Yum! Brands, Inc. (YUM) Q1 2013 Earnings Report, Transcript and Summary

At this time, I would like to welcome everyone to the Yum! Brands first quarter 2013 earnings conference call. [Operator instructions.] Mr. Steve Schmitt, Vice President of Investor Relations, you may begin the conference.

Good morning everyone and thank you for joining us for our earnings call. 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 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 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 to find disclosures and reconciliations of non-GAAP financial measures that may be used on today's call. Finally, we would like you to please be aware of the following Yum! investor events occurring in the next three mos. Our April same-store sales release for our China division will be May 10, after market hours. Our Taco Bell investor analyst conference will be May 21 in Irvine, California. And our second quarter earnings release will be Wednesday, July 10. On our call today is David Novak, Chairman and CEO; Rick Carucci, President; and Pat Grismer, our CFO. Following remarks from each, we will take your questions. Now I’ll turn the call over to David Novak.

Thank you Steve, and good morning everyone and thank you for joining our call. While better than expected, the first quarter was extremely difficult for Yum! Brands. As anticipated, intense media attention surrounding poultry supply in China significantly impacted KFC’s sales and profits. Earnings per share declined 8% versus prior year, as our China division operating profit fell 41%. Operating profit increased 19% at Yum! Restaurants International and 5% in our U.S. business. While we’re certainly not happy with our overall results, as we look at how our China sales evolved through March, we were making progress and it was pretty close to where we thought we’d be. Unfortunately, our quest for a full sales recovery has been dampened by the intense publicity of avian flu in China, beginning in early April. Now the last time we were significantly impacted by avian flu was in 2005. The sales impact was initially dramatic at KFC, but relatively short lived, lasting about three months. We anticipate this will once again be the case, but there’s no way to be certain. Based on our results through the first three weeks of April, we expect China division same-store sales will be down about 30% for the month. You will see the actual numbers in our sales release scheduled for May 10. Putting the avian flu situation aside, I’d like to share some of what the team in China is doing to restore consumer trust in the KFC brand and to enhance our industry leading supply chain practices. Immediately after the Chinese New Year, in late February, we launched what we’re calling Operation Thunder. To the Chinese consumer, this signifies swift, decisive action, which is exactly what we’re doing to address consumer perceptions related to the safety of our chicken in China. As part of…

Thank you, David. Good morning everyone. At Yum! Restaurants International, our strategy remains to drive aggressive international expansion and build strong brands everywhere. What I would like to do today is review the nature of our growth. The growth from YRI continues to be driven by our franchisees and our strength in emerging markets. In 2013, you will see that our equity presence in select emerging markets will also contribute to this growth. One characteristic that we love about YRI is the recurring and growing nature of its franchise fees. These franchise fees will approach nearly $1 billion in 2013, which represents 10% growth versus 2012. Our franchisees are investing heavily behind our KFC and Pizza Hut brands and are aggressively building new units. During the first quarter, we developed 147 new units, and 90% of these units were opened by franchisees. We continue our rapid pace of expansion throughout the year, and expect to set a record by building over 950 new units in 2013. This franchise growth provides a large cash stream for Yum! It also generates significant value for our shareholders. We believe that the capital free franchise business at YRI is unique, given that it provides income and cash that is large, growing, global, and diversified. We’re delighted to be meeting with over 500 of these franchisees, representing over 100 countries, at our upcoming biannual franchise convention in Beijing, where we will discuss our strategies and initiatives. We look forward to working together with our franchisees to develop even more profitable growth opportunities in the years ahead. As we have said before, Yum! is the clear leader in emerging markets. 70% of the new YRI units in the first quarter were in emerging markets. The bulk of the emerging market business will continue to be led…

Thank you, Rick. As you heard from David and Rick, Yum! Restaurants International and our U.S. division are delivering solid results, yet we obviously have our challenges in China. We continue to see this as a temporary setback, and remain as bullish as ever on our long term growth prospects. As evidence of that, we are continuing to invest in the future. With these investments, and given the demonstrated growth potential of our businesses, I’m very confident that our track record of double digit EPS growth will be restored in the years to come. I’ll now provide some additional perspective on our first quarter results and share our EPS outlook for the second quarter and full year. For the first quarter, we recorded an 8% decline in EPS before special items, which was significantly better than the 25% decline that we had previously estimated. This better than expected result was primarily driven by stronger than expected sales in China during the Chinese New Year holiday period in February. Now I’ll share some performance highlights for each major division. In China, operating profit declined 41% in the first quarter, prior to foreign currency translation, driven by a 20% drop in same-store sales. With a sales decline of this magnitude, China restaurant margin was severely impacted, down 7 percentage points versus prior year. Bear in mind, this dynamic works in both directions, so as our China sales recover, we expect a similar rebound in restaurant margin. On the development front, China had an exceptional quarter, opening 226 new restaurants, or nearly 4 per day. With Chinese New Year following relatively late in the quarter this year, our world-class China development team was very intentional about pulling units forward into the first quarter to benefit from peak seasonal sales. Yum! Restaurants International reported…

[Operator instructions.] Your first question comes from the line of Sara Senatore with Sanford Bernstein

I just wanted to talk a little bit about your China recovery cadence. I think historically you said the avian flu has been very short in its impact. Just want to sort of get a sense of if you look back at ’05, are we talking about a month, or two months? Or kind of what the overall cadence is? And then also, on the same, related topic, it looks like you managed margins very, very well in China, so maybe can you just talk a little bit about what kind of variable expenses are there in payroll and occupancy that allowed you to hold margins that well given the negative costs in the quarter?

With respect to to the impact of avian flu, when we look back at how this has impacted our business in the past, what we have seen is a sharp impact initially that then diminishes over a period of about three months. So we’re expecting about the same recovery period this year. And so just to reinforce then, in terms of our overall sales recovery, what we are currently estimating is a 6-9 month recovery period, with same-store sales in China turning positive in the fourth quarter. And then with respect to your question on margin, there were obviously a number of moving pieces here. The most significant variable in that equation is transactions. And so the transactions did hit us significantly in the first quarter, and as that reverses, it will certainly work to our advantage over the course of the rest of the year. With respect to the composition of our restaurant costs and the variable components, there is a fair amount of variability in rent expense where many of our units have a variable rent component, as well as the fact that a portion of our labor expense is variable. And also, keep in mind that advertising, which runs about 4% of sales, is also nearly entirely variable. And so that gives us some ability to mitigate the impact of the transaction deleverage.

And your next question comes from the line of John Ivankoe with JPMorgan. John Ivankoe – JPMorgan: Also staying on China if I may, and a few different topics. Firstly, obviously first quarter development was exceptional, especially for a two-month quarter, and I think David, for emphasis, a few times you said you expect 700 for the year. So I guess at this point, trying to get a sense whether the avian flu and the December price [unintelligible], kind of having you back off the development maybe, at least as I’m interpreting, maybe slightly, especially relative to prior years? You know, if there are other issues that we should be sensitive to? And then the second question, if I may, is on gross margins in China, or cost of goods sold looked at inversely, that was very, very low. The COGS was very low in the quarter, and some may have interpreted that you would invest in gross margins to kind of really sell the value message to consumers, whether now or at some point in the future. So just wanted to get a sense of how you may use the COGS line or gross margins to invest to get back traffic when the time is right.

Well, I think, first of all, on the development, we think that staying the course on the number that we provided at the analyst conference back in December was that we said we’d open at least 700 units. We still think that’s the right number. I think the reason why we believe it’s the right number and we’re staying on it is that we’re still out developing competition by a wide margin, as I said, we still have that first mover advantage that we’re opening up in 100 new cities this year. So we don’t really see any urgency to expand more rapidly in this current environment. I think the China team has always been given the charge that this is a business that’s a jewel. Polish that jewel, keep making it as strong as you can. And we’ve never ever forced or challenged the team to grow at a faster rate than it ought to, and I think as we look at the year, and where we’re at, we just think that we’re going to make the prudent and the right decisions as we go forward. And that number will be at least 700 restaurants, so that’s kind of how we’re looking at that. In terms of investment in the value proposition, we have great cost structure. We’ve always done what’s right for the customer. We have a number of value initiatives planned, even with this current challenging environment. And what I expect, given everything that’s going on, the launch of Operation Thunder, with the quality assurance campaign that we’ve launched, we’ve got some significant innovation coming, value promotions going, we expect to go into 2014 with KFC being stronger than ever. And that’s our goal. This is obviously a challenging time, but that doesn’t mean that you just can’t keep investing and building the brand and setting yourself up for the future. And we love our positioning with KFC in China over the long term.

And John, to build on David’s comments on the cost of sales and the implications for our margin, in the first quarter, we were fortunate enough to experience food cost deflation of 5%, and we had a 3-point benefit of pricing from actions taken last year. So a rollover pricing benefit, if you will, of 3 points. Those two elements combined helped to blunt the impact the transaction deleverage on our overall margins, and help to keep our cost of sales percentage in a good spot, despite the fact that as you say, we were offering more value during the quarter to help support more transaction growth.

Your next question comes from the line of David Palmer with UBS.

I know it’s probably tough to tease this out, but has the talk about antibiotics died down? Is your team’s perception that as we get past the avian flu issue, that you’re going to be in another level with antibiotics, and maybe there’s even, crazy as it sounds, a silver lining to the avian flu issue in that it’s sort of wiped clean or perhaps permanently pushed back into the back of people’s consciousness, the whole antibiotics issue that was at the fore a few months ago?

I think what we’re pleased with is the publicity on the poultry issue has really subsided, and we’re moving more into the process and continued process of building consumer confidence. I think basically what we need in China is just to get the time that we’ve seen historically has brought our business back. And that’s really the way we’re looking at it. I wouldn’t even comment on your hypothesis. I’ll leave that to you. What we think we need is really the gift of time to build consumer trust back and keep building the brand forward as we move ahead.

Your next question comes from the line of Joseph Buckley with Bank of America

Two questions. One back on the China margins. Can you walk through what’s happening with labor inflation? And obviously labor costs up year over year, but with a little better control than I might have guessed. And just kind of curious if the wage inflation has subsided any.

With respect to China labor inflation in total, at the restaurant level, we experienced about 14% inflation, more or less in line with our expectations. The wage rate component of that was up 8%. So the difference reflects growth in the cost of employee benefits and growth in the cost of management labor.

And then with all the poultry issues and supply chain changes, how does this affect you looking out to 2014 and beyond from a cost standpoint? And then as you continue to grow, is the poultry industry capable of growing with you?

At present, we don’t expect the increased rigor of supply chain management practices is going to have a material effect on our poultry supply costs. In fact, we have reason to believe that flock yields could improve as a result of some of these more stringent practices and that will help to diminish the cost of any new procedures that may be put in place at our suppliers to continue to drive even higher levels of quality. And then in terms of longer term supply, we remain confident that the larger producers will continue to grow and meet our supply requirements. So we’re not concerned that we’re going to face a situation where we’re going to be supply constrained in a way that is going to put upward pressure on poultry costs.

And then just going back to the China labor thing for a moment, if I look at labor costs per store, they’re very flat year over year. So is that just adjusting to the lower level of business, staffing-wise? Or is there something else that would drive that given the inflation numbers?

No. What I can tell you is that clearly in the current environment the team is very much focused on running as efficiently as possible, but because we do see this as a temporary situation, we’re not taking actions that would in any way compromise the service that we’re providing our customers.

Your next question comes from the line of John Glass with Morgan Stanley.

I wanted to come back to this notion of it will take time to get through this, and that’s probably true in this situation, but it won’t necessarily prevent the next episode, and it will inevitably be something else. So there are two issues in China that seemed to be needing to be addressed longer term. One is your supply chain. And what I’m seeing is that chicken production in China is more fragmented. It’s not vertically integrated like it is in the U.S. So on that first point, is there an opportunity to help suppliers vertically integrate in China so you don’t see uncertainty. Maybe it’s using a multinational company, for example, as a key supplier. Where do you stand on that? And secondly is response to rumors. It seems like you’ve been caught off guard a few times in terms of rumors, and social media has exacerbated this. Has there been a seismic shift, or has there been a change in the way you’re choosing to respond to rumors more quickly or more effectively?

First of all, what I think we’ve done on the supply chain is we’ve taken swift, decisive action to work with our suppliers to get an even more enhanced supply chain system. As I talked about earlier, we’ve eliminated over a thousand chicken houses from our supply chain. To your point, we are working with our suppliers to support the integrated farming system, developing best practices, working with them very closely. And as far as social media goes, we have beefed up our social media monitoring system dramatically. So I think our intention as a consumer company is to be best-in-class in this arena, and I think that’s happening across the board in all of our divisions. It’s the number one priority of Jonathan [Blum], our public affairs officer, and we are very, very focused on this, and I think doing an excellent job. In fact, being world class in social media, digital, is a major strategic objective of ours, and last week we just spent, as a team, a couple of days visiting places like Twitter and Square, just to get totally on top of what’s going on in the world today. Which I think we are. But at any rate, I think we’re taking all the actions we need to take to ensure that our industry leading supply chain is even better as we go into the future. We do everything we can to be on top of social media and use it as an advantage, and be able to counter any false claims that come about. And I think we’re on top of both of these issues.

Your next question comes from the line of Michael Kelter with Goldman Sachs.

You guys are assuming a return to positive same-store sales before the year’s out, and it makes sense, given prior similar incidents recovered at that pace, but how do you know that this time there hasn’t been more permanent or maybe just semi-permanent damage to the KFC brand in China? Is there something you’re seeing specifically that gives you confidence? Or is it just relying on the historical analogues?

I would say the fact that we have seen sales start to come back in February and March, as David had said, about where we expected, gives us confidence that this recovery period of six to nine months is a reasonable expectation. Before the recent publicity of avian flu, we were seeing the recovery, and we continue to expect, therefore, that a full recovery will happen in that six to nine month period, particularly given the fact that we expect this dramatic impact of avian flu will persist for only about three months or so. We’ve weathered many storms like this, so we do have a number of data points to inform our point of view at this point in time. And again, based on what we saw happen over the course of Q1, and as we reported our March sales, which as you know, for our China division, fall into Q2, we remain confident that we’re looking at a six to nine month sales recovery period.

And then on a similar kind of a point, you guys have presented your brand tracking scores in China over the last several years. Can you tell us what you’re seeing in the latest read from the consumer in your brand tracking? What parts of your score have fallen off the most versus what’s holding up?

I think we’d have to get back to you on those specific numbers, and maybe share them on the next call if you’d like. I think one of the things that we are tracking is as we build awareness of everything that we’re doing with Operation Thunder is just improving consumer perceptions and the answer is the more people are aware of what we’re doing, the better they feel about coming back into our business. And so I think that’s something that we’ll continue to track. But without question, we have a beloved brand with KFC. And as you know, when you have great brands, you just have to keep doing the things that build a great brand, and you come back. Every great brand comes back, and KFC is in a powerful position. And whatever issues there are in the category, or with food safety, or whatever, we’re top of the class in terms of being a brand that people can rely on. So I think that’s what gives us so much confidence, as we go into the future. We know we’re doing the right thing. I think the big message we have for Yum! Brands this year is staying the course. We have growth staring us in the face all around the world. Everywhere we look, we see growth opportunities. We are the leader in emerging markets, not just China. We’re continuing to build our brands the right way. And we have growth opportunity that is unparalleled. Even as we look at China. You’ve got 300 million consumers, they’re going to 600 million. And you know, we see this as the number one retail opportunity in the world. Nothing has really changed from last year, other than the fact that we have a challenge that we have to…

Your next question comes from the line of Brian Bittner with Oppenheimer. Brian Bittner – Oppenheimer: I’d love to talk about something else, but I’m actually going to ask about China.

That’s all right. It’s a big opportunity for us.

You know, this must be tough to really answer, but I’m going to ask it anyway. You know, based on the trends that you’re seeing throughout April, I think this avian flu thing really, I think the first press release or whatever came out about March 31, so it’s been about three and a half, four weeks. It’s subsided a little bit, but not a lot. But based on the trends you’re seeing throughout the month, do you think April represents a bottom, down 30%, and you start the recovery from there? Or based on what you’ve seen historically and based on what you’re seeing in April, could it worsen in May? Or could it be as bad in May? Or do we start the recovery from this April number?

Certainly we hope this is the low point. It’s very difficult to predict the exact trajectory of a sales impact like avian flu. So it’s tough to call at this stage. But, again, based on our past experience with incidents like this, we believe that impact will go away in about three months.

You’re right. You’re asking sort of like the mother of god question. Nobody knows the answer to this one. But no two crises are the same. We can only look back. But we’ve weathered other storms in the past. And to put this in context, the last time the China business was significantly impacted by avian flu was 2005. Our China division operating profit was $200 million. And at that point, it declined about 6% versus the prior year. Last year we made over a billion dollars, and I think that’s a real testament to just the power and resilience of the brand. So I don’t know what’s going to happen in the next few quarters, two months. Your guess is as good as mine. I’m not a soothsayer. I’m not a predictor on these kinds of things. So we’ll just watch the press coverage, we’ll pay attention to what’s going on, but most importantly, we’re going to continue to build the value, and build the brand, and build the innovation that we know is going to set us up for the long term. So I can’t really call exactly what’s going to happen in the next two to three months. I don’t think anybody can. What we can tell you is that this is a dramatic impact on our business. It’s short lived, and the period, in the past, has been about three months.

And we are continuing to take actions, as we have in the past, to remind consumers that fully cooked chicken is perfectly safe to eat, and we’re reminding them, in several different ways in store and television, and so forth.

I appreciate the answer. And then another quick follow up, just on the margins. I think you said deflation of 5% in the quarter, 3% pricing. What are we thinking for kind of a full year effect as far as food cost inflation or deflation and a full year pricing impact so we can think about food margins going forward?

At this stage, we have no reason to move off of the full year guidance we’ve provided at our December analyst conference, which for food costs is low single digits, and for labor, mid teens inflation. So we would stick to that as a full year expectation. As it relates to what our reported margin is, I’m not going to speak to what that number is going to be or what it might look like in any given quarter. There are so many different moving pieces here, as I’m sure you can appreciate. The biggest lever for us is transactions. And so we’ve taken a big hit on transactions. We expect those transactions will come back. So the deleverage impact that we’ve experienced thus far will reverse as those sales come back, and that’s going to be the biggest driver of our margin performance balance of year. We do have some rollover pricing benefit, which benefited us in the first quarter. That will continue to have some impact, albeit a bit less, in the second and third quarter, but at this stage, I don’t feel that it’s appropriate to provide a full year number on margin or certainly not to talk about what’s going to happen in Q2 versus Q3.

Got it. But just to be clear, what’s happened so far has not really changed the food cost inflation trajectory? You still expect back half inflation?

That’s correct.

Your next question comes from the line of Diane Geissler with CLSA.

I have another question on China, and this really relates to the whole issue of food safety. China has had a number of scares in a variety of industries, including dairy and hog raising, and I guess my question is really have you seen any movement on the part of the Chinese government to change regulations and/or make it easier for the big integrated processors to expand? You’ve talked about culling from your system the small house operations, but have there been any shifts in terms of biosecurity from the government? Or helping multinationals site houses, whether that’s through better land use rights, negotiations, etc.? Just in terms of how you see that supply chain going forward over the next five, 10, 15 years?

I think the biggest thing with the new government in China, new regime, is food safety is high on their priorities. So I expect there to be more diligence and more work with major companies like ourselves. As the leader, we see our task as setting the standard, and that we plan to work, and are working, very closely with the government to do everything we can to be the leader in food Safeway. But I think it’s really too early to talk about any seismic changes that are occurring. But I do believe that the food safety will become even better and more enhanced over the long term given everything that’s going on and the focus of the government.

And then just on real estate, do you see any shifts in terms of development and your ability to site new stores this year and into 2014?

No material change that we see. As we’ve said before, our new unit development program is shifting increasingly to the lower tier cities where the development opportunities are more compelling, margins higher, returns higher, and we’re also shifting more from KFC to the Pizza Hut brand. And that will continue. In terms of our ability to secure the sites and the development of infrastructure to create the opportunities for us, we don’t see that changing.

Your next question comes from the line of Keith Siegner with Credit Suisse.

Just one more question on China. Thinking through the long term company restaurant margin outlook, 20% has been a number that you’ve offered for some time. 2011, 2012, and now 2013 all below this. We’ve added in the Little Sheep concept, which has slightly lower margins. Is this still the right long term target? Is that what you’re planning for? Is this something that a return to positive comps can help you achieve? Or is this now a multiyear process to get back to that target given the acute challenges of this year?

We continue to believe that 20% margins are imminently achievable with our China business, and it’s not just comps that are going to get us there. Certainly in the short term, the transaction recovery is going to be the single biggest driver of margin improvement. No doubt about it. However, there are a couple of other things to keep in mind. The first is ongoing asset leverage as we continue to add new layers to our business, to our existing restaurants. Whether it’s 24-hour operations in our KFC business or breakfast at Pizza Hut, these new sales layers are going to better leverage the existing investment we have and provide that leverage on fixed cost. And then the other is the impact of portfolio shift. As I mentioned, when we look at our new unit development program going forward, for the KFC brand we are continuing to shift from the tier one and tier two coastal cities to the tier two inland and tier three and below cities, where margins are significantly higher and we are continuing to shift more of our new unit program from KFC to Pizza Hut. And I want to point out, even though this wasn’t in our release, that even in a quarter where same-store sales were down for our Pizza Hut casual dining business, margins were still well above 20%, and even close to 30% in the lower tier cities. This is going to be an increasing focus of our development program going forward, and that’s going to benefit the portfolio restaurant margin for our China business. So I think it’s important to keep in mind those three factors. It’s transaction recovery, it’s ongoing asset leverage as we introduce new sales layers, and it’s a shift in our development program and how that’s going to benefit portfolio margins.

One very quick follow up, if I can. Thinking through Little Sheep now, which you’ve basically anniversaried since the acquisition, is this at the point now where regardless of all this other noise, can Little Sheep be a tailwind to that margin curve this year maybe, and over the next couple of years as well?

I think it’s premature to say that it’s going to be a margin tailwind this year. But our long term expectations of the growth that we will get out of that business to be high. It is a relatively small portion of our portfolio today, but we didn’t buy it, as you know, for the 400-500 units that are in the ground, but for the several hundred units that we know we will build over the next several years. And with the improvements that we are bringing to the concept and our operations knowhow, we are optimistic that the margins are going to improve significantly. And at that stage, with a larger scale business, and much better margin performance, then the Little Sheep business will be helpful to our overall margin.

Little Sheep is very small at this stage, but we expect it to get a hell of a lot better. We’re improving the concept every which way we can, so there’s only upside. But, you know, it’s not a big tailwind for us.

Your next question comes from the line of David Tarantino with Robert W. Baird. David Tarantino – Robert W. Baird: I just wanted to ask about your thoughts or preliminary thoughts on 2014. I know you don’t want to give any guidance at this point, or specific guidance at this point, but I was just wondering if you think 2014 could be a big rebound year in terms of the earnings growth given the expected sales recovery in China? So for example, soft year in 2013, followed by a well above average year in ’14? And by the time you get to 2015 maybe you’re back on your long run trend line? Just any thoughts on how you think it might play out would be helpful.

I think you’re thinking about it exactly the right way. Let me tell you, if 2014 is not a big bounce back year, we will all be very disappointed, because that is our expectation. We have a high degree of confidence that is going to be the case. And as I said in my remarks earlier, 2013 is an aberration. So I wouldn’t spend too much time focusing on 2013 results. Not to suggest that we’re not focused on doing the best job possible, but as it relates to how you think about our business, and what we’re going to deliver, and how we’re set up to continue to grow, I encourage you to continue to focus on 2014. We do expect that we will begin to see a strong recovery next year.

Our great and late chairman Andy Pearson had a great line. He said the best way to have a great year is to follow up a bad one. Well, we clearly have a bad one this year, and so we expect next year to be very, very good, and we have very high expectations for ourselves. I think the important thing for our investors to know is that we’re building the platforms that we think will establish the long term growth. If you take Taco Bell for example, we are really leading in terms of improving our quality, innovation with what we’ve done with Frito Lay and the Doritos Locos Tacos line. We have world class operations. We’ve been focusing on that for some time, but we’re ranked in the top three across every key measure in operations that we look at. We’re building it for the long term. At Pizza Hut, we’ve got good value proposition, good innovation. We’re working on a major platform in chicken, where we can really develop our sales as we go forward. Across the board, we’re working on the sales layers, the breakfasts and beverages and things that we think will give us the incremental sales that will be significant over the long term. So what we’re focused on this year is staying the course and building a sustainable growth engine for the long term. And nobody expects us to grow at least 10% next year. We expect to do a lot better.

And the other important point to reiterate, David mentioned this in his remarks earlier, is the impact of the new unit development in China. So last year we opened about 900. This year we’re saying at least 700, so that’s 1,600 between the two years combined. Collectively, that will deliver about $2 billion of system sales, which represents about a 25% increase on the base. So think about it. As we recover from the effects of this late December incident and the more recent avian flu publicity, we have all these new assets on the ground generating sales and profits that will contribute significantly to our growth in 2014.

But the proof’s in the pudding, you know? I mean, you can look at this and you can see all kinds of potential, but as my father used to tell me, potential means you haven’t done it yet. So we’ve got to turn around China, we’ve got to keep building these businesses, and then I think the businesses will end up being where they ought to be. And this is a growth company.

Your next question comes from the line of Andy Barish with Jefferies.

Two quick YRI questions. On the avian flu, do you expect a little bit of impact in some of your other Asian markets? And then just a clarification on the Pizza Hut U.K. franchise renewals. The deal closed in the fourth quarter, but the renewal fees and new franchise stuff came in in the first quarter?

I’ll respond to that piece first. The franchise ownership transfer, with the transfer fees and the renewal, wasn’t related to the Pizza Hut U.K. business. It related to a different market for us, where there was a transfer in ownership from one franchisee to another. That happened in YRI’s first quarter.

Regarding impact of avian flu, I don’t think what’s happened in China is going to impact other markets. I think what will happen is if that appears in those markets. We’re obviously going to keep a close eye on that. We’re prepared in advance to communicate what our response would be, which is what people have said here before, which is properly cooked chicken is perfectly safe to eat. So we’re ready for the possibility, but I don’t think it’s going to have an impact unless it hits other countries.

Your next question comes from the line of Mitch Speiser with Buckingham Research. Mitch Speiser – Buckingham Research: I’ll try to avoid the China questions. It seems like we’ve gotten a lot of different angles on that. Although I’m sure there’s probably some more. But just on the balance sheet, there wasn’t a lot of share repurchase in the quarter. And you are, I think, under 1x levered. Could you maybe just discuss if there are any constraints to using the balance sheet a little more aggressively in general, and using share repurchase in particular?

We continue to take a look at this, and we’re quite happy with where things are at right now. We’re generating enough cash to pay the meaningful dividend and return remaining cash to share repurchases at a level that will accomplish what we expect as it relates to contribution to earnings per share growth. We’re not interested in leveraging up at this stage and putting at risk our investment grade credit rating. We believe we’re in the sweet spot as it relates to how we balance these things out and the implications for our overall cost of capital. So no plans to do what you’ve suggested.

And separately, just on the second quarter, I think you mentioned down double digit. Obviously that’s a wide range. Maybe any more particular range, obviously that could be down 10% or down 30%. Any incremental info on how to model the second quarter would be helpful. And does the very weak second quarter results on tap, obviously it’s China driven, but does some of it relate to the very typical comparison at Taco Bell?

No. Certainly Taco Bell was not playing into how we’ve characterized EPS results in Q2. What we’ve said is that it will be a significant double digit decline. By far our low point of the year. But because we delivered so much better results in the first quarter, that puts us in a position to cover the unexpected severe impact of avian flu on second quarter results and thus hold to our full year estimate of mid single digit down. And just given that the wildcard here is China sales recovery, which is very difficult to call, I don’t think it makes sense to give a more precise estimate of what that second quarter will be. But we want everyone to know that it will be a significant double digit decline.

And regarding the overlap of Taco Bell from a sales perspective, it is a huge overlap, as you point out. As I said on my speech, we grew 6% in the first quarter on top of 6% last year. And the second quarter Taco Bell last year had 13% same-store sales growth, which is obviously a huge number. We look at it as anything positive being a really good result there. And what the team has put in place, in the launch of Cool Ranch Doritos Locos Tacos, I think we have a decent chance of accomplishing that.

Your next question comes from the line of Jason West of Deutsche Bank.

Just a bigger picture question on China. We have seen a bit of a continued deceleration in GDP growth and retail sales growth in that market. I was just wondering how that plays into your longer term thinking on unit growth. And does it really matter if GDP is up 7 or 10, or do you have just so much room in the smaller cities that it really doesn’t play into your growth algorithm at all?

We see the biggest macro is the growing consumer class, growing from 300 million to 600 million. So let’s say it grows from 300 to 550 or 300 to 500, it’s still a lot. And we’ve got lots of upside as we go forward. So that’s the big macro that we look at, the growing consumer class and growing disposable income. We think both those things will be moving in our direction and that’s the key.

Your next question comes from the line of Jeff Omohundro with Davenport and Company.

Just wanted to expand a little bit on the Taco Bell momentum that you referenced. I was just wondering if you could maybe address the Cool Ranch DLT launch with regard to mix shift and just how it compared with the original DLT launch. Again, particularly since you’re overlapping such challenging prior year comparisons.

When Doritos Locos Tacos was launched in 2012, with nacho cheese, the peak mix was about 11-12%. And when it was [off air] sort of towards the end of the year, beginning of this year, it got down to about 4%. So we left it on the menu, but we weren’t promoting it for a period of time. When we relaunched Cool Ranch, we got about that same level of mix, about 11-12% of mix.

That’s a huge number for Taco Bell. Anything over 3% is big. If you haven’t tried it yet, you ought to. If you like Doritos, you can’t eat just one. Try the boneless chicken at KFC too while you’re at it. That’s really good. Then if you need another meal, go have cheesy crust pizza.

Your next question comes from the line of Jeffrey Bernstein with Barclays. Jeffrey Bernstein – Barclays: Two follow up questions. One on China. I know you talked about the complete confidence and the full sales recovery. Obviously some of these issues have been compounded, which makes teasing it out somewhat difficult. I think most people agree that the supplier issue and the avian flu issue will ease with time, and you have history for that. But any thoughts on, I know we had seen a slowdown in trend in October, November, December, which was talked about at your analyst day. I know it was tough to kind of look at it. At that point in time, there was some debate whether average check had gotten too high, or whether there was too much price. I’m just wondering how you think about what gives you the confidence in the full sales recovery, or what would you see that would make you more cautious that maybe the initial issue back in the fourth quarter of ’12 might be more severe than you might have thought. And I had a follow up.

I think we know that we’re constantly improving our value equation, constantly building awareness of the sales layers we have, with delivery and 24-hour service, and breakfast. So we’ve got things that we’ve invested in to give us a base that we can build on. And we think it’s early days. I mean, we’re not capacity constrained. It’s not like we can’t make more chicken, sell more products, and build our day parts. Our average unit volumes are $1.7 million to $1.8 million at KFC and Pizza Hut. The average unit volumes for McDonald’s is $2.6 million in the United States. So we think that one of the ways McDonald’s got there is they kept building those incremental day parts over time. And that’s what we think we clearly have the opportunity, as we move ahead. And I think that’s just fundamentally, when you look at our asset base, and how we can leverage it, that gives us a lot of confidence. These are very untapped day parts that we’re just in the early days on. So I think that’s the biggest opportunity.

The other thing that’s going to help is if you look at the quarters balance of year, the last are the less challenging, if you will, and certainly that’s going to contribute to our ability to deliver improving results balance of year on the underlying business.

Your next question comes from the line of Jeff Farmer with Wells Fargo.

Just again staying away from the China discussion, just looking for a little additional color. I think you said 240 basis points increase in the U.S. restaurant margin. Looks like you called out Taco Bell sales leverage and some refranchising as drivers. But what was the approximate margin benefit from each of those things? And I guess more importantly, as you look out to 2013 full year U.S. margin, what type of guidance can you give us for that?

What we saw in Q1 we expect to be about what we’ll see for the full year. The impact of refranchising was about half of the margin improvement we saw in the U.S. in the first quarter.

And that carries through to all four quarters?

There will be some variability from quarter to quarter, but on a full year basis we expect to see about 17% margin for the U.S.