百勝餐飲集團 (YUM) 2014 Q2 法說會逐字稿

Good morning.

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

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

Brands second-quarter 2014 earnings conference call.

(Operator Instructions).

Thank you.

Mr. Schmitt, VP of Investor Relations and Corporate Strategy, you may begin your conference.

Thank you, Shawn.

Good morning, everyone, and thank you for joining us.

On our call today are David Novak, Chairman and CEO, and Pat Grismer, our CFO.

Following remarks from David and Pat, we will take your questions.

Before we get started, I would 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 at yum.com to find disclosures and reconciliations of non-GAAP financial measures that may be used on today's call.

We are broadcasting this conference call via our website.

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

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.

Finally, we would like to make you aware of the following upcoming Yum!

investor events.

Our China investor and analyst conference will be on September 16 and 17 in Shanghai, China.

Our third-quarter earnings release will be on Tuesday, October 7. And our 2014 New York investor and analyst conference will be on Thursday, December 11, in Midtown Manhattan.

With that, I would now like to turn the call over to David Novak.

Thank you, Steve, and good morning, everyone.

I'm pleased to report Yum!

Brands is well on its way to delivering full-year EPS growth of at least 20%, with second-quarter EPS growth of 30%, excluding special items.

Just as important, I'm confident we're building momentum behind major initiatives around the world that will sustain double-digit EPS growth in 2015 and beyond.

Looking at the quarter, we're obviously pleased with the continued progress we're making at KFC in China, as evidenced by strong sales and margin growth as well as improving new-unit returns.

Our KFC division, which is our second largest profit contributor behind China, also continues to deliver solid sales and profits.

When taken together, our China and KFC divisions comprise nearly two-thirds of our total operating profit, so it's great to see both performing well.

Another highlight is our Taco Bell breakfast platform is off to a great start, and we expect to build off this momentum going forward.

Now let me give you more color on each of our divisions.

Let's begin with China.

Our China division delivered system sales growth of 21% in the quarter, as we opened 104 new units and grew same-store sales 15%.

It's great to see such a strong top-line growth, and fortunately this top-line growth flowed through nicely to the bottom line as operating profit grew an impressive 188%.

The China team deserves a lot of credit for doing an excellent job driving restaurant margins of almost 17% during the quarter and over 19% in the first half.

At KFC China, our goal is to improve our already strong economic model and make KFC, which is the number one most popular brand in China, even more youthful, contemporary, and energetic.

We have maintained our value anchors and still have RMB6 breakfast offerings and RMB15 lunch offerings, but have shifted our focus from price/value-led growth to higher quality and more profitable transaction growth.

Our primary focus going forward will be on more premium innovation delivered with a superior customer experience.

We're confident we're on the right path to evolve KFC into an even better, higher quality, and more profitable business model as we keep the brand contemporary.

With the recent launch of the KFC menu revamp in our more than 4600 restaurants in over 950 cities across China, we introduced 15 new products at one time and leveraged four popular celebrities to promote four signature product platforms.

Our campaign clearly resonated with consumers, as KFC delivered same-store sales growth of 21% in the quarter.

It's important to note that while our guest check has increased, our value scores have also improved.

In addition to intensive product innovation, we're enhancing the customer experience with the launch of redesigned packaging, contemporary staff uniforms, new menu boards, branded service, and a new restaurant design, which we will be rolling out over time.

On the digital front, we have begun rolling out free Wi-Fi.

We also have a new mobile app coming which will provide consumers the convenience of pre-ordering with electronic payment.

And we have more exciting news coming balance of the year.

So let me sum things up for KFC China.

We're confident we are presenting an even better KFC our customers will continue to appreciate and a business model that is rapidly improving new-unit returns, setting us up for continued, aggressive development in the future.

Turning to Pizza Hut Casual Dining, which is arguably one of the greatest success stories in our industry the past few years.

We are clearly the number one Western casual dining chain in China, with hardly any midscale competition.

And if you follow us, you know Pizza Hut Casual Dining goes well beyond pizza, as almost two-thirds of our sales are non-pizza items, bringing our pizza and more positioning to life.

During the quarter, we delivered system sales growth of 16% and opened 36 new units, further strengthening our category-leading position.

Same-store sales were flat in the quarter, but keep in mind we're overlapping 7% positive same-store sales in 2013, which was our strongest quarter last year.

Looking ahead, we have exciting product news coming, and the business is on track to deliver another solid year in 2014.

Most importantly, the business model and new-unit returns are firing on all cylinders with two-year cash paybacks.

In fact, we are aggressively expanding into lower-tier cities.

We are now in 305 cities and expect to have over 1200 units by the end of the year.

That's more than double our unit count only three years ago, and we're just getting started.

Now, the other exciting thing about Pizza Hut is our separate and distinct Pizza Hut Home Service business, where we deliver an all-meal home replacement to Chinese customers.

In fact, over 40% of the menu consists of Chinese food.

We have borrowed from the innovation and know-how we developed with East Dawning, our Chinese fast food concept.

So not only are we delivering pizza, but we're delivering a full array of Chinese menu options in a small-box format that will drive aggressive expansion.

We believe we have innovated our way to not only offer up pizza, but Chinese food in a scalable, highly profitable fast-food format.

We now have over 200 units in 26 cities, and we're really beginning to rapidly scale this brand across the country.

So with the strong foundation in place and with enormous demand for home meal replacement in China that will only grow over time, we expect our Pizza Hut Home Service business will contribute more meaningfully in the years ahead.

Last but not least, we continue to work hard to turn around Little Sheep, which has clearly been a major disappointment and continues to be so since we acquired it in 2012.

We'd like to take a step back and look at the big picture of China.

We'll always be focused on improving our unit economics by growing average unit volumes.

But what excites us the most is the largest component of our ongoing growth model in China is new-unit development.

And we are as confident as ever we are still on the ground floor with constant, aggressive expansion ahead.

That's because in China, we now generate three-year cash paybacks at KFC as we've improved the business model and two-year cash paybacks at Pizza Hut Casual Dining.

New-unit returns are outstanding for these two power brands.

And, importantly, our overall returns are getting stronger as we continue to shift more of our development to Pizza Hut Casual Dining and KFCs in tiers 3 through 6 cities, where our unit economics and returns are strongest and the consuming population is getting larger and larger.

In terms of our new-unit potential, the macro trend we remain most enthusiastic about is the large and growing consuming class, which is expected to double from 300 million people in 2012 to 600 million people by 2020.

And disposable incomes are growing right alongside it.

In 2014, we fully expect to open at least 700 new units, and the long-term outlook is bright for KFC, Pizza Hut Casual Dining, and now Pizza Hut Home Service.

Moving to India, as discussed, we have made the strategic decision to invest ahead of the growth curve to develop a business that we are confident will drive substantial growth for Yum!

in the years ahead.

We currently have over 700 units, and we are full-steam-ahead with this development as we expect to open another 150 new units this year.

We are well on our way to a target of 2000 units by 2020.

We're hopeful the new political leadership in India will create a stronger economy and more pro-business environment as we invest in this country that has well over 1 billion people.

Now let me share you some perspective on our three brand divisions, starting with KFC.

Our KFC division, which generates over 90% of its profits outside the United States, delivered a solid second-quarter led by strong international performance.

Importantly, our international new-unit pipeline remains extremely robust.

We expect to open at least 650 new units outside the United States this year and grow operating profit consistent with our full-year guidance of more than 10%.

I recently attended KFC's global marketing planning meetings in Dallas, where we had nearly 30 countries represented in one room.

Now, during these meetings all our CMOs from around the world shared their marketing calendars and plans for the coming year.

There's no question we're building more know-how and getting better at advertising, innovation, and value in digital.

Our expectation is that this will result in higher same-store sales growth in the years ahead.

And even though we have nearly 14,000 restaurants in over 110 countries around the world, with only two KFC restaurants per 1 million people outside the United States, we still have a long runway for future growth.

Our business model is powerful, and our development pipeline is strong.

Now let me give you an update on Pizza Hut.

We're obviously disappointed with second-quarter results and particularly with the very poor performance in our US business, which contributes about half of Pizza Hut's division's total profit.

We now expect full-year operating profit at Pizza Hut to fall well short of our initial expectations.

We've had our ebbs and flows versus the competition over the years, and I can assure you we will be back.

In fact, we intend to launch a number of major initiatives in the United States to reignite sales beginning in the fourth quarter.

Our plan is to launch a major new advertising positioning along with innovations designed to better connect with millennials and separate us from the competition.

To this end, I encourage you to try our new Hershey dessert cookie.

You should also know we will sharpen our focus on value and intend to leverage our more competitive offers to drive digital activations.

Our goal is to not only to catch the competition on the digital front, but to surpass it in 2015.

We know we have a great brand to work with at Pizza Hut.

Even with our recent challenges in the United States, Pizza Hut has the highest average unit volumes in our category and over 2800 more restaurants than our nearest US competitor.

Over the past two years, we've also been outgrowing the competition in terms of new-unit development.

In fact, we expect our fourth consecutive year of positive net new-unit growth.

Importantly, the majority of new units will be opened by franchisees, which speaks to the strength of the Pizza Hut business model.

All of this gives us confidence going forward, and we expect to show significant progress balance of the year and 2015.

Globally, we are sharing best practices to drive sales growth, and we're making focused investments to accelerate our pace of new-unit development, especially across the delivery and express channels.

We expect to open a record 450 international new units this year for Pizza Hut and expect this number to grow significantly in the years ahead.

So to sum it up, we're bullish on our long-term growth prospects at Pizza Hut.

We're confident we have the right teams in place, plans, and structure.

We expect much better performance going forward and to make significant progress by the year end.

Finally, at Taco Bell, obviously the big news for the brand is that on March 27, it will be a date that'll go down in history as we launched our national breakfast platform.

Here are the facts.

Our breakfast day-part mix -- the mix around 7% of sales in the second quarter.

We fully expect breakfast to be incremental, adding anywhere from $70,000 to $120,000 per unit in annualized sales.

Remember, McDonald's gets about $1 million in sales before we have even opened our doors in the past.

This is a huge opportunity for Taco Bell, and we're already making money in breakfast even though we've added incremental labor and food costs are slightly higher.

We generated tremendous buzz around our products and marketing, and we actually celebrated a record-breaking sales week in the quarter.

And for the long-term, there's no question we've enhanced our brand position as the choice of the new generation.

And in fact, Taco Bell was recently recognized by NPD Crest for being one of only three restaurant brands to over-index with millennials, along with Starbucks and Chipotle.

So overall, we're extremely pleased with the breakfast launch and the direction we are heading for Taco Bell.

Now, the big question you're probably asking is, is given the success of the breakfast lunch, why did same-store sales increase only 2% in the quarter?

Keep in mind that during the first two months of the quarter, our media emphasis was almost totally on breakfast.

Once we returned to advertising our core business, it was with Cool Ranch Spicy Doritos Locos Tacos Chicken; and frankly, this product underperformed versus our expectations.

We believe that it ended up being too much of a niche product to overlap the 15% growth we've had over the past two years with the introductions of Doritos Locos Tacos and then Cool Ranch, two of the most popular product introductions in the history of our entire category, not just Taco Bell.

Nevertheless, Taco Bell's same-store sales were positive 2% in the quarter; and we've said all along that Taco Bell would be a first-half/second-half story.

In fact, trends have improved with the recent launch of Quesarito, which proves that when you have great innovation, balance of day, coupled with a strong breakfast line, it's a powerful combination.

Looking ahead, we'll be introducing mobile ordering, and we have significant value innovation planned in our core business to drive growth balance of the year and beyond.

Our franchisees are in breakfast to win, and have been also cheering us on to broaden our breakfast offerings with new products that we already have in the pipeline.

All in all, we're pleased to have lots of innovation coming across all day-parts to drive growth in a very challenging environment.

Today's launch of our Power Cantina menu, a line of high-protein products that I love, is just another example.

Importantly, our ongoing product innovation is backed by solid operations and attractive unit economics, which allows us to open over 100 net new units this year, representing a 10-year high.

We are confident we will ultimately achieve our goal of at least 8000 Taco Bell restaurants in the United States by leveraging our asset throughout the day.

We have great progress now in breakfast, we have happy hour, we have the fourth meal; we see this as a power brand that can be leveraged throughout the day.

Now taking a step back, when you look at Yum!

in total, we believe we are well positioned to deliver on the three things that drive shareholder value in retail: driving new-unit development, building same-store sales, and doing these in a way that generates high returns.

In terms of development, and our new-unit opportunity in emerging markets remains the best in retail.

We have a two-to-one lead over our nearest competitor in emerging markets, and our opportunity to expand remains enormous.

We have only two restaurants per million people in emerging markets compared to 58 per million people in the United States today.

Clearly, this is a long runway for growth and gives us tremendous confidence in our ability to continue our aggressive expansion for many years to come.

Furthermore, we have over 40,000 restaurants around the world, with all kinds of ideas in the hopper and clearly significant capacity to grow same-store sales and average unit volumes.

The fact we have an under-leveraged asset is a great weapon as we go into the future.

Meanwhile, our returns on invested capital have consistently been among the highest in our industry.

Over 90% of our restaurants outside of China are owned and operated by franchisees.

We simply love the franchise model, which will generate about $2 billion in franchise fees in 2014.

These franchise fees provide us with a large, reliable, and growing stream of cash which, combined with the profit from our equity stores, enables us to invest in high-return growth opportunities and return significant cash to our shareholders.

So let me wrap things up for Yum!

Brands.

On the whole, we are pleased with our overall second-quarter and year-to-date results.

We expect a strong bounce-back year in China and solid full-year performance at KFC.

At Taco Bell, we're pleased with breakfast and confident in our balance-of-the-year plans, and expect a much stronger second half.

And at Pizza Hut, we expect full-year operating profit to fall well below our initial expectations.

We obviously have major work to do to get our Pizza Hut US business on more competitive footing, and we're confident that we will do so and transfer the learnings that we have around the globe.

When you add it all up, we expect full-year EPS growth of at least 20%.

Equally important, I'm confident that we are building momentum behind major initiatives around the world that will sustain double-digit EPS growth in 2015 and beyond.

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

Thank you, David, and good morning, everyone.

In my remarks today, I will cover three areas: our second-quarter results, our outlook for the second half of 2014, and what we're doing to drive long-term value for our shareholders.

For the second quarter, our results were similar to Q1, with a very strong bounce-back in China, solid growth at our KFC division, mixed results at Taco Bell, and poor performance at our Pizza Hut division.

Overall, worldwide operating profit increased 34% in constant currency, and EPS grew 30%, excluding special items.

We've now produced two quarters of strong EPS growth and are well on our way to delivering on our commitment of at least 20% EPS growth this year.

China division profit rebounded sharply from the second quarter of 2013, which was the low point of last year, and grew 188% in the quarter.

Importantly, KFC's same-store sales improved sequentially on a one- and two-year basis, growing 21% in the quarter on the strength of our comprehensive restage of the KFC brand.

And while Pizza Hut Casual Dining same-store sales were flat in Q2, we're pleased that we grew system sales 16% with continued rapid development of this highly profitable concept.

We're also very pleased with our continued margin improvement in China, with first-half restaurant margin above 19%.

And with our current outlook for the second half, we're confident that China's full-year restaurant margin will be at least 18%, or nearly 3 points above 2013 and back to where we were in 2012.

I'm also very happy to report that China's new-unit returns have strengthened considerably.

As you'll recall from our December investor conference, cash paybacks at KFC in 2013 averaged a very respectable four years despite short-term sales pressures.

As David mentioned, with the recovery we've seen in our business this year, cash paybacks on new KFC restaurants in China are now three years.

Pizza Hut Casual Dining cash paybacks in China remain a very impressive two years.

This is great news for our shareholders, as we expect to open at least 700 new restaurants in China this year and pave the way for high-return new-unit development in 2015 and beyond.

As for our other divisions, KFC produced a very solid quarter, with 12% profit growth in constant currency, a significant improvement over Q1.

Taco Bell also improved versus Q1, but results were mixed in a challenging US environment, with profits declining 2% in the quarter.

Taco Bell restaurant margin decreased 2.7 percentage points as we invested in our national breakfast launch and were impacted by commodity inflation of 5%.

Now, as David mentioned, we're very pleased with the national launch of breakfast, and we know the business will benefit from this additional sales layer for years to come.

We continue to expect much stronger results in the second half from Taco Bell.

Our Pizza Hut US division, on the other hand, is in turnaround mode.

We expect results to improve balance of year but Pizza Hut division to fall well short of our initial expectations.

As CFO, I can assure you that we're not holding back from making strategic investments to right the ship.

We're strengthening our global digital capabilities and investing in field-level G&A to open new Pizza Hut markets and accelerate our pace of new-unit development.

I expect our investments in international development to begin paying dividends this year with record new-unit openings, and to see results from our digital investments and other brand-building initiatives in 2015.

Now I'd like to discuss our outlook for the second half of the year.

In China, we expect to achieve at least 40% operating profit growth for the full year, excluding the impact of foreign exchange, driven by improvements in both sales and restaurant margins.

We expect restaurant margins to remain strong, as we've remained diligent in making our labor model more efficient at our KFC business.

Margins will also continue to benefit from our move toward higher quality, more profitable transactions, as well as our development shift to lower-tier cities for KFC and a higher mix of Pizza Hut restaurants.

Partially offsetting this, we're expecting commodity inflation of about 3% and modestly higher labor inflation than we saw in the first half of the year.

So when you add it all up, we're expecting full-year margins of at least 18%, as I said earlier, or back to where we were in 2012, even with the dilutive impact of Little Sheep.

Sales in China continue to be difficult to predict.

Our best estimate is that with the more difficult overlaps we face in the back half of the year and with the current trends we're seeing in our business, full-year same-store sales growth will likely be towards the low end of our guidance range, or in the high single digits.

And, as always, if we can do better, we will.

Now, as David mentioned, Little Sheep results continue to be disappointing, and diluted overall China restaurant margin by 0.6 percentage points in the quarter.

We're continuing to focus on improving this business.

However, if Little Sheep's performance does not improve, we may be required to further impair the business in the back half of the year.

Outside of China, we expect KFC to continue to produce solid results.

As I mentioned before, we expect Taco Bell profit performance to improve significantly in the second half, as pricing should offset commodity inflation, breakfast builds momentum, and higher-margin products like the new Quesarito drive more dollars to the bottom line.

We also expect Pizza Hut results to improve from the first half as we advance our value proposition globally and bring more product innovation and more compelling value news and digital activation to the US business.

Overall, we expect solid growth in the second half and are confident in delivering at least 20% full-year EPS growth.

And if we can do better, I assure you we will.

Now, I'd like to share how we're driving long-term value for our shareholders.

Yum!

is a reliable cash-generating machine, and this year we expect to generate over $3 billion in operating EBITDA, an all-time high.

This includes over $2 billion in franchise fees from our growing, global, and diversified royalty stream.

We reinvest a substantial portion of our operating cash flow, or about 40%, to drive the growth of our businesses.

We also continue to optimize our equity portfolio by increasing the weight of high-return businesses, including emerging markets overseas and Taco Bell in the US, where restaurant margins are in the high teens.

This has positioned us well for future earnings growth and, importantly, has set us up to achieve higher returns on invested capital, which we expect will top 20% in 2014.

Second, we pay a dividend which we've grown at a double-digit rate every year since we first paid a dividend over nine years ago, making us one of only 11 companies in the S&P 500 to do so.

Our dividend yield is currently just under 2%, which is very competitive for a company with our growth profile.

And third, after investing behind growth and paying a meaningful dividend, we returned all available cash to our shareholders in the form of share repurchases.

Each of these levers - our large and growing franchise business combined with high-equity, high-return equity investments, a growing dividend, and value-creating share repurchases - work together to drive strong returns for our shareholders.

So let me wrap things up.

We're pleased with our strong second-quarter results, which were led by outstanding performance in our China division and solid growth at our KFC division.

Our strong start to the year, coupled with our ongoing growth investments, has clearly set us up to deliver on the strong bounce-back year that we expected in 2014.

I'm confident in the strength of our business model and will continue to make the investments necessary to sustain double-digit EPS growth over the long term.

And with that, we'll be very happy to take your questions.

(Operator Instructions) Keith Siegner.

I was wondering if you could give a little more details on the China same-store sales breakdown, in terms of price, mix, and traffic.

Assuming mixed maybe was a big contributor here, where is the mix coming from?

Is this the change in occasion?

Is it less promotions, et cetera?

And then maybe how do you see those three pieces moving in the second half to jive with the guidance that you just gave for same-store sales?

Thanks.

Yes, Keith, very happy to do that.

So, we'll focus on KFC, where we had 21% same-store sales growth in the quarter.

About half of that was driven by mix; and of that mix component, the majority is attributable to the fact that we overlapped a significant decline in high-check family business from last year.

You may recall that from last year's result.

Average spend, however, also benefited from the launch of our premium-positioned menu revamp.

So those two things together drove about half of that same-store sales increase.

Now, we also had about 4 points of pricing, which we felt good about considering that we took absolutely no pricing last year.

And that was more or less in line with inflation on a two-year basis and, as far as we know, in line with competition.

And then we had transaction growth that delivered another 6 points.

I think the important thing here, and what I am most pleased with, is that despite the fact that we had significant lift in average spend and we had a contribution from pricing, our value scores improved.

Our value scores improved with the launch of our new menu, and they improved even with the pricing that we took.

So we feel very good about the composition of our sales growth in the second quarter.

Thank you.

Thanks, Keith.

Next question please, Shawn.

David Tarantino.

Pat, I just wanted to follow up on your outlook for the same-store sales in China for the year.

You mentioned that you expect comps to come in towards the lower end of your prior guidance.

And I was just wondering if you could add some context to that statement.

Is that simply because of the comparisons that you are facing in the back half of the year?

Or are you seeing any changes in the sequential volumes that might concern you and maybe point you more conservatively relative to your prior guidance?

Well, David, I think the first thing to point out is that we're confident that we're going to deliver at least 40% full-year operating profit growth in China on the strength of our recovery in restaurant margin, which, as I mentioned, is at the high-end of our guidance range.

Now, as we've said all along, sales are difficult to predict with precision, and we know that China is a volatile market.

But our best estimate today, based on the current trends that we see in our business, is that same-store sales will likely be towards the lower end of our range.

And it's with that combination of higher-end margin and lower-end sales, if you will, that we get to that 40% operating profit growth that we need to deliver on our commitment of at least 20% EPS growth for the year.

Now, in terms of what's driving the softer result in the back half of the year, is you've got to remember that we've adopted the strategy of pivoting toward higher-quality, more profitable transactions.

And we feel very good about that because that yields a much healthier business model, which bodes well for future development.

The second piece is that the easiest overlaps are behind us.

Remember, the first half of last year, sales were down 20%; same-store sales were down 20% in China.

And in the back half, same-store sales were down only 7%.

So, yes, we are lapping still a negative number, but the overlap is harder in relative terms.

And so it's a combination of those things that would contribute to a softer result in the second half versus the first half; but, again, still ladder up to the 40% operating profit growth and the 20% EPS growth, at least, that we've committed to deliver.

As I've always had in the past, we're going to always have bumps in the road with same-store sales.

In June, we had a Brazilian Samba-themed promotion around football that frankly didn't resonate like we'd hoped.

We're now moving to a signature value program where we borrow from the success we had at Pizza Hut, where we are offering one of our revamped products per day at a half-off price.

It's only one product.

And then this has been a part of our ongoing plan, so we're just beginning to launch that program.

It's early days; we'll see how it does.

The one thing that we know, as Pat said going forward, is that it we're driving profitable transactions and improving our business model.

And importantly, when we look at where we're at today, all of our major attributes for the brand are improving.

We're the preferred brand - taste is better; value for the money is better; and our safety scores are back to where they were in 2012.

So the brand is certainly bouncing back.

When we look at the whole China business in total, getting at least 40% profit growth this year and having at least high single-digit sales growth for the full year, we feel very good about that.

And it's a great base for us to move into 2015 and beyond.

Thanks, David.

Next question please, Shawn.

Jason West.

I guess just going back to the comments around the China unit economics and the store growth outlook, given what you guys are seeing today and the improving economics, is it fair to say you are going to sustain this 700 gross opening rate going forward?

Or would you like to see that number go higher overtime?

Or do you feel like you'd like to moderate that number?

Just if you could talk a little bit about that, it would be helpful.

Well, Jason, I can assure you we wouldn't moderate that number.

We expect to deliver at least 700 new units this year.

That's lapping 740 from last year.

We remain as bullish as ever about the long-term growth prospects in China, and we feel very good about how our unit-level economics have strengthened.

David has said before that we did some of our very best work last year in the midst of a crisis to make our business even better.

And new-unit economics are as strong as they've ever been.

Even last year, with the pressure that we felt on sales, we had four-year cash paybacks at KFC.

This year, we're back to three-year, and that includes in tier 3 cities and below, 2 1/2-year cash paybacks on KFC.

Pizza Hut Casual Dining cash paybacks have sustained at two years, so we feel very good about the position of our brands.

We feel great about the overall returns we're seeing on these investments, and we have every reason to believe that we're going to drive high levels of investment going forward, maintaining the high levels of discipline and rigor around our capital investment process.

I think the other thing that we think going forward, we're going to have another weapon in our arsenal with Pizza Hut Home Service.

And this is a small-box format where we are delivering not only pizza but also Chinese food.

We think we've actually backed our way into a Chinese fast-food format, with great economics coupled with the pizza that will allow us to get some dramatic expansion as we go into the future.

And again, this is a small box, so the investment costs are not that significant.

The main point I would like to make on this is that we have never, ever chased a number.

We obviously think we'll do better than 700 and we want to grow that number as we go forward.

But we're going to stay very, very disciplined as we have in the past.

What I've told Sam and the team, and this will continue to be our policy, is we've got these incredible brands.

They are like diamonds; we need to polish those diamonds.

They'll only grow as fast as our people capability can allow us to do it, and that we can get the right locations in the right places that we need to be in as we go forward.

And the beautiful thing about our business in China is that the business models are great and the business is strong.

We are not on any hurry.

We don't have to hurry.

We just need to grow this business the right way.

So we will be very focused, very disciplined, look at our returns, and only grow as fast as the locations are there and we have the people capability.

And remember, I think this year we'll hire at close to 10,000 management trainees that will come into our system and three years from now will be ready to be restaurant general managers.

And we're doing that in anticipation of the significant growth that we expect to have across KFC, Pizza Hut Casual Dining, and now Pizza Hut Home Service.

Thanks, Jason.

Shawn, next question please.

David Palmer.

Thank you.

Question on Taco Bell.

You mentioned Quesaritos is helping the non-breakfast business.

Have you been able to keep the breakfast sales stable even when you're pointing your advertising energy to non-breakfast items like Quesarito?

And in the second half for Taco Bell specifically, should we be expecting -.

Can you speak up, David?

We can't hear you.

David?

We can't hear you.

Can you hear me okay now?

I can hear you better now, but we couldn't - we got the first half of the question, I think.

But you might want to repeat it so everybody can hear it.

(Multiple speakers).

Let me just repeat that.

With Taco Bell, you mentioned Quesaritos helping the non-breakfast business.

Have you been able to keep breakfast sales stable even when you're pointing the advertising energy to the non-breakfast items like Quesarito?

And then in the second half, just specifically with the P&L for Taco Bell, are we going to see significant digital launch costs as you roll that out for that brand?

Thanks.

David, I'll go ahead and address the digital launch costs.

We do expect to be launching that later in the year, sometime in the fourth quarter.

The additional investment against that is working in our forecast for the full year, and we continue to expect that Taco Bell division profits will be about in line with their ongoing growth target of about 6%.

But those costs are loaded into our G&A forecast for the year.

And the breakfast numbers remain relatively stable.

We feel very good about the base that we have with breakfast at Taco Bell.

We have more news coming, and we think we have the combination of the breakfast news plus the other day-part news, so it will give us the one-two combination that we have to have to really go forward.

I think breakfast is just critical to us on a number of fronts.

First of all, we've got this asset that basically has been empty until 11 o'clock, and so we're beginning to leverage that asset.

And we're also leveraging it on a profitable basis.

Remember, it took, I think, McDonald's eight years to make money in breakfast.

We're already at above breakeven, so we feel good about getting $70,000 to $120,000 in sales per unit on an annual basis.

So this is a great vehicle for us.

And I think this category is very tough.

You've got to have constant innovation.

And to be able to innovate across all dayparts to drive your same-store sales versus just the traditional lunch and dinner dayparts, I think it gives us an opportunity to even bring more consumer news, more excitement to the Taco Bell brand as we go forward.

And regardless of what we market and how we market it, if you look at what we're doing, it all drives the Taco Bell brand forward.

The Ronald McDonald advertising took our overall brand imagery, I think, up to some of the highest levels that we've ever seen.

So we're building the brand in all that we do, and now we can build the brand across all the dayparts.

So I'm very enthusiastic about breakfast.

Just about a month ago, I was out in a California meeting with the Taco Bell franchisees, and they are in it to win.

They are seeing now that this is really working for them, and they all understand what this can do for their business over the long term.

So when we got into this, it was like, how do we get in with minimum investment, minimum products, minimum complexity.

Now the franchisees are saying, hey, bring us more new products.

Let's really go after this.

So that's a good thing.

And we have - obviously there's pockets of strengths of where we're doing better than other places, but overall we really are doing extremely well.

We have a national proposition, and we're going to stay after it.

This is something that we are absolutely committed to make successful as we go in the future.

And we believe very much in the one-two punch.

We think we've got to have breakfast, and we think we've got to have the day-part news -- product news to drive the other dayparts as well.

So we have the Quesarito; we have the protein line of products that we just introduced; we've got a number of value initiatives coming forward with product innovation to go along with it.

I think we had an analyst meeting where many people tried a lot of the products that we've had out there.

We got a very inventive group out of Taco Bell, and we think we're going to have a lot of news.

So, unlike some brands that are wondering what to do next, we've got dayparts to leverage, and we've got all kinds of product innovation that we can keep bringing into the hopper.

So Taco Bell, we think, is in very good shape and feel very good about the second half.

Thanks, David.

Next question please, Shawn.

Brian Bittner.

Obviously, the Pizza Hut business outside of China, I guess, continues to be a drag on the profits.

And obviously, you're going to try to turn around that Pizza Hut business outside of China, but I'm just wondering if there's a scenario where, as you trying to do so, maybe you look at possibly splitting that business off, either through a sale or a spin.

Or is that something that's not possible if you want to hold onto the China piece of Pizza Hut?

If you could just talk about that and why you wouldn't maybe look at transaction like that.

Well, first and foremost, we believe in the power of global brands, and we believe we're very good at running global brands and that we're going to be able to maximize the sales and the profitabilities of that brand over the long term.

We think our structure is focused so that we can get after the opportunities that we have, and we think we're going to drive significant growth for Pizza Hut in the future.

We are very bullish on Pizza Hut for the long term.

And a lot of what we've done this year - you really, obviously, you can't see in the numbers.

But we are investing heavily in doing it globally, along the digital fronts and also in terms of driving future development.

We think we have significant opportunities in the delivery carry-out business and the express business.

And we've got major new initiatives that will be implemented in the United States in terms of both the advertising positioning, which we think will be global, and also the innovation that we think will be global.

And we believe that this will travel, and we think we're going to get significant growth out of Pizza Hut in next year and beyond.

So we think we are structured just fine.

There's all kinds of things that you can do financially to think about reengineering the business, and all kinds of scenarios have been brought up over the last 15 years.

We look at everything, but we are absolutely committed to our current structure, believe it's right, and we think our shareholders are going to benefit from it over the long term.

Brian, what I would add to that, just to build on David's points, we look at everything through a long-term growth lens.

And so we don't overreact to short-term issues in our business.

And it wasn't more than two years ago that Pizza Hut was on top.

We have a powerful brand; we can beat the competition; things have softened the last couple of years.

We've taken our learnings, and we're redoubling our efforts to bring the business back next year.

Thanks, Brian.

Next question please, Shawn.

Sara Senatore.

Just a follow-up on China, if I may.

The margins keep beating to the upside, I think, versus the investors' or Street expectations.

Can you talk a little bit about why that is?

Is it your costs like commodities, and labor inflation are coming in lower than expected?

I recognize that you got a lot of leverage and you have a more profitable transactions from the menu revamp.

But if you can just talk about that in the sense of the outlook for costs.

And a related question is Pizza Hut is such a good business in China, the unit economics are still very good.

Is the slower comp just the difficult compare?

Is there something in the environment?

Could it possibly be related to the acceleration in unit growth?

Thank you.

Yes, Sara, I'll take the question on China margin.

We are absolutely delighted with the progress that we're making and continuing to make with a 6-point improvement in margin versus prior year in the second quarter.

You're right that the menu revamp helped from the mix perspective as we pivot toward those more profitable, higher-quality transactions.

With respect to how things are trending and what gets us to the higher end of the range, you are also right that the inflation outlook has tempered.

So, whereas at the beginning of the year we were expecting a bit higher inflation on food cost, we're closer to around 1% for the year.

And labor inflation is at the lower end of our range.

We had guided low double digits; it's going to be pretty close to 10%.

So those things together bolster our confidence that we're going to get to at least 18% margin for China division for this year.

I think regarding Pizza Hut Casual Dining in China, obviously our same-store sales were flat.

They're softer than what we would like, but we were overlapping 7% same-store sales growth in 2013, which was the highest of that year.

Our system sales growth is 16% in the second quarter, and our business model and returns are firing on all cylinders.

We've got two-year cash paybacks on new units; we'll have 20%-plus margins for the full year.

And remember, we've grown our average unit volumes 30% in the past three years.

And we're doing this with basically no midscale competition out there today -- or on the immediate horizon, anyway.

And we're expanding breakfast into more and more cities.

We now have breakfast in 229 stores, which is about 20% of our units.

So we have a pretty amazing growth story, and we're as bullish as ever about the future growth prospects for Pizza Hut Casual Dining.

I think as we go forward we think we have - the big story for the Pizza Hut is the rapid new-unit development that we have with two-year returns and with average unit volumes that are already generating by themselves today 20%-plus full-year margins.

Thanks, Sara.

Next question please, Shawn.

John Ivankoe.

Actually a follow-up on that question.

It sounds like maybe in the second half for KFC that same-store traffic might be pretty close to flat given what your menu mix is.

And from what I understand, pricing that was taken in the fourth quarter and maybe some more pricing that was taken in the second quarter.

So, maybe elaborate on that.

And if I may, it is unusual to see a company focus on margins in a recovery - allow lower traffic growth.

In other words, you're not necessarily trying to gain back the traffic that you lost in the previous year.

So, David, you're obviously very experienced just in terms of what you've seen over your career.

Maybe an example of previous success where you can focus on a higher-margin customer and almost willingly allow some of your lower-margin or maybe more price-sensitive customers drop out of the brand as you focus on overall profitability.

Well, John, I think that -- first of all, I don't think we're focused on margin.

I think what we've been focused on is rebuilding the brand and making the brand more contemporary for a changing China.

And so I think the thing that we're most excited about is that with the revamp that we have - the comprehensive program we put in terms of service, uniforms, where we're headed with digital, all this stuff - it's we're contemporizing the brand for a changing China.

And the research measures basically are all moving in the right direction.

So we're building the brand.

We've got a preferred brand; taste; value for the money; safety is back where it was in 2012.

All of the measures that you want to see going up are going up.

So I think, first and foremost, what Sam and the team have been focused on is rebuilding the brand and rebuilding the brand the right way.

When we look back a couple of years ago in 2012, I guess it was, 2011, we had 20% transaction growth, which kind of blew everybody away.

And that came primarily from value-driven transactions.

Which are good, okay?

But not necessarily sustainable from a profit perspective in terms of really driving our business model for the long term.

So what we've done now is we still have RMB6 lunches and - breakfast and 15 RNB lunch items.

But we've shifted our marketing focus to more focusing on the premium line, which we think is more in line with where consumers are going today.

And as a result of that, we are getting significant same-store sales growth, some traffic growth, but we're getting a much better business model as we go forward that we can build from.

And we really like that as we think about where we're headed.

So I don't think that we're just margin driven.

I think we're very focused on building the brand and doing so in a manner that will strengthen our business model that will give us the best possible new-unit economics that will allow us to open up as many restaurants as we can.

And, John, I'll just add on that to say we're not going to comment on what we expect transaction growth to be in the back half of the year.

But building on what I said earlier, we do expect that comps in the second half will not be as strong as they were in the first half, in part because we are lapping more challenging numbers.

Also, there's no reason to believe, as you suggested, that the pricing we've taken this year is putting pressure on pricing.

Because as we've mentioned the value scores have improved with the brand relaunch and with the pricing, and we feel that the pricing we've taken is entirely in line with inflation and not ahead of competitors.

Yes, I think that's the big point.

We're improving the overall brand dynamics.

From preferred brand to value-for-the-money scores, those are going up.

And we've been very, very mindful of the pricing.

When I think about building the brand from a margin perspective, there's very few brands that I think have been that successful in terms of getting there by taking price and not taking price smartly and all that.

So you asked me, historically, what have I learned?

If you price without being aware of where you stand with your brand and what your brand is capable of doing, you go down a very slippery slope.

But we've priced and reorganized our menu and restructured our menu and innovated around our menu to improve the brand dynamics.

And that's all the feedback we're getting from the customer is telling us.

The other thing, the best time to take price is before you have big news.

So we did it in Chinese New Year, for example.

We did it just before Chinese New Year, and then we also did it just before we did the revamp.

And so, I think the big point I'm making is we're not building this brand from a margin perspective; we're building this brand from a brand perspective, and we're doing it in a way that happens to get better margins.

Thanks, John.

Next question please, Shawn.

John Glass.

Pat, can you maybe just frame what your base case is for Pizza Hut this year?

Your profits declined 15% to 20% in the first half.

Is it very possible or likely you'll see the same kind of decline, at least in the current quarter or the third quarter?

And maybe help us more than - maybe just put some numbers or framework around how we should think about the full year.

Yes, John, I'm not providing any more specific guidance on full-year profit performance out of the Pizza Hut division.

Only to indicate that the results will be below our expectations this year -- well below our expectations.

And we had guided that the results would be below the ongoing growth model that we had established for the division.

And I really don't care to provide anything more specific than that at this stage.

Thanks, John.

Next question please, Shawn.

Joseph Buckley.

Two questions, I'll throw them both out.

Again, on the higher quality, more profitable sales in KFC China, is there risk that you are going to confuse the consumer?

In 2012, you hit value hard; so hard that on that great comp number, your margins got killed.

And now in recovery mode, I'm not sure exactly how you're repositioning it higher -- if it's meal combinations or different offerings or what it is.

But it sounds pretty different.

And if you could elaborate on that, I'd appreciate it.

And then just on Pizza Hut, the Pizza Hut international business was pretty weak also.

Could you talk a little bit about that?

And we're used to seeing Pizza Hut have a tough year, a good year, alternating.

And this looks like two tough years in a row.

And, again, if you could comment on more on the international piece, I'd appreciate it.

First of all on KFC, I don't think we are confusing the customer whatsoever.

I think the brand is just being presented in a new, improved way.

We still have value offerings.

It's not like we're advertising on television, gee, there's no value at KFC today.

We still have the RMB6 breakfast.

We still have the RMB15 lunches.

We're introducing news around new products and new advertising with celebrities.

And I think people - every brand measure is moving up, and there's no - we're not getting anything from customers that says they're confused.

So I would say the answer to that is no problem.

What I would say as well, we all know from our experience that great brands follow the customer and give the customer with the customer wants.

And consumers in China are ecstatic.

Their expectations are increasing.

They're becoming even more sophisticated, and this is what they want.

We're giving them what they want, and that's what they're telling us.

But I think consumers want great value, which we have; best in the category.

In basis with the number of bests that we've had.

And they want great taste, which is we know - has proven where our measures are high.

And we're the preferred brand.

So I think KFC is absolutely fine.

I think Pizza Hut globally - the division itself is underperforming.

And I've already detailed all the things that we're doing to get the business turned around, and expect to have a much stronger year next year.

We have a very good brand - the best brand, we think, in the category - and we've underperformed versus competition.

And we think we will make significant progress next year.

And I'd also remind you that we expect record level development globally with the Pizza Hut brand, and the vast majority of that will be done by franchisees.

Franchisees would not be investing behind the concept unless they believe we have a powerful economic model backed by a great brand.

Thanks, Joe.

Next question please, Shawn.

Jeffrey Bernstein.

Just two quick follow-ups.

One, just on that topic of the value versus the premium.

Just maybe you can give some color in terms of where the brand stands in terms of sales value versus premium.

We often get that color in the US, but just - you talked about two years ago, the big value push versus today.

Any kind of color in terms of how you mix value versus premium?

And separately, just the Taco Bell, just to clarify what you said earlier, I guess it's running still mid-single-digit breakfast.

I think you had said longer-term you were pushing for high single digit.

I'm just wondering how you gauge whether or not it's cannibalizing the lunch and dinner.

It seems like the advertising dollars got shifted.

But now as it shifts back, how do you get a good read that the consumer is now coming for breakfast and therefore not coming for lunch or dinner?

Thanks.

Well, I'll address the Taco Bell question first, Jeffrey.

We've looked at this several different ways.

But as we read the net list that we're getting in our breakfast daypart, which we define as sales before 11 AM, we compare that to what we were getting before we nationally advertised and launched breakfast.

We're seeing about a 5-point lift, which, relative to the mix, reinforces for us that this is a highly incremental layer for us.

We also look at the performance of the stores, and this is the vast majority of the stores which offer breakfast, versus a small group - but nonetheless meaningful group - that doesn't offer breakfast, and we see dramatic difference in same-store sales growth.

Those data points reinforce our belief that what we're seeing here is a highly incremental layer.

And we also believe that we have a good read on what drove the relatively soft performance balance of days we've talked about before with the media shift and the underperforming promotion.

I think in terms of the percent of the KFC menu that's value driven, I think it's probably around 10%.

Thanks, Jeff.

Next question please, Shawn.

Jeff Farmer.

Just coming back to margins a little bit, but from a different tack.

So, with what you guys have been able to achieve with KFC China in terms of driving margin efficiencies, you've been very good at detailing this in terms of sales forecasting, labor scheduling, reduced operating hours, things like that.

I'm just curious what the opportunity is for you to pull some of those same levers as you look at some of these larger developed markets in the KFC division.

So I recognize that those are 90%-plus franchise markets, but it just seems to me that there's a healthy opportunity, at least on the operational side, to share some of those best practices with some of your bigger franchise groups out there.

Absolutely, Jeff.

We are not pleased with the overall margins we're seeing for our KFC global brand division.

Bear in mind, working in that number would be some of our businesses in more developed markets which are on the lower end of the spectrum as it relates to margin performance.

And then we have some businesses in there that are in emerging markets which benefit from the relatively low labor and rent costs.

That's not to say that we don't have opportunities to deliver a better result for both emerging and developed markets.

And we are moving aggressively to share learnings around how we can optimize food costs, optimize labor costs.

As you say, capitalize on the outstanding know-how we have in China, given the impressive results they delivered, and make sure that we're leveraging that to achieve similar gains in our KFC global business.

We also continue to look at opportunities we have to optimize our equity portfolio.

We have the earn-the-right-to-own philosophy.

And where we have equity businesses that are underperforming, then we make those adjustments in order to optimize the result for our shareholders.

So, really, through a series of tactics - leveraging the know-how we have in our organization and the good, strong discipline we have around margin management - we are keen to improve those margins because we know there is opportunity in our KFC global business.

Thanks, Jeff.

I'm sorry.

Real quick, if I could add just one more quick question just on the P&L.

So any type of high-level, absolute dollar interest expense number you can roughly guide us to for 2014 as we think about that relative to 2013?

I think we guided to about a $10 million reduction because of the refinancing we did last year, Jeff.

Okay, thank you.

Shawn, we'll take our last question.

R.J. Hottovy.

Just a quick question about innovation on a broader level.

I know you've been running a few fast-casual tests in the US, and just wanted to see broadly what is your plan for some of these smaller concepts?

I know it's not a meaningful part of the business.

But as you see longer-term (technical difficulty) you just testing for learning or just kind of - just broadly get a sense of the fast-casual concepts start to pop up a little bit here and there, West Coast and Texas, just what the thoughts are behind those.

Thanks.

Yes, we are testing some fast-casual concepts, primarily as innovation labs where we can really learn more about what customers think about some of these products.

Some of these products we expect to come into our base business, or derivatives of them.

If we have some learning that suggest that we have bigger ideas, I guess we might start to think about it bigger.

But it's more of a real focus on learning, more about the fast-casual segment, and using it as an incubator for what can go into the base business.

So we've got a Mexican concept that's being opened up on the West Coast.

We've got chicken, small-box format, being tested in Dallas.

So we're looking at that, and we're also looking at small-box derivatives off of our base brand to give us more opportunities as well, which we think it probably is the biggest idea of all.

Thanks, R.J. And just a modification to the response in the interest expense, it will actually be similar to last year.

So, I think, David, that's our last question.

All right.

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

Let me summarize: we expect to have at least 20% EPS growth this year, and we'll do better if we can, obviously.

The key points I'd like to leave you with is we're back on track with China with a better business model and better brand dynamics.

We have three-year paybacks at KFC, two-year at Pizza Hut, and we're continuing to make significant progress with Pizza Hut Home Service.

Number two, Taco Bell is successfully establishing breakfast.

We believe that what we're doing at Taco Bell, how we're building the brand, the one-two combination of breakfast plus the innovation we have coming is going to continue to improve our unit economics, and help us take Taco Bell from 5000 stores to 8000 stores.

Our franchisees are in the breakfast program and into it to win.

Number three, KFC global is getting better and better around the world, and we expect continued success there.

Pizza Hut, next, is a major turnaround mode, but we expect to go into 2015 very strong and benefit from the fact that we will be overlapping a not-so-hot year this year.

And, last but not least, one of our big engines at Yum!

is new-unit development, and we will have over 2000 new units opened in 2014.

So we're very confident we will get back to our ongoing growth model of delivering at least 10% earnings-per-share growth on a sustainable basis.

So, thank you very much.

Appreciate you being on the call.

This concludes today's conference call.

You may now disconnect.