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Executives

Tim Jerzyk – SVP, IR

David Novak – Chairman, President & CEO

Richard Carucci – CFO

Analysts

Jeff Omohundro – Wells Fargo Securities

David Tarantino – Robert W. Baird

David Palmer – UBS

Greg Badishkanian – Citigroup

Jeff Farmer – Jefferies and Company

Jason West – Deutsche Bank

John Glass – Morgan Stanley

Sara Senatore – Sanford Bernstein

Jeffrey Bernstein – Barclays Capital

John Ivankoe – JP Morgan

Joe Buckley – Banc of America Merrill Lynch

Keith Siegner – Credit Suisse

Mitch Speiser – Buckingham Research

Matt Van Vliet – Stifel Nicolaus

Yum! Brands, Inc. (YUM) Q1 2010 Earnings Call Transcript April 15, 2010 9:15 AM ET

Operator

Good morning. My name is Janice and I will be your conference operator today. At this time, I would like to welcome everyone to the 2010 first quarter earnings conference call. After the speaker's remarks, there will be a question and answer session. (Operator instructions)

At this time, I would like to turn today's conference over to Mr. Tim Jerzyk, Senior Vice President, Investor Relations. Thank you.

Mr. Jerzyk, you may begin your conference.

Tim Jerzyk

Thank you, Janice; and good morning, everyone. Thanks for joining us on the call. This call is being recorded and will be available for playback. We are broadcasting the conference call via our website, www.yum.com. Please be advised that if you 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 the 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 a couple of upcoming Yum! investor events, where you will have a great opportunity to meet leadership teams from our businesses. May 18, we will host YRI Investor Day in Dallas; followed by Pizza Hut Investor Day on May 19, also in Dallas. Space is limited, so please notify us if you plan to attend these great events. Also, on Tuesday, July 13, our second quarter earnings will be released and a conference call will follow – will be held the next morning on July 14.

On our call today, you will hear from David Novak, Chairman and CEO, and Rick Carucci, our CFO. Following remarks from both, we will take your questions. Now I will turn the call over to David Novak.

David Novak

Okay, thanks, Tim; and good morning, everyone. I am pleased that based on our strong first quarter performance, we are well on our way to achieving our ninth straight year of achieving our annual target of at least 10% EPS growth. Our first quarter worldwide operating profit grew by 17% and EPS increased 23% before special items. We are particularly pleased with our business in China, which reported robust profit growth of 37%, driven by both strong unit development and same-store sales growth.

In the United States, we were also pleased to see the significant sales improvement from the low point of the fourth quarter, particularly at Pizza Hut. However, U.S. profits were down 9% and same-store sales declined 1%.

At Yum! Restaurants International, we increased system sales by 1% and profits by 2% prior to foreign currency translation, primarily due to new unit development. While clearly we have more work to do, overall, we were pleased with this start to 2010.

Now, let me take you through our key strategies and trends for each of our divisions.

First, let us talk about China, where we continue to build leading brands in every significant restaurant category. We are particularly pleased with the performance in our China business. Same-store sales grew by 4%, and units expanded 14%, while restaurant margins were at a record level of nearly 27%. All combined to generate robust profit growth of 37%. This is particularly impressive, when you consider that we were lapping 30% profit growth in the first quarter of last year. New unit development continues to be the major driver of our growth, and we remain the largest U.S. retail developer in China. We opened up 96 new units this quarter, and our China new unit returns continue to be the best in our business. In terms of scale, we surpassed 3500 units, strengthening our leading position in the world's largest growth market.

KFC is our largest brand in China, with nearly 3000 units in over 650 cities, with superior averaging of volumes of $1.4 million per year. We are continuing to grow our business and leverage our assets. A key KFC initiative is delivery, which is now available in over 110 cities and nearly 1000 units. This is proving to be a developing sales layer for us, now representing over 3% of sales. KFC Breakfast is another way we are leveraging our assets, as we now have national distribution. KFC Breakfast represents nearly 7% of transactions, and continues to steadily grow. Importantly, KFC continues to build its leading image in China across key brand majors.

Pizza Hut Casual Dining continues to be the leading western casual dining concept in China, with 467 units in 122 cities. Our new menu strategy continues to drive double digit same-store sales growth. We offer a broad variety of entrees, including beef, chicken, and rice dishes, along with appetizers, beverages, and desserts. Amazingly, we are actually updating 25% of our menu every six months with new products to keep the concept fresh and relevant. We are having solid success building a true casual dining concept, with everyday affordable value.

We also continue to invest behind the development of our emerging brands, Pizza Hut's Home Service in the home delivery category, now has over 100 units in 11 cities and East Dawning, our Chinese fast food brand continues to progress as we drive for scalable economics.

Next, Yum! Restaurants International, where our strategy is to drive aggressive expansion and build strong brands everywhere outside of China. New unit development, which like China, is a key driver of growth for this business, and continued with 109 openings this quarter in more than 40 countries. Approximately 90% of this growth came from our strong network of around 1,000 franchisees. We expect to deliver our goal of adding about 900 new units for the full year. Our first quarter same-store sales declined 1%, after adjusting for timing of Chinese New Year's. Overall, we drove 2% operating profit growth, excluding foreign currency translation for the quarter.

KFC is focusing its attention on driving value around the world to build sales momentum in what remains a somewhat challenging consumer environment. We are expanding our value menu to more markets, using proven strategies that have been very successful in markets like South Africa and the United Kingdom.

Additionally, we continue to build our new incremental sales layers. Our Crushes line of frozen beverages continues to expand and is now available in over 2000 units in over 25 countries. Our KFC Breakfast initiative, we call it KFC A.M., also continues to grow with nearly 400 units in four markets.

Pizza Hut continues to make progress, elevating its brand offering and strengthening its position as the leading western casual dining concept, with everyday affordable prices. While we have weaker transaction trends due to Pizza Hut's higher average guest check, we are encouraged by the progress we are making with our expanded menu, including a wider variety of appetizers, beverages, entrees, and desserts.

Yum! Restaurants International's new growth markets, France, India, and Russia, delivered 14% system sales growth prior to foreign currency translation this quarter. KFC France opened its 100th unit and is moving towards having the scale to ultimately have national television advertising. We expect this will drive further brand awareness, particularly in the provincial cities. In Russia, we continue to drive sales growth in KFC Rostik's units, and now have over 150 units in 22 cities. Our business in India continues to perform well, with solid same-store sales growth and new unit expansions. We now have 74 KFCs in 13 cities, and 159 Pizza Huts in 33 cities. KFC is now leveraging television advertising to build brand awareness and promote new products in India.

Taco Bell International continues to expand, with our first unit in Bangalore, India in that country's largest mall, Mantri Mall. You might have read in the Wall Street Journal that our initial sales at this store has been extremely strong, and transactions have actually exceeded 1000 per day. The results from other recent openings in Spain, Dubai, Cyprus, and Panama, have also been very encouraging, with our stores comfortably exceeding sales targets. Looking ahead, we are on track to open two new Taco Bell units in London in the second quarter and expect to open new markets like Korea, Kuwait, Peru, and Columbia later this year.

Next, onto our U.S. business, where our focus is to improve our brand positions, consistency, and returns. As we noted in our earnings release, performance in our U.S. business for the first quarter was relatively weak, with same-store sales down 1%, and operating profit down 9%. But we were pleased with the significant improvement from the fourth quarter of 2009.

Pizza Hut led the way with 5% same-store sales growth, driven by the success of the $10.00 Any Way You Want It promotion. There is no doubt America loves Pizza Hut pizzas, so this has addressed our number one problem, we were simply too expensive, and now, we are working on ways to sustain this value. Going forward, we are also striving to transform Pizza Hut from just pizza to pizza, pasta, and wings. Tuscani Tuesdays offers consumers Pizza Hut's pastas at a great value of $10.00 and Wing Wednesdays offers consumers Pizza Hut's award-winning chicken wings also at great value. Pizza Hut has clearly turned the corner on sales trends.

At Taco Bell, we were disappointed with the 2% decline in same-store sales, but encouraged by the fact that our transactions were positive for the quarter. We had experienced some trade down with less drink and combo incidents. Taco Bell's pipeline of products is strong for the balance of the year, focusing on value to the consumer in a market clearly focused on everyday low prices.

KFC's performance improved sequentially, but we still have our work cut out for us. We are focused on three key areas as we turn the brand around, balanced options featuring Kentucky Grilled Chicken; portable product innovation like the new Double Down Sandwich made from two boneless fillets, grilled or fried; and improved operations.

Overall, our U.S. performance has improved from the low point of the fourth quarter. We expect this trend to continue, especially as we move into the second half of the year, both in terms of our top line sales, and profit performance.

One other note. I am sure that you also noticed from our release that we took a non-cash charge that basically reflects the beginning of refranchising KFC to 5% ownership. That is also our goal for Pizza Hut, where we have already begun the journey, and are well on our way.

So let me wrap up the first quarter. Overall, by saying we are off to a strong start in 2010. While the global operating environment remains challenging, we are especially pleased with the strong performance in our China business, and the improving trends we are seeing in our U.S. business, which we expect to continue to build as the year progresses. We are confident we are well on our way to delivering another year of at least 10% earnings per share growth, which would be our ninth year in a row of meeting or exceeding this target.

Now let me turn it over to Rick Carucci, our Chief Financial Officer.

Rick Carucci

Thank you, David; and good morning. In this section of our call, I am going to comment on three areas: our first quarter results, our outlook for the business during the balance of 2010, and our strategy in emerging markets.

As David mentioned, we are very excited about our first quarter results. I am sure any CFO will tell you that they would much prefer a strong start than having to play catch-up. As we review a few of our highlights, let us start with China.

We had a very strong Chinese New Year holiday. This led to first quarter system sales growth of 15%, including same-store sales growth of 4%. Sales were solid across the country, including the high export regions. While we are not yet ready to say that the Chinese consumer has fully recovered, we are starting to see signs that the consumer environment is improving. As an example, consumer confidence in China has increased year-over-year the last three months. A big driver of sales continues to be our development results in China. New unit economics remains strong and we expect that we will continue to expand broadly across China. Our profit growth of 37% was also driven by record first quarter margins, as we benefited significantly from chicken cost deflation versus prior year, and lower-than-trend wage inflation.

Now on to Yum! Restaurants International. Overall, our sales results were relatively weak in our large developed markets like Japan and Canada, as well as equity business like Australia and Mexico. These markets dampened the overall sales results for YRI in the quarter. The good news is that YRI still benefited from broad-based new unit development of 3% in the first quarter. However, this led to only 2% profit growth prior to currency translation. We did benefit from a $14 million Forex item in the first quarter, which resulted in YRI reported profit growth of 13%.

Next, in the U.S., we continued to battle high unemployment and an industry focused on value. However, our U.S. business realized significantly better sales performance than we saw in the fourth quarter. On the whole, our U.S. restaurant margin declined 90 basis points versus prior year, primarily due to the decline in same-store sales. Commodity deflation of $5 million was offset by a modest impact from sales mix shift. For example, Taco Bell experienced a higher mix on the Why Pay More menu and had lower drink incidents. While trying to improve our value offerings, we also managed our business with tight cost management. In the U.S., we reduced our G&A by $6 million. When you pull it all together, we are pleased with where we stand after the first quarter.

Now, let me share with you some of our thoughts for the remainder of 2010. We expect our second quarter sales dynamics to be similar to the first quarter for our divisions. We expect moderate same-store sales growth in China in the second quarter. For the U.S., in the second half of the year, we expect positive sales growth. The key reason is that our comparisons versus prior year gets significantly easier. Remember, we are lapping a second half where U.S. sales were down 7% in 2009. We do not expect China's exceptional margin performance in the first quarter to continue. We expect some commodity inflation in the back half of the year, and we also forecast greater impact from wage inflation. Wage inflation was lower than normal in 2009 and is significantly picking up again in 2010. For the full year, we expect moderate year-over-year margin improvement over last year's 21% margins in Mainland China.

Our after-tax results in the second quarter will be challenged, as we roll over a 16.4% effective tax rate before special items from the second quarter of 2009. Special items are very difficult to predict and can be quite lumpy. However, this year it appears that we have more downsides than upsides. During the first quarter, we took a special items charge that included a $56 million expense from U.S. refranchising. This includes gains from the sale of 46 restaurants sold in the first quarter. This also reflects that we floated for sale a significant number of KFC U.S. company units. Our accounting policy is to recognize a non-cash write-off for potential losses from refranchising when units are offered for sale.

In the second quarter, we will also lap a $68 million one-time non-cash gain in 2009 related to increasing our ownership in the KFC Shanghai joint venture. Overall, as David said, we are confident we are on track to meeting our objective of at least 10% earnings per share growth.

As we have shared with you before, one of Yum's unique strength is our presence in emerging markets. Today, I would like to give you a few more insights into this significant growth opportunity. Emerging markets, as defined by World Bank's guidelines, generally includes countries whose gross national income per capita is less than $12,000. This group includes countries like China, Indonesia, Malaysia, India, Russia, Vietnam, and Brazil, all of which have near or over 100 Yum! restaurants. The good news is that collectively, these emerging markets are growing their economies at a fast rate. With a booming middle class population in emerging markets, we strongly believe there is a long run rate for restaurant growth in those countries. As you may recall, I have talked about our penetration of three units per million people internationally, versus the 60 units per million we have in the U.S. Further, in the top 10 emerging markets, we currently have 1.5 units per million people. This demonstrates that we are clearly on the ground floor of this huge growth opportunity.

Today, we have nearly 10,000 units in the emerging markets, or roughly 55% of our total YRI and China units. We are the largest restaurant company in emerging markets, and we are growing at a faster rate than our major QSR competition. With a five year period ending in 2009, we added about 4,000 net new units in these markets, a 12% compound annual growth rate. This compares to a 1% compound annual growth rate in the balance of our international operations.

As another benchmark, we currently have almost two times the number of emerging market units as McDonald's, and we have added more net units than McDonald's at a 3 to 1 rate during the past five years. And here is another important point. Most of our competitors aren't even trying to open restaurants in many of these emerging markets. Our experience is that it usually takes about 10 years to get to 100 units in a new country. This is the point at which you could begin to scale a concept as you have a proven consumer proposition, a more efficient supply chain, and access to mass media such as television. Overall, for emerging markets, Yum! enjoys the combination of an existing lead in penetration, a higher growth rate, and the knowledge of the lead times it would take others to have a meaningful presence in these markets. This provides Yum! with an opportunity to increase our competitive advantage that will likely last for a very long time. In the upcoming calls and investor meetings, we plan to provide more color commentary around our growth opportunities in emerging markets.

In summary, given our plans and our first quarter results, we believe Yum! is well positioned to once again deliver solid financial performance in 2010. At the same time, we are equally excited about the foundation we are building in emerging markets to drive strong performance for many years to come.

Back to you, David.

David Novak

All right. Thank you very much, Rick, and let us open it up for Q&A.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Your first question comes from the line of Jeff Omohundro with Wells Fargo Securities.

Jeff Omohundro – Wells Fargo Securities

Thanks. I just had two questions on the domestic business. First, on the Pizza Hut value effort, I want to give a little more color on the – in fact, I am checking mix of the $10.00 promo. And given the response, do you think you will extend the LTO beyond the original plan, how are you thinking about sustaining value there going forward? And I have one more question, thanks.

Rick Carucci

Okay, well, Jeff, as you know, you know, we posted strong sales in the first quarter of 5% and the promotion has been very successful and the reason is it has addressed our biggest problem, which is value. You know, I think that what we have seen is that our comparable margins have held steady, as we have had the sales lift and we have had strong flow through, which has offset a lot of the price discounting that we typically have had this with this promotion, obviously. And the good news for us is that the brand metrics have really held solid, so the brand is in fact improving in terms of its consumer perspective. So, what we are doing right now is we are looking and working very hard with our franchisees on ways to sustain our everyday value proposition. And the franchisees are very committed to this, but it does seem that the turnaround in the business and the power of making our brand more affordable and accessible to the vast majority of customers.

David Novak

And Jeff, just regarding your question on check, check was down about, you know, close to about 10%, but the transactions increased at a much faster rate than that.

Jeff Omohundro – Wells Fargo Securities

Thanks. And my other question was on Taco Bell. Just how are you assessing the consumer response to the Pacific Shrimp Taco? I am asking this because of the new protein efforts there and should we expect to see more efforts along those lines? Thanks.

Rick Carucci

You know, I think that the product response to the product has been – or the consumer response to the product has been very good. People like the product itself, and we actually had some product supply issues because the shrimp tacos basically flew off the shelves. So, I think it is the first time we ever had a fish product during Lent, which made a lot of sense, so I think that you will see that on a targeted in and out basis, as we go forward.

Jeff Omohundro – Wells Fargo Securities

Thanks.

Rick Carucci

Okay.

Tim Jerzyk

Thanks, Jeff. Next question please, Janice.

Operator

Your next question comes from the line of David Tarantino with Robert W. Baird.

David Tarantino – Robert W. Baird

Hi, good morning, it's David Tarantino. Congratulations on a great start to the year. My question is on China. I was wondering if you could give more granularity on your thoughts on what is happening in the consumer environment. You mentioned you are not ready to call a recovery in the Chinese consumer yet. Your results were pretty strong in the quarter. So, my question is, what is giving you pause on calling for that recovery?

David Novak

Yes, when we look at China, we look at a bunch of different measures from an economic standpoint. One of the things I highlighted in my speech is one of the things we look at is consumer confidence and that has gone up the last three months, which is good, but it is still below what it would have been, I would call it about a year or a year-and-a-half ago. So, you know, we still have ways for it to go. We are starting to see exports rise as well. Governments, local governments are confident enough to start to increase wages again at a pretty high rate, which puts us on the margin side, but it is an indication that the people are starting to feel more bullish about the economy. You still have the push towards the central and west that we have talked about before and those economies are still doing a bit better than the coastal economies and we will continue to move some of our development in that direction. You know, I would say it’s better than it was, but not, you know, not what it was, let us say before things started going south.

David Tarantino – Robert W. Baird

Okay, very helpful. And one follow-up question on that is, are you seeing anything since the close of your first quarter that would suggest that type of low to mid-single digit comp would not be sustainable for the rest of the year?

Rick Carucci

Well, what we sort of said is for the second quarter, we expect similar types of numbers, and we call something out of it is a significant difference, but we haven't seen a significant change since the first quarter.

David Tarantino – Robert W. Baird

Great, thank you.

David Novak

Remember, last time, we called out Pizza Hut, but we don't call out a couple of points up or down.

David Tarantino – Robert W. Baird

Great. Thank you very much.

Tim Jerzyk

Thanks, David. Next question please, Janice.

Operator

Your next question comes from the line of David Palmer with UBS.

David Palmer – UBS

Hi, guys, sorry for the background noise, kind of on the road here. I wanted to ask you a question about the U.S. business. You know, just a little general question, I mean, obviously, the cost for that first quarter was down significantly. You are not going to get any favors from food costs from this point forward as much. You know, it might be the trend in sales that makes you feel better, but you know obviously the starting point in terms of trend rate on profit was not exactly a great one. How do you feel, you know, what is the feeling about this U.S. business profit wise for the year? Obviously, you are not up to giving guidance, but any comments would be helpful.

Rick Carucci

You know, just to put some of the sales and profits and commodities and inflation in perspective, we, you know, remember what I said, put it in my speech is, our overlaps get significantly easier the second half of the year. So we are not necessarily assuming a great economic recovery for our sales to get better. We started lapping -7% in the second half of 2009. So we are still running the business as if things are going to be pretty tight with the consumer and you know, things are better than they were for us obviously in the third quarter or fourth quarter last year. But, you know, we have still have ways – you know, we still have a ways to go before we are going to say there is an economic recovery in the U.S.

On the commodity side, we had a little bit of commodity deflation in the first quarter. Our current guess is that it will be about flat for the full year. So we don't see a huge difference there. So we will continue to try to do what we do in these types of times, as when we have value initiatives, we try to have some great product initiatives, because obviously you need to have innovation as well, and then we will manage to cross three types and we are looking at both productivity initiatives at all of our brands and I think the team has done a pretty good job of managing those costs. In terms of the profits in the first quarter, our overall sales were down 1%, our company sales were down 2%, so that is probably why the profits, if you put that in perspective is really why we were down 9%. So given the -2% in company, that is pretty much where we would expect to be, given that sales level.

David Novak

And I think, David, in the end, as we look at how it all adds up, we are still comfortable with saying that we can grow our profits 5% in the U.S.

David Palmer – UBS

Thanks. And congrats on the quarter.

Operator

Your next question comes from the line of Greg Badishkanian with Citigroup.

Greg Badishkanian – Citigroup

Great, thanks. Yes, and good quarter, guys. Can you talk a little bit about the pizza category in the U.S.? Who do you think you are taking share from and how sustainable do you think that is going to be over the next few quarters?

David Novak

Well, I think what we have done is we have made ourselves much more competitive on the pricing front, and that is we are seeing our gains coming. Usually when we grow like we are growing right now, it comes from the overall category, and the mom and pops.

Greg Badishkanian – Citigroup

And do you think over the next few quarters, this could be sustainable, or do you think you have seen some marketing and more exposure by consumers to good promotions, maybe that fizzles out or do you think that is going to be a sustainable –?

David Novak

I think the category has always been enormously competitive and always, especially on the pricing front, and I think that the fact that we are being more competitive on the pricing front today and the fact that the system is committed to that, means that we should have more sustainability in our overall brand over time.

Greg Badishkanian – Citigroup

Great, thank you.

Tim Jerzyk

Next question please, Janice.

Operator

Your next question comes from the line of Jeff Farmer with Jefferies and Company.

Jeff Farmer – Jefferies and Company

Great, thank you. Good morning. You guys have been running without menu pricing in China for at least six months according to my model. What is the opportunity in coming quarters, especially if you expect to see some inflation in the back half of 2010?

Rick Carucci

Yes, we are obviously looking at that now, we are trying to balance. You know, again, as we sort of said before, the Chinese consumer is still soft. We had, obviously, a very favorable first quarter, because as we mentioned, the labor was unusually low, costs were unusually low. So we will have to look at that, but you know, the good news is we have got some very positive profits going into that timeframe, but we are studying what we want to do now for the back half of the year, but we are not going to do anything at least for the next several months.

Tim Jerzyk

Thanks. Next question, please, Janice.

Operator

Your next question comes from the line of Jason West with Deutsche Bank.

Jason West – Deutsche Bank

Yes, thanks guys. Just wondered if you could update us on the KFC business in the U.S. You know, last quarter, you talked about some of the franchisees were behind in making royalty payments. You guys had a fairly sizable charge there. You didn't see one of those this quarter. If there is some improvement you are seeing there, and then talk about the likelihood that you get a big transaction done or multiple transactions done on the refranchising side as well as the success of the new products you just launched, thanks.

Rick Carucci

Well, on the bad debts side, we are going to keep our eye on that it, it actually did a little better in the first quarter. So our receivables are better and hopefully, we get into a higher seasonals time as the year gets over. So keeping our eye on that, but probably a bit better than we were in the fourth quarter. Regarding refranchising, just to put that into context again for people who may not be as familiar, you know, we were on a three year refranchising program that really started in the beginning of 2008, and our goal was to go from over 20% of our U.S. restaurants for company owned to about 10%, which as David said, about 5% at the KFC and Pizza Hut level.

In the first two years of that, we finished Long John Silver refranchising. As David said, we are well on our way on Pizza Hut, and we think we will be close to finishing that within the original three year timeframe, which would have ended in 2010, and then what we said in December is that we are behind on KFC. We started late on KFC, and therefore, we think the total program will take a bit longer than we originally thought.

So KFC, we really just started in earnest this quarter, in terms of loading deals. So, we will have to see how, we have a lot of work to do on that stuff, we are just hearing some potential buyers, so we have a long way to go on that side. So we are going after it, so we now think it is the right time to market. We think the brand is performing better than it was a while back and you know, we are excited about some of the product initiatives that we have done and that we are going to do going forward.

David Novak

Just from an overall business perspective, you know, KFC continues to be our biggest challenge in the second quarter, we will likely be negative as we overlap last year's successful Kentucky Grilled Chicken launch. However, we have got some really good programs, including the launch of the Double Down Sandwich, which we just introduced and we have a Pink Bucket promotion coming up, where we donate $0.50 of every bucket sold to fight breast cancer, which we feel very good about as well. As we move forward, we are really focused on more innovation around portable products and high end offerings. So we are going to leverage both our grilled and fried and boneless offerings, as we go forward. So for the full year, you know, we expect to see improvements in sales and definitely more profitability as we go forward.

The other thing we are very focused on and passionate about and Roger Eaton is leading the charge on this at KFC is that we are improving operations and because we see that definitely as our single biggest opportunity to drive sustainable same-store sales growth. So, you know, there is a lot of work going on right now. We put our best leaders that we have around the company. We have brought in a lot of talent at KFC, we are totally passionate toward turning around the U.S. business and I am really proud of the efforts that are going on, but there is a lot of wood to chop, so to speak.

Jason West – Deutsche Bank

Okay, thanks for the color, guys.

Tim Jerzyk

Thanks, Jason. Next question, please, Janice.

Operator

Your next question comes from the line of John Glass with Morgan Stanley.

John Glass – Morgan Stanley

Hi, thanks. Two questions. My first one is on YRI. Can you just walk through a couple of the key markets there and why you think your sales has remained somewhat soft, for example the Australian market, maybe a little commentary on the UK as well, please?

Rick Carucci

Well, I think you know YRI in Australia has had a real strong run, great track record of consistency, and you know frankly, I think we have fallen a little bit behind on the pipeline in the innovation that we had typically had coming out of Australia. And so, we expect that business to perform better and it should. The brand is very strong there and we have tremendous opportunity to keep growing as well. In the UK, we are very pleased with the progress that we have made with KFC. KFC had an outstanding year last year in the United Kingdom, you know, where we were up double digits in sales and profits. And you know, the KFC business is beginning to build some momentum there. Pizza Hut, you know, is our big challenge there. We are in the midst of really trying to transform and turn that brand around, become a stronger casual, affordable casual dining entry or competitor, and I think we are really more in the early days of really making a substantial change there. The team is on it, but we have got more work to do.

John Glass – Morgan Stanley

And just as it relates to the inflation that you are expecting commodities in China, and wages, can you maybe quantify what kind of increases you would expect in the back half and even this quarter with a 4% comp increase, it looks like you would de-lever things like payroll and occupancy. So what kind of comp do you need this year in China in order to offset those increases and those fixed costs?

Rick Carucci

Well, in terms of the wages again, just background again, as we had some good labor initiatives from the productivity side in China in 2009, and then in the second half of 2009 in particular, the government really, this is mostly local governments, really didn't take out minimum wages. They had very small increases in minimum wages. So in the first half of this year, we are benefiting from that and like I said, we are going to get ahead with this probably harder than normal in the second half of the year. So we increased versus prior year in the first quarter 2.5 margin points and what we set for the full year is we will have a moderate increase. So in terms of sales, we don't have an exact sales number is what you need, but probably modest same-store sales growth in order to deliver that kind of margin improvement for the full year.

John Glass – Morgan Stanley

Are we just going up at double rates right now or do you expect them to this year? What is the order of magnitude of wage increase do you think?

Rick Carucci

Well, I think what is happening is we benefited, as I said, in the first part of the year, we had lower than normal. So normally, the wages in China, if you go over about a four year period, they are in the 8% to 10% level. We actually had rates lower than that in the first half of this year, and expected to be higher than that in the balance of the year. That is probably an average of about 10% or so for the full year.

John Glass – Morgan Stanley

Thank you.

Tim Jerzyk

Thanks, John. Next question please, Janice.

Operator

Your next question comes from the line of Sara Senatore from Sanford Bernstein.

Sara Senatore – Sanford Bernstein

Hi, thank you, it is Sara Senatore. Just actually a couple of sort of disparate follow-ups here. First, on pizza, I think you said that you thought that the share gains were coming from independents maybe, I mean all the publicly traded, you know, pizza guys, or other guys reported actually big improvements in costs. So, I guess, you know, at some point, those share gains have to level off. So I was just wondering, you know, is there any other place that you can get the market growth from, I think actually one of your competitors said that the market has been in decline for something like 10 years, and now it is actually turning positive. So I am just trying to figure out, again if there is, you know, the sort of sustainability. So that is the one follow up, and then I have another on China.

Rick Carucci

I think one of the big things we have in marketing as you guys all know, there is nothing like the power of having the leading brand with the leading image. And when your are value competitive, your odds of success are much better. So you know, this has always been a slug it out, very competitive share gain and category. What we are trying to do is have a two-fold strategy. One is to be much more competitive in the pizza world, which we have done. And you know, the real challenge we have now is to drive sustainable everyday value as we go into the future and the team is working very hard on how to stay competitive on the value front, because we have seen the real power of it.

But the other thing we are trying to do is that we have tremendous opportunity to leverage our assets with the variety that we have invested in the last couple of years. For us, that means establishing the pasta occasion and the wing occasion as separate and distinct occasions for Pizza Hut and marketing them primarily during the week, so that we leverage the assets that we have. So, our strategy is to fight it out for share in the pizza category, leverage our leadership and now competitive value, and then, leverage the asset that is definitely under-utilized at Pizza Hut through the variety that we have created, the pasta and the wings, by really going after the earlier week occasion.

Sara Senatore – Sanford Bernstein

Okay, thanks. And then just on China, I just want an update on the new unit volume versus existing insofar there obviously you did 4% comps, 14% unit growth and your total systemized sales growth was less than the sum of that. So are we still looking at sort of a $200,000 difference in new unit volumes and can you talk about what the ramp is generally for units as they come online, just you know, apples-to-apples is a new unit less, lower volume than what it may be in year two or three?

Rick Carucci

Yes, I mean, generally, we have been at this strength for a few years now, which is our average unit volumes are about 1.4 million and new units come in probably about 1 million, 1.1 million. Right? So we are at about a 300,000 gap versus a new unit, and that strength has been going on for a while, and part of that as we go into smaller cities, where we have a little bit more inflows as we are developing into existing cities, and that is the reason why there are lower sales levels. We sort of said before as you get to the smaller cities, the good news is, even with those lower sales, our margins are similar, because our cost structures are lower there. In terms of ramp-up, it is hard, because we have so many new units are coming in on top of each other, but our sales rates are generally a bit higher in the smaller cities as we open. So they will tend to grow at a higher rate in the first, let us say, four or five, years than the general cities would.

Sara Senatore – Sanford Bernstein

Okay, thank you.

Tim Jerzyk

Thanks, Sara. Next question please, Janice.

Operator

Your next question comes from the line of Jeffrey Bernstein with Barclays Capital.

Jeffrey Bernstein – Barclays Capital

Great, thank you. A couple of questions as well. One, just on the U.S. business, you haven't talked much about Taco Bell. I think you said you were somewhat disappointed with the down 2% comp. Just wondering whether you could talk a little bit more about, I think you said this was a new trend of people skewing more towards the Why Pay More and perhaps less drink incidents. Just wondering whether you could talk about that specific to Taco Bell and whether, you know, what the impact has been from the competitive discounting kind of jumping into Taco Bell's kind of more discounted push, just trying to size up the Taco Bell business, and then I had a follow-up question.

Rick Carucci

Okay. Well, first of all, we will always be disappointed with any kind of negative same-store sales growth. So, you know, clearly we were down 2% in the first quarter. As you know, the overall industry trends have been negative since June of 2009, and you know, we do have the strongest value position in the category. What we saw in the first quarter was that our transactions were positive, but we did have a lower average guest check, less drinks and combo meals. And you know, we also have, most of our media spend was on the value, the $0.89 beefy five-layer burrito, and so we did have the Why Pay More usage increase to about 20% of our mix versus the 15% of the mix. So this is like – this is, you know, what we were able to obviously maintain. Perhaps, we haven't seen the research yet, even fortify the value position that we know is going to be really essential as we go forward. And we were able to do it in a competitive category, where you are basically, you point out the issue, more and more people are at the low end.

What we really are pleased about is that we had positive transactions. So more people are coming to Taco Bell this year than last year, and so we can build off of that strength. Our biggest challenge is to get same-store sales growing again at Taco Bell. You know, we are obviously happy that the transaction has picked up, but you know, it is much easier to build your sales off of positive transactions. So we believe, as we look at our programs and our initiatives, that our value and our innovation is strong enough for us to get modest same-store sales growth for the balance of the year. And as we pointed out at the Analyst Meeting that we had in New York, we are also extremely enthusiastic about the results we are getting from our more longer term initiatives, breakfast, home meal replacement, beverages, these big sales layers, we have a lot of big ideas in test that we are feeling better and better about as we go forward.

So, we are very optimistic about the future of this brand. You know, we think we can get modest same-store sales growth for the balance of the year, but let us slug it out. I mean, it is definitely a slug-it-out category right now. What we are most excited about is just the long-term prospects of Taco Bell, where we begin to add some of these sales layers that we are talking about that we think can actually help us become a net new unit developer of Taco Bell. So brands, moving along, competing well in a very tough category with all kinds of upside.

Jeffrey Bernstein – Barclays Capital

Okay, and just a separate question as it relates to China, the positive 4% comp, I know last quarter you were hesitant to really call much in the way of trends in China because of the whole New Year shift. And with that now behind us, I think you feel that the New Year shift was pretty strong. Are you able to size up how much of that 4% came from New Year's and kind of otherwise assess the underlying trend or you really can’t even take a stab at it until we do another couple of months?

Rick Carucci

Yes, it is really hard to, and that is why we sort of said before, and I still believe that we will have a better handle as we get through this quarter other than Chinese New Year. We had a very strong holiday, and so that was a good sign, but we haven't seen, we just need a longer period of time before we can judge beyond that.

Jeffrey Bernstein – Barclays Capital

Thank you.

Tim Jerzyk

Thanks, Jeff. Next question please, Janice.

Operator

Your next question comes from the line of John Ivankoe with JP Morgan.

John Ivankoe – JP Morgan

Hi, thanks. I wanted to revisit YRI and the sales performance over the last couple of quarters, and I guess, you know, we don't have a lot of data points, but you look at results like, you know, out of Dominoes, out of McDonald's, even out of Starbucks for example, and their international results are much better, from a same-store sales perspective, even if they are developing units in certain markets. So I mean, can you just kind of go back, you know, to YRI and talk about, you know, I think you mentioned kind of getting back on the new product pipeline in Australia, but is there anything that is really going to change from a management perspective in terms of, you know, core competencies like product development, advertising, operations, maybe even remodels? I mean is there is something that you think really needs to be redone in that marketplace is kind of the first part. And then secondly, you know, looking at the company's store margins in YRI, they continue to be under pressure, and you know, last year, it was evidently because commodity prices were contracted at the same time, but we are not really seeing relief in margins overall there, so if you can just comment on focus on company store margins in the YRI division as well, thanks.

David Novak

All right, John. You know, there is no question that YRI is off to a slow start with comps down 2% and we have got work to do to regain our sales. So you point out the issue and definitely we are on the case. We are focusing on value, primarily in developed markets, given the tough environment. What we are doing is, we are taking a lot of the know how that we have on permanent value menus from the success of markets like in South Africa, which is we have a streetwise menu and we are expanding that successfully into the UK, where it now has like 14% of the mix and a significant amount of incremental sales.

We are also revisiting our core signature items with new insights on products that are very unique in the marketplace, our Twister and our Singer sandwiches for example. And we have also put together an initiative where we are launching regional successes from the past into new markets, like the Wrap Star sandwich, Fillers, and Hot Rods, these are promotions that have done well in other markets that we will be moving into new markets. So we are trying to roll out and expand the proven winners into more geographies. We also are continuing to roll out new incremental sales layers. So Crushers, which is our line of frozen beverages is now in 2000 units and we are shooting to have it at 4000 units by the end of the year. So we expect that to give us a bit of a lift. And we are hopeful that we will see a better half, a better second half in 2010. You know, our first half lap was plus 4% of sales and the second half is minus 1%. So we are hopeful that with the initiatives we have got going, we will be able to see better performance in YRI. So you know, we are definitely on the case. I think the team, our management is working on the right things, and you know, we are going to make progress.

Rick Carucci

Yes, regarding your question on the margins, John, that is pretty much driven by where we had sales weakness and strength. Your point is not really driven by commodities. Commodities don't have the shifts in YRI that we have had in the U.S. or China over the last few years. So as we said before, they are relatively flat. So, a couple of our businesses, like Pizza Hut UK, as David said, in his speech and comments, they have been under-performing and that hurt our overall YRI margins. And Pizza Hut in the UK is, you know higher transaction businesses and the economy is a little soft. Our experience is they usually suffer a little bit more. So the margins have pretty much followed the sales in this case, so Australia is an equity business, as David said, it isn't performing as well as normal and you saw that in the release. So that has also hurt on the margin side. So Australia, and Pizza Hut UK are two of the countries that brought the margin down in the first quarter.

John Ivankoe – JP Morgan

And in terms of that value menu, I mean, how significant will that be across YRI in 2010, I mean, what is the timing of some of that? The value menu?

Rick Carucci

It is hard to quantify, because, you know, John, we have been doing value for a while. So quite a few countries already have sort of a value menu. So what they are trying to do is to bring those learnings to other markets, it is done sequentially, so it is not like we have a launch of value July 1. A lot of countries have already had it; we are introducing it in more countries as we speak. So there is not an event that we could really quantify easily.

John Ivankoe – JP Morgan

Thank you.

Tim Jerzyk

Thanks, John. Next question please, Janice.

Operator

Your next question comes from the line of Joe Buckley with Banc of America Merrill Lynch.

Joe Buckley – Banc of America Merrill Lynch

Hi, thank you. Two questions as well. In China, was there any natural advantage to the New Year falling in February as opposed to January, or is it immaterial which month it falls in?

David Novak

It doesn't really matter that much. It is just more a function of, you know, we have lap in terms of outside of China YRI, because sometimes it falls in the quarter, out of the quarter. But we really haven't seen anything dramatic in shifts between January and February.

Joe Buckley – Banc of America Merrill Lynch

Okay. And the plus 4% in mainland China, were transactions up more than that, was check actually down, or would check be flattish and transactions up around 4%?

Rick Carucci

I don't have the exact numbers, but it is similar.

Joe Buckley – Banc of America Merrill Lynch

Okay.

Rick Carucci

Transactions would have been similar to sales.

Joe Buckley – Banc of America Merrill Lynch

Okay. And lastly, there was some story I was reading about some Internet coupon deal that kind of went awry in China. Is that anything to be concerned about, or is that kind of a minor PR bump in the road?

David Novak

We made a couponing error and caused some concern to some customers. We apologized for doing that. It is a short term issue.

Joe Buckley – Banc of America Merrill Lynch

Okay. And then, two questions on healthcare. Any sense of the cost for Yum!, and then any pushback from franchisees in terms of buying units, you know, with the prospect of higher healthcare costs out of the not-so-distant future?

David Novak

Joe, this year, we anticipate a small impact of about $6 million for the loss of tax reductions for retiree medical benefits. The major impact of this legislation will hit in 2014 and, you know, with our anticipated ownership change, we are going to 5% ownership with Pizza Hut and KFC. By 2014, we think it is going to cost Yum! about $20 million to $30 million based on the existing work force structure that we anticipate. So, as you know, there is lots of legislative details to be ironed out in the next couple of years. The real challenge is that this is going to be about $10,000 to $15,000 per store cost to our franchisees, beginning in 2014. And we are going to work with them to mitigate the cost. So, we have got plenty of time I think to deal with the issue, but it certainly is an issue and you know, I think all this is well understood by any franchisee who would be purchasing stores.

Joe Buckley – Banc of America Merrill Lynch

Okay, thank you.

Tim Jerzyk

Thanks, Joe, next question please, Janice.

Operator

Your next question comes from the line of Keith Siegner with Credit Suisse.

Keith Siegner – Credit Suisse

Thanks. I want to ask a question about Taco Bell. We have walked through the top line initiatives and earlier in the call, you talked about how some of the domestic margin impacts came from the deleverage at Taco Bell. I wanted to ask you if you could give a little bit more detail on the status and opportunity behind the four wall cost save initiative at Taco Bell that Greg Creed laid out at the December Analyst Day. So any details on the status and opportunity there would be appreciated. Thanks.

David Novak

Keith, they have actively implemented all those things. So you are seeing that, saw that part of the results of that last year and you are seeing the continuing benefit now.

Keith Siegner – Credit Suisse

Okay. And then, one other question. The charge for the KFC units that are looking to be refranchised, was this for all of the units, like all 600 that you hope to refranchise, was this just a portion? And if it is just a portion, roughly how many was discharged in relation to how many units?

David Novak

We have just sort of said it is a significant portion. So it is the lion's share of what we think we are going to be doing.

Keith Siegner – Credit Suisse

Okay, thank you.

Tim Jerzyk

Thanks, Keith. Next question please, Janice.

Operator

Your next question comes from the line of Mitch Speiser with Buckingham Research.

Mitch Speiser – Buckingham Research

Thanks very much, and just another question on China. Just trying to get a sense, with comps up 4% in the first quarter, that was versus an up 2%. And you are saying similar trends, yet the comparison is a whole lot easier I believe that was down 4% in the second quarter last year. If you go back two years, I think the comparisons were similar. So can you maybe just drill down a little bit deeper into why you think the trends would not accelerate? It sounds like you are being conservative, but is there anything that happened in the first quarter on the positive side that maybe doesn't flow through into the second quarter?

Rick Carucci

Yes, Mitch, I mean, we have tried to look at this like you have in different ways. One year or two year, three years actually is sometimes the best way to look at it. And so, I wouldn't overstate the prior year trend. Just remember, last year was sort of an unusual year for China in terms of how people reacted to the economy, more violently than usual. I think as we look at this year, we just sort of, you know, in total, we told you what we believe as we expect moderate growth off of those numbers that you saw in the same quarter last year.

Mitch Speiser – Buckingham Research

Fair enough. And a separate question. I was – in the segment data, corporate expenses I believe came in at around $30 million in the first quarter. It was versus $46 million last year. So that definitely added a couple of cents to earnings. On the corporate expense side, is this $30 million per quarter run rate, is this, should we expect that going forward or was it unusually low in the first quarter and it will renormalize?

Rick Carucci

Yes, it was unusually low. We had an unusually large upside in the first quarter. What we said in December for the full year in the U.S., I will talk to U.S. as well as the Yum! piece of it. On the U.S. side, we saw about a $6 million reduction in G&A. What we said at the beginning of the year, is we expect the impact from refranchising to be in the $20 million range and we thought that we would be able to offset that money through G&A savings, right? So the $6 million in the U.S. and sort of the $13 million in unallocated, we are pretty much at that point now. We will probably get a little bit more upsides the rest of the year, but not nearly as large as what it was the first quarter.

Mitch Speiser – Buckingham Research

Okay, thank you.

Tim Jerzyk

Thanks, Mitch. Janice, we have time for one more question.

Operator

Your last question comes from the line of Steve West with Stifel Nicolaus.

Matt Van Vliet – Stifel Nicolaus

Yes, hi, guys, this is Matt Van Vliet for Steve this morning. Just a question on Pizza Hut and I guess the thought going forward on the next round of promotions, is the $10.00 price point something that is important to keep, whether you limit offerings or just kind of change the messaging there and keep that $10.00 price point or do you feel the sort of variability of getting whatever you want on a pizza is more important than you might raise the price there, maybe just thoughts on that and the potential to really bundle the pasta and the wings and the pizza together, it seems like most of the messaging out there is one or the other and I know you have talked about generating separate occasions for each of those, but maybe just your thoughts on the bundling as well. Thanks.

David Novak

Well, I think that most important thing is relative value. You know, obviously, the $10.00 pizza Any Way You Want It is in the strong relative value, and we are working on ways to keep that alive. This is a very competitive category, so the last thing I would do is tell everybody what we are going to be doing. But I think obviously relative value is the real key here. We are more into creating separate occasions than necessarily bundling. If bundling happens with pasta and chicken, fine, but we think the bigger idea is to try to create separate occasions. I hope that was helpful.

Matt Van Vliet – Stifel Nicolaus

Good, all right. Thank you.

David Novak

All right. Let me wrap things up briefly. You know, just some closing comments here. We continue to execute against our global growth opportunities, both in China as well as Yum! Restaurants International, with our leading industry new unit expansion. Our focus is global, which is particularly strong in emerging markets like China and India. KFC is a leading western brand in many emerging markets and the fastest growing western brand and we are very pleased to be so well positioned in the fastest growing economies of the world, with expanding middle class populations as Rick pointed out earlier.

In the United States, we are making progress, competing in a tough macro environment. We are encouraged by recent sales trends at each of our brands, but know that we have plenty of opportunity to drive value and innovation as we improve operations. We are continuing to make solid progress against our goal of reducing U.S. company ownership to 10% or less, targeting ownership of 5% of both Pizza Hut and KFC.

In closing, 2010 is off to a good start. We had a good quarter and we expect to deliver our target of at least 10% EPS per share. So thank you all for participating in the call. We appreciate the good questions.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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Source: Yum! Brands, Inc. Q1 2010 Earnings Call Transcript
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