Yum Brands Inc (YUM) — Q4 2015 Earnings Call Transcript

Thanks, Tom. Good morning everyone and thank you for joining us. On our call today are Greg Creed, CEO; and Pat Grismer, CFO. Also on today's call is Larry Gathof, Yum!'s Treasurer who will be participating in Q&A. Following remarks from Greg and Pat, we'll take your questions. I want to thank all of you who joined us in Texas for our Investor Conference in December. I would like to remind everyone that the presentations from this conference are available on our website. 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 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 future use of the recording. Finally, we would like to make you aware of the following upcoming Yum! Investor Events, our first quarter 2016 earnings will be released on Wednesday, April 20th. And with that, I'd like to turn the call over to Mr. Greg Creed.

Thank you, Steve, and good morning, everyone. I'm pleased that you could join us today as we share with you the opportunities ahead for Yum! as well as a review of our results. Before we get started, I want to underscore what I presented at our Investor Day in December. 2016 will be a transformational year for Yum!, as we complete the spinoff of our China division, ultimately creating two powerful independent focus growth companies. The fundamental goal of Yum! however is unchanged. We are 100% dedicated to building and strengthening KFC, Pizza Hut and Taco Bell all around the world as strong brand critical to delivering the same growth and creating shareholder value over the long-term. I’m pleased with the positive sales momentum we generated across the majority of Yum! In the fourth quarter. KFC China, for example, grew same-store sales 6% in the last quarter of 2015. This was a sequential improvement from the third quarter and in line with our expectations. Outside of China, each of our brand divisions grew same-store sales on a one and two-year basis. Our U.S. results in the fourth quarter were particularly strong for all three brands, as KFC posted six consecutive quarters of same-store sales growth. Taco Bell continued to outperform the category and Pizza Hut grew same-store sales 2%. On a tuning basis our fourth quarter comps in the U.S. were the best of the year with Pizza Hut at plus 2%, KFC at plus 8%, and Taco Bell at plus 10%. These successes complemented our international results in the quarter where KFC posted 2% same-store sales growth with solid results in both emerging and developed markets and Pizza Hut grew same-store sales 3% in emerging markets. Fourth-quarter EPS grew 11%, with full-year EPS growth of 3% in 2015 despite a 7% decline in the first half and 6 percentage points of foreign currency headwinds. For the full year, our brand divisions collectively grew operating profit 8% in constant currency, which is in line with our ongoing growth model targets. This was led by 12% operating profit growth at Taco Bell, a remarkable result given the significant investments we made in the fourth quarter to position the brand for continued momentum and category leadership for the years to come. Operating profit grew 8% in constant currency in China with impressive cost management partially offsetting weaker than originally expected sales results. We added more than 2,300 new units globally in 2015 and as I look forward out to 2016 to be a year of improved performance building on the fourth quarter's momentum. This year we expect to open nearly 2,400 new restaurants, which means we’re opening over six restaurants a day, laying the groundwork for future growth. With all of this in mind, we are reiterating the guidance we initially gave you in December. Given the results we have seen year-to-date and the plans we have laid out for each of the brands, we're confident in our ability to deliver 10% operating profit growth in constant currency in 2016. Now I'd like to discuss what gives me confidence in the future for each of our businesses. After that Pat will walk you through the financials. So first China, as I mentioned, KFC which represents about 75% of the division's operating profit grew same store sales 6% in the fourth quarter continuing the sequential improvement we saw throughout the year. System sales grew 9% in the quarter as we added 114 net new units, crossing the 5,000 unit mark. I'm thrilled the China team is applying global best practices, fresh thinking, and new insights to revitalize the brand and achieve attraction with consumers. Early test results of proven global sales volume packages are encouraging and the implementation of this program should drive transactions and benefit the division later this year. One example is box meals which have proven successful globally and we expect to be similarly well received in China. I can assure you we are taking the right steps to grow the business and the momentum we are seeing makes me confident, we will. Pizza Hut Casual Dining in China, which has represented about 25% of China's operating profit, has proven more challenging. System sales in constant-currency grew 4% in the fourth quarter, as we added 151 net new units, but same-store sales declined 8%. The macroeconomic environment and volatile stock market has impacted the Casual Dining segment and we know we have to generate more exciting news and value to counter this headwind. We'll be more focused on value going forward with workday lunch specials and value pieces as well as other initiatives to drive traffic. We have our work cut out for us here and we'll be moderating our redundant pace a bit this year. Nevertheless, the China team has a number of strategies and concepts in test that we expect to improve results. We now have substantial run rate for new units and same store sales growth for China's leading western Casual Dining brands. Before I move on to the other divisions, I want to give you a quick update on January sales in China. We are encouraged by what we are seeing at KFC, but Pizza Hut sales remain soft. It's difficult to gauge exactly where the first quarter will finish, especially given the earlier timing of Chinese New Year. But at this point we expect same-store sales growth to be up low-single digits for the division which sets us up well for the balance of the year. We expect solid KFC sales going forward and even with the potential of negative results at Pizza Hut Casual Dining in the first half we are reconfirming our full year guidance for the China division to generate same-store sales growth of 2% to 3%, operated profit growth of 10% in constant-currency and to open 600 new restaurants. Now turning to our three brand divisions, KFC is a franchise-led emerging powerhouse. Franchisees opened 85% of our 705 new international restaurants in 2015. Total system sales grew 11% in emerging markets for the year with particular strength in Russia and Central and Eastern Europe. In fact, Russia has generated system sales growth of at least 40% in each of the last four years. I'm also encouraged by our recent performance in developed markets such as Australia, Japan and the United States. These results reinforce my confidence in the brand's ability to drive sales going forward. We don't only have an ability to generate meaningful growth in mature markets where we have a long established presence; we also have tremendous potential in emerging markets where we have a significant lead over the competition. So, we are taking our global brand identity and unifying that with local cultural insights to expand and grow our business around the world. We are 100% focused on our real, authentic and freshly prepared food and merging that with value and innovation to drive results. On the international front, we've enjoyed success with lunch and dinner box meals and we're delighted by the ideas created in the United States are finding their way into the system. For example, we just introduced Nashville Hot in the U.S., which is a spicy version of our crispy chicken inspired by one of Nashville's most famous dishes. The New Year pipeline at KFC remains impressive. In KFC's top 12 emerging markets, excluding China, we only have one restaurant for every 1 million people. Today, with an aggregate population of 3 billion people in these markets, think of the potential. Across the world we have plans in place to grow sales and to build on the division's consistent operating growth performance. I'm confident KFC will continue to excel and reward shareholders for years to come. At Pizza Hut U.S. we are starting to turn the corner with our focused emphasis on making it easier to get a better pizza. This runs the gamut from improved operations and insight-driven food innovation to digital enhancements and consistent value. While we recognize there's a lot more work to do, we are now generating consistent public transactions and same-store sales growth in the United States. Equally significant and as you heard in December, we reached an important agreement with our U.S. franchisees. Starting in January, we began the overhaul of our assets, replacing ovens and upgrading in-store technology. From a marketing calendar perspective we are focused on a balanced approach. This begins with premium product innovation such as our recent launch of Stuffed Garlic Knots Pizza to protect and improve unit-level economics. You may also have seen the launch of our $5 Flavor Menu, the most compelling value menu in the pizza business. In conjunction with our ongoing $6.99 any pairs deal, it will provide our customers with great value on an ongoing basis. We are encouraged by the solid year at Pizza Hut in the United States and we believe we have the right strategy going forward. Our international business at Pizza Hut is led by strength in emerging markets but offset by weakness in some of our developed markets. We believe we can apply best practices from the U.S. business to drive growth in these developed markets going forward. Finally, Taco Bell delivered a fantastic 2015 surpassing $9 billion in system sales and we expect a solid year in 2016 as well. Taco Bell is on the cutting edge of QSR and it again received gold standard for social engagement, product development, brand positioning and advertising. We have several new exciting products launching this year including one we'll announce during the Super Bowl. So, be sure to watch the first half to see the national introduction. Our innovation focus extends beyond just food. We are encouraged by early results of our delivery program and our developing expansion plans for additional cities. The addition of our loyalty program in November built on our mobile app and will increase brand affinity as it rewards social behavior. So furthermore, we are focused on our core value messaging to drive transactions. We continue to build on our breakfast daypart where sales are growing at twice the rate of our business as a whole; in fact we grew breakfast transactions 6% in the fourth quarter. Given the brand's strong economics and broad franchise appeal, we continue to accelerate New Year openings both domestically and internationally, with a record number of U.S. openings in 2015 and we expect to build upon this in 2016. I am particularly excited that we're starting to see some traction expanding the brands internationally. We know this process will take time but we're making real progress here. Our growth spends both domestically and internationally will lay the groundwork for higher operating profit growth in the years to come. With all this progress, you can see why I am very excited about what's happening in our company. We are unveiling the biggest strategic move in the history of Yum! with our spin-off of the China business. We are confident this will create two large optimally structured independent companies with unique investment profiles. Yum! China will target 50% ongoing EPS growth as it focuses solely on Mainland China and will pay the new Yum! a 3% license fee. New Yum! will become a high-margin global franchise company targeting 15% shareholder return. Recapitalization plans are underway and will be completed in the first half of this year. We see substantial value in our shares at common prices as we have repurchased 23 million shares from the announcement of the separation through last night. I want to assure you that while this spin-off transaction is critically important, we're not going to let it distract us from running the business in China or anywhere else. All three of our brands have significant opportunities for growth as they progress along the journey to brand excellence. We expect to achieve 10% constant currency growth and operating profit this year as a company and are setting up two separate companies that will lead the restaurant industry going forward. Yum! is in a unique position. We have three iconic brands and are making them even stronger. As you've heard me say before, my goal as CEO is to build three global iconic brands that people trust and champion. We are well on our way to achieving this, led by our brand positioning, courageous leadership, and committed team members and franchisees. Needless to say, there is a lot to be excited about Yum! and I could not be more pleased to lead this company into its next stage. And finally, as you all know, this is Pat's last earnings call with Yum! and I'd like to take this opportunity to thank him for his leadership, his hard work, and an unwavering drive to raise the bar of Yum!. He will be missed across the organization. As you may have seen in our 8-K filings, we have appointed our current Corporate Controller, Dave Russell, as interim CFO, and I look forward to working with him while we complete our search for a permanent CFO. And with that, it gives me great pleasure to hand the call over to Pat.

Thank you, Greg, and good morning, everyone. In my remarks today, I'll cover three areas: our fourth quarter results, our outlook for 2016, and an update on the separation of our China business. I too am pleased with the overall sales momentum that we demonstrated in the fourth quarter where EPS excluding special items grew 11%. Reported EPS growth was considerably higher as last year's fourth quarter included a non-cash special item charge related to the impairment of our Little Sheep concept in China. Excluding special items and the impact of foreign exchange, operating profit grew a healthy 17% in the fourth quarter led by system sales growth of 6% and restaurant margin improvement of over 3 percentage points. I'll now take you through our results by division, starting with our China business. For the division overall, same store sales grew 2% in the fourth quarter. As we pre-announced, KFC grew same store sales 6%, which was sequentially better than Q3 as we expected. We're encouraged by the positive momentum in our KFC China business particularly as it is sustained into the New Year. Same store sales at Pizza Hut Casual Dining however have remained sluggish and declined 8% in the fourth quarter. As Greg said, the China team is addressing this matter with urgency and we will update you on our progress through the year. Restaurant margin management continues to be a bright spot in China's performance. For the fourth quarter, China restaurant margins improved more than 4 percentage points versus the prior year to 11.4%, helped by sales leverage at KFC and productivity improvements across the division more than offsetting sales declines at Pizza Hut. As a reminder, our fourth quarter is a seasonally low sales period for the China division, so the absolute restaurant margin tends to be lower at that time of year. Full year restaurant margin was 15.9% for the division, an improvement of 1 full percentage point. It's not often that you see restaurant margins expand with declined sales, so this highlights the extent of the China team's efforts to improve profitability through cost controls. I am proud of the team's continued focus on productivity and confident this bodes well for further profit growth in China as same store sales continue to recover and unlock significant profit leverage in the business. Given our continued strong belief in China's long-term growth potential and encouraged by continued strong cash paybacks on new units, we opened 743 new restaurants in 2015. And while we're prudently dialing back the pace of new unit development in 2016, targeting about 600 new restaurant openings, we also expect fewer closures this year. So our net new units will be similar to 2015. Our decision to temper the pace of development balances the reality of current market conditions with the opportunities we have to enter new trade zones and expand our presence in existing ones. We are also making good progress on modernizing our estate. In 2015, we remodeled about 500 restaurants in China, and we plan to remodel about another 550 in 2016. By the end of this year, we will have remodeled or newly built about 45% or nearly half of our China's estate in a three-year period. Now moving to our global KFC division, which posted its eighth consecutive quarter of same store sales growth. System sales growth was especially strong in emerging markets up 10% led by Russia and Southeast Asia. International developed markets also delivered solid system sales growth up 6% led by Australia, Japan, and Western Europe. And the U.S. recorded its sixth consecutive quarter of same store sales growth at 3%. Restaurant margins grew 90 basis points to 14.7% in the quarter and improved 150 basis points for the year to nearly 15%. Operating profit grew 7% in the quarter before the impact of foreign currency translation. Adjusting this for the lap of a one-time favorable pension resolution as well as incremental advertising expense associated with our U.S. acceleration agreement, operating profit grew 11% in the quarter roughly in line with KFC's ongoing growth model. Importantly, KFC set another new record for international development in 2015 opening 705 new restaurants, demonstrating the power of this global iconic brand. Our global Pizza Hut division delivered 1% same store sales growth for the quarter led by 2% same store sales growth in our U.S. business, which accounts for about half of division system sales. Operating profit improved 6% in constant currency driven by higher franchise fees and higher restaurant margins, partially offset by an increase in U.S. G&A including severance and other one-time costs. Restaurant margins actually improved 240 basis points in constant currency for the quarter driven by same store sales leverage and commodity depletion. For the year, Pizza Hut opened 429 new international units. While this was below our initial forecast for 2015, we now have a more robust development pipeline and are confident that we'll open at least 525 new international units in 2016. Finally, Taco Bell posted 4% same store sales growth in the quarter. Restaurant margin improved 3.1 percentage points to 23.7%, raising full year margins to approximately 22%, a remarkable achievement for this powerhouse brand. Operating profit, however, declined 7% in the fourth quarter due to an expected increase in G&A related to performance-based incentive compensation, strategic growth investments including restaurant technology and international supply chain, and other non-recurring costs. We believe these investments will strengthen the brand and help to sustain positive momentum in the business. As evidence of the one-time nature of these expenses, we actually expect Taco Bell's G&A to decline in 2016. Additionally, we expect restaurant margins to remain above 20%, even with our more aggressive push on value. On the development front, we opened 276 new stores in 2015. This included 41 units outside the U.S., four times the number we opened in 2014, demonstrating the progress we're making to ramp up international development. 87% of the division's new restaurants were opened by franchisees reflecting the attractive investment return the Taco Bell brand generates. I'd now like to talk about our 2016 outlook. Supported by the results we've seen year-to-date, we continue to expect to deliver operating profit growth of 10% in constant currency this year. And while I won't be providing quarterly guidance, I'd like to point out that certain brands are facing hurdles, both prior year laps and timing of current year expenses which will weigh on first half results. As a consequence, we expect second half operating profit growth will be directionally stronger than the first half. This is consistent with our plans coming into the year and we remain confident we will achieve our full year operating profit guidance. Now I'd like to quickly cover our spin-off plans. We're making good progress and are on track to complete the separation of our China business by the end of this year. A major part of our plan is to optimize the capital structure of Yum! Brands and return $6.2 billion to shareholders prior to the separation to the issuance of new debt. From the time we announced the separation through last night, we've repurchased 23 million shares. While our weighted average basic share count for the quarter was 433 million, our basic share count as of February 2, 2016 was 411 million. We see value in repurchasing our shares at what we consider to be discounted prices and view this as a prudent use of shareholder capital. I'm also happy to report that we're on schedule to complete our recapitalization in the first half of the year, issuing incremental debt of approximately $5.2 billion and we plan to maintain roughly 5 times EBITDA leverage going forward. We're now in the process of finalizing the form and timing of this financing. Now I'm sure you've noticed the volatility in the high-yield debt market particularly within the energy and materials sectors. We'll continue to watch this closely, but we're pleased that the rates on our future debt remain very attractive on a historical basis and we're coasting ahead with our plans. So, let me wrap things up. 2016 will be an exciting year for Yum! Brands. Not only do we expect to deliver 10% operating profit growth in constant currency, but we're proceeding as expected with the separation of our China division into an independent publicly traded company. Yum! China will have no external debt and will self-fund growth capital, while generating significant free cash flow in year one and on an ongoing basis. The New Yum! will be a global diversified franchise company with an optimal capital structure. By 2017 we will be 96% franchised with a stable but fast-growing free cash flow strength. I'm pleased I was able to participate in this landmark decision for the company and that we are optimizing shareholder value by creating two powerful investment opportunities. I'm very confident in both companies' future growth prospects and look forward to their ongoing success. And with that I'll open the call to Q&A.

Pat, first could I just follow-up on the question comments you made about certain brands facing certain hurdles in the first half. Are these sales hurdles, profit hurdles, which brands? Can you just directionally point us in the right direction so we can model in appropriately?

It is a combination of both sales and spending. Clearly in the case of Pizza Hut in China our expectations for the first half are more muted, and we expect their sales recovery to improve in the back half of the year. So, that'll be around the first half results. At the same time we have spending in some of our global brand divisions that will be more heavily concentrated in the first half of the year and then in the second half of the year we'll be lapping some of the investments that were made in G&A and so that will contribute to the shape of earnings over the course of the year.

How much did Pizza Hut China influence the margins this quarter? In other words, is there a real separation happening? I suspect there is, but could you quantify the effect that Pizza Hut is having on the margin for China? Also, can you discuss why now isn't the time to develop Pizza Hut delivery more aggressively, considering there seems to be a significant untapped opportunity while also facing some challenges with the dine-in business?

Yes, first with respect to margins in China, I'm not going to bifurcate by brands but it is fair to say and as you've seen from the comps that we've reported that the sales performance at Pizza Hut Casual Dining was not as strong as for KFC in China. And that's largely due to more significant transaction declines in that business and so did weigh more heavily on Pizza Hut China margins in particular. And then with respect to development, you're absolutely right, it's early days for the Pizza delivery business in China and so we will be picking up the pace of development for that particular concept as we look to temper the pace of development of both KFC and Pizza Hut Casual Dining in 2016.

Just a question on the role of value at Pizza Hut China. Could you just give us perhaps a little bit of a retrospective and looking forward about what value you need for that brand? Did Pizza Hut China really get away from five-star dining at three-star prices in recent years, making it more vulnerable now? And can you share what you brought out so far and the sort of value you might be thinking about for the brand? And do you think that's going to be enough to offset the casual dining weakness in the country? Thanks.

Sure, David. Well, I think first of all, obviously the macros which have got worse since December, since we were all together in December, and I think we all know that macros impact casual dining more than they impact QSR. So, I think there's definitely that issue. I would agree with you that we've not had enough value in use to overcome this backdrop. I think we've also as we've spoken out in previous calls, there is a lot of discussion around steak and fajitas and there wasn't as much discussion if you just think about pizzas. And so I think our ability to talk value but to talk value around pizzas, I think you'll see more of that going forward. So, yes, the answer is we got to focus on the core to strengthen our brand positioning. We have got to target value to increase transactions such as smart value across daypart. We also have to I think improve our in-store experience in order to stay ahead with the competition. And I think the other thing we have got to be a leader in digital we got to stay relevant. And I think there's a lot of things that we can do in that market as well. To I guess round out the answer, we've got about five value programs in test for Pizza Hut in China. We're going to see some early encouraging results but that's going to take us some time to get into the marketplace and as Pat said I think you'll see a much better second half than you'll see first half out of Pizza Hut China.

Two quick questions, sorry folks, the first one being when we look at the success of the three global brands particularly here in the U.S. in recent quarter on both sales and margins perspective, how should we think about that margin trajectory into this year? We've got easing costs, we've got very intense competition, how do we think about the margins for those three segments this year? And then to follow that up, can you give us an update on the plans to refranchise those three brands, the plan to go from 91% to 95% by the end of '17, how is that progressing? And maybe to be some extent how does the success of those brands recently impact that refranchising effort? Thanks.

Certainly, Keith. First in terms of margin performance in the three global brands, bear in mind our equity ownership in those three global brand businesses, I think collectively is in the order of 10%, so it's a franchise-driven business. But nonetheless, we do focus on restaurant margins both for the benefit of our company as stated and importantly to ensure that our franchisees are realizing good returns on their investments. I would say overall we're pleased with the progress we're making on margins for our KFC global division to improve about 1 percentage point versus last year was quite a significant accomplishment, a combination of same store sales growth and productivity improvements contributing to that. At Pizza Hut equally happy with the progress we've made this year to your point supported by the commodity inflation as well as in the last quarter some sales growth. And then for Taco Bell another banner year with restaurant margins on a full year basis, we are on 22%. As we build on that momentum into next year, we are expecting our KFC and our Pizza Hut businesses to continue to realize margin improvement aided by same store sales leverage as well as a more modest commodity outlook than we've seen in some years before. In the case of Taco Bell, my expectation is that margins will be up above 20%, perhaps a bit below where they were in this year because of the more aggressive push on value and a more temperate approach to pricing. And then in terms of the refranchising, the teams are very much committed to realizing the objectives that we laid out to achieve 96% franchise ownership by the end of 2017. In the last 30 days Greg and I have met with each one of the global brand divisions to review their refranchising plans and their very discrete plans around specific geographies and pacing associated with that. Given the complexity of some of these transactions, we would expect the refranchising activity to be more heavily concentrated in 2017.

I would like to add a point regarding the brands following up on your question, Keith. I am really excited about the progress we are making, especially in Southeast Asia since January. The positioning of our three global brands is beginning to take shape on a global scale. There is always the iconic KFC, along with the initiative to enhance Pizza Hut and, of course, the ongoing development of Taco Bell. Not long after we launched our improvements at Pizza Hut, I was in Thailand and noticed well-defined plans aimed at our growth and making operations smoother. What truly encourages me is that now that we have clarified the positioning for these three brands, I am witnessing this strategy being implemented across the 126 countries where we operate. This gives me confidence that we can continue to achieve same-store sales growth moving forward.

I just have a question on the new unit development and maybe just more a clarification. So when we think about the units that you're opening in China this year, can you give us a breakdown between KFC and Pizza Hut? And then as the Pizza Hut slowdown just in your model, is it temporary or is it more a shift from actual buying into delivery units?

Certainly, Diane. When we look at the 740 or so that we opened this year, about 350 were KFC, 280 at Pizza Casual Dining and the balance split between the Pizza Home Service and Little Sheep. When we look out to 2016 and our expectation of around 600 new unit openings, that’s about 20% reduction. That about 20% reduction applies almost equally to KFC and the Pizza Hut. So we're looking at deceleration in the pace of development for both KFC and for Pizza Hut Casual Dining. And we don't expect that that is an indication of how things are going to play out much longer term. It's just that as I mentioned in my prepared remarks earlier, given current market conditions, we feel that it's prudent to dial back in that but we continue to be very confident in the value we will create from these investments as we're continuing to see cash payback to around three years and we know the long-term growth potential of the market remains significant. So we do expect that at some point in time the pace of development will increase for all brands.

I think the discussions that I have been having with Micky are really around, we still see 20,000 plus restaurants on the horizon as an opportunity. I think that we still believe in the growth story of China, the consuming class; the economics not what they used to be but it's still better than most other places in the world. And I think as we get these brands fully positioned and we get back to doing the things that we've spoken about that we need to do. I think long-term we remain still committed that this is at least in what I'll call my horizon 20,000 restaurant unit opportunity for the China business.

Hi, thank you for the question. You guys, I was surprised to see a tick down into your conference in emerging markets at KFC and a little bit more material at Pizza Hut, particularly in light of commentary about strength in Russia, strength in Eastern Europe. I am curious if there is any particular regions of the world you would point to that are causing a little bit of softness there and what might be causing that?

Karen, what I'd highlight for both KFC and for Pizza Hut in terms of the emerging markets which remain strong overall given what we're seeing by way of system sales growth is that the same store sales growth has probably been a bit below our expectations for some of the emerging markets in Southeast Asia.

Thank you very much. Actually, just two restaurant margin questions. One in China, Pat, I think you said for this full year it was 59 plus 100 basis points and that was quite impressive considering the sales decline. As we think about 2016 and you talk about 2% to 3% comp growth, I'm wondering, why perhaps the guidance? I think you've mentioned in the past maybe 15% plus margin in '16. Wondering why it wouldn't be significantly higher if presumably due to those positive comps? And maybe you can offer some food and labor commentary. And a similar question on Taco Bell, I mean Keith said right, greater than 20% margin in '16 but down from '15 it sounds like there is a big value push perhaps coming. So I'm wondering, if you guys can just talk a little about the category, with a little bit discounting going on seems to have intensified of late and where Taco Bell is well positioned to respond to that. Thanks.

Certainly, and we'll start with China. We finished the year from a margin perspective in China stronger than we'd expected. And so our current expectation is that margins in 2016 will be about in line with 2015, so around 16%. As you mentioned, we're expecting to realize some benefit from same store sales growth but we're taking I'd say a more tempered approach to pricing, given the focus on value as the team’s emphasis is on building transactions, building healthy transactions. And so that may mean that we wouldn't take pricing that we might have in the past to fully offset inflation and we'll be much happier with an outcome where we'd build transactions with that margin, as opposed to growing margins. And so that's the outlook for China. As it relates to Taco Bell, I'd say things are a little bit similar in the sense that the emphasis will be on value to build on a great momentum we had in 2015. We are expecting modest inflation, I'd say probably more than we've realized historically in the labor category for our company stores. We're anticipating there could be some movement in wage rates and I'd say modest outlook on commodity inflation for the Taco Bell business.

Let me talk to the whole question about value. I think the great thing is that Taco Bell is incredibly well-positioned; it remains the value leader. But look, we've all seen what's been happening in the marketplace in the early year: five for $4, four for $4, two for $2, so let's not kid ourselves. So, there's been a fair amount of value initially out there. So as you would expect from a well-positioned brand, they are back looking at the calendar, I think you'll see some changes that will come out. Obviously, they have got this great new product launch coming out on Sunday, so I think that will have a positive impact on the brand. They will do the right thing and I'll make sure that they continue to be well positioned in the value leader in the marketplace going forward that's what you should expect great brands to do.

Thanks, guys. I've two questions, first is on China, kind of following up. In the fourth quarter you did have great margin leverage again and operating profit growth of almost 200% on a 2% comp and you're expecting similar comps going forward as you had in the fourth quarter. So can you just talk again a little bit more about what investments are being made in China that are going to keep the margin and profit growth more in check as your guidance kind of suggests? And then I do have a follow-up.

Well, first in terms of China margin for 2016, as I mentioned, there will be much stronger emphasis on value in order to simulate traffic and as a consequence we're not necessarily expecting that pricing will fully offset inflation. What we're expecting by way of inflation in 2016 is about 1% for food and high single-digits for labor, but again we're not expecting to fully offset that to pricing, as maybe has been our past practice, as the team is refocusing on building transactions. We're counting on continued productivity improvements probably not the heroic improvements that we've seen in years past. If we do better than 2% to 3% comps in 2016, we would expect margins to improve but we're not planning for that right now. The other variable though is labor efficiency, because the team let's face it has consistently surprised us to the upside and that could provide further tailwind to China margins in 2016. We think at this stage guiding about flat margins year-over-year, is appropriate.

A question on China margins. Obviously you guys were happy with margins, given the comps in 2015. You were happy with the levels in the fourth quarter as well. But the question that has to continue to be asked and certainly we've been asking it for the last couple of years; to what extent that attention to cost controls, labor efficiency, other OpEx efficiency, what have you, has actually in some way contributed to the lack of traffic recovery that you guys have consistently expected? So I just want to see whatever research or information, anything qualitative, quantitative that you may have to make everyone comfortable that you haven't gone too far. And in that context, is some of the guidance on China margins in 2016 an admission that there are no more structural cost cuts or tactical cost cuts that exist within the China system and that margins are really now going to be a function of comps?

Let me start with that. I will take that. The customer metrics for KFC have returned to levels seen before the incident, so regardless of which metrics you consider, they are all significantly back on track. In fact, in absolute terms, the metrics for Pizza Hut are higher than those for KFC. They may not have regained momentum as quickly, but they are still higher overall. Additionally, there's substantial work underway on menu simplification. We need to focus not only on labor and other costs but also on how to simplify the menu to enhance the customer experience. In both KFC and Pizza Hut, our goal is to provide the best casual dining in-store experience to maintain our competitive edge. We're implementing various initiatives, such as simplified menu boards and box meals, to streamline ordering and reduce queue times. We're dedicating considerable effort to ensure margin improvements do not negatively affect customer experience, and all evidence suggests there is no impact on this front. Micky is very committed to enhancing the speed of service, especially in KFC, and there are multiple initiatives in place that should improve that experience, increase throughput, and contribute to sales and transaction growth.

My question is on the Pizza Hut business in China. And I know this might be a hard question to answer, but I was wondering if there is any way you can dissect how much of the comps weakness you've seen recently is more related to macro issues versus internal issues? And I guess said differently, is there any benchmarks within that market that you're looking at that would say you are underperforming or overperforming relative to the industry there? And then I have a follow-up.

We don't have the same detailed information available in the U.S., such as credit and MPD data, to address your specific inquiry. It's clear that casual dining faces challenges from macroeconomic factors, a trend observed not only in China but globally. These macro changes typically impact casual dining more heavily than quick-service restaurants. If I were to identify four main factors, they would be macro conditions, lack of sufficient value offerings to counter the macro backdrop—leading us to conduct various macro tests in the market with urgency to implement these initiatives. Additionally, there's increased competition, although I don't anticipate most competitors will scale as broadly as Pizza Hut. Lastly, while aggregators do play a role, they represent a small share of total sales. Hence, the primary factors affecting our performance include macro conditions, value offerings, competition, and aggregators. Although I can't provide specific percentages, these are the key areas we're focusing on to improve our performance. Our strategy involves enhancing our brand position, boosting value-driven transactions, providing an exceptional in-store dining experience, and leading with digital initiatives like free Wi-Fi, queue ticketing, pre-ordering, as well as collaborations with platforms like Alipay and WeChat for cashless payments and loyalty programs. These are our responses to the areas impacting Pizza Hut China's performance.

So a couple questions on Pizza Hut. I guess your U.S. comp seemed to come in at the low end of expectations, at least as you stated at your December Analyst Day and international is a little uninspiring. So first question is any color as to why? And then I guess two related questions would be, you outlined the path to achieving a 3% comp at Pizza Hut at the Analyst Day with various initiatives, but it seems a little optimistic on a blended basis. And then the last portion of the question is there any way to accelerate the common POS conversion? Because it seems like one common system might really be the backbone that you would need before comps can really re-accelerate. Thanks.

Let me start with the U.S. comps. I mean, they were plus 2%; it was our best quarter in three years. And I agree, it sort of pales with the KFC two-year comp talking about a 10%, but it was our best quarter in three years. And as I indicated in my prepared remarks, I'm very encouraged by the start for 2016 for Pizza Hut. And what I'm encouraged about is how rapidly this whole idea of we need to make it easier to get better is going around the world. I know that in the past if I had turned up in Bangkok two months after we came up with an insight of easy beats better, I probably would not have seen that being impacted or reflected in the work either to make us better or make this easier. So I'm encouraged by the start for Pizza Hut in 2016. I have confidence that you will see us deliver sequential improvement in same-store sales this quarter versus the fourth quarter. And every journey has to start somewhere and I think that journey started in the fourth quarter of 2015. And then I am encouraged by how rapidly we are taking this idea and seeing it now being impacted and addressed by all of our teams around the world.

And then, Karen, as to your question regarding the common POS, the team estimates it will take a couple of years to migrate all of the restaurants in the U.S. to a common platform. So they are targeting end of 2017 to accomplish that. It is a high priority, but given the extent of integration between those different POS systems and back-of-house and other applications, it will take some time in order to do it properly and minimize disruption to our business.

Just two separate questions. One, can you breakout in the China comp for the quarter kind of where you are on pricing and then I guess if mix was meaningful there as well? And then separately, Pat, now that we are a little closer to the leverage event, do you have any updates on how you're thinking about use of proceeds? Would you lean more on an accelerated share repurchase or are you also considering a special dividend or more of a gradual buyback? Thanks.

Certainly. In the fourth quarter, the 2% increase in the China comp was made up of a 4% contribution from pricing, along with a positive impact from sales mix. However, there was a decline in transactions that offset some of this growth, resulting in the 2% comp. Regarding our leverage event and the use of proceeds, a lot will depend on valuation and market conditions at that time. It's still too early to determine precisely how we will return the cash.

Pat, just a quick housekeeping, if you can give us the puts and takes on China margins this quarter. And then separately, as China food costs continue to be quite favorable, I know there's a little bit of inflation for next year as well as some more resilient pricing. Should we expect you to sacrifice this favorability for traffic in order to more aggressively pursue value in 2016, both China brands, relative to the promotions you ran in 4Q?

Okay, Andrew. First in terms of the drivers of Q4 margin, we were very pleased with the performance in the quarter. Margins were up versus prior year about 4.5 percentage points, and here's how it breaks down. When you take the 4% pricing, add to it the mix benefit, and strip off the impact of the transaction decline, that's about a net 2 point benefit. On top of that, we had a 3 point benefit from productivity, and another 1 point benefit from closed stores. Offsetting that was a 1.5 margin attributable to inflation. Commodities were flat, but we had 6% inflation on labor. And so that's basically the lock to the 4.5 point gain in margin versus prior year. In terms of how we are thinking about 2016, as I mentioned before, the team is very much focused on building transactions. So while we do expect some modest inflation from a commodity perspective, up about 1% and high single digits for labor, we're not planning to take pricing to entirely offset that. We will look to some ongoing productivity improvements to help mitigate the impact of inflation. But the goal is to at least maintain margin year-over-year at around 16% and to achieve meaningful improvement in transactions.

Just a single follow-up on a handful of earlier questions. So I believe it was at your December Analyst Meeting you noted that Pizza Hut Casual Dining is listed with several of the online aggregators. I think you said the sales mix coming from those channels is something less than 5% mix. I'm just curious: do you expect that sales mix to grow? And then more broadly and more importantly, what's the longer-term strategy with those aggregators as you move forward and they potentially become a little bit more powerful?

To answer your question, the percentage of sales from those channels is still low. In Q4, KFC accounted for about 2% of total sales, while Pizza Hut Casual Dining also made up around 2% of total sales. Pizza Hut's other service contributed approximately 30% of total sales, although that represents a small segment of the pizza business. We are actively collaborating with these aggregators and will continue to engage with them. It's important for us to ensure we preserve customer data and protect our brand's integrity during this collaboration. The key aspect of our relationship is that aggregators prefer partnering with established brands like ours, and we are committed to maintaining clear brand positioning and safeguarding our customer information in the marketplace.

Had a technology question. During the prepared remarks, you said you were pleased with the level of mobile engagement at the Taco Bell brand and the deliveries that may come out of that. I just wonder, if you had any additional color on that and kind of the quantitative measures that we might be able to look at? And then secondly, any kind of takeaways or learnings you can apply to either the rest of the U.S. or even potentially on a global basis from those technology endeavors?

Yes, I would say that we are very pleased with the progress we're making on the digital front at Taco Bell. You'll recall that we launched our Taco Bell app in the fourth quarter of 2014. To-date, we have about 5 million app downloads. When we look at the behavior of those customers who are ordering through the app, the average check is higher by about 30%. So we're very much encouraged by those early results. We are looking to build awareness of the app to drive utilization. And an important part of that is the introduction of a loyalty component to the app, a game. That was launched in late 2015. It's the first loyalty program of its kind that rewards social behavior and the first reward that was offered for customers who play the game was a free Taco Bell Freeze. So there is a lot of excitement around that. The app is also configured in a way that drives exploration of the menu. So it has helped to create a lot of buzz and a lot of active engagement with our heavy users, very high levels of social sharing of the rewards we've observed and the overall user response has been very positive. So the focus now is having launched the app and more recently, the loyalty program is to drive awareness. And so we do expect to see even greater trial in the coming months. The goal is, you know, for Taco Bell is to strengthen its position as an on-demand brand and so leveraging technology to do that is an important part of the brand's priority going forward.

What I really love about it is the customization happening. We recently received certification from the American Vegetarian Association for Taco Bell. We might not be able to run an ad on TV to highlight that, but we can use the app. It's fascinating to see that we're actually getting people to switch from beef to beans as a protein. From a margin perspective, that's beneficial for us and it also pleases the customer. I appreciate that we can leverage the mobile app to convey a more nuanced story about the brand. It's a great story, but it’s not something we would typically share on mainstream TV. With this, we can spread that message, making the brand more relevant, and that’s what truly matters.

Two quick ones. One more on China. I was wondering, if you could give us general sales trends update on maybe where you saw some weaknesses or some strength by tiers or geographies or perhaps locations? And then second on Taco Bell. Was wondering, if you could give us a little bit more color on those G&A investments. What were they exactly? Can you confirm that the majority of the year-over-year spike in G&A at Taco Bell was of one-time nature, which you alluded to?

Certainly, Paul. So first on China same-store sales, similar to recent quarters, performance was stronger in Tier 1 cities at both brands. Our view is that customers in lower tier cities have been more significantly impacted by the softening economy, particularly around the industrial cities, which have been more heavily affected by China's slowing export trade. But that's the only meaningful difference really to call out. And then as it relates to Taco Bell's G&A, as we mentioned, the increase in the fourth quarter was expected and it's fair to characterize a large chunk of the incremental G&A as being nonrecurring. So some components would include performance-driven incentive compensation, because they had an absolute blockbuster year, and so they were paid accordingly. We plan for a 100% payout, so that contributes to a year-over-year decline as we think about 2016. There were some investments that were made and some strategic growth initiatives that would highlight international supply chain development. I would also highlight the digital initiatives, like the ones we just talked about. And so that contributed to a spike in the fourth quarter. And importantly, we think about those as investments to sustain the positive momentum of the brand. I think good businesses that are strong performing businesses reinvest profit upside to sustain the momentum and that's exactly what's happened at Taco Bell.

I believe that both new plants and the existing strong trees require water. It's not enough to just water the new plants; you also need to nurture the established ones to ensure they remain healthy and continue to thrive. That's what I observed with our investment in the fourth quarter. I'm pleased we made that investment. It was the right decision, and you will see the benefits reflected in Taco Bell's future performance.

Thanks for squeezing me in. Two more questions on Pizza Hut China. First, you mentioned the smaller tier markets being hit harder by the macro. The Pizza Hut expansion numbers the last three or four years have been pretty aggressive, and have you extended the brand into areas where the economic development did not follow or are there cannibalization issues behind Pizza Hut? And then secondly in Pizza Hut, I know you mentioned a 20% reduction in expansion will be across both brands. But within Pizza Hut, how will that break down in financial plans for 2016 between home delivery and casual dining?

Yes, first of all, I will address your last question first, Joe. The slowdown in development for the Pizza Hut brand is only for the casual dining business, not for the delivery business. Regarding the performance of Pizza Hut across cities, I would not attribute variable performance to development decisions or higher than expected cannibalization necessarily. It is more a function of variable levels of macro pressure across these cities.

Okay. Well, I think that wraps it up. I want to thank everyone for being on the call today. Thank you for taking the time to be with us. And I know I've said this as well, but I do want to thank Pat. Pat joined Yum! at Taco Bell when I was the CMO and he was the Head of Strategic Planning. He has been a true friend. He has been a great resource. He has been a great leader, and I want to thank him. And I want to wish he and his family all the very best for the future. Thanks. Thanks everybody.