百勝餐飲集團 (YUM) 2015 Q1 法說會逐字稿

Good morning.

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

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

Brands first-quarter 2015 earnings 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).

I now turn the call over to Steve Schmitt, Vice President of Investor Relations and Corporate Strategies.

You may begin your conference.

Thanks Lisa.

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

On our call today are Greg Creed, our CEO, and Pat Grismer, our CFO.

Following remarks from Greg 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 risk factors included in our filings with the SEC.

In addition, please refer to the Investors 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 conference will be held Wednesday, May 13 to May 14 in Shanghai, China.

This will be followed by our India investor conference on Saturday, May 16 in New Delhi.

Our second-quarter earnings will be released on Tuesday, July 14.

With that, I would now like to turn the call over to Mr. Greg Creed.

Thank you, Steve, and good morning everyone.

You can never be pleased when you report an EPS decline for the quarter, but the story behind the numbers gives me even more confidence that we can and will deliver at least 10% EPS growth in 2015.

I would summarize our performance as our KFC and Taco Bell divisions are firing on all cylinders, China is clearly improving, and there is still much work to be done at Pizza Hut.

Let's start with China.

Same-store sales declined 12% for the quarter, but that doesn't tell the whole story.

The fact is that the business is clearly improving.

Same-store sales and customer metrics continue to move in the right direction.

In addition, the team has done an impressive job managing costs and delivered restaurant margins of nearly 19% in the quarter.

It's the combination of these three elements that gives me confidence we will deliver on the first half/second half performance transformation I described at our analyst meeting in December.

Just last month, Sam Su and I assembled a task force to share insights and experience from other parts of our business with the KFC China team.

While the local team clearly has an unsurpassed knowledge of the China market, other teams from around the Yum!

world have broad expertise and know-how we thought could benefit the China team and vice versa.

There was tremendous teamwork and best practice sharing going both ways, and I was truly impressed by the talent of our teams.

We also reviewed China's marketing plans for each brand and are left even more confident in our outlook for the year and the strong second half we expect.

And here is why.

First, KFC.

We recently launched the first of our two menu revamps planned for the year.

This initiative will be phasing over the next three months and includes eight new products focused on lunch and dinner.

In addition to traditional KFC offerings, this revamp includes products aimed at consumers interested in healthy alternatives such as herbal tea and seafood.

We are also continuing our premium coffee rollout.

Priced 40% below Starbucks and 20% less than McCafe, our freshly ground coffee is offered throughout the day.

Initial readings show an incremental weekly sales layer of around $300 per store, and we are just getting started.

As of quarter end, we were in 1,300 stores spanning 10 cities.

By year-end, we expect to have premium coffee in almost 2,500 stores.

Our expectation is that coffee will become a solid sales layer to further build growth upon.

And we continue to innovate on all fronts, not just our menu.

This includes accelerating asset enhancements, digital marketing and leveraging our online delivery platform.

Clearly, there's a lot to be excited about with the KFC China.

At Pizza Hut casual dining in China, we are also encouraged by the ongoing improvement in same-store sales.

We are leveraging the asset throughout the day with the rollout of breakfast and continue to expand our late-night offering.

Pizza Hut is a new development product -- development machine and we are excited about the recent launch of our sizzling fajitas leveraging our stone pan platform.

In addition to the Pizza Hut casual dining business, we continue to expand our home service offering where we are approaching 300 units in China.

This business offers a diverse menu with Chinese food comprising nearly half of its products.

Any way you look at it, the Pizza Hut business has a long runway for growth in China.

So, to summarize China, we are making continued progress with sales and customer metrics.

We're pleased with the productivity gains in our restaurants, and we have confidence in our marketing plans for the balance of the year.

Most importantly, we continue to develop new restaurants with confidence, laying the foundation for future growth in the world's fastest-growing economy.

Outside of China, I'm excited to report that the strong momentum at KFC continued.

Same-store sales growth of 5% built upon last quarter's 4%.

The division opened 72 new international restaurants in 36 countries.

Nearly 80% of these restaurants are open in emerging markets.

I was particularly pleased with the continued impressive growth from our Russia business where system sales grew nearly 50% in constant currency.

Simply put, KFC is a franchise-led global powerhouse with a significant lead in many emerging markets and tremendous growth ahead.

With its always original positioning, I believe KFC is poised to deliver consistently strong results going forward.

One of the significant competitive advantages KFC has is its partnership with strong international franchisees.

I personally believe that our franchisees are one of our Company's greatest assets and one of the keys to success in this business is to work with your franchise partners.

On February 27, the KFC US team led by Jason Marker reached an agreement with our franchisees to work together as true partners.

This agreement gives us clear marketing control for the first time as well as an accelerated path to improved assets and customer experience.

Pat will share the financial details with you during his remarks.

Moving to our Pizza Hut division, where our results have admittedly been soft, and worse yet, we are being outperformed by the competition.

As you know, we recently launched a new pizza platform in the US where over half of the division's profits are generated.

This new platform gives our customers unparalleled variety with exciting new toppings, crusts and flavors.

Unfortunately, we haven't been as effective as we would like with our marketing, and need to balance its appeal to Millennials with mainstream pizza customers.

We intend to do this going forward while working with our franchisees to bring more competitive value to the market.

I'd like to take this opportunity to announce an investment we've made which will improve our Company's capability and benefit Pizza Hut and all of Yum!.

Clearly, one of the towering strengths of Taco Bell is its superb consumer insights.

Over the years, a lot of it came from the Collider lab, an insight driven marketing company.

Because better consumer insights is on our key priorities, we decided to bring Collider in-house.

Its very first priority will be Pizza Hut in the US.

In fact, we made its former President, Jeff Fox, the Chief Concept and Brand Officer of the division.

We believe Collider's insights will be extremely valuable to Yum!

overall and it's going to start with Pizza Hut.

On the international front, Pizza Hut continues to expand rapidly and we opened 35 new international restaurants in 20 countries during the quarter.

Our brand-focused structure is clearly paying dividends on the development front and we expect record international expansion this year.

We're also making the needed investments in digital for all of Pizza Hut.

We have a firm grasp on what needs to improve and are taking the necessary actions globally to drive better performance.

Now, turning to Taco Bell, which had another great quarter, same-store sales grew 6% and operating profit jumped 37%.

The division opened 47 new restaurants with franchisees opening 89% of these units.

I have never been more confident in Taco Bell's ability to reach its goal of becoming a $14 billion business with 8,000 restaurants.

By all measures, Taco Bell continues to go from strength to strength and I am thrilled to see the team take the brand to a whole new level.

Breakfast is doing well, owning a 6% mix and restaurant margins approached 20%.

I recently spent time in some test markets and seen what they have in store, and I can assure you our innovation pipeline will remain strong.

International also continues to build upon the strong momentum from 2014 with 5% same-store sales growth in the quarter and a particularly strong performance in Latin America and Canada.

While international is only a small contributor today, we continue to build brand awareness and to improve our economic model as we look to accelerate our international growth plans.

So, in conclusion, we are making great strides across Yum!.

I could not be more excited about the opportunities ahead of us as we recover in China, build upon our existing momentum at KFC and Taco Bell, and focus on turning around Pizza Hut.

I am especially encouraged by the bench of talent we have across Yum!

and how we are leveraging that to benefit the entire organization.

We are in a unique position at Yum!

with three distinct brands that we will strengthen and grow into three iconic global brands that people trust and champion.

We remain focused on the three keys to driving shareholder value -- same-store sales growth, new unit development, and generating high returns on invested capital.

I believe this combination of efforts will enable us to reestablish our track record of consistently delivering double-digit EPS growth in 2015 and the years ahead.

And with that, I'll turn it over to my partner, Pat.

Thank you, Greg, and good morning everyone.

Today I'll discuss our first-quarter results and share perspective on our second-quarter and full-year outlook.

First-quarter earnings per share, excluding special items, decreased 8%, which was substantially better than the decline we were originally expecting.

I am pleased with the quality of this upside as it was led by better-than-expected sales and restaurant margins at KFC China.

With overall trends sustaining in China and with the outstanding momentum we have in our Taco Bell and KFC businesses, we are confident that we will have a strong second half and deliver at least 10% EPS growth this year even with stronger-than-expected headwinds from foreign exchange.

Now I'd like to provide some color on our first-quarter results by division.

In China, operating profit declined 31%, prior to foreign currency translation, as same-store sales were down 12% in the quarter.

Sales were strong during the Chinese New Year period comprising the last two weeks of China's eight-week fiscal quarter.

And although restaurant margins of 19% were 4.5 percentage points lower than last year due to transaction deleverage, this is a significant improvement over the 7 point decline we experienced in the preceding quarter as pricing and labor productivity more than offset inflation in food and labor costs.

What this means is that restaurant level profit flow-through is actually getting stronger thanks to the hard work of our local team to deploy labor more efficiently and to manage a more profitable mix of menu items.

More importantly, this bolsters our belief that China division restaurant margins will return to the 20% range as sales are recovered, and that this recovery has the potential to unlock approximately $600 million of operating profit.

Another important driver of our growth in China is new unit development.

And because we continue to shift our development focus to lower tier cities, tighten our site criteria and improve our investment model, we've been able to maintain a high rate of new store openings despite the temporary softness we've seen in topline results.

In the first quarter alone, we opened 171 new restaurants in China.

That's an average of nearly three restaurants per day, bearing in mind that China's first quarter spans the months of January and February.

We are confident that these investments will yield strong returns and continue to expect 700 new restaurants this year.

Also, with the breadth of our market presence and the scale of our development team, we have the ability to capitalize on China's expanding economy in a way that no one else can in our sector.

Moving to our global KFC division, which posted a very strong quarter with solid growth in sales, margin and profit.

System sales growth was especially strong in emerging markets, up 11% before foreign exchange, led by Russia, Africa and Thailand.

International developed markets also delivered solid system sales growth, up 6% before foreign exchange, led by Australia, the UK and Continental Europe.

And the US delivered its third consecutive quarter of solid same-store sales growth with comps up 7%, the best performance by this business in almost 10 years.

Division operating margin increased about 2 percentage points in the quarter to 26%, driven by franchise-led new unit development and stronger restaurant level margins across the board.

All of this combined to yield division operating profit growth of 11%, excluding the impact of foreign exchange.

KFC opened 72 new international restaurants in the quarter, and similar to previous years, we expect our new unit development to ramp up significantly as the year progresses.

With the upward momentum we have in this business, we expect KFC to open 700 new international restaurants outside of China and India this year, setting a new record for this growing global brand.

Same-store sales were flat for our global pizza division with growth of 2% in emerging markets and 1% in international developed markets and a decline of 1% in the US.

Operating margin decreased 1.5 percentage points to 30%, largely due to strategic investments in international G&A to support future growth, contributing to a 2% decline in operating profit prior to foreign currency translation.

And while the sales and overall profit results are disappointing, last year's global brand restructuring has brought 100% leadership focus to the opportunities we have to improve Pizza Hut's overall brand position, operations, and digital experience globally.

We are already seeing the benefit of this in development as Pizza Hut opened 70 new restaurants in the first quarter, including 35 new international restaurants, setting us up to have another year of record development with 600 new international restaurants expected in 2015.

Importantly, about 90% of these restaurants will be opened by franchisees, demonstrating strong belief in the brand's potential.

We are also continuing to invest heavily behind digital and are seeing a promising return on these investments.

Currently, digital sales in the US account for over 40% of delivery and carry out sales versus about 30% a year ago, and we expect this to trend higher over time.

This is important because digital orders provide customers with a superior ordering experience, drive higher levels of loyalty, and generate higher average spend.

And finally, Taco Bell posted an exceptionally strong quarter with same-store sales growth of 6% and restaurant margin of nearly 20%, which is about 4 points better than last year, as pricing and favorable menu mix more than offset inflation during the quarter.

As a result, operating margin increased about 5 percentage points to nearly 27%, lifting operating profit by 37% versus prior year.

As Greg said, we could not be more pleased with the insight-driven brand building efforts at Taco Bell, evidenced by category leading innovation and disruptive advertising.

This obviously includes our new breakfast layer which has a sustained sales mix at a very healthy 6%.

Additionally, we opened 47 new restaurants in the first quarter with nearly 90% opened by franchisees, and are well on our way to opening 150 net new restaurants this year with international development accelerating in the years to come.

Any way you look at it, Taco Bell is a category leader and a brand on the move.

Now I'd like to talk about our 2015 outlook.

As I mentioned earlier, we expect EPS growth of at least 10% this year.

Outside of China, we expect KFC and Taco Bell to have very good years, while Pizza Hut could remain soft.

Therefore, the key to double-digit growth this year is a strong second half for China.

In that regard, while monthly sales can be highly variable in a recovery environment, overall sales trends, key consumer metrics and balancing your marketing plans give confidence that China will have a strong second half.

And as I said before, the team has done an outstanding job of managing restaurant margins.

And based on year-to-date results, we continue to expect full-year China restaurant margins of at least 16%.

As I mentioned previously, foreign currency translation has become an even stronger headwind for us.

Based on current spot rates and projections, we now expect that foreign exchange may impact full-year EPS by approximately 5 percentage points.

This is 1 additional point of headwind compared to what we signaled on our last call.

To be clear, this exposure is one of profit translation and does not impact our competitive position as it relates to how we price our products around the world.

So if you step back and think about how 2015 is developing, it's very consistent with our expectation coming into the year, which is a negative first half followed by a very strong second half driven by China.

While first-quarter performance was better than we anticipated but still negative, second-quarter EPS will most likely show a steeper decline versus prior year, but let me put this into perspective.

First, this is largely due to the fact that we are expecting a higher year-over-year quarterly tax rate compared to Q1.

Second, we will be lapping China's strongest quarter from 2014 which you may remember included same-store sales growth of 15% and operating profit growth of nearly 200%.

And third, while we are expecting Taco Bell to deliver another quarter of double-digit profit growth, it won't be 37% as it was in Q1.

So, for the second quarter, we're estimating EPS will lag prior year by about 20%, but we continue to believe that we have the overall business momentum that sets us up for a strong second half to achieve at least 10% EPS growth of the full year.

Now, before we move to Q&A, I'd like to provide some financial highlights of the agreement we reached with our KFC US franchisees which Greg briefly mentioned.

Building on the strong business momentum that's been built over the last year and in return for brand marketing control which will empower our KFC US leadership team to sustain a turnaround of this business, we will be investing approximately $185 million over the next three years.

This investment will include new back-of-house equipment and incentive to accelerate asset remodels and incremental advertising money, all of which are essential to contemporize the brand and regain traction with consumers.

From a timing perspective, we expect to invest approximately $100 million this year with the remaining amount split between 2016 and 2017.

Due to the unique long-term brand building nature of these investments, they will be classified as special items with the exception of advertising of about $20 million per year.

Although this is a relatively modest investment in the scheme of Yum!, it is obviously quite significant to KFC US and we are confident it will unlock significant value in years to come.

So let me wrap things up.

We are pleased that our first-quarter results were stronger than expected due to robust performance at Taco Bell and KFC as well as the ongoing sales and margin recovery in China.

We continue to expect at least 10% EPS growth this year with a very strong second half.

And we look forward to updating you further as the year progresses.

And with that, I'll open up the line to Q&A.

(Operator Instructions).

Diane Geissler, CLSA.

Good morning.

I just wanted to ask about your overall expectations for same-store sales growth in China.

Obviously, the first quarter was ahead of what you had articulated on your last quarterly call.

You've given guidance negative first half, negative second half -- or positive second half.

But could you just talk about it in terms of what are your expectations on a percentage basis now that you've outperformed in the first quarter and you have new product launches, etc.?

Certainly.

You may recall that we had guided in December to full-year same-store sales growth of 3% to 7%.

That's still an appropriate range.

We may be coming in closer to the lower end of that range, but importantly, we do expect to see sequential improvement in Q2 sales over Q1, and then a strong second half particularly as we lap the supplier incident that occurred in July.

Okay.

Terrific.

Thank you.

David Palmer, RBC.

Thanks.

Pat, you just said that you expect the same-store sales decline rate to moderate in the second quarter versus the first quarter for China.

Did I catch that right?

That is correct.

We do expect sequential improvement quarter over quarter, and I would highlight even with the stronger comps that we are lapping from last year.

The last quarter there, you were talking about the promotion misses that may have happened in China, the Korean boy band promotion.

Is there any color you can offer to us about what changes are already happening?

I know there was a new menu that was probably in the works for some time, but perhaps a commentary about that menu.

But also some things that you're thinking about in terms of a direction of the market that we may not see here for KFC in particular in China.

Good question.

As we said, we got off to a bad start with the year because of the boy band.

What I was really pleased with was how quickly we reacted and had a very strong Chinese New Year promotion.

We got back to building an emotional connection with our customers.

We got back into Original Recipe.

We got back into buckets of chicken.

And I think that was a very clear lesson for us.

The good news is on the menu revamp, this is going to be eight new products over about three months.

What I like about it is the lessons that we've learned this time is that -- and I think this is sort of the lessons we took from the Taco Bell breakfast launch, which is you can put a menu out there but you actually have to promote specific products.

So, I'm pleased that we've got a very strong menu, but we'll also have very strong product promotions.

David Tarantino, Robert W. Baird.

Hi.

Good morning.

A question about the China trends.

I think the release mentioned upward momentum in the consumer scores that you are seeing.

I was wondering if you could maybe provide a little bit more context on what you are seeing and where you are from a consumer trust and feedback perception versus where you were heading into the supplier incident last year.

Sure, David.

I think the good news is, as you would know, we measure a number of attributes, clearly value for money, food safety, trustworthiness, and favorite QSR brand.

The good news is we are making improvement across all of those metrics.

And I think what you will see is it's not a linear improvement, but we can definitely see period to period that we are making improvements across the board.

So I am actually really encouraged it's an across-the-board customer metric recovery rather than just in one or two specific elements.

And any context on kind of where you are now versus where you were last June for example, maybe how much of the gap you've closed from the decline you saw post the incident?

Yes, sure.

I think on things like trustworthiness, we are pretty much almost back to where we were prior to the incident.

Things like value for money we are doing better.

The good news is we have the right trajectory on all of the elements, and that's what really pleases me.

Great.

Thank you very much.

Jeff Farmer, Wells Fargo.

Can you provide the transaction price mix and mix components for that minus 14% KFC China comp, and just beyond that what your pricing expectations are for the balance of the year?

Yes.

In terms of the mix, the comp was led by a transaction decline.

Check was marginally positive for the quarter.

And in terms of pricing, we look to take pricing in line more or less with inflation.

We are targeting about 3 points for the full year.

Keith Siegner, UBS.

Thanks.

Pat, if you could dig in a little bit more into the China company restaurant margins for us, just a little bit more breakdown about where the costs are coming from.

Maybe is it all KFC?

What about Pizza Hut?

What about Little Sheep?

And then can you give us an -- or even amongst labor and your other pieces, you did some high-level, but more granular details would be helpful.

And then also what's going on from an underlying labor and commodity cost perspective in China?

There hasn't been much volatility in labor.

Is that still the case, around 10%, and then what does the commodity cost inflation pressure look like?

Thanks.

Certainly.

So first, in terms of how we break down the margin variance year-over-year, we are very pleased with 19% margin in the quarter.

It was 4.5 percentage points below where we were in the first quarter last year.

We lost about 4 margin points from transaction de leverage and another 3 margin points from inflation.

But we offset that with about a 2 point margin benefit from pricing, and then the other 0.5 point benefit was a combination of productivity initiatives slightly offset by the impact of a new unit.

So that kind of breaks down the margin drivers.

In terms of what we are seeing by way of inflation, the good news is, on the commodity front, things are looking a little bit better than we had originally guided.

I think, in New York, we guided around 2% to 3% of commodity inflation.

It looks like we are going to be closer to 2% maybe, so slightly better there.

The labor front, the situation hasn't changed.

Call it low double digits, around 10%, that's what we saw in the first quarter and that's more or less what we expect for the full year.

Thanks.

John Glass, Morgan Stanley.

Thanks.

Maybe just a few sort of detailed questions, but Pat, the G&A this quarter ran above I think what your annualized rate was.

Maybe there was some FX in that.

But how do you see G&A playing out this year?

Is there more investment spending perhaps required than you thought, or is this just more about timing this quarter?

It's more about timing because we are -- what you are seeing in the early part of the year is the full effect of the investments, the strategic investments that we've made in our Pizza Hut division importantly, in international, to build capability and development in digital, which is where we see the biggest opportunity to strengthen our competitive position.

So as we've lapped those investments that were made over the course of 2014, you will see less of an increase year-over-year in G&A.

No reason to change our guidance for full year on G&A.

Okay.

And then just two other quick ones.

Forgive me if you said this.

What was the labor inflation in China this quarter?

And also since tax does play a big role in where you shake out in the second quarter, what is the rate you are implying in the tax rate in the second quarter?

Labor inflation in China was about 10%.

In terms of tax, I mentioned in my earlier remarks that is the key driver of the difference in -- the expected difference in Q2 EPS performance versus Q1.

Tax worked to our benefit in Q1.

It's going to go against us in Q2, and that change alone drives about a 7 point swing in EPS growth versus prior year.

Okay, great.

I can back into it from there.

Thank you.

Joseph Buckley, Bank of America.

Thank you.

A question on China also I guess.

So I think, Pat, you said the full-year guidance, the plus 3% to plus 7%, is intact, but you're thinking more the lower end.

And I guess that seems curious to me with the first quarter coming in better than expected.

So could you comment on that, and maybe at the same time address Pizza Hut?

I guess I was a little surprised Pizza Hut was down as much as it was in the quarter.

Just kind of the dynamics that are going on in that business would be helpful.

Yes, certainly.

You may recall from our financial modeling session in December that we said we needed at least 3% same-store sales growth in China to achieve our China profit growth objectives consistent with delivering 10% EPS growth or better for all of Yum!.

So based on current trends, we still fall within that range of 3% to 7%.

We still have a big chunk of the year ahead of us, so it's always tough to call these things.

But what I am suggesting is that it may be closer to the lower end of the range than the higher end of the range.

But importantly, we have a lot of confidence in the productivity initiatives that the team delivered in Q1 and we believe that those will sustain through the balance of the year.

So, any relative softness in sales will be made up for with better performance from a profit flow-through perspective.

And then quickly on Pizza Hut, as we said before, Pizza Hut is recovering more strongly than KFC, and that continues to be the case because KFC has faced two supplier incidents in two years.

This is the first incident for Pizza Hut, so we are seeing the consumer metrics and the sales recover faster than at KFC.

From a margin perspective, we posted 19% on the quarter.

Pizza Hut was actually slightly north of 20%.

If I just go back to the first question, is there a reason though you are thinking the comp numbers would be at the low end, given first quarter better than expectations in China?

Just as we read on the sales as we extrapolate them through to the end of the year, again it's always tough to estimate sales, particularly at this point in the year, particularly in a recovery environment.

But if I had to make a call today, I would say it would be closer to the lower end.

However, it still gives us the momentum necessary to deliver the strong second half, which is important to our ability to achieve at least 10% in EPS and still achieve the sequential improvement in quarter-on-quarter same-store sales.

Okay.

Thank you.

Brian Bittner, Oppenheimer.

Thanks.

On the Taco Bell business, the 6% comp you achieved there, was that relatively balanced?

I guess meaning did you see positive comps outside of your breakfast daypart?

And on top of that, what is breakfast mixing as a percent of the business now?

The answer is yes.

We saw a good balance in the Taco Bell performance across all dayparts, so when you grow 6% same-store sales growth, even though breakfast was still around the 6%, it obviously means we are getting growth in breakfast.

So we saw good, consistent growth across all dayparts.

And I think that's because we've got innovation, which is clearly relevant to more than one day part.

We've got very disruptive advertising.

And I think all of that is working along with our improved customer service and continued to create value.

I think that's the reason why we are delivering such a consistent performance.

And the mix?

The mix is 6% for breakfast.

And just a quick follow-up on Taco Bell, 37% operating profit growth is obviously really good, and it looks like there was just discipline up and down the P&L.

But one thing that jumped out at me was the food margins, and the 200 basis points you got there.

What was going on there?

Was that just breakfast being a better food margin business, or did you see some commodity tailwinds?

Absolutely, we have seen commodity tailwinds.

And that remains a source of upside for us for the full year.

Again, taking you back to where we were at in New York when we provided guidance around commodities, at the time we were expecting about 2% to 3% at Taco Bell.

It is now looking like it's going to be flat, closer to flat.

And that's because while we are still expecting inflation in beef, it's not going to be as extreme as we had thought.

We are actually seeing higher deflation for cheese than we had originally expected, and we are also seeing now deflation in chicken.

So all of those things are working in our favor.

At the same time, we got the benefit of pricing actions we took last year.

So not a lot by way of new pricing actions, but importantly well over from last year when commodity costs had spiked.

What makes me feel really good is that even with that significant pricing benefit versus the commodity inflation that we see today, our value scores are actually getting stronger.

I think it's because of the way the team has been very thoughtful and very intelligent around the way they're taking pricing.

They've taken pricing when we've introduced new innovation.

They've taken pricing when we've offered new value on the menu.

And I think it's because of this discipline that they've been able to strengthen their value scores, and we feel very good about where things are at with margins today at Taco Bell.

Great, thanks.

Jeffrey Bernstein, Barclays.

Thank you very much.

Two questions, one just on China and maybe the broader industry perhaps, but just wondering.

The pace of the recovery obviously weighted to the second half but you seem pleased with that pace.

I'm just wondering whether you think that's consistent across the broader industry, or maybe in your research any reason why perhaps your recovery, as you've noted in the past, is maybe going slower than expected or maybe slower trajectory relative to peers.

I'm just wondering what has kind of been called out in terms of why KFC might be seeing that slower than previously desired trajectory.

I think the answer is, as we said earlier, KFC has not had one but two sequential incidents, which we've never experienced before.

And I think that's I think one of the key underlying reasons why you may be seeing the KFC recovery go.

The good news is it is sequentially getting better, maybe why the absolute recovery is taking a little longer.

I think that really remains the key reason and that's what we are seeing in all the work that we're doing in China.

If the AUVs, I mean the goal -- it sounds like the goal is obviously to get them back to full strength.

But if for whatever reason they didn't get back to full strength, if perhaps the recovery took longer or never got to levels, do you think it's reasonable to still get back to that kind of 20% plus restaurant margin?

Or maybe asked a different way, what would have to happen in 2015, whether it's comps, margins, returns?

What would lead you to maybe slow historic growth in 2016 and beyond?

Would it be if the comps didn't get back to full strength or could you still grow at the 700 plus pace set out if you're still hitting that 20% margin?

There's no doubt in our mind that comps -- that same-store sales will return.

That is average unit volumes will return to where they will -- or where they were in 2012.

It's not a question of if; it's just a question of when.

That's not going to happen in 2015 and we've never said that.

But we remain very confident in our ability to continue to grow our sales layers and achieve the comps, the AUVs that we had in 2012.

With that then will come the improvement in margins.

Just as we've seen margins hold up really well even under sales pressure, we know that when the sales come back, there's enormous operating leverage in our business.

And so I remain confident that we will get back to 20%.

It's tough to say exactly when that's going to happen, but from where I sit, that remains a reasonable expectation for that business in the midterm.

I just think that we are a brand-building company.

And every day, each one of our brands in 126 countries we operate is really focused on four things: making our brands more relevant; making them more engaged; making them more connected; and demonstrating that we care.

And I think if we follow that philosophy on all of our brands in every country in which we operate, we will continue to see strong same-store sales growth across the business.

What I would also point out is that when we look -- and we shared these numbers before -- when we look at the top 10% of our KFC restaurants in China, we see average unit volumes that are well above $2 million, close to $2.5 million or more.

That compares very favorably to what McDonald's has achieved by way of global average unit volumes.

So versus where we stand today, there's nothing but upside.

And we are confident we are not only going to get back to where AUVs were in 2012, we're going to shoot beyond that.

Again, it's tough to say exactly when that's going to happen, but we do have strong belief in our ability to rebuild sales and to bring with that then the restaurant level margin, importantly, reinforced by all the great work the team has done to drive significant productivity improvement during a period of sales softness.

Karen Holthouse, Goldman Sachs.

Thank you.

Actually a question on Pizza Hut.

The comment about working on sort of better value constructs for the brand, how should we think about the reasoning behind that?

Has there been an issue with value scores deteriorating, changes in competitive intensity, or maybe the thought process is using more aggressive value as a way to sort of induced trial of the new Flavor of Now menu.

I think the answer is that we -- an analysis of our performance suggests that we just went value competitive in the marketplace, whether that was entry price point, whether that was single pizzas, whether it was pairs.

So we clearly have a lot of work to do.

What I'm excited about is that the team met with the franchisees.

We've had a value summit in the last couple of weeks.

We've shared all the information and all the knowledge around our value positioning and what we have to do.

And I think what you'll see is us come out aligned as one system in order to make a stronger value statement in the marketplace.

Within that, just as a quick follow-up, is there a particular price point you're focused on, and is it going for -- are you thinking of it more as an entry-level price point or some sort of bundled value that you need to go after?

I think the answer is all of the above.

We have to have good entry-level price point.

We have to have good single pizzas.

We have to have good pair pizzas, and we have to have good abundant value.

And I think we can and will do much better across all of those elements of the price value equation.

Great.

Thank you.

Andrew Charles, Cowen & Co.

Great, thanks.

Pat, can you talk about the China pricing schedule for the year?

It sounds like you had some price benefit in 1Q and you're now aiming for 3% price behind where you had it at the analyst day.

But guidance to the low end of 3% to 7% China same-store sales.

Is the situation still fluid enough that you'll consider holding back on pricing in favor of traffic?

We are always very thoughtful around pricing, in much the same way I described Taco Bell, thinking very carefully around when we are introducing innovation and making sure we protect value on the menu as we have done in our China business.

For KFC in China, we had about 3% of total pricing in the quarter.

2% of that was roll-over from last year.

Now, we took an incremental 2% pricing action in the middle of January, which yielded about 1% of pricing benefit on the quarter.

We continue to maintain the value anchors.

We see no reason to take significant incremental pricing actions beyond this, but we read the situation based on how things are trending in the business, being very sensitive to value scores, and the importance of value to regaining traction with consumers.

On the Pizza Hut side, we took 2.5% pricing in late 2014, so we have the rollover effect of that playing out in Q1.

So there again, just being very sensitive to where things are in the brand, looking at future pricing actions potentially timed to the introduction of new product innovation and maintaining those strong value anchors on the menu.

That's helpful.

Greg, with the spring menu revamp, how would you classify the price points?

Are they more value oriented, the premium price?

Is it a mix?

Just any thoughts there?

Yes.

I think across -- when you've got eight new products across the menu, it's a combination, as we said earlier.

So there's products for lunch and dinner.

It's across varying price points.

And what I like is I think the presentation of these products and the position of these products is really good having had a chance to visit them.

So it's not one particular focus.

Great.

Thank you.

Jason West, Credit Suisse.

Thanks.

Just two questions.

One, on the outlook for the year, are you guys still assuming flat KFC profits in China in the guidance?

And secondly, the cost savings that you realized in the first quarter, which I think surprised some of us, is that a new round of productivity initiatives that have now kicked in, or is that sort of a continuation of the productivity that you guys have been working on for a while, and if you could talk about how that extends into the rest of the year.

Thanks.

Certainly, Jason.

I'll address the second question first and then come back to the outlook for the full year.

On the margin front, one of the things I love about our China team is that they have a mindset of continuous improvement.

So as you know, they made extraordinary progress on restaurant level productivity in the middle of 2013 and into the early part of 2014.

All of those initiatives and the associated margin benefits have sustained into 2015, but they have come in over the top of that with some new productivity initiatives which proved instrumental to their ability to deliver the better-than-expected margin performance in the first quarter.

And there were really three elements to this.

The first is with respect to what we call pacesetter analysis, which is essentially benchmarking the best team labor performance within the specific sales spans for each one of our brands.

They moved that from an annual discipline to a quarterly discipline.

And they set targets accordingly, after having conducted market tests to ensure there was no impact to the customer experience.

So effectively, through that more rigorous approach to labor planning, they were able to tighten the labor schedules in a way that ensured that we continued to meet customer expectations but do it a lot more efficiently.

The second piece was around the mix of student and part-time team members, so they increased the mix and that delivered a benefit to labor in the quarter, and that was a sustained balance at year-end.

And the third was just taking a harder look at management staffing levels in the context of where sales are at and adjusting plans and managing to that.

So again, three elements to the work they did this quarter, which we see sustaining through to the balance of the year.

Can I just add, I want to reinforce one point that Pat.

This productivity has not been at the expense of the customer experience.

I think it's very important that we do continually monitor the customer experience as we go through this process.

And what I am really happy with is the customer experience has actually grown slightly despite this fact we've made these productivity improvements.

So, I think that all bodes well for the future.

Maybe the last point I would make on it is the combined effect of these new productivity initiatives contributed about 1 to 2 points of margin improvement versus prior year.

And again, we see that sustaining through to the end of the year.

Now, the first question you asked was about our outlook for China profit and the extent to which we are assuming some profit improvement at KFC.

We are assuming that KFC will improve profits this year.

That is working in our full-year outlook for EPS growth.

And when you add it all up in conjunction with what we are expecting out of the other divisions and even with the stronger-than-expected headwind from foreign exchange, we get to at least 10% EPS growth.

Thank you.

Sara Senatore, Bernstein.

Thank you.

I have a question and then a follow-up on earlier commentary if I may.

The question is about unit growth in China, because I think that's always been the key pillar you all have seen in terms of value creation.

It looks like the store closures have certainly come down.

I was just wondering if, when you think about that 700 growth but looking at kind of what the net, sort of the net would look like, is it safe to say that you're kind of past the point where you've closed all of the kind of low performing stores?

And I guess can you give us a sense of what the returns on the new stores are looking like now, and what the mix is between your tier 1-2 versus lower tier cities?

Certainly.

Starting with closures, we had a higher than normal level of closures last year for China division led by Little Sheep.

So as we were consolidating the estate, there was significant impact to the unit count in China.

Most of that is now behind us.

So when you look at our core brands, actually closures in 2014 were lower than they were in 2013 and we expect 2015 to be below 2014.

There will always be closures in a restaurant business the size of ours, but we do see that moderating.

And then in terms of the returns, we are very pleased with the returns we are seeing in our new unit investments.

As you know, we've continued to shift the mix of development down to the lower tier cities for KFC, and then more broadly to Pizza Hut, given the relative strength of the Pizza Hut economic model.

So here are a couple of stats for you that could help with that.

So for KFC, in the first quarter, 67% of our new unit openings were in tier 3 and below cities, and that compared to 53% for the entire year of 2012, so quite a significant shift there.

And then for our Pizza Hut casual dining business, for the first quarter, that brand accounted for 35% of total division new unit openings and that compares to 24% for all of 2012.

So again, you can see the shifts that are happening in our portfolio, and all of that is informed by our discipline around where we direct our capital.

We deploy capital to the higher return opportunities.

That's been good discipline in China over the years and we are continuing to move in that direction.

And so that gives us confidence in the continued investment we are making in that business.

And I would say as it relates to the 700 that we are expecting this year, there's every reason to believe, over the long run, as our business grows, that that number will edge higher.

Back in 2012, we opened nearly 900 units, so we certainly have the capacity and we have unmatched capability to do it.

For us, it's all about being very disciplined, not getting too far ahead of ourselves and making sure that our capital is deployed to the highest return opportunities.

Great, thank you.

Just a follow-up I had for Greg actually was the idea of these best practices sharing that you talked about in China.

I think one of the I'm sure concerns you've heard is the idea that with the portfolio of brand, maybe there aren't that many benefits to having altogether, they should be run separately.

So can you maybe give an example or talk about what kinds of best practices can be shared across different brands where you couldn't get the benefit of just looking internally within one brand and the highest performers within that brand?

Sure.

I'll give you the specific example of the China business.

The six people that we took, three of them worked at KFC outside of China but three of them worked at Taco Bell.

I think -- so the Taco Bell team included people who are very strong in advertising, product positioning, digital, social, mobile.

And that's where we think Taco Bell probably excels.

And so I think our ability to take people not just from within the brand or within a geography across brands and across geography is something that is particularly unique to Yum!.

Thank you very much.

John Ivankoe, JPMorgan.

Thank you.

I wanted to follow up on labor, or I guess what we talked about is labor efficiency in China.

There's been basically three years of reduced not just labor dollars per store but labor hours per store more specifically.

And can you help us understand what productivity means?

Is it kind of tightening up the number of hours a given employee works?

Is it kitchen labor?

Is it front of house labor?

Is it the number of managers that you use?

Maybe it's even the number of managers that you have in training.

Just can you kind of put some structure for us just in terms of exactly what efficiency means and why it is the right thing for the brand in a recovery?

And then I have a follow-up as well.

You clearly understand our business very well because everything you mentioned forms part of what the team has done to drive year-on-year improvement in labor productivity.

And as I said before, one of the things we love about the team is they have a continuous improvement mindset.

We continually help them out as the best operating team we have anywhere in the world, and they continue to take it to the next level.

So they are managing to a tighter schedule, but that schedule is fully informed by, as I mentioned, more frequent updates to their pacesetter analysis and taking it through full market testing.

So we have confidence, as Greg mentioned before, that we are not doing this to an extent that is going to adversely impact the customer experience.

But at the same time, the team continues to reengineer the back of house.

So they have a team of very skilled engineers who look at equipment layout, who look at how labor is deployed behind the front counter to better accommodate the lines that develop at our restaurants at lunch and at dinner time more cost-effectively.

So there's a lot of intelligence and thought and rigor that is applied to how we do this, but it's that continuous improvement mindset that is really at the heart of it all.

Okay.

Thank you for that.

And secondly, the performance of the brands tiers 1 and 2 versus tiers 3 through 6, and I was hoping you could elaborate on some of the increased competition that you've seen across the markets, whether that's continuing in this current economy, or it might be encouraging people to open less stores, and in other words lessening some of the competitive impact.

The trends continue to show competition intensifying in the higher-tier cities, so that's no change from before.

But interestingly, and this is consistent with what we said on our Q4 earnings call, we are seeing better recovery.

We are seeing actually stronger same-store sales performance of those tier 1 cities relative to lower tier cities, so that trend has persisted.

And still the development tilt is towards 3 through 6, so what does that tell you in terms of does it make sense to shift development, or is to tier 3 through 6 still where you want to be putting your new footprint?

It absolutely makes sense to continue to pivot toward the lower tier cities for two reasons.

First of all, there's more opportunity because those markets are less penetrated, and we have the ability, unlike competitors, to move quickly and gain that first mover advantage.

And then secondly, there's a superior cost structure where labor and rent costs are lower in the lower tier cities.

Therefore, the sales hurdles are lower, and therefore we get higher returns on investment because, remember, we are getting the same AUVs, or average unit volumes, in lower tier cities as we are in the higher tier cities.

So we get the same sales volume but with a higher margin and with a similar investment.

So the returns are superior and there are more opportunities out there because those cities are more rapidly developing and they are less heavily penetrated.

Before we get off the question, just to further build on our know-how sharing, I think labor productivity is another example where we share labor productivity learnings from around the world.

So as you probably know, we have some pretty high labor markets, Australia and the UK, and we are able to share those learnings on like transactions per labor hour and obviously share that best practice in not just China but obviously around the world and again not just within KFC but across all the brands.

So I think labor productivity is another example of the power of Yum!.

Thank you.

R.J. Hottovy, Morningstar.

Yes, thanks.

I just had a quick question about the KFC segment, really two questions.

First is just kind of give us some examples of what's driving that strong 7% same-store sales growth and expectations going forward.

And then secondly, just a little bit more color on the new franchise agreement that you have in place, just in terms of the $100 million or the $185 million in terms of the timing of that investment.

More importantly, when you expect to see some of the benefits from the marketing and the reimaging capacity that you're going to bake into that investment program.

Why don't I take the first part.

I think the success has been we launched this $5 box, and what we've done is we've stayed on this $5 box.

Traditionally, at KFC, we've tended to have a sandwich promotion and then we'd go back into buckets.

The challenge is you put -- it doesn't matter how many people eat out of a $20 bundle, it's still $20 on television.

I think what the team has learned and has really stayed rigorously on is the $5 box.

Now we have about four different versions of it, so there's obviously variety we can offer the customer.

It also enables us to come back with different insight and new communications.

But I think the consistency of staying around this really powerful entry price point has really been one of the keys to success at KFC in the US.

And then on the agreement we've reached with our US franchisees and the financials around that, $185 million in total, most of that being recorded as special items.

The advertising piece, which amounts to about $20 million per year, about $10 million or so is going to fall into 2015.

That will flow through regular operating income, and that is reflected in our guidance still of at least 10% EPS growth this year.

In terms of the benefits, this is a multi-year program, so we expect that the benefits will accrue over the long-term as well.

And we expect to see benefits from each element of that program.

So we do expect sales to be better with the incremental advertising.

We do expect to see sales lift from the incentive that we are offering to accelerate the pace of remodels, such that 70% of our KFC US estate will be a current image by 2017.

And then we are expecting to see sales lift from the investment we are making for our franchisees in new equipment which puts them in a position not only to offer the more contemporary menu but to do so in a fashion that provides a better customer experience with better reliability.

And there will be a sales benefit associated with that and we expect that will build over time.

And that's the underlying business case here.

It's a sizable investment for a business of KFC US' size, but we do expect to see the value of that business improve significantly on the back of these investments and with the outstanding brand strategies that Jason Marker and his team have put in place.

So I want to thank everybody for being on the call.

I know today is a very busy day with a lot of restaurants releasing earnings, so that you took the time to be with us we really appreciate.

I just want to reiterate that we believe we are well set up to deliver at least 10% EPS growth not only in 2015 but beyond.

Thanks for being with us today, much appreciated.

This concludes today's conference call.

You may now disconnect.