Section I: Management Presentation
Good morning. My name is Angela and I will be your conference operator today. At this time, I would like to welcome everyone to the Yum! Brands third quarter 2013 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.
I would now like to turn the call over to Mr. Steve Schmitt, VP of Investor Relations. Sir, you may begin.
Steve Schmitt – VP, IR
Thanks, Angela. Good morning everyone and thank you for joining us. On our call today are David Novak, Chairman and CEO; Rick Carucci, President and Pat Grismer, our CFO. Following remarks from David 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 on 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 www.yum.com to find disclosures and reconciliations of non-GAAP financial measures that may be used on today’s call. We’re 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 you to be aware of a couple of upcoming Yum! investor events. First, our 2013 New York investor and analyst conference will be Wednesday, December 4 in Midtown Manhattan. Second, our 2013 fourth quarter earnings release will be Monday, February 3.
With that, I would like to now turn the call over to Mr. David Novak.
David Novak – Chairman and CEO
All right. Steve, thank you very much and good morning to everyone. There are three key messages I want you to take away from our call this morning. Number one, we are very disappointed with our overall third-quarter results and the fact we now believe China same-store sales will unlikely be positive for the fourth quarter. Frankly, these results were well below the high expectations we have for our business.
Number two, there were some bright spots in the quarter and we are pleased with Pizza Hut Casual Dining in China, overall China restaurant margin, international development momentum and Taco Bell. And number three, despite current challenges, we remain as confident as ever in our ability to deliver strong sustainable growth in the years to come.
For the third quarter, earnings per share, excluding special items, declined 15% versus prior year. This included a 10 point adverse impact from a higher tax rate, driven by an increase in our tax reserves. Additionally, based on KFC China sales for September, which is part of China division’s fourth quarter and a less than expected sales lift from the launch of our new beef burger, it’s now unlikely that China division’s same-store sales will be positive for Q4, although we do expect to show improvement. Obviously, we are falling short of our Q4 guidance of positive same-store sales growth. We are now estimating a high single to low-double-digit percentage decline in full year EPS, excluding special items.
We also recorded a significant non-cash special item charge in the third quarter for the write-down of Little Sheep intangibles. While we are deeply disappointed with our Little Sheep results so far, the team is taking steps to strengthen the concept and improve operations. And we remain confident that we will create a significant value over the long term through new unit development in China’s large and extremely popular hot pot restaurant category.
If you followed us over the years, you know that our target has always been consistent dynasty-like performance growing at least 10% year after year. And in fact, the business accomplishment we’re most proud of is that prior to this year we delivered double-digit EPS growth for 11 consecutive years. This places Yum! Brands among an elite group of companies to deliver this track record of performance.
Now we’ve certainly been humbled by this year’s performance. But I want you to know that we are confident and determined to reestablish our track record of sustainable growth in the years to come. I also want to assure you that we’re working very hard right now to recover from the one-two punch of China poultry supply incident in December and the unexpected bout of avian flu in the spring.
Let me share with you some of the actions we’re taking over the next few months to continue to rebuild consumer trust at KFC China and gain more sales and profit momentum as we enter 2014, which we expect will be a bounce-back year for Yum! Brands.
Our number one priority at KFC China is to build and reinforce positive consumer perceptions around the safety of our food. And while our key brand attributes have improved significantly from where they were in the first few months following the December incident, the fact is, is that they remain below 2012 levels. The KFC brand is showing its resilience and we are confident that a full recovery is in store but more time and effort are required.
So in November, our plans are to launch what we are calling our [I Commit] campaign. We expect this to be a powerful new quality assurance campaign featuring actual representatives of our over 300,000 KFC employees, suppliers and poultry farmers in China. Our quality assurance message will be delivered in an authentic manner and will be centered on the theme that KFC is safe for my family, friends and me and hence, safe for you.
We are also leveraging our massive network of employees and suppliers through social media. The goal is to leverage the fact that KFC brand is part of the of fabric of China and of course, all of this is on top of the Operation Thunder actions we initiated earlier this year to strengthen our poultry supply chain.
On the marketing calendar front, we’ll be following up the recent new product introduction of our beef burger with promotions featuring chicken on the bone, wings and beverages. At the same time, our China team will remain very focused on operating efficiency. We were really pleased to see a nearly 20% restaurant margin despite the decline in sales. I want to recognize the team for really buffing down at the store level. Pat will share more details on this in his remarks.
In short, I’m confident we’re doing the right things to rebuild consumer trust at KFC China and we expect to have momentum heading into 2014. The good news is we’ll begin overlapping very weak same-store sales in December and we’ll have this unfortunate benefit across most of next year. And we plan a number of major menu and value innovations to ignite the sales growth in 2014. Sam Su will share more details of our initiatives during our December meeting in New York.
Now the obvious question is why do you think sales momentum stalled in China? I’ve always said that no two crises are the same. And we always said that we would need to get to time and that it would take at least nine to 12 months. So far, it’s nine months and counting and not happening as fast as we had hoped.
Now, as I just mentioned trust scores are improving significantly, but still below 2012 levels. We believe this is because KFC’s leadership in size has grown exponentially over the years, and our customers’ expectations of the KFC brand have grown along with it. Social media has also exacerbated the issue and kept the dialogue alive. And macros haven’t helped.
While we’ve announced process improvements, communicated a trust message, and we’ve had value promotions, frankly, we haven’t had the kind of major innovation that could turn the tide. And like I said, we are working hard to get back on track, and we are confident that we will.
On the China development front, we continue to expect at least 700 new units in 2013. This means we will have opened around 1,600 new units in a two-year period, and we expect another strong year of development in 2014, all of which will provide substantial momentum for our China division as sales continue to recover at KFC.
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