Home » Yum! Brands, Inc. (NYSE:YUM) Q3 2013 Earnings Conference Call Transcript

Yum! Brands, Inc. (NYSE:YUM) Q3 2013 Earnings Conference Call Transcript

Furthermore, we have nearly 40,000 restaurants around the world that have all kinds of capacity to grow. This represents a huge opportunity for same-store sales growth. In addition to our ongoing efforts to drive sales through improved product innovation, marketing, and operations, we’re developing major new sales layers, broadening our menu variety, expanding our day-parts, and opening new channels with digital.

I’ve mentioned our breakfast rollouts at Pizza Hut Casual Dining in China and at Taco Bell, but we’re also doing this at KFC in many of our emerging markets. Pizza Hut WingStreet in the U.S. is another example of what we’re doing to leverage our home delivery capabilities and drive higher levels of asset utilization.

Meanwhile, our returns on invested capital have consistently been among the best in the retail industry. We love the virtually capital free franchise model, which will generate over $1.8 billion in franchise fees this year. These franchise fees provide us with a large, reliable, and growing stream of cash which, combined with the profit from our equity stores, enables us to invest in high-return growth opportunities and return meaningful cash to our shareholders.

Speaking of shareholder cash payouts, I’m pleased to note that we recently increased our dividend by 10%, marking our ninth consecutive annual double-digit percentage increase. Since 2004, the year we instituted a dividend payment, we’ve returned over $11 billion to shareholders in the form of dividends and share repurchases, all while also continuing to invest in future growth. The mere fact that we’ve increased our dividend in a down year demonstrates the power of our operating cash flow and the confidence we have that our investment model will deliver strong shareholder returns for many years to come.

In summary, after over a decade of growth, 2013 is clearly proving to be a setback. However, we are confident we will restore our track record of double-digit EPS growth in 2014 and well into the future. We have an established track record. In fact, our compound annual growth rate in EPS is above 10% over the past 12 years, and that includes this year. I want to emphasize that we know these results are yesterday’s news, but we firmly believe that Yum! is a company on the ground floor of global growth, and recognize that it’s “show me” not “tell me” going forward.

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Having said this, we have every belief and enormous intentionality that we’ll begin to get back on track in 2014. We expect to have a strong bounce-back year, driving EPS growth of at least 20%, which is admittedly now off a lower base than we had hoped for. And as always, if we can do better, we will.

Now let me hand it over to Pat Grismer, our CFO.

Pat Grismer – CFO

Thank you, David. As David said, 2013 is a very challenging year for Yum! Brands, and our third quarter results were certainly below expectations. I’ll cover the details in a couple of minutes, but I first want to echo David’s view that we don’t consider these results indicative of Yum!’s ongoing performance or future growth potential. We’re confident that our global brands, competitive position, and investment opportunities remain compelling, and we’ll deliver double-digit EPS growth for many years to come.

One of the first things I want to do is to explain the timing of our revised guidance for fourth quarter same-store sales growth in China. We had very high expectations for the month of September with an exciting new product introduction at KFC, the beef burger, and with a much easier comparison from last year. The fact is that we expected a much better result and in hindsight, we were wrong.

When you step back and look at our business this year, there’s no doubt that the unprecedented decline in EPS before special items has been led by the temporary issues at KFC China, with the balance of our portfolio generally meeting full year plan.

Remember, Pizza Hut has continued to deliver outstanding results in China, and our other major divisions, Yum! Restaurants International in the U.S., are generally on track to achieve their full year ongoing growth targets, generating significant cash flow. Importantly, we’ve been able to sustain high rates of investment and have even been able to raise our dividend despite the challenges in China. It takes a company of considerable strength and confidence to do that.

Today I’ll provide some additional perspective on our third quarter results, our full year outlook, and Yum! shareholder cash payouts. I’ll then share some initial thoughts on 2014.

For the third quarter, we recorded a 15% decline in EPS, before special items, which is obviously disappointing. This decline was led by sales and profit declines in our China division, as well as a higher tax rate. Our third quarter tax rate increased from 25% to 33%, driven primarily by a tax reserve adjustment, which negatively impacted EPS growth by 10 percentage points in the quarter. This increase relates to the continuing dispute with the IRS regarding a valuation of intangible assets, which has been disclosed in our prior SEC filings. For the full year 2013, we now expect our global effective tax rate to be approximately 28%.

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Reported EPS declined 67%, primarily due to a non-cash special item charge of $258 million to reflect the partial impairment of Little Sheep intangible assets. Partially offsetting this is the non-cash $74 million special item gain that we were required to recognize last year upon our acquisition of Little Sheep to write up our previously owned interest to fair value at the time.

As I mentioned on our second quarter earnings call, Little Sheep results were trending below our expectations, due in part to a longer than expected approval process and ownership transition. Our efforts to regain sales momentum were then thwarted by negative publicity surrounding quality issues linked to the hot pot category in China, even though Little Sheep was not involved. This has further delayed our expansion plans, which were a key component of our initial valuation. Although we remain confident in the long term prospects of the Little Sheep brand, we determined that it was appropriate to write down our investment in the quarter because of the sustained negative sales performance.

Now I’d like to dig a little deeper on each division’s third quarter results. In China, operating profit declined 14% in Q3, prior to foreign currency translation, driven by an 11% decline in same-store sales. This decline in same-store sales included a 14% decline at KFC and 5% growth at Pizza Hut Casual Dining. Overall, China division restaurant margin was above 20%, excluding the negative impact of Little Sheep, or 19.5%, including Little Sheep. And while restaurant margin declined 1.9 percentage points in the quarter, this is a remarkable achievement when you consider the extent of our same-store sales decline.

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