Yum Brands Inc (YUM) — Q1 2015 Earnings Call Transcript

Thanks, Lisa. Good morning everyone and thank you for joining us. On our call today are Greg Creed, our CEO; and Pat Grismer, our CFO. Following remarks from Greg and Pat, we will take your questions. Before we get started, I would like to remind you that this conference call includes forward-looking statements. Forward-looking statements are subject to future events and uncertainties that could cause our actual results to differ materially from these statements. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC. In addition, please refer to the Investors section of the Yum! Brands’ website at yum.com to find disclosures and reconciliations of non-GAAP financial measures that may be used on today's call. We are broadcasting this conference call via our website. This call is also being recorded and will be available for playback. Please be advised that if you ask a question, it will be included in both our live conference and in any future use of the recording. Finally, we would like to make you aware of the following upcoming Yum! Investor events. Our China Investor Conference will be held Wednesday, May 13th to May 14th in Shanghai, China. This will be followed by the India Investor Conference on Saturday, May 16th in New Delhi. Our second quarter earnings will be released on Tuesday, July 14th. With that, I would now like to turn the call over to Mr. Greg Creed.

Thank you, Steve, and good morning everyone. You can never be pleased when you report an EPS decline for the quarter, but the story behind the numbers gives me even more confidence that we can and will deliver at least 10% EPS growth in 2015. I would summarize our performance as our KFC and Taco Bell divisions are firing on all cylinders. China is clearly improving and there’s still much work to be done at Pizza Hut. Let’s start with China. Same-store sales declined 12% for the quarter. The best I could tell the whole story. The fact is that the business is clearly improving. Same-store sales and customer metrics continue to move in the right direction. In addition, the team has done an impressive job managing costs and delivered restaurant margins of nearly 19% in the quarter. It’s the combination of these three elements that gives me confidence we will deliver on the first half, second half performance transformation I described at our Analyst Meeting in December. Just last month, Sam Su and I assembled a task force to share insights and experience on other parts of our business with the KFC China team. While the local team clearly has an unsurpassed knowledge of the China market, other teams from around the Yum! world have broad expertise and know-how that we thought could benefit the China team and vice-versa. It was tremendous teamwork and best practice sharing going both ways and I was truly impressed by the talent of our teams. We also reviewed China’s marketing plans for each brand and are even more confident in our outlook for the year and the strong second half we expect. And here is why. First, KFC. We recently launched the first of our two menu revamps planned for the year. This initiative will take over the next three months and includes eight new products focused on lunch and dinner. In addition to traditional KFC offerings, this revamp includes products that cater to consumers interested in healthy alternatives such as herbal tea and seafood. We’re also continuing our premium coffee rollout priced 40% below Starbucks and 20% below McCafe; our freshly ground coffee is offered throughout the day. Initial readings show an incremental weekly sales lift of around $300 per store and we’re just getting started. As of quarter end, we were in 1,300 stores spanning 10 cities. By year-end, we expect to have premium coffee in almost 2,500 stores. Our expectation is that coffee will become a solid sales layer to further build growth upon. And we continue to innovate on all fronts, not just our menu; this includes accelerating active enhancements, digital marketing, and leveraging our online delivery platform. Clearly, there’s a lot to be excited about with KFC China. At Pizza Hut Casual Dining in China, we are also encouraged by the ongoing improvement in same-store sales. We’re leveraging the assets throughout the day with the rollout of breakfast and continue to expand our late-night offerings. Pizza Hut is a new product development machine and we’re excited about the recent launch of our sizzling fajitas leveraging our innovative platform. In addition to the Pizza Hut Casual Dining business, we continue to expand our home service offering where we’re approaching 300 units in China. This business offers a diverse menu with Chinese food comprising nearly half of its products. Any way you look at it, the Pizza Hut business has a long runway for growth in China. So to summarize China, we’re making continued progress with sales and customer metrics. We’re pleased with the productivity gains in our restaurants, and we have confidence in our marketing plans for the balance of the year. Most importantly, we continue to develop new restaurants with confidence, laying the foundation for future growth in the world’s fastest-growing economy. Outside of China, I’m excited to report that the strong momentum at KFC continued. Same-store sales growth of 5% built upon last quarter’s 4%. The division opened 72 new international restaurants in 36 countries. Nearly 80% of these restaurants were opened in emerging markets. I was particularly pleased with the continued impressive growth from our Russia business, where system sales grew nearly 50% in constant currency. Simply put, KFC is a franchise-led global powerhouse with a significant lead in many emerging markets and tremendous growth ahead. With its always-original positioning, I believe KFC is poised to deliver consistently strong results going forward. One of the significant competitive advantages KFC has is its partnership with strong international franchisees. I personally believe that our franchisees are one of our company’s greatest assets, and one of the keys to success in this business is to work with your franchise partners. On February 27th, the KFC U.S. team led by Jason Marker reached an agreement with our franchisees to work together as true partners. This agreement gives us clear marketing control for the first time, as well as an accelerated path to improve assets and customer experience. Pat will share the financial details with you during his remarks. Moving to our Pizza Hut division, where our results have admittedly been soft and worse yet we’re being outperformed by the competition. As you know, we recently launched a new pizza platform in the U.S., where over half the division’s profits are generated. This new platform gives our customers unparalleled variety with exciting new toppings, crusts, and flavors. Unfortunately, we haven’t been as effective as we’ve liked with our marketing and need to balance its appeal to Millennials with mainstream pizza customers. We intend to do this going forward while working with our franchisees to bring more competitive value to the market. I’d like to take this opportunity to announce an investment we’ve made that will improve our company’s capability and benefit Pizza Hut and all of Yum! Clearly, one of the towering strengths of Taco Bell is its superb consumer insights. Over the years, a lot of this came from the Collider-Laban insights-driven marketing company. Because better consumer insights is one of our key priorities, we decided to bring Collider in-house. Its very first priority will be Pizza Hut in the U.S. In fact, we made its former president, Jeff Fox, the Chief Concept and Brand Officer of the division. We believe Collider’s insights will be extremely valuable to Yum! overall, and it’s going to start with Pizza Hut. On the international front, Pizza Hut continues to expand rapidly, and we opened 35 new international restaurants in 20 countries during the quarter. Our brand-focused structure is clearly paying dividends on the development front, and we expect record international expansion this year. We’re also making the needed investments in digital for all of Pizza Hut. We have a firm grasp on what needs to improve and are taking the necessary actions globally to drive better performance. Now turning to Taco Bell, which had another great quarter. Same-store sales grew 6%, and operating profit jumped 37%. The division opened 47 new restaurants, with franchises opening 89% of these units. I’ve never been more confident in Taco Bell’s ability to reach its goal of becoming a $14 billion business with 8,000 restaurants. By all measures, Taco Bell continues to go from strength to strength, and I’m thrilled to see the team take the brand to a whole new level. Breakfast is doing well, accounting for a 6% mix, and the restaurant margins approach 20%. I recently spent time in some test markets and seen what they have in store, and I can assure you our innovation pipeline will remain strong. Internationally, also continues to build upon the strong momentum from 2014, with 5% same-store sales growth in the quarter and particularly strong performance in Latin America and Canada. While internationally it’s only a small contributor today, we continue to build brand awareness and to improve our economic model as we look to accelerate our international growth plans. So in conclusion, we are making great strides across Yum! I could not be more excited about the opportunities ahead of us as we recover in China, build upon our existing momentum at KFC and Taco Bell, and focus on turning around Pizza Hut. I’m especially encouraged by the bench of talent we have across Yum! and how we are leveraging that to benefit the entire organization. We are in a unique position at Yum! with three distinct brands that we will strengthen and grow into three iconic global brands that people trust and champion. We remain focused on the three keys to driving shareholder value: same-store sales growth, new unit development, and generating high returns on invested capital. I believe this combination of efforts will enable us to re-establish our track record of consistently delivering double-digit EPS growth in 2015 and the years ahead. And with that, I’ll turn over to my partner, Pat.

Thank you, Greg, and good morning everyone. Today I’ll discuss our first quarter results and share perspective on our second quarter and full year outlook. First quarter earnings per share excluding special items decreased 8%, which was substantially better than the decline we were originally expecting. I’m pleased with the quality of this upside, as it was led by better-than-expected sales and restaurant margins at KFC China. With the overall trend sustaining in China and with the most outstanding momentum we have in our Taco Bell and KFC businesses, we’re confident that we’ll have a strong second half and deliver at least 10% EPS growth this year, even with stronger-than-expected headwinds from foreign exchange. Now I’d like to provide some color on our first quarter results by division. In China, operating profit declined 31% prior to foreign currency translation, as same-store sales were down 12% in the quarter. Sales were strong during the Chinese New Year period, comprising the last two weeks of China’s eight-week fiscal quarter. Although restaurant margins of 19% were 4.5 percentage points lower than last year due to transaction de-leverage, this was a significant improvement over the 7-point decline we experienced in the preceding quarter, as pricing and labor productivity more than offset inflation in food and labor costs. What this means is that restaurant level profit flow-through is actually getting stronger, thanks to the hard work of our local team to deploy labor more efficiently and manage a more profitable mix of menu items. More importantly, this bolsters our belief that China division restaurant margins will return to the 20% range as sales are recovered and that this recovery has the potential to unlock approximately $600 million of operating profit. Another important driver of our growth in China is new unit development, and because we continue to shift our development focus to lower-tier cities, tighten our site criteria, and improve our investment model, we’ve been able to maintain a high rate of new store openings despite the temporary softness we’ve seen in top-line results. In the first quarter alone, we opened 171 new restaurants in China, that’s an average of nearly three restaurants per day, bearing in mind that China’s first quarter spans the months of January and February. We’re confident that these investments will yield strong returns and continue to expect 700 new restaurants this year. Also, with the breadth of our market presence and the scale of our development team, we have the ability to capitalize on China’s expanding economy in a way that no one else can in our sector. Moving to our global KFC division, which posted a very strong quarter with solid growth in sales, margin, and profit. System sales growth was especially strong in emerging markets, up 11% before foreign exchange, led by Russia, Africa, and Thailand. International developed markets also delivered solid system sales growth, up 6% before foreign exchange, led by Australia, the UK, and Continental Europe. And the U.S. delivered its third consecutive quarter of solid same-store sales growth with comps of 7%, the best performance by this business in almost 10 years. Division operating margin increased about 2 percentage points in the quarter to 26%, driven by franchise-led new unit development and stronger restaurant-level margins across the board. All of this combined to yield division operating profit growth of 11%, excluding the impact of foreign exchange. KFC opened 72 new international restaurants in the quarter, and similar to previous years, we expect our new unit development to ramp up significantly as the year progresses. With the upward momentum we have in this business, we expect KFC to open 700 new international restaurants outside of China and India this year, setting a new record for this growing global brand. Same-store sales were flat for our global Pizza Hut division, with growth of 2% in emerging markets and 1% in international developed markets and a decline of 1% in the U.S. Operating margin decreased 1.5 percentage points to 30%, largely due to strategic investments in international initiatives to support future growth, contributing to a 2% decline in operating profit prior to foreign currency translation. And while the sales and overall profit results are disappointing, last year’s global brand restructuring has brought 100% leadership focus to the opportunities we have to improve Pizza Hut’s overall brand position, operations, and digital experience globally. We’re already seeing the benefit of this in development, as Pizza Hut opened 70 new restaurants in the first quarter, including 35 new international restaurants, setting us up to have another year of record development, with 600 new international restaurants expected in 2015. Importantly, about 90% of these restaurants will be opened by franchisees, demonstrating strong belief in the brand's potential. We’re also continuing to invest heavily behind digital and are seeing a promising return on these investments. Currently, digital sales in the U.S. account for over 40% of delivery and carry-out sales versus about 30% a year ago, and we expect this to trend higher over time. This is important because digital orders provide customers with a superior order experience, generate higher levels of loyalty, and result in higher average spending. Finally, Taco Bell posted exceptionally strong quarterly results with same-store sales growth of 6% and a restaurant margin of nearly 20%, which is about 4 points better than last year, as pricing and favorable menu mix more than offset inflation during the quarter. As a result, operating margin increased about 5 percentage points to nearly 27%, lifting operating profit by 37% versus the prior year. As Greg said, we could not be more pleased with the insights-driven brand-building efforts at Taco Bell, evidenced by category-leading innovation and disruptive advertising. This obviously includes our new breakfast layer, which has sustained the sales mix at a very healthy 6%. Additionally, we opened 47 new restaurants in the first quarter, with nearly 90% opened by franchises, and we are opening 150 net new restaurants this year, with international development accelerating in the years to come. Any way you look at it, Taco Bell is a category leader and a brand on the move. Now, I’d like to talk about our 2015 outlook. As I mentioned earlier, we expect EPS growth of at least 10% this year. Outside of China, we expect KFC and Taco Bell to have very good years, while Pizza Hut could remain soft. Therefore, the key to double-digit growth this year is a strong second half for China. In that regard, our monthly sales can be highly variable in a recovery environment. Overall sales trends, key consumer metrics, and balance to your marketing plans give us confidence that China will have a strong second half, and as I said before, the team has done an outstanding job managing restaurant margin. Based on year-to-date results, we continue to expect a full-year China restaurant margin of at least 16%. As I previously mentioned, foreign currency translation has become an even stronger headwind for us. Based on current spot rates and projections, we now expect the foreign exchange to impact full-year EPS by approximately 5 percentage points. This is one additional point of headwind compared to what we signaled on our last call. To be clear, this exposure is one of profit translation and does not impact our competitive position as it relates to how we price our products around the world. So if you step back and think about how 2015 is developing, it’s very consistent with our expectation coming into the year, which is a negative first half followed by a very strong second half driven by China. Our first-quarter performance was better than we anticipated, but still negative. The second quarter EPS will most likely show a steeper decline versus the prior year. But let me put this into perspective. First, this is largely due to the fact that we’re expecting a higher year-over-year quarterly tax rate compared to Q1. Second, we will be lapping China’s strongest quarter from 2014, which you may remember included same-store sales growth of 15% and operating profit growth of nearly 200%. Third, while we expect Taco Bell to deliver another quarter of double-digit profit growth, it won’t be 37% as it was in Q1. So for the second quarter, we’re estimating EPS will lag prior year by about 20%, but we continue to believe that we have overall business momentum that sets us up for a strong second half to achieve at least 10% EPS growth for the full year. Now before we move to Q&A, I’d like to provide some financial highlights of the agreements we reached with our KFC U.S. franchisees, which Greg briefly mentioned. Building on the strong business momentum that’s been built over the last year, and in return for brand marketing control, which will empower our KFC U.S. leadership team to sustain a turnaround of this business, we will be investing approximately $185 million over the next 3 years. This investment will include new back-of-house equipment and incentives to accelerate asset remodels and incremental advertising money, all of which are essential to contemporize the brand and regain traction with consumers. From the timing perspective, we expect to invest possibly $100 million this year with the remaining amount split between 2016 and 2017. Due to the unique long-term brand-building nature of these investments, they will be classified as special items with the exception of advertising of about $20 million per year. Although this is a relatively modest investment, it is obviously quite significant to KFC U.S., and we’re confident it will unlock significant value in the years to come. So let me wrap things up. We’re pleased that our first quarter results were stronger than expected due to robust performance from Taco Bell and KFC, as well as the ongoing sales and margin recovery in China. We continue to expect at least 10% EPS growth this year with a very strong second half, and we look forward to updating you further as the year progresses. With that, I’ll open up the line to Q&A.

I just wanted to ask about your overall expectation for same-store sales growth in China. I mean obviously the first quarter was ahead of what you had articulated on your last quarterly call. You’ve given guidance of negative first half and positive second half. But could you just talk about it in terms of what your expectations are on a percentage basis? Now that you outperformed in the first quarter and you have new product launches, etc.

Certainly, Diane. You may recall that we had guided in December to full-year same-store sales growth of 3% to 7%. That still is an appropriate range; we may be coming in closer to the lower end of that range. But importantly, we do expect to see sequential improvement in Q2 sales over Q1 and then the strong second half, particularly as we lap the supplier incident that occurred in July.

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

That is correct. We do expect sequential improvement quarter-over-quarter, and I would highlight even with the stronger comps that we’re lapping from last year.

The last quarter there, you were talking about the promotion misses that may have happened in China, the Korean boy band promotion. Is there any color you can offer to us about what changes are already happening? I know there was a new menu that was probably in the works for some time, but perhaps a commentary about that menu. But also some things that you're thinking about in terms of a direction in the market that we may not see here for KFC in particular in China. Thanks.

Yes sure, David. Good question. As we said, we had a bad start with the boy band. I was really pleased with how quickly we reacted and had a very strong Chinese New Year promotion. We got back to building an emotional connection with our customers. We got back into the original recipe, we got back into buckets of chicken, and I think that was a very clear lesson for us. The good news is on the menu revamp, this is going to be 8 new products over about three months. What I like about it is the lesson that we’ve learned this time is that, and I think this is for the lessons we’ve talked about from the Taco Bell breakfast lunch, which is you can put the menu out there. But you actually have to promote specific products. So I’m pleased that we got a very strong menu. But we also have very strong product promotions.

Hi. Good morning. A question about the China trends. I think the release mentioned upward momentum in the consumer scores that you are seeing. I was wondering if you could maybe provide a little bit more context on what you are seeing and where you are from a consumer trust and feedback perception versus where you were heading into the supplier incident last year.

Sure. But I think the good news is, as you would know, we measure a number of attributes clearly: value for money, food safety, trustworthiness, and favorite brand. The good news is we’re making progress across all of those metrics, and I think that what you’ll see is not a linear improvement. But we can definitely see period to period that we are making improvements across the board. So I’m actually really encouraged, and it’s across the board in a recovery rather specific elements.

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

Yes, sure. I think on things like trustworthiness, we're pretty much almost back to where we were prior to the incident; things like value for money, we’re doing better. The good news is we have the right trajectory on all of the metrics.

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

Yes, in terms of the mix, the comp was led by transaction decline; check was marginally positive for the quarter. And in terms of pricing, we love to take pricing in line more or less with inflation. We’re targeting about 3 points for the full year.

Thanks. Pat, could you elaborate on the restaurant margins for our China operations? Please provide more details on where the costs are originating. Is it primarily KFC, or is there additional information for Pizza Hut and Little Sheep? Also, can you give us more specific data on labor and other cost components? It would be helpful to have a deeper understanding. Additionally, what is the current situation regarding labor and commodity costs in China? Has labor remained stable, around 10%, and what does the inflation pressure look like for commodities? Thank you.

So first, in terms of how we break down the margin variants year-over-year, we are very pleased with a 19% margin in the quarter. It was 4.5 percentage points below where we were in the first quarter last year. We lost about 4 margin points from transaction de-leverage and another 3 margin points manipulation. But offset that with about 2 points of margin benefit from pricing, and then the other half-point benefit was a combination of productivity initiatives, slightly offset by the impact of new units. So that kind of breaks down the margin drivers. In terms of what we are seeing by the way of inflation, the good news is on the commodity front, things are looking a little bit better than we originally guided. I think in New York we guided around 2% to 3% of commodity inflation; looks like closer to 2% maybe so slightly better there. The labor front, the situation hasn’t changed, call it low double digits around 10% that we saw in the first quarter, and that’s more or less what we expect for the full year.

Thanks. Maybe just a few sort of detailed questions, but Pat, the G&A this quarter ran above I think what your annualized rate was. Maybe there was some FX in that. But how do you see G&A playing out this year? Is there more investment spending perhaps required than you thought, or is this just more about timing this quarter?

It’s more about timing because what you are seeing in early part of the year is the full effect of the strategic investments that we made in our Pizza division importantly and international, to build capabilities in development and digital which is where we see the biggest opportunity to strengthen our competitive position. So as we lap those investments that were made over the course of 2014, you’ll see less of an increase year-over-year in G&A. No reason to change our guidance for the full year on G&A.

Okay. And then just two other quick ones. Forgive me if you said this. What was the labor inflation in China this quarter? And also since tax does play a big role in where you shake out in the second quarter, what is the rate you are implying in the tax rate in the second quarter?

Labor inflation in China was about 10%. In terms of tax, I mentioned in my earlier remarks that it is the key driver of the expected difference in Q2 EPS performance versus Q1. Tax worked to our benefit in Q1; it’s going to go against us in Q2, and that change among drives about a 7-point swing in EPS growth versus prior year.

Thank you. A question on China also I guess. So I think, Pat, you said the full-year guidance, the plus 3% to plus 7%, is intact, but you're thinking more the lower end. And I guess that seems curious to me with the first quarter coming in better than expected. So could you comment on that, and maybe at the same time address Pizza Hut? I guess I was a little surprised Pizza Hut was down as much as it was in the quarter. Just kind of the dynamics that are going on in that business would be helpful.

Yes certainly. Well you may recall from our financial modeling session in December that we said we needed at least 3% same-store sales growth in China to achieve our China profit growth objectives consistent with delivering 10% EPS growth or better for all of Yum! So based on current trends, we still fall within that range of 3% to 7%. We still have a big chunk of the year ahead of us, so it’s always tough to call these things, but what I’m suggesting is that it may be closer to the lower end of the range than the higher end of the range. But importantly, we have a lot of confidence in the productivity initiatives the team delivered in Q1, and we believe that those will sustain through the balance of the year. So any relative softness in sales will be made up with better performance from a profit flow-through perspective. And then quickly on Pizza Hut, as we said before, Pizza Hut is recovering more strongly than KFC and that continues to be the case because KFC faced two supplier incidents in two years. This is the first incident for Pizza Hut, so we are seeing the consumer metrics and the sales recover faster than at KFC. From a margin perspective, we posted 19% on the quarter. Pizza was actually at 20%.

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

Just as we reevaluate the sales as we extrapolate them to the end of the year. Again, it’s always tough to estimate sales, particularly at this point in the year, particularly in a recovery environment. But if I have to make a call today, I would say that we are closer to that lower end; however, it still gives us the momentum necessary to deliver the strong second half, which is important to our ability to achieve at least 10% in EPS and still achieve the sequential improvement in quarter-on-quarter same-store sales.

On the Taco Bell business, the 6% comp you achieved there, was that relatively balanced I guess, meaning did you see positive comps outside of your breakfast day part? And on top of that, what is breakfast mixing as a percent of the business now?

Sure, so the answer is yes, we saw good bounce in the Taco Bell performance across all day parts, so when you grow 6% same-store sales even though breakfast was still around 6%. It obviously means we’re getting growth in breakfast, so we saw good consistent growth across all day parts. And I think that’s because we’ve got innovation which is clearly relevant to more than one day part. We’ve got very disruptive advertising and I think all of that is working along with the improved customer service and continued great value. I think that’s the reason why we’re delivering such a consistent performance.

I wanted to follow up on Taco Bell. The 37% increase in operating profit is impressive, and there seems to be strong discipline throughout the profit and loss statement. However, I noticed the food margins and the 200 basis points increase in that area. Can you provide insight on that? Was it primarily due to breakfast having better food margins, or did you benefit from some favorable commodity trends?

Brian, absolutely. We have seen commodity tailwinds and that remains a source of upside for us for the full year. Again, taking you back to where we were at in New York when we provided guidance around commodities, at the time we were expecting about 2% to 3% at Taco Bell. It’s now looking like it’s going to be closer to flat, and that’s because we’re still expecting inflation in beef but it’s not going to be as extreme as we have thought. We’re actually seeing higher deflation for cheese than we had originally expected, and we’re also seeing now deflation in chicken, so all of the things are working in our favor. At the same time, we got the benefit of pricing actions we took last year, so not a lot by way of new pricing actions but importantly roll over from last year when commodity costs had spiked. What makes me feel really good is that even with that significant pricing benefit versus the commodity inflation that we see today, our value scores are actually getting stronger, and I think it’s because of the thoughtfulness and intelligence around the way the team has taken pricing. They’ve taken pricing when we’ve introduced new innovation. They’ve taken pricing when we’ve offered new value on the menu, and I think it’s because of this discipline that they’ve been able to strengthen their value scores, and we feel very good about where things are at with margins today at Taco Bell.

Two questions, one just on the China maybe the broader industry perhaps, but just wondering the pace of the recovery obviously went to the second half that you seem pleased with that pace. I’m just wondering whether you think that’s consistent across the broader industry or maybe in your research any reason why perhaps your recovery as you’ve noted in the past is maybe going slower than expected or maybe a slower trajectory relative to peers I’m just wondering what has kind of been called out in terms of why KFC might be seeing that slower than previously desired trajectory?

Jeff, I think the answer is we’ve said early that KFC has not had one but two sequential incidents, which we’ve never experienced before. I think that’s one of the key underlying reasons why you may be seeing the KFC recovery though the good news is it is sequentially getting better; maybe while the absolute recovery is taking a little longer. I think that really remains the key reason and that’s the key thing we’re seeing in all of the work that we’re doing in China.

If the average unit volumes are the goal and it seems like the aim was to return to full strength, do you think it's realistic to expect to achieve a restaurant margin of over 20%? What happened in 2015, regarding comparable sales, margins, and returns, that might cause you to slow store growth in 2016 and beyond? Would this be contingent on achieving full strength in comparable sales, or could you still maintain the growth rate of over 700 if you're hitting that 20% margin?

Jeffrey, there’s no doubt in our mind that comps, that same-store sales, will return that is averaging along. It will return to where they were or where they were in 2012. It’s not a question of if; it’s just a question of when. That’s not going to happen in 2015, and we’ve never said that. But we remain very confident in our ability to continue to grow our sales layers and achieve the comps, the AUVs that we had in 2012. With that, then will come the improvement in margins, and just as we’ve seen margins hold up really well even under sales pressure, we know that when the sales come back, there’s enormous operating leverage in our business. And so I remain confident that we will get back to 20%. It’s tough to say exactly when that’s going to happen, but from where I sit that remains a reasonable expectation for that business in the mid-term.

Jeff, I just think we’re a brand-building company, and every day each one of our brands in 126 countries we operate is really focused on four things: making our brands more relevant, making them more engaged, making them all connected, and demonstrating that we care. And I think if we follow that philosophy on all of our brands in every country in which we operate, we will continue to see strong same-store sales growth across the business.

And Jeffrey, what I would also point out is that when we look and share these numbers before, and we look at the top 10% of our KFC restaurants in China, we see average unit volumes that are well above $2 million, close to $2.5 million or more. That compares very favorably to what McDonald’s has achieved by way of global average unit volumes. So versus where we stand today, there’s nothing but upside, and we’re confident we’re not only going to get back to where AUVs were in 2012, we’re going to shoot beyond that. Again, it’s tough to say exactly when that’s going to happen, but we do have strong belief in our ability to rebuild sales and to bring with that the restaurant level margin, importantly reinforced by all the great work the team has done to drive significant productivity improvement during the period of sales softness.

Actually a question on Pizza Hut, is the comment about working on sort of better value construct for the brand. How should we think about the reasoning behind that? Has there been an issue with value scores deteriorating, changes in competitive intensity, or maybe the thought process is using more aggressive value as a way to sort of induce trial of the new flavor of the new menu?

I think the answer is that our analysis of performance is just we just went value competitive in the marketplace whether that was entry price point, whether that was single pizzas, whether it was pays. So we clearly have a lot of work to do. What I’m excited about is that the team with franchisees we’ve had a value summit in the last couple of weeks. We’ve shared all the information and all of our knowledge around that value positioning and what we have to do, and I think what you’ll see is us come out aligned as one system in order to make a stronger value statement in the marketplace.

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

I think the answer is all of the above. We have to have good entry-level price points. We have to have good single pizzas. We have to have good pan pizzas, and we have to have good abundant value. And I think we can and will do much better across all of those elements of the price-value equation.

Pat, you talked about the China pricing schedule for the year. It sounds like you had some price benefit in 1Q and you’re now aiming for 3% price at the high end where you got to be analyst a put guidance for the low end of 3% to 7% China same-store sales. Is the situation still fluid enough that you’ll consider holding back on pricing in favor of traffic?

Well we’re always very thoughtful around pricing in much the same way. I just want Taco Bell thinking very carefully around when we’re introducing innovation and making sure that we protect value on the menu as we have done in our China business. For KFC in China, we had about 3% of total pricing in the quarter; 2% of that was roll over from last year. Now we took an incremental 2% pricing action in the middle of January which yielded about 1% of pricing benefit on the quarter. We continue to maintain the value, and of course, we see no reason to take significant incremental pricing actions beyond this, probably the situation based on helping the trending in the business in very sensitive the value, of course, and the importance of value in regaining traction with consumers.

That’s helpful. And then Greg, the spring menu revamp. How would you classify the price points? The more value and should be value-oriented, the premium price, the mix, just any thoughts there?

When you go through any products across the menu, it’s a combination as we said earlier. So there are products for lunch and dinner. It’s across various price points, and what I like is that I think the presentation of these products and the position of these products is really good having had a chance to do it. So it’s not one particular focus.

Thanks. I have just two questions. One on the outlook for the year, you guys still assuming flat KFC profits in China in the guidance? And then secondly, with the cost savings that you realized in the first quarter, which I think surprised some of us, is that a new round of productivity initiatives that have now kicked in or is that sort of a continuation of the productivity that you guys have more or less accounted for a while? And if you talk about how that extends into the rest of the year. Thanks.

I’ll address the second question first and then come back to the outlook for the full year. On the margin front, one of the things I love about our China team is that they have a mindset of continuous improvement. So as you know, they made extraordinary progress on restaurant-level productivity in the middle of 2013 and the early part of 2014; all of those initiatives and the associated margin benefit have sustained into 2015. But they are coming over the top of that with some new productivity initiatives, which prove instrumental to their ability to deliver the better-than-expected margin performance in the first quarter. The early three elements to this, the first is with respect to what we call pace setter analysis, which is essentially benchmarking the best team labor performance within the specific sales band for each one of our brands. They moved out from an annual discipline to a quarterly discipline and they set targets accordingly after having conducted market tests to ensure that there was no impact on the customer experience. So effectively through that more rigorous approach to labor planning, they were able to tighten the labor schedules in a way that ensured that we continue to meet customer expectations. But they do it a lot more efficiently. The second piece was around the mix of students and part-time team members. So they increased the mix, and that delivered a benefit to labor in the quarter, and that sustained the balance of the year. The third element was taking a hard look at management staffing levels in the context that our sales were out and adjusting plans and managing to that. So again, three elements to the work they did this quarter which we expect to sustain through the balance of the year.

I just wanted to reinforce one point that Pat made. This productivity has not been at the expense of the customer experience. I think it’s very important that we do continually monitor the customer experience as we go through this process, and I’m really happy that the customer experience is actually growing slightly bigger, effectively making productivity improvements, and so I think overall it bodes well for the future.

And maybe the last one I would make on it is that the combined effect of these new productivity initiatives contributed about 1 to 2 points of margin improvement versus prior year, and again, we see that sustaining through to the end of the year. Now the first question you asked, Jason, was about our outlook for China profit and the extent to which we’re assuming some profit improvement at KFC. We’re assuming that KFC will improve profits this year; that is reflected in our full-year outlook for EPS growth. When you add all that together, in conjunction with the fact that we’re expecting the other divisions, and even with this stronger than expected headwind from foreign exchange, we get to at least 10% EPS growth.

Thank you. I have a question and then a follow-up on your commentary, if I may. The question is about unit growth in China, and I think that’s always been we keep Yen always in terms of value accretion. It looks like the store closure has certainly come down. I was just wondering if when you think about that 700 growth and looking at kind of what the net through the net would look like. Is it safe to say that you kind of passed the point where you’ve closed all of that kind of low-performing stores? And I guess can you give us a sense of what their returns on the new stores are looking like now and what the mix is between tier I and II versus lower-tier cities?

Certainly, Sara. So first, starting with closures, we had a higher than normal level of closures last year for the China division, led by underperforming sites. So we were consolidating these states; there was significant impact on the unit count in China. Most of that is now behind us, and so when you look at our core brands, actually closures in 2014 were lower than they were in 2013, and we expect 2015 to be below 2014. There will always be closures in a restaurant business the size of ours, but we do see that moderating. And then in terms of the returns, we’re very pleased with the returns we’re seeing on our new unit investments. As you know, we continued to shift the mix of development down to the lower-tier cities for KFC and then more broadly at Pizza Hut given the relative strength of the Pizza business model. So here are a couple of stats that could help with that. For KFC in the first quarter, 67% of our new unit openings were in tier 3 and below cities—which compares to 53% for the entire year of 2012. So that’s quite a significant shift there, and then for our Pizza Casual Dining business, for the first quarter, that brand accounted for 35% of total division unit openings, which compares to 24% for 2012. So again, you can see the shifts that are happening in our portfolio, and all of that is informed by our discipline around where we direct our capital. We’ve redeployed capital to the higher return opportunities; that’s been good discipline in China over the years, and we’re continuing to move in that direction. It gives us confidence in the continued investment we’re making in that business, and I would say as it relates to the 700 restaurants we’re expecting this year, there is every reason to believe over the long run that as our business grows, that number will edge higher, back in 2012 we opened nearly 900 units. So we certainly have the capacity and unmatched capability to do it. For us, it’s all about being disciplined and not getting too far ahead of ourselves, and making sure that our capital is deployed to the highest return opportunities.

Great, thank you. And just a follow-up I had for Greg actually was the idea of these best practices during he talked about in China. I think one in the, I’m sure concerns you’ve heard is the idea that with the portfolio brands maybe the all that many benefits to have altogether. They should be run separately so, can you maybe give an example or talk about what kinds of best practices can be shared across different brands that where you couldn’t get the benefit of just looking internally within one brand and at the highest performance within that brand?

Sure, Sara. I’ll give you the specific example of China: there are six people that we took—three of them worked with KFC outside of China but three of them worked with Taco Bell—and I think the Taco Bell team included people who are very strong in advertising, product positioning, digital, and social media, and that’s where we think Taco Bell probably excels. So I think our ability to take people not just from within the brand or within the geography but across brands and across geography is something that is particularly unique.

I wanted to follow up on the labor, I guess what we talk about this labor efficiency in China. There has been basically 3 years of reduced, not just labor dollars per store but labor hours per store more specifically, and can you help us understand what productivity means, and is it tightening up the number of hours the given employee works? I mean, is it kitchen labor? Is it front of house labor? Is it in the number of managers that you use? Maybe it’s even the number of managers that you have in training. Just you kind of put some structure process in terms of exactly what efficiency means and why it is the right thing for the brand in a recovery, and I have a follow-up as well.

John, you clearly understand our business very well because everything you mentioned is part of what the team has done to drive year-on-year improvement in labor productivity. And as I said before, one of the things we love about the team is that they have a continuous improvement mindset. We continually help them as the best operating team we have anywhere in the world, and they continue to take it to the next level. So they are managing to tighter schedules, but that schedule is fully informed by us. I mentioned more frequent updates to their pace setter analysis and taking it to full market testing. So we have confidence, as Greg mentioned before, that we are not doing this to an extent that is going to adversely impact the customer experience. But at the same time, the team continues to re-engineer the back half. So they have a team of very skilled engineers who look at equipment, labor, who look at how labor is deployed behind the front counter to better accommodate the lines that develop at a restaurant at lunch and dinner time more cost-effectively. So there’s a lot of intelligence and thought and rigor that is applied to how we do this, but it is that continuous improvement mindset that is really at the heart of all of this.

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

The trend continues to show competition intensifying in the higher tier cities, so that’s no change from before. But interestingly—and this is consistent with what we have said in our Q4 earnings call—we are seeing better recovery; we are seeing actually stronger sales to our sales performance in those tier 1 cities relative to the lower tier cities, so that trend has persisted.

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

It absolutely makes sense to continue to pivot towards the lower tier cities for two reasons. First of all, there is more opportunity because those markets are less penetrated, and we have the ability unlike competitors to move quickly and gain that first mover advantage. Secondly, there is this superior cost structure, where labor and rent costs are lower in the lower tier cities. Therefore, the sales hurdles are lower and therefore we get higher returns on investment because remember we are getting the same AUVs—average unit volumes in lower tier cities as we are in the higher tier cities. So we get the same sales volume but with higher margin and with similar investment. So the returns are superior, and there are more opportunities out there because those cities are more rapidly developing and they are less heavily penetrated.

Just to further build on that, this labor productivity is another example where we share labor productivity around the world. So as you probably know, we have some pretty high labor markets, Australia and the UK, and we are able to share those learnings on transaction per labor hour and obviously share that best practice not just around but all around the world and again not just within KFC but across all the other brands. So I think the labor productivity is another example of the paradigm.

Thanks. Just had a quick question about the KFC segment, I really have two questions. First is just kind of give us some examples of what is driving that strong 7% same-store sales growth and expectations going forward, and then secondly just a little bit more color on the new franchise agreement that you have in place just in terms of the $100 million of the $185 million in terms of the timing of that investment and more importantly when you start to see some of the benefits from the marketing and the re-imaging capacity that you are going to bake into that investment program?

I think the success has been, we’ve stayed on as far the other box and traditionally at KFC we tend to have, our sandwich promotions that we got in the markets, and the challenge is as you put it, it doesn’t matter how many people eat out of the $20 bundle; it’s still $20 on the television and I think what the team has learned and it’s really stayed rigorously on is the fact on the box. So now we have about four different versions of it, so there is obviously variety that we can offer the customer, and also enables to come back with different insights and new communications. But I think the consistency of staying around is really powerful entry price point has really been one of the keys of success at KFC in the U.S.

And then on the agreement we have reached with our U.S. franchises in the financials around that, $185 million in total, most of that being recorded as special items. The advertising piece, which amounts to about $20 million per year, about $10 million or so is going to fall into 2015, that will flow through regular operating income, and that is reflected in our guidance still of at least 10% EPS growth this year. In terms of the benefits, this is a multi-year program; so we expect that the benefits will accrue over the long term as well, and we expect to see benefits from each element of that program. So we do expect sales to be better with the incremental advertising; we do expect to see sales lift from the incentive that we are offering to accelerate the pace of remodels such that 70% of our KFC which stable will be a current image by 2017; and that we are expecting to see sales lift from the investments we are making for franchises in new equipment which puts them in a position not only to offer the more contemporary menu but to do so in a fashion that provides a better customer experience with better reliability, and there will be a sales benefit associated with that, and we expect that to build over time, and that is the underlying business case here. The size of the investment for a business of KFC U.S. size is significant, but we do expect to see the value that business improve significantly on the back of these investments and with the outstanding brand strategies that Jason Marker and his team have put in place.

So, I thank everybody for being on the call. I know today is a very busy day with a lot of restaurants releasing earnings. So that you took the time to be with us, we really appreciate it. I just want to reiterate that we believe that we are well set to deliver at least 10% EPS growth not only in 2015 but beyond. Thanks for being with us today. Much appreciated.