share count to decrease by 6%.

In summary, we expect 2006 to be another successful financial year for our shareholders, because we expect to deliver 2006 EPS of $2.89 or at least 14% growth versus last year.

Another year of strong cash flow and substantial cash payout to our shareholders, and finally we expect to continue building long-term value in our international businesses, YRI, and China.

YRI through a high return franchise expansion and development of emerging megamarkets like India, Russia, and France, and in China, with high return company restaurant expansion of multiple Yum!

Brands.

Yum! clearly has the opportunity and the capability for long-term growth with annual EPS growth of at least 10% year after year.

That's it for me, David.

Back to you.

Thank you very much, Rick.

It's becoming more and more apparent we are a global growth company with tremendous upside and new unit potential.

There's no doubt in my mind that we'll have at least 20,000 restaurants in China some day, and we're taking the right steps to put our brands on the map in India, Russia, and Continental Europe.

We obviously had an excellent third quarter and fabulous year-to-date results.

Our China and YRI growth engines are firing on all cylinders.

U.S. business has now softened after a string of very strong comps, but we are confident Taco Bell and KFC are in good shaped while we're focused to turn Pizza Hut in the U.S. around.

Net/net, our international divisions continued to drive our growth, and our U.S. business generated substantial, relatively stable cash flow, which we return to shareholders.

Now before we go to Q&A, we need to make an announcement.

As you may have seen, Starbucks recently announced that they are going to provide same-store sales on a quarterly basis versus by month.

We have evaluated their move and believe it makes sense for us as well for the following reasons.

Number one, one of our key strengths is our portfolio and our track record has demonstrated that our portfolio has delivered each of the past five years.

We've delivered consistent results and our total business is stronger than ever.

Number two, we add shareholder value primarily through expansion of our brands around the world, building new restaurants in places like China with high returns.

Quarterly and annual results fully explain this progress.

Number three, our focus is on the total business and longer term quarterly results are more indicative of our performance and how we add value.

And finally, number four, it sends the right message to all of our teams.

We don't run this business month to month.

It's building long-term value that counts.

So we have decided that period ten sales will be our last period sales release.

Now we'll be happy to take your questions.

[OPERATOR INSTRUCTIONS] David Palmer with UBS.

Are we ready to go?

Sir, just one moment.

Sir, your first question comes from David Palmer with UBS.

Thanks.

Congratulations on the quarter.

I wanted to ask you about the U.S. business.

It seems like September trends for the industry accelerated a bit, but maybe only as much as what the comparisons might have dictated.

In other words the two-year trend didn't do anything all that spectacular.

I was wondering if your -- first you'd comment on the industry environment and secondly, with regard to Taco Bell and KFC, obviously you've seen an increase in everyday low pricing options out there, McDonald, Wendy's.

Is there anything -- and you're talking about how you're pushing up some changes in the KFC product calendar for '07.

I'm wondering if that's causing a bit of soul searching on those two brands in terms of what foot forward in terms of marketing and menu innovation you put.

In other words, do you think you're doing -- you can just leave your menu innovation schedule intact and just go with it, or do you have to change what you're doing?

Thanks.

I think, just first of all in terms of the category, we think the category is basically in the same shape it was three or four months ago.

It's a tough category.

I think when we look at what could be impacting our business that we didn't foresee last year, I think it's the introduction of two chicken products, one of them being the $0.99 sandwich that Wendy's introduced and the other being the $1.29 chicken wrap that McDonald's introduced.

We do believe that both of those products had impact on KFC and to a certain extent, it impacted Taco Bell as well, because they are more in the value arena.

As we look at our Taco Bell and KFC in particular, David, we really feel like everything that we're doing on those brands is right in terms of the positioning of the brands, the overall advertising campaigns, and the fact that we continue to have a full-court press on developing product news.

So I think the way how we kind of look at it, while we had a tremendous string of continuous same-store sales growth and our two-year numbers are great, we look at it in the last three months, it's sort of been like we're down 7 to 3 at half-time, so we've gone back into the locker room, we've looked at our game plan, and we really think that the playbook that we have is right and what we want to do is just make sure that we execute it as strongly as we can.

But let's take Taco Bell for example.

Would we change the advertising?

Think outside the bun, is I think, most people would say it would be right up there with, it's in the top tier of any advertising campaign in the industry.

And then when we look at our product pipelines at both Taco Bell and KFC, we've got a lot of news coming up.

What we're doing now is trying to decide which news is the most valuable, which news will have the most impact, and we're planning our calendar to really give the consumer as much power as we can.

Because I think what we have learned is that you need more news today to win.

We think we're losing more out to other competitors product news introductions than on the value front.

In other words, we think Wendy's had more product news with the $0.99 -- their $0.99 chicken sandwich than we did when we came back and just reinforced the snacker product that we introduced last year.

We think McDonalds had more news with their $1.29 snack wrap.

So we think we've been outnewsed.

Now, the good news is, we've got a lot of news at Taco Bell and KFC and we can get back in that game and you will see us play that game well next year.

And I think the two-year trends I think are important because it says, don't throw the baby out with the bath water here.

The worst thing we could do is over react to the business that we have right now.

But I can tell you, I think I read somewhere where somebody was wondering whether we were interested in turning around the U.S. business, and that's so far from the truth, it's unbelievable.

We are all over this like a fly on honey and we're going to do everything we can to turn this business around.

Thank you.

Thanks, David.

Next question, please.

Glen Petraglia with Citigroup.

Rick, just first, a clarifying question.

The period-ending share count, if you could share that.

And then also if you could give a preliminary outlook for commodities in 2007?

The quarter-end share count was 265, that's absolute basic shares, 265 million shares.

Okay, thanks.

Commodity for background for 2006, again, before we get into 2007, is that we had very favorable commodities, were about 35 million year-to-date, 10 million in the third quarter.

We expect positive commodities in the fourth quarter, probably less than the first three quarters.

We don't have a great handle, yet on 2007.

Right now, we're not expecting anything unusual.

We'll have a lot more to report at our December meeting.

But it's safe to say that you would likely be flat to potentially slightly up in many cases?

Yes, early indications are what I'd call normal low level inflation.

Okay.

Thanks.

Thanks, Glen.

Next question, please.

John Ivankoe with JP Morgan.

Thanks.

The question is actually on China.

Obviously the returns for the overall market and presumably new unit returns are fairly exceptionals driven by your sales to investment ratios.

Specifically, the margins that we're seeing reported on your income statement.

And what I'm looking for is, how do you feel about having a 23.7% margin?

Is that kind of the level that we should be thinking about you making longer term, is that for whatever reason kind of a peakish margin in the quarter?

Will new units, do you think, be higher than lower than that?

And in parenthetical to that, does it make sense at any point to perhaps lower that margin to make your business even more attractive to more consumers as you expand throughout China?

Good question, John.

First of all, the China margins in the third quarter are a bit normal than our full-year numbers just because of seasonality.

So seasonality did drive third quarter above normal.

But our year-to-date margins are over 21%.

I personally believe that 20% margins are sustainable in China for a few reasons.

First of all, as we go to these smaller cities, even though our average sales are below what we're getting in the bigger cities, our margins are actually higher.

So those businesses are performing well and our returns are higher there as well.

So we feel great about that development.

And the second piece is our competitive position continues to improve in China.

If you really look at it, we've been adding 400 restaurants for the division, but just on the KFC side, close to 300 restaurants the last couple of years, which is three to one our nearest competitor.

So our power in the marketplace continues to improve and we've been able to leverage that on the cost side.

So we feel -- I feel that our margins there are sustainable.

And as income grows there, we are already becoming more and more affordable to people.

We're expanding our reach as much as we want to, really, because of the income level rising as opposed to needing to discount our products.

Can I ask you a question just related to food and paper costs in China?

It looks like according to my numbers that it's dropped about 250 basis points over the last three years.

Is that something that you're just able to -- is it your distribution efficiencies, is it better purchasing, is there something going on in that market that should allow that trend to continue?

Well, first of all, I think the reason we've achieved it, John, is what we were talking about earlier that our purchasing power and number of units we have continues to increase.

So we get more efficiencies as we and our suppliers get bigger supporting us.

So there's been natural ability to manage costs.

So I do expect to continue to see some improvement there, probably not at the rate that we've gotten over the last several years.

So we expect that rate of improvement to moderate over time.

But we also believe we have the opportunity to take modest pricing over time because our cost structure has improved so much, we've taken very limited pricing in China.

When we have taken limited pricing, the market has been able to absorb that.

The other thing, John to your point earlier about providing value to the customers, we have over 6,000 transactions a week in KFCs and the only way we've been able to get to that point is because we have everyday affordable value.

We're going to make sure we keep that up.

Thanks, John.

Next question, please.

Jeff Omohundro with Wachovia.

Thanks.

Just two questions.

First, I wonder if you can give us an update on your thinking around KFC U.S., the famous bowls, where we are on the product cycle on that with the upcoming line extension?

Is that becoming -- is the mix sustaining, is that becoming more of a core product and what the outlook is on that.

And then secondly, if you could remind us, what accounts for the differing performance between mail in China and Shanghai recently?

I will speak first of all to your point about the famous bowls.

Basically, what we're coming back to with the famous bowl product is basically a reprise of our national introduction that we had earlier in the year, so it's the same product.

The product has been very successful, it's achieved our mix levels that we were looking at and we see this as a permanent product on the menu.

In fact, we have a number of line extensions in the hopper that are very unique and differentiated versus our original offering that we think will give us some product news.

Tim or Rick --?

Jeff, just to clarify your question, was mainland China sales performance versus division China?

Yes, division China.

Again, just for background, China division includes Taiwan and Thailand.

Effectively, the bigger problem we actually had was in Taiwan where we were lapping very strong performance last year and where the market softened this year.

We also were down a little bit in Thailand which had been strong all year, in other words, the week of softer sales with the coup there.

Those sales have pretty much bounced back.

Again, -- so we feel that those businesses will bounce back, but just will provide a short-term direct -- probably for about another month or two.

Great.

Thank you very much.

Thanks, Jeff.

Next questions, please.

Mark Wiltamuth with Morgan Stanley.

Was going to ask some questions here on the Pizza Hut home service rollout in China.

If you could just give us some idea of the pacing of the rollouts you're expecting there, and maybe contrast the returns you get on that business relative to the KFC store growth in China?

Well, I think the, first of all, we've just basically developed the Shanghai market.

We're going to be going -- in November we have our strategy plan session with the team there in China and I think we could give you more detail on that after that meeting.

So we're really not at a point where we'd want to talk about that yet.

In terms of the economic bottle on pizza home service, it's a much slower investment base.

It was trading a couple hundred thousand, 200, 250,000 per unit and its margins are lower than our base KFC or Pizza Hut business probably roughly in the 15% range.

But with those numbers and that investment return, it has very strong returns.

So higher returns than the KFCs?

It's similar, but again it's very early days.

Thank you.

Thanks, Mark.

Next question, please.

Joe Buckley with Bear Stearns.

Thank you.

Two questions.

One on China.

As you start opening more in small markets and the AUVs come down a bit, will you step up the expansion rate to keep the overall topline growth in the low 20% area, or how do you approach that from a planning perspective?

Well, we try to open them as fast as we can, Joe, so we've been moving at a very high rate.

I think as the -- if you look at it over time, at some point the unit growth rate will have to decline.

At that point, though, we still believe we'll have probably more opportunity for same-store sales growth.

Historically, we've really pretty much grown same-store sales with our unit development.

It's been at such a high rate.

We think over time we'll probably have more of a blend between unit development and same-store sales growth.

Having said that for the next several years, we believe unit growth will still dominate what's driving the growth there.

The mainland China same-store sales number of 12% in the quarter, what is that compared to a year ago?

We don't have it handy, Joe.

I'll have to give you a call back.

I guess it was probably flat to up slightly, something in that range.

Well, again, third quarter last year, we were -- we still had some of the affects of Sudan Red, so it was probably negative, I would guess, in the third quarter last year.

Let's not guess, we'll get back to you.

Fair enough.

Then just one on the U.S., that $250 million number that you're going to reach from refranchising this year, your original two-year number was 300 million, so I'm assuming that two-year number is going a lot higher as well.

Can you update us on that?

We'll have to update you on that in December.

It will be higher, but we'll give you a more precise number.

Okay, thank you.

[OPERATOR INSTRUCTIONS] There are no further questions at this time.

Okay.

Well, thank you very much for being on the call.

We're off to another good year -- not off to the year, we're about ready to finish another good one and we look forward to 2007, look forward to seeing you at our investor conference in December.

Thanks.

Thank you for participating in today's teleconference.

You may now disconnect.