Good morning ladies and gentlemen, at this time I would like to welcome everyone to the Yum! Brands 2009 first quarter earnings conference call. (Operator Instructions) I will now turn the call over to Mr. Tim Jerzyk, Senior Vice President of Investor Relations and Treasurer; please go ahead sir.
Good morning, everyone. Thanks for joining us today. This call is being recorded and will be available for playback. We are broadcasting the conference call via our website at www.yum.com. Please be advised that if you ask a question, it will be included in both our live conference and in any future use of the recording.
I would also like to advise that this conference call includes forward-looking statements that reflect management’s expectations based on currently available data. However, actual results are subject to future events and uncertainties. The information in this conference call related to projections or other forward-looking statements may be relied on subject to our Safe Harbor statement included in our earnings release last night and may continue to be used while this call remains in the active portion of the company’s website at www.yum.com.
In addition, we would like you to please be aware of several upcoming Yum! investor events, where you’ll have a great opportunity to meet leadership teams from our businesses. First coming up next we have on June 24 we will host Pizza Hut Investor Day in Dallas and will follow the next day with YRI Investor Day, Yum! Restaurants International, on June 25 also in Dallas.
We’ll give you a double back-to-back chance to meet with both teams in Dallas. Then July 29 is KFC Investor Day in Louisville, and then August 11 is Taco Bell Investor Day in Irvine, California. Please notify us if you plan to attend these events. And then lastly our next second quarter earnings release will be on Tuesday, July 14. That’s a quick update of our calendar of events coming up.
On our call today you will hear from David Novak, Chairman and CEO, and Richard Carucci, our CFO. Following remarks from both, we will be happy to take your questions. Now I will turn the call over to David Novak.
Thank you Tim, and good morning everybody. I’m very pleased to report better then expected first quarter EPS growth of 14% before special items. The power of our global portfolio allowed us to overcome a challenging environment with modest system sales growth of 4% and operating profit growth of 7% prior to foreign currency translation.
Importantly the momentum behind the key driver of our global business, international development, continued with a record 256 new restaurants opened outside the United States including a first quarter record of 98 new restaurants in Mainland China.
Additionally we generated worldwide same store sales growth of 1%, the 22nd consecutive quarter of positive same store sales growth including 2% growth in Mainland China and 6% growth in Yum! Restaurants International, offsetting the decline that we had in the United States.
Our operators also improved our worldwide margins by more then one point from the benefit of a combination of pricing taken in the second half of last year, managing the details and productivity, and moderating commodity inflation.
Overall this was a strong start to what everyone knows is a difficult year. Now let me take you through our key strategies and the results of each of our divisions.
First let’s talk about China, where we have the unique strategy to leverage our powerful team and infrastructure to build leading brands in every significant restaurant category since we’re on the ground floor of this important market.
Overall China continues to be the fastest growing major economy in the world, even as it weathers an obvious bump in the road. Importantly I think its safe to say based on our results that our Yum! China business stands on solid ground given our strong profitability, powerful new unit economics, and the strength of our leading brands.
For the first quarter our China division drove strong results. System sales growth was 12% prior to foreign currency translation. New unit development included 98 new openings in Mainland China, the best start to a year we’ve ever had. Additionally same store sales growth was plus 2%. Importantly our restaurant margin was up 1.7 points.
All of this led to impressive profit growth of 21% excluding positive foreign currency translation, lapping 23% growth last year. I’m proud of our China team for delivery such as strong quarter in a tough year and at the same time, continuing to make investments in our emerging brands.
You may remember in December that we told you that our China business was planning for a weaker first half of 2009. We expect that to continue as we lap 14% same store sales growth and 38% profit growth in the second quarter. Richard will go into more detail on these numbers later on.
Now let me give you a little more color on each of our China brands, KFC continues to lead the western QSR category with nearly 2,600 units today, and impressive average unit volumes of $1.4 million, which is even more impressive given the fact that the average ticket of about $4 in China is less then half that of the US level.
We are clearly appealing to the mainstream masses in China. We continue to leverage our new incremental sales layers at KFC including breakfast, delivery, and multiple proteins. Importantly, we continue to generate high returns on our KFC new unit development with cash-on-cash paybacks of just over two years.
Pizza Hut Casual Dining continues to be the leader in the western casual dining category with 429 units in 107 cities and our closest competitors have less then 30 units. Pizza Hut is dialing up the dining experience through a broader menu including new entrees with beef, chicken, and shrimp, along with more and more beverages and desserts and our Chinese customers are loving the new Pizza Hut.
We are also building new units in more tier 3 cities. And as I said we continue to invest behind the development of our emerging brands. Pizza Hut Home Service, a new category that we are building, continues to grow and we expect will add over 20 new units this year and add four new cities to our fold.
With [east dawning] our Chinese fast food brand we have plans to open about 10 units this year as we develop the operating platform for large scale and get our unit level economics to where they need to be. In March we also announced a new investment in Little Sheep, the leading chain in China’s large high growth hot pot restaurant category. The hot pot category is a new category for us and generates an estimated nearly $1 billion of sales in China.
Little Sheep has seen impressive growth since it first opened its doors nine years ago and now has 375 units and a proven management team that will continue to be solely accountable for running the day-to-day operations.
In addition to our portfolio of leading brands, we believe we have key long-term strategic advantages in Mainland China. First, an unmatched development team which we know is the largest on the ground in Mainland China. Importantly this team has the knowhow around development in over 550 cities. We are literally across the country in China and establishing scale everywhere.
Second we have an unparalleled distribution system which has the capability to bring food and supplies to all these areas of this very large geography that Mainland China represents.
Third we have developed targeted management manufacturing facilities for specific products we serve such as our proprietary egg tart dessert which is a significant part of our KFC menu mix now. And finally we have a strong and very tenured executive management team and a tremendous bench of RGMs that are ready to open new units.
This operating capability gives us the ability to open up great restaurants with great returns and give our customers a great experience. We believe when you combine these strategic advantages with the strength of our leading brands and the high returns that we have, we are able to have big growth opportunities ahead of us in China for the long-term.
There is no question clearly that Yum! is doing its part to stimulate the Chinese economy. Over the next three years we plan to invest over $1 billion in new capital in Mainland China, build 1,500 new restaurants, and add over 75,000 new jobs to the economy.
China continues to be the largest restaurant opportunity of the 21st century and is clearly a place that we plan on doing business for a long, long, long time.
Now, on the Yum! Restaurants International, which represents the balance of our international operations, where our strategy is to drive aggressive expansion and build strong brands everywhere. Here I would like to acknowledge that more then 700 franchisees around the world which are opening over 95% of our new units and keeping this business on track for profitable growth.
For the first quarter system sales grew 10% prior to foreign currency translation including same store sales growth of 6% and development of 145 new restaurants in more then 45 countries. Operating profit growth was 4% excluding foreign currency translation and was lower then our sales growth as expected, primarily due to the lap of a lost tax benefit in Mexico. I’ll let Richard Carucci, our CFO, give you more details with his comments.
The best news for this division, was in addition to the strong new unit opening was the strong performance in YRI’s two largest KFC company markets; the UK and Australia, along with our franchise in Japan. These more mature businesses generated solid same store sales growth in the first quarter and showed the resilience of the KFC brand when we’re well operated even in a tough economic environment.
In our Yum! Restaurants International emerging markets I want to highlight the great progress our team is making in India where our KFC same store sales growth was better then 30% for the first quarter and margins substantially improved versus year ago. We are absolutely confident we are well on our way to developing proven unit economics and that will allow us to reach a scalable business model for KFC. We are also very excited about introducing Taco Bell into India later this year.
Finally Yum! Restaurants International is in the process of rolling out KFC’s biggest global initiative to build an incremental new sales layer around its new Crushers beverage line. Crushers was launched first in Australia last year and we’re expanding Crushers to more countries and more stores this year and expect them to be in about one-third of our YRI KFC system by year end.
Crushers is successfully bringing KFC a new base of products that will allow us to begin building a full line of contemporary beverages that can be enjoyed as snacks and desserts.
At Pizza Hut we are expanding value options at Yum! Restaurants International, enhancing our dining menus and varieties, and which includes the expansion of [inaudible]. Longer-term we believe that Yum! Restaurants International is the division with the greatest potential given the five billion people. We’d like them to spend a billion dollars per person, but five billion people in the over 100 countries represented, where we have only three restaurants per million people compared to 60 restaurants per million in the US.
The strength of our over 700 franchise partners and their commitment to building new units should make this our largest division one day. In fact our team is working on both goals to make YRI a $1 billion profit division in the future.
Next, let’s talk about our US business where our strategy is to dramatically improve our brand positions, consistency of performance, and returns. Here I’m proud of the profit growth our teams are generating and the long-term brand building we are doing even though we have mixed results on sales.
Our first quarter sales in the US were lower then expected, the same store sales declined 2% due to weakness at KFC and Pizza Hut. Importantly our margins were up due to higher guest checks and moderating commodity inflation along with productivity measures taken in the restaurants.
We also began to see the benefit of actions we took in late 2008 to reduce our US cost structure. Overall we were able to generate operating profit growth of 7%. Taco Bell continues to perform well in this environment even though it faces more pressure as more and more QSR sandwich chains offer $0.99 value menus.
You will see new Frutista frozen flavors and continued innovation around our why pay more value platform. The brand continues to be well positioned for a successful 2009 after a solid first quarter. And remember Taco Bell generates 605 of our US profits.
Pizza Hut performance was impacted by declining dinner sales across the industry as more consumers chose to cook at home. We expect the next couple of quarters to be challenging for Pizza Hut in the US as the consumer continues to be under pressure and in part due to the lap of the strong results of Pizza Hut generated last year.
Value continues to play an important role with our customers and is a challenge for us and so we’re currently promoting our Panormous Pizza for $10. While we are slugging it out on sales, we are making strategic investments this year to more firmly entrench our Tuscany Pasta sales layer and nationally launch our Wing Street line of flavored chicken wings.
We are convinced an arsenal of pizza, pasta, and chicken will allow us to leverage our assets more fully throughout the week which we believe is critical to Pizza Hut’s long-term success. The Tuscany Pasta sales layer continues to contribute a healthy mix of sales particularly in the early part of week and benefited from the added variety of lasagna.
On the chicken front, Wing Street continues to grow with about 150 new units this quarter and we will be on air with television in the fourth quarter with advertising where we’ll be talking about the great opportunity for even more variety people can enjoy with Pizza Hut.
There’s no question we will go into 2010 a stronger and more vibrant brand with better capability to leverage our delivery business and assets.
On to KFC where there’s no question we underperformed this quarter and we were also impacted by weak dinner sales. Our big new initiative however is to build a new sales layer at KFC and that’s with Kentucky Grilled Chicken, which was launched here in the United States. As the brand’s most successfully tested product, Kentucky Grilled Chicken offers consumers a new way to enjoy the great taste of KFC and will broaden the appeal of the brand.
I want to comment Roger Eaton and the team for the absolutely great job they have done in rallying the system around the KFC’s biggest launch of this new product. We really encourage you to come and try the unfried side of KFC and we hope you enjoy this product as much as our customers tell us they do. Its absolutely a terrific, terrific product and we’re very, very proud of it.
So let me wrap up and put the total Yum! Brands experience into perspective and tell you how I think you should look at Yum! Brands’ performance. We have clearly gotten off to a better then expected start this year, but realize its early and there is a lot of hard work yet to do. So don’t get ahead of us either for the second quarter or for the full year.
However, I can confidently tell you that we plan to do what it takes to continue our track record of meeting our target of 10% earnings per share growth this year. Now let me turn it over to Richard to give you the financial update.
Thank you David, and good morning everyone. In this section of the call I’m going to comment on three areas; our first quarter results, our outlook for the second quarter, and our approach for managing our business during the balance of 2009.
As David mentioned first quarter results came in better then anticipated as we delivered EPS growth of 14% excluding special items. The upside versus expectation was driven primarily by strong profit performance in China, strong margins in the US, and a favorable tax rate for the quarter.
Please note that reported EPS declined in the first quarter. This was driven by the sale of our minority interest in KFC Japan in the first quarter of 2008, which resulted in a $0.13 per share gain. As we have stated previously EPS excluding special items is more indicative of the performance of our ongoing business.
Now let’s dig into the first quarter results and let’s start with China, China division system sales grew 12% excluding foreign currency. We were pleased that division operating profit grew at a healthy 21% excluding forex. As David mentioned this is on top of operating profit growth excluding forex in 2008 of 23%.
The strong profit performance was fueled by new restaurant development and strong margins versus prior year. In the first quarter we opened a record 98 new restaurants in Mainland China. New units continue to meet our high expectations with projected return on investment of about 30%. This is an all-in return taking into consideration estimated sales transfer of nearby stores and an allocation of corporate G&A.
Trust me, as long as we continue to expect this type of return we will continue to rapidly expand in China.
Restaurant margins were 23% in the first quarter or 1.7 points above prior year. This increase in margin was primarily driven by 2008 pricing actions and moderating commodity inflation. You may recall that throughout 2008 margins were negatively impacted by significant commodity inflation partially offset by pricing.
It is nice to see the commodity environment move in a more favorable direction. In fact, we now expect $50 million of commodity deflation in China for the full year after the first quarter that saw commodity inflation of $3 million. Now let’s move to Yum! Restaurants International.
Top line growth remained robust as system sales growth prior to forex translation was 10% and was driven by same store sales growth of 6% and net unit development of plus 5%. Importantly our franchisees continue to lead this growth as they opened 97% of our first quarter new restaurants.
As expected YRI margins were down one point, primarily due to the loss of our exemption of the Mexican value added tax, or VAT, as well as commodity inflation. Since we lost this VAT exemption in the first quarter of 2008, VAT will not impact our results for the remainder of this year.
YRI completed the first quarter on target by growing operating profit 4% excluding foreign currency translation and continued to achieve balanced growth driven by our outstanding franchise partners. However, forex is having a major impact on this business, dampening first quarter profits by $21 million and resulting in lower dollar profits in 2009 then 2008.
In the United States same store sales decline of 2% came in below expectations due to declines of 3% of Pizza Hut and 7% at KFC partially offset by same store sales growth of 2% at Taco Bell. Despite these negative US sales, we saw a first quarter US margins grow 80 basis points. We are seeing an improved commodity environment in the US. In the first quarter we saw commodity inflation of $9 million which was below our expectations.
For the balance of 2009 we currently expect to see modest commodity deflation. US profitability in 2009 will benefit from the restructuring which was completed in late 2008 and early 2009. The $20 million in G&A savings in the first quarter was slightly ahead of schedule mainly due to project timing.
We continue to anticipate $50 million in cost savings for the full year. We are quite proud of the efforts of our US teams to achieve these productivity improvements. This blend of restaurant margin improvement and G&A reductions led to operating profit growth of 7% in the US in the first quarter.
Our full year 2009 profit plans has always been backend loaded so we are quite satisfied with our first quarter profit performance. While we are planning for a weak consumer atmosphere to persist we are excited by the recent launch of Kentucky Grilled Chicken. This thoroughly tested product has demonstrated the ability to bring in new customers to our restaurants and successfully broaden the appeal of the KFC brand.
Prior to closing the books on the US I would like to briefly mention that our refranchising program has continued to progress forward. Although tight credit markets continue to slow certain transactions, we refranchised over 100 restaurants in the first quarter, predominantly Pizza Huts, and we are on pace to achieve our full year target of 500 refranchised units.
When you pull it all together it is great to see each of our divisions achieve profit growth prior to forex translation in this challenging environment.
The EPS growth of 14% before special items also benefited from the significantly lower tax rate and few average diluted shares outstanding. All in all, we were quite pleased with our first quarter results.
Now let’s look forward to the second quarter, we continue to expect the first half of Yum!’s year to be more difficult then the second half. We expect that the second quarter will likely mark the low point of the year. This is due to a number of factors that include: lapping the all time low tax rate of 14.8% last year, continued negative impact from foreign currency of nearly $25 million on YRI’s operating profit, lapping over $10 million in property sales gains and lease terminations as well as the potential increase in impairment charges, an extremely tough lap in Mainland China.
Let’s remember that during 2008 the same store sales comparisons in Mainland China were plus 125 in Q1, plus 14% in Q2, plus 5% in Q3 and plus 1% in Q4. The difficulty of the second quarter lap is typified by last year’s March amazing same store sales growth of 28% for KFC. In 2009 March same store sales growth was negative as we lapped this incredible performance.
The lap eased considerably to single-digit growth by the end of the second quarter. While we will likely see negative overall same store sales in the second quarter in China, we have already begun to see improvement in current trends.
After what we expect will be a challenging second quarter we’ll be roughly where we expected to be when we started the year, poised for a solid second half due to some easier expected overlaps. In particular we are overlapping significantly easier sales numbers for our China business as I just outlined.
We expect to experience favorable year over year commodity cost upsides. The introduction of Kentucky Grilled Chicken, which combined with other initiatives should generate better US sales results. We expect the negative impact of forex to moderate during the year especially in the fourth quarter. While we have talked about the numbers it may be useful to review how we are approaching the way we are managing the business during this year.
First of all, we are living in a difficult environment to make forecasts. As you all know over the past year we have seen huge volatility in the stock market and in commodity markets. In our restaurant world it is harder then normal to predict how sales and costs will play out the remaining part of this year.
We are focused on continuing our streak of consecutive years of double-digit EPS growth. I am very proud of how Yum! managed its costs in the first quarter and will continue to run our business assuming that it will be a difficult economic environment.
In the slug-it-out environment that David talked about, we have every expectation our people will meet their cost targets in areas that they can control. We will not however sacrifice our long-term growth. We recognize that one of the things that makes Yum! special is our global growth. As we have stated before, we believe we have a very long runway for this growth.
Therefore we will continue to make investments. As an example, we continue to build new [east dining] units in China and new Taco Bell units in YRI even though we recognize that these brands will probably not contribute significantly to Yum!’s overall profits for the next 10 years.
The first quarter announcement of a 20% stake in a China hot pot concept is another indication of our long-term approach to growth and investment. We remain very confident of our growth strategies. We believe we are making strong progress in developing sales layers. We remain the largest retail developer outside the US and we are strengthening our brands around the globe.
I believe we are doing this in a way that is both consistent with our people-oriented culture and is very mindful of our responsibility to add shareholder value. I am confident that we will end 2009 with an even stronger and better positioned company.
Now let’s open it up for questions.
(Operator Instructions) Your first question comes from the line of David Palmer - UBS
David Palmer - UBS
Question for you in terms of the US business particularly those dinner oriented concepts, it seems like the high price point items these days, even when they are appropriate for a family party, are just turning out to be a very difficult sale, they’re perhaps doing worse then you would have gotten in a test result even when that test was as recent as 2008. For instance you rolled out lasagna this quarter, I’m wondering how much that puts at risk this grilled chicken rollout that would of course be that same sort of target, multiple party family group that’s been so under pressure, how you’re thinking about how in general you’ll position stuff for the family better to make it work.
I think you know, whenever you have a marketing opportunity that’s big, its usually when you’ve solved the biggest problem that occurs most frequently. And the biggest problem that occurs most frequently for KFC is that people are looking for a non-fried option. So this is a quantum problem that we’ve got a great solution for.
So we think that this brand, this product will hold up well in this environment. The other thing is the team has done a very good job to think about the challenge of dinner and if you’ll notice we’re currently launching Kentucky Grilled Chicken with a two piece complete meal offering for $3.99, and people believe this to be a tremendously good value at the low end so we’ve got a strong low end value.
The other thing is is that we’ve got breakthrough bucket promotions scheduled because now we give the consumer the choice of both fried and grilled products. And the other thing that we’ve done is that we’ve significantly improved the quality of our advertising versus test. We’re basically asking people to unthink KFC. You think of us primarily as fried chicken, well we’re not only fried chicken, that great fried chicken you love, but we now have unfried chicken as well.
And we’re challenging America to taste the unfried side of KFC. So, we’ve got a, the team has done rallies all around the United States. Our team members are very excited about this product. They’ve all tried the product. Our customer compliments are coming in at higher levels then any that we’ve had for any product. So we’re very excited about this. Its early in the launch but we think that this brand or sub brand of KFC, Kentucky Grilled Chicken, will hold up well in this pretty challenging environment for dinner as you pointed out.
David Palmer - UBS
One quick question, with regard to China, are you seeing two year trends stable or improving in a way that makes you feel pretty confident that the comparisons will bear out and that you’re going to get back to positive territory maybe within this second quarter for China, any color there would be great.
Well we expect them, again, what happened in the second quarter as we mentioned, it was a very high overlap in total, plus 14%. But we had almost unprecedented levels month to month, which we had plus 28% in March as we said. It actually drops to plus 85 in May on the KFC side. So over the quarter we probably expect to see similar types of two year growth, but we’re going to see different types of results month to month just because of the unusual 2008 overlaps.
Your next question comes from the line of Jeff Omohundro - Wachovia
Jeff Omohundro - Wachovia
Another question on China, I wonder if you could just give us a little bit of a broader update on the consumer environment there, your sales building initiatives, and how you’re sustaining your average check in that market.
We really haven’t changed our approach that much in China. One thing to keep in mind is just the impact that we had on pricing and inflation last year. We had very large commodity inflation on chicken that started in late 2007 that went throughout last year. That sort of forced us almost to take pricing throughout the year, and always chasing that piece. So the impact that pricing had actually moderate throughout the year because we start to unravel, unwind from those price increases that we took in 2008.
But basically the trends that are different in China really the stuff that David talked about in his speech, we continue to build sales layers in breakfast, delivery, and more proteins and that’s the direction we keep going in China as we continue to broaden our menu and broaden our appeal.
Your next question comes from the line of Jason West - Deutsche Bank
Jason West - Deutsche Bank
Just wanted to touch a little bit on the margin improvement globally and particularly in the US, I guess I was a little surprised by the strength of the margin rebound particularly with the negative trends, comp trends in the US, and you touched on some productivity initiatives there. If you just get into a little more detail on what drove the margin improvement and sort of what kind of things you’re doing in the first quarter that you weren’t doing the last few years.
We’ve been working hard, so one of the things that didn’t happen, which I mentioned earlier, where we did benefit from commodities and the relationship between commodities and pricing. But we’ve been working hard on the little things so its sort of the day in and day out pieces but you probably also saw some improvement in the labor line and as an example of that, at Taco Bell had a get ready in the morning program that simplified the start up of their operation which allowed them to take labor out.
And all the brands are doing sort of their versions of that and so what usually happens with stuff, it’s a bunch of little stuff but I think part of it is we sort of knew coming into the year we were going to have to be very focused on the cost side and we got the benefit of not having to chase the price in commodity piece so now you’re seeing that flow all the way through.
Jason West - Deutsche Bank
And I guess it looks like your outlook is a little on the conservative side, I mean if you carry through this kind of margin improvement for the rest of the year, or was there certain things in the quarter that will be difficult to sustain, maybe with pricing rolling off or something like that. I’m just trying to understand how to think about the rest of the year on the margin side.
Well as I sort of said, its really hard to predict what the sales and commodity impact will be exactly so we gave you our best expectations of that in the call. We’re going to keep working on those other little things. So I don’t know if we’ll always get as big an impact we had on the labor side. On the flipside of that though I expect during the year we may benefit a little bit more on some leases because we are obviously pushing back on lease costs and we probably will get some benefits of that later part of the year.
So its, I’m hoping that we continue to get these types of productivity initiatives throughout the year but we’ll see how it plays out.
Your next question comes from the line of Thomas Forte – Telsey Advisory Group
Thomas Forte – Telsey Advisory Group
I was hoping you could give us an update on [for] Pizza Hut in the US and for Kentucky Fried Chicken, what percentage of their sales are from the dinner day part and then when we think about in the US, the monthly comp trends, was there a significant difference between January, February, and March.
I think you’re looking at the percent of the dinner day part for KFC I think is around the 65% range, 60% to 65% range and I think it would be the same for Pizza Hut in the dine in business but its obviously much higher in the delivery/carry out only business.
Thomas Forte – Telsey Advisory Group
And then one quick follow-up, how would you characterize the performance at KFC since the rollout of the value menu.
I think we improved our transactions but we didn’t get the overall sales lift that we would like to have had because the dinner day part has been so soft for us. So, we’re very excited about the new chapter that is just beginning this week and we expect it to pay off for us.
I’m hopeful that the combination of the grilled and the value will play off each other, in other words, grilled gets some new customers to the restaurants. When they come there they see that we also have the value menu so I’m hoping that that interaction works well throughout the balance of the year.
I think just to put what we’re doing in the US into perspective, I’m actually very pleased with the direction that we’re heading at all of our brands, as challenging as this time is and this year is. But you know, KFC for the first time, we now have a national value menu and hats off to Roger Eaton and the team for being able to get the franchisees on board on that and the franchisees are very excited about the direction of the company.
We now have a very valid non-fried product that we’re extremely proud of so the two biggest issues we had at KFC, which is value and the need for a non-fried option, we’ve at least got something on the table that we can build from as we go forward. So there’s no doubt in my mind that we have positioned our back of the house capability with the addition of ovens. The focus that we put on operations at KFC, the team has been just relentless at getting our stores clean, getting our staffing right, getting ready for this launch.
So, and while we’re not perfect, we’re definitely moving in the right direction from an operating standpoint and I think we’re doing the right things to get KFC set up for more growth in the future. Pizza Hut which is also being hit by the dinner issue that we’ve talked about, strategically we are right on the money with what we’re doing. We are continuing to [fortify] our pizza position by improving our product quality with the improved ingredients.
We’ve launched a tremendous value initiatives with Pizza Mia and Panormous, but more importantly we’re broadening our menu to include both pasta and chicken. We’ll be launching Wing Street nationally with national advertising in the fourth quarter of this year. And there’s no doubt that as we go forward that pizza plus pasta plus chicken is going to give us a greater opportunity to leverage our assets throughout the week and we’re also working on lower priced items that will help us get into the lunch/snacking day part as we go forward.
So the team is very focused on leveraging the assets that we have which is a huge advantage that we have and moving away from just being a Friday, Saturday, Sunday business. So that’s, there’s no doubt that strategically we’re doing the right stuff there. I think the biggest challenge we have at Pizza Hut is we’ve got to communicate it.
When you stand for pizza for 50 years, and that’s what you are, its hard to overnight get credit for having phenomenal pastas, which we have and by the way the customers tell us they want this, okay, and its hard to get credit for having chicken. And its going to take time for us to communicate this and what we’re really pushing for as a team is more provocatively communicating the tremendous transformation that’s going on at Pizza Hut.
And I’m confident that the team will do that over time. Taco Bell, which is 60% of our profits in the US, is having a very solid year and we expect it to have a very solid year. We continue to add to the quality of the menu. We continue to fortify, about our why pay more value proposition. You’ll be seeing some great chicken products that will be introduced in that as we go forward. And we’re making our beverage line, Frutista, even more and more appealing as we think about how we leverage that equipment.
And we’re also testing some stuff to really leverage our assets even further. Everything from breakfast to dinner meals, a lot of things are going on. So strategically, I am absolutely convinced that we’re doing the right stuff in the US and there is no doubt in my mind that we’re going to get through this year and be stronger and better as we go into 2010.
So this is a slug-it-out year clearly. We’re not happy with what’s going on with our dinner business which is Pizza Hut and KFC primarily, but I am very happy with the actions that we’re taking to build these brands, make them more broadly appealing as we go into the future which is really the must have that we’ve got to have in the US.
Your next question comes from the line of John Glass – Morgan Stanley
John Glass – Morgan Stanley
A couple of questions, this thing first with the US and your comments on Taco Bell, it does seem as if the brand has slowed sequentially, I think there was high single-digit comps in the back half of last year and I don’t know what the year over year comparison was, but maybe if you could indicate what that was and if that was one of the issues, and also are you beginning to lap value or is it a competitive issue, why did you see that sequential slowdown at Taco Bell.
I think we have always seen at Taco Bell, when everybody gets in the $0.99 value game which everybody’s doing, and gets into that game, that has some impact on Taco Bell’s business. We’re number one in value. We have built that value. The consumer tells us we’re number one in value and so no one is better positioned then Taco Bell is from the value front.
But make no mistake about it, there isn’t anybody in the industry that isn’t doing some sort of value menu today and trying to get into that $0.99 or lower game. So that clearly takes some of the fun out of your business, even though you’re as strong as can be. And I think that’s exactly what’s happening with Taco Bell right now. We have a very strong platform, the number one platform in value in the category which is allowing us to get positive same store sales growth and we’ve got the why pay more menu that we are going to be bringing news to as we go forward.
But this is, I characterize this as a slug-it-out year. This is, you’ve just got to take the gloves off, slug it out, take on competition, keep building your brands, and be strong as hell as you go into 2010. And I’m very confident that Taco Bell is doing the right stuff there, but there’s no doubt that we’ve got a lot of competition that’s getting into our arena that wasn’t there before.
Just from a numbers standpoint, you’re right, last year throughout most of the year we were running about 8% same store sales growth. That was due in part for our, we were overlapping problems from the previous year. Going into the year we didn’t expect to have that kind of growth rate. Its probably a little lower then what we would like it to be for the reasons David just talked about.
John Glass – Morgan Stanley
And then on China, I appreciate your comments on pricing and how that’s helped margins, your labor line though was, dollars grew at a lesser rate then your units even, so have you been doing something in the restaurants in China to adjust labor as you’ve seen sales that were softer year on year and then also in answering that you talked about commodity deflation of $50 million, what was your initial expectation for commodity dollar impact.
The margin piece first, on the labor side, the thing that we have done is we’ve reduced the number of managers in the restaurants, in some of the lower volume restaurants and that was sort of a planned initiative that started towards the back end of the year.
I believe we thought that commodities would be about flat when we started the year and so we went from flat to an estimate of minus 50. Obviously what I said about being hard to forecast in this environment is true, but the leading reasons for that decline, really the biggest one is chicken. We sort of documented chicken stuff in the past and the second is oil. So those are what’s driving the $50 million difference.
Your next question comes from the line of Greg Badishkanian - Citi
Greg Badishkanian - Citi
Just two questions, first on China, beside the difficult comparison in March, have you noticed any difference in consumer trends, are they trading down or is there anything that you’re seeing there.
We haven’t seen a lot, starting towards the end of last year what we saw a little bit on the trade down side was little lower incidents on drinks. And since then we really haven’t seen anything significant.
Greg Badishkanian - Citi
And April I’m assuming picked up a little bit because compares are a little bit easier.
We expect again, as we sort of said we weakened in March because we were overlapping the 28, April is still a fairly tough overlap and then it gets to I think it was about 20 for KFC and it gets to plus 8 in May, so its in May when we’ll start we think to see an improvement in the trends.
You’ve got 28%, 20%, and 8%.
That’s for KFC.
That’s for KFC which is obviously the mother load in China so, we’re overlapping phenomenal performance.
Greg Badishkanian - Citi
Good performance last year, absolutely. And on the US side, turnaround with KFC grilled chicken, have you gotten some early indications from franchisees and customers in the test markets, based on all of that would you expect, how much type of pick up would you expect once consumers become aware of that new product.
The only thing I can say is that we’ve got the highest compliments that we’ve ever received at KFC on any new product. People are literally calling in and saying we love this product and thank you very much for bringing into our menu. Look, we just started the advertising so I mean I, its very early days but we are very confident that it will improve trends based on the previous tests that we’ve done and we’re even more confident that the KFC brand is going to be a lot better because of it and it gives us a lot more opportunity as we move ahead.
And remember there’s no, actually the margins were better on Kentucky Grilled Chicken then it is from on our fried product. So there’s every incentive in the world to sell people a lot of grilled chicken which is something that we haven’t had in previous efforts.
Your next question comes from the line of Joe Buckley - Banc of America
Joe Buckley - Banc of America
Couple of questions on China as well, first just a clarification on that monthly trend and this may not be the way to look at it but help me here, if I add up 28, 20, and eight and divide by three I get 18 to 19% same store sales growth for the second quarter, I realize those are the KFC numbers but am I thinking about that the right way. Is that the KFC compare?
That is the KFC compare only, that excludes Pizza Hut. Pizza Hut did not have the same significantly strong numbers.
Again Pizza Hut last year we had [added] a lot of units so they had very modest same store sales during that period.
Joe Buckley - Banc of America
The macro news out of China seems like its getting better the last several weeks and again I’m kind of curious what you’re seeing there and your check was up in the quarter, do you feel compelled to do discounting, are you moving in that direction, or just kind of what you’re hearing from Sam’s team over there in terms of their read on the economy and the consumer.
Well I think its definitely a more challenged consumer, you know you guys read everything that we read, what’s going on, the GDP I think last was reported at 6.1%. Most economists are saying that you’re going to have a stronger second half. Retail sales were up 15%. Disposable income up 10%. These are the things that everybody is basically reading and are aware of.
Listen, what we do at KFC and Pizza Hut and what we’ve been doing in China is building great brands and the great thing is is that we started these brands from scratch and they’re like diamonds, and we just keep polishing the diamond and what I love about what the team is doing is we’re just trying to be more proactive and being ahead of the consumer.
We’ve got shrimp and beef now that we didn’t have last year. We’re delivering KFC chicken. We didn’t deliver KFC chicken so that’s going to be getting us into the dinner day part, get us into more office business, get us into more convenience. We’re broadening the appeal of the brand. We now have breakfast in 91% of our stores. Its still less then 10% of our mix. We know what the kind of breakfast that McDonald’s has built over time.
Well, we’re building that breakfast and so that gives us lots of upside as we go in the future. So I think what the team has been very focused on is not over reacting to short-term issues and making sure that we build the overall value of our brand by giving the consumer lots of innovation. Our strategy at KFC has been innovation. And I’ve heard some people talk about, well our street vendor has taken business away, well street vendors have been around since the Ming Dynasty.
And we got, we don’t have any issues with street vendors. What we have issue, that’s making sure that we just keep making our brand stronger. If you look at Pizza Hut in China, what we’ve just done at Pizza Hut is we’ve added tremendous variety, beef proteins, more fish, rice dishes, more beverages, more desserts, we’re trying to make sure that we get even better at delivering five star quality at a three star price. That’s what the big brand positioning is there.
And the team has been very proactive because we don’t want any casual dining competitor come into China and have more of a better casual dining offer then us. And one of the things that we’ve learned in other parts of the world, is that we hung in with just pizza for way too long and so the team has been very proactive to learn from the past on Pizza Hut and making sure that we really drive the heck out of the Pizza Hut business by broadening beyond pizza earlier in our lifecycle.
So it’s a very proactive move. And then I think we’re taking on pizza at home service. We’ve got one number national call system. That category is coming. So I think the big message I’d like our investors to know about China is that we’re great at brand building in China and I think that what I commend the team on doing is being proactive at building the brand and broadening the appeal of the menu.
Our value bases, the surveys that we do, is very, very competitive and we don’t think we’re really taking a backseat to anybody on the value front. And at the same time we’re obviously opening up the new units which I think, as Richard pointed out, we got two year cash on cash paybacks, you got 30% returns including cannibalization. And it’s a pretty nice formula over there which we don’t take for granted and I think the only thing we can do to screw it up is to not keep building the brand.
That’s what the team is really, really focused on.
If I just had to categorize what we’ve felt from an economic standpoint, I won’t go all the way back to the Ming Dynasty, but just in the last year, is that we felt the earthquake last May so we were flying, you sort of, you heard about the numbers that we gave you on the same store sales during the second quarter.
And then we felt again towards the end of the year, when you had the whole news from the US etc. where the China consumer got a bit more conservative. We haven’t seen a lot of huge swings after that time up or down. It was never as bad as what people were saying it was going to be in my judgment and I haven’t seen any huge swings the last few months either. So I’d say those have been the two events that we sort of felt.
Just to give you a little bit more color like in KFC, we’re in 25 markets right now with delivery. We’ll be going to 60 as we move into the year. We’ve got new products coming in at breakfast, our Szechuan beef wrap is now being marketed more aggressively. These are all things, some are beverages. We also introduce new summer beverages, that’s coming.
So, there’s a good lineup of activity as we go forward, let’s not call it activity, how about action.
Joe Buckley - Banc of America
The Taco Bell slowdown, I realize you got a national footprint but I think you [skewed] at California and I guess I’m curious if California is an issue behind that Taco Bell comp slowdown.
I wouldn’t lay it there, we’ve had the same types of trends that other companies have had. The states have been tough, have the ones that have been tough in housing and the overall economy, places like California, Florida, Las Vegas, but I don’t think its that big a part of our, of the slowdown.
Joe Buckley - Banc of America
Last question, the guidance left out those two words, at least, that we’ve become accustomed to hearing and given the big first quarter bead I guess I’m curious why.
Well I’ll tell you, I’ll answer that, first of all in the fourth quarter we said we were going to do 10% and everybody thought we were being way too optimistic. So if people said you get 10%, my God that would make you one of the few great companies in this kind of year. So, 10%, we’ll do 10%. Of course, if we can beat 10%, we’ll beat 10% but we just thought it was a great way to take some of the feedback that maybe we were a little too optimistic in the year.
Your next question comes from the line of Steven Kron - Goldman Sachs
Steven Kron - Goldman Sachs
In the US, just going back to Taco Bell for a second, obviously seems as though there’s some incremental competition there as everybody is going towards this $1.00 or $0.99 menu. Given that its 60% of your profitability can you just talk us through a little bit of how the profitability of that brand is holding up with 2% same store sales and I guess related to that, if I back out a big part of the year in the US as the G&A cost saves, if I back out the $20 million that you reported, I think the core business profitability was down 6%. I think your target is for that to be 6% growth in the year excluding the cost saves, so can you just walk us through kind of what needs to happen from the comp line to get to your goals.
Well in terms of Taco Bell on the profitability side, Taco Bell, we’re not going to breakdown brand by brand on profits, but Taco Bell because they have the best sales outperformed out total US business and I mentioned on the margin initiatives, the one that I did mention was that Taco Bell initiative in terms of having the morning startup being more efficient.
So we’re very pleased with the work that’s being done there.
Steven Kron - Goldman Sachs
And as far as kind of the second piece to that, the down 6% profit excluding the G&A going to plus 6% for the year.
Keep in mind the margins were up almost two points so it was more then just G&A. The only thing is keep in mind KFC and Pizza Hut comps were negative. We expect as the year progresses, I think we mentioned it earlier in the call, that we expect especially the second half performance led by the two that were down, KFC, the grilled chicken launch, we expect some benefits from that.
And we always expected the second half to be stronger. That was what we said even back in December. Its always going to be a tough first half.
Steven Kron - Goldman Sachs
On the Kentucky Grilled Chicken launch, as far as year over year comparability on media impressions, is that significantly higher or are we thinking is that ultimately it’s the same amount of money being spent, its just on a new platform.
I think we’ve put a lot up against this, but its I think basically within the same budget that we had last year. There isn’t any incremental spending behind it. One thing I would point out to you though is that one of the marketing things that we will be doing on Monday, April 27 is that we’ll be making that on Friday and we’re going to be offering a free piece of chicken at every KFC, all day, any time the restaurant is open.
So, we’re going to be encouraging all America to come in and try Kentucky Grilled Chicken and get a piece of it and enjoy it. We think it’s a product that if we can get it in people’s mouths, are going to come back and eat it again and again, because it stands up to our, the quality of our original recipe. And so, the key here is to getting [trial] and that’s what we’ll be doing.
But we are not making a significant incremental investment from an overall media perspective behind Kentucky Grilled Chicken.
Steven Kron - Goldman Sachs
Sticking with the US, talking about the dinner day part at Pizza Hut and KFC, you kind of attributed what you think is the competitive move of consumers moving back to the maybe at home consumption I believe, to what extent do you think some of these casual diners which seem to be moving their menu price points down and that seems to be intensifying further, how much of that could be playing a role because it doesn’t look like its going to get much easier.
We haven’t quantified that. Really couldn’t quantify that right now. I always say this, when anytime anybody starts getting in your arena, it takes the fun out of your business. So I don’t think anybody is walking around saying, this is a really fun year. I don’t care who you’re talking to, because everybody is very, everybody is striving to get those sales dollars out there.
Having said that, there’s nothing like having great powerful brands and there’s two things that drive your business in any kind of situation like this. We’ve done all kinds, we’ve looked at every economy and all the history, the brands that are offering great innovation and offering good relative value, they can do well in these times. And I’m very proud of the performance of Taco Bell. Taco Bell improved their margins. Taco Bell had positive same store sales growth overlapping 9% growth last year. So I think Taco Bell had a pretty damn good quarter and we think that Taco Bell is going to have a very good year.
KFC and Pizza Hut have not had enough true innovation or enough value to separate themselves from the rest of the pack and as I’ve said before that’s when you’re results languish. And I think KFC’s challenge is to make sure we launch Kentucky Grilled Chicken well and get trial of that product and I think the numbers will reverse in spite of the fact that people are eating or cooking more at home.
I think if we do the job and do it well and this product is as good as we think it is, we’ll be able to report some good results and that’s what our intent. I think our challenge at Pizza Hut is that our product innovation is a lot better then our marketing because we’re not getting enough credit for the fact that we got unbelievable pastas, at incredible value, and our pizzas are in the same vein. So we’ve got to really start marketing the transformation that’s going on there so the consumer really gets it.
Because right now, I think where we stand primarily for pizza versus pizza and the pastas that we have and then we’ve got to build awareness of Wing Street in the fourth quarter when we launch that brand with national advertising which I think because it is real innovation and it will see positive results from that.
So we don’t really have a lot of stories to tell around here. The bottom line, this is like what are we doing, okay, to win in the marketplace and I think we did enough to win with Taco Bell in the first quarter and not enough at KFC and Pizza Hut in the first quarter and hopefully we’ll be able to make more progress as we move through the year.
Your next question comes from the line of Jeffrey Bernstein - Barclays Capital
Jeffrey Bernstein - Barclays Capital
A couple of questions as we kind of think about you mentioned the back half of the year presumably getting better, being more second half weighted, if it was necessary that you needed more levers to pull to drive the 10% loss EPS growth, just wondering whether you see the G&A opportunity as potentially more meaningful. It seems like you kept the $60 million, you achieved 20 sooner then you thought, whether there’s upside there or whether you’d reconsider share repurchase as we move half way through the year with cash accumulating, I’m just wondering what are the potential levers you might have there.
Well we’re not planning any other major actions at this time so I think it’s the actions we’ve taken will be where we’re at. I think $60 million is still a pretty good number. What I said before though is we each have our budgets, given that we’ve sort of said it’s a slug-it-out year, I don’t think anyone’s going to miss their numbers. So if anything, there may be some small upsides to that number, but I wouldn’t assume anything significant.
On commodity inflation, we did have some, keep in mind from a US perspective we had I think about $8 million of inflation in Q1 in the US and we’ll probably have just a little bit in Q2 and then in Q3 and Q4, the back half is definitely deflation. So even though you had a pretty significant benefit in Q1, there is still a pretty good swing from first half to second half in that category as well.
Jeffrey Bernstein - Barclays Capital
So the US cost of goods that already over 100 basis points of favorability this quarter would only seem to accelerate in terms of additional favorability the rest of the year.
Just in terms of commodity inflation the best year over year will probably be Q3. So you have a little bit of inflation this quarter, a little bit less next quarter but still some inflation and then the back half will be all deflation. So there will still be continuing benefits.
Jeffrey Bernstein - Barclays Capital
And the potential for share repurchase, I know you talked about reconsidering midway through the year, is that something that you would do at this point or are you still looking to stockpile cash.
We are very focused on strengthening our balance sheet in very tough financial times and we have no plans for share buyback at this point in time for this year, no plans at least. We’re always evaluating that but we’ll be in the second half focused on debt reduction.
Jeffrey Bernstein - Barclays Capital
Just on China, just wondering it seems like you’re going full speed ahead which seems to be the right approach for you, I’m just wondering whether you’re seeing [press] disparity by tier, I know you said you’ve kind of changed your growth plans periodically just based on tier 1 versus tier 6, just wondering whether you’re seeing disparity in terms of results there that would lead you to change your growth plans, or how the different tiers stacked.
No over time what’s occurred is that we probably have been going into the year a little bit more aggressive on the lower tiered places and a little bit more conservative on the top tier cities, especially on the Pizza Hut side. On the KFC side, we are looking at probably some shifts not necessarily by tier but geographically depending on sort of the impact on the export business. But those are not hugely significant but there will be some adjusting that occurs there.
Jeffrey Bernstein - Barclays Capital
Are you seeing the southern markets be weaker then the northern, was that by geography what you mean by that.
Eastern and southern are a bit weaker. They tend to be the areas that have impacted more on the export reduction.
Our southern markets are definitely several points below the market average, which is what you would expect.
And I think in its own way kind of points out the strength of our China business because we’re so dispersed throughout the country in 500 cities, and we can go where the fish are really biting.
As Richard said earlier, we are looking at the central and west as I’m sure as you’ve read the government is spending a lot more money infrastructure wise in the central and west part of the country. We have representation there already because of our distribution system that can take us anywhere and we’re going to continue to leverage that as Richard said.
Jeffrey Bernstein - Barclays Capital
Just lastly the KFC with the grilled product I think you said at the Analyst Day, that I guess in test market that it was doing something like an initial 8% lift to sales and you thought you’d be able to capture or keep 4% of that, or half of that over time, is that still a reasonable assumption layering in on top of what your current comp trends are.
No, I think we said [what was going to say] about the grilled, again a lot of things have changed in terms of where the base business was etc. so obviously next call we’ll have a lot more to say on the results.
Your next question comes from the line of Steve West – Stifel Nicolaus
Steve West – Stifel Nicolaus
Just a quick question on the grilled chicken sales and kind of following up on that last question, what are the sales trends that you did see in the test markets, was there a big spike when you’re kind of supporting it with TV advertising and then followed by subsequent pullback, it seems like that’s what I’ve seen in a couple of the test markets I’ve seen out there.
What we saw was, we saw a decent spike but it was actually a build in spike. It wasn’t the way some promotions were where the first week or two weeks is the strongest and [inaudible]. It actually built more then some of our other promotions did and then again, we had several test markets and it held at different times half its value once we took it off etc. but then we pulsed it as well with some smaller advertising thereafter.
So again I think that this is going to be quite different for some of the reasons David talked about and that we’re putting a very big effort against it right now with different types of advertising and my guess is even the way we decide to pulse future advertising maybe a bit different then the test. But the thing that was good about the test is that a decent chunk of it stayed on even with very limited advertising and clearly our goal is to make this, not just a permanent part of the menu but a significant part of the menu for a long time.
Steve West – Stifel Nicolaus
Have you gotten any kind of consumer feedback on, I know the chicken tastes great but its smaller and so I was wondering in this value environment are you getting kind of any consumer pushback on paying the same price for what appears to be a smaller piece of chicken.
I think consumer generally knows its smaller because there isn’t breading on the chicken. We have had in some isolated markets some issues with piece size which we’ve gotten all over and its mainly where products might not have been in the spec range so we’re very well aware of that but we have not had any abnormal complaints.
In fact what we are getting is abnormal compliments. We’re getting more compliments at KFC then we’ve ever had in our history on any product.
And I would add since I have some KFC background, I’m even getting compliments from the buy side community from folks who are already trying it and I’ve never gotten that before.
Well those guys don’t have a heart. Just kidding.
Your next question comes from the line of David Tarantino – Robert W. Baird
David Tarantino – Robert W. Baird
Congratulations on a good start to the year, question on the outlook, what type of comps do you think you need to get to a 10% EPS growth number for the year given all the improvements you’re seeing in the cost outlook.
I couldn’t begin to answer that exactly because obviously so much depends on China and not just the US so, but what we are assuming in general is that because of the commodity piece is we can do with lower sales then normal. So normally we say same store sales in the two to three range, we could do with probably several points below that in this commodity environment and get to where we want to get to.
But obviously it depends on a lot of factors, but that’s sort of one thing to think about. Probably throughout the globe, I sort of think China as well, we could probably get there with a couple points less then normal if the commodity situation holds the way we’ve sort of talked about it today.
A couple of points for the full year.
David Tarantino – Robert W. Baird
And then a question on the YRI business, which was very strong on the top line and you mentioned a few countries in particular, the UK and Japan and Australia, are you seeing the economies in those markets start to rebound or improve or are you doing something specifically to drive the business there.
Actually I was talking to Albert [Milotti], who’s doing a great job running our Australian business last night, and actually the economy is looking tougher there. The unemployment is projected to go, get higher, so I think what we have in our global markets is one of the big advantages I think we do have is we have less competition. When we look at global brands, you’re looking at McDonald’s, Pizza Hut, and KFC primarily in most markets. You can add Burger King, and Dominos in other markets but you don’t have the tremendous proliferation of chains that you have in the United States there so, people, when people say well you ought to be doing better in a tough economy, I think its better to do better in a tough economy when you have less competition.
But I also can tell you that we’ve had tremendous innovation in Australia, Japan, and the UK on a relative basis and it goes back to that formula I was talking about earlier. When we’re doing our job we do well and I think it’s a combination of us doing our job well plus less competition I think allows us to be successful there.
Your next question comes from the line of Fitzhugh Taylor - Thomas Weisel Partners
Fitzhugh Taylor - Thomas Weisel Partners
I just had more of a longer-term question, you mentioned earlier in India in the call, there are obviously a lot of similarities from population and unit growth opportunities with China and I was wondering if, how much you’ve considered maybe an owned infrastructure and owned unit system there similar to China versus to the typical franchise YRI model.
I think we’re looking at balanced approach in India, not as dramatic as what we have in China which is primarily all equity but what we are doing right now is we’re investing equity to get KFC and Taco Bell established. Pizza Hut there is basically 100% franchise and so what we think we’ll have over time in India is a balance between equity and franchise, both KFC and Taco Bell.
So, we’re very optimistic about India because our brands are being so well received and people like the food so much. We actually think Taco Bell may have the highest degree of opportunity in India because of the great vegetarian products, the carrier, the spiciness of the food, which we can even modify to be more relevant to the Indian taste. So these are brands, both KFC and Taco Bell, that we’re very well prepared to invest equity in but at the same time, we think we’ll have a balance between equity and franchise long-term in India.
And regarding your question on distribution, in China we got into that when obviously the economy was infant when we got there, but you didn’t have a lot of professional distribution that we thought had the ability to get national scale quickly, that could handle things like refrigeration etc. In India there actually are a couple of very professional distributors already established there so there’s really not the need to do that.
Your next question comes from the line of Mitchell Speiser - Buckingham Research
Mitchell Speiser - Buckingham Research
First off, just on YRI with comps up 65, is that a system wide comp or a company operated comp.
Mitchell Speiser - Buckingham Research
Can you give us just some of the highlights and lowlights on that six, it was particularly strong, was there anything that was particularly weak or just above average.
I’d say, well first of all we’ve got some detail in the release in terms of geography, nothing really jumps out of the page. I think [inaudible] one of the things that I’ve been pleasantly pleased and surprised with is just the number of countries that we’ve had that are positive. Whenever you obviously have a global business, we’re in 100 countries we have a large number of them usually up and down at a point in time and probably for the last year and a half, we’ve had an abnormally large percentage be up and that’s sort of been holding up pretty well.
Our weakest markets, that impact us the most, have been a couple of our equity markets, Mexico and Pizza Hut Korea. We haven’t seen big trend changes in those businesses. They’ve been an issue for the last year or so.
Mitchell Speiser - Buckingham Research
Just on KFC US, I think last quarter you may have mentioned a comps target of 7% for the year, are you revising that target at all.
What I sort of said before is our expectation is probably a couple of points lower at least in the US for the full year but we haven’t sort of broken that out by brand yet.
That’s because of Q1 being below what we expected.
Mitchell Speiser - Buckingham Research
And the China comp target of 5% is still on track at this point.
We’re going to update our sort of numbers at the next release sort of across the business, again early to try to make the full year call changes at this point but again, probably we expect China to be worse then what we thought in the first half but we still feel pretty good about what we thought would happen in the second half.
Mitchell Speiser - Buckingham Research
Just on the US cost savings, the $20 million that happened a little sooner then expected, can you just identify maybe some of the bigger buckets in that $20 million.
Well the $20 million, the overall piece, I mean most of it we did expect, it was due to headcount reductions associated with the restructuring that we did of our business. The extra amount is just sort of we had some projects timing across the board that some of that money is going to be spent later in the year but again, the large part of it we did expect its just a little higher then what we thought it would be.
Your next question comes from the line of John Ivankoe - JPMorgan
John Ivankoe - JPMorgan
Question on YRI if I may, obviously the division did not participate in the commodity improvement of the store level cost management as did the other divisions, and that is even excluding the Mexico VAT change, so if you could whether for the rest of 2009 or going into next year what could change that. Is it just a matter of focusing on those numbers and secondly, do you think your G&A is structured correctly in dollars for YRI especially given the fact that I guess you said 95% of your growth is from franchisees.
Well the first piece of it, you’re right, the commodities in YRI are different then US and China and there’s a couple of reasons for it. First of all YRI tends to have longer-term contracts so we did not get as big a downside, nearly as big a downside in YRI last year because we were locked in on longer-term contracts in 2008 then we experienced in the US and China.
And we’re sort of getting the reverse of that this year as we did lock in some of the longer-term contracts in 2008 before sort of the commodities came down. So we were locking in higher costs for 2009 YRI so YRI will sort of either reverse of what the US and China was, was that they weren’t impacted too much this year.
We expect them to not get the benefit this year though as well and in fact, so they’re probably get more of that benefit in 2010 if things stay low. So that’s one piece of it. The second dynamic on the YRI piece is that a fair number of the costs, especially of a couple of our equity markets, Japan, sorry Korea and Mexico, were sort of either US based or influenced strongly by the US dollar. So we are getting some commodity inflation due to that in some of our equity businesses.
So we expect commodity increases at YRI to get slightly less as the year unfolds so we expect less of an increase in the balance of 2009 then what we saw in the first quarter but we still expect overall increases of YRI.
John Ivankoe - JPMorgan
On G&A, I mean that hasn’t been a focus for you, obviously the US has and the money you’re taking out is significant, is there a similar type of thought that you might be able to put to work at YRI.
Let’s remember, on the US piece what drove it was the refranchising, right, so it takes fewer resources to manage a franchise restaurant then it does a company owned restaurant and that’s really what drove the US piece of it. YRI ownership percentage has been there, again, it goes up and down slightly but its pretty much stayed where its been for a while. So the only place, time we expect to see anything on the G&A side was if we refranchise a market which in the scheme of things isn’t going to make a huge difference on the overall number.
And clearly we are investing in some of the growth markets like India, France, etc. where we’re building up longer-term businesses in those countries when you start out you do have a little bit more as a percentage of sales on G&A so we’ll get some benefit of G&A leverage down the road as those markets become more mature.
Your final question comes from the line of Keith Siegner – Credit Suisse
Keith Siegner – Credit Suisse
Quick question on Pizza Hut, we’ve talked about the strategy, we’ve talked about one of the biggest challenges being communicating the changes in product offerings, as you think about this year, you’ve got Wing Street coming really in fourth quarter, you’ve got the Panormous, and you are lapping last year’s pasta hut introduction, how should I think about the marketing budget for this year. How you improve that awareness and communicate those changes, so how you approach the marketing budget for the balance of this year pre that fourth quarter introduction, and maybe what you do with pricing and promotional effort to help as well.
Well I think, again we aren’t spending incrementally. We’ve got significant budgets because we’ve built into our contracts in both company and franchise stores so, the advertising is more of a fixed cost but what the team is doing is they’re focused on layers, tiered spending, making sure that we spend on pasta and pizza simultaneously and then when we launch Wing Street it will be supported with money that’s been put in to the budget as a percent of Wing Street sales.
So, I think I would look at the way we spin the market to bring more on a layered basis or a tiered basis.
Keith Siegner – Credit Suisse
In China one of the things that we talked about back at the Analyst Day and in the original guidance for the year was the opportunity for G&A leverage in this model going forward and despite the profit upside in the quarter actually G&A was pretty much flat as a percent of sales year over year, really wasn’t a lot of leverage. How should we think about given the potentially weaker first half sales environment potential for G&A leverage in China this year.
What we have said is that if you look at our broad model that in the past we have not gotten G&A leverage, right, so if you look at how we’ve gotten sales and profits in the past it was pretty much led by unit development. We expect still unit development to take the largest part of our growth but what we said would occur over time is we get a little bit more from two areas. One pricing which we’ve already started to do, that was led by unusual chicken cost increase a year and a half ago. So we expect to get modest pricing and we also said we should start to see some G&A leverage.
I think we had about a point of leverage in the first quarter so we saw a little bit of it coming but I think where we’re going to get it is still going to be over time and it doesn’t have to be a huge amount of money. Don’t forget we’re continuing to invest in start up ramps like [east dining] and pizza at home service etc. but we are starting to see a little bit of leverage on the KFC side.
I expect that leverage to hopefully grow a little bit over time.
And we did in total revenues we were up 19% and our G&A was up 16% so we did get a little bit of leverage, the growth was less then revenue, that is definitely a little bit better then in the past and then also keep in mind we were lapping leap year which impacted the top line by a couple of points.
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
I’ll just briefly wrap up here, first our China business is on solid ground and continues to grow as we build leading brands and develop new units with high returns. We believe the Chinese economy is stabilizing and remember China is still the number one restaurant opportunity for the 21st century and we are very well positioned there.
Second Yum! Restaurants International continues to be the division that we think has the greatest long-term potential for Yum! Brands and continues to produce consistent results with the strength of its broad based business in over 110 countries with 700 franchisees.
Third our US business is now set up with a more efficient operating structure and is focused on executing new incremental sales layers that we’ve talked about and our ownership strategy. We expect that with the moves that we’re making this year to strengthen our brand. We expect each one of our brands to go into 2010 stronger and better positioned more with opportunities to leverage the assets that we have.
And finally we expect to generate a huge amount of cash coming from each of our divisions as we grow our business and maintain our industry-leading return on invested capital. And with all these things we expect to, we can achieve our EPS growth target of 10% in 2009 and beyond. I want to emphasize that the second quarter will be our toughest quarter but we expect very good second half performance.
So with that I will close and thank you all for being on the call and go out and try Kentucky Grilled Chicken and the unfried side of KFC. Appreciate it.
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