百勝餐飲集團 (YUM) 2013 Q1 法說會逐字稿

Good morning.

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

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

Brands first quarter 2013 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).

Mr. Steve Schmitt, Vice President of Investor Relations, you may begin your conference.

Thanks, Amanda.

Good morning, everyone, and thank you for joining us for our earnings call.

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

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

Please be advised that if you have asked a question it will be included in both our live conference and in any future use of the recording.

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 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 the following Yum!

investor events occurring in the next three months.

April same-store sales release for our China Division will be made 10th after market hours.

Our Taco Bell investor and analyst conference will be a 21st in Irvine, California and our second quarter earnings release will be Wednesday, July 10.

On our call today is David Novak, Chairman and CEO; Rick Carucci, President; and Pat Grismer, our CFO.

Following remarks from each, we will take your questions.

Now I will turn the call over to David Novak.

Thank you, Steve and good morning, everyone, and thank you for joining our call.

While better than expected, the first quarter was extremely difficult for Yum!

Brands.

As anticipated, intense media attention surrounding poultry supply in China significantly impacted KFC's sales and profits.

Earnings per share declined 8% versus prior year as our China Division operating profit fell 41%.

Operating profit increased 19% at Yum!

Restaurants International and 5% in our US business.

While we are certainly not happy with our overall results, as we look at how our China sales evolved through March, we were making progress and it was pretty close to where we thought we would be.

Unfortunately, our quest for a full sales recovery has been dampened by the intense publicity of avian flu in China beginning in early April.

Now, the last time we were significantly impacted by avian flu was in 2005.

The sales impact was initially dramatic at KFC but relatively short-lived, lasting about three months.

We anticipate this will once again be the case but there is no way to be certain.

Based on our results through the first three weeks of April we expect China Division same-store sales will be down about 30% for the month.

You will see the actual numbers in our sales release scheduled for May 10.

Putting the avian flu situation aside, I would like to share some of what the team in China is doing to restore consumer trust in the KFC brand and to enhance our industry-leading supply chain practices.

Immediately after the Chinese New Year in late February, we launched what we are calling Operation Thunder.

To the Chinese consumer this signifies swift, decisive action, which is exactly what we are doing to address consumer perceptions related to the safety of our chicken in China.

As part of this initiative, we announced several enhancements we are making to our supply chain.

One specific enhancement was to work with our suppliers to eliminate over 1000 small and less modern chicken houses where risk could be the highest.

We want our suppliers to only work with the most sophisticated chicken farms in China.

We also launched an aggressive quality assurance program including 30-second television commercials.

Our strategy is to build as much awareness as possible of our industry-leading quality assurance processes.

Our research indicates the more people hear about what we are doing, the more willing they are to come back into our restaurants.

Additionally, we are continuing to build the KFC brand with major news around value and innovation.

Our goal is to come out of this stronger than ever on our food safety perceptions in China and get sales back on track as fast as possible.

These are certainly trying times for our KFC China business, but I want to be crystal clear that we do expect a complete sales recovery.

In previous years, we have faced SARs, Sudan Red and previous avian flu situations, and in every case we have bounced back.

And when sales do come back, we're going to benefit from the additional 1600 restaurants we will have built during 2012 and 2013.

We have a world-class team and unmatched distribution system and industry-leading advertising resources.

KFC is a powerful and resilient brand that is loved throughout China.

We expect to bounce back stronger than ever.

We think staying the course on at least 700 new units is the right number, recognizing we are still out-developing competition by a wide margin, still have first mover advantage by entering over 100 new cities and have no urgency to expand more rapidly in the current environment.

And remember, this means we will open about 1600 new units in two years.

There's no question we are continuing to capitalize on the number-one retail opportunity in the world.

As I have mentioned before, the most positive new news in recent years at Yum!

is the incredible performance at Pizza Hut Casual Dining in China.

We continue to have less than three-year cash payback and are successfully expanding across lower-tier cities.

While sales started a bit slow in the first quarter, we are pleased that March same-store sales grew 4%.

We have major product news with stone pan steak this year and we are beginning to expand breakfast into more cities.

We are very bullish on Pizza Hut Casual Dining this year and in the years to come.

Overall in China, we are going to stay the course with our strategy to have leading brands in every significant category.

We will continue to build our two big brands, KFC and Pizza Hut Casual Dining, and we will continue to invest behind Pizza Hut Home Service, Little Sheep, East Dawning, and we opened 226 new units in our first quarter and are well on our way to open at least 700 restaurants this year, which, again, we believe is a very good number.

Outside of China, we expect solid on-target performance for Yum!

Brands and as I evaluate our strategies, I have concluded that, just like China, we have the right strategies in place and the best thing we can do for our shareholders is to stay the course with what we have been focusing on.

We are very focused to be the emerging market leader in the restaurant category and positioned for growth in so many countries around the world.

At Yum!

Restaurants International, we are going to continue with our strategy to drive aggressive international expansion and build strong brands everywhere.

Our new unit pipeline has never been stronger.

We expect to open over 950 new restaurants this year and grow operating profit consistent with our ongoing growth model of at least 10%.

I am very pleased that our US business will be a net new unit developer for the second consecutive year.

Importantly, Taco Bell, which represents about 60% of our US profit, had a strong first quarter and continues to have success building on its Doritos Locos Tacos and Cantina Bell platforms.

We expect our US profits to grow in line with our ongoing growth model 5%.

Finally, we are investing in and developing a great business in India which will drive substantial future growth for Yum!.

So to wrap this up, 2013 is obviously going to be a difficult year for Yum!

Brands due to our challenges with KFC in China.

Our Yum!

Restaurants International and US businesses are well positioned to deliver against our growth targets and drive future growth for years to come.

I'm confident our China business will bounce back strongly and lead the way to restoring our track record of consistently delivering double-digit EPS growth in 2014, 2015 and beyond.

Now Rick Carucci will take you through our strategies for Yum!

Restaurants International and the US business.

Thank you, David.

Good morning, everyone.

At Yum!

Restaurants International, our strategy remains to drive aggressive international expansion and build strong brands everywhere.

What I would like to do today is review the nature of our growth.

The growth at YRI continues to be driven by our franchisees and our strength in emerging markets.

In 2013, you will see that our equity presence in select emerging markets will also contribute to this growth.

One characteristic that we love about YRI is the recurring and growing nature of its franchise fees.

These franchise fees will approach nearly $1 billion in 2013, which represents 10% growth versus 2012.

Our franchisees are investing heavily behind our KFC and Pizza Hut brands and are aggressively building new units.

During the first quarter we developed 147 new units and 90% of these units were opened by franchisees.

We continue our rapid pace of expansion throughout the year and expect to set a record by building over 950 new units in 2013.

This franchise growth provides a large cash stream for Yum!.

It also generates significant value for our shareholders.

We believe that the capital-free franchise business at YRI is unique, given that it provides income and cash that is large, growing, global and diversified.

We are delighted to be meeting with over 500 of these franchisees representing over 100 countries at our upcoming biannual franchise convention in Beijing where we will discuss our strategies and initiatives.

We look forward to working together with our franchisees to develop even more profitable growth opportunities in the years ahead.

As we have said before, Yum!

is a clear leader in emerging markets.

70% of the new YRI units in the first quarter were in emerging markets.

The bulk of the emerging market business will continue to be led by franchisees.

However, over the last few years, we have also developed a Company-owned presence in some select high-growth countries.

These include Russia, South Africa and Turkey.

Three years ago, we had no Company-owned restaurants in these markets; today, we now have about 230 Company units.

We are bullish on all three of these markets.

Over the past two years, Russia has led our entire system in same-store sales growth.

This continues to be the case so far in 2013, where Russia posted system sales growth of 45% in the most recent quarter, driven by development and same-store sales growth of 25%.

We have been able to step up new unit development this year and we are encouraged by the initial returns we are getting on our new Company-owned stores.

In the continent of Africa, we are also expanding aggressively.

We are building off an established base of about 700 stores in South Africa, where we are the clear market leader.

Africa is one of the fastest-growing regions in the world with over 1 billion people throughout the continent.

Remember, it represents a tremendous long-term growth opportunity.

We completed the acquisition of our Turkey business earlier this month.

Turkey is a fast-developing country of about 75 million people.

With only about 60 KFC and 45 Pizza Hut restaurants, there is no question we will have a huge potential for growth there.

We already ramped up development and expect to open about 25 new restaurants this year.

Our acquisitions in these three countries advances our strategy to increase ownership in high-growth, high-return businesses.

I want to emphasize that we believe our Company ownership is helping to accelerate growth.

In 2010, we had a total of 63 new units in these three countries combined.

This year, we expect to add over 170 units, and about 50 of those will be Company-owned.

It is likely that the new unit builds in these countries will continue to grow.

The combination of aggressive franchise growth and an equity presence in select countries should help us extend our lead in emerging markets.

We are generating strong growth and believe we can do so for a long, long time.

As a reminder, Yum!

currently has around two restaurants per 1 million people in the world's 10 largest emerging markets.

Assuming we maintain our current pace of development, we would have only about four restaurants per 1 million people in these markets by the year 2020.

That compares to 58 restaurants per 1 million in the US today.

Overall, the Yum!

Restaurants International business is on track for another solid year in 2013.

Clearly, we have a long runway for growth at YRI.

Now onto our US business.

Before I get into the US business performance, it is interesting to note that the US business has a royalty stream in excess of $800 million.

Therefore, when you put YRI and the US together, they will produce about $1.8 billion of franchise revenue in 2013.

That is almost double what we produced as a Company 10 years ago.

While our US business is beginning to develop net new units, it is more reliant on growing same-store sales for its growth.

In our category, you grow same-store sales by offering strong value and introducing innovative new products.

In the past year, I don't think anyone has done a better job of innovation than Taco Bell.

Taco Bell grew same-store sales by 6% in the quarter, and that's on top of 6% growth in the first quarter last year.

We are now in the midst of launching Cool Ranch Doritos Locos Tacos.

Our new marketing campaign, Live Mas, is resonating well with consumers, and the brand is generating lots of excitement in social media.

We expect to sell about 100 million Doritos Locos Tacos during the second quarter.

This continues to be one of the most successful new product launches in our history.

As we look at the balance of the year, we believe that we have a strong product offerings.

Because these are backed by solid operations and increased media weights, we believe that Taco Bell is well-positioned to have another successful year in 2013.

Pizza Hut and KFC sales in the US during the first quarter were softer than we would have liked.

In this environment, you win by providing compelling value and innovation.

In hindsight, some of our competitors did a better job of this then we did.

We expect to fare better the balance of the year and we are particularly excited about the recent launch of KFC's Original Recipe Boneless Chicken.

We are continuing to add net new units at both Pizza Hut and Taco Bell.

The Pizza Hut Delco Lite format is generating excitement among our franchisees and is allowing us to add more units in small-town America.

Taco Bell is following Pizza Hut's lead and is also going after more rural new units.

Taco Bell is again adding net units in 2013 and the combination of a new smaller building asset design and a franchisee rural incentive should lead us to even more net unit growth and openings in 2014.

When we look at the US, we are building the foundation for a business that we believe will provide better and more consistent performance.

To sum it up, while China is clearly experiencing a challenging year, the rest of Yum!

is performing pretty well.

We believe we are well positioned for the future and these divisions are on track to achieve our full-year growth targets for 2013.

Now let me hand things over to our CFO, Pat Grismer.

Thank you, Rick.

As you heard from David and Rick, Yum!

Restaurants International and our US division are delivering solid results, yet we obviously have our challenges in China.

We continue to see this as a temporary setback and remain as bullish as ever on our long-term growth prospects.

As evidence of that, we are continuing to invest in the future.

With these investments and given the demonstrated growth potential of our businesses, I am very confident that our track record of double-digit EPS growth will be restored in the years to come.

I will now provide some additional perspectives on our first-quarter results and share our EPS outlook for the second quarter and full year.

For the first quarter, we reported an 8% decline in EPS before special items, which was significantly better than the 25% decline that we had previously estimated.

This better-than-expected result was primarily driven by stronger-than-expected sales in China during the Chinese New Year holiday period in February.

Now I will share some performance highlights for each major division.

In China, operating profit declined to 41% in the first quarter prior to foreign currency translation, driven by a 20% drop in same-store sales.

With a sales decline of this magnitude, China restaurant margin was severely impacted, down 7 percentage points versus prior year.

Bear in mind that this dynamic works in both directions.

So as our China sales recover, we expect a similar rebound in restaurant margin.

On the development front, China had an exceptional quarter, opening 226 new restaurants or nearly four per day.

With Chinese New Year following relatively late in the quarter this year, our world-class China development team was very intentional about pulling units forward into the first quarter to benefit from peak seasonal sales.

Yum!

Restaurants International reported operating profit growth of 19% in the first quarter, excluding the impact of foreign currency translation.

We benefited from a major franchise ownership change this quarter which added transfer and renewal fees as well as from changes to an overseas pension plan.

These items added 8 percentage points of operating profit growth to YRI's overall performance.

And, as expected, re-franchising the Pizza Hut UK dine-in business late last year benefited YRI's operating profit growth by another 3 percentage points.

Adjusting for these items, YRI's core business delivered about 8% operating profit growth this quarter.

Importantly, YRI continued to drive impressive unit growth, opening 147 new restaurants in the quarter, including 103 new units in emerging markets.

Same-store sales grew 1%, which was softer than expected as weak results in Japan and Western Europe adversely impacted YRI's same-store sales by about 2 percentage points.

However, we experienced strong same-store sales growth in our equity-led emerging-market businesses in Russia, South Africa and Thailand and were pleased with the sustained improvement of our KFC Australia business.

Restaurant margin increased 1.4 percentage points at YRI largely due to the re-franchising of our Pizza Hut UK dine-in business.

Moving to the US, first-quarter operating profit grew 5% versus prior year.

Excluding the impact of re-franchising, operating profit grew a very respectable 7%.

This performance was led by Taco Bell, which had an outstanding quarter with 6% same-store sales growth and restaurant margin improvement of 2.4 percentage points.

It's clear that our customers love both Nacho Cheese and, now, Cool Ranch Doritos Locos Tacos and without a doubt, Taco Bell is a leading performer in the category.

In fact, this marks the fourth consecutive quarter that Taco Bell has outperformed the category, demonstrating the positive momentum we have with a powerful brand that represents about 60% of our US profit.

And while sales at Pizza Hut and KFC fell below our expectations in Q1, their profits were more or less on plan.

For the US division overall, restaurant margin increased 2.4 percentage points in the first quarter, including 1.3 percentage points from refranchising.

Importantly, this marks the fifth consecutive quarter of year-over-year margin gains in the US.

Finally, speaking of US re-franchising, we continue to make good progress with our program, which we expect will be substantially completed by the end of this year, bringing our franchise ownership in the US to over 90%.

This ownership strategy along with our improved unit-level economics positions the US for more consistent profit growth in the years ahead.

Now I will turn to EPS expectations for the second quarter and full year.

As you know, the most sensitive variable in this year's profit forecast is China same-store sales, so I'll start with that.

As disclosed in our 8-K filing on April 10, March same-store sales declined 13% in our China business with KFC same-store sales declining 16% and Pizza Hut Casual Dining same-store sales growing 4%.

As David mentioned, we continue to expect this sales recovery will take time.

However, the recent publicity on avian flu will add even more choppiness to that recovery, weighing particularly heavily on second-quarter results.

Based on our results through the first three weeks of April, we expect China Division same-store sales to decline about 30% for the month with KFC significantly negative and Pizza Hut Casual Dining positive.

Prior instances of avian flu have been short-lived at KFC, and with this as our assumption we believe our overall recovery will be no different from our previous estimate with China Division same-store sales turning positive during the fourth quarter.

We will continue to temporarily provide monthly updates on same-store sales in China and will report April sales on May 10, 2013, after market hours.

Despite the start of our recovery from the China poultry supply situation that occurred in late December and with the unexpected impact of avian flu publicity that started in April, we are forecasting a significant double-digit EPS decline for Yum!

in Q2 and expect this to be the low point of our year thus far.

As for the full year, our EPS expectations are essentially unchanged at this stage.

We're holding our full-year forecast at a mid-single digit decline because of the risk that avian flu publicity has added to our China sales recovery.

Essentially, we are estimating that all of the EPS upside we saw in the first quarter versus our earlier estimate will be offset in the second quarter due to the impact of avian flu.

That said, I want to emphasize that it is extremely difficult to forecast sales or profits in China right now.

This was already a challenging proposition, and the recent emergence of avian flu has only added to the uncertainty.

Despite our short-term setback in KFC China, our long-term growth model is still intact, driven by new unit development, same-store sales growth and high returns on investment.

The good thing about our business is we are a cash generating machine.

Even with this year's disappointing EPS results, we expect free cash flow well over $2 billion, which includes a franchise royalty stream of nearly $2 billion.

We also remain committed to using our operating cash flow to invest behind the growth we see in our business with over $1 billion of capital expenditures expected this year while returning all remaining cash to shareholders through dividends and share repurchases.

Our investment in new unit development is skewed towards high-growth emerging markets such as China, India, Russia and Africa, and these development opportunities remain very robust.

We continue to believe that China is the number one retail growth opportunity in the world and continue to forecast at least 700 new units there this year.

Given the pace of development we achieved in the first quarter, we expect our new units in China to be more heavily weighted toward the first half of the year and we expect this intense pace to ease, balance of year.

As always, we approach our China development with extreme rigor and will continue to monitor new unit performance and adjust our expansion plans as appropriate.

We also expect to open at least 150 new units in India this year with over half of these being KFCs, thereby growing our KFC store base by over 30% versus prior year.

At YRI, we expect to build over 950 units, including 80 units in Africa, 60 units in Russia and 50 units in Thailand.

Finally, driven by the irresistible returns of our Pizza Hut Delco Lite's and the improved economics of our Taco Bell units, we expect the US will be net unit positive again in 2013.

In summary, 2013 is shaping up to be a very challenging year for Yum!

and while we take account of these results, we view this year as an aberration that neither erases our track record of performance nor diminishes the growth opportunities that we are uniquely well-positioned to capture.

I'm confident we will bounce back strongly and regain our status as a double-digit growth company in the years ahead.

And now we will be happy to take your questions.

Sara Senatore, Sanford Bernstein.

I just wanted to talk a little bit about the China recovery cadence.

I think it implies a fairly sharp -- yet I think you said historically the avian flu has been pretty short in its impact.

I just wanted to get a sense of, if you look back at 2005, are we talking about a month or two months, or what the overall cadence is.

And then also, on the same related topic, it looked like you manage margins very, very well in China.

So maybe can you just talk a little bit about what kind of variable expenses are there in payroll and occupancy that allowed you to hold margins so well, given the negative comps in the quarter?

First, with respect to the impact of avian flu, when we look back at how this has impacted our business in the past, what we have seen is a sharp impact initially that then diminishes over a period of about three months.

And so we are expecting about the same recovery period this year.

And so, just to reinforce, then, in terms of our overall sales recovery what we are currently estimating is a six- to nine-month recovery period with same-store sales in China turning positive in the fourth quarter.

And then with respect to your question on margin, they were obviously a number of moving pieces here.

The most significant variable in that equation is transactions, and so the transactions did hit us significantly in the first quarter.

And that, as it reverses, will certainly work to our advantage over the course of the rest of the year.

With respect to the composition of our restaurant costs and the variable components, there is a fair amount of variability in rent expense, where many of our units have a variable rent component, as well as the fact that a portion of our labor expense is variable.

And also keep in mind that advertising, which runs about 4% of sales, is also nearly entirely variable.

And so that gives us some ability to mitigate the impact of the transaction deleverage.

Thank you.

John Ivankoe, JPMorgan.

Also staying on China, if I may, and two different topics -- firstly, obviously first quarter development was exceptional, especially for a two-month quarter.

I think David, for emphasis, a few times you said to expect 700 for the year.

So I guess at this point, trying to get a sense whether the avian flu and the December crisis, that's kind of having you back off the development maybe, at least as I'm interpreting, maybe slightly, especially relative to prior years through other issues that we should be sensitive to.

The second question, if I may, is on gross margins in China, or cost of goods sold, to look at it inversely; that was very, very low.

The COGS was very low in the quarter, and some may have interpreted that you would invest in gross margins to really sell the value message to consumers, whether now or some point in the future.

So I just wanted to get a sense of how you may use the COGS line or gross margins to invest to get back traffic when the time is right.

Well, I think, first of all, on development, John, we think that staying the course on the number that we provided at the analyst conference back in I guess it was December was that we said we would stay at least -- we would open at least 700 units.

We still think that's the right number.

I think the reason why we believe it's the right number and we are staying on it is that we are still out-developing competition by a wide margin, as I said.

We still have that first mover advantage that we are opening up in 100 new cities this year.

So we don't really see any urgency to expand more rapidly in this current environment.

I think, as the China team has always been given the charge that this is a business that's a jewel; polish that jewel, keep making it as strong as you can.

And we've never, ever forced or challenged the team to grow at a faster rate than it ought to.

And I think, as we look at the year and where we are at, we just think that we are going to make the prudent and the right decisions as we go forward, and that number will be at least 700 restaurants.

So that's how we are looking at that.

In terms of investment in the value proposition, we have great cost structure.

We've had great cost structure.

We've always done what's right for the customer.

We have a number of value initiatives planned, even as we are in this current challenging environment.

And what I expect, given everything that is going on, with the launch of Operation Thunder, with the quality assurance campaign that we have launched, we have got some significant innovation coming, value promotions going on, we expect that to go into 2014 with KFC being stronger than ever, and that's our goal.

This is obviously a challenging time, but that doesn't mean that you just can't keep investing and building the brand and setting yourself up for the future.

And we love our position with KFC in China over the long-term.

And John, to build on David's comments on the cost of sales and the implications for our margin, in the first quarter we were fortunate enough to experience food cost deflation of 5%, and we had a 3-point benefit of pricing from actions taken last year, so a rollover pricing benefit, if you will, of 3 points.

Those two elements combine helped to blunt the impact of the transaction de-leverage on our overall margins and helped to keep our cost of sales percentage in a good spot despite the fact that, as you say, we were offering more value during the quarter to help support more transaction growth.

David Palmer, UBS.

You know, it's probably tough to tease this out, but has the talk about antibiotics died down?

And is your team's perception that as we get past the avian flu issue that you are going to be at another level with antibiotics, and maybe even there is a, crazy as it sounds, a silver lining to the avian flu issue in that it sort of wiped clean or perhaps permanently pushed back into the back of people's consciousness the whole antibiotics issue that was at the fore a few months ago?

Thanks.

Well, I think, David, what we are pleased with is the publicity on the poultry issue has really subsided and we are moving more into the process and continued process of building consumer confidence.

I think basically what we need in China is just to get the time that we have seen historically has bought our business back, and that is really the way how we are looking at it.

I wouldn't even comment on your hypothesis.

I will leave that to you.

What we think we need is really the gift of time to build the consumer trust back and keep building the brand forward as we move ahead.

Thank you.

Joseph Buckley, Bank of America.

Thank you, two questions, one back on the China margins.

Can you walk through what is happening with labor inflation?

Obviously, labor cost up year-over-year, but with a little better control than I might have guessed.

And just kind of curious if the wage inflation has subsided any.

With respect to China labor inflation in total at the restaurant level, we experienced about 14% inflation, more or less in line with our expectations.

The wage rate component of that was up 8%.

So the difference reflects growth in the cost of employee benefits and growth in the cost of management labor.

Okay.

And then a question -- with all the poultry issues and supply chain changes, how does this affect you looking out to 2014 and beyond from a cost standpoint and then actually continuing to grow?

Is the poultry industry capable of growing with you?

At present, we don't expect that the increased rigor of supply chain management practices is going to have a material effect on our poultry supply costs.

In fact, we have reason to believe that flock yields could improve as a result of some of these more stringent practices, and that will help to diminish the cost of any new procedures that may be put in place at our suppliers to continue to drive even higher levels of quality.

And then in terms of longer-term supply, we remain confident that the larger producers will continue to grow and meet our supply requirements.

So we are not concerned that we are going to face a situation where we are going to be supply constrained in a way that is going to put upward pressure on poultry costs.

Okay.

And then, again, just to flip back to the China labor thing for a moment, if I look at labor cost per store, they look very flat year-over-year.

So is that just adjusting to the lower level of business, staffing wise?

Or --

Exactly.

-- is there something else that would drive that, given the inflation numbers?

No.

What I can tell you is that clearly in the current environment, the team is very much focused on running as efficiently as possible but, because we do see this as a temporary situation, we are not taking actions that would in any way compromise the service that we are providing our customers.

John Glass, Morgan Stanley.

Thanks very much.

I wanted to come back to this notion of it will take time to get through this, and that's probably true in this situation but it won't necessarily prevent the next episode and there will inevitably be something else.

So there are two issues in China that seem to be -- need to be addressed longer-term.

One is your supply chain.

And my understanding is chicken and chicken production in China is more fragmented; it's not vertically integrated like it is in the US.

So on that first point, is there an opportunity to help suppliers vertically integrate China so you don't -- so you have a certainty -- maybe it's using a multinational company, for example, as a key supplier, where you stand on that.

And secondly his response to rumors.

It seems like you have been caught off-guard a few times in terms of rumors, and social media has exacerbated this.

Has there been a seismic shift or has there been a change in the way you are choosing to respond to rumors more quickly or more effectively?

Well, first of all, I think what we have done on the supply chain is we have taken swift, decisive action to work with our suppliers to get an even more enhanced supply chain system.

As I talked about earlier, we have eliminated over 1000 chicken houses from our supply chain.

To your point, we are working with our suppliers to support a vertically integrated farming system, developing best practices, working with them very closely.

And as far as social media goes, we have beefed up our social media monitoring system dramatically.

So I think our intention as a consumer company is to be best in class in this arena, and I think that's happening across the board in all of our divisions.

It's the number-one priority of Johnathan Blum, our Public Affairs Officer, and we are very, very focused on this and, I think, doing an excellent job.

In fact, being world-class in social media, digital is a major strategic objective of ours.

Last week, we just spent as a team a couple of days visiting places like Twitter and Square, just to get totally on top of what's going on in the world today -- which I think we are.

But at any rate, I think we are taking all the actions we need to take to ensure that our industry-leading supply chain is even better as we go into the future.

We do everything we can to be on top of social media and use it as an advantage and be able to counter any false claims that come about.

And I think we are on top of both of these issues.

Alright, thank you.

Michael Kelter, Goldman Sachs.

So you guys are assuming a return to positive same-store sales for the year is out, and it makes sense given prior similar incidents recovered at that pace.

But how do you know that this time there hasn't been more permanent or maybe just semipermanent damage to the KFC brand in China?

Is there something you are seeing specifically that gives you confidence, or is it just relying on the historical analogues?

Michael, I would say that the fact that we have seen sales start to come back in February and March, as David said, about where we expected, gives us confidence that this recovery period of six to nine months is a reasonable expectation.

Before the recent publicity of avian flu, we were seeing a recovery and we continue to expect, therefore, that a full recovery will happen in that six- to nine-month period, particularly given the fact that we expect this dramatic impact of avian flu will persist for only about three months or so.

We have weathered many storms like this, so we do have a number of data points to inform our point of view at this point in time.

And, again, based on what we saw happen over the course of Q1 and as we reported our March sales, which, as you know, for our China Division fall into Q2, we remain confident that we are looking at a six to nine-month sales recovery period.

And then on a similar kind of a point, you guys have presented your brand tracking scores in China over the last several years.

Can you tell us what you are seeing in the latest read from the consumer in your brand tracking?

What parts of your score have fallen off the most versus what is holding up?

I think we have to get back to you on those specific numbers and we can share them on the next call, if you would like.

I think one of the things that we are tracking is, as we build awareness of everything that we are doing with Operation Thunder is this improving consumer perceptions.

And the answer is the more and more people are aware of what we are doing, the better they feel about coming back into our business.

So I think that that's something that we will continue to track.

But without question, we have a beloved brand with KFC.

And as you know, when you have great brands, you just have to keep doing the things that build a great brand, and you come back.

Every great brand comes back, and KFC is in a powerful position.

And whatever issues there are in the category or with food safety or whatever, we are at top of the class in terms of being a brand that people can rely on.

So I think that's what gives us so much confidence as we go into the future.

We know we are doing the right things.

I think the big message we have for Yum!

Brands this year is staying the course.

We have growth staring us in the face all around the world.

Everywhere we look, we see growth opportunities.

We are the leader in emerging markets, not just China.

We are continuing to build our brands the right way and we have growth opportunity that is unparalleled.

Even as we look at China, you have got 300 million consumers that go on to 600 million, and we see this as the number one retail opportunity in the world.

Nothing has really changed from last year other than the fact that we have a challenge that we have to work through.

And we have worked through these challenges in the past and we are not only doing it with KFC right now, we also are building Pizza Hut.

Pizza Hut, as I mentioned, is the biggest new news at Yum!

Brands.

We are opening up in new cities with three-year cash-on-cash returns.

We are definitely going to have the leading brands in every significant category.

And then, as you were listening to the call, look at what is going on in the United States.

We have improved our margins for five consecutive quarters.

Taco Bell, which is 60% of our profits, is looking more and more like a power brand.

I don't think anybody is doing a better job of marketing or innovating than Taco Bell.

And so we really -- we think we are doing the things that really set this business up for the long-term.

Our margins improved at YRI.

Why?

Because we have restructured the business, we've re-franchised our UK business.

So all of this sets us up for the future.

2013, for all of our shareholders out there, I want you to know it's very disappointing to us.

We've got a track record we love, but we want to get it back and we want to come back in 2014 stronger than ever.

And every sign I see as I talk to our people around the world and I see what's going on is that we are putting things in place to make sure that we continue to get back on that track record.

And that's the goal, because we deliver and we are going to deliver consistently over the long-term.

Thank you very much.

Brian Bittner, Oppenheimer.

I'd love to talk about something else, but I'm actually going to ask you about China.

(laughter) that's alright; it's a big opportunity for us.

This must be tough to really answer, but I'm going to ask it anyway.

Based on the trends that you're seeing throughout April, I think this avian flu thing really -- I think the first press release or whatever came out about March 31.

So it's been about 3.5, 4 weeks.

It has subsided a little bit but not a lot.

But based on the trends you are seeing throughout the month, do you think April represents a bottom, this down 30%, and we start the recovery from there?

Or, based on what you've seen historically and based on what you are seeing in April, could May see -- could it worsen in May, or could it be as bad in May, or do we start the recovery from this April number?

Brian, certainly, we hope this is the low point.

It's very difficult to predict the exact trajectory of a sales impacts like avian flu, so it's tough to call at this stage.

But, again, based on our past experience with incidents like this, we believe that that impact will go away in about three months.

I think it's a really -- you are right.

You are asking sort of like the mother of God question.

Nobody knows the answer to this one.

Okay?

But not two crises are the same.

We can only look back.

But we've weathered other storms in the past.

And to put this in context, the last time the China business was significantly impacted by avian flu was 2005.

Our China Division operating profit was $200 million.

And at that point, it declined about 6% versus the prior year.

Last year, we made over $1 billion.

Okay?

And I think that's a real testament to just the power and the resilience of the brand.

So I don't know what's going to happen in the next few quarters, two months.

Your guess is as good as mine.

I'm not a soothsayer; I'm not a predictor on these kinds of things.

So we'll just watch the press coverage, we will pay attention to what's going on, but most importantly, we are going to continue to build the value and build brand and build the innovation that we know is going to set us up for the long-term.

So I can't really call exactly what's going to happen in the next two or three months.

I don't think anybody can.

What we can tell you is that this is a dramatic impact on our business.

It's short-lived and the period in the past has been about three months.

And we are continuing to take actions, as we have in the past, to remind consumers that fully-cooked chicken is perfectly safe to eat, and we are reminding them in several different ways in-store and television and so forth.

No, I appreciate the answer.

And then another quick follow-up, just on the margins, I think you said deflation of 5% in the quarter, 3% pricing.

What are we thinking for a full-year effect as far as food cost inflation or deflation and a full-year pricing impact so we can think about food margins going forward?

At this stage, we have no reason to move off of the full-year guidance we provided at our December analyst conference, which for food cost is low-single digits, and for labor, mid-teens inflation.

So we would stick to that as a full-year expectation.

As it relates to what our reported margin is, I'm not going to speak to what that number is going to be or what it might look like in any given quarter.

There are so many different moving pieces here, as I'm sure you can appreciate, the biggest lever for us is transactions.

And so we have taken a big hit on transactions.

We expect those transactions will come back.

So the de-leverage impact that we've experienced thus far will reverse as those sales come back, and that's going to be the biggest driver of our margin performance, balance of year.

We do have some rollover pricing benefit which benefited us in the first quarter.

That will continue to have some impact, albeit a bit less in the second and third quarter, but at this stage I don't feel that it's appropriate to provide a full-year number on margin or certainly not to talk about what's going to happen in Q2 versus Q3.

Got it, but just to be clear, what has happened so far has not really change the food cost inflation trajectory.

You still expect back half inflation.

That's correct.

Okay.

Diane Geissler, CLSA.

I have another question on China, and this really relates to the whole issue of food safety.

So China has had a number of scares in a variety of industries, including dairy and hog raising.

I guess my question is really, have you seen any movement on the part of the Chinese government to change regulations and/or make it easier for the big integrated processors to expand?

You've talked about calling from your system the small house operations.

But have there been any shifts in terms of like bio-security from the government or helping multinational site houses, whether that's through better land use rights, negotiations, etc., just in terms of how you see that supply chain going forward over the next 5, 10, 15 years?

I think the biggest thing with the new government in China and new regime is food safety is high on their priorities.

So I expect there to be more diligence and more work with major companies like ourselves.

As a leader, we see ourselves as -- our task is to set the standard, and that we plan to work and are working very closely with the government to do everything we can to be the leader in food safety.

But I think it's really too early to talk about any seismic changes that are occurring, but I do believe that food safety will become even better and more enhanced over the long-term, given everything that's going on and the focus of the government.

Okay, I appreciate that.

And then just on real estate, do you see any shifts in terms of development and your ability to site new stores this year and into 2014?

No material change that we see, Diane.

As we've said before, our new unit development program is shifting increasingly to the lower-tier cities where the development opportunities are more compelling, margins higher, returns higher.

And we are also shifting more from KFC to the Pizza Hut brand, and that will continue.

In terms of our ability to secure the sites and the development of infrastructure to create the opportunities for us, we don't see that changing.

Okay, terrific, thank you.

Keith Siegner, Credit Suisse.

Just one more question on China -- thinking through the long-term Company restaurant margin outlook, 20% has been a number that you have offered for some time.

2011, 2012 and 2013 all below this, we've added in the Little Sheep concept, which has slightly lower margins.

Is this still the right long-term target?

Is that what you are planning for?

Is this something that a return to positive comps can help you achieve, or is this now a multi-year process to get back to that target, given the acute challenges of this year?

Thanks.

Keith, we continue to believe that 20% margins are imminently achievable with our China business, and it's not just comps that are going to get us there.

Certainly, in the short-term, the transaction recovery is going to be the single-biggest driver of margin improvement, no doubt about it.

However, there are a couple of other things to keep in mind.

The first is ongoing asset leverage.

As we continue to add new layers to our business, to our existing restaurants, whether it's 24-hour operations in our KFC business or breakfast at Pizza Hut, these new sales layers are going to better leverage the existing investment we have and provide that leverage on fixed cost.

And then the other is the impact of portfolio shift.

As I mentioned, when we look at our new unit development program going forward for the KFC brand, we are continuing to shift from the tier 1 and tier 2 coastal cities to the tier 2 inland and the tier 3 and below cities where margins are significantly higher.

And we are continuing to shift more of our new unit program from KFC to Pizza Hut.

And I want to point out, even though this wasn't in our release, that even in a quarter where same-store sales were down for our Pizza Hut Casual Dining business, margins were still well above 20% and even close to 30% in the lower-tier cities.

This is going to be an increasing focus of our development program going forward, and that's going to benefit the portfolio restaurant margin for our China business.

So I think it's important to keep in mind those three factors.

It's transaction recovery, it's ongoing asset leverage as we introduce new sales layers, and it's the shift in our new unit development program and how that's going to benefit portfolio margin.

That's very helpful.

One very quick follow-up, just if I can -- thinking through Little Sheep now, which you have basically anniversaried since the acquisition, is this at the point now where, regardless of all this other noise, can Little Sheep be a tailwind to that margin curve this year, maybe even, and over the next couple years as well?

I think it's premature to say that it's going to be a margin tailwind this year, but our long-term expectations of the growth that we will get out of that business -- to be high, it is a relatively small portion of our portfolio today.

But we didn't buy it, as you know, for the 400 to 500 units that are in the ground, but for the several hundred units that we know we will build over the next several years.

And with the improvements we are bringing to the concept in our operations know-how, we are optimistic that the margins are going to improve significantly.

And at that stage, with a larger-scale business and much better margin performance, then the Little Sheep business will be helpful to our overall margin.

Little Sheep is very small, okay, at this stage, but we expect it to get a hell of a lot better.

We are improving the concept every which way we can, so there's only upside.

But it's not a big, big tailwind for us.

David Tarantino, Robert W. Baird.

I just wanted to ask about your thoughts or preliminary thoughts on 2014.

I know you don't want to give any guidance at this point or specific guidance at this point, but I'm just wondering if you think 2014 could be a big rebound year in terms of the earnings growth, given the expected sales recovery in China.

So, for example, a soft year in 2013 followed by a well above average year in 2014, and by the time you get to 2015 maybe you are back on your long-run trend line.

Just any thoughts on how you think it might play out would be helpful.

Well, David, I think that you are thinking about it exactly the right way.

Let me tell you, if 2014 is not a big bounce-back year, we will all be very disappointed because that is our expectation.

We have a high degree of confidence that is going to be the case.

And as I said in my remarks earlier, 2013 is an aberration.

So I wouldn't spend too much time focusing on 2013 results -- not to suggest that we are not focused on doing the best job possible.

But as it relates to how you think about our business and what we are going to deliver and how we are set up to continue to grow, I encourage you to continue to focus on 2014.

We do expect that we will begin to see a strong recovery next year.

Our great and late Chairman, Andy Pearson, had a great line.

He said the best way to have a great year is to follow up a bad one.

Well, we clearly have a bad one this year.

Okay?

And so we expect next year to be very, very good.

And we have very high expectations for ourselves.

I think the important thing for our investors to know is that we are building the platforms that we think will establish the long-term growth.

If you take Taco Bell, for example, we are really leading in terms of improving our quality, innovation with what we have done with Frito-Lay and the Doritos Locos Tacos line.

We have world-class operations.

We have been focusing on that for some time, but we are ranked in the top three across every key major and operations that we look at, building it for the long-term.

At Pizza Hut, we've got good value proposition, good innovation.

We are working on a major platform in chicken where we can really develop our sales as we go forward.

Across the board, we are working on the sales layers, the breakfasts and the beverages and things that we think will give us the incremental sales that will be significant over the long term.

So we really -- what we are focused on this year, as I mentioned earlier, staying the course and building a sustainable growth engine for the long-term.

And nobody expects us to grow at least 10% next year.

We expect to do a lot better.

And the other important point to reiterate -- David mentioned this in his remarks earlier -- is the impact of the new unit development in China.

So last year, we opened about 900.

This year, we are saying at least 700, so that's 1600 between the two years combined.

Collectively, that will deliver about $2 billion of system sales, which represents about a 25% increase on the base.

So think about it.

As we recover from the effects of the late December incident and the more recent avian flu publicity, we have all these new assets in the ground generating sales and profits that will contribute significantly to our growth in 2014.

But the proof is in the pudding, you know.

You can look at this and you can see all kinds of potential.

But as my father used to tell me, potential means you haven't done it yet.

Okay?

So we have got to turn around China; we've got to keep building these businesses, and then I think the businesses will end up being where they ought to be.

And this is a growth Company.

Andy Barish, Jefferies.

Actually, two quick YRI questions.

On just the avian flu, do you expect a little bit of impact in some of your other Asian markets?

And then just a clarification on the Pizza Hut UK franchise renewals.

So the deal closed in the fourth quarter, but the renewal fees and new franchise stuff came in here in the first quarter.

I will respond to that piece first, Andy.

The franchise ownership transfer with the transfer fees and the renewal wasn't related to the Pizza Hut UK business.

It related to a different market for us where there was a transfer in ownership from one franchisee to another.

That happened in YRI's first quarter.

Regarding impact of avian flu, I don't think what's happened in China is going to impact other markets.

I think what will happen is if that appears in those markets.

We are obviously going to keep a close eye on that.

We are prepared in advance to communicate what our response would be, which is what people have said here before, which is properly cooked chicken is perfectly safe to eat.

We are ready for the possibility, but I don't think it's going to have an impact unless it hits other countries.

Mitch Speiser, Buckingham Research.

Thanks very much, and I'll try to avoid the China questions.

It seems like -- I think we've gotten a lot of different angles on that, although I'm sure there's probably some more.

But just on the balance sheet I would like to ask about, there wasn't a lot of share repurchase in the quarter.

You are, I think, under one times levered.

So maybe just discuss if there are any constraints to using the balance sheet a little more aggressively in general and using share repurchase, in particular.

Mitch, we continue to take a look at this and we are quite happy with where things are at right now.

We are generating enough cash to pay the meaningful dividend and return remaining cash to share repurchases at a level that will accomplish what we expect as it relates to contribution to earnings per share growth.

We are not interested in leveraging up at this stage and putting at risk our investment-grade credit rating.

We believe that we are in the sweet spot as it relates to how we balance these things out and the implications for overall cost of capital.

So no plans to do what you have suggested.

Okay.

And separately, just on the second quarter, I think you mentioned down double-digit.

Obviously, that's a wide range.

Maybe if -- anymore particular range?

Obviously, that could be down 10% or down 30%.

Any incremental info on how to model the second quarter would be helpful.

And does the very weak second-quarter results on tap -- obviously, it's China-driven, but does some of it relate to the very difficult comparison at Taco Bell?

No.

Certainly, Taco Bell is not playing into how we have characterized EPS results in Q2.

What we have said is that it will be a significant double-digit decline, by far our low point of the year.

But because we delivered so much better results in the first quarter, that puts us in a position to cover the unexpected severe impact of avian flu on second-quarter results and thus hold to our full-year estimate of mid-single digit down.

And just given that the wild card here is China sales recovery, which is very difficult to call, I don't think it makes sense to give a more precise estimate of what that second quarter will be.

But we want everyone to know that it will be a significant double-digit decline.

And, Mitch, regarding the overlap of Taco Bell, from a sales perspective, it is a huge overlap, as you point out.

As I said on my speech, we grew 6% in the first quarter of top of 6% last year.

In the second quarter, Taco Bell last year had 13% same-store sales growth, which is obviously a huge number.

We look at it as anything positive being a really good result there.

And what the team has put in place in the launch of Cool Ranch Doritos Locos Tacos, I think we have a decent chance of accomplishing that.

Jason West, Deutsche Bank.

Just a bigger picture question in China.

We have seen a bit of a continued deceleration in GDP growth and retail sales growth in that market.

I'm just wondering how that plays into your longer-term thinking on unit growth.

And does it really matter if GDP is up 7% or 10%, or do you have just so much room in the smaller cities that you really -- it doesn't play into your growth algorithm at all?

We see the biggest macro is the growing consumer class, going from 300 million to 600 million.

So let's say it goes from 300 million to 550 million or 300 million to 500 million.

It's still a lot, okay?

And we've got lots of upside as we go forward.

So that's the big, big macro that we look at -- the growing consumer class and growing disposable income.

We think both of those things will be moving in our direction, and that's the key.

Jeff Omohundro, Davenport & Co.

Just wanted to expand a little bit on the Taco Bell momentum that you referenced.

I just wonder if you could maybe address the Cool Ranch DLT launch with regards to mix shift and just how it compared with the original DLT launch, again particularly since you are overlapping such challenging prior-year comparisons.

When Doritos Locos Tacos was launched in 2012 with Nacho Cheese, the peak mix was about 12%, 11% to 12%.

And when it was off-air sort of towards the end of the year, beginning of this year, it got down to around 4%.

So we left it on the menu, but we weren't promoting it for a period of time.

When we re-launched Cool Ranch, we got about that same level of mix, about 11%, 12% of mix.

That's helpful, thanks.

That's a huge number for Taco Bell.

Anything over 3% is like big, okay?

So it's -- if you haven't tried it yet, you ought to.

If you like Doritos, you can't eat just one.

Many times.

Try the boneless chicken at KFC, too, while you are at it.

That's really good, too.

The boneless chicken is good.

Then if you need another meal, go have a Cheesy Crust Pizza.

Jeffrey Bernstein, Barclays.

Just two follow-up questions, and one on China.

I know you talk about the complete confidence and the full sales recovery.

Obviously, some of these issues have been compounded, which makes teasing it out somewhat difficult.

I think most people will agree that the supplier issue and the avian flu issue will ease with time, and you have a history for that.

But any thoughts on -- I know we had seen a slowdown in trend in October, November, December, which was talked about at your analyst day.

I know it was tough to look at.

At that point in time, there was some debate whether average check had gotten too high or there was too much price.

So I'm just wondering how you think about -- or what gives you the confidence in the full sales recovery or what would you see that would make you more cautious that maybe the initial issue back in the fourth quarter of 2012 might be more severe than you might have thought?

And then I had a follow-up.

Well, I think that we know that we are constantly improving our value equation, constantly building awareness of the sales layers we have, the delivery and 24-hour service and breakfast.

So we've got things that we have invested in to give us a base that we can build on.

And we think it's early days.

We don't have -- we are not capacity constrained.

Okay?

It's not like we can't make more chicken and sell more products and build our dayparts.

Our average unit volumes are $1.7 million to $1.8 million at KFC and Pizza Hut.

The average unit volumes in McDonald's is $2.6 million, okay, in the United States.

So we think that one of the ways how McDonald's got there is they kept building those incremental dayparts over time.

And that's what -- we think we clearly have the opportunity as we move ahead.

And I think that, just fundamentally when you look at our asset base and how we can leverage it, that gives us a lot of confidence.

These are very untapped dayparts that we are just in the early days on.

So I think that's the biggest opportunity.

The other thing, Jeffrey, that is going to help is that as you look at the quarter's balance of the year, the lapse are less challenging, if you will.

And, certainly, that's going to contribute to our ability to deliver improving results balance of year on the underlying business.

Jeff Farmer, Wells Fargo.

Great, thank you, just, again, staying away from the China discussion, just looking for a little additional color.

I think you said 240 basis points increase in the US restaurant margin.

It looks like you called out Taco Bell sales leverage and some re-franchising as drivers.

But what was the approximate margin benefit from each of those things?

And I guess more importantly, as you look out to 2013 full-year US margin, what type of guidance can you give us for that?

What we saw in Q1 we expect to be about what we will see for the full year.

The impact of refranchising was about half of the margin improvement we saw in the US, in the first quarter.

Okay, and that carries through, to your point, all four quarters?

More -- and there will be some variability from quarter to quarter.

But on a full-year basis, again, we expect to see about 17% margin for the US.

Okay, thank you very much.

Thanks, Jeff.

I think that's our last question for today.

I wanted to thank you for joining our call.

Once again, please remember to mark your calendars for upcoming investor events, and we look forward to speaking with you soon.

Thank you.

This does conclude today's conference call.

You may now disconnect.