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Yum Brands Inc. (YUM)

Q4 2005 Earnings Conference Call

February 7th 2006, 9:15 AM.

Executives:

Tim Jerzyk, Vice President, Investor Relations

David C. Novak, Chairman, President and Chief Executive Officer

Richard T. Carucci, Chief Financial Officer

Analysts:

Joseph Buckley, Bear Stearns

David Palmer, UBS

Rachael Rothman, Merrill Lynch

Larry Miller, Prudential

Jeffrey Bernstein, Lehman Brothers

John Ivankoe, JP Morgan

Steven Kron, Goldman Sachs

Peter Oakes, Piper Jaffray

David Palmer, UBS Warburg

Operator

Good morning my name is Lee and I will be your conference operator today. At this time I would like to welcome everyone to the Yum Brand Incorporated Fourth Quarter 2005 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remark there will be a question and answer session. If you would like to ask a question during this time simply press “*”, then the “1” on your telephone keypad, if you would like to withdraw your question press the “#” key. Thank you. I would now like to turn the conference over to Tim Jerzyk, Vice President of Investor Relations. You may begin sir.

Tim Jerzyk, Vice President, Investor Relations

Thanks Lee and good morning everyone. Thanks for joining us on the call. The 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 then in any future using the recording. I will also like to advise that this conference will include forward-looking statements that reflect management’s expectations based on currently available data. However actual results are subjected to future events and uncertainties. The information in this conference call related to projections or other forward-looking statements maybe relied on subject to our Safe Harbor statements which is included in our earnings release in last night. And may continued to be use while those call remains in the active portion of the company’s website, which will be until 5 PM Eastern Time, Friday, February, 17 2006. On our call today we will have David Novak, Chairman and CEO; and Rick Carucci, our CFO. Following their remarks from both, we will take your questions.

Now I’ll turn the call over to David Novak.

David C. Novak, Chairman, President and Chief Executive Officer

Thank you, Tim, and good morning everybody. As you may have seen from our release last night we reported another year of double digit EPS growth, up 13% exceeding our commitment for at least 10% growth for the fourth year in a row. There is no doubt our diversified global portfolio of leading brands is delivering a consistency level that shareholders desire. That’s why we are focused on building what we call the Yum! Dynasty, becoming acknowledged as a team that wins again and again, which is why we are working to build consistency in all of our businesses around the world. We know the best companies drive growth year-after-year and we want to continue to do the same thing. Going into 2006 we are very confident that we can again grow EPS by at least 10%. In fact, I’m pleased to report that on the strength of fourth quarter results we have already raised our forecasted EPS for 2006 to $2.79, which includes options expenses or growth of at least 10%.

For 2005 prior to option expense, worldwide operating profits was up 7% and worldwide system sales grew by 7%. Given all the challenges we had last year with the ingredient issue in mainland China, the consumer concerns about avian flu, Hurricane Katrina and record gasoline prices, we were obviously pleased to be able to deliver 13% EPS growth behind the strength of our global business. Still we look back on 2005 and think what might have been. You can see that only if China had stayed on its normal growth path we were on our way to a fabulous year. Having said that, stuff happens every year and we still keep hitting the 13% growth level.

Looking ahead to 2006, we are confident that we will deliver at least 10% growth and we are pleased to be off to a great start as you saw in the sales numbers for period one last night. Now let’s review our key highlights from 2005, our early 2006 performance and what we see for the full year based on what we know today. Let me briefly update you on our global expansion progress. First, in our high return China division we are aggressively expanding in the fast food category with KFC and the casual dining category with Pizza Hut new restaurants. Year-over-year unit growth for 2005 was 19%. In mainland China alone, our unit growth rate was 25%, and we expect to open another 400 new units in 2006.

Second, in our high return Yum! Restaurants International division, with over 11,000 restaurants, unit growth continues at a solid 4% rate, led primarily by our over 700 international franchise partners. And we are opening new KFC and Pizza Hut restaurants in over 50 countries. In 2006, we expect to continue our track record of expansion and open 750 new restaurants. Finally, our third key opportunity for growth. US multi-brand expansion continues at a strong pace of 17% year-over-year. We just passed the 3,000 level in terms of number of US multi-brand restaurants at the end of the third quarter. That translates to 17% of our restaurant, US restaurant system. We see further expansion of the multi-brand concept across the US with an expected 550 new additions in 2006. As you can see, we’re continuing to expand our global business on a number of fronts with our portfolio of leading brands. We see plenty of room to continue this profitable expansion.

I’m also pleased to report our blended US same-store sales growth was plus 4% for last year, lapping a solid 3% in 2004. Importantly, despite the issues we had with our significant China business last year, our worldwide system same-store sales grew by 2%. Of course, I don’t want to give you the impression most everything is just perfect in our global portfolio. As always we will talk about where we’re working to get better performance. But at the risk of being too competitive, I do want to point out a very good thing about our company, having a global portfolio of brands, you don’t have to be perfect everywhere to deliver solid consistent results.

Now let me talk in a little more detail about our global portfolio. As we have said, our number one key strategy is to build dominant restaurant brands in China. So let’s look at our China business first.

The January results show that we continue to make slow but sure improvements in sales trends, since the ingredient issues we had in Q2 2005. Based on our research, KFC brand strength in China has returned to previous strong levels, so we expect KFC sales will fully recover overtime. As you saw from the release last night, we’re expecting solid double-digit growth in system sales for Q1 and that is lapping plus 26% growth a year ago. We think that goes well for the future. There is still some concern about avian flu, but consumers seem to be getting more and more used to all the press and becoming less and less concerned about eating fully cooked chicken, which we are aggressively communicating is perfectly safe to eat. We are continuing to move ahead in China with a business-as-usual posture. As a result, you can count on KFC in mainland China to continue to build on its QSR leadership position. If things change in our outlook we will let you know.

We ended 2005 with 1557 KFC’s in mainland China, far exceeding any other similar business there. We are clearly the dominant QSR brand in China. Importantly, KFC in China continues to be a leader in innovation. We were first to bring franchising to mainland China in 1992, first to open a drive-through restaurant in 2002. And we have been very proactive in bringing to our Chinese customers the types of foods that address their concerns for a balanced lifestyle. Now, with all the marketing effort to address the supplier issues behind us our marketing thrust in 2006 is to do what we do best, reemphasize the fun experience of eating our delicious chicken.

Our calendar has lots of product news and we will continue to roll out breakfast, expand our unique line of desserts which we intend to drive an additional sales layer. Our Pizza Hut casual dining business in mainland China had another exceptional year with 35% unit growth and positive same-store sales growth. Our Pizza Hut business in mainland China is even more entrenched as the number one leader in the branded casual dining category. Branded competition, as a matter of fact is virtually nonexistent. And yet we are now over 50 cities. Clearly, Pizza Hut is the dominant casual dining brand. Given that our China division continues to generate the highest return on incremental capital, we are especially pleased that we set a new record with over 400 new restaurant openings for 2005. We expect a similar development level again in 2006. There is no one else in China expanding at this level with the returns we are generating, and we continue to outpace McDonald’s 3 to 1 in expansion.

Our leadership is unquestioned and the gap is growing. We are confident China will grow profits at least 20% this year because of our dramatic new unit expansion in 2005 and because sales are recovering. We are also expanding Pizza Hut Home service and East Dawning concepts and we will update you on our expansion progress later in the year. Again, our goal is to dominate in these two categories. You can count on us to continue to aggressively execute our number one strategy, to build a portfolio of dominant restaurant brands in China.

Our second key strategy is profitable international expansion outside of China with our YRI division. So let’s talk about Yum Restaurants International. This business continues to generate healthy unit growth, earns high returns, and grows profits even while we make substantial investments for the long term in some mega-market opportunities like India, Russia and continental Europe. Our franchise only business continues to perform extremely well. Our franchisees led overall YRI performance for 2005, and as a result, YRI again met our long-term target growth rate of at least plus 5% growth for system sales.

Operating profit grew 14%, which was in the high end of our target range of plus 10 to 15%. Our franchise-only business is an extremely high return business representing nearly 40% of YRIs annual profit and is generating solid unit growth and same-store sales growth. From a shareholder perspective, you’d be pleased to know this growth is very geographically diverse. We are operating KFC and Pizza Hut restaurants in about 100 countries. Our company equity market performance on the other hand has been a bit uneven. Our Mexico and Australian company markets are doing well. However, in the UK and South Korea, our businesses there have not executed as well as we would have liked. We are aggressively working on the marketing and operating opportunities and expect better results later in 2006. As you may recall, Mexico was struggling prior to 2005. We are now back on track and we fully expect strong performance again in 2006.

Importantly, in terms of YRI new restaurant development, we delivered the sixth straight year of over 700 new restaurant openings with a record 780 in 2005. Importantly, 93% of these openings were by our franchise and joint venture partners. Given the number of countries where we operate today, our infrastructure in place, over 700 franchise partners and new mega markets to develop, our confidence is high that we can keep doing this for many years to come.

Now let’s talk about our US portfolio where we continue to be focused on steadily improving operations and expanding with multi brand innovation. Taco Bell in the United States continues to be one of the best and most consistent performers in QSR. The brand is perfectly positioned in the QSR category with the ability to generate brand-building ideas such as the successful Crunch Wrap and the innovative Big Bell value menu. As you saw in last night’s release, the Big Bell value menu delivered great performance yet again with plus 11% same-store sales growth in period one by innovation with a new and better cheesy bean and rice burrito.

The “Think Outside the Bun” advertising campaign continues to break through the clutter and the Taco Bell team delivers impact retail food news. We remain confident in the prospects for Taco Bell to deliver at least plus 2 to 3% same-store sales growth in 2006. Our confidence is backed by a fully tested and locked in calendar for all of 2006. Taco Bell’s growth in the last four years has made it our biggest business in terms of profit generation. As we discussed in our recent December Investor Meeting, we’re beginning to step up unit growth at Taco Bell as unit economics are outstanding for both company and franchise partner development. We are going to make it happen with our exciting newly designed bold choice restaurant design along with KFC and Long John Silver’s as multi-branding partners.

Some of you could be skeptical about being in a growth in the US, but remember Taco Bell only has 5,000 traditional restaurants compared to McDonald’s with 14,000 in the US. Now let me review our KFC US business. We continue to be very pleased with the turnaround at our KFC business, now with 15 straight periods of same-store sales growth with the latest news release last night. As you may have seen, KFC US got off to a great start in 2006 with plus 8% same-store sales growth. The KFC team has done a great job of focusing on our core customer and building new, sustainable sales layers. You should expect to see us continue that approach in 2006. Looking back at 2005, we focused on building sales layers in three areas the individual eating occasion, including, lunch the family home meal replacement occasion at dinner. And distinctive and unique meal options for QSR users. The Snacker chicken sandwich for $0.99 was launched last March and was a huge success. It targeted the individuals looking for great value in a QSR meal. We will continue to build on this KFC sub-brand through 2006.

The KFC Variety Bucket was a hit with families looking for good value and variety in the dinnertime slot. In period 13, a build your own version was a success. We will continue to leverage this KFC product, which provides a unique way for families to solve their home meal replacement needs. Finally, KFC’s Flavor Station, which we launched in the fall of 2005, continues to be a success. It provides a distinctive and totally unique way for the QSR consumer to enjoy chicken. Flavor Station was launched with three favorite sauces offered as a choice to sauce wings. This past month we just came back to Flavor Station featuring bonus wings around a product that is relatively unique within the quick service restaurant category, only at KFC.

And you saw the results last night plus 8% same-store sales growth. Again, as I said earlier, expect KFC to build further on these three key successes in 2006 with even more exciting news to build these new sales layers. In addition we expect to have one totally new product that we’re all excited about and ready to launch later this year that will create a new category for KFC. The key is KFC’s 2006 calendar is fully tested and ready to go. We are currently in a local option window at KFC this period and are market testing for first half 2007. For the year, we have 10 tests planned and ready to go targeted for the 2007 calendar. Importantly, while we’re making great progress at KFC US with our product pipeline development and marketing with very fundamentally sound consumer insights, we are also very focused on steadily improving our operations. We are pleased to report the KFC US system just set a record high with their January chain score of just over 50% with perfect scores. It is a great progress from the low 40s where we were at a year ago, but we still have a long way to go and are as focused as ever to run great restaurants at KFC as well as around the world.

One final note on KFC US. As we have talked in the past about the requirement for the KFC US system to upgrade all restaurants to current standard. We are pleased to report progress continues with about 60% of the system completed. Over the next three years there will be a major upgrade to the restaurant base for KFC in the United States and all the work must be completed by the end of 2008. The key overall take away is we remain very confident KFC US will meet our target for at least 2 to 3% same-store sales growth in 2006.

Now on to Pizza Hut US. For the last year Pizza Hut same store sales were flat. We expected a better Q4 but didn’t quite get there. We continue to see this as a short term bump in the road. We were up 5% in 2004, and flat last year. We are confident the Pizza Hut team is executing the winning long term strategy in a tough competitive category. We still expect to win more than we lose in this category and we expect to be positive in terms of same-store sales for 2006. Frankly, we generated lots of news last year, but did not win on value. We believe we must win on both fronts to consistently drive same-store sales growth, so improving our value offering will be our number one focus while we continue to be the best pizza innovator. Right now we are doing what we do best, pizza innovation by offering our new Cheesy Bites Pizza, it’s a innovative, fun, interactive pizza for the entire family. We are optimistic about making progress at Pizza Hut in 2006.

On the value front the team will be executing value ideas throughout the year, and given the competitive nature of the category I won’t go into the details. What I can say is that we expect Pizza Hut to return to positive same-store sales growth in 2006. In the US, given the strength of our programs we expect solid same-store sales performance again in 2006, at least plus 2 to 3% growth. We also expect at least 5% growth in US operating profit for the year. Financially we are very focused on continuing our track record of excellent financial management. We are committed to invest new capital at the right returns. As a result we expect to maintain our industry leading 18% ROIC. We also continue to build a strong balance sheet, buy back stock with substantial amounts of cash, and pay a meaningful dividend.

Now let me turn it to Rick Carucci, and he will take you few more of the details of the quarter and the trends. Rick?

Richard T. Carucci, Chief Financial Officer

Thank you, David and good morning everyone. I’m going to discuss three items. The review of the fourth quarter, a brief review of the important trends and how these trends impact our 2006 outlook and an update of our cash-flow expectations and our plan for this cash flow.

Let me begin with the quarter four review. Prior to expensing stock options we came in with EPS of $0.81 for the quarter or 11% growth. Overall we are particularly pleased to finish out this challenging year with 13% EPS growth. We had some areas come in more favorable than we thought back in October and of course a number of items came in less favorably than we thought. The good news is we netted out $0.03 better than we thought we would.

Now let’s get into some of the details of our fourth quarter. I will point out that these results exclude stock option expensing. First on the business side, our international division had profit growth in local currency of about 11% before the benefit of the 53rd week. Our franchise only businesses continued to perform extremely well with double-digit sales and profit growth. This performance more than offset some uneven company market performance primarily in the UK business. Overall this division pretty much ended the year as expected.

Our China division results were a major drag on the fourth quarter with weak sales due to avian flu concerns and lingering consumer concerns related to the earlier supplier ingredient issue. As a result, operating profit was $12 million below last year and well below our target level. However, the good news is sales trends appear to have bottomed in the second half of November and as a result we had a better than expected December. Fourth quarter profits were a little better than we thought at our December Investor Meeting.

In the US, same-store sales performance remains solid with 4% blended growth. During the quarter we absorbed about $4 million of one-time costs related to Hurricane Katrina. Additionally, utility costs shot up and were about $3 million more than expected. We expect this energy cost trend to continue into Q1 of this year. Overall we were pleased with the improved US profit performance during the quarter. Before the benefit of an extra week in Q4, US operating profit was up 5% before option expensing. Importantly, US restaurant margin improved by nearly 1 point versus last year prior to the 53rd week benefit. While we’re happy with this improvement, we need to see this improvement continue during 2006. We are very focused on this aspect of our business.

One other point I would like to make about US performance and this is noted in the release last night. As we re-franchise the US business to our target of 20%, this will negatively impact revenue growth. These impacts are noted in the release and we will continue to point them out during 2006. The trade-off is lower revenue from the franchise royalty versus 100% of sales at retail if it were a company unit. Of course, there is normally no Yum! capital invested with a franchise restaurant.

Now just to recap fourth quarter and address why we came in better than expected. Our tax rate was lower than last year, better than we expected and benefited this quarter’s EPS by about $0.05 versus what we had previously expected. China came in about 2 cents better than we thought based on the better December. There were several unanticipated downsides which offset some of these upsides.

Let me briefly walk you through these. Most of these were explained in last night’s release as well. The biggest cost increases were one-time corporate expenses. First we incurred $0.02 of additional expense for discontinued corporate software development projects. We don’t anticipate any additional material costs related to those projects. Second, we incurred $0.02 of additional cost related to long term employee benefit liability. This is driven by actuarial methods and we made an adjustment for a lower discount rate to better reflect market rates and the low interest rate environment. That totaled $0.02.

Third, we made an adjustment to the gain of the Poland IPO reported in Q2 based on all aspects of the deal being closed and audited; this was an additional $1.5 of unexpected cost. Overall we thought it was a greater fourth quarter with growth coming from YRI and the US business within our global portfolio. China had a difficult fourth quarter due to sales performance below our target, but we experienced slightly better than expected December performance. It was good to end the year in China on an upside.

Moving now to 2006. You’ll note in the release this morning that the New Year got off to a really good start with solid period 1 sales results for the US portfolio of plus 5%. We did have some benefit from great US weather. We are confident of reaching our plus 2% to 3% same-store sales growth target for the US in 2006. YRI also got off to a strong start with plus 7% growth in system sales in local currency. We do expect that the UK will remain somewhat of a drag on YRI performance particularly in the first half. However, our franchise only markets remain very strong. As a result, you should expect YRI performance for the first half of 2006 to look very similar to 2005’s results.

Our China division is certainly off to a good start. Our sales are not being impacted by avian flu to the degree they were two months ago. As David said, we will continue to move ahead with the business as usual posture there. When we first look at China performance in 2006, we should reflect on the sales and profit performance during 2005. From a sales perspective, the China division had a great first quarter in 2005, with 26% systems growth. Sales for the balance of the year were soft. The weakest sales period was in the middle of second quarter due to our supplier ingredient issue and the middle of the fourth quarter due to avian flu concerns.

Our China division profit results during 2005 generally mirrored the sales performance. However, our profit performance was particularly below expectations in quarters 2 and 4. Q3 was bolstered by supplier recovery with $14 million benefiting in the third quarter 2005 and 10 million in the fourth quarter. Therefore, when we look at 2006, we expect the year-over-year profit growth to be particularly strong in Q2 and Q4. We also anticipate a relatively weak first quarter in China in 2006.

One trend you should take note of is the higher energy costs we mentioned earlier. That will impact Q1 cost in the US. The impact is about 7 million to $8 million of inflation versus last year, or about 20% inflation on the line item; it represents about 3% of sales. One last point, we do expect about $0.01 of unfavorable foreign currency impact for YRI in Q1. There will be a modest benefit offset in the China division. As always, you can track our progress during the Q4, we provide you with the international division, China division and US sales updates every four-week period.

Now I’d like to briefly update you on our adoption of FAS 123 or employee stock option expensing. The impact is noted in yesterday’s release. We had previously noted that expensing our stock options would have an annual cost of $0.12 per share. The actual results came in at $0.13 as the first quarter was a bit higher than expected. We also anticipate $0.13 cost for full year 2006. Our release last night has all the details on quarterly splits, line of business impact and the breakout between G&A and restaurant costs.

My last topic today is brief review of our cash flow generation. We ended the year with a record of $1.2 billion in net cash provided by operating activities. We invested 609 million in our business for capital spending for the year and generated FCF of $629 million. In addition, we generated 145 million from re-franchising proceeds, $148 million in employee stock option proceeds and $81 million from sales of surplus property and equipment and other items. When you add it all up that is about $1 billion in available cash.

Consistent with our previously stated approach, we delivered most of that substantial cash back to the shareholders in the form of share buyback. 21 million shares to be exact. We think we got a very good value. Diluted Share Count and Shareholders Dividend. Our diluted share count decreased by 2% to 298 million shares for the full year and by 5% in Q4 to 292 million shares. This is the lowest level since quarter four of 2000. In addition, we now pay shareholders a meaningful quarterly dividend, which was recently increased by 15%. For 2006 and 2007, we continue to expect a very similar picture with substantial levels of free cash flow. In addition, our balance sheet continues to strengthen as our key financial ratios continue to improve.

Before I leave cash flow I’d like to point out one key fact. Each business, the US, YRI and China all fund their own growth and each division generates free cash flow. I want to provide a brief update of our ROIC. As David mentioned from a return perspective Yum! achieved another year of 18% ROIC. This is especially encouraging since we were able to achieve this result while absorbing the options expenses previously discussed. We have been able to achieve strong returns at Yum largely from discipline in two areas, first, we continue to be disciplined in our ownership decisions. Over time we have re-franchised our smaller markets and our lower return restaurants. This has allowed us to concentrate our ownership efforts on markets where we achieve scale, strong returns and higher growth. We continued this trend during 2005 as we re-franchised restaurants in the US, Pizza Hut Canada, Pizza Hut France and Pizza Hut Australia. Altogether we re-franchised 524 restaurants globally during 2005.

Second, we maintained strong discipline in building our new units and spending every incremental dollar. This discipline includes quarterly tracking of new unit performance and in-depth capital reviews twice a year. If return performance is strong, we continue to build and invest cash. As an example, we have never capped China expansion as their actual expansion typically exceeds our original capital plan. Similarly, we do not allow markets to spend their annual capital plan if the new unit performance is below our expectation. It is typical for us to reduce our capital spending either in a market or a particularly geography within a market or a particular type of asset. We will continue to maintain this discipline in ownership decisions and new unit capital going forward. As an example we plan to re-franchise more than 450 US restaurants during 2006 and about 170 YRI restaurants.

Finally, we always have the opportunity to acquire a brand that could fit our global portfolio. However, we have said any possible acquisition would need to fulfill three key requirements, one, it must increase Yum’s overall growth rate. Two, it must leverage our international strength and capability. And three, it must generate positive shareholder value with potential upside. Clearly we have seen more opportunity for high return growth in our existing global portfolio and in the opportunity to buy our stock at a good price.

In wrapping up, we expect 2006 to be another successful financial year for our shareholders because we expect to deliver EPS of $2.79 or at least 10% growth versus last year. This assumes the base of $2.54 for 2005, which is post-stock options expense and includes a $0.01 special item credit. Our sales overall in 2006, were off to a strong start. We finished the year better in China than expected; given improving sales in new our unit performance we are optimistic that China will achieve its 20% growth target in 2006. Overall we expect 2006 to be Yum’s fifth consecutive year of double-digit EPS growth and meeting our shareholder commitment of at least 10% EPS growth. Back to you, David.

David C. Novak, Chairman, President and Chief Executive Officer

Rick I think you sounded up very well, why don’t we just go straight to the questions.

Questions-and-Answer Session

Operator

Thank you. At this time I’d like to remind everyone, if you would like to ask a question press “*”, then the “1” on your telephone keypad. And we will pause for just to moment to compile the Q&A raster.

Your first question comes from Joseph Buckley with Bear Stearns

Q - Joseph Buckley

Thank you, couple of questions with respect to China. Talk a little bit about the 12% system wide sales forecast for the first quarter; put that in perspective for us if you can, around the timing of the Chinese New Year and the comparisons from last year?

A - David Novak

The timing of the Chinese New Year, you asked Joe?

Q - Joseph Buckley

Yeah, in January obviously up a lot more than that; much tougher comparison coming in February. And I guess maybe one way to slice it would be, how did system wide sales go as January progressed? I mean, is that number inflated by a big final week of January sales number?

A - David Novak

The answer to that is no. But Rick is going to answer the rest of the question.

A - Richard Carucci

Again, just for everyone’s benefit, the reason it is hard to read China in just January results is that we have a difference in timing of the Chinese New Year between 2005 and 2006. The Chinese New Year occurred in February of 2005 but it is occurring in January of 2006. So we usually get a build up and then very strong sales during that period. So in that sense, sales did increase during the course of the month, but that was related to seasonality. As we said, we’ll have a much better hand on China sales once we look at the full quarter.

Q - Joseph Buckley

What does this 12% imply in terms of same-store sales for mainland China? Can you address that?

A - Richard Carucci

It is probably in the vicinity of down somewhere in the mid-single digit range. But the 22% for January, Joe, was actually better than what would be implied by the calculation you normally would do. It looks like there were a lot of units added near the end of the quarter, so the comp number for January was actually in the high single digit range.

Q - Joseph Buckley

Okay. And then kind of a big picture question. I know you are moving your business model a little bit more towards franchising. Obviously there is a lot of restructuring focused on the industry. You’ve got businesses with disparate growth rates, any thoughts of taking your business model further in one direction or the other or trying to do something to isolate the growth potential in China?

A - Richard Carucci

Why don’t I take that? In terms of the re-franchising in the US, you know we’ve been pretty consistent in trying to re-franchise underperforming restaurants for a period of time. So we will continue to do that. We do that in international as well. In international markets we also continue to divest of low scale or low return markets. So you can expect to see that. In terms of any major restructuring in China in particular, we don’t expect any. You know we are very happy with China; it is still a very high growth, high returning business. So, we love that business and you know we provide information on that as a separate division so investors can take a fair look at that, but we have no plans for doing any significant restructuring.

A - David Novak

I think, I guess one other point on that just in terms of big picture. One of the things that we’ve we just sort of operated up against as a basic tenet of our company from the minute we were spun off is that you, is what we call earn the right to own. You know, we are not going to own anything unless we get a return that well exceeds our cost of capital. We’ve been very disciplined on that, that is why I think our ROIC is leading the industry. And you know we look at every business, every year and analyze its potential down the road. And when we look at China, I mean, we are on the ground floor of an emerging category and there is just no other place we’d rather be. You look at Taco Bell; you see a business where we have a 70% market share. We’re just beginning to grow new units now and we’re also really high on the opportunity for global expansion given the fact that the menu has been improved so significantly from a quality standpoint. And then when you look at KFC and Pizza Hut, we have re-franchised more in those markets because of the lower growth rate. So I think we are extremely financially focused, I think we have a good strategy and I think the last thing I would say is we believe in our core business hugely. That is where we want to spend our money and that’s where we think we can really grow our business.

A - Richard Carucci

Thank you Joe, next question please Lee

Operator

Your next question comes from David Palmer with UBS.

Q - David Palmer

Hi thank you. Could you perhaps delve a little bit into the UK and perhaps Korea, just describe for us what problems you see for your brands there? Thank you.

A - David Novak

Okay. Hey David, you know in our South Korea business we’re in the midst right now of working to get stronger performance there. I want to point out in South Korea it really has minimal impact on our overall growth rate because the business is pretty small. Having said that, you know, working on just improving the overall value equation there and getting products that, you know, we think are more tailored for the Korean taste there. So I think that’s actually, even if we turn it around, sort of a small upside for us for the year. The UK is a much bigger business for us and it is a higher priority in terms of getting the business moving. The one thing I’d point out on the UK, last year was our first soft year we’ve had in the UK, last the previous five years were extremely strong. We think what happened last year is that it was primarily a case of self-inflicted wounds. What we’re doing right now is we’re doing what we always do when our businesses get soft, we’re going back to the consumer, trying to figure out what the big consumer insight is that is going to turn the business around, and do better marketing and steadily improve our operations. I think in the UK we’re doing that in a much more difficult retail environment right now. But I think the teams are very focused on turning the business around and we expect to see progress. But I don’t think we see an immediate turnaround in the UK but I think you will see steady progress throughout the year. Our basic belief is that our brands are extremely strong everywhere around the world. When we go awry one way or the other, it is usually because we are not in tune with the consumer the way, how we need to be with our marketing and our value equation. And, you know, what we’re trying to do overall is institutionalize everywhere what we know really works. And for example, in April we’re going to have a global marketing summit, April 25th. We’re bringing in all of our general managers, all of our CMOs, all of our food innovation people and we’re going through the processes that we know if we consistently apply them and consistently execute them we get great results. That is one thing about being a restaurant company; we can codify what works and leverage our scale. We really are good at this when we execute well, and what we’re try to do now is get everybody better at doing it on a consistent basis. And when we do our business is up. And when we don’t our business is down. Right now in the UK, I don’t have any magic answer to give you right now, other than the fact we haven’t done a great job in marketing and we can do a better job in operations, which is a continual challenge I think around the world. But we just haven’t been in tune with the consumer like we should. But I guarantee you once we get it right, the brand is going to respond just like it does everywhere else, whether it’s the United States, the Mideast or China, you pick the place; when we get the consumer equation right we turn the business around. So this is I think a, what we think is a short-term hiccup, we can certainly manage it within the year. We’re going to make steady progress and just stay tuned. I think you will just kind of have to trust us on this one.

Operator

Your next question comes from Rachael Rothman with Merrill Lynch.

Q - Rachael Rothman

If you could talk a little bit about China for the full year, in light of the troubles that you guys encountered in 2005, I guess I would have expected to see a bigger lift going into 2006, if you could comment on that just for the full year. And then for your tax rate, I know you guys said it was 5 cents in the quarter versus what you had said in your third quarter press release. Can you talk a little bit about what tax rate guidance is embedded in your 2006 EPS estimate and what changed between now and third quarter? Thanks.

A - Richard Carucci

Okay. Let me talk first about China then we’ll move to the tax rate. Again China, the reminder is lapping, first quarter lapping very strong numbers that we had in first quarter of 2005. So you know, given the fact we had softness from first the supplier issue and then from avian flu, we were expecting our sales to struggle in the year-over-year comparisons in the first quarter. If you look at the balance of the year from a sales basis, sales after Q4 relatively weak throughout the year as I mentioned earlier. So we do expect our year-over-year growth rate to strengthen as the year unfolds. Regarding the tax rate, first of all, I was very happy with the tax performance. It was better than what we thought. But still, the full year number came in within our range; our full year tax rate was 26.2%. The Quarter 4 number was better than we thought really because the full year rate was better than we thought. So the tax team has done a great job again in 2005 delivering a fantastic result. In 2006, our guidance remains the same, which is the 26% to 28% tax rate for the full year. We don’t have any input on quarterization at this point, there’s a lot of moving parts, but our full year rate is 26 to 28.

A - David Novak

And I guess one other point on China; it’s obvious I think from your question you think we might be being conservative. I think last year we built 400 restaurants; we have that going into the year, that helps drive the profits, obviously. What we’re committed to doing is driving at least 20% profit growth in China. We’re confident we can do it this year. If we can beat it, we will. So I think that 20% rate is something that we think can drive profitable growth with and we’re confident that we can do it.

Q - Rachael Rothman

And then just quickly, have we seen the last of the Sudan 1 recovery or are you guys expecting another redemption or recovery in first quarter?

A - Richard Carucci

Can you repeat the question?

Q - Rachael Rothman

Sorry, yeah.

A - Richard Carucci

In terms of financial recovery from the supplier, we are not expecting anything in 2006.

Q - Rachael Rothman

Alright, perfect. Thank you so much.

A - Richard Carucci

Thank you, Rachael. Next question please Lee.

Operator

Your next question comes from Larry Miller with Prudential.

Q - Larry Miller

Hi thanks. First, if I could just, I have two questions, but if I could just follow-up on a previous question. In period 1, YRI sales were up well over 2%, that’s the first time I have seen it in several quarters. And I was curious, was that the strength of the franchise only business you mentioned or was there some turn potentially in the UK?

A - David Novak

The number was actually 7% in local currency terms for YRI in P1. As far as the trends, Larry, it was basically a continuation of what you saw in the fourth quarter and for most of last year. There really wasn’t any change at all business to business.

Q - Lawrence Miller

Okay. Thanks. And then you talked about acquisitions and you have rumored to be either interested or a potential bidder in some of the recent brands like Dunkin’ and Quiznos. Can you talk about, just generally speaking, how you view acquisitions, what holes you might have in the portfolio and then the number of brands you guys think you can effectively operate in the US?

A - David Novak

I think that, you know, we are looking at, when we look at acquisitions, the first thing I want to say is we like our core business. We don’t like our core business, we love our core business. We have so much upside in terms of growing our brands globally and we actually believe we are going to be able to get growth in the US, okay, this year and beyond in terms of new units. So we don’t believe we have to acquire anything to continue to grow at least 10% in EPS growth, so having said that, we look at everything all the time. We’re a big company; we wouldn’t be doing our shareholders a very good service if we didn’t look at options that were out there. Anything that we would acquire we’d want to improve overall growth rate, we’d want it to leverage our international capabilities and we’d want it to provide obvious shareholder value with a significant upside going forward. This is not an easy screen to pass these days. Just, there isn’t a whole lot out there that we think has a lot more potential than our current business, and frankly people are paying extraordinary prices for things right now, and that is just kind of hard for us to rationalize. So we’re going to just stay close to the knitting, do what we do best, which is grow our business. And we’ll keep looking at things as they come along. We will be rumored to be in everything that anybody is buying because we are obviously one of the few strategic buyers out there and, you know, we’re learning what we can. But the main thing I want to point out is we love our core business.

Q - Lawrence Miller

You think you have the capability to run several more brands?

A - David Novak

I think we could run a lot more brands if we wanted to. The real question is whether it is going to add a lot of value for our shareholders. If we buy, any brand that we’d buy we’d look at management capability, you know we’d consider a lot of different things. We want to be the leader in branded restaurant choice. And in that includes multi-branding great brands. That is what we want to be the best in the world in. Right now we have the number one leading brand in the world in Mexican category with Taco Bell, 70 shares. Pizza Hut number one pizza brand, KFC number one in chicken with a 50% share of fried chicken. We got the leader in fish and we got A&W which gives us a hamburger entry. So we are in the five major categories right now. And we don’t have Taco Bell, Long John Silver or A&W at all seeded on an international basis.

Q - Lawrence Miller

Okay.

A - David Novak

So we have plenty of upside as we go forward. And our challenge is just to get the right re-sourcing up against the biggest ideas that we have so we pace and sequence properly so we can get great, continue to get excellent growth with great returns.

Q - Lawrence Miller

Okay, thanks. Last question. You talked about some communications you were doing in China regarding the bird flu. First of all, what are you guys doing? And secondly, was that partly behind the reason that you saw less impact in terms of sales impact?

A - David Novak

Well, I think first of all we have been communicating in our restaurants that fully cooked chicken is safe to eat; our product is safe to eat. It is not going to be an issue as it relates to avian flu. I think that when you have something that hangs around and lingers in the press for a long time, after a while the consumer kind of gets tone deaf to it and you get back to normal. And I think that is what we’re seeing right now, is that it’s obvious a potential factor, but it is sort of business as usual, upward and onward, and people are getting back into their normal consumer habits. You know, we think it’s had a little bit of a lingering effect, but it’s not something we can point to a dramatic impact at this stage.

Q - Lawrence Miller

Thank you very much.

A - David Novak

Thank Larry. Next question please Lee.

Operator

Your next question comes from Jeffrey Bernstein with Lehman Brothers.

Q - Jeffrey Bernstein

Thank you very much. First for David on the broad quick-service chicken category, I know you have seen some recent success at KFC. You mention in the release what you think is a clear turnaround for the brand in ‘05. Just wondering, first, if you think, I guess if you attribute the recent strengthening in sales primarily to the new products you spoke about. And I guess importantly, do you think the brand can maintain these consistent results or would you think you might be in for a little bit more near-term volatility. Seems like there is ongoing in, and now new competitive pressures from a lot of the varied menu category focusing on more chicken and less beef. Just wondering your big picture thoughts? Thanks.

A - David Novak

I think the chicken onslaught of competition has been around for quite a while now because the category, the chicken category is a dynamic category and it’s growing. We’re very confident about 2006 at KFC for one simple reason. We tested everything. You know, we put it into our field ready process. We’ve done multiple test markets, and the products we’ll be rolling this year we are very confident that we’re going to overlap last year because we saw that kind of performance in test market. The one thing I feel extremely good about with KFC is that you know brands need to find their sweet spot. And you know what we’re doing is we’ve really found the sweet spot for KFC in the sense that we are proud as hell to serve fried food. You know, and leveraging purchase frequency up against our core user and you’re going to see that, with products like the Variety Bucket, the Snacker, the Flavor Station, all these are great tasting, fried products that are you know right in the mainstream of what we do. And I think that we’re very confident that we have a lot of news coming that will sustain the trend. In February, for example, we’re doing a local market window where we’ll be testing a number of different ideas for KFC. We’ll have 10 test markets this year for KFC and hopefully that will feed into 2007. This is the same marketing process that we used at Taco Bell, which has helped us drive consistent same-store sales. It is also the same process that I was making, mentioned to early that we are going to be training all of our people on in April. Because we know what to do we just got to execute it consistently. So I’m very confident that the KFC team has its act together and we are going to be able to sustain this.

Operator

Your next question comes from John Ivankoe with JP Morgan.

Q - John Ivankoe

Great, hi thanks, two questions. Rick, the first one is for you. Could you help us understand, and this is as it relates to the YRI company store margins, how much those margins were actually helped by re-franchising presumably in fourth quarter and what the effect of re-franchising will be in ‘06? And if you could also quantify the incremental investment in some of the development markets as it affected margin in the fourth quarter and ‘06 as well? And then I have a follow-up.

A - Richard Carucci

John, just on that first piece, a couple of the details on the margin for YRI, there was actually, the Puerto Rico re-franchising is still a negative impact on margins as we have explained. If you go back to some of the earlier releases, I think maybe in the first quarter. So…

Q - John Ivankoe

How much was that just as a reminder in the fourth quarter?

A - Richard Carucci

It was less than half a point, it was like in the 3, 4 tenths of a point kind of range. That was negative and then the rest of the re-franchising that we mentioned going on last year at YRI was probably about the opposite impact positively. So net, right for last year was probably no impact, just because of the Puerto Rico re-franchising in late 2004.

Q - John Ivankoe

So, it is therefore fair to assume Puerto Rico is now lapped and so your re-franchising will actually be a benefit then in 2006?

A - Richard Carucci

Yes, it should be.

Q - John Ivankoe

Okay. What about the development markets incremental, positive or negative as it affected margins in the fourth quarter and ‘06?

A - Richard Carucci

Probably slightly negative, but the big problem we have in margin in 2005 for YRI was this performance of the UK and the Korea markets. That by far was bigger than any of the re-franchising impact. So to your point, the slight benefit of re-franchising in 2006, slight negative of developing markets in 2006. But our margins are going to be based on our performance overtime in the UK and that primarily UK but our other company-owned markets.

Q - John Ivankoe

It didn’t look like there was anything particularly unusual on the sales side in the fourth quarter. Was it all just, that was all comp driven relative to the previous quarters in the year? The fourth quarter performance?

A - Richard Carucci

Again, what’s occurred in the second half for YRI, we expect to continue at least into the first quarter and up to the first half, is overall sales have been about, have been pretty good. But it has been weak company-owned markets and very strong franchise markets. The UK never really recovered from the bombings in the middle of the year and the retail environment there. So that has sort of kept the lid on the sales within that market and that impacts the margins. So overall sales again as we said before, has been sort of uneven company performance and very strong franchise performance.

Q - John Ivankoe

Okay. And if I may, David Novak, a question for you as it relates to Pizza Hut. It is clear the US businesses have understood what well tested product development means and how successful Taco Bell and now KFC has been in terms of achieving desired results in any given period. Could you juxtapose that with Pizza Hut and secondly give us confidence that the value strategy that you are enacting in 2006 will bring better results than the value product you ran in the period one brought?

A - David Novak

I think if you look at Taco Bell and KFC last year, one thing that they both have when you look at our consumer ratings is we improved our value perceptions. KFC through primarily due to launch of the Snacker, $4 meals, Variety Bucket, Taco Bell through the launch of the Big Bell value menu. When you look at the difference with Pizza Hut, Pizza Hut stood, spent too long on the product innovation side without having the right arsenal on the value side, whereas, while Domino’s was launching $5 pizzas and now their $7 spectacular 7s and there was lots of counting. We were too focused on just single mindedly on the product innovation. We’re working at how do you improve your value equation and defend your economics in the category right now. That is always a balancing act. You know we do not have a Big Bell value menu today; we don’t have the Snacker today at Pizza Hut. We’re working on getting that. We are going to slug it out with all of our couponing and price promotions, like we just recently did the Pizza Hut pairs; we think that the Pizza Hut pairs could be a consistent value layer to go along with our product innovation. But I think, John, the proof is really going to be in the pudding in terms of how we put all this together and I don’t think there’s anything I could say today that would make you confident other than the fact that when you start seeing it show up in our same-store sales. And that is what we are committed to doing.

Q - John Ivankoe

Well David, even in period 1, I mean a negative 4, you know is kind of a bad number regardless of what the comparisons were. Why that, I mean, if we were to just look at that one period on a post mortem basis, why don’t you think that resonated with the consumers at all?

A - David Novak

We had an advertising campaign or execution that was very confusing. You know we didn’t really articulate what the view, what the deal was. While it was cute and you had, but we looked at it, we didn’t communicate it as well as we could have.

Q - John Ivankoe

And that go through the testing process you’re currently using for the brand for other products?

A - David Novak

You know, processes are like a hammer. A hammer works, right? But if I use a hammer it doesn’t work very well sometimes because I’m not very good carpenter, okay. You’ve got to have, there’s some human element that comes into every process. We made a, you know, we had somebody using a hammer that did a pretty poor job with it last time. Okay. There is no process that is going to execute anything. It takes people to execute things. When you have a big business around the world sometimes you’re going to miss, even if you know what is right, okay. We clearly can do better. I can tell you the Pizza Hut team definitely feels the pressure, okay, to improve their execution. But I’m very confident at the same time that we got the team that can get that done.

A - Richard Carucci

John, one further point. I do think you are going to see more fluctuation in Pizza Hut than some of our other brands, one because of the competitive factor. And secondly, you tend to buy one or two products at a time. You know, you order a pizza for the evening. When we do value, for example, in Taco Bell or KFC, oftentimes people will have a separate occasion for that value or will add it on to a meal they were purchasing. For example, the Snacker at $0.99, some people would come in as a special occasion for that, which is what we wanted. But we also got people who were buying a bucket of chicken and then, while they are waiting in the drive, while they are driving home eating the Snacker. I do think the other brands have a few more levers to play than Pizza Hut.

A - David Novak

The other thing, too, I would say is we are damn good at innovation. And what we just launched with this Cheesy Bites Pizza, if you haven’t tried it, you ought to try it. It is eye popping pizza, visually looks very unique and different. And it is a great tasting product. So we are not all stupid all the time at Pizza Hut, okay. What you brought up about how we did value the last period kind of sounds like me at one of our monthly calls. And, I think in retail one of the things happening is you’ve got to be right everyday to win. We’re right more times than we’re wrong. And we’ll be right more times in the future than we’re wrong.

Q - John Ivankoe

Good. Enough thanks.

Operator

Your next question comes from Steven Kron with Goldman Sachs.

Q - Steven Kron

Great thanks, hi guys. I have two questions, the first one to follow-up. David, you mentioned your studies would suggest that the brand strength and the brand positioning of KFC in China is back to maybe pre-Sudan 1 level. That would kind of imply that the negative comps that you’re seeing there is more of a function of perhaps avian flu, unless it’s competitive environment or cannibalization. But my question, maybe you can address that, but my question is really I think you talked about pulling back on your consumer communication. I’m just wondering why educating them now is still not relevant and then I will…

A - David Novak

We still educate people in store about, you know, the safety of our product. That is happening. But last year with Sudan Red, for example, we had to go out on television, we had safety assurance ads, where we literally went back, and a lot of our ads said our products were safe to eat, we focused on quality. It was more serious in tonality than what we would have liked to do on an ideal basis. Now we are back into doing what we do. Which is we sell fun food, it’s delicious to eat, brings people together, happy times, good times. That is really what we want to focus on. Last year we had to sort of batten down the hatches and make people feel, understand that we were committed to food safety, committed to them and apologize, which is something you need to do in China, we apologized for the error in our supply chain. And so we were kind of on the defensive. Now we’re back on the offense.

A - Richard Carucci

And Steven, just to clarify we haven’t said we are back to the previous levels. As Tim pointed out if you try to sort through, we think we are down in the single digit same-store level roughly in China right now. To David’s point, at that level you can talk to the consumer about our news and our products, quality, etc. When you are down in the 20% range, you have a different message. So we like the arena we’re playing in now and that plays to our historical strength.

Q - Steven Kron

Okay. The second question I had also in China is for you, Rick. You reported restaurant margins in fourth quarter 13.9. I guess the question is, is the margin, should we be looking at margin decline coming solely from these negative comps or are there other things on the cost side that may keep margins a little bit more at bay as we start to get sales recovery? And maybe you could just talk about the margin build as we move through the year.

A - Richard Carucci

Well, the margin is primarily driven by the sales. We saw that during the year. The team actually did a great job when sales did come back of quickly getting the margin back. When you look at the sales performance and the margin performance, it correlates exactly in China. We are very confident that our cost controls there are good and that when the sales come back the margins will come back.

A - David Novak

Steven, in terms of the other components you will see, we are still seeing labor inflation and we expect that to continue, probably mid-single digit range. But we’re also continuing to work on getting product cost efficiencies that; we definitely have plenty of room there. You will see some within the restaurant cost level you will see some offsets, food cost likely coming down and labor going up.

Q - Steven Kron

Okay thanks.

A - David Novak

Thanks Steven. Next question please.

Operator

Your next question comes from Peter Oakes with Piper Jaffray.

Q - Peter Oakes

Hi good morning. Going back over to Pizza Hut for a moment, is the comp there benefiting by approximately 1% still from Wing Street?

A - Richard Carucci

Yes, that would be the case.

Q - Peter Oakes

Okay. Now that Wing Street is getting the critical mass that it is, is that prompting, some reallocation of the marketing spend at Pizza Hut possibly contributing to that?

A - Richard Carucci

Yeah, Wing Street is still growing and we expect to get a lot more traction actually in this year as we get more franchisees into it. The marketing for Wing Street is incremental and not out of the Pizza Hut budget.

Q - Peter Oakes

Okay, that is helpful. And actually, on multi-branding as a whole this quarter, you didn’t break out the composition. Is that something you will go back to, breaking it out so we can see that or is this kind of new disclosure going forward?

A - Tim Jerzyk

It is available on the website. There is a link at the end of the release, Peter, and just go to the link and click on it, the same schedule will pop up that is on the website.

Q - Peter Oakes

Thanks a lot.

A - Tim Jerzyk

Thanks Peter. Next question please Lee.

Operator

Our final question comes from David Palmer with UBS Warburg.

Q - David Palmer

Could you perhaps remind us if you anticipate reported gains or losses from re-franchising and obviously this will happen both in US and in International? Not only in 2006, but over the next few years and while you are at it could you remind us if you had some guidance or give us some feel as to cash proceeds from re-franchising, not just 2006 but over the next few years? Thanks very much.

A - Richard Carucci

I will start and I’ll let Tim fill in. For 2006 of re-franchising we said 0 to 15 million in terms of the P&L impact in ‘06. We also said over a two year period about a flat impact from re-franchising.

A - Tim Jerzyk

Yeah, re-franchising proceeds, David, will be about in the same range as you saw for ‘05 in that 1, 50s kind of range. It will depend, you know the timing will definitely vary and you know all dependent upon when we close these deals and we want to do it the right way so that when we turn these businesses over to our franchisees they’re locked and ready to go. So it’s very difficult to project the timing, but that is kind of what we expect on average over the next couple of years.

Q - David Palmer

Okay thank you.

David C. Novak, Chairman, President and CEO

Okay well let me rap it up reporting we will sigh out. In summary, we had a good fourth quarter and we had another very good year last year, up 13% in EPS. As we look into 2006, the business is off to a good start. China is getting better; UK is our biggest challenge, with our Yum Restaurants International Business, Pizza Hut is our biggest challenge in the United States. I can assure you we are all over both of those opportunities. And when you add it all up, we’re very confident that we continue to generate at least 10% EPS growth in 2005 with our portfolio and 2006, I’m sorry, and we’ll do better if we can. Hi thank you very much and appreciate you all.

Operator

Ladies and gentleman this concludes today’s Yum Brand Incorporated Fourth Quarter 2005 Earnings Conference Call. You may now disconnect.

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