Yum Brands Inc (YUM) — Q2 2019 Earnings Call Transcript

Thank you, operator. Good morning, everyone, and thank you for joining us. On our call today are Greg Creed, our CEO; David Gibbs, our President, Chief Operating Officer; and Dave Russell, our Senior Vice President and Corporate Controller. Following remarks from Greg and David, we'll open the call to questions. Before we get started, I'd 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 our earnings releases in relevant sections of our filings with the SEC to find disclosures and reconciliations of non-GAAP financial numbers that may be used on today's call.

Thank you, Keith, and good morning, everyone. We are pleased to report another strong quarter with system sales growth of 10%, including 5% same-store sales growth and 7% net new unit growth. Focus on our four growth drivers, increased collaboration, and our unrivaled culture continue to fuel these results. As usual, David and I will talk you through the lens of our four key growth drivers. I'll provide an update on our relevant, easy, and distinctive brands, or RED for short, as well as unrivaled culture and talent. Then, David will discuss bold restaurant developments, unmatched franchise operating capability, and some additional and exciting news on talent. I am thrilled to report that KFC delivered its 16th consecutive quarter of positive same-store sales growth. This global powerhouse is seeing broad-based strength across the world, with standout performances across many of our largest markets, which translated into impressive global system sales growth of 10% with same-store sales growth and net new unit growth of 6% each. Now, many of you have been asking what’s fueling the recent broad-based performance? Well, there are a number of factors, including that the consumer is healthy, KFC has a robust digital and delivery strategy globally with over 12,000 restaurants delivering on just one metric. A perfect example is the KFC Annual Market Planning Meeting, which is one of the first global collaboration meetings we instituted and which continues to gain momentum and impact each year. At our recent 2019 KFC AMPM, we had a record number of franchisees and team members in attendance. We also attended the Pizza Hut AMPM earlier this week, and I was impressed with how Vipul Chawla and teams are focused on the things that matter most. Without question, these forms of collaboration are a unique competitive advantage for all our franchise partners and team members globally. Now back to KFC’s quarter. Internationally, sales callouts include Japan, Africa, Iberia, Indonesia, Germany, Australia, China, Latin America, and the Caribbean. You’ll notice I included more markets than usual, but again, strength was broad based with eight out of thirteen markets reporting at or above 6% same-store sales growth. The recipe for success has a consistent theme: disruptive value coupled with amplified innovation, compounded by an effective digital and delivery strategy. Specifically, Japan and Africa led the way, each with double-digit same-store sales growth. Japan’s 18% same-store sales growth was driven by renewed focus on value, along with the well-received chicken pack and Peri Peri Chicken innovation. Africa’s 10% same-store sales growth was backed by the Wrapstar Lunchbox value promotion and the innovative Crunch Double Down. Iberia’s 11% same-store sales growth was driven by continued momentum from strong media campaigns and their third-party delivery partners. Now, moving on to KFC U.S., where same-store sales grew 2% in the quarter. We continue to focus on core menu items balanced with an accelerated pace of promotion. This quarter began with the innovation of bringing back the very successful Chicken and Waffles and then introducing Cinnabon Biscuits. Value also remained a focus, launching a new channel for A La Carte menu items, a 2 for $6 Mix and Match. Combined, our new value proposition drove transactions for the quarter and allowed customers flexibility to build their own meals. We are excited about the operational ease and the increased check through our franchisees. Moving on to our Pizza Hut division, in the U.S., system sales grew 4% with same-store sales growth of 2% and flat unit growth. Transactions for the quarter grew 3% due to continued compelling value, operational execution, and our growing loyalty program, Hut Rewards. As you may have seen earlier this week, in partnership with our franchisees, we’ve updated the $5 line-up to the $5 and up line-up, where we will continue to offer the same favorites at more flexible price points. While we are pleased with positive transaction growth this quarter, we know that same-store sales growth in the U.S. will continue to be choppy without transforming the asset base. We plan to lean into accelerating the transition of our Pizza Hut U.S. style to a more modern delivery and carryout-focused asset base, which will position the Pizza Hut brand for faster growth in the U.S. We are excited about collaborating with franchisees who are capable, well-capitalized, and committed to the brand, and who have the growth mindset to accelerate closure of underperforming dining stores. By the same token, we will need to directly address franchisees who are burdened with too much debt or aren’t committed to the long term. Thus, in some cases, these businesses will need to be restructured in the near-term to address capital structure and leverage issues, particularly those with greater dining exposure. We view this as a positive move for the brand. Before moving on to Pizza Hut international, I want to briefly update you on our excitement around our partnership with GrubHub and the opportunity to leverage it as an additional sales channel for Pizza Hut. While customers are placing their orders on the GrubHub app or website, Pizza Hut drivers are completing the deliveries to ensure a hot, reliable experience. We ended the second quarter with over 300 locations on GrubHub and plan to expand this further in the third quarter. We’ve found that the GrubHub customers are incremental, and some customers are trying our products for the first time. Pizza Hut International system sales grew 15% in the quarter, driven by a 10-point benefit from the addition of the Telepizza units in Q4 of last year, while same-store sales growth was 2%. We were pleased to see same-store sales growth in markets like China, Europe, Brazil, Indonesia, and Hong Kong. I recently visited Latin America and saw some of our newly converted Telepizza units. I am impressed with the team and how they are executing at a high level to drive tremendous early results. Pizza Hut continues to develop tailored actions for our largest dining markets while transforming toward a more compelling off-premise focused asset strategy. Now, last but definitely not least, Taco Bell, where system sales grew 10% with same-store sales growth of 7% and net new unit growth of 3%. Taco Bell has now reported positive same-store sales growth in 17 of the last 18 quarters, including 12 consecutively. Starting with the U.S., we continue to focus on both value and innovation, starting Q2 with the $1 Loaded Nacho Taco, followed by the $5 Grande Nacho Box and the return of Nacho Fries. The Grande Nachos Box was a standout as the amount was a truly abundant value at just $5. The buzz-worthy moment of the quarter was the announcement of the Bell Hotel in June. Reservations for a Taco Bell-inspired stay in Palm Springs sold out in two minutes. Our ALL ACCESS strategy to create a frictionless customer experience is sharper than ever. Taco Bell now has kiosks in over 4900 restaurants and expects to complete the full U.S. rollout this year. Delivery is now live in 4500 Taco Bell restaurants in the U.S. The customer experience has been positive, with the main reason for getting Taco Bell delivered being cravings for the food. Mobile and online ordering continue to be a priority, and we are seeing strong results with over 11 million registered users. Additionally, click and collect functionality is vital on Tacobell.com and the Taco Bell App. Taco Bell International saw strong sales momentum around the globe, driven by a focus on Cult Icons, Value Boxes at power price points, and product innovation. Our value boxes introduced earlier this year continued to drive growth in India, the UK, and Spain. We continue to build global brand awareness by successfully incorporating U.S. programs into globally relevant promotions. As for our unrivaled culture and talent, as I mentioned earlier, we have two important assets: our brands and our people. We feel great about the level of talent we have and have been fortunate to promote many top leaders internally. We’ve made the decision to further strengthen our bench and enhance talent as a competitive advantage by investing in new world-class talent. I’d like to start with an enthusiastic thank you to David Gibbs for his incredible leadership as President and CFO over the last three years. He was a great partner to me during our spin-off of Yum! China and adapting our financial and business strategy to be more focused, more franchise, and more efficient, all with accelerated growth. Since the beginning of the year, he has taken on additional responsibilities as Chief Operating Officer, leading to impressive results while we searched for a new CFO. I am excited to have Chris Turner join the Yum! family as Chief Financial Officer. Chris will assume global responsibility for finance, corporate strategy, supply chain, and information technology. From his time at PepsiCo to his years at McKinsey & Company, Chris is a well-rounded business leader bringing nearly 20 years of strategy, finance, and operations experience. His commercial experience in the quick service and retail sectors, along with a track record of growth leadership and commitment to culture and talent development, make him a perfect fit for the CFO role. We’ve also finalized our roles for our brand CEOs as David will discuss in more detail in a few minutes. Finally, we take our role as a global citizen and our impact on society and the environment very seriously. We have recently updated our Recipe for Good, outlining our public commitments concerning food, the planet, and people. We’ve made progress over the past year regarding our citizenship and sustainability agenda to drive socially responsible growth and manage risk better. I truly believe we are leveraging our scale to help address major global issues. And with that, it gives me great pleasure to introduce our President and Chief Operating Officer, David Gibbs.

Thank you, Greg, and good morning, everyone. Today, I’ll discuss our second quarter results, our remaining transformation initiatives, bold restaurant development, unmatched franchise operating capability, and some exciting news on unrivaled culture and talent. Our second quarter results included core operating profit growth of 18%. As Greg mentioned, we delivered system sales growth of 10%, same-store sales growth of 5%, and net new unit growth of 7%. A major contributor to this success was KFC, our largest division in units and profit contribution, with 6% growth in both same-store and net new unit growth contributing to 10% system sales growth in the quarter. Contributors to KFC’s strength were again broad-based. Japan and Africa, which together represent 8% of KFC’s system sales, performed particularly well. Taco Bell had another tremendous quarter with 10% system sales growth driven by 7% same-store sales growth. Our second quarter results are lapping the distribution disruptions in our KFC UK business in 2018. We estimated the 2018 same-store sales growth at KFC was negatively impacted by 1% in both Q1 and Q2, resulting in a full-year negative impact of 50 basis points for KFC and 25 basis points for consolidated Yum! Additionally, we estimated the negative impact on KFC’s 2018 core operating profit growth was 5% for the first quarter, 3% for the second quarter, and 2% for the full year. Again, now that we have lapped the disruption, there will be no benefit from easier laps going forward. I’ll now update you on our 2019 EPS outlook and the moving pieces that will impact our reported results versus adjusted EPS guidance, all detailed in a table within our earnings release. First, there is no change to our goal to deliver at least $3.75 in 2019 adjusted EPS. As a reminder, this target excludes any benefit from the 53rd week in 2019, changes in FX rates, special items, or any gains or losses associated with our Grubhub investment. We estimate the benefit of the 53rd week on the $3.75 guidance to be approximately $0.06. Our updated estimate of the impact of FX rate movements is now a $0.08 headwind to the $3.75 number. This headwind is based on applying current forward rates to local currency forecasts, which will vary over time. Year-to-date 2019 special items are a $0.01 headwind, while year-to-date Grubhub mark-to-market adjustments are a $0.01 tailwind to the $3.75 figure. Taking these items into account, as outlined in our earnings release, the GAAP equivalent to our adjusted 2019 EPS guidance of at least $3.75 is at least $3.73. Now turning to our transformation initiatives to be more focused, more franchise, and more efficient to deliver growth to our shareholders. With our target franchise mix of at least 98% reached in the fourth quarter of 2018 and with focus on our four growth drivers consistently at the heart of everything we do, I'll update you on our plans to be more efficient. In summary, we remain on track. G&A was 1.6% of system sales in the second quarter, while 1.7% of system sales remains the appropriate target for full year 2019. Additionally, our CapEx guidance is unchanged from last quarter. Our ex-special items effective tax rate for the quarter was 23.7%, above the 20% to 22% range we provided at our Analyst Day last December. We are not changing our annual tax rate guidance at this time. However, it's difficult to forecast this rate with pinpoint accuracy in the near-term due to the uncertainty of equity compensation payouts and a continually changing tax landscape across the over 145 countries where our system sales are generated. We will continue to update you as we progress through the back half of the year. As for our capital return plans, our goal to return $6.5 billion to $7 billion of capital to shareholders over the three-year period from 2017 to 2019 remains firmly on track. During the second quarter, we repurchased 1.9 million shares for $196 million at an average price of $104 per share. When combined with dividends, we have already returned $5.7 billion to date. Now let's discuss our growth drivers, beginning with unmatched franchise operating capability. I'm pleased to report improvements across Taco Bell. In the U.S., 6 million more cars drove through drive-throughs compared to Q2 2018, and our guests received an experience that was on average seven seconds faster. This attention to improving speed and customer satisfaction broke two weekly sales records just one week apart. Internationally, I visited Italy and Romania, where we spent time with our reigning KFC franchisee of the year, Sphera. We launched Taco Bell in Bucharest with encouraging results. At Pizza Hut, we continue to execute on our hot, fast, and reliable initiatives. In the U.S., we also perfected the original pan pizza, results in improved customer feedback scores. Internationally, we are continuing to run workshops on speed to taste with our franchise partners leading to customer satisfaction score improvements in Malaysia, Kuwait, and UAE. Pizza Hut digital ventures also expanded its Fast Casual Digital Store platform to Japan and Mexico, bringing the total store count to over 2500. KFC’s continued development momentum included 232 net new units with strong trends across China, Asia, Russia, Thailand, Latin America, and the Caribbean. In the U.S., we strive for positive net new unit growth while transforming our asset base to the American Showman image. We closed the quarter with over 1600 American Showman restaurants as 104 remodels were completed. Taco Bell continued to grow in the U.S. with 18 net new units during the quarter. Internationally, Taco Bell opened 13 net new units in 11 countries while signing massive franchise agreements in India and Portugal. We are particularly excited about India and our partnership with Burman Hospitality, our largest Taco Bell development agreement to date, which plans for 600 Taco Bell restaurants over the next ten years. We continue to garner interest in our global Taco Bell brand. Pizza Hut's transition to modern delivery carryout assets will strengthen the Pizza Hut business in the U.S. and set up faster long-term growth. We believe Yum! will deliver 4% annual net new unit growth on average over the next several years. Importantly, closures will be of our lower volume stores, minimizing financial impact and resulting in better long-term profitability. As for our strategic alliance with Telepizza, the integration continues to go very well, reporting positive net new unit growth. Regarding our unrivaled culture and talent, I am excited to have finalized our roles for our brand CEOs. First, Mark King, former President of Adidas Group North America, will join as Taco Bell Division Chief Executive Officer effective August 5th. Mark brings extensive retail experience and a track record for driving growth, innovation, brand relevance, and culture. Under Julie Felss Masino and Liz Williams, the Taco Bell team has been delivering fantastic results. Second, Artie Starrs, President of Pizza Hut U.S., has been promoted to Pizza Hut Division Chief Executive Officer. I am confident Artie will help strengthen Pizza Hut’s competitive position globally and partner well with Vipul Chawla, President Pizza Hut International. Third, KFC Division Chief Executive Officer, Tony Lowings, has had an incredible start under his leadership, accelerating results across the board. In summary, the first half of 2019 was a strong start to the year. We always expected a stronger first half due to less challenging laps. With three category-leading iconic brands and a diversified global business, Yum! is well-positioned to accelerate growth and improve franchise unit economics by leveraging our scale and expanding digital technology and delivery. We look forward to updating you throughout the remainder of 2019. Now, the team and I are happy to take your questions.

Thanks. Just a little bit of a longer-term question on Taco Bell and international development. I recently listened to a podcast with Liz Williams. Those are good interviews, and it reminded me that you have one of your better executives working on that, and you just mentioned that 600 unit development deal. I am wondering if India is maybe uniquely fertile and if there will be other development deals around the corner.

Sure, David. Yes, it was a great deal, 600 units in India, and the business in India is doing incredibly well. We have over 50 units in both the UK and Spain. We have opened four units in Australia as well, and those are off to a really good start. We plan to open over 100 units internationally with Taco Bell this year, and we're seeing good progress.

One of the keys to India is that we have established the brand there over time, and now we have the right partner, Burman Hospitality. Finding the right partners and establishing the brand are key elements in scaling the business.

Thank you. Next question, please?

Hi, thank you. A couple of different questions related to your current franchise community. There’s a common theme of consolidating franchisees worldwide, allowing franchisees to have scale. How much more do you think should occur within Yum! and is there still potential to accelerate unit growth? Also, how are you monitoring the leverage that the franchisees are taking?

Our franchise-base has an average of about 25 stores, which is larger than most in the industry. We encourage consolidation in fragmented markets, but we believe that having bigger, better-capitalized franchisees is beneficial. We monitor franchisees' financial health to ensure that they can grow and support our brands.

Our franchisees are engaged, as seen by record attendance at our recent AMPM. Their energy and commitment to growing our iconic brands encourage me.

Thank you. Next question, please?

Hi, thank you. I have a question about Pizza Hut and traffic versus ticket. Traffic grew globally, but ticket seemed negative. Are you seeing this in other markets too? And as I know you are closing some stores, that should benefit same-store sales if they are weaker performing.

We had a strong transaction quarter overall. Pizza Hut U.S. trends were up 3, along with Taco Bell and KFC trends. We’re focused on both everyday and disruptive value to drive transactions. Our partnership with GrubHub is allowing us to reach a wider audience, which promotes transaction and sales growth.

Thank you. Next question, please?

Thanks very much. Just following up on Pizza Hut's transformation in the U.S. You have about 7,500 units, so would you be net closing around 500? What do you think the company's role in this is? Will there be assistance in managing this transition?

Yes, your numbers are about right. We have about 7,449 Pizza Hut assets in the U.S. As far as the closure timing, it’s hard to estimate. We aim to minimize gaps. We know the economics of building a modern delivery asset are strong, and I suspect we will be able to maintain and rebuild in the same areas.

We are committed to an asset-light model, but there may be specifics where we deploy some capital to facilitate market transitions. We will keep you updated as we sort through the details.

Thank you. Next question, please?

Hi, good morning. Congratulations on the strong momentum. Following up on the Pizza Hut closures in the U.S., will these be lower volume units? Would the net reduction have a smaller impact on system sales than unit count?

Yes, the stores closing will generally be lower volume. This means the overall impact on system sales will be less than the unit count reduction. Our goal is to close underperforming locations and replace them with modern delivery assets, resulting in better economics.

Thank you. Next question please?

Thanks for the question. Can you discuss Taco Bell's strength and delivery performance? Are there any share gains in lower price point items where other brands seem softer? How do you frame Taco Bell's back half of the year regarding product and marketing?

When you deliver a plus seven on trends, you are doing things right. Delivery, value, and innovation are key drivers. Our marketing pipeline looks strong, with exciting plans for Q3 and Q4 that we feel good about.

While we had a strong first half, we expect trends to return closer to our long-term guidance range in Q3 and beyond, as laps get tougher.

Next question, please?

Great, thanks. Following up on Dennis’ question, regarding the tortilla shortfall at Taco Bell in early July, can you speak to its scope and impact on sales? Should we expect any residual drag in August?

The supply issue was limited to 10-inch tortillas for items like quesadillas and burritos, impacting us for about nine days. It did have a very minimal impact on sales. We have addressed these shortages with our supplier and are working to ensure we won’t run into this again.

We have time for one more question, please?

Can you talk more about the accelerating unit openings at KFC globally? I know China is a big part of it, but outside of China, are you seeing improvements? Is KFC becoming a consistent system sales growth driver?

We’re pleased with KFC development progress and it is strengthening each quarter. We will not provide guidance by brand, but we will continue to support growth by capitalizing on system sales growth.

Thank you all for being on the call today. I am thrilled to share our strong Q2 results, with broad contributions from all our iconic brands. We expect slower growth in the second half of 2019 due to more challenging laps, but I am confident our strong business and unrivaled culture will deliver lasting growth and maximize shareholder value in 2019 and beyond. Thank you for being part of the call.