Yum! Brands, Inc. (YUM) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Ashley and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Yum! Brands third quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session (Operator Instructions) Thank you. Mr. Tim Jerzyk, Senior Vice President of Investor Relations, you may begin your conference.

Thank you, Ashley. Good morning everyone and thanks for joining us today. This call is being recorded and will be available for playback. We are broadcasting the conference call via our website, www.yum.com. 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. I would also 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 statement in our earnings released last night and the risk factors included in our filings with the SEC. In addition, please refer to the Investors section of the Yum! Brands’ website to find disclosures and reconciliations of non-GAAP financial measures that may be used on today's call. Also we would like you to please be aware of a couple of Yum! investor events; Thursday, December 06, we will host our Annual Investor Update Meeting in New York City and then Monday, February 04, 2013, our fourth quarter earnings will be released. Now I’ll turn the call over to David Novak.

Thank you very much Tim and good morning everyone. Before I talk about our third quarter performance, I think it’s important to note this past Sunday, October 7th marked our 15th anniversary as a company. From the very beginning, our formula for success has been people capability first, satisfied customers and profitability follow; I am proud of how we went to get our ownership culture we’ve developed and pleased with the strong returns we’ve generated for our shareholders. As we look back over the past 15 years, we take satisfaction by what we’ve been able to accomplish, but as you’ll hear more about today, we’re even more excited about the unfinished business that lies ahead. When we started our company, we benchmarked high performing companies and all were known for their consistent double-digit annual EPS growth. As a result, we built our company around the objective of delivering dynasty like performance of at least 10% annual EPS growth. We just raised our guidance and we expect that 2012 will mark the 11th consecutive year we deliver at least 13% EPS growth before special items. As you know, there are three keys to driving shareholder value in retail; new unit development, same-store sales growth and high returns. Our new unit opportunity in China is the best in retail and our opportunity to expand is now bigger than ever throughout the emerging markets. As I said before, Yum! Brands is about China and so much more. As evidenced about 60% of our profit is generated in emerging markets which is where the real economic growth in the world is occurring today. This growth, combined with the facts that we have powerful global brands and only two restaurants per million people in emerging markets compared with 58 restaurants per million people in the…

Thank you, David. Let me start this morning with Yum! Restaurant International which is perhaps the most under appreciated piece of Yum! YRI has a great business portfolio. There are tremendous development opportunities in emerging and underdeveloped markets and over 85% of YRI’s 14,000 restaurants or franchise. This combination creates a steady stream of franchise royalties and strong growth. For the quarter, YRI delivered system sales growth of 4% and operating profit growth of 14% prior to foreign currency translation. Same store sales increased 2% led by a 5% increase in emerging markets. These YRI same-store sales were negatively impacted by about one point due to calendar shift of Ramadan into the third quarter of 2012. With the results we have seen so far this year, we are well on our way to build 900 new units in 2012. While Yum! Restaurant International has tremendous growth opportunities in many parts of the world. I am going to spend some time today talking about the roles of four markets, France, Germany and Russia as well as the African continent. First let me put France, Germany and Russia into perspective. In these three countries combined, McDonalds has about 2,900 units and makes well over a $1 billion in profits. Last year in these countries YRI had 383 restaurants that made less than $30 million in profits. So we know we have a tremendous runway for growth. In France, we have 143 restaurants, we are on the air with national television advertising and we have the highest KFC average unit volumes in the world. We are using a business rental program which we patterned after the successful model used in France by McDonalds. This approach combined with the strong KFC consumer proposition is driving disciplined unit growth. We are making significant progress building…

Thank you, Rick. To start, I would like to thank our operating divisions for their outstanding third quarter performance as 19% EPS growth excluding special items was led by an impressive 18% growth in operating profit prior to foreign currency translation. It’s great to see each of our businesses deliver such strong results reflecting the resilience of our global brands and business models in uncertain times. As David and Rick have already summarized third quarter results for each of our divisions, I will limit my Q3 remarks to three key items of interest. China restaurants margin, China new unit development and Yum! shareholder cash payouts; I’ll then lay out our expectations for the fourth quarter and share some initial thoughts on 2013. First China restaurant margin; you’ll recall that China margin was down 4 percentage points in the second quarter compared to prior year. As we expected, this trend reversed in the third quarter with margin improving modestly over prior year due to based pricing actions and lower inflation. For the third consecutive quarter, inflation rates fell for both labor and commodities in Q3 coming in at 8% and 2% respectively. This result reinforces our belief that China can sustain a restaurant margin of 20% over the long run. Second, China new unit development; as David mentioned, our China division now expects to open over 750 new units this year. To put this into perspective, I would like to point out that a couple of years ago in 2010; China’s new unit growth rate was 13%. This year, it is 18% on a much larger store base. This is a clear breakthrough in development performance and a testament to the size and scale of our China development team. Of course, in light of these development results, we're sometimes asked whether…

(Operator Instructions) Your first question comes from David Palmer with UBS.

Good morning and congrats on the quarter and also thanks for the details on this call. You mentioned the China economy is slowing and the fourth quarter same-store sales were at less pricing and that leads you to the low single digit to flat guidance there. Is there anything beyond, in the details of your business and the trends that you are seeing that gives you visibility in terms of where things may bottom in terms of same-store sales and I mentioned that just naturally investors are going to be off balance until they figure our where the bottom in your at least the same-store sales are going to be, is there any sense of that for you in your China business? Thanks.

David I don’t know I’ll drill the answer to that. First of all, we’re not economist or we’re not, we can’t we have not really seen or read any news or have any real news that you really don’t have or you can’t read about already and what we do see is clearly that there is an economic slowdown in China which again is not any news than we talked about this the last time. I think the biggest thing that I would want to just point is we’ve been able to deliver consistent results and we’ve been able to do that year-after-year. And I think it’s because our business model is really strong and obviously China even with its challenges is still growing at a reasonable pace. It’s up, GDP was up 7% in the second quarter; it’s expected to be up 8% in 2013 according to the Financial Times and retail growth is supposed to be double the GDP. I think for us, the biggest tailwind we have is just the consuming class continues to grow expected to double in the next 10 years. And you guys read the same stuff we read and look same facts are reported. Personal incomes, the middle class incomes are rising, which is also a big plus. And as you saw, our infrastructure, the infrastructure growth is really continuing to grow at a higher rate. So we’ve got all these new cities and clusters and trade zones coming into play that we’re able to now penetrate. And so I think the big news for us is old news frankly is that we’re really in position to capitalize on what’s going on in China more which is still the fastest growing economy more than any other retail in the world, we have got leading brands, a business model with three year cash-on-cash, the returns, competitive brand positions that are better than they have ever been. We have got unmatched development capability, you have seen our management team in action; they have been together for a long time, gets better and better, and a lot of young talent coming in. We own our supply chain and we are just attracting top talent, I mean the fact that I pointed out in my remarks, we have 10,000 management trainees this year and 2,000 ready to go assistant managers. So, I think, I look at this business long-term, I have to say you know we’re going to have our ups and downs right now, we’re kind of based in a slower economy, but I am always going to be glad, I wake everyday and know that we have a position we have in China and I think as we look to the long terms, we are very confident in what we have ahead of us.

And David, what I would add to that is that we’ve clearly acknowledged the same-store sales have slowed down in part because we are lapping extraordinary performance from last year, but also because the economy is swelling. But I also pointed out that given the accelerated pace of new unit development this year, tracking at 18% as we enter next year we are going to be less reliant on same-store sales growth to achieve our 15% profit growth for the China division. So when you add that all up, when you consider the pace of development, when you consider the pricing that we have rolling into next year and the ongoing strength of our new product pipeline, not to mention, the strong people capability as David mentioned, we continue to be very optimistic that we will achieve that 15% profit growth for China next year.

Thanks. Next questions please Ashley.

Your next question comes from Michael Kelter with Goldman Sachs.

Hi guys, I have I guess two questions. The first one is, how can we be confident in positive China same-store sales in ’13 and as per your guidance when traffic is running negative right now, the economy is still decelerating and you’ll have less pricing rolling through the P&L next year. So essentially what I am asking is what are you seeing that makes you, that makes positive your base case? And then secondly, the accelerated new unit development in China; you talked about why you are comfortable with the pace of opening in the prepared remarks and it all makes total sense. But I just wanted to ask, if you were in fact growing too fast and may be making some mistakes that were being obscured by the near term growth that it provides, how would you know it before it was too late; what are you looking at?

I am happy to respond to that Michael and I’ll start with the second piece on development. As I mentioned, we have extraordinary development capability in China. We review the performance of our new units routinely paying attention to every possible operating metric you can imagine and there is extreme diligence around how we manage our new restaurant portfolio including shifting as I mentioned development from the Tier 1 cities of where returns have softened into the lower Tier cities where we have higher margins and our returns are outstanding. So we do capitalize on what we learned from recent new store openings to inform how we manage our pipeline going forward. So there is extreme diligence and vigor around that entire process; regular review by again a team that is very, very experienced and unmatched in capability in China. As for the second question on positive same-stores sales for next year, we do have four points of pricing as we enter next year and depending on how we construct our plan for next year, we may find opportunity to take additional pricing. But at the same time, we are confident in our track record of new product innovation and how we have been able to grow our business overtime we have added sales layers to our business. We're not fully penetrated in all of those sales layers. So as we move those two, 100% penetration and we continue to introduce new product innovation. We're confident that we'll be able to generate eventually the same-store transaction growth along with the check growth that comes from pricing to achieve the same-store sales growth on New Year. Now as we said before, there can be volatility from quarter-to-quarter. So I am talking about a full-year basis when I say that we're optimistic that we will deliver the same-store sales growth in 2013.

I think one other really good example on just how we approach development, a couple of years ago, Pizza Casual Dining, our unit economics had slowed down and so we did not expand further. We didn’t move into Tier III, Tier IV, Tier V cities at all. What we did as we went back and the team revamped our business so that we added much more menu variety and we also took our value equation where we went with a eat like a rich man, eat like a poor man approach where we had a great every day value entry pricing, half priced menu, entrees on a daily basis and the transactions and profits just went through the roof. And then we started expanding into three, four and five cities. So, I think that’s a great example that where we really follow our mantra which is don’t get you cash out in front of your people capability and or your business model and we constantly are tracking our performance quarterly with what we call our new unit tracking system as Pat talked about, but that’s a great example of how we look at things. I tell the guys all the time and I’ve said this before, we got a great diamonds, great brands, keep caution don’t grow any faster than we grow. And what’s happening though is that we’re able to grow fast because the opportunities are out there and increasing and we’re able to deal with great returns for our shareholders. So we’re confident that we’re growing the business the right way and I can assure you that the team has been told and from day one we’ve never been chasing a number. The number just keeps getting bigger and bigger than what any of us ever expected. We went into this year with a projection of 600, okay, this was after we did 650 last year. Why was it 600? Don’t grow faster than what we need to, we don’t give, we’re not trying to be heroes, we’re trying to build a heroic business.

Next question please Ashley.

Your next question comes from Jonathan (inaudible) with Robert W. Baird.

Pat just a follow-up question on the restaurant margin outlook for China for Q4. And I’m wondering specifically what your current expectation is in terms of commodity and wage rate inflation?

Absolutely, as I mentioned in my prepared remarks, we are expecting modest year-over-year improvement in China margins in the fourth quarter comparable to what we saw in the third quarter but how we will get there will be a bit different. We’re expecting for example, a positive impact from inflation because we expect there will be in fact deflation on our commodities in China in the fourth quarter. And we’re expecting a lower a benefit from pricing as we rollover some pricing actions we took last year. We’re expecting the impact from new store development to be about the same. So when you add all of those factors together, we’re looking at that point of improvement on margins year-over-year excluding the impact of Little Sheep.

Okay. And I guess one more clarification question just on the expectation for slower China comps in Q4. You mentioned that you’re cycling price and you already recycled some again in November. So I just want to ask and I am wondering specifically on the traffic component for China, how much slow in you expect for that factor in Q4 and then whether or not you have actually seen that materialize yet quarter-to-date?

Well, just to recap a little bit. In Q3, what we have with 6% same-store sales growth, we had about a 7% pricing advantage. So as David mentioned, transactions were down about a point. And what we are expecting for Q4 as same-store sales growth of low-single digits to flat and we have about five points of pricing benefits, so that would give you low-single digit same-store transaction declined in the fourth quarter.

Okay, got it and which you read the pricing as a proxy for overall check growth?

Yeah.

Thanks Jon. Next question please Ashley.

Your next question comes from Jason West for Deutsche Bank.

Just one thing on the modeling or as two things on the China revenue side that did come in a little bit below our total revenue for that segment even tough the comps were better than we expected. So it looks like the new store productivity had slipped a little bit. I don’t know if you can talk about that, what maybe the drivers of that and then just secondly, should we remodeling unit growth in China next year similar to what you are doing this year because I think historically once you step it up, you have kept it at the higher rate, thanks?

Hey John, this is Tim Jerzyk. It’s hard for us to understand exactly what you were expecting; we kind of give you our best thoughts on that even on the last call. I am not sure what you are expecting for Little Sheep. I know there were some discussions we have had with other analysts about the expectations from royalties from Little Sheep and it was a shorter than what had people expected. So that might be or where we were below what you expected. Our new store productivity has consistently been very much stable over the last five years, six years; it’s about 30% less than our average unit volumes of our business net holding steady for both Pizza Hut and KFC.

Okay then on the development side?

Okay, in terms of development outlook for next year?

Right, so we would be modeling similar unit openings in China for next year that you did this year?

Well Jason, we will be providing that guidance at our December Analyst Conference as we had in years past.

Thanks Jason. Next question please Ashley.

Your next question comes from Brian Bittner with Oppenheimer.

Two questions on the US business. Number one, as this big (inaudible) from the Doritos, Locos Tacos somewhat fades a bit at Taco Bell when can we expect you to come out with some more SKU’s to sustain the momentum particularly the cool ranch which is something I am just really excited for and waiting for and then also just a very strong comps at Pizza Hut, if you can just talk about that do you think it is a result of a strong category in the quarter or there are something different you were doing in 3Q to take some significant market share?

Well Brian, on the first piece, we are not going to give out the exact date, but we expect to have extensions of Doritos, Locos Tacos in next year and part of the reason we pushed that into 2013 was because we were so successful, it basically used all of our available supply of Taco shelves, but maybe you said coupon right before the positive come out since you are big fan of the product volume as well. Regarding Pizza Hut, we’ve had pretty good success through the course of the last year on the boxes, so our box promotions have been very successful and we use those heavily in Q3 and we will probably continue to go on those going forward.

But do you think that the category was strong in the third quarter or I mean do you think a large part of kind of the upside in the comp was market share gains because of the box?

Yeah, we haven't gone into some of the detailed pieces; I would say we didn’t see a huge - the stuff I have seen, I haven't seen huge changes in overall category in the quarter.

Thanks Brian. Next question please Ashley.

Your next question comes from Andy Barish with Jefferies.

Hey guys, can you talk about the inflation, particularly the food cost commodity side of things. It seems as if there is something more than just the raw material input cost using up a little bit. I wasn’t aware of some of the changes in the U.S. distribution side of things or maybe it's more full priced product being sold, you know, DLT at $1.29 instead of a regular Taco. Can you give us a little bit more flavor or color on sort of that benefit for commodities and maybe an initial look at 2013?

Well, I’ll certainly comment on 2012 again any guidance on 2013 will defer to our December Analyst Conference. As far as 2012 is concerned, we have seen significant benefit from what we call our restaurant margin initiatives focused on supply chain efficiencies. And you see that rolling through the U.S., so to recap what our quarterly commodity inflation trend has been in the U.S. Q1 at 4%, Q2 at 1% deflation, Q3 2% deflation, we’re expecting for Q4, 1% deflation so you can see a nice trend there which to your point reflects not only what we’re seeing is a general softening and commodities prices, but the added benefit of the supply chain efficiencies we’re gaining through these initiatives. And that just takes us to flat on commodity inflation for the year, so its market price movement along with advantage we’re gaining through our supply chain initiatives.

The supply chain initiative is a good example, but David has talked about quite a bit on some of the previous calls. We’re doing a much better job of sharing, learning between divisions either between the U.S. and international or even within U.S. division. So this is actually initiative that was spearheaded by Pizza Hut that we’ve now taken to the other U.S. businesses and now to other markets around the world. So we have a bottleneck consultant and just looked at how we could be more efficient in some of the supply chain opportunities that we had. And we’re seeing some benefits of that this year and I expect to see some benefits for that next year as well.

And any guess at selling more full priced product whether it’s Taco Bell or China now kind of lapping the big value platforms that you put in place in 2011 in terms of the benefit of higher gross margins?

Yeah, well obviously as you look at what we want to do in all of our brands in the U.S. and around the world, we’re always looking at but what we call menu mix management and you know what you would take for pricing and how do you offer value to the consumers and what prices are your new initiatives. And we have benefited this year to the point that you are making as with Doritos Locos Tacos we think in some cases people are probably trading out of regular Tacos for those and those are priced at a higher level. And as we look at 2013, at least in one of our divisions that I have seen some detail, we probably will have more of our initiatives to say the higher priced items which should help us on menu mix. So we why make sure we could stay focused on core value in some of that main parts of our menu.

I think one of the things that we are very pleased about in terms of our competitive positions with KFC, with Taco Bell and Pizza Hut in U.S. is that we are very competitive on everyday pricing basis. Taco Bell is renowned industry leader for price value and Pizza Hut with its $10 large pizza pricing structure that we continually reinforce is competitive on an everyday basis. So when you have that everyday pricing in place, when you come in on top of that with the innovation, you are able to do the menu management that Rick is really talking about. And that's a formula that we are going for all around the world, I mean it’s we believe that low everyday pricing, entry pricing and then you innovate the heck out of the business and I think we do a pretty good job of that.

Thanks Andy. Next question please Ashley.

Your next question comes from Greg Badishkanian with Citigroup.

Great, thanks. Hey, just two quick ones. First is, how much of the China slowdown besides though I say the 200 basis point tougher compare is due more to the economy versus pricing; I mean what do you see as kind of the biggest factor there? And then just on the U.S. side, the Cantina product, it sounds like it’s having some good momentum, is that due to more trading up or you are getting more new customers from that product?

On the China comps Greg, it’s really difficult to segment the change quarter-over-quarter into how much is driven by the economy versus the comps and the comp is pretty clear. But we have acknowledged that there has been a slowing trend in the China economy and that’s impacting the retail space broadly and we are feeling some effect of that.

Regarding the Cantina Bell products, we don’t have a lot of breakdown mathematically on new customer’s etcetera; it’s difficult to get QSR space. We do have anecdotally as a few things, first of all we are seeing more people at lunch time and that the people who buy Cantina products have higher ticket, which is obviously expected given the price point of the product. So we are seeing sort of that benefits on that products and you know we think that if that’s casual guys, so it taught us a lesson which is that people want in a very high quality even food that are going spend more money if they get speed and convenience and obviously with the distribution that we have in restaurants around the country we are able to do that. And one of the other things that’s great about that product is that our team loves it. First of all, Lorena Garcia the chef who created a very, a professional personality and she has been very visible to the product launches to our chains through videos and personal appearances and the teams just loves serving the product and getting new customers. And the other anecdotal thing I would say is that our products are skewed a little bit more towards lunch and female customers; again that’s anecdotal math behind that, but that’s what we are hearing from our folks.

Just a little bit more perspective on China. I think when you think about the economic slowdown in China, think about our business in the context of that because keep in mind; we're overlapping 19% same-store sales growth with transaction growth of 27% during the third quarter of last year. So that’s two years same-store sales growth of 26% and two years transaction growth of 26%. That’s pretty amazing and then think about we’ve added over 750 restaurants. So, I think immediately the economy is slowing down but when you look at our business performance in this environment, I think you would have to say it's the transient in any kind of economic headwind or whatever (inaudible) you would like to use.

Great. Next question please Ashley.

Your next question comes from Jeffrey Bernstein with Barclays.

Just two follow-up questions. One, I know in your prepared remarks you talked a little bit Pat about the return of cash to shareholders, the balance between I guess repo and dividend. Just wondering one whether you would consider shifting that balance more from share purchase to perhaps pushing the dividend. I know it's currently just South of the 2% yield level and whether or not you would separately consider increasing leverage, obviously with rates where they are today and then just as a follow-up on the US talk about side of things. Just wondering whether you can give any kind of color in terms of the whether be the mix in terms of what you are selling or whether you think early read on (inaudible) in terms of mix or any kind of data points you can provide there. I know everyone focusing on Doritos and (inaudible) but perhaps if you are seeing broader strength that you think would be sustainable beyond those two products, any color would be great?

All right. Jeff I’ll address the question on cash payouts. We’re very happy with the mix of cash return that we’re providing our shareholders today. We’re delighted to taken up our dividend by 18% and to be on track to complete another year of significant share repurchases. In our view, this is a good mix. We do look on at our capital structure and determine whether or not a different approach is going to be better for shareholders. At this stage even given low borrowing rates, we don’t think that it makes sense to lever up, to position ourselves to pay either higher dividend or to repurchase more shares. We believe that the strength of our operating cash and the growth in our cash flow year-over-year positions us well to continue to grow our dividend and to continue to accomplish significant with the share repurchases and there are no plans today to shift that strategy. But it is something that we do look at from time-to-time.

Regarding your question on mix at Taco Bell traditionally a lot of our product at a particular point time does come from new products that we introduced. The overall Taco mix has gone up considerably so we know that Doritos Locos Tacos piece has been was largely incremental when we launched it. And that’s our total Taco mix is in the mid-teens to low 20s. So we took that up with the launch of the Doritos Locos Tacos. And that part is right now is having about a 7% mix or so. Cantina Bell is about a little under 5% mix right now. And obviously we want to grow that overtime.

Those are very high mixes for Taco Bell.

Okay.

The thing that we just came back from the franchise convention in Colorado, where we were celebrating the [58th] anniversary. I think the people are very excited, the franchises are excited about just the quality, ingredient to upgrade and the fact that we are seeing more up scale consumers and we are seeing more females as Rick pointed out. So this is something I think will build over time. I think one fact what is over 200 million Doritos Locos Tacos have been sold. So this is like, this is prior the most talked about product in our industry right now. I mean and people can't wait for the Doritos. And we really feel like Cantina Bell is just puts us into a whole rein of target and relevant and price value. I mean this product is third of the price for what you get at some of these places. Its two-thirds of the price and consumers recognize us. So we think that overtime.

Thanks, Jeff. Next question please Ashley.

Your next question comes from Bryan Elliott with Raymond James.

I guess, I just like to get your thoughts on the sort of reality of $7 to $8 corn for globally for 2013 and what you are thinking about that might mean both for purchasing power of your emerging consumers as well as obviously the cost of goods, so I just, I know you don't want to but make any specific comments about ‘13 but just few general thoughts on that significant issue?

Well as you say Brian, it is a significant issue. It is relevant to our business. We will provide guidance at the December Investor Conference but just to provide a little bit of perspective over the years we have seen commodity peaks like this and we have dealt with them. We dealt with them through a combination of pricing and productivity measures and we don’t expect that 2013 is going to be any different in that regard.

Do you see a risk to purchasing power given the percentage of sort of an emerging markets or percentage of income of those new middle class consumers that still goes to food overall potentially being a purchasing power decrease?

Nothing material but as you have heard say before in these emerging markets we are continuing to see expansion of the consuming class overall that will more than make up for any impact that might be for the purchasing power as the consequence of the shifting commodity prices.

If I can sneak one more in and the YRI slow down was pretty meaningful from first half to third quarter across broad range of geographies, could you feel that back a little bit and is that average ticket, is it traffic, is it competition reducing increasing the amount of sales may be at about lower ticket or promoted items, just give us a sense of what the competitive landscape is there, how much of it may be competition versus consumer behavior change?

I don’t think competition has changed much. So I don’t see that any of the changes is really due to that when you are looking on a total YRI basis, just do want to remind a couple of things that we did talk about is that Ramadan had about 1 point swing for the overall business. So on the emerging market business we said was plus 5% for the quarter, we think it had a 2 point impact; it wasn’t clear from my comments with Ramadan moved forward in 2012, so we expect the bounce back in those markets in the fourth quarter and so far we’ve actually seen that so and we gave Middle East as an example where we had big impact negatively in the third quarter. That will have an impact positively in the fourth quarter.

Thanks Brian. Next question please Ashley.

Your next question comes from John Glass with Morgan Stanley.

Thanks. I wanted to revisit the China unit opening schedule question again. Two parts to it, one is, I understand you want to be cautious in terms of not out running your resources, but it looks like your history in China there has only been one year in last decade where you’ve opened fewer units in a subsequent year versus a prior year that was a six. So why wouldn’t so another 50 be the new run rate just based on that history and based on your willingness or desire to manage your business in a fairly constant level, but that’s question number one? And number two, and during these periods of rapid expansion or acceleration of unit growth, the question often comes up about new store productivity and the easiest way for us to measure that is just store volumes, not returns because we can’t look at the cost as easily as you can, but just the store volumes. What factors are going to drive and move around the store volumes as we calculate them; in other words, are there in your six tier markets lower volumes, it doesn’t look like from most recent materials, but if they are and then also, would there be brand make shift for example as Pizza Hut home delivery going to be a bigger piece of your unit openings next year and will that change volumes materially for the overall blended. If you can comment on those two, I appreciate it.

Yeah John, I’ll respond to the first piece with respect to new store volumes, to your very point, you know, we’ve seen very high volumes in the lower tier cities. So any shift in the mix of development across the tiers is not going to have an impact to new store productivity. And the same would hold for brand mix shift; well, yes, we will be picking up the pace of pizza delivery or pizza home service development overtime; it’s not going to be to an extent, but it’s going to have a material impact to new store productivity. And then as it relates to new unit openings, again, we’ll provide guidance on next year at our December Analyst Conference. Certainly, given the pace of development this year and how we have grown our capability in China to support a new store program of this magnitude, it gives a lot of confidence that we have reached a new level, but we’re not providing guidance on next year’s development at this stage.

John, we have our annual operating plan for China in the next couple of weeks and we’ll go into more detail on this. But the message the team is going to be that and just keep building a quality business and the number will be what it is. But obviously, look we’re not building this business to open up 750 restaurants a year. We want to get to over a 1,000 capability. So that’s our – and we want to just keep getting bigger and bigger and better and better, but doing it the right way. So we’ll give you more color at the upcoming meeting.

And just you mentioned 1,000 units; over what timeframe do you think you require to get to 1,000 units a year?

I don’t know; sometime in my lifetime you know.

Okay.

I’ll have an answer to that; you know if you’ve followed our company since the very beginning, we’ve never really given a number and never really told people that we’re going to try to get to that. But the whole thing has been build people capability so that we can grow, build the brands. Our brands, what gives you the ability to grow fast is when you’ve got great brands with a great economic model which we do and I think the good news for us is that we still have less than three year cash on cash, cash payback. So we got a great, great business model. And I think that the thing that gives us a lot of confidence is when you can match that business model with the people capability, you can do very amazing things like the team has done this year and I think that, we went into this year with a target I think of 600 and in the previous year, we had opened 656 okay and the number is going to be over 750. I kind of liked that approach to business; I would rather have a number that’s going to force us to go through all the disciplines to make sure that we are doing the right things and then I would like to surprise you, okay, with performance that's the right kind of performance and that's kind of our approach. So everybody has their own models and everybody builds their own kind of forecast and this stuff and we kind of layout what we layout, and you guys can do your own math, but we are trying to run the business on the basis of given our shareholders great returns and at the same time making sure we’re building our brands the right way.

Thanks John. Next question please Ashley.

Your next question comes from Mitch Speiser with Buckingham Research.

Great, thanks very much and yes, I do have another question on China. I guess maybe, a lot of the questions are alluding to and I’ll ask you in a separate way, is that with unit growth accelerating can maybe give us a sense of what the cannibalization factor may be has been in year’s past and do you expect that cannibalization factor to increase or remain steady or perhaps even decrease just say over the next few quarters? And then separately, just on KFC versus Pizza Hut, if you can give us what the comps were for each concept in the third quarter and it looks like maybe, is Pizza Hut maybe suffering more of a -- or having more of a slowdown than KFC and maybe how we should look at the outlook just given that Pizza Hut as a higher price point if perhaps KFC might potentially comp better than Pizza Hut has been comping a lot better than KFC over the past several quarters? Thank you.

Yeah Mitch this is Tim. Yeah, by brand it was six for KFC and eight for Pizza Hut in Q3, sorry we didn’t put that in there; that was my call, because it was virtually identical I figured out it wasn’t necessary, but clearly it is, so I’ll be sure to put that in there from now on. Cannibalization, a year in China for the investor conference, I think you’ve got a sense for what we are doing and it think that they basically reiterated what so, where are we getting these additional new units that David was talking about with the 750 versus 600 target coming and 656 last year. It’s really a lot of what [Lily Shay] our former CFO said last December and it was that government is building on infrastructure and they are building out this mega city clusters and we are getting more locations in the lower tier cities; there is more transport hubs which they identified had, identified in the presentation and then also Pizza Hut Casual Dining as we have been saying that’s a new opportunity for us in going beyond Tier I and Tier II and which is what it had been pretty much up until like 18 months ago. We have actually opened up a 170, over 170 over the last four quarters of the Pizza Hut Casual Dining compared to 115 last year and by opening Tier III, IV and V to Pizza Hut Casual Dining that’s basically almost a billion people that now we can add distribution to for that brand versus where it wasn’t before. In terms of the cannibalization, what we had said before was about one and five new stores of KFC had cannibalized in the past up to may be as much as 20% but I haven’t seen anything lately on that, Mitch. I believe that my guess would be the numbers are a lot, is lower. Just because we're building so many more in new cities and we're building so many more Pizza Huts where the cannibalization factor is probably a lot less. So it was a factor maybe, three, four, five years ago but it's not really that much of a factor today and what it looks like.

I am sorry if you could just maybe just comment on the Pizza Hut comp versus KFC in terms of, it looks like Pizza Hut might be slowing on a year-over-year basis and maybe a faster pace than KFC, is that something that do you think we should expect given that the ticket is higher or is the fact that there is less competition for Pizza Hut that the out performance of Pizza Hut can continue or you think it can continue when you look at the outlook?

You know, I think for one thing, we can give more color but just to give you a little bit of a background on that, I think Pizza Hut had 11 straight quarters of double-digit same-store sales growth coming into this quarter and it's lap was even more significant than KFC in Q3, it was lapping like 30% growth over the past three years. So, yeah it just slowed down, but I mean those are still big numbers and I think importantly for us, which is what we’ve been saying, it moves that brand into a very growth oriented position or now we can really grow this with great economics at least equal to KFC and the average unit volumes are comparable to KFC. So it's plus eight but it's lapping some big, big numbers over the last three years. Thanks Mitch. Next question please Ashley.

Your next question comes from Joe Buckley with Bank of America.

Thank you for bearing with us. A couple of questions on China and then one on food cost. So in China did the timing of the openings very much this quarter with a very backend loaded that would be my first question. And then secondly, the transaction count decline presumably it includes the benefits of breakfast and delivery in 24 hours. So when the core dayparts how significant with the transaction count decline. And then just a last one you talked about 4% pricing in China going into 2013, if food costs are moderating and if you’re expecting to continue to moderate at least in the early part of next year, what sort of the rationale behind the pricing even so after transaction counts?

Joe, I’m happy to respond here. In order starting with in the timing of openings, I don’t know that the distribution of our new store openings this year is any different or materially different from last year. But with respect to the transaction decline I don’t know what it is for core dayparts when you strip out the new sales layers. I really can’t respond to that question. And then finally with respect to next year’s pricing versus inflation, as I said in my remarks or in a response to another question that we could take pricing next year there are no, there are no definite plans at this stage to do that. You are right that given what we’re seeing by way of commodity deflation in China in the fourth quarter those trends will likely persist into at least the first half of next year. So we’ll provide more context to you at the December conference in terms of our views on same-store sales and how much pricing and when we might take it. But the fact is that the new pricing strategy that we implemented over the course of Q2 and into Q3 is one the China team is very happy with that increase the level of sophistication and we are able to go and segment their market and determine variable pricing and that will likely continue into next year.

Joe, on the transaction piece, just one point on that when I looked at the daypart mixes they didn't change. So while we don't have what the core was, it doesn't look like it was something in particular related to any particular daypart or core, that’s the best I can tell from what I have seen.

Thanks, Joe. Next question please Ashley.

Your next question comes from R. J. Hottovy with Morningstar.

I just had one quick question and its kind of an ancillary question to the unit development growth that you are planning for the next couple years. How comfortable are you in terms of the unit growth with what we have seen in terms of bank and potential constraints for franchise financing right now. Just I wanted you to take on kind of the overall data on financing the franchisees at this point across YRI and potentially China as well? Thanks.

Yeah. And we haven't seen any issues of getting access to credit for our international business, a lot of our international franchisees are pretty big players and they have been in the business for a while. So a lot of their growth they are able to fund through existing cash flows as well, so we don't see that as (inaudible) in anyway to our growth going forward.

Thanks, next question please Ashley.

Your next question comes from John Ivankoe with JPMorgan

Obviously, you guys have demonstrated I mean so much success in emerging markets and more examples necessary you mentioned China being the highlight. But then we look at developed markets, and so I wanted to really relate these two points as last year we talked about may be talking talk about refranchising being more down than what it had been in previous years, we are obviously success with the brand this year and it looks like talk about refranchising is all but about the stock. So of course the question in the US is one I put Taco Bell in the hands of franchisees when the economics are so strong and allow them to grow and develop the brand as really as franchisees can and then secondly, having been with McDonalds recently in Europe and studying their markets every year, the demographics in the competitive markets of France and especially Germany will repeat this being very good by a lot of people so I mean why not take that risk and put it solely in the hands of franchisees and pursue a rental model with all and in other words why not you pursue development in continental Europe on the peer capital way franchise model versus directly or indirectly investing your own capital?

Let me then make sure I have the first part of this right and I will clarify my comments on refranchise. In the US we are basically done with our hitting our targets for KFC and Pizza Hut which we say we wanted to get down to about 5% ownership level in both of those brands and we are close to those, we will be close to those numbers actually now. On the Taco Bell side, our goal was to take the Taco Bell ownership level down from sort of the low 20’s to about 60% by the end of next year. We are continuing along that path. So we have been doing modest refranchising for Taco Bell over the last year and a half we will continue that over the next year and half. So that’s what we are doing on the US side. Regarding the question on France and why would we pursue the business rental model versus franchising; the first piece of that we really did is that was delayed to get growth. When we were looking at France, the unit, the great news about France is that we have highest average volumes in the world. The bad news about France is its very expensive. So not that many franchisees, who, when you had the brand that was new in the market, you know, had several million dollars that they were able to put down on a new unit and what we found as we started the business rental model is we’ve been very pleased with the quality of the franchisees. It is we maybe didn’t have as best to as much capital what was required there. So we found that we were happy with the way the restaurants were being operated. We believe we could have a big business there from an opportunity standpoint that we talked about before and you know we believe that we’re having the right level of case of growth there. So we feel pretty good about how things are developing in France and we do have a few franchisees over there at the beginning and they are doing some growth at new units, but we expect a fair amount of our development to stay in the business rental model.

And if I can ask Rick, in Germany, which is you perceived is being the more, competitive global QSR market, and might there be a shift you know overtime in both of those markets, to your pure franchise model when the franchisees get established and the economics get to be more proven?

We’ll always look at what we think the right mix is between company; we will probably have all three there. We have some company ownership; there we have the business rental model and we have straight franchising. We probably continue to have the blend, continue to look at that overtime, but right now we're pretty happy with the current mix that we have.

And maybe things for us, you know, on this John is how little of a business we have there already; I mean yes, we have now economics that we think are scalable. So I think that what we try to do is we try to learn from each other and we also try to learn from competition. And I think McDonalds has shown us that the business rental models are where you can expand with good returns over the long-term in continental Europe and I think we’ve gone to school on that model and we think it can work for us. And the good news for us is that we’re just, we’re really ground floor; we’re ground floor on this. And we have a capital monitoring system that we put into place and I’m sure we’re going to monitor the unit economics. It’s something says that we shouldn’t be going that way we can always pullback. But right now we’re really talking about our business, it’s pretty insignificant that we think can become very significant and I think that’s the real point for our shareholders. I think it’s upon us to really do whatever we can as Rick said to really grow the business and we think that the business rental model unlocks that growth for us and held a lot faster than if we were just working with the pure franchise business. Given where we’re at, at such an embryonic stage and as to your point earlier is that if things change down the road, we can always look at the mix of our ownership. That’s something we’ve done throughout our history and I think pretty well.

And with respect, there’s an interesting contract is, okay I understand. Thank you.

We cannot give more colors and sorry. Next question please Ashley.

Your next question comes from Sara Senatore with Sanford Bernstein.

We have only time for one question from you Sara. Sara?

And she has (inaudible).

Okay, one more question please.

Your next question is from Keith Siegner with Credit Suisse.

Thanks; a question for you either Pat or Rick. Can you please give us an update to the status of the efforts to sell the Pizza Hut UK business, and then just add to the little bit, does your guidance for what company restaurant margins at YRI might look like post site divestitures still remain intact especially given the strong margin performance of YRI this quarter, thanks?

Yes, we are in very active discussions with a buyer for the business and we remain optimistic that deal will close by the end of the year. And as we said before we expect that will or when we complete that refranchising that YRI will see two points of margin improvement. Now, you know how these deals go and it’s possible that the deal could slip into early part in next year but we are optimistic that we will see close by the end of the year.

Yeah. As Pat said, we are in active negotiations where we believe it will close this year but we are going to have the right deal. So if slips into next year, we are okay with that too.

Okay. Thank you all for being on the call. So let me rap up the Yum! Story overall, we are having another solid year and we are raising our full year EPS guidance to at least 13%, 11 straight years of least 13% EPS growth it’s something that we really proud of, with record international unit development, we are confident on our future growth as well. So as we look at 2013 we are confident of our international businesses that are set up for continued growth and our US businesses on more solid putting to drive more consistent results going forward. We have track record to prove how powerful our growth model is, with the expected opening of 1,750 international units this year and our strategies in the based business, we definitely feel we are in good position for next year and expect to continue our track record of double-digit earnings growth in 2013 and beyond. We got our December analyst meeting coming up Investor Conference and we can’t wait to sit down and talk to you about how we are in the ground floor of global growth China and a whole lot more. So, talk to you soon thanks.

That concludes today’s conference. Thank you for your participation. You may now disconnect.