百勝餐飲集團 (YUM) 2015 Q2 法說會逐字稿

Good morning.

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

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

Brands second-quarter 2015 earnings and conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you.

Steve Schmitt, you may begin your conference.

Thanks Jana.

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 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 this recording.

Finally, we would like to make you aware of the following upcoming YUM investor events.

Our third-quarter earnings will be released on Tuesday, October 6.

And with that, I'd like to turn the call over to Mr. Greg Creed.

Thank you, Steve, and good morning everyone.

As you saw in our release yesterday, EPS in the second quarter, while below prior year, exceeded our original expectations.

I am encouraged by the progress we have made and have every reason to believe we will deliver a strong second half and full-year EPS of at least 10%.

Overall, I would summarize our second-quarter performance as very similar to our first-quarter results.

Taco Bell is firing on all cylinders.

KFC delivered another solid quarter.

China continues to improve.

And while we are making progress, there is still much work to be done at Pizza Hut.

Let's start today's discussion with China.

Same-store sales continued to show steady but slower than expected progress.

This quarter's 10% decline marked an improvement from the 12% decline last quarter despite a more difficult overlap.

There is no doubt in my mind that we will make a full recovery over the long term and return to historic average unit volumes.

We have the two strongest brands in China by a wide margin but, frankly, the recovery is taking longer than we would like.

We need to be more aggressive, more innovative and much more disruptive to step change the business.

I have challenged the China team to do all these things with a sense of urgency because we know that, when we step up our performance in China, our brands perform.

So to be clear, we are 100% committed to not only recovering but growing our unit volumes in China.

With overall customer metrics trending up, we know we can achieve this.

We are sharpening our communications and bringing new excitement to our menu.

We've learned from experience that we must innovate our way to recovery, and that's just what we are going to do.

To this point, in the second quarter, we launched the first of two menu revamps at KFC.

This consisted of eight new products focused on lunch and dinner.

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

We also recently launched our second menu revamp focused on breakfast.

We know breakfast is an underdeveloped daypart for us in China, comprising about 7% of sales.

These two menu revamps provide new products throughout the day and give us a one-two punch of innovation we know our customers will love.

Additionally, we continue to roll out our premium coffee.

As of quarter end, we offered our coffee in over 2,000 stores, providing an incremental sales lift of about a point for the stores offering coffee.

The key to success in this business is to grow existing or create new sales layers to build on.

We are excited that premium coffee is already driving sales and profits while giving us another platform to grow from going forward.

We're also making progress with digital marketing and our online delivery platform.

We believe these initiatives make KFC even more contemporary, maintaining a high degree of relevance to the Chinese consumer.

In short, the KFC business we are building back will be based on new product innovation and balanced nicely with everyday value anchors.

We are continuing down the path to make KFC even more youthful and contemporary.

All of this is part of making China's number one foreign brand even more relevant going forward in an increasingly competitive market.

At Pizza Hut Casual Dining in China, we continue to expand units at a high pace with great returns.

Same-store sales declined 4% in the quarter, but this marked an improvement from our first-quarter performance and the brand is positioned for a strong second half.

We continue to leverage the asset throughout the day with the rollout of breakfast and our expansion into late-night.

We are also excited about Pizza Hut's home service offering where we have nearly 300 units in China.

Anyway you look at it, Pizza Hut in China has a long runway for growth ahead.

In conclusion, we're making continued progress in China and we remain bullish on our long-term prospects there.

With cash paybacks of about three years, we're confidently investing in new unit expansion.

We have leading brands in an enviable competitive position in the world's fastest-growing economy.

We expect to open 700 new units in China this year and believe we can substantially expand our footprint over time.

Moving on to our KFC division, I am pleased to report the division continued to produce solid results.

Same-store sales grew 3% and the division opened 122 new international restaurants in 39 countries.

Nearly 75% of these new restaurants were opened in emerging markets.

I am particularly pleased with the impressive growth we continue to see out of Russia, where same-store sales grew 14%.

I traveled to Russia in May, and I have to tell you this is one of the most impressive teams we have anywhere in the world.

Their combination of brand positioning, operational excellence and product innovation gives me confidence that we will continue to win in this important market.

In developed markets, the UK and Australia once again posted impressive results with excellent same-store sales growth.

This is evidence that our KFC brand can deliver remarkable results in both emerging as well as developed markets.

I believe we can apply the same strategy such as breakthrough product innovation, compelling value and world-class operations, which are propelling these businesses to other developed markets.

Just think how our results would be transformed if we could achieve Australia's 2.3 million average unit volumes in all of our markets.

Now turning to the Pizza Hut division, same-store sales were even in the quarter but trends in the US sales improved across the quarter.

We complemented our innovation focus with compelling value offerings such as any medium pairs for $6.99, and the $12.99 Big Dipper pizza, which provided momentum.

We also continue to make strides around digital -- around driving more digital sales.

For example, home meal replacement digital orders were 42%, up 10 percentage points from the second quarter of 2014.

As we discussed last quarter, we are working to attract new millennial customers with our Flavor of Now menu while also providing our loyal mainstream customers with their favorites.

I firmly believe Pizza Hut has enormous potential that recent results do not reflect.

We are intently working to become more competitive.

Turning around these results will not happen overnight, but through our focus on value, our assets, digital and messaging, we are relentlessly working on realizing the full potential of our brand.

We are encouraged that Pizza Hut International continues to develop at a high rate and we expect record international expansion this year, laying the groundwork for future growth.

Last but not least, Taco Bell.

I am very pleased with the results out of the division this quarter.

Same-store sales grew 6%, operating profit increased 29%, and we opened 58 new restaurants.

Keep in mind we launched breakfast at Taco Bell in the second quarter of 2014, so this marks the first quarter we are lapping breakfast.

With breakfast at 7% of mix, restaurant margin exceeding 20% and a flourishing innovation pipeline, I am confident that we will see continued positive momentum going forward.

Taco Bell's goal is to be America's favorite millennial brand and we are making substantial strides to deliver on that aspiration.

For example, we just announced we are expanding our delivery testing with DoorDash in select locations.

I'm delighted with the strong initial test results.

And this is just another example of Taco Bell proving it is on the cutting edge of QSR.

Taco Bell International continued to build awareness and improve its economic model.

Same-store sales grew 7% in the quarter with particularly strong performance in Latin America and Canada.

We have now opened 18 new restaurants this year, including four with open kitchen formats.

We're still in the first innings of international expansion for Taco Bell, but I know that this one day will become our third global brand.

So in conclusion, we have multiple opportunities for growth across each YUM division.

We are making continued progress in China.

Taco Bell is going from strength to strength.

KFC continues to build on its momentum and Pizza Hut is in turnaround mode.

I could not be more thrilled to lead this company into next phase of growth.

Our brand building agenda led by consumer insights is underway and driving our brand and product positioning.

As I mentioned last call, we recently acquired Collider Lab to help elevate this agenda.

I'm especially pleased with how Collider is integrating this thinking into each brand to improve our insight-driven marketing.

I'm also pleased the Pizza Hut team has added expertise in big data analytics.

This is allowing the brand to segment customers in ways we've not done before that should lead to more effective marketing going forward.

And in true YUM fashion, we are planning to spread this know-how throughout the organization.

Since assuming my current role, I have been on the road visiting many of our international markets.

To say I like what I have seen would be an understatement.

I've walked away from each visit grateful that I have inherited such a strong business with great franchise partners, fantastic leaders, and the potential for enormous growth.

Of course, everywhere I go, I see opportunities to improve our company.

But I'm confident that our brand building focus combined with the technology, innovation, marketing, and operation efforts underway will help unlock this potential.

Now, some of you may want to ask today about our views around corporate structuring related to our China division, including a shareholder suggestion that was well-publicized this quarter.

We don't plan to discuss that and distract from our second-quarter results.

But we want you to know this.

The YUM Board of Directors regularly reviews strategic options to optimizing long-term shareholder value, including those involving corporate structure.

We routinely dialogue with shareholders, listen to their ideas and thoroughly evaluate those which may be in our shareholders' best interests.

In any event, our top priority is to get our China business back on track and we are making steady progress, as evidenced by our first and second quarter results.

As we have discussed, we expect to have a strong second half of the year based on continued progress in China and fully expect YUM to deliver at least 10% EPS growth in 2015.

In summary, 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 now turn things over to Pat.

Thank you, Greg, and good morning everyone.

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

For the second quarter, as Greg mentioned, our results were very similar to Q1.

Earnings per share, excluding special items, decreased 5%.

This was substantially better than the decline we had originally estimated.

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

With the continued progress we are expecting in China, we remain confident that we will have a strong second half and deliver at least 10% EPS growth this year.

Reported EPS declined 28% in the quarter.

This includes a $68 million non-cash special item charge related to our decision to sell Mexico real estate, negatively impacting reported EPS by $0.13 in the quarter.

This item reduced our ex-special tax rate by approximately 2 percentage points, benefiting ex-special EPS growth by 3 percentage points this quarter.

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

In China, operating profit declined 25% prior to foreign currency translation led by a same-store sales decrease of 10%, which was sequentially better than Q1's performance despite a more challenging lap.

Restaurant margins were 14.6% in a seasonally low quarter.

This was 2.2 percentage points lower than last year's Q2, yet it was a significant improvement from the 4.5 percentage point decline we saw in the first quarter, demonstrating continued progress.

The margin decline resulted from transaction deleverage and inflation, partially offset by pricing and labor productivity.

Our team in China continued to do an outstanding job of driving restaurant operating efficiency through improved store level sales forecasting and better labor scheduling.

Importantly, they accomplished this while maintaining our high standards of customer service.

This continues to bolster our belief that China division restaurant margins will return to the 20% range as sales recover and that this recovery has the potential to unlock approximately $600 million of operating profit from our existing store base alone.

In addition to the profit leverage we will realize as sales recover, we continue to open new units with confidence, which is a key driver of future growth.

We opened 80 new restaurants in the second quarter, bringing our first-half total to 251 new units in China.

We continue to shift our new unit development toward higher return investments as we are more selective in tier 1 and tier 2 cities and continue to upweight development in tier 3 through tier 6 cities.

Similarly, we continue to shift more of our new unit development to Pizza Hut casual dining, which generates our strongest returns in China.

Based on the results we are seeing in these new restaurants, we are confident that these investments will yield strong returns and we remain on target to open 700 new restaurants this year.

Now moving to our KFC global division, which posted another solid quarter with growth in sales, margin and profit.

System sales growth was especially strong in emerging markets, up 12% before foreign exchange, led by Russia, Africa and Central and Eastern Europe.

International developed markets also delivered solid systems sales growth, up 5% before foreign exchange, led by Australia, UK and Western Europe.

And KFC in the US delivered its fourth consecutive quarter of solid same-store sales growth with comps up 3%.

Division operating margin increased 1.3 percentage points in the quarter to 21.9%, driven by same-store sales growth, franchise-led new unit development, and stronger restaurant level margins across the board.

And while increased advertising expense related to our ongoing US turnaround program impacted the division's profit by 2 percentage points in the quarter, KFC Global's operating profit still grew 10% excluding the impact of foreign exchange.

An important element of this is robust franchise-led international development as KFC opened 122 new international restaurants in the quarter, and is on pace to set a new record this year, opening 700 new international restaurants outside of China and India, including a recent new market opening in Myanmar, demonstrating the strength and broad appeal of this iconic global brand.

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

Division operating margin decreased 90 basis points to 22.6% as strategic growth in investments in international G&A offset improved restaurant margins, which benefited from lower cheese costs.

While sales were even with last year and short of expectations, we are confident we are making the right investments to improve Pizza Hut's overall brand position, operations, and digital experience globally.

New unit development continues to be a bright spot for Pizza Hut as the division opened 101 new restaurants in the second quarter, including 66 new international restaurants.

Franchisees opened 92% of these new international units, underscoring their confidence in the brand.

We are confident we will have another year of record development with about 550 new international restaurants in 2015.

And finally, Taco Bell posted another exceptionally strong quarter with same-store sales growth of 6% and restaurant margin of 23%, which is more than 5 points better than Q2 of last year.

As a result, operating margin increased 4.7 percentage points to 29.5%, lifting operating profit by 29% versus prior year.

We could not be more pleased with the performance of our Taco Bell team and their continued focus on category leading innovation across every aspect of their business.

This obviously includes our new breakfast layer, which increased to a very healthy 7% sales mix.

Additionally, we opened 58 new restaurants in the second quarter with nearly 90% opened by franchisees and are well on our way to opening at least 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 powerhouse brand with outstanding momentum.

Now I'd like to shift gears and talk about our full-year outlook.

We fully expect to deliver EPS growth of at least 10% this year.

Given our first-half EPS decline of 7%, we will need nearly 30% EPS growth in the second half of the year to reach this target.

We believe this is achievable.

The key to this EPS bounce back is a sales recovery in China, and we are confident we will deliver solidly positive sales numbers going forward, especially as we lap the supplier incident from July 20 of last year.

I am extremely confident that, as sales return, profits will flow through nicely, given the continuous cost management initiatives we've seen through our first half.

With first-half China restaurant margin already over 16%, we now expect full-year restaurant margin to be closer to 17%.

As a reminder, 60% of China's operating profit historically is earned in the second half of their fiscal year, which includes seven of 12 months.

Outside of China, we expect KFC to have another solid year and Pizza Hut to fall well short of its ongoing growth target despite the improving results we expect balance of year.

For Taco Bell, although we expect solid performance balance of year, we expect much more moderate profit growth as we overlap stronger sales and margin performance from last year.

I do want to point out foreign currency translation remains a strong headwind as we continue to expect this to impact full-year EPS by about 5 percentage points.

However, this impact is included in our EPS forecast of at least 10% growth.

To be clear, this exposure is one of profit translation and does not impact our ability to price our products competitively 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.

And importantly, we continue to invest behind the business, opening 2,100 new international restaurants in 2015.

Outside of China, approximately 90% of our new units will be opened by our franchise partners.

So let me wrap things up.

We are pleased that our second-quarter results were stronger than expected due to robust performance at Taco Bell as well as the continued recovery in China.

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

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

(Operator Instructions).

David Tarantino, RW Baird.

Hi, good morning.

My question is on the China sales recovery.

And I guess the first part is how would you frame up your current expectation for comps for the year now?

I think last quarter you were pointing towards the low end of your 3% to 7% guidance.

So I just wanted to understand where you are thinking now.

And then specifically, you mentioned that the recovery is going I guess slower than expected.

So could you talk about maybe why you think that's the case and whether you think it's macro-related or more specific to the brand metrics that you are seeing.

This is Pat.

I'll take the first part of your question and Greg will respond to the second part.

So as to our expectations for full-year same-store sales growth in China, at this stage of the year, it still remains difficult to call.

We will certainly keep you updated as the year progresses, but certainly based on everything we've seen to date and our forecast balance for the year, full-year same-store sales growth in China could be in the low single digits.

We do expect both KFC and Pizza Hut same-store sales growth to turn strongly positive as we lap the initial impact of the OSI publicity later this month.

This will fuel a strong second half for China and enable us to deliver EPS growth of at least 10% for the year.

I would also point out that, from a profit perspective, stronger-than-expected margin performance has offset the impact of a slower-than-expected sales recovery in China, and we expect this will continue balance of year, thereby preserving our overall profit outlook.

Let me answer the second part of that question.

I think the good news is that sales are recovering.

We went from minus 12% to minus 10% despite a more difficult lap of plus 15%.

The good news is that the consumer metrics are improving, trending in the right direction.

As always, these are never linear, unfortunately, but we do know that when we compare this to previous recoveries we're going in the right direction, making progress across the board.

So I feel good and we remain obviously bullish on China.

We continue to invest in China.

And I think as you know, these customer metrics are the harbinger of future sales performance.

So I think, with all that said, we remain very bullish and confident and continue to invest.

John Ivankoe, JPMorgan.

Thank you very much.

A follow-up on that and maybe an addition as well.

Could you diagnose why specifically you think China was below your own expectations in the second quarter, especially given the customer metrics which have been trending up throughout the year?

And secondly, it is clear that with it being a little bit below your expectations and perhaps a tweak down in the comps in China for 2015, it is interesting to juxtapose that with the China margin numbers going up.

So just a philosophical question is why not reinvest some of that margin to regain the traffic?

Or in other words, how confident are you that the focus on margin is not a reason in and of itself why comps might be slightly below expectations?

I think the slower-than-expected recovery -- remember we've had two safety issues which we've never had before.

We have never been able to model two safety issues before, and there's obviously some slowness in recovering that.

But there has been no impact on our customer metrics as we measure from an operating point of view, and so I think, in that sense, we are going to continue to push aggressively.

We need to be more innovative.

And the way I look at it is with where we are today, Pat has given you the right guidance, but we've still got six months of the year to go.

And right now, what I am trying to do is aggressively bring outside ideas from YUM into China.

As we said earlier, we've got really a number of our KFC businesses on fire, whether that's Russia, the UK, Australia, or South Africa, and I think there's a number of product innovations, there's a number of value plays that those markets have played.

And I'm very confident that we can bring those to bear.

And that said, I still expect a strong second half in China.

Sales will go positive, we will continue to make progress and I think we can bring the power of YUM to bear by taking these ideas from those powerhouse countries and have China test those.

This is Pat.

I'll just add a couple of other comments which is that we feel very good about the productivity gain the team has made in China.

We believe that they are sustainable, as Greg mentioned.

They have not impacted customer service levels.

And frankly what they've effectively done is strengthen underlying unit level economics which not only gives us continued confidence to invest at the rate that we are behind new unit development but also reinforces our belief that, as sales recover, that we will see significant profit leverage in the business.

If I was to make one last comment, I would say we need to balance value with innovation.

There's no doubt innovating our way out of this is the best way to do it, and that's what we're going to stay focused on.

John Glass, Morgan Stanley.

Thanks.

Good morning.

First, on China comps, has the recent decline in the Chinese stock market had any impact on sales?

Do you notice a correlation there at all?

We don't.

This is Pat.

We don't see a correlation.

We think actually a very small percentage of customers have been impacted by that.

As to whether or not it has impacted broader consumer confidence, we have no reason to believe at this stage that that is the case.

Greg, if I could ask one more.

You did open up that you talked about the possibility of this China spin notion.

I know you don't want it to be a distraction.

Do you view that as a distraction in and of itself for the recovery of China so that you might want to wait until China recovers before entertaining that idea?

I think, as I said in my prepared remarks, we don't want to talk about it.

Obviously, we review our shareholder proposals.

But I can assure you the China team is focused on one thing.

Their number one priority and my number one priority is getting China sales back into sort of stronger growth.

Diane Geissler, CLSA.

Good morning.

Is it safe to assume that you kept your guidance for the full year at at least 10% EPS growth because of the uncertainty around the China comp?

Is that the biggest holdback despite the fact that the margin is so much better than you expected?

And then I also -- maybe I'll let you answer that first.

This is Pat.

Happy to respond to that question.

I think what you are implying is that maybe the full-year guidance is conservative.

And I would say absolutely not.

And I do want to put it in perspective because you have to bear in mind that we are at the midpoint of our year.

EPS is down 7% and as I said in my prepared remarks earlier, to achieve full-year growth of at least 10%, EPS needs to grow nearly 30% in the second half of the year.

And I don't think of that as an overly conservative number.

Obviously, it's heavily dependent on the results of our China division where profits were down about 30% in the first half of the year.

And in order for China to deliver on its expected share of second-half EPS growth, second-half profits there need to be more than double what they were last year.

But we are confident China can deliver this result, but with 60% of their profits being generated in the second half, I don't think it's prudent to adopt a more aggressive stance and lean in on this.

Additionally, as I mentioned, foreign-exchange headwinds are much stronger than we had originally estimated, but this is factored into our overall EPS guidance.

So I just want to make it very clear that we expect to have a strong second half based on the continued progress in China and we fully expect to deliver at least 10% EPS growth for the year.

Okay, thank you.

And then I wanted to ask on the comments about the new unit mix leaning more heavily on lower tier cities and also into the Pizza Hut franchise and home delivery.

Can you talk a little bit about your development expectations for this year and even into next year in terms of what we should be thinking about KFC versus Pizza Hut or versus Pizza Hut home delivery and then higher tier cities versus lower tier cities?

Just trying to frame that up.

Certainly.

As I mentioned, our capital investment follows returns.

So where we generate the higher returns is where we are directing more of our capital spending.

That has been the case for the last few years.

And just to put it in perspective, for the quarter, 60% or 62% of KFC new unit openings were in tier 3 and below cities.

Back in 2012, that number was 53%.

So you've seen a pretty significant shift there.

And then as it relates to Pizza Hut casual dining for the quarter, that business accounted for 35% of total division new unit openings.

In 2012, that number was 24%.

You can expect those trends will continue because, again, that's where we see the stronger returns and our capital investment will follow the returns.

I'm not going to give preliminary guidance for 2016 as it relates to either number of units or the mix of units, but I will tell you that we will continue to direct more of our capital investment money toward the higher return opportunities, which at the moment are with Pizza Hut casual dining and for the KFC business in the lower tier cities.

David Palmer, RBC Capital Markets.

Thanks.

Could we talk a little bit about the marketing and menu news from China?

In particular, how do you think the new menu is performing at KFC China?

And any data points would be helpful with the impact to your marketing, even as we look into 3Q.

Thanks.

I think, as we said, obviously we saw sequential improvement from minus 12% to minus 10%.

The new menu items are accounting for about 15% of sales, so they certainly have got traction with the customers.

I think that's also another good data point.

And I think the consumer metrics continue to show improvement.

So I think, if you look at our continuous improvement, you look at the percentage of mix from these new items and you look at the continued improvement in our consumer metrics.

And I think that all bodes well, as Pat has said, that we will have a strong second half, we will go into positive same-store sales growth.

And I think I remain completely confident.

Now, can we take ideas from around the world between now and the end of the year and test those?

Yes.

Do I still have a sense of urgency?

Yes.

Could we do things more speedy?

Yes.

So as you probably expect, that's occurring.

That's why we are at the half-year mark and there's still plenty of time for us to still evolve and tinker with the calendar between now and the end of the year.

Is there anything specific that you learned that you think warrants tweaking that you could call out from first half, things that worked and didn't work?

The other way I look at it, there are some great products outside of China that are doing very well whether it's the UK, Australia, South Africa or Russia.

So what I have done is I have put the China team obviously in direct contact with those businesses.

And I know that a number of those ideas are currently being concept tested in China as we speak.

So it's been more that I've seen some really powerful ideas outside of China that I think have relevance in China, and then I really asked the China team to concept test those.

And if necessary, we will make changes to the calendar in the back half of the year.

Thank you.

Joseph Buckley, Bank of America.

Thank you.

A couple of questions on China as well.

Do you think that the slower-than-expected sales trend is still related to the Shanghai Husi incident, or do you think it's related to broader things happening in China, whether competitively or just somewhat slower growth?

This is Pat.

I think it is fair to say that what the brand or the brands are recovering from is the incident from last year, because that's what had the dramatic impact to sales starting in the middle of last year.

And we are continuing to recover from that.

I think it's also fair to say, as we have said on previous calls and at our investor conference, that the environment in China has changed in terms of becoming more competitive, and so consumers do have more choice.

That has raised the bar on us to innovate more than we have in the past, to keep pace with a changing Chinese consumer, and to continue to move even more aggressively on things like digital.

So I think it is fair to say that the environment has changed, but we are changing in response to that.

If I can build on that, Joe, we have markets that are much more competitive than China that we compete in and we compete very successfully in.

Again, we can use YUM Know-How to share where we've been very successful in markets that have even probably two or three times the amount of competition.

We can bring that Know-How to bear to help the China team as they obviously move to more rapidly improve the sales performance.

Do you have a sense of what the Chinese restaurant market as a whole is doing?

Has that slowed significantly also?

I don't.

That's -- no, I don't.

I think generally the economy is growing at a slower pace, so it's fair to say that and that that is putting pressure on retail generally.

But I think we also need to bear in mind that with GDP growing this year at around 7%, it remains the fastest-growing large economy in the world.

Brian Bittner, Oppenheimer.

Thanks very much.

My question is I think I'm just a little confused on why there's kind of a tone change in the way you're talking about how sales are tracking versus your expectations, just because the guidance for the second quarter was for sequential improvement.

You did that.

We haven't even started lapping the July 20 fall off in the business yet.

That comes in a week.

Is there something that's happened, say in June since the quarter end, that's causing the tone change or were your expectations (technical difficulty) significant sequential improvement relative to what occurred?

This is Pat.

Nothing specific that has changed to drive that.

Just as we step back and we look at the performance in the first half of the year, it's fair to say that same-store sales, while recovering, haven't been recovering at the pace that we had originally anticipated.

Thankfully, we are seeing that offset through improved productivity in the stores and those margin gains are therefore muting the profit impact of a slower-than-expected sales recovery.

But make no mistake.

The sales recovery is happening not only based on what we see in terms of same-store sales and the fact that in the second quarter we lapped a harder comp, so we got sequential improvement on top of lapping a harder comp, but also based on what we see in our key consumer metrics, which, as Greg mentioned, are a leading indicator of where sales will go.

But we felt that it was important to acknowledge that sales are progressing at a slower-than-expected pace, and that is factored into our full-year EPS guidance of at least 10%.

I think I want to make sure everyone understands we still expect a very strong second half and that we will deliver at least 10% for the full year.

And you also mentioned -- am I still here with you guys?

You also mentioned that same-store sales in China could be low singles for the year, which would still imply double-digit comps in the second half.

Is the confidence behind that just the way the core trend accelerated from the first or second quarter, like on a two- and three-year basis?

Is that what ultimately gives you the most confidence in double-digit one-year comps in the second half?

You are right that we do expect a very strong same-store sales growth in the second half, particularly as we lap last year's OSI incident.

And there are multiple indicators that substantiate this view, one-year, two-year, three-year, four-year comps for KFC.

We look at absolute transaction volumes on a de-seasonalized basis.

We look at key consumer metrics, which, again, are all moving in the right direction.

So all of that together giving us confidence that we'll get the second-half bounce back necessary to achieve the profit growth objectives in China, which underpin at least 10% EPS growth for the year.

Jason West, Credit Suisse.

Yes, thanks guys.

I'm not sure how much you are willing to talk about other structural ideas, but the idea of recapitalizing the balance sheet has come up, particularly given the substantial franchise assets you guys have.

I'm just wondering if you could give your updated thoughts on that, particularly as you move towards sort of the 95% franchise mix outside of China.

Does that start to change your thinking around the capital structure?

And then also looking at what's happened across some of your franchise peers.

Thanks.

This is Pat.

No change to our policy, which is to optimize our capital structure based on what we believe is in the best interest of shareholders, which is to maintain that low investment-grade credit rating.

And so our policy hasn't changed.

And no specific guidance as to what that capital structure might look like when we complete the three-year re-franchising program we announced in December.

Okay.

But even as a more franchised business, you would still like to keep that in investment grade?

We look at our capital structure from an enterprise perspective.

We don't segment our balance sheet according to one part of the business versus another.

So we have to bear in mind, in our China business, we have a substantial equity presence with all of the operating leases which function as virtual debt, if you will, which plays into how we optimize our overall capital structure for our shareholders.

Karen Short, Deutsche Bank.

Just a couple of questions on Pizza Hut.

So I guess you have taken some aggressive stances with your value positioning more recently, but I guess it doesn't seem to be resonating with the customer.

Or maybe asked another way, do you think it's a value issue, a trial issue, a frequency issue or anything else?

Because obviously your peers are generally doing extremely well.

Thank you for asking a non-China question.

In all seriousness, yes, our peers are clearly outperforming us.

I think there's no one silver bullet to the solution.

You saw us in the quarter playing in more stronger value, which actually over the quarter did show improvement across the quarter's performance.

And I expect that to continue going into the second half the year.

But this is a sort of total re-look which is we have to be -- we have to have -- assets have to be upgraded, we have to have a compelling value.

We have to have compelling innovation.

We have to deliver a superior experience.

We have to improve our eCommerce digital experience.

So there's a lot of work that's got to get done.

I'm very confident in the team that's in place to make that happen.

We've brought some new people onto the team in Pizza Hut, so we have invested in areas like digital marketing, food innovation, eCommerce.

As we said on the call, we actually are getting into big data analytics and we are really starting to see some early signs of, I think that will help us position the brand better and actually really understand where the business has gone to.

So it's holistic.

We're on it.

We've brought people into it.

I'm very comfortable and happy with the leadership that we've got in place to deliver on it.

We are not happy with the progress, but we are making progress and I think you'll see us continue to make more progress as the year unfolds.

Jeffrey Bernstein, Barclays.

Great.

Thank you very much.

Just unfortunately, I wanted to hit back on China for a second.

Two things, one just on the comp.

I'm wondering, as you look at it perhaps slightly below expectation, whether you see it maybe as performance by market or daypart or weekend, weekday.

I'm just wondering.

As you slice the down 10% which we can't do, is there any particular area of concern?

And my other question was just broadly on the positioning of the brand.

I think, most recently, you kind of were focused a little bit more on premium with promotions and whatnot.

I'm just wondering whether the recent challenges lead you to once again maybe broaden that out, focus a little bit more on value to retain that lower income consumer.

Thanks.

This is Pat.

I'll respond to your first question and Greg will tackle the second.

First, with respect to what we are seeing in the comps and whether when you look at various ways of segmenting it we are seeing material differences, the only thing I would highlight is that we are seeing stronger performance in our Tier 1 cities at both brands.

It seems that the Tier 1 consumers are less fazed by the supplier publicity this time around.

And I would say that's especially encouraging because that's where we have a higher concentration of stores, and also face the strongest competition.

So, I think that's further evidence of our brand's ongoing recovery and resilience.

There are some regional economies that are more dependent on industrial production and they are feeling more pressure from slower economic growth and we are seeing the effects of that in weaker sales performance in those regions, particularly in some lower tier cities.

And in response to that, KFC has recently launched regional promotions with 10RMB Burger to help stimulate traffic.

But that's the only thing that really bears mentioning in terms of any variations in comps across the entire market.

Just to talk about the positioning, I think, yes, we probably have to find a better balance between innovation and value.

Again, if I go back to the KFC markets that are really outperforming, whether it's Russia, Australia, South Africa, the UK, what you will see in those markets is we have great entry price points, we have great value for money, we have really chicken-focused innovation, and we are really doing disruptive things in the marketplace.

So, I think -- and then we have -- I guess it also goes without saying we have great leaders running those businesses as well.

I think that we are going to have to find more balance, but I'm very confident that we can find that balance and I'm very confident that we have got the ideas and the resources around YUM in order to accomplish that.

Sara Senatore, Bernstein.

Thank you.

I have two follow-up questions.

One is about Pizza Hut and one, not to belabor the point, also about China.

So on Pizza Hut, could you just talk about the developed markets outside the US, and in particular diagnose maybe?

Are the issues the same out there?

And is it stepped-up competition, digital, value, marketing?

Just so I kind of understand because it feels like broadly the brand sort of stepped back a little bit in the last couple of quarters.

And then the follow-up on China is really one about timing.

And I guess you laid out sort of $600 million in EBITDA, which is a big number, but it's less impressive if it takes five years to materialize.

And so do you have internally a sense of at what point you decide, okay, this business may not go back to peak volumes?

And likewise how long do you decide, when you're looking at strategic alternatives, how long do you give yourselves to make decisions?

I'm just trying to frame timing from both fundamental and strategic standpoints.

Let me answer the first part of the question.

I think with our Pizza Hut business, a strong US helps a strong global business.

There's no doubt about that.

So, having said that, I think, outside of the United States, our assets are in much better shape than they are in the United States.

But I do think in terms of things like value, eCommerce and digital, we need to accelerate our progress in those areas.

So, I think our assets are in great shape.

I think our food quality is in great shape.

I think the food innovation is in great shape, but there's no doubt that I think value as well as the whole customer experience in eCommerce are areas that we need to make sure we remain competitive in as leaders in those places.

This is Pat.

I'll respond to your second question as to the timing around recovering the $600 million in EBITDA.

We have never been specific as to a timeframe for that.

What I want to let you know, however, is we are absolutely confident that the business will return to those 2012 peak average unit volumes.

And we are absolutely confident, based on the progress the team has made to improve unit level economics that, as the sales recover, there will be significant profit flow-through on the sales.

As to the timing of that, it's tough to call.

And I'm not going to make a prediction based on that, nor am I going to talk about how that may play into the timing of any structural moves, because our top priority, regardless of what we do structurally, is to bring that business back in terms of sales and profits.

And so that's why the focus is, as Greg mentioned earlier, on more disruptive innovation, continued strong value offers, all the things that we need to do to make our brand positions even stronger in an environment that has, over time, become more competitive.

Keith Siegner, UBS.

Pat, I'm going to apologize but I'm going to follow up a little bit on that.

Look, margins in China have come in much better than you expected.

You reiterate the 20% -- the confidence in the 20% long-term.

We talk about the $600 million and it's not sure when there's timing, or when the timing would happen.

But let me ask it a different way.

Given the success in the productivity initiatives and what you've achieved on the margins, it would seem to me that you should be able to recover the 20% long before you recover the peak AUVs.

Is there any reason why that wouldn't be the case?

No, I think that's a fair statement, because the underlying economics have gotten stronger.

So as the sales come back, the flow-through will be at a much higher rate.

That's it for me.

Thanks.

Karen Holthouse, Goldman Sachs.

Hi.

I'm actually going to not ask a question about China, but instead look at the Taco Bell business in the US where two-year trends continue to accelerate.

Just thinking through the moving pieces of that, could you help us understand how much of that might be coming from still continued growth in the breakfast daypart versus value versus any other specific product innovation?

I think the good news is the Taco Bell performance in the US is holistic, which is -- it has great entry price point value.

They have had growth in breakfast from 6% to 7% mix, which I think takes it to like $90,000.

In the West Coast, it makes us now over 10%.

The innovation that was run in the quarter was compelling, disruptive, and the assets are in great shape.

The customer experience is improving.

It's holistic.

It's all the things.

And at same time obviously they're starting to experiment with things like delivery and on the cutting edge of that, the mobile app.

I think everywhere you turn, this brand is so relevant to its target audience and I think so clearly positioned with products that are driven out of real consumer insights.

I think that's why they've had a great first half and that's why we remain confident they will have a great second half, and obviously 2016 and beyond.

Great.

Thank you.

Andrew Charles, Cowen & Company.

Thanks.

Two questions for me.

First, if the key to the China term will be innovation and breakfast only represent 7% of sales and seems to be performing well already, why not double down efforts on lunch and dinner in the back half of the year and continue innovating around these dayparts to turn China faster?

I think my answer would be having done this myself when I was running Taco Bell, you've got to balance this out, which is you've got all these dayparts we're going to try to get growth from.

And what we've seen in the past, even if we sort of overinvest in certain areas, it's better to have a balanced spend behind breakfast, lunch, and dinner and then even if you've got enough money, the dayparts like late-night and snacking.

So I think that this year we've got great products.

They're putting the right amount of resources behind it.

We've got the current promotional, the wing bucket, which is off to a nice start, and I think this balanced investment behind all the dayparts is the right way for us to invest in the business.

This is Pat.

I would just build on Greg's comments by highlighting the important role that coffee will play in building multiple dayparts.

So while it's an important part of our breakfast daypart, it also contributes to afternoon tea time and it contributes to late-night.

And we are very excited with the results we are seeing from coffee and how it has lifted sales at the 2,000 units that have already gotten the premium coffee program, and we will be expanding that to more units by the end of the year.

So far this year, there's been a seasonally high amount of KFC China store closures.

Are these stores -- how would you categorize them?

Are they primarily located in Tier 1 tier 2?

Again, what's driving the decision to close these stores rather than refranchise them?

This is Pat.

We make those closure decisions one unit at the time.

It's not always a function of underperformance.

There may be forced closures due to -- come up upon the end of a lease and weren't able to renew on favorable terms.

So there could be a variety of things driving that.

But we don't expect a substantial increase in KFC closures for the full year versus last year.

And in fact, we expect total closures to be slightly down versus last year because last year's number was propped up by substantial consolidation of the Little Sheep estate.

Jeff Farmer, Wells Fargo.

Thank you.

Sorry, Greg, to keep hitting you on China.

But the last time KFC China saw a rapid same-store sales recovery, the concept had a sizable mix and menu pricing tailwind with it looks like mix alone represented more than half of that 21% same-store sales growth.

The concept is still in the second quarter of 2014.

So with that, how should we thinking about the role mix and menu pricing are expected to play in the China same-store sales recovery in coming quarters?

And to that point, have you already begun to see the return of the higher average check family visits that were a big benefit a year ago in the recovery process?

This is Pat.

I'll respond to your question and Greg may add some things.

But from a sales recovery standpoint, our focus is primarily on traffic.

It's rebuilding traffic.

From a pricing perspective, our policy is unchanged, which is we generally look to pricing to work with productivity to offset inflation.

We are very conscious of the important role that value plays in building traffic over time, so we wouldn't expect mix to be an outsized contributor to sales growth going forward.

The emphasis will be more on traffic driven through a combination of value and innovation.

I would just echo that, which is this is going to be a balance of disruptive innovation and value, and I think the combination of those is exactly what we need to focus on.

Just a quick follow-up, where does pricing stand right now, menu pricing, or actually heading into the back half of 2015?

This is Steve.

Pricing is about 3% and that should be pretty consistent through the year.

And just another data point on your question, the quarter, the check was relatively flat.

It was up about 2 points but it was primarily driven by transactions.

R.J. Hottovy, Morningstar.

Thanks.

I actually had a question on India.

Obviously, it's a small part of the business today but one that you've spoken about in the past having a great long-term potential.

You've now had three quarters of double-digit comp declines in the region.

Just curious what's driving that, and if that's changing some of your thinking about long-term unit potential in the region.

Thanks.

I think we remain very bullish on India in the long-term.

There's no reason not to.

There's massive population and urbanization of that population, and there's obviously underlying economic growth.

I think that we did expect -- I think with the Modi government change, there may have been a sort of perceptible change in consumer perception.

And like I guess that probably hasn't had -- we haven't seen that.

What I like is that we have an incredibly strong team in India, and I have to say they are probably the best team we have at building know-how.

The Indian team do not suffer from non-embedded here.

And they are very aggressively learning what we've got and what is working, as I said, in countries like Australia, South Africa, the UK and Russia.

And they are already concept testing, and they recognize that value remains an issue, entry price point value remains an issue, and obviously innovation, so the same things we keep talking about.

But what I want to give them credit for is really reaching out to the list of YUM, building know-how, taking the advice back into India and with a real sense of urgency actually pulling them into the marketplace.

So I am long-term bullish.

I love the team and I think they are doing all the right things in order to accelerate the sort of improvement momentum in same-store sales.

Paul Westra, Stifel.

Great.

Thank you very much.

Just for some clarity on China, maybe help here with the last question, when you say the comp performance is a little bit below expectations, you mean below your original positive 3% to 7%, so your comments today saying comps could be in the low single digit positives.

Second-half comps are still looking to be more positive than the first half was negative.

I just want to make sure that's clear.

That is correct

Absolutely correct, Paul.

Great.

And then when you mentioned your transaction trends on a DC line basis continue to sequentially improve, you are seeing sequential, again, month-to-month traffic recovery versus -- yes.

I wouldn't say month-to-month.

Certainly quarter-to-quarter.

We never said that the recovery was going to be linear, and so there's natural choppiness from month to month.

But as we step back and look at how traffic has rebuilt since the incident last summer, we are seeing a nice, steady improvement in that curve.

Okay.

I guess then my last sort of new real question, I guess go back to the color on your China average check strategy I guess maybe before the dual crises, my understanding and I know part of the renovation program was if anything designed to enhance KFC's sort of premium brand position, maybe move the check up, all things being equal, move people up the menu.

We certainly can understand the focus on traffic here.

Is that still a sort of latent opportunity intermediate-term or how does that play in I guess the new menu here.

I think there's a couple of things.

One, the amount of remodeling going on in China is accelerating, enjoy what's coming and I think found a way for us to be much more focused on our remodeling of the assets.

So the good news is we are sort of doubling the number of assets that are getting remodeled.

So that is a great way of keeping our assets relevant.

And then I think it's just back to the point we've been making also about balance.

We actually have to balance paying menu with what I call disruptive innovation and wow value.

And I think our ability to do that as well as improve the assets and obviously deliver a superior customer experience, all of those combined will be what sort of makes us long-term successful.

And as we keep saying, yes, we will have a strong second half, we will go positive.

We remain very confident in the long-term of China.

Thanks Paul, and thank you all for joining us today.

This concludes our call.

Thank you.

Thanks everybody.

This concludes today's conference call.

You may now disconnect.