百勝餐飲集團 (YUM) 2012 Q2 法說會逐字稿

Good morning my name is Keisha and I will be your Conference Operator today.

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

Brands second-quarter 2012 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, Mr. Tim Jerzyk, Senior Vice President of Investor Relations, you may begin your conference.

Thanks, Keisha, good morning, everyone, and thanks for joining us today.

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 recording.

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 and the risk factors included in our filings with the SEC.

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

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

We also like you to please be aware of a few Yum!

2012 investor events that basically the balance of the year.

On August 22, we will host a YRI, Yum!

Restaurants International Investor Conference in Plano, Texas.

On September 12 and 13, we will host an investor conference in Shiyan, China.

This will be followed by an event for investors in Vietnam on September 15.

If you are interested at all, please get with us very soon seats are filling up fast.

Tuesday, October 9 third-quarter earnings will be released.

Finally, our annual investor update meeting will take place up December 6 in New York City.

As you may have seen recently, Rick Carucci was been our CFO for the past seven years has been promoted to President of Yum!

Brands.

Rick will be here today and will be available for questions.

Pat Grismer has been promoted to CFO replacing Rick.

Pat's been with Yum!

for 10 years, was previously CFO of Yum!

Restaurants International and most recently Yum!'s Chief Planning and Control Officer.

Pat will provide comments today, review our financial performance, and (inaudible) will provide comments today on the call as well.

Now I'll turn the call over to David Novak, our Chairman and CEO.

Thank you very much, Tim, and good morning, everyone.

I'm pleased to report we've generated strong system sales growth in each of our divisions, China, Yum!

Restaurants International and the United States and India.

In the second quarter, we did this with robust new unit development and exceptional same-store sales growth.

Operating profit increased 8% while EPS growth of 1% was negatively impacted as expected by a higher tax rate compared to last year.

Our US business increased operating profit 26% in the second quarter and drove our overall operating profit growth.

Based on our first-half results and solid current sales trends, we reconfirm our full-year guidance of at least 12% EPS growth excluding special items.

In China, our strategy is to build leading brands in every significant category.

System sales increased 27% or 23% excluding the sales associated with our acquisition of Little Sheep.

This increase was driven by an 18% increase in new units and a 10% same-store sales growth.

We opened 160 new restaurants in the quarter and are pleased to raise our full-year projection for new restaurants in China to at least 700 from our previous guidance of at least 600, and that will be a new record.

Despite this extraordinary top line growth, I'm sure you noticed operating profit was down 4% versus last year before foreign currency benefit.

Due to a 4 percentage point decline in restaurant margin.

We expect this to be short-lived as our menu initiatives including pricing begin to take hold and inflation moderates.

As a result, we expect modest margin improvement in the second half of this year and double-digit profit growth.

Pat Grismer, our CFO, will be taking you through this in more detail during his remarks.

There's no question that the China economy is slowing and sales for retailers including us will likely soften especially as we overlap such strong performance from last year.

We continue to be confident in our strategy of driving affordability to the growing consuming class and it's backed by extremely strong business model which is driving record new unit development.

Now given what we're all reading about, the Chinese economy, I'm sure the question on your mind is, what are our expectations for sales growth in the second half of the year in China?

As you know, there are two components of our system sales growth, new unit development and same-store sales.

As I mentioned earlier, we expect to build a record number of new units in China this year.

So I think it's safe to say that we feel pretty good about our new unit potential continuing to drive substantial growth not only this year but over the long term.

The most compelling stat we have is we only have four restaurants per million people in China compared to nearly 60 in the United States and the consuming class is expected to double to over 600 million people by 2020.

As for same-store sales growth, our results over the past six quarters have been sensational.

And as we've said to you before, we simply cannot expect this double-digit pace to continue over time, although we do expect to do well.

Keep in mind we'll be overlapping 20% same-store sales growth from the second half of last year.

So while it's difficult to call, our expectation is that we should be in the mid single-digit range as we overlap last year's incredible growth.

One of the things I'm most pleased with is that by the end of the year, our average unit volumes will be $1.7 million for KFC and Pizza Hut dine in.

And not only has this number grown 25% over the past five years in local currency, but that's on top of doubling the number of restaurants we now have in China.

Even more impressive, the top 10% of our restaurants now have volumes of nearly $3 million, so clearly we have a strong track record of growing same-store sales and units with plenty of room to continue this growth.

KFC now has 3917 restaurants in China with average unit volumes of $1.7 million and continues to expand in new cities as well as increase its penetration in existing markets.

We continue to make progress expanding day parts in building a sales layers that further leverage these nearly 4000 KFC assets.

Virtually all KFCs in China serves breakfast, which now accounts for 7% of sales, half offer delivery service and over half have 24-hour operations.

The good news is we know we're in the early innings with these initiatives and have sales growth ahead.

Pizza Hut casual dining now has 696 restaurants and continues to open successfully even into lower tier cities.

Its strategy to offer tremendous variety, everyday value and refresh 25% of its menu twice per year has consistently driven sales and profit growth.

In fact, this marks the tenth consecutive quarter of double-digit same-store sales growth at Pizza Hut casual dining.

I'd like to congratulate Peter Kao, our entire-- our Pizza Hut General Manager, and the entire Pizza Hut team for this tremendous accomplishment.

Based on how the Pizza Hut team has broaden its appeal, you may have noticed that we are now successfully opening new stores more aggressively including tier 3, 4 and 5 cities.

In fact, we saw a 28% increase in new units this quarter for Pizza Hut casual dining.

Clearly Pizza Hut casual dining like KFC is a power brand in China.

Importantly, new unit returns for our two leading brands in China, both KFC and Pizza Hut, are among the best of our business with cash paybacks within three years.

We also continue to make progress developing our emerging brands in China.

Pizza Hut Home Service now has 139 units and East Dawning our Chinese fast food brand now has 30 restaurants.

We're also in the midst of integrating Little Sheep the leading hot-pot brand in China into the Yum!

portfolio.

We obviously acquired Little Sheep to strengthen its operating model and increase its market leadership position.

I want to point out the results have been soft since before its acquisition and the trend has continued post-acquisition.

Due in part to the long approval process in transition, we're behind where we expected to be.

We are however beginning to see sales stabilize.

We know this is a powerful brand and we have the expertise to make it even stronger.

We have completed management integration into Yum!'s China team and have new initiatives moving through the pipeline.

We didn't buy this business for its 400 plus units, we bought this brand for its potential to join Pizza Hut as the unquestionable leaders in casual dining and the potential to open thousands more restaurants.

I'm confident our team is taking the necessary steps to build this business for the long term.

Moving onto Yum!

Restaurants International, you may recall that Graham Allan retired from our Company late last year.

Micky Pant has taken over the reins and is making major headway.

We are realigning Yum!

Restaurants International shifting more resources to the field and have organized our know-how building around emerging and developed markets.

In fact, Micky and Sam Su, our Yum!

Vice Chairman and China CEO, conducted a know-how building seminar which lasted a week in Shanghai for emerging markets all for general managers and major franchisees that have emerging markets, and this proved to be a great example of how we're leveraging our people capability to make our global brands even stronger.

The China model is obviously a winner and we want to spread it across the emerging markets.

Our strategy at Yum!

Restaurants International remains to be drive aggressive international expansion and build strong brands everywhere.

System sales increased 7% in the second quarter prior to foreign currency translation.

Units increased 3% and overall same-store sales grew 4% while operating profit increased 6% in the quarter.

We continue to produce strong results in YRI's high growth emerging markets with system sales growth of 13% led by 9% same-store sales growth and a 7% increase in units.

Our new unit growth potential in emerging markets is arguably the best in retail with less than two restaurants per million people in the world's 10 largest emerging markets, we know we have a long long runway for future growth.

We're especially pleased with our sales performance in Russia with system sales growth of 44% including 32% same-store sales growth, which is the best in our business.

Our transition from Rosticks KFC to standalone KFC is about 90% complete and having a positive impact as-- with our customers as we focus on improving operations and offer compelling value.

These results give us even more confidence we can build a strong profitable business in Russia.

Micky Pant, Rick Carucci and I will be traveling to Russia in August and will give you more color on this exciting growth opportunity during our next call.

In Africa, another of our strategic markets, we continue to drive aggressive expansion throughout the continent.

By the end of the year, we expect to be in about 20 African countries with tremendous growth potential.

The projected population growth in African countries like Nigeria is staggering and we're establishing market leadership positions with KFC to capitalize on this opportunity.

We expect the vast majority of our growth in Africa to be franchise driven.

We acquired 70 restaurants in South Africa last year to establish brand leadership and help drive franchise expansion across the continent.

In Western Europe our brands are significantly underpenetrated.

We continue to believe Europe is a significant long-term growth opportunity.

We believe this because our restaurants in France have the highest average unit volumes in the world for KFC.

We continue to build our scale and increase television advertising.

It's no secret that McDonald's has over 2600 restaurants and makes over $1 billion in France and Germany alone.

We only have 218 KFC restaurants and make less than $30 million, so we know there's substantial room to grow into a major business in the years to come.

With that said, we struggled in France in the second quarter with a decline in same-store sales of 4%.

We remain confident in our strategy and continue to utilize a franchise business rental model to drive new unit development and returns.

We've also taken this approach to Germany where we have an even higher transactions than France and should have the necessary scale to utilize TV advertising next year.

Clearly, Europe has its challenges so we expect our third-quarter results to be choppy as we go after a much bigger prize for the long term.

For YRI overall, operating profit grew 7% in the first half of the year driven by solid sales performance.

In the second half of the year, we expect healthy top line growth, improved restaurant margins and less G&A spending versus year ago to drive improved profit performance.

In the United States, our strategy is to dramatically improve our brand positions, consistency and returns.

The good news is we had another great quarter with operating profit up 26%.

Taco Bell, our most profitable US brand led the way with 13% same-store sales growth and the historic launch of Doritos Locos Tacos.

We're also excited about the July launch of Cantina Bell with its exciting new ingredients like whole black beans, cilantro, white rice and corn pepper sauce, inspired by celebrity chef Lorena Garcia.

This initiative is designed to broaden the appeal of Taco Bell offering fast casual type products at two thirds of the price.

If you haven't tried these products, you got to get out and do it.

Along with Doritos Locos Tacos, we have made major headway at Taco Bell and are extremely optimistic about the future.

We continue to make progress with the First Meal and plan to have breakfast at Taco Bell nationally by 2014.

Greg Creed and his dedicated team and our franchisees are totally committed to taking Taco Bell to new heights and have worked very hard to reignite the power of the brand.

A couple of weeks ago I met with the Taco Bell franchisees at a top to top summit and they are very enthusiastic about where we're headed and they're excited about all the quality upgrades and product innovation that we have and are committed to growing this great brand.

Now one thing you should recognize is the launch of Doritos Locos Tacos represents one of the biggest breakthroughs in our industry.

In fact, innovations like this don't come along very often.

So while there's no question Taco Bell is on its way to having an outstanding year and laying the foundation for the future, we're not counting on double-digit same-store sales growth going forward.

Now Pizza Hut delivered another solid quarter of results.

It's combination of leveraging value, using its $10 large pizzas and bundling complete meals in $10 and $20 boxes with chicken, breadsticks and desserts, this all along with the traditional Pizza Hut pizza innovation continues to resonate with our consumers.

We've also entered the sandwich category with the P'Zolo and continue to innovate with products like the new garlic bread pizza.

Scott Bergren, our Pizza Hot COO-- CEO, and his entire team are committed to growth and I'm confident Pizza Hut will continue to build on its track record in success and drive consistent growth.

The KFC in the US, our business is stabilizing.

We're working with our franchisees and profits are improving.

Overall al our US business had a strong first half.

I'm especially pleased with the strong sales momentum and tremendous innovation at Taco Bell and the sustained growth at Pizza Hut where we have definitely soled our value equation.

I'm confident we're improving our business model in the US but we all understand there is a tremendous amount of work get to do and we're excited to continue to get after it.

Now let's talk about our India division where our brands are all about the youth and providing an aspirational experience for our customers.

We have 479 restaurants in our India division and expect to open over 100 new units this year.

Our business model is getting stronger and stronger every day working in both large and smaller cities.

I just returned from India and I could not be more excited about our growth prospects with four brands, KFC, Pizza Hut Casual Dining, Pizza Hut Home Service and Taco Bell.

The brand has gone to school on what makes KFC and Pizza Hut so successful in China and we're applying these strategies to India.

Based on the unit economics we're seeing, we believe there's a compelling reason to put even more capital to work at KFC in India.

Overall while we're making substantial progress, we don't anticipate meaningful profit contributions from our India division for the next couple of years.

We are laying the foundation for this business to have a significant impact on Yum!'s profit growth in the future.

Just like China, we want to have leading brands in every significant category in India.

In summary, the Yum!

business is in very good shape and we look forward to a solid second half and full-year EPS growth of at least 12%.

Now let me hand it over to Pat Grismer, our Chief Financial Officer.

Thank you, David.

Today I'm going to comment on our second-quarter results and our expectations for the second half of the year.

Also, with a step change that we've achieved in new unit growth, I'm going to provide some perspective on how we're building momentum in the retail development.

Overall, second-quarter financial results were marked by very strong top line performance with worldwide system sales growth of 8% driving operating profit growth of 7%, excluding the impact of special items and foreign currency.

Although EPS was up only 1% on a comparable basis, this was after an expected 10 percentage point impact of lapping last year's unusually low second-quarter tax rate of 16.7%.

In China, we delivered our sixth consecutive quarter of double-digit same-store sales growth, an impressive system sales growth of 23%, excluding the impact of our Little Sheep acquisition.

This was offset by a 4.1 percentage point decline in restaurant margin and a significant investment in G&A to further extend our unique growth capabilities.

For the second quarter and year to date, our margin decline in China was driven by persistent high inflation, labor investments to expand our strategic sales layers like 24-hour operations and delivery and incremental cost associated with the ramp up of our restaurant development program.

Our first half margin of 19.1% was about 1 percentage point lower than we had originally expected largely due to the manner in which we implemented our pricing actions.

As Rick explained on our first-quarter call, we have recently adopted a more targeted and strategic approach to our pricing in China to every day affordability for the growing consumer class while achieving about 20% margins over time.

To that end, our plan included a phased implementation of price increases as well as an increase in the number of pricing tiers across the country.

To better match our pricing to trade area specific purchasing power and operating costs.

While we're confident in this approach, it has taken more time to implement than we expected.

And coupled with the restaurant labor investments necessary to enable our increased pace of development, has driven margin below our forecast.

Clearly, we're not happy with a 4.1 percentage point margin decline in China even though this is short term.

However, our pricing is now in place and we look at the process we've used as a responsible investment in the long-term growth of our business.

This approach protects our consumer value proposition, supports an accelerated pace of new restaurant openings and helps us to achieve about 20% margins on a sustainable basis.

We believe this is a winning long-term strategy.

Later on I'm going to talk about why we expect our China margin will improve modestly in the second half of the year.

At Yum!

Restaurants International, we delivered solid system sales growth of 7% and operating profit growth of 6% excluding foreign currency translation.

Emerging markets continued to be Yum!

Restaurants International's growth engine with a 9% same-store sales growth and 8% operating profit growth excluding the impact of foreign currency.

In addition to Russia as David mentioned, we were very happy with the double-digit system sales growth in Latin America, Africa and the Middle East, further demonstrating the strength of our emerging market position.

Additionally, over 60% of YRI's new units were opened in emerging markets.

Despite strong sales overall, YRI's restaurant margin was down 1.1 percentage points in the quarter driven by temporary cost pressures in Thailand and the same-store sales decline in France partially offset by improved margin performance at Pizza Hut UK.

From a G&A perspective, YRI decided to restructure for stronger field support.

We believe this will position us to grow faster in the long term but we incurred $5 million of one-time costs in the quarter related to this decision.

In the US, we had very strong performance from each of our brands with operating profit up 26% in the quarter.

I was especially encouraged by the fact that each of our US brands delivered same-store sales, margin and profit growth for the second consecutive quarter.

Please note that 26% operating profit growth was after the resolution of a California employment lawsuit at Taco Bell which resulted in a pretax charge of $17 million in the quarter.

US restaurant margin was a very healthy 17.5% for the quarter including 19.4% at Taco Bell and 17.8% at Pizza Hut.

Our overall increase of 5.8 percentage points over prior year largely resulted from sales leverage as well as continued progress on supply-chain efficiency.

On the latter point, Pizza Hut has led the US system, a recent example being a redesigned pizza box which has not only yielded substantial cost savings but has reduced environmental impact as well.

Stepping back and looking at the first half of the year, I'm pleased with the overall quality of our growth as 8% system sales growth prior to foreign currency translation converted to 12% operating profit growth which in turn drove an 11% increase in EPS prior to special items.

Demonstrating the power of Yum!'s portfolio, the temporary margin decline in China was offset by a resurgence in our US business led by outstanding performance at Taco Bell, our largest and most profitable US brand.

Now I'm going to talk about our expectations for the second half of the year when we expect our China and YRI businesses will deliver a larger share of our overall earnings growth.

In China, while it took longer than we anticipated, we now have our pricing in place.

With a significant reduction in food inflation, we anticipate modest year-over-year margin improvement in the second half breaking the pattern of recent margin declines.

This is prior to the inclusion of Little Sheep which could adversely affect our restaurant margin percentage by about 1 percentage point in the third quarter as hot-pot sales are seasonally low in the warmer summer months.

This margin improvement combined with healthy same-store sales growth and continued strength in new unit development will deliver strong double-digit profit growth for China in the second half of the year.

Looking ahead, we continue to believe our China restaurant margin will sustain around a 20% level over time.

Let me take you through the four main reasons why we believe this.

First, we have the unique ability to grow our business across the entire country, with unmatched development resources and a proprietary distribution network.

This enables us to increase our mix of higher margin restaurant located in lower tier lower cost cities, offsetting the lower margins of tier 1 cities where rent and labor costs are relatively high.

Second, we're growing Pizza Hut Home Service and East Dawning, our emerging brands, which dilute restaurant margin by about 0.5 of a percentage point today.

As we scale these businesses and improve their unit economics, overall margin should benefit.

Third, we have potential upside from restaurant productivity initiatives and expect to gain more supply chain efficiencies over time as we continue to leverage our size.

And fourth, we have a strong track record.

Consider this, over the past five years, our China restaurant margin has averaged a little over 20% with a low of 19% as we drove average unit volumes up by 25% in real terms, even as we doubled our restaurant count in an inflationary environment.

Taking all these factors together, we're confident that we can achieve and maintain margins of about 20% in China for the foreseeable future.

At YRI, we expect solid sales growth to continue balance of year.

We also expect improved margin performance, accelerated net unit development and more moderate G&A growth in the second half.

These factors combined set up YRI for stronger profit growth in the back half of the year.

We also plan to complete the refranchising of our Pizza Hut UK business later this year and expect this transaction to be accretive to earnings going forward.

In the United States, we expect modest profit growth in the third quarter, but have a fourth quarter headwind of $18 million as we lap last year's 53rd week.

We expect full year US margin improvement of about 3 percentage points.

We also continue to make progress with our refranchising objectives.

By the end of this year, we expect our ownership level to be around 5% at Pizza Hut and KFC.

We expect to retain a higher ownership level at Taco Bell, but to reduce our current ownership from 22% to about 16% by the end of next year.

We believe this will lead to even better results for our shareholders over time.

In summary for the full year, we're expecting significant profit growth from each of our divisions led by strong sales performance across our entire business.

And when you add it all together, we expect full-year EPS growth of at least 12%, excluding special items.

Now I want to take a minute and talk about the momentum we're building in new unit development.

As you know, our ongoing profit growth model is very much new unit driven.

The good news for our shareholders is that our development pipeline and capability have never been stronger.

And because of that, we're now projecting a record 1700 new international units in 2012.

With now 1000 people on our development team in China, we have unparalleled resources and know how to take our growth to the next level.

As David mentioned, we have raised our China development forecast to at least 700 new units, which not only extends our position as the largest and fastest growing retail developer in China, but also expands the first mover advantage that is underpinned many years of exceptional growth.

When you consider that this equates to opening about two company-owned restaurants per day, with cash paybacks averaging less than three years, you can appreciate the shareholder value created by this extraordinary development program.

At YRI, which is about 90% franchised, we expect to open about 900 new restaurants this year, over 60% of which will be opened in high-growth emerging markets.

This pace of development demonstrates the attractive investment returns that our restaurants offer and reflects the underlying health of our brands in many parts of the world.

In India, we're just getting started and expect to open over 100 new restaurants this year led by equity investments at KFC where our investment returns have averaged over 20%.

With YRI and India combined, we expect to open a record of at least 1000 new international restaurants this year outside of China.

Although we tend to focus on our international development opportunity, the fact is that in 2012 we'll also have our highest number of new unit openings in the US since 2002.

We've modestly increased net units at Taco Bell for four consecutive years and look for the pace of development to increase going forward.

At Pizza Hut, 2012 will mark the second consecutive year of net unit growth after a decade of declines as our low-cost delivery carry out units are gaining traction in the system.

Overall, I'm obviously very pleased with our step change in new unit development.

As we said before, there are three main drivers of shareholder value, new unit development, same-store sales growth and high returns.

As CFO it's comforting to note that a large portion of our EPS growth is in the ground before we even start each year.

And with record new unit development expected this year, we've never felt better about our future growth.

David, back to you.

Thank you very much, Pat, appreciate it.

So in summary, the Yum!

business is a very good shape and we look forward to a solid second half and full-year EPS growth of at least 12%.

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

(Operator Instructions) David Palmer.

Good morning, The reason for that profit shortfall in China, it's not the usual one which we generally anticipate would be sales or maybe a food cost spike, you mentioned some reasons the slower than expected pricing rollout, the accelerated unit development and why the margins were down last quarter more than expected.

But obviously the street is hearing about these reasons more now after the quarter that we heard before.

You're giving some comforting guidance and commentary about your margin opportunities in China for the second half and beyond, but the natural question comes back to Yum!'s forecasting ability for that China division.

Have you thought about that and how you can better anticipate your profit performance and communicate that to the street going forward?

David, why don't I take that since I was the one who gave the previous forecast.

China is a pretty difficult business to forecast now than compared to let's say five years ago.

If go back a long time ago, almost all of our profit growth was generated by new unit development.

We could count on cost of sales being pretty stable and us getting synergies in that area, et cetera.

So we pretty much were able to grow our bottom line with our top line.

If you look at there's just more moving pieces today.

There's been -- there's higher labor inflation, a lot more volatility on commodities than there used to be.

And probably the only thing I think we missed is we maybe missed some of the inefficiencies of going from 500 new units a year to 700 new units a year, so I think we did have some teething problems around new unit development and it's impact on operations that perhaps maybe we could have anticipated better.

But whenever you have a high company-owned business, China is 90% company-owned or so, you're going to have volatility when you have same-store sales and cost of sales moving.

So I think that-- and then you have an uncertain economic situation to look at.

The piece that we sort of anticipated but maybe not to the extent of it is we did know sort of a quarter ago that we were going to have pricing impact and when we started executing that pricing impact we just stretched it out a little longer than what we thought at that point last year and that was just sort of an on the ground decision based on the reactions that we were getting as we were putting that in place.

But as Pat said, those are done now.

So from a pricing standpoint, we've pretty much done the lion's share of what's going to impact the balance of year.

And David the other thing I would add to what Rick has said is that we had effectively guided that margins on a quarter would be down about 3 points and they were in fact down about 4 points, so we missed it by about 1 point.

So yes, it was a bit of -- a bit off from what we had indicated, but to Rick's point, with the team on the ground is in the best position to read what's happening in the retail environment and to make the right decision as it relates to how we execute our pricing actions and then their judgment it made sense and we support them on is to go a little bit slower.

Even just the overall strategy remember is that what we want to do is continue to drive affordable accessibility for the growing consumer class.

We thought if-- and that's one of the big things that's been driving us and what I continually tell the team is keep polishing the diamond.

Okay we've got great great brands there, keep making our brands affordable, make sure we have great operations, make sure the assets look great and the numbers will take care of themselves.

And we obviously take a great deal of pride in doing what we say and I think we have a very good internal forecasting process and we tried to do the very best job we can guiding and we were off 1 point in China this quarter.

So, but I'm not going to apologize for that.

Thank you.

Thanks, David.

Next question please, Keisha.

Michael Kelter with Goldman Sachs.

I wanted to ask about the price increases that you're taking in China given the timing.

It seems like there might be a risk at least in my mind to traffic trends if you're taking prices went McDonald's seems to be investing in value, local competitors will have more P&L room for promotions given lesser food inflation, consumers are perhaps becoming a little bit more value conscious over there.

Can you talk about maybe some of the early experiences you've had now with the price increases in place and how you mitigate that risk?

Thanks.

Well, Michael, first as to the extent of pricing that we took as we said, the pricing was phased-in over time and it was in the low single-digit range, in the range of 3% to 4%.

Moreover, the team put a great deal of thought into how and where to take that pricing based on their analysis of purchasing power and cost.

And that's why we decided to take it slow is that the team is very sensitive to consumer environment currently and clearly as David mentioned is interested in maintaining the strong value position that we offer consumers.

So in our judgment, we believe that the amount of pricing that we took was entirely appropriate based on what we've read over time.

And so we do not expect that there's going to be an adverse consumer reaction to the amount of pricing that we've recently implemented.

The last thing the customer is going to see in China is sticker shock, okay?

So I think we've done a very prudent job of managing pricing and again with the primary objective of being affordable and I think that continues to be the case and we're not really concerned about that.

Thank you very much.

Thanks, Michael.

Next question please, Keisha.

Jason West with Deutsche Bank.

Yes, thanks, guys.

Just another question on China you talked, David, about sort of mid single-digit expectation on the back half of the year.

Just if you could give us any color on how things progressed through the quarter if you're starting to see some signs of stabilization that gives you comfort with that number or are you still seeing consumers tighten the belts and it's unclear when things will stop deteriorating there?

We really don't comment on how we're proceeding during the quarter.

I just think that we're very confident on our long-term business model in China.

We think we're making each of our brands stronger this year and we'll report our numbers out like we always do and not before.

So --

And Jason the other thing I would add is that I think it's important to look at our comps on a two-year basis, right?

So as David said in his speech a couple of times, as we enter the back half of the year, we are lapping an extraordinary performance, right, over the back half of last year same-store sales were about 20%.

So with that said and given how we performed in the first half of the year, we stand by our forecast for balance of year.

Mid- single digits on average.

Okay, thanks, Jason.

Next question please, Keisha.

Jeffrey Bernstein with Barclays.

Great, thank you very much.

Just to perhaps shift gears to the US business.

Two-part question, first I'm just wondering whether you can assess how you view the competitive dynamic, it seems like we're seeing a little bit more aggressive value and promotional activity at a couple of your larger burger peers and others and even the pizza segment where things seem similar?

So I'm just wondering if you could talk about the landscape as we look to the back half of the year?

And then perhaps as an aside with people pushing value, I'm just wondering whether you can give us an update on the commodity inflation perhaps for each segment of '12, I know there's obviously been a spike more recently and I'm just wondering whether you have confidence in your second half outlook, whether there's any volatility to that or whether the risk is more at '13 from a commodity standpoint?

Thanks.

I'll handle the environment before you get into commodities.

It's -- I would call the US as sort of in a process of a rocky recovery.

So you do see it from an industry standpoint you see sort of a couple of good months and then a bad month and similar from a week to week basis.

So it's -- things are not great and they're not terrible, they're sort of mediocre in terms of the marketplace right now.

In terms of our business, I feel pretty good with the-- I feel very good about the programs that we have in place.

David talked about Pizza Hut, I'm sorry Taco Bell on the call, and if I look at the balance of the year for Pizza Hut and KFC in terms of the plans we have in place, I feel good about our ability to be positive in the back part of the year.

And Jeffrey, as to your question on inflation, relative to the guidance we provided on the -- or in New York on full-year inflation for each one our divisions, based on what is happening in commodity markets, what we're currently forecasting is low single-digits inflation in each of our divisions.

And as we mentioned earlier in our remarks, that's one of the reasons why we're confident that we'll see the modest improvement in margins in China in the back half of the year.

Thanks, Jeff.

Next question please, Keisha.

Joe Buckley from Bank of America.

Thank you.

Pat, just to follow up on that, so the food cost inflation in China you're saying the second half of the year will be up low-single digits or has it subsided enough that you could see that for the full year?

More on a full-year basis what we're seeing is low-single digits in China.

Certainly it would be close to flat even in the back half of the year for China, including in the fourth quarter the prospect of some deflation given that we are lapping very high inflation last year.

Okay, and then just a couple of other questions on the China margin and some just to clarify what was already said.

So do you think the 20% China restaurant level margin is attainable this year or given the shortfall this quarter, will be below that, do you think?

It will be very difficult for us to get to 20% this year because of the decline we experienced in Q2.

We see that we're going to be in the 19% to 20% range, it's tough to call at this stage, right?

But long term no doubt about it, we see our way to 20% on a sustainable basis.

Okay, and then could you comment on the promotional environment there and if that had any impact on the second quarter margin, was there more discounting or promotional activity year over year?

That was not a big factor in our margin performance in the second quarter.

Okay, and then just one more on the same topic and then I'll let someone else go.

So is the pricing now you mentioned 3% to 4% pricing, is the pricing up about 6% or so year over year, and when do we roll over or lap some additional pricing?

I think there might have been something in September of last year if I'm not mistaken.

That's correct.

Current pricing, including our most recent actions, is on the order of 7%.

There were two separate actions taken in the fall of last year, one in September, one in November, so those will roll off as we approach the fourth quarter.

Okay, how much were those can you share that?

2%.

2% in each case?

Okay.

Okay, thank you very much.

All right, thank you.

Thanks, Joe.

Next question please, Keisha.

John Glass with Morgan Stanley.

Thanks.

Just first following up on that if pricing is 7% at least going into the third quarter, are you assuming traffic is positive in the mid single-digit mix or is that not part of that assumption?

With respect to transactions, given that we are lapping extraordinary traffic growth in the back half of last year, I would say that the traffic growth will be flat to slightly positive, but that is a effectively working in our guidance for now back half of year of mid-single digits same-store sales growth.

Appreciate the clarification.

And can you just to the extent help us just decompose the labor deleverage this quarter?

Because wage inflation was less than last quarter and I know you called out some specifics around both the 24 hour initiative delivery as well as the new stores.

Is there a way to tease out how much of that is from each of those components and is any-- how much of it is one-time and contained in this quarter and how much is it expected to be an ongoing phenomena because those initiatives continue?

Yes, John, we normally wouldn't going into that level of detail here.

I mean clearly, it was a contributor to the margin decline on a year-over-year basis.

The good news is that we're making this investment to grow these strategic sales layers.

So as we roll out more 24-hour operations, as we roll out more delivering in KFC, yes there's an upfront investment, it's slightly dilutive to our margins but the important thing is that we're creating the platform for future growth.

Yes, but just one more--

And also just, I'm sorry, John, just one last point.

As you think about the impact of labor of course the other big one which we mentioned on the call is what happens when you ramp up new unit development and to the point Rick made before, when you move from a run rate of 500 to 600 new restaurants a year to something north of 700, you have to make an investment in the operating capability.

And that's been one of the keys to our success in China is that we don't grow ahead of capability.

We build the capability first and then we open the restaurants and what that requires is an investment in restaurant labor so that we have the pipeline of RGMs fully qualified ready to run these restaurants to our standards.

What is your, just last question, what is your expectation of Little Sheep dilution to margin for the full year in China and I presume that your guidance of 19% to 20% excludes that?

That is correct.

And thank you for clarifying that, so our guidance on margin excludes the impact of Little Sheep.

As we mentioned in the earnings release for the quarter, Little Sheep diluted margins by 0.3%.

On a full-year basis it may, in fact it will probably be a bit more than that I mentioned in my remarks, but the impact in Q3 alone could be up to a full percentage point.

As to the impact to overall profits, at this stage we would say that it will have a negligible impact.

Thank you.

Andy Barish with Jefferies.

Just two quick updates on some bigger picture issues.

First on FX for the year, just given the dollars spent.

And then secondly on with the terrific results out of Taco Bell and the margin numbers, is that -- you're refranchising I guess is that still moving forward or is there some thought maybe you want to keep some more of those assets given the improved performance?

All right, I'll take those questions in turn.

First on foreign exchange, reflecting back on what we guided in New York, you may recall that at that time, and certainly as I think everybody appreciates given how volatile the global markets have been, it's really tough to forecast these things, I wish I had that kind of forecasting precision.

But back in New York, we said that we expected for the full year China to deliver a $40 million 4X benefit and YRI to present a $10 million 4X exposure, so a net of $30 million.

Based on what we have experienced halfway through the year and we're currently projecting based on forward rates, China we believe is going to deliver a benefit of $25 million so that's down from the $40 million, and YRI because of what you just mentioned, the situation with the dollar, YRI will present an exposure of $20 million.

So a net of only plus $5 million, so we've gone from plus $30 million to plus $5 million, that is working in our current guidance of at least 12% EPS growth.

And secondly, on US refranchising, Rick can comment.

I know change in the plan is sort of as Pat mentioned, the goal is still to have Taco Bell go from roughly 22% to 16% ownership and we said we'd do that over a two to three-year period and we're on track towards delivering that.

We feel very good as Pat sort of mentioned that by the end of year we'll meet the refranchising target for KFC.

So we're making good progress along that front.

Thanks.

Thanks.

Next question please, Keisha.

David Tarantino with Robert W. Baird.

Hi, good morning.

Just a couple questions on China.

First, I was wondering if you could maybe give us some perspective on what you're seeing in the consumer environment in general?

Are you noticing any behavioral shifts or regional changes in demand?

And maybe compare the slowdown that we're experiencing over there to what you've seen previously when the economy softened a bit?

Why don't I take that just from a historical context and Pat may want to add to it.

Is that we always have a hard time in our part of the world when China slows down they still have pretty strong GDP growth by our standards.

But to your point that the consumers to get more cautious.

So we are starting to see more sales at retailers in China.

We probably expect that to continue as we go over time.

Discounting, like I said discounting and we expect probably that will-- could make it necessary to continue to provide the value that David talked about in terms of our approach to China.

But the thing that so -- if you look at consumers we do think they're going to get a bit more cautious, the biggest trends that we continue to see, and this has probably been magnified in the first part of this year, is tier 1 cities are growing at a slower rate.

And as you look at tier 1 and tier 2 in probably coastal cities because of exports appear to be slowing, they'll probably be hit harder.

So one of the things we feel fortunate about is the new unit development that Pat took us through we're doing very well and continue to do very well in tier 3 through 6 cities and those are generally performing at a higher rate.

And right now it's also higher same-store sales in those areas.

David, the other thing I would add, and I'm sure you read the same economic reports that we do and of course recently it was announced that GDP in China had slowed from 8.1% to 7.6%, but remarkably consumer spending rose as a percentage of overall growth from what was 47% of GDP growth last year in the first half to 58% in the first half of this year.

So broadly, the extent to which consumer spending is contributing to the growth of the economy is improving and certainly that works in our favor.

Okay that's helpful.

And then I guess maybe one follow up related to the step up in unit growth.

Could you maybe just talk about your confidence in ramping up the pace there and maybe some of the incremental openings really focused on those tier 3 through 6 cities or is it more broad-based across the country?

Well, as I said in my remarks, we have an extraordinary development team in China that numbers roughly 1000 people.

And that capability is unmatched and is a competitive advantage for us and gives us the ability to drive to a new level of unit development.

And as I mentioned, one of the reasons why China G&A is up I think it's 23% in the quarter is in part because of the investment, the significant investment we're making in this growth capability and that gives us a lot of confidence to sustain this high rate of new unit development.

As to the distribution of these new units across tiers, over the last few years, and this will continue into the future, we're seeing more of a skewing of our development toward those lower tiered cities where we have unique presence and capability.

And that works in our advantage as I mentioned from a margin perspective because it is in those lower tier cities that we have more favorable cost structures that allow us to generate higher margins and better returns.

Great, very helpful.

Thank you.

Thanks, David.

Next question please, Keisha.

Howard Penney with Hedgeye Management.

Thank you very much.

I was wondering if you could articulate the thought behind the acceleration and growth in China?

Back at the analyst meeting in New York, you sort of articulated the thought process that you would have incremental growth coming from other regions of the world to be able to hit 10%.

So is the acceleration in China allowing you to complete that 10% growth rate or are there other macro factors or competitive factors that are leading you to accelerate the growth rate in China?

Well just going back to December, I think that the biggest thing that occurred was the Chinese economic plan and the infrastructure development getting accelerate.

And we talked about those clusters cities and so a lot of new railroads, airports and then malls associated with those places have been sprouting up and we've going into those and those probably places that we didn't expect to have a couple of years ago.

And then the other big part of the increase is just been, as David talked about, the great performance in Pizza Hut.

And Pizza Hut also being able to be successful below tier 2 cities.

So those are the two biggest drivers that we're leveraging and that's -- as you know if we went back three years ago we wouldn't have anticipated we would have hit these levels this quickly.

And there's some teething pains associated with that from a profit standpoint but we're obviously delighted that the number was able to reach what it reached so far.

So we're not looking for it to accelerate beyond that.

Yes, and Howard just as a reminder, as we mentioned, when you look at our international development outside of China, so taking YRI and India together we're now projecting gross builds of at least 1000 which again is a record for Yum!.

Still there's the notion that there's an increased competitive presence in China not part of the process?

Yes, well, I think the competitive nature in China is definitely higher in the tier 1 cities.

In the rest of China, I think as I said before and we said on different occasions, I think our competitive position has actually improve.

Because we're getting more and more units into these smaller tier cities before anybody, national chains Chinese or Western, are able to get there.

So there's a different dynamic by location.

So definitely to your point, Howard, I think the tier 1 cities and even the tier 2 cities are starting to get more competitive, but we really haven't seen that in the lower tiered places.

And will this make it harder the competition to grow in those lower tier cities?

That's our hope.

Thank you.

Thanks, Howard.

Next question please, Keisha.

Bryan Elliott with Raymond James.

I'd like to move to the labor situation in China.

Intrigued with the high rate of wage inflation and wondering if that's doing anything to turn over?

Are people being lured away to higher paying jobs in other fields and turnover is rising and so replacement and training costs are rising, or are we able to sustain the historical turnover rates and just having to meet the market on wage increases for existing workers?

And also whether it's more difficult to hirer maybe potential managers in the high wage inflation environment?

Well first of all, I think that the-- our ability to hire and retain talent in China is renowned.

I mean we have outstanding operating capability there.

In fact, we've recently created a what we call Whampoa, it's our training academy for the entire retail industry.

Basically we're bringing in management recruits out of college, telling them that within four years they can become a restaurant general manager, potentially a franchisee inside of our Company and if they want to move on and move into another industry, they can be well trained and perfectly prepared to go into retail opening up many many different careers.

So we hired thousands of management recruits this past year and we think that our goal with operations is to have KFC be the operating mecca for talent not only for ourselves but the rest of the industry.

Just like I think historically in marketing P&G has been the marketing training grounds for a lot of people.

So we have-- today when you look at our RGMs, 90% of our RGMs are at least college graduates and we see that number actually edging up over time.

The quality of our jobs, the perception of our jobs, is very very high in China.

Consider this, these people are running $1.7 million businesses.

They have up to 100 employees, okay?

They have huge general manager responsibilities and they're being very competitively paid, so.

And we have a culture that is I think very, very highly regarded and respected in the country.

One of the things that's interesting, I was in -- I gave a speech to -- in Shanghai at Fudan University and there were -- they had 300 seats, there were 600 people in the auditorium.

They were literally packing the aisles and almost sitting on top of each other and the Dean of the business school asked, how many of you have been to a KFC or a Pizza Hut in the last week, okay?

Everybody raised their hand.

And our ability to build great brands is very highly respected in China and so we think -- the thing that I'm most pleased about is that we continue to build operating capability.

It's that operating capability that's allowing us to open up all the restaurants and continue to get the great returns.

So, I think the ability to attract and retain talent is probably -- well we've always thought our operations was our biggest competitive advantage and I think it is today.

That along with the local team that understands how to really build brands.

But the operating capability is something we're very confident and we will never ever take our eyes off of it because we know that people capability is the key to getting great returns for the long term.

How about on the hourly side, crew side?

We're not seeing -- we're not seeing any real impact one way or the other on turnover.

And just to build on that, Brian, one of the things that we -- we think are best part-time laborers in China are college students and the percentage of college students has actually been rising over time.

I think over 50% now.

Okay, great.

Thank you.

Thanks, Bryan.

Next question please, Keisha.

Keith Siegner with Credit Suisse.

Pat or Rick, just one last thing on China margins, just to maybe ask it at a slightly different way.

You answered one of the questions earlier saying maybe one of the things that you missed were inefficiencies of accelerating the pace of unit openings.

So just at the highest level, and maybe for 2Q and the full year 2012, what is the basis point impact on China restaurant level margins from that acceleration of unit growth?

Like what was the drag on Q2 and what do you anticipate the full 2012 drag to be from that acceleration?

Thanks.

Yes, Keith, it was about 1.25 and that's what we're expecting for the year.

Okay, even though fourth quarter you'll start to lap against a really accelerated pace of unit openings last year.

I would think the pressure might get a little easier as the year progresses.

I'm not calling it on the quarter.

Okay.

In terms of our outlook but in Q2, the impact was about 1 point and as we look at the year, again we would say it's about 1 point.

Okay.

All right, thank you.

Thanks, Keith.

Next question please, Keisha.

Mitch Speiser with Buckingham Research.

On China first, regarding labor, should we just continue -- should we continue to expect double-digit wage rate growth for the foreseeable future?

Yes.

Okay, thank you for that short to the point answer.

(laughter) And just a couple of other questions, most of my China questions have been answered.

In the US, I think you mentioned modest third-quarter profit growth, can you discuss that?

Does it have to do with any change in the top line trend or is it more on the cost side, if you can explain that given a great profit growth quarter in the second quarter?

Just let me clarify it.

I was answering a question I thought about sales growth.

So what I should-- they asked about the environment for sales we just sort of said we expect positive sales for the KFC and Pizza Hut brands combined for the balance of the year that we didn't think the environment was going to cause anything.

I don't think we gave a profit outlook by the quarter.

Well I thought in the prepared remarks, there was something about modest profit growth in the US in the third quarter, did I misread that?

Yes, that is correct.

But when we look at the full back half of the year given the headwind we're facing with the lap of the 53rd week, we wouldn't say that it's modest for the back half it's more of the third quarter phenomenon as we expect that sales growth will temper a bit from what we've seen in the first half of the year, low-single digits.

Okay, thanks.

And on YRI, in the press release it mentioned that emerging market comps were up over 9% -- about 9% which sounds particularly strong.

Can you give us a sense given that you have given guidance in the other regions, do you expect that emerging market comp growth to continue at a similar rate?

Generally, yes.

Great, that's all I need to know.

Thanks very much.

Thanks, Mitch.

Next question please, Keisha.

Sara Senatore with Sanford Bernstein.

Sounds like the China topic has been exhausted, so I wanted to ask about YRI and sort of the [combined] margin expectations for improved performance in the back half.

I know you talked about more moderate G&A growth and accelerated net unit development and I can see why that should support faster growth, but can you just talk a little bit about what exactly went on with the restaurant margins?

And is the expectation that things get better, does that imbed the fact that the refranchising in the UK business would automatically just give you back I think 200 basis points to margins?

Yes, Sara, first to clarify, our forecast of improved margins for YRI in the back half of the year does not assume the benefit of Pizza Hut UK refranchising.

When we complete that transaction as we mentioned we expect about a 200 basis point improvement to YRI's margins overall.

As to why we believe this situation is going to improve, it's important to recognize that in the second quarter, a key contributor to the decline was that we had a spike, a temporary spike in costs in Thailand at a time we were lapping quite extraordinary margins in Thailand.

Thailand margins overall are very good, but it just so happens that given the timing of certain expenses including an increase in some wage rates that we took more of a hit in the second quarter, we see the situation for YRI overall in the back half of the year moderating where there's less pressure from unusual cost increases like this, that combined with ongoing momentum in our productivity initiatives and what we expect we will see from same-store sales leverage leads us to have confidence that we'll see in an improved margin performance from YRI in the back half of the year.

Okay, thank you.

Thanks, Sara.

Next question please, Keisha.

John Ivankoe with JPMorgan.

Thank you.

David, you said something interesting in answer to a question about a manager potentially becoming a franchisee in China.

I mean could you elaborate a little bit on that what you meant?

And secondly in a completely different direction, the credit markets seem to be in very, very good shape for a Company like yours and your debt to EBITDA and debt to free cash flow are at levels that probably people couldn't have imagined 10 years ago.

So kind of looking at opportunities that may be presenting themselves, you have new CFO, maybe some different ideas in terms of what the capital structure could be, to what extent could you use the debt side of the balance sheet to enhance equity returns?

Well thank God we got a new CFO.

(laughter) Rich Carucci was really--

That's of course not what I meant, but I mean it's just a matter of -- (multiple speakers) And I'm looking forward to seeing you, and by the way congratulations on the job very well deserved.

Thank you.

Let me talk first of all about the China franchise.

Well first of all in China we are and will continue to be predominantly Company-owned.

However, we are doing franchising on a limited basis and we're doing it more on a single store owner basis and we've been-- one of the things that we've been experimenting with and executing to a certain extent is taking great restaurant operators in our Company and giving them the opportunity to run restaurants in China.

So we think that that will continue to be the case as we get bigger and bigger and bigger especially across the number of different concept areas that we're in.

And I'll turn to my new CFO to give you his perspective on our capital structure.

And as to our capital structure, I would say that we're happy with where we're at now and how we've managed it over time because we've gotten extraordinary results.

We continue to take a look at what's happening in the market and what might make sense for us and for our shareholders and so we'll continue to do that and apply the same good discipline we have for the last several years.

So no changes anticipated at this stage but we do continue to look at it.

And if I may ask a question, like why wouldn't there be more debt on-- I mean just asking it a little bit from more directly, why wouldn't there be more debt on your balance sheet at this point?

John, you got to keep in mind, we've talked about this, you got to keep in mind every day when we're building basically two new stores a day in China, most of them, virtually all of them are leased.

So we're adding leverage to our balance sheet in the minds of the rating agencies every day.

So you got to keep -- they look at it from the full perspective, they capitalize the leases, so when you look at that, you got to keep that in mind even though the balance sheet debt may look low, they definitely take that into account.

And as we've said previously, we had -- we were BBB minus and I think we're still BBB minus with one of the agencies.

We want to be BBB solid after the financial crises.

We felt like having another-- a little bit more margin of safety was important and that's basically where we are kind of but not quite yet with all three of them.

So as much as some people would like us to add debt, we feel good about where we are given what we've learned over the last few years as Pat said.

I think what -- I think the important point too that you bring up which we take a great deal of pride in is that we are dramatically different Company as you point out than we were 10 years ago.

And that we have the ability to invest tremendously behind the core growth of our business which is our number one priority.

We are able to buy back stock and we're able to pay a good dividend.

And our ability to do all three of those things has only gotten better.

And I think that's what I think is exciting as we think about the tremendous growth prospects we have ahead.

Okay?

With that I'd like to wrap it up.

Thank all of you for being on the call.

As I said before, and I think it's a good summary of where we stand, the Yum!

business is in very good shape and we look forward to a solid second half and a full year EPS growth of at least 12%.

So thank you very much, appreciate it.

And this does conclude today's conference call.

Thanks for your participation.

You may now disconnect.