百勝餐飲集團 (YUM) 2011 Q3 法說會逐字稿

Good morning.

My name is David and I will be your conference operator today.

At this time I would like to welcome everyone to the Yum!

Brands third quarter 2011 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 session.

(Operator Instructions).

Thank you.

I would now like to turn the call over to our host, Tim Jerzyk, Senior Vice President of Investor Relations.

Sir, you may begin.

Thanks, David.

Good morning, everyone, and thanks for joining us.

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 the recordings.

I would also like to remind you that this conference call includes forward-looking statements.

Forward-looking statements are subject to future events and uncertainties that could cause our actual results to differ materially from these statements.

All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release released last night and the risk factors included in our filings with the SEC.

In addition, please refer to the Investors section of the Yum!

Brands website to find disclosures and reconciliations of non-GAAP financial measures that may be used on today's call.

Finally, we would like you to be aware of a few upcoming Yum!

investor events.

Our annual investor and analyst conference in New York City will be Wednesday, December 7.

Please register for that as soon as possible.

On Monday, February 6, 2012, fourth-quarter earnings will be released.

This was previously scheduled for February 1, so please adjust your calendars.

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

Following remarks from both, we will take your questions.

Now I will turn the call over to David Novak.

Okay, thank you, Tim, and good morning everyone.

Before I talk about our third-quarter performance, I think it's interesting to note that this Friday, October 7 is our founder's day and marks the 14th anniversary of our Company.

From the very beginning, our formula for success has been people capability first, satisfied customers and profitability follow.

I'm proud of the How We Win Together ownership culture we have developed and pleased with the strong returns we've generated for our shareholders with our share price up well over 500% since our spinoff from PepsiCo.

I'm even more pleased we continue to have tremendous optimism about the future growth of our Company.

Our people know the three keys to driving shareholder value, and believe me we're focused on them now more than ever -- new unit development, same-store sales growth and return on invested capital.

Our new unit opportunity in China is the best in retail and our opportunity to expand is bigger than ever as we know India, Russia, Africa, France and Germany have all reached inflection points for growth.

We're also laying the foundation for more substantial same-store sales growth in our 38,000 restaurants by developing breakfast, beverages and broader menu variety that will leverage existing assets and make our brands even more relevant.

Meanwhile, our returns should continue to be among the best in retail with return on invested capital of over 20%.

I often say the best thing about business is the unfinished business.

Clearly, we are on the ground floor of global growth with decades of unfinished business ahead.

Now onto our results.

I'm pleased to report 13% EPS growth for the third quarter excluding special items and confidently reaffirm our full-year EPS growth forecast of at least 12%.

We're proud that 2011 will mark the 10th consecutive year we exceed our annual target of at least 10% EPS growth.

Our strong performance in China and other emerging markets continues to be the catalysts of our growth.

We now expect to open about 1500 new international units this year which not only adds to earnings for 2011 but sets us up for an incremental growth in 2012.

We are particularly pleased with our China business which reported record transaction growth and record expected new unit growth.

There's no question China has powerful brand equity of both KFC and Pizza Hut with outstanding new unit returns.

At Yum!

Restaurants International, system sales grew 8%, including 13% system sales growth in emerging markets, both prior to foreign currency translation.

In the US, we saw another quarter of poor results in what remains a tough environment.

Now let me take you through our key strategies and trends for each of our divisions.

First, I would like to thank all of you that attended our recent China Investor Conference in Shanghai and saw the leadership and tremendous operating team we have there.

I would like to thank Sam Su and the team for hosting our guests at this great event.

I'm obviously very proud of our China team's continued strong performance.

For the third quarter, units expanded 14% and same-store sales grew 19%, driven by same-store transaction growth of 27%.

Our China division's operating profit has grown 15% year to date excluding the impact of foreign currency and translation.

Operating profit grew 7% this quarter excluding foreign currency translation.

Keep in mind that we were overlapping our participation in the World Expo in Shanghai which added about $10 million of profit to last year's number.

Excluding this overlap, our China team delivered another double-digit earnings growth quarter.

New unit development continues to be the major driver of our growth and we remain the largest US retail developer in China.

We have opened 329 new units through our first three quarters and expect to open a record 600 this year which will be a record development year for us in China.

Our China new unit returns remain a key focus for us and continue to be the best in our business.

Now let me share with you a few highlights from each of our leading brands in China.

Let's start with KFC.

We added 110 new units this quarter and now have nearly 3500 restaurants, making KFC the largest Western QSR concept in China.

While we're certainly viewed as the chicken experts, our menu includes beef, seafood and rice dishes as well as other products with broad appeal to Chinese customers.

Our brand strategy is to be rooted in China and our diverse menu offerings are proof positive we're delivering on this goal.

We're working on four key initiatives that will grow the business and build strong unit economics well into the future.

First, KFC breakfast is in virtually all of our restaurants.

Our breakfast day part has seen its transactions double this year, accounting for about 30% of total transaction growth.

Our menu has broad appeal to Chinese consumers who are increasingly eating breakfast outside of home.

We made the decision to offer compelling value to drive traffic to build this under-utilized day part.

We knew this would have a negative impact on our check average and in fact accounts for about half of our total check decline this year.

Even with all of this transaction success, breakfast still accounts for 7% -- only 7% of our overall sales.

We're clearly on the ground floor of building this important day part.

Next is delivery, which is now available in over 1600 KFC restaurants.

This fast-growing delivery segment is primarily in higher tier cities.

We're also expanding our 24 hour operations initiative now in about 50% of our restaurants.

Finally, let me talk about our new lunch and afternoon snack value initiatives.

As we look at the inflationary environment and the Chinese consumer sensitivity to rising prices, we made the conscious decision to bring even more customers into our restaurants.

This has resulted in extraordinary traffic gains.

With that said, higher inflation more than offset the modest pricing we took earlier this year and was the primary driver of our decline in margins.

As you would expect, we're taking very prudent steps to adjust this going forward.

As you saw, our third-quarter margins were still over 21% and we expect margins to continue to sustain in the 20% range on an annual basis.

Any way you look at it, the KFC brand in China is having an incredible year.

All of our research tells us we're building our leadership position and making our brand even more relevant.

The tremendous increases in new units and traffics puts us in a nice position to continue our strong growth in 2012.

Now we also have achieved tremendous growth and vibrancy at Pizza Hut in China.

Pizza Hut Casual Dining goes beyond pizza and continues to unquestionably be the leading Western casual dining concept in China with over 560 units in over 120 cities.

This quarter marks the seventh consecutive double-digit same-store sales growth quarter for Pizza Hut Casual Dining.

The menu is revamped twice a year and continues to offer a broad variety of entrees, including beef, chicken and rice dishes along with appetizers, beverages and desserts.

We are having tremendous success building a true casual dining concept with everyday affordable value.

In fact, our new unit returns are now comparable to KFC and we expect to open about 100 Pizza Hut Casual Dining restaurants this year.

We are especially pleased to be opening Pizza Huts not only in the largest cities, but in tier 3, 4 and 5 cities as well.

We also continue to invest behind the development of our emerging brands.

Pizza Hut Home Service in the home service delivery category now has over 120 units in 12 cities.

East Dawning, our Chinese fast food brand, continues to make progress as we drive for scalable economics.

In summary, our China business is having a fantastic year.

The progress we're making in executing our China strategy to build leading brands in every significant restaurant category is exceptional.

Next, Yum!

Restaurants international -- before I speak about this quarter's results, I would also like to thank all of you that attended our YRI Investor Day in Dallas this past August and saw leadership present the tremendous emerging market opportunities we have as was the recent success we're having in France and Germany.

I would like to thank Graham Allan and the team for hosting our guests at this event.

For the quarter, YRI produced solid results with system sales growth of 8% and operating profit growth of 3%, both prior to foreign currency translation.

Same-store sales increased 3%.

Operating profit was negatively impacted by $6 million or 5% due to anticipated closures related to our decision to completely re-franchise our Pizza Hut business in the UK.

As our focus shifts to high-growth, high return businesses, we decided this business would be better served in the hands of a capable franchisee.

The re-franchising decision for this business reinforces our commitment to shareholders to leverage high-return franchise fees and concentrate even more Company equity on high-growth, high-return businesses in emerging markets.

New unit development is a key driver of growth for this business and continued with 193 new units this quarter, including 127 new units in emerging markets.

Over 90% of these units were opened by our strong network of franchisees and we continue to expect to open about 900 new units at Yum!

Restaurants International for the full year.

It's the new unit development specifically in emerging markets that sets Yum!

apart and is positioning YRI for many successful years in the future.

Over 85% of the 14,500 traditional restaurants in this division are franchise units which generate a steady, growing stream of franchise royalties.

Yum!

Restaurants international has five markets we are particularly excited about -- India, Russia, Africa, France and Germany.

Last year, these markets contributed about $60 million of profit to YRI, but our projections call for that number to grow to over $300 million over the next five years.

Today, I want to talk about two of these significant opportunities, Germany and Russia, where I recently spent time with our talented local teams.

Before I talk about Germany, I think it is important to briefly discuss the success we're having in France to give it some context.

Our restaurants in France actually have the highest average unit volumes in the world for Yum!.

It's also the first market where we experimented with a business rental program to drive unit development and returns.

The reason I bring this up is that we have taken this successful model and applied it to Germany.

Today in Germany, we have 75 KFCs, mid-teen margins and more transactions per store than we do in France.

The team is committed to tripling its restaurant count to 225 units in the next five years.

Remember, our experience tells us it takes time to build the brand the right way.

But once you get to about 100 units, your scale allows you to accelerate growth.

Within the next 18 months, we plan on utilizing national television advertising for the first time because of that scale.

As I said, our transaction volumes are strong.

We have also averaged 5% same-store sales growth over the past five years and we now have margins in the mid-teens.

So our new unit economics are coming together.

Our challenge going forward is to secure great sites in Germany as fast as our people capability allows.

KFC has a long way to go in Germany.

The team is rallying behind this slogan KFC Wonderland in the Making.

And after seeing the business firsthand and seeing the action walking grip and our Germany -- our Germany general manager and his team are taking, I'm confident that we're going to get there.

We know that McDonald's makes more money in France and Germany alone than we make in all of Yum!

Restaurants International.

Our intention is to build a big business in these countries as well and we're making significant progress to do just that.

Russia is another country where we have to tip our hat to McDonald's, who we estimate makes over $1 million profit per restaurant annually.

We also have aggressive growth plans in Russia.

In July of last year we completed our acquisition of Rosticks and got full control of the KFC Rosticks brand in Russia, giving us 151 restaurants.

Recently we began rebranding the KFC Rosticks units to KFC stand-alone restaurants.

Our results have been excellent.

This year, same-store sales growth has been over 20% and restaurant margins are in the high teens.

The best is yet to come as we are just getting started with our single-minded focus on KFC in Russia.

Overall, Yum!

Restaurants International growth and development is on track.

It's great to see our leading position in emerging markets complemented by ground-floor opportunities in continental Europe.

Our strategy remains to drive aggressive expansion and build strong brands everywhere.

Next, onto our US business where our focus is to improve our brand positions, consistency and returns.

As indicated on our second-quarter call, we knew operating profit would be challenged in the third quarter, and it was.

Operating profit declined 16% as same-store sales fell 3%, and higher commodity costs weighed on margins.

Taco Bell, our largest and most profitable brand in the US, saw same-store sales decline 2% in the quarter.

While this is not an acceptable result for us, it is an improvement from the 5% decline we saw in the second quarter and it is versus more difficult comparisons from last year.

The team is working incredibly hard to get Taco Bell back on a growth track and we're confident we will do so.

We have market tested category breakthrough innovation in the pipeline that will re-energize the Taco Bell brand towards the end of the first quarter of next year.

In the meantime, it's all hands on deck to get Taco Bell back on the growth track.

Overall, while our US business results have certainly been disappointing, we have aggressively developed category-leading innovation and have productivity initiatives planned to dramatically improve both sales and profit performance in 2012.

Let me wrap up the total Yum!

story.

Overall, we're having another solid year.

10 straight years of double-digit EPS growth is something not too many companies can claim.

With very strong performance in China and other emerging markets as well as robust new unit international development, we're confident in our future growth as well.

So as we look to 2012, we're confident our international businesses are set up for continued growth and we have plans in place to dramatically improve US profitability.

We have a track record that proves how powerful our growth model is.

With the expected opening of 1500 international unit new units this year and our strategies in the base business, we're in a good position for next year and expect to continue our track record of double-digit earnings growth in 2012 and beyond.

Now let me turn it over to our Chief Financial Officer, Rick Carucci.

Thank you, David, and good morning everyone.

Today I'm going to provide some commentary on our third-quarter results and our outlook for the balance of 2011.

I will then review changes we're making to our business portfolio and provide some of our initial expectations for 2012.

During the first two earnings calls this year, I categorized our 2011 results as a tale of two cities.

Strong international growth, especially in China, has been in contrast to poor US performance.

This quarter, it's essentially more of the same.

China produced another impressive quarter.

Revenue increased an amazing 35% as we benefited from new unit growth, same-store transaction growth of 27% and favorable foreign exchange.

On the other hand, profit growth in margins were less than what we would expect with this type of sales increase.

Operating profit grew 7% in the quarter excluding foreign exchange or 11% adjusting for the 2010 impact of the Shanghai World Expo.

Margin declined 3.9 percentage points to a little over 21%.

Let me walk you through the details on margins.

With commodity inflation of 8% and labor inflation of about 20% in the quarter, we had some significant headwinds.

Margins in the quarter were also affected by the new business tax this year and the overlap of the Expo.

Taken together, commodity inflation, labor inflation, the business tax and the Expo overlap caused about 7 points of margin pressure.

The pricing we took in the first quarter helped offset about 3 of the 7 points.

There were some other moving pieces, but the gap between the inflation and pricing is by far the biggest contributor of the 3.9-point margin decline versus last year.

So let's briefly discuss some of the other moving pieces.

First, our new unit development pace picked up significantly this year.

The additional labor and preopening expenses offset some of the margin benefit of our transaction growth.

Additionally, some of our same-store sales growth Western provide targeted day part value initiatives that David walked you through.

Due to the higher cost of these initiatives, the profit flow-through through this transaction growth was less than what you would normally expect.

Going forward, we realize we have some work to do to close the gap between pricing and inflation.

We're taking actions to do this.

Our first step was a 2% price increase implemented the last week of September.

Going forward, we expect even higher inflation in the fourth quarter.

We now expect mid-teens food inflation and labor inflation of about 20% in the quarter.

To help offset this, we expect to tweak our value offerings late this year.

Despite these initiatives, this level of pricing still lags the impact of the high inflation rates.

We therefore expect a decline in fourth-quarter year-over-year margins.

We continue to expect restaurant margins of about 20% for the full year.

Going forward, we see no reason why we cannot continue to deliver at least 20% margins in China.

We believe that we will perform well financially because we have all of the necessary leverage including a strong competitive position, purchasing scale, a seasoned management team, a nationwide presence and expanding day parts.

In addition, the combination of our cell phone distribution system and large development team allows for profitable unit expansion in lower tier cities.

We really like our position in China.

We have excellent sales momentum and expect solid double-digit same-store sales again in quarter 4.

Our development continues to be robust.

600 new units is clearly an impressive number and we continue to generate cash paybacks of less than three years.

This is a portfolio that delivers high returns and high growth.

Let's move to Yum!

Restaurants International.

Our YRI business had another solid quarter with same-store sales growth of 3%.

Operating profit growth of 3% prior to ForEx included the impact of some one-time items.

Excluding a $6 million impairment expense for the Pizza Hut UK business, operating profit growth was 8% for the third quarter.

Additionally, YRI experienced a $4 million expense for the biannual franchise convention.

On the positive side, we received $5 million generated from the change in ownership of one of our large KFC franchisees in Australia.

Restaurant margin declined 0.2 points to 12.3%.

This decline was driven by soft sales and inflation in Australia and weak margins in the Pizza Hut UK business.

Although margins continued to improve in Thailand and France, the year-over-year impact was less than in previous quarters.

We still expect margins to improve significantly for the full year.

As we continue to update our ownership portfolio and increase our scale in key markets, our margins should continue to improve.

Overall, we believe that Yum!

Restaurants International business is gaining strength.

We're particularly pleased with our new unit development and exceptionally strong performance in emerging and under-penetrated markets.

We believe that these factors provide a solid base for sales and profit growth in 2012 and beyond.

Our US business had a disappointing quarter.

Sales improved versus the second quarter, but inflation hurt margins.

Looking to the fourth quarter, we expect that sales will remain a challenge.

We will likely see another same-store sales decrease.

Fortunately, we expect to benefit from the overlap of high G&A costs from last year as well as a 53rd week this year.

This should help improve US operating profits in the fourth quarter considerably.

As we finish looking at 2011, let me provide some more expectations about the impact of the 53rd week this year.

The 53rd week provides a $25 million operating profit benefit.

This represents a $0.04 EPS benefit in the fourth quarter.

This benefit is split between the YRI and US businesses, and for the full year we committed about $20 million in higher-than-normal spending.

This spending includes development and operational initiatives for our Pizza Hut US business and the higher impairment expenses at Pizza Hut UK.

The bulk of this spending is already reflected in our year-to-date financial results, while about $3 million of the $20 million is spending that is anticipated in the fourth quarter.

When you put all of this together, we're still quite confident that Yum!

will deliver EPS growth of at least 12% in 2011.

Before we look ahead into 2012, let's first reflect on some key decisions we made this year to realign the Yum!

portfolio.

Our philosophy is simple.

We reduce Company ownership in highly penetrated or under-performing markets.

We increase exposure in emerging and under-penetrated markets.

We have continued to be disciplined and proactive in managing this aspect of the business.

In 2011, we made several decisions that will serve to reduce our financial footprint in highly-penetrated markets.

First of all, we continued our US refranchising program.

This year's focus is on refranchising KFC restaurants.

For the full year, we expect to be franchise about 400 restaurants and the majority of these are KFC units.

We expect to end the year with about 500 KFC company-owned restaurants.

The game plan is to retain 5% ownership, or less than 250 units.

This quarter, we also announced an agreement to sell Long John Silver's and A&W All American Restaurants.

I know it's tough to run a business during a selling process and I would like to thank the LJS and A&W teams for all of their hard work this year.

The deal is expected to close in the fourth quarter and we wish our franchise partners and the team every success going forward.

In our release, we all so announced the decision to refranchise our Pizza Hut UK business.

We believe this will improve Yum!

Restaurants International's profits and margins.

Every year, we increase our exposure in high-growth emerging markets through our new unit growth.

This year, there are also two potential transactions that could increase our ownership in under-penetrated markets.

We made a bid to acquire Little Sheep in China and we plan to acquire a KFC South African franchisee.

We're still awaiting China government approval and have nothing new to report on Little Sheep.

So let me talk about Africa.

We expect to close on the South African deal later this month.

We already have a great franchise business in South Africa with over 600 restaurants.

We believe that the 70 units we are acquiring will provide another growth vehicle in that country.

These restaurants will also provide a base for us to train our franchisees in the balance of Africa.

We remain hopeful that in the long-term, Africa can become a large franchise business and a meaningful source of growth.

In the past year we opened the KFCs in 4 new countries in Africa and our goal is to spread aggressively across the continent.

As we head into 2012, we believe that our portfolio has never been stronger and that we're building upon our advantage in emerging markets.

We're still in the process of developing detailed plans for our businesses in 2012.

Therefore, I will not talk about sales and profit plans today.

As usual, we will share information on these subjects at our December meeting.

However, I do want to share some initial thoughts for 2012 and some items that will influence our performance.

We are fortunate that our new unit development usually provides us with a head start on building a profit plan.

This year is no exception.

The development of 1500 new units outside the US in 2011 will provide us with a head start for 2012.

Overall, we expect new unit development to contribute about half of our 2012 growth.

We expect to see benefits in 2012 from share repurchases.

In our release, we pointed to year-to-date 2011 share repurchases of $545 million.

We expect about $800 million in repurchases for the full year and a similar amount in 2012.

The impact of these share repurchases should provide 2 points of 2012 EPS growth.

While it is uncertain how the dollar will perform against most other currencies next year, it's probably a good bet that we get RMB translation benefits again in 2012.

Now don't get me wrong; we spent 2012 to be another challenging year.

The economic climate is very uncertain.

Inflation could also rear its head, especially in the first half of the year.

We know that we need to turn around our US business, but Taco Bell is a resilient brand and we will have easy overlaps next year.

As David mentioned, in addition to our innovation pipeline, we will be taking a hard look at managing costs within our US business.

I do have a lot of confidence in our business model.

I have faith in our team's ability to grow the business and manage costs tightly.

Our global portfolio has delivered 13% annual EPS growth over the past decade.

This decade has included quite a few individual challenging years.

I also just told you that our portfolio has never been stronger.

Therefore, I believe that 2012 will be another year where Yum!

will deliver strong results for our shareholders.

Back to you, David.

Okay, Rick, thank you very much.

And let's open it up for questions.

(Operator Instructions) David Palmer, UBS

Thanks, hi, guys.

I'm sure you're going to get a lot of questions about the China margins this quarter and there are many reasons for that.

You stated some of them.

But just taking a step back, I'm curious about the strategy for China in 2011.

Are you getting from this business what you thought you would get at the beginning of the year?

And I guess I'm drilling into the fact that you had accelerating inflation and you knew that.

You were also pursuing two major value menu launches, one at breakfast earlier in the year, one at the beginning of third quarter with the lunch stuff.

And in all this time, you've waited on pricing since late January.

You have not raised price, and even back in January it wasn't a hell of a lot of price.

And then on top of that, you are embracing a rather expensive ramp-up in unit development here in the third quarter, putting further pressure on margins.

And so I'm wondering, and I guess a lot of folks are wondering, why have you been so stingy on the price, and are you getting some sort of reaction on all of this stuff that you weren't expecting?

Any help on this would be great.

Well, David will talk about the consumer side, and then I will handle the financial aspect of it, David.

Well, first of all, David, our strategy is a brand-building strategy and an asset leverage building strategy.

And what we are trying to do is make our brand as compelling and as relevant and as ubiquitous as it can possibly be in China.

And if you look at the real success factors in this category, you have a broad menu, you leverage your asset throughout the day and you make your products affordable on an everyday basis.

And in China, we're doing this and we're doing it with great margins this year.

And I think what I feel terrific about is that we're getting everything that we want to get out of China.

We're continuing to grow this business and we have a great team of people there that are focused on building this brand and building day parts and leveraging that asset throughout the day.

But they're first and foremost brand builders, and I think that is what we're doing.

We have tremendous operational excellence.

We're maintaining fantastic operations as we're dramatically improving our transactions.

Our average unit volumes now are $1.7 million.

So we're getting -- our new unit cash flows and the margins are as good as they have ever been.

And so we're having another excellent year in China on top of a great year last year.

So strategically, the only thing I think we have done is further solidified our strength with the customer.

We will have -- this year, we're going to set a record for new units.

We're going to have 600 new units.

So just think of the transaction growth we're achieving, sales growth we're achieving, the margins that we have and we're still adding a record number of 600 units.

So, to me, looking back and stepping back and looking at China, it would be hard for me to say, if someone said can we write this story last year, at the beginning of January, could we have this kind of performance?

I would say give it to me, give it to me this year, give it to me next year, keep it going.

And the best thing about our business is that we've got KFC moving on all cylinders in China.

And also, as I mentioned in my earlier remarks, we have Pizza Hut now which has been dramatically transformed.

Were going into 100 -- we're going to open up 100 stores in Pizza Hut this year.

We're going into tier 3, 4 and 5 cities in Pizza Hut; we only have 500 units.

So we are constantly just trying to build these brands the right way.

I have always said that we've got these tremendous diamonds, we've just got to keep polishing them and growing them the right way and our people capability has never been better, the brand has ever been stronger, and Yum!

in total is going to have another excellent year.

Just on the financial side, David -- and by the way I'm in the same place that David is, as I think China is having a spectacular year overall.

You know, we are still new at the game of value in China, some of the value initiatives.

So the first ones we did were earlier this year in breakfast and then around April time at lunch and snacking.

So we're still on version 1.0 of doing value initiatives.

And all along, we recognized we're going to read the consumer and see what we did.

I think we're very happy with the transaction gains that we had.

We have quite a bit of growth in breakfast, which is fantastic.

We probably had a little bit higher mix to some of those value initiatives than we would have guessed at lunchtime.

But we always knew going into this that we could adjust.

The only thing that makes the adjustment tricky is in the fourth quarter, inflation towards the end of the third quarter is a little bit higher than what we were anticipating.

To your point, we're anticipating high inflation.

But the labor inflation, starting the year we thought it would be in mid-teens, and in the quarter was 20%, and we think it's probably going to be at 20% in the fourth quarter as well, and then commodity inflations we thought would not get up -- not get higher in the fourth quarter.

So that's -- the biggest issue that we probably have is the adjustment towards the value, it will take us, say, a little bit of time.

But, again, I couldn't be happier with the overall results.

The profit results we have year to date excluding ForEx of 15%, and that is on top of 26% last year.

So we feel -- I will take it as David says.

Regarding the unit development, to me that's a no-brainer if you could get more units in China.

The team is extremely disciplined on development.

And one of the good things that came out of the last five-year plan is that the government sort of is starting to build city clusters around some of the major cities -- about 20 or 25 major cities.

We think that gives us new unit opportunities.

One is, some new trade zones will be developed as they are going to build housing in those areas, but they're also building trains and buses and stations and all of that, which those type of infrastructure things help us.

So it has really been a combination of that investment and the trade zones that that opens up for KFC.

As well as, David in his speech talked about how Pizza Hut is now able to get into tier 3 and tier 4 cities much more profitably than before.

So that has allowed us to increase our Pizza Hut development significantly.

So if we could build 600 units a year ago going forward, and if that causes us a quarter issue with labor, that's like a no-brainer.

We still get less than three-year paybacks on those investments.

So we feel great about where we stand in China.

So, in summary, both KFC and Pizza Hut brands have never been stronger.

Both brands are more ubiquitous than ever before.

We're leveraging our assets throughout the day.

We're opening up new units with returns that are at least if not better than any we have ever had, and we're more optimistic than ever about the breadth and future of these two brands.

And with the China consuming class going from 300 million to 600 million over the next -- in the coming years, we couldn't be in a better place.

So very pleased with this year in China.

Thanks, David.

Next question please.

David Tarantino, Robert W.

Baird.

Hi, good morning.

Just a quick follow-up on some of the discussion related to China margins.

Rick, I was wondering if you could maybe comment on how the team there is planning to manage the long-term structure of the China margins.

I know you have given us a little bit of ground this year, but the economic models still remains quite healthy.

So should we think about China as maybe a 20% type restaurant margin over the next several years, and the plan is not to necessarily recover some of the margins that you have lost this year?

Maybe just explain how you're thinking about that business.

Yes, I think to your point, David, clearly the inflation this year is higher than normal, so it's hard to chase inflation when it's that high.

Our hope is that inflation, especially commodity inflation, will abate by midyear next year.

Labor inflation we think will remain high, but not as high as it was in the back part of this year.

So in terms of how to deal with inflation, though, I do want to emphasize that we're in a better position to do it than we think everybody else.

We have the different levers that I talked about in my speech in terms of different day parts, a strong distribution system, and so we could take pricing in different areas and different parts of the country, etc.

And with our capability, we think we are better equipped than pretty much anyone else there to deal with inflation.

You know, probably game plan is that we will gradually take pricing and catch up to inflation.

And then when inflation abates, we'll be back -- to your point, think we expect -- I would call it at least 20% margins.

But again, we knew we were off of very high margins a year ago.

So we never thought -- going into this year, we didn't anticipate we would keep that level of margin.

So I think somewhere between a little over 20% is probably where the margin will shake out over the next couple of years.

Great, thank you.

Thanks, next question please.

Greg Badishkanian, Citigroup.

Hey guys, this is (inaudible) actually on behalf of Greg.

It looks like you guys had a nice improvement at Taco Bell this quarter, and maybe a little bit sooner than you had initially anticipated.

I think you called out 4Q for that improvement back into 2Q.

So what do you think are the factors behind that improvement?

Has the lawsuit concern sort of abated?

And has that momentum continued into 4Q as well?

Well, I think Taco Bell is making steady improvement, but it is slow improvement.

And we're obviously not pleased with our same-store sales.

Anytime your same-store sales are down, you can't be at all pleased about it.

But, to your point, we have improved.

We went down from 5% in the second quarter to down 2%, and our two-year numbers are plus 1, if you look to your basis.

But I think it has just been more of the same without any significant breakthroughs.

What we've really been working on this year is, first of all, just across the board around the world at Yum!

Brands, we've been focused on operational excellence and making sure that we deliver a great experience to our customers.

We've been focused on maintaining our number one value initiative.

But, what we really think is going to really get Taco Bell moving and back on the growth track is more category innovation.

And so what I'm really pleased about is, this year, we have proven in test market that we do have exactly that coming forward which will be launched at the end of first quarter.

Taco Bell in conjunction with our 50th anniversary will be reinventing the taco.

We have some major news coming.

So I think you're going to see some pretty much blocking and tackling, more of the same until we get to the end of the first quarter, and then we think we will have a significant uplift in our business.

And just to add to David's comments about what we see through the balance of the year and into the early part of next year, just as a reminder, the laps for Taco Bell do get a little bit more challenging in Q4.

So that, combined with the fact, as David said, the real look forward is the new innovation coming in at the end of Q1 next year.

Thanks.

Next question, please.

John Glass, Morgan Stanley.

Thanks very much, I have two questions.

The first one, is it worth or is it even possible in China to get better visibility on pricing on food for the security purposes?

In other words, McDonald's is experiencing what they claim is low-single-digit inflation right now.

And I know you can't speak to that specifically, but it does underscore that it is possible to get lower volatility in food.

It would seem, since you have the ownership of the distribution you would have a natural advantage there and see lower volatility, and yet you're seeing higher volatility.

So can you explain why that is the case?

And is there a movement now to change how you purchase food to avoid these situations in the future?

I really, John, can't talk to McDonald's, but I will talk to what we have.

If you look at -- to your point, if you look at what our food inflation has been -- if you look over the last five, six years, it has been way below what the inflation rate has been for food.

And we were getting purchasing efficiencies and all of those benefits as well.

So we have a world-class supply chain group in China.

We have very strong distribution.

So our costs are, I think, very well managed there.

The challenge that we have had really has been on the proteins the last several years.

So when you have seen this spike, it has really been related to -- we think it's been going with the market on both pork and chicken.

So pork has had a lot of several price spikes the last few years.

That has an impact on chicken, because those are the two leading proteins in China.

So that is really what has been driving the volatility, we think, on the chicken has really been what has happened on the pork side in China.

We are hoping that that will abate early next year on the pork side and that we will start seeing better chicken costs I would say starting at around the second quarter next year.

But that's a guess at this point; we will give you better data, if we have it, in December.

Okay.

And then can you just decompose that 700 basis points pressure you talked about, Rick, on the labor side between wage rate inflation with the new openings put on that?

And then on the food side, what is just the inflation versus what is the impact of these promotions?

Yes, if you just want to think about it simplistically on a year-to-year basis, there's obviously a lot of moving parts.

If you take 8% food inflation on our base of about 34% or so, you get a little under 3 points of inflation on the food side.

If you take 20% inflation on labor, which is about 14% last year of our base costs, that gets you to, again, a little under 3%.

So food inflation, labor inflation in Q3 is equal to about 6% impact on margins.

And, I'm sorry, then the remaining 100 basis points has to do with the value promotions?

Well, yes.

Then there's a lot of other moving part points.

In my speech, I talked about the business tax, the Expo lap in Q3 that was about a point, but then you obviously have benefits from transaction gains, etc.

But from an inflation standpoint, it was about 6 points of the issue.

Unfortunately in Q4 that goes up to about 8 points because we said we expect mid-teen inflation on the food side and it's still about 20% on the labor side.

So the September price increase will basically offset that increase.

And then I mentioned before, we're going to tweak our value initiatives which will be another step in that direction.

But, yes, that is what we didn't expect.

We didn't expect the fourth quarter to be 2 points higher than the third quarter.

So that piece we were taken by surprise on.

Thank you.

Thanks, John.

Next question please, David.

Michael Kelter, Goldman Sachs.

I was curious to follow up on your comments about right-sizing the cost structure in the US.

Now with operating profits down as much as they are, are we talking about just sharpening the pencil, or further on the spectrum a formal restructuring or somewhere in the middle?

What kind of things are you looking to do?

Well, we've always looked aggressively at our cost structure.

We have also -- over time, we mentioned we're continuing to refranchise our business in KFC.

And, therefore, as we do that, that will have a modest impact on our cost structure.

We will continue to look at this.

We're still developing plans as we go forward.

We will probably have more to say on it in the fourth quarter, Michael.

All right, and then on an unrelated kind of housekeeping note, from a financial perspective, what should we expect the impact of the Long John's, A&W and Pizza Hut UK refranchising on the P&L?

Are those actions accretive, dilutive or roughly breakeven?

What do you think?

About breakeven.

The LJS will be very slightly negative impact, about flat.

And then the Pizza Hut UK, depending on when it occurs, will be slightly positive.

Thank you very much.

Thanks, Michael.

Next question please, David.

Joe Buckley, Bank of America Merrill Lynch.

Thank you.

Rick, first a simple one.

If you said this, excuse me, but what are you thinking on the full-year tax rate?

Are you still thinking around 26%?

Yes, no change there.

Again, as we said before, it's the hardest one to predict, Joe, so it moves around based on one-time events.

That's just how the accounting works.

Okay.

And then, another question on the China margins.

The strength in breakfast and the development of the delivery and even the 24-hour business, are all of those dilutive to margins, and can you quantify the impact of developing those additional sales layers, the impact on margins?

On breakfast, what we're selling now at breakfast now is probably about 8 points higher food cost as a percentage of sales basis than the rest of the menu.

Delivery I really can't speak to.

Okay.

I think that's all I have right now, thank you.

Thanks, Joe.

Next question please, David.

Larry Miller, RBC.

Yes, two quick questions as well.

So you mentioned tweaking the value menu in China.

Can you give us a sense of what you are doing and how it might stack up competitively?

It looks like a lot of other folks are doing value as well.

And then secondly, just on the negative mix in China, you said half of it was related to your value initiatives.

What would you describe the other half to?

Thanks.

Can you repeat the second part of the question again?

So you had a negative mix in China; I think it was close to 8 or 9 points of negative mix.

You said half of that was related to the value initiatives at breakfast.

What is the other half on the negative?

Is it consumer push-back on pricing?

Is it some other initiatives that you have, or is it competitive pressure?

What would be the other half?

Larry, I think -- we assume you're talking about check average, which we said breakfast was about half of that.

If we're wrong on the assumption, let us know.

But the rest of it would be the value initiatives at lunch and afternoon snack.

Okay.

And we're not going to tell you, obviously, for competitive reasons exactly what we're going to do on the value side.

But, we're looking at those bundles.

So, for example, we have a RMB6 offering at breakfast and a RMB15 offering at lunch, and we're looking at what the composition of those bundles are.

Okay, thanks.

Thanks, Larry.

Next question please, David.

Jason West, Deutsche Bank.

Yes, thanks guys, just two questions.

First on the outlook for 2012, I know you don't want to get too specific, but big picture, should we assume another sort of above average type of year on China comps given the amount of pricing you're probably going to have on the menu for next year?

Or how should we think about the mix versus traffic?

You're lapping some big traffic numbers, but also some big negative mix numbers.

Just trying to think about the components of comps in China next year.

Yes, it's a hard one to call.

To your point, we are going to get the benefits of pricing.

On the other hand, we expect that to continue into next year.

On the other hand, we're lapping some extraordinary large increases in transaction.

So we just don't know where will shake out to be honest with you.

But, again, I do want to remind you, our model doesn't require the type of sales growth that we had this year.

Our model requires more like about a 5% or 6% same-store sales growth.

So we may have more visibility as we get deeper into this year, but obviously we expect the fourth quarter to still be strong.

We have a lot of momentum right now.

Okay.

I think the other thing too is that, as we look at the sales, remember, we are very early days on all of the day part initiatives that we are driving up against.

So breakfast, for example, is only 7% of our total sales mix.

We've only got delivery on 1500 units.

So we're 24-hour services.

All this is early days on the asset leverage.

And we, of course, will have lots of product news like we have in our China business on both brands.

So I think there's tremendous upside as we go forward.

Okay, just a quick one on the unit growth.

Is the 600 number for China kind of the number going forward that we're using for 2012 as well, I'm assuming?

I think it's as good a number as any right now.

Okay, thanks, guys.

Thanks, Jason.

Next question please, David.

John Ivankoe, JPMorgan.

Hi, thanks.

It's (inaudible) on for John.

Just in terms of the US, it sounds like you have committed yourself to a pretty major reinvestment in terms of Taco Bell beginning early next year.

And I know that the brand probably does have the highest profitability of your three brands, but it does seem like the return on investment would be higher if you directed it towards maybe an acceleration of growth in one of the international businesses.

So could you just talk a little bit about your thoughts based on the earn the right to own premise about refranchising that brand potentially even doing to 5% like KFC and Pizza Hut?

Well, first of all, we have the (technical difficulty) [earn-]it-right-now mentality around the world.

So we look at -- we're looking at Taco Bell just like we've looked at Pizza Hut and KFC, and we do think that there is some opportunity there.

You know, I think in terms of next year, I don't think we look at it as a year of reinvestment.

We just think we look at a year of a lot of the investments that we have made paying off because we've made investments in the pipeline.

We have some proven products that we feel good about and we expect that we'll be able to drive the top line.

The biggest thing that is impacting our business at Taco Bell this year is the sales deleverage, and we think we ought to be able to get same-store sales growth as we go forward.

We're also going to be expanding breakfast next year in the Western part of the United States, and we think that will begin a march towards the long-term rollout of breakfast on a national basis.

And, John, just to build on David's point, the margins and the profit history of Taco Bell over the last decade has been quite different than KFC and Pizza Hut, and that will be reflected in our plans.

Okay, thanks.

Next question please, David.

Jeffrey Bernstein, Barclays Capital.

Great, thank you.

A couple of questions.

Just first looking to on the China front, I think you mentioned a couple of times that momentum thus far in the fourth quarter has sustained itself.

Obviously we've heard a lot of cautionary comments on China and a slowing in trend.

So I just wanted to confirm that over the past month, since these results are reflecting that you're not seeing any deceleration or any shift in the consumer spending habits on the China comp.

And then just kind of looking at China with the high teens comp you're doing right now, once you lap the value side of things, what do you think is the underlying run rate ex the value that we should be assuming?

Like how much of that comp light that you're getting that is value offer-driven so we can kind of assess the underlying run rate?

And that I had a follow-up.

We don't discuss trends within a quarter, but we do discuss if there is a major change from the last quarter.

So we have nothing to tell you, which I guess tells you something.

Regarding what the underlying rate -- it's really hard to call.

There's just too many moving parts with different inflation rates, different labor rates etc.

What I would say, though, is that I've seen a lot of reports on China and while people are trying to estimate what is going to happen to their economy, and I'm not sure if they're going to be any better than people trying to estimate what happens in the US economy.

I think from our business, what we keep our eye on is the point that David made earlier about what is happening in the middle class.

And everything that we see is that the increases in the labor rates, the people moving from the countryside to the city, the establishment of the city clusters, etc., I sort of like those type of macro trends, and to me I haven't seen any deterioration of those.

If anything, I think the five-year plan may have helped us a little bit because labor is going to grow a little bit -- labor rates are growing a little bit faster and we're going to get that infrastructure in those city clusters.

So I feel pretty good still about the -- I'll call it the broad macros.

In terms of month-to-month, quarter-to-quarter economic trends, I don't know if we're any better than anybody else who is out there.

But as I said before, I feel we could deal with the environmental shifts whatever they are pretty well given the quality of our team, our national presence and the different day parts that we have.

Okay, and then just a follow-up.

You mentioned Taco Bell specifically next year obviously benefits from having easy compares, as you mentioned.

And then it seems like the back half of the first quarter, you are pretty excited about the product innovation.

I'm just wondering whether the breakfast reference was something totally additive to those other things.

Any color you can give -- I know breakfast has been a focus for a long time now and it has been in test for a long period of time.

I was just wondering if you could give any color in terms of what you're seeing in the test markets to give confidence to roll it out in 12, at least to the Western part of the US.

Well, we've had test markets in the Western part of the US, which says basically we'll be able to expand breakfast there and do it well.

And we're continuing to develop the breakfast day part and our product innovations around that and how we approach value for the rest of the country.

So we are beginning to roll out in the area where we think that we have the greatest opportunity for success.

Yes, I think it will only have a modest impact next year.

I think the bigger thing that we're trying to do with breakfast is we mentioned awhile back, we're doing I will call it a gradual breakfast where we're opening earlier and serving breakfast items and then continuing does breakfast items for a good part of the day.

So we think that, given that trend, that we could get a fair number of franchisees to pick up breakfast over time.

So the first tranche of that is really in the West next year.

So I look at that as a key.

If that is successful then the other parts of the country should be able to go along because it's not nearly as big of an investment than when you're opening up very early for breakfast and have the labor challenge that we've had before.

So I think what you will probably see happening is a gradual roll and a gradual impact on sales.

Thank you.

Thanks, Jeff.

Next question please, David.

Sara Senatore, Sanford Bernstein.

I must have misspoke on the call.

It is Sara Senatore at Bernstein.

We know who you are Sara (multiple speakers)

It's my pseudonym.

So, actually, I just wanted to follow-up a couple of things that have been touched on already.

One was the unit growth outlook in China.

Actually I had sort of been hearing I think for a while we've been hearing this idea that unit growth with like the number of units would step up but the pace of unit growth was slow.

But it actually feels like the pace of growth is kind of holding steady.

So I wanted to see if anything had changed there.

And then the second question was more about back to the inflation issue, which is only that, historically, most of your inflation I think, and certainly most of the volatility has come from food.

So we could be fairly comfortable that your comps would kind of move with that food inflation directionally generally speaking.

Now a lot of it is coming from wages.

So is there any concern that it won't be -- the matching won't be quite as good between what you are able to do on the top line and what kind of margin pressure you're saying on that line item?

Let me do the second question first.

I think the inflation piece, the volatility just makes it hard to get the timing exactly right.

So I think that to your point the wage -- commodity inflation will probably dictate what happens to quarterly margins.

The labor side of it, to your point, is a structural component, but as you also pointed out -- so we expect that to continue.

So we expect high labor inflation to continue, not at the pace we had in the third quarter, but it's going to be at least double-digit.

It could even approach the mid-teens would be our guest over the next couple of years.

So we think that is structural.

But to your point, we sort of know that is coming so we could plan our margins and our pricing accordingly for that.

It is a commodity thing.

It's a harder one to call, and therefore, that is the one that we may get ahead of or behind of over time.

In terms of the development part of your question, if you really look at it, it's really hard to predict when you would get the spike in development.

But it hasn't been a continual climb.

So if you look at what has happened historically, we were about 250 units and we were at that for a few years, then we went up to the 350 to 400, and then we quickly went to 500.

And then we've been at 500 for a few years now.

And so we couldn't call when we would get another jump.

So what we used to say to your point, or what I personally use to say is we expect the absolute numbers to go up but the percentage to go down just because our base keeps getting bigger.

I think over time that is probably still a good generalization, but we have a hard time predicting when the spikes will come.

We didn't know that they would do these city clusters.

We weren't sure when Pizza Hut dine-in would get more profitable in tier 3 and tier 4 cities.

So that is just hard the call.

So right now, I feel very pleased we're at a 600 base, and we'll just have to play it by ear from there.

Thanks.

Thanks, Sarah.

Next question, please, David.

Mitch Speiser, Buckingham Research.

Great, thanks very much.

In emerging markets in general, the comps seem to be very strong, obviously driven by your brand and compelling value.

But if we were to drill doing to perhaps the relationship between wage rate growth and comps growth, do you find a clear correlation between the two?

And if so, does that maybe make the year-ago comparisons less important when you're thinking about setting your comps targets?

Yes, it's a good question.

I don't know if we have enough data because you had this spike-up occurred just this year.

So we think it's generally unbalanced; it's probably a good thing.

In the short term it's harder because we have to deal with it from a pricing and managing the inflation side of it.

But it is bringing more people in terms of affordability into our restaurants.

And we just on at the visibility to give you sort of give you more math around that.

So it's just sort of what it looks like on a broad basis.

And just a quick follow-up -- with traffic up so tremendously, are there any capacity issues?

It sounds like most of the traffic was probably at breakfast, or the increase, which is probably low capacity.

But when we think about KFC in particular in China, can you just talk about any capacity constraints whatsoever?

Well, we have a lot of units.

That is one of the reason we had units is to make sure we could still provide a great experience to our customers.

Breakfast -- we were --we knew we had capacity at breakfast, so we weren't really capacity constrained there at all.

That was a day part that was light so we had to bring some more labor in over time.

We actually started breakfast a long time ago.

So we have still a lot of capacity at breakfast.

Our hardest time is still weekends, so our biggest capacity situation are weekends.

So for example when we did the day part initiative in China, that was a weekday-only initiative, as an example.

So that is probably where our biggest bottleneck is, and the way we relieve that bottleneck has been through adding units.

And as David has mentioned in the past, we should have really good operations there as well.

So we think we are still providing a good experience to our customers, and when the lines sort of get too big, we sort of build more units.

Great, thank you.

Thanks Mitch, next question, please, David.

Keith Siegner, Credit Suisse.

Thank you.

Just a question on YRI.

At the company store base, the AUVs were up 35%.

I'm just having a little bit of a hard time understanding that against a system comp of, let's say 3%.

So I know that FX and both the Mexico refranchising help, but they can't account for the whole difference.

If you could just help me get a little bit of an understanding on, say, where that AUV growth is coming from.

Is it different comps at Company stores versus franchise?

Is it because most of the new Company openings are in France where AUVs are high?

And then one quick follow-up to that -- quick follow-up to that -- I will come back to the follow-up, so let's start with that.

Keith, it certainly is a portfolio mix issue as we've talked about on several occasions in the past.

France is definitely entering into the mix with the highest average unit volumes.

And then, also, same-store sales have been stronger this year in Company stores.

Okay, and then the follow-up is, as you re-franchise Pizza Hut UK, whenever this happens -- it's roughly 470 units -- it's a third of the YRI Company store base.

As that happens, what does this do to Company AUVs and margins?

Just a general direction, or more detail, whatever you would be willing to offer, would be helpful.

Thanks.

The AUV is probably not as big an impact.

Margins will be very favorable probably by about 1.5 points or so.

We'll have to give you the math as we get closer to.

(multiple speakers) yes.

Okay, thank you.

Thanks Keith.

Next question, please, David.

Larry Miller, RBC.

My question was answered, thank you.

There no further questions Sir.

Do you have any closing remarks?

First of all, I would like to thank everybody for being on the call.

Yum!

Brands is going to have another very strong year, achieve at least 12% earnings per-share growth.

I would also like to today, since this is our founders week, I would like to thank all of our shareholders who have been so supportive over the year.

We have a number of shareholders who have been with us from the very beginning, so I would like to thank you for that support.

You know, we have done well at Yum!

Brands in the past.

What has us most excited about is what we can get done in the future.

We believe in our business model.

We believe in our brands and our people capability has never been better.

So I'm very confident that we will be able to continue to deliver.

So, thank you very much.

This concludes today's conference call.

You may now disconnect.