Yum! Brands, Inc.
Q1 2018 Earnings Call Transcript

Published: 2 May 2018

[Operator:]

Good morning. My name is Shelby, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Yum! Brands Q1 2018 First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Mr. Keith Siegner, Vice President of Investor Relations and Treasurer. Please go ahead, sir.

[Keith R. Siegner:]

Thank you, Shelby. Good morning, everyone, and thank you for joining us. On our call today are

[Greg Creed:]

Thank you, Keith, and good morning, everyone. Yum! Brands delivered first quarter system sales growth of 4% in constant currency, including 1% same-store sales growth and 3% net new unit growth. Consistent with our expectations, core operating profit growth for the first quarter was flat, and we are maintaining all aspects of our full year 2018 guidance. As a reminder, our full year core operating profit guidance of approximately flat includes 6 to 7 percentage points of headwind from the timing impact of refranchising and associated G&A savings, along with 2 to 3 percentage points of headwind from the revenue recognition accounting standard. Regarding our transformation initiatives, this quarter marks the start of the second full year of our transformation journey. And I am pleased to report we remain on track with our efforts to ensure Yum! is a more focused, more franchised and more efficient company. We've discussed that part of this transformation journey is to accelerate growth by focusing on four key drivers

[David W. Gibbs:]

Thank you, Greg, and good morning, everyone. Today, I will discuss

[Operator:]

. Your first question comes from Matt McGinley of Evercore SI (sic) [ISI].

[Matthew Robert McGinley:]

Thank you. My first question is on the core operating profit.

[Greg Creed:]

Matt, we're just trying to get the volume up a little bit. Hang on. Okay, try again.

[Matthew Robert McGinley:]

Okay my question – can you hear me now?

[Greg Creed:]

Yes.

[Keith R. Siegner:]

Yes.

[David W. Gibbs:]

Yes.

[Matthew Robert McGinley:]

Okay, great. So my question on the core operating profit is for the year, you expected that to be flat overall. You were flat in the first quarter, despite what you called out as a 3 point headwind from the UK. And I would think that as the year progresses, that you would get more of that G&A reduction in the back half. Other than that revenue recognition change that you'll have, that will probably more negatively impact you in the fourth quarter, what gets worse from a run rate perspective as the year progresses?

[David W. Gibbs:]

This is David. Let me give you a little sense for how the cadence of operating profit will work during the year, as we get to that flat guidance for the full year. The second quarter will probably be our weakest quarter of the year, as we expect to report negative core operating profit. I would point out that we're lapping in the second quarter $9 million worth of one-time benefits at KFC, which we called out during last year's second quarter call. So those one-timers are part of the lap and, obviously, present some headwind. We also have the refranchising impact and the Pizza Hut Transformation Agreement spend contributing to that being a tougher quarter lap. And we expect the quarters to get better as the year goes on. When we get to the fourth quarter, we'll be lapping actually the Pizza Hut transformation spend of $15 million in the fourth quarter of last year, so that presents a tailwind for us in terms of reported operating profit growth. And we're also lapping, you guys will remember from fourth quarter last year, that we refranchised close to 900 units. So that will be taking a toll on us before we get to the fourth quarter, but once we get to lapping it, we will, obviously, won't have as much of a headwind from that. And then to your point about G&A, it's not as if the G&A reductions build so that they're much bigger in any one quarter. We think that they will occur mostly pro rata during the course of the year, but the G&A obviously is a little bit of a tailwind to the year, but unfortunately more than offset by the impact from refranchising. So that's basically how you build the year to flat.

[Matthew Robert McGinley:]

Thanks for that. And then on the KFC system sales in the UK, and I think I understand the issues that you had there, but are you fully moved past those issues or is there some residual issues you have from a customer standpoint that when you have those closures or the inability to supply product, that the customers don't come back immediately? Just kind of curious if you're fully moved on from those issues or if this is still a sort of a residual impact into the second quarter.

[David W. Gibbs:]

No. Obviously, the challenges are to make sure we have full supply in the restaurants and that we ensure that we can get supply there on a timely basis. We're mostly past that and mostly back up and running. But out of an abundance of caution, we're waiting until we're 100% confident before we turn the media back on.

[Greg Creed:]

Yeah, I think that's a key point. Yes, we ran, I thought, a rather clever ad when we were in the middle of the crisis but, obviously, we stopped advertising while we didn't have supply. So I think we're excited to get all 871 restaurants back and we'll be excited to turn on the marketing machine. I think we'll get a very good response from the customer, who realizes this was a distribution issue. And I think we're going to get a lot of support when we turn the marketing machine back on.

[David W. Gibbs:]

Yeah. So the marketing should turn on later in the month. Obviously, the impact of the event was being felt in the first quarter, which we've reported on. And we will see some continued impact into the second quarter as well, also contributing to the second quarter being the worst quarter of the year, most likely.

[Matthew Robert McGinley:]

Okay. Thank you.

[Operator:]

Your next question comes from John Glass of Morgan Stanley.

[John Glass:]

Thanks. Good morning. On the Pizza Hut International comp decline, first, how much of that was simply due to the China results, which we saw last night, or is it a broader issue, or maybe you could just talk about the markets where you're seeing that and what the specific issues are? And is this a dine-in versus delivery? Is there any kind of way to look at it on those two dimensions strength versus weakness?

[David W. Gibbs:]

On the actual numbers, I think if you back out China, it's closer to flat for International, but I'll let Greg comment on it.

[Greg Creed:]

Yeah. I think if you look at the numbers and you broke out dine-in versus delivery, the delivery numbers are stronger, obviously, than the dine-in numbers. And, John, it's like everything. When we get value right, when we get product right and we get it hot and fast, we do very well. So I think, as I alluded to in my presentation, we've got three specific actions we're taking. We're going to take those with the markets that need to and, obviously, we're confident that that will improve our performance in same-store sales growth in Pizza Hut International.

[John Glass:]

Okay. And then, just on the UK, is there some sort of recovery that's available to you? Did you put that into your forecast or would that be upside if there was insurance recovery or some other benefit that you might get from this from the distributor or some other source, insurance company, for example?

[David W. Gibbs:]

Obviously, yes. The parties that were responsible, we've been in discussions with them. And we've reached a settlement. We can't really go into any details on that, but that is baked into our numbers. And that's why, as Greg mentioned in his speech, we think we've helped the franchisees get through this to the point where we can get the business back on track very quickly and get everybody back to a healthy situation.

[John Glass:]

Got it. Thank you.

[Greg Creed:]

Thanks, John.

[Operator:]

Your next question comes from Dennis Geiger of UBS.

[Dennis Geiger:]

Morning. Thanks for the question. Could you provide a bit more detail on what you're seeing from all the recently-launched initiatives in place at Pizza Hut in the U.S.? I know early stages, but just thinking about loyalty, the thermal pouch, new app, increased marketing spend, Greg, I know you talked about improvements in internal metrics and, obviously, very solid one year trends, but anything else on customer satisfaction metrics, what the franchisees are telling you just as we think about assessing the continued pace of the turnaround? Thanks.

[Greg Creed:]

Sure, Dennis. I think, as you said, obviously, loyalty numbers are growing. We just added more cheese to the pizza, so we're improving the product. Our conversion numbers definitely improved in the quarter. Our speed improved during the quarter. So I think all the things that we're doing, hiring delivery drivers, the hot pouches. So the food is hotter. It's getting there faster. Conversion is stronger. So that's what we're seeing across all of our metrics. And what's interesting is, as David alluded to, that 2,000 restaurants have changed hands. What we're seeing with some of these new franchisees is some of our new franchisees are actually delivering the best operating metrics. So we're encouraged that as these new franchisees come on board, embrace the strategy and the tactics that Artie's putting in place, that we're actually seeing these new franchisees jump to the top of the operating metric performance.

[Dennis Geiger:]

Thank you.

[Operator:]

Your next question comes from Chris O'Cull of Stifel.

[Chris O'Cull:]

Thanks. Good morning. I know you mentioned that KFC and Taco Bell's point-of-sale system will be fully integrated with Grub's. Does this mean the company will have access to the customer data from the Grub orders? And will this integration allow you guys to communicate back to the Grub customers with ordering updates, incentive offers, rewards et cetera?

[Greg Creed:]

Obviously, as part of the deal with Grub, we have access to the data. I mean the sense of data is keen about our customers, so we'll have access to -- the Taco Bell customers will have access to the Taco Bell and the KFC will have access to KFC. So I think, obviously, having access to that data is critical. The teams are focused now on integration. And then, I think what you'll see – and the third thing, and David alluded to it is, both David and I were at both the KFC and Taco Bell franchise conventions in Q1, which Grubhub presented at both of those conventions. And the response was very positive to the presentations and I think very positive to the long-term relationship we're going to have with Grubhub.

[Keith R. Siegner:]

Thank you. Next question, please.

[Operator:]

Your next question comes from Jeff Farmer of Wells Fargo.

[Jeff D. Farmer:]

Thanks. When your global franchise ownership mix reaches that 98% or so roughly, I guess, over the next coming quarters, where do you expect that consolidated restaurant level margin run rate to settle versus where it is today?

[David W. Gibbs:]

Yeah. I think on margin, we've been very consistent in saying that the margin can be misleading now, because we own so few company stores. We're at 97% today, so 98% is not that far away. I think we're at 1,345 company units on our journey to get below 1,000. So, for example, Pizza Hut margin is only represented by 100 stores. We've got over 16,000 stores in the Pizza Hut system; 100 stores don't represent margin at all. And we're very committed to having this model where we own stores to learn, so we'll do testing in those company stores that may depress margins, and that doesn't bother us at all. We may own stores in a few markets where we're trying to make market entry. And we want to show our franchise partners that we'll put our capital out in front and invest in those stores to spur development by then. So I wouldn't give a forecast of where our company margins are going to be, nor would I get too focused on them as they become such a small subset of the overall system. They really don't represent the performance of the business.

[Jeff D. Farmer:]

Okay. And you just touched on it, but of those few hundred-plus units left to refranchise, any color as to where we should expect that refranchising to take place across the divisions?

[David W. Gibbs:]

Yeah, obviously, with Pizza Hut down to 100, there's not a lot more left to refranchise there, so, yeah, I can tell you it would be the remaining Taco Bell and KFC brands. But, as you can imagine, we also don't reveal the plans for where we're going to refranchise. Deals fall apart. Deals come together. We want to give ourselves all the flexibility to get to the number the right way.

[Greg Creed:]

Yeah. I think, as David said, we remain really confident that we will get to the 98% and own less than 1,000 restaurants by the end of this year.

[Jeff D. Farmer:]

All right. Thank you.

[Operator:]

Your next question comes from John Ivankoe of JPMorgan.

[John William Ivankoe:]

Hi. Great, thank you. You guys are obviously seeing some correlation across disparate Pizza Hut International markets, at least that's what it sounds like in your prepared remarks and also what we can see in some of the tables in your press release. So, I guess, is there anything that's changing in early 2018? And I know you did make the point that delivery is outperforming dine-in, but hopefully we can go a little bit deeper into that. Firstly, were there any lessons learned from the U.S., especially with dine-in and delivery being two different models that have now converged together, that we can apply to the various international markets? And secondly, if you can remind us what percent of stores internationally currently offer delivery? And can that percent materially tick-up as a way to offset the weaker dine-in sales?

[Greg Creed:]

Okay. Well, I'll address the first one, which is what we are learning from the U.S. that we can take internationally. Great value, clearly, I think for all brands and most markets, value remains an imperative and we're obviously focused on that. So great value, great product, in the U.S., we've just announced we're putting more cheese on our products that not only makes it taste better, it also delivers the product hotter because, obviously, more cheese keeps the heat, plus the new pouches. And then I think making sure that we're hot and on time. So I think it's really about just executing the fundamentals and making sure that each of the markets has great value, has a great product and is executing hot and fast.

[David W. Gibbs:]

Yeah. As far as the percentage of stores offering delivery, internationally, it's 60%. And just as more color on Pizza Hut, internationally, the Pizza Hut dine-in stores are actually mostly in generally pretty good shape. And we have a lot of markets where the dine-in business is healthy, in contrast to the U. S. So it's not a perfect analogy between what's going on in the U.S. And Pizza Hut, more than our other brands, really does tend to be unique market-to-market, where it's been built up as a delivery brand in one market, a dine-in brand in another, a higher-end dine-in brand in some markets, a more family dining in another. So it's a little bit more complex in terms of how we take learnings from one market to another. However, we think there's a lot of learnings on the digital side. Pizza Hut, with, obviously, many billions of dollars of digital sales in the U.S., is working closely with our international team to take those learnings and make sure we have the best digital experience around the world, as another example of where we're sharing know-how.

[John William Ivankoe:]

And that follow up, I mean, can that 60% be materially higher in terms of stores that offer delivery?

[David W. Gibbs:]

Yeah. In fact, as we move forward with Pizza Hut internationally, the Pizza Hut team has done a really nice job of developing what they call their fast casual Delco model or Super Delco. It goes by a number of different names, which has a dine-in component, but also is set up to do delivery the right way. A big part of this is just getting all of our assets to have a back-of-house that has delivery capability. That's a challenge we still face in the U.S. and that we continue to face internationally. And we know that the more we can lean in on delivery, the better set up for long-term success, the better delivery is doing today, as Greg mentioned. So a big part of this strategy is delivery and digital-centric internationally.

[John William Ivankoe:]

Thank you.

[Operator:]

Your next question comes from Gregory Francfort of Bank of America.

[Gregory R. Francfort:]

Hey. Just a question on the Taco Bell margins, and I know the company stores are not a big piece of the base right now, but a little bit softer this quarter. How much of that was due to the Nacho Fries?

[David W. Gibbs:]

Sure. As you mentioned, we had great margins at Taco Bell but softer on a comparison basis. The launch of Fries was definitely a factor in that. I think the team did the right thing and made sure we staffed up as we launched the product and learned about how we can best operationalize it. And so, that was a big factor in some of the margin impact. We also had a little impact from refranchising. And then I would remind you that all quarter long, we were on air with dollar value. So we had a number of things pressuring margin a little bit, but still all-in-all in the context of our margins and our long-term guidance, good margins.

[Gregory R. Francfort:]

Yeah, got it. Thanks. And then, Greg, just how do you think digital ordering plays out over the long-term from a consumer perspective? As a consumer, am I going to have three or four brand apps on my phone? Am I going to have one order aggregation app? I'm just curious what you think the consumer-facing side or mobile device side of the equation will be in a couple years?

[Greg Creed:]

I think, first of all, there will be more, obviously, mobile ordering. What's interesting, I was actually at somewhere the other day and I have this bad habit now of looking at people's front page of their phones. And I saw the Pizza Hut app on a lot of phones, right? So I think having got in early with Pizza Hut, I think you'll find the same with Taco Bell and I think we'll also do the same as we get through Grubhub and do business that way. So I do think orders on mobile will grow. I do think people will have potentially more than one or two apps. They're not going to put every brand that's out there. And I think that's just another reason to make your brand relevant, distinctive, and easy, because I think the brands that offer relevance to the customer, are distinctive in the customers' mind and make it easy to order, easy to pay, easy to get, will be the ones that will either see their app as front page apps.

[Operator:]

Your next question comes from Sara Senatore of Bernstein.

[Sara Harkavy Senatore:]

Thank you very much. Just a follow-up on Taco Bell and then a question about Grub, please. So, on Taco Bell, you mentioned how successful Nacho Fries were. And I think we had read that stronger even than Doritos Locos, perhaps, at the launch. So, I guess I was a bit surprised comps weren't a bit stronger. Granted, you're lapping an 8% compare, but could you talk about maybe was it just check compression from the dollar menu and the value push or to what extent was that just a function of a difficult comparison versus a daypart or a menu segment maybe not working as well? And then, I do have another question, please.

[Greg Creed:]

Sure. Well I think the good news is 25% incidence, a quarter of the orders going out with Fries was great. Obviously, 8% was a tough number to lap, given what's going on in the marketplace. We were happy that we lapped with a plus 1%. Obviously, $1 Fries, part of it is the fact that they're $1, which also helped the business and helped drive incidence. And I think what we like, what we saw was a lot of it was incremental. So I think that, obviously, probably helped check. It did help check in the quarter. I think the good news is that we're not a one-trick pony when it comes to value. We've got now the Triple Melt Burrito and Nachos in Q2, so we've got a lot of I think – I'm not sure tricks is the right word. We've got a lot of really smart plays around value. And I believe that we will continue to do very well in this very tough marketplace with a brand like Taco Bell.

[Sara Harkavy Senatore:]

Great. Thank you. And then, just the follow-up was on Grubhub. Can you just talk a little bit about the decision to make an investment versus just doing these things through some kind of partnership? Because I know we heard last night from Yum China that they are actually trying to shift more of their ordering to their own platform and a little bit away from aggregators. So I'm just trying to contextualize that in terms of global trends and, again, a decision to sort of tie a partnership closer than just having some sort of contractual agreement.

[David W. Gibbs:]

Yeah, obviously, with the pickup in business going to aggregators, this is an opportunity in the industry for us. And we just thought, given our scale and all the knowledge we have about delivery through the Pizza Hut brand, that we had a lot to offer to an aggregator partner. And that's why we wanted to – but, at the same time, we also wanted to have a front seat with what we think is the best run aggregator and understand their business model and how we could best utilize it and partner together to grow both of our businesses. So the investment was part and parcel to getting a board seat at Grubhub and we thought it was the right thing to do. Obviously, we're pleased the stock has responded positively and that our investment is up. But it really was more about getting a seat on the board of directors and having a different kind of partnership, other than just commercial terms. We want this to be a partnership where we share more knowledge between the two companies at a deeper level. We're actually planning on going up to visit with them with our senior team in a couple of months, things you wouldn't do if you just had commercial terms between two entities.

[Greg Creed:]

I also think that our investment enables Grubhub to expand to gain national distribution quicker. So I think they spoke about they are actually getting into penetrating more markets more quickly. So we like the fact that our money could be directed to helping them do that, because, obviously, the broader the presence of Grubhub, the better it is for us once we get the integration complete. So I think it's a really good partnership. I think it was a great investment. I think it's great to have the board seat. And I think you will see great things come from this, once we get the integration complete, we put the marketing effort behind it and Grubhub expands their national distribution. I think this is all upside for both parties.

[Operator:]

Your next question comes from Andrew Charles of Cowen & Company.

[Andrew Charles:]

Thank you. On the upcoming Taco Bell after dark initiative, how does this tie in to the Grubhub partnership, which presumably should benefit you most at late night? And will the after dark initiative be customer-facing with opportunities to layer in Grubhub marketing to the initiative as you go through the summer?

[Greg Creed:]

Well, I think there is two things going on. First of all, one is operationally what David was talking about was I think applying the focus that we apply to other dayparts to obviously dinner and late night. We do believe there's a huge amount of upside. I think for competitive reasons, we don't want to give too much away on what we're doing after dark from a consumer-facing perspective. That would be not in our best interest, so I'll refrain from that. But I just want to let you know that we are going to – or the operators will put additional focus on our customer service, our speed of service, our accuracy and all of those key operating metrics for both dinner and late night as we go through the summer.

[Keith R. Siegner:]

Next question, please. This will be our last question.

[Operator:]

Your final question comes from David Tarantino of Baird.

[David E. Tarantino:]

Hi, good morning. My question's on the unit development, which seems to be picking up momentum. And I was wondering if you could just give us an update on your thoughts on how you get to that level of unit growth that's needed to deliver your goal of 7% system sales growth? And in particular, whether your confidence in getting there has changed following a lot of these refranchising transactions you've completed.

[David W. Gibbs:]

Yes. I think our confidence is increasing in unit development as we start to put some results up on the board. We mentioned that we had 239 net new units open in the first quarter of 2018. That compares to about 100 less last year so that's 100 unit pickup, about half coming from China, which reported yesterday. And some of you may have noted they took their unit guidance up. They also commented on the great cash paybacks they're getting on KFC and Pizza Hut. So that's all very positive when one of our largest developers is taking their guidance up. We're seeing the actual numbers increase. And then to your point about the refranchising, as I think we've mentioned in some other calls, we've used the refranchising as an opportunity to make sure we pick well-capitalized franchisees that are committed to growth and then have development agreements typically as part of those refranchising deals. So our pipeline, as we get more and more of the refranchising done, our pipeline for new unit development is building up with these Development Agreements being put in place. So, yeah, we're really excited. We had a step-up in development in 2017, which you guys would have noted, a couple hundred units versus 2016. We're looking to do the same thing in 2018. And we're certainly not stopping there. We think this is an important part of the journey to get to 7% is getting a more reliable contribution from development at a higher number than we have in the past.

[David E. Tarantino:]

And, David, if I could just follow up on that, do you think with these refranchising transactions that take a little bit of time for that pipeline to build, I would assume, and do you think we'll see a bigger inflection in 2019 and 2020 than what we've seen last year and this year or is it more going to be a kind of a gradual ramp up?

[David W. Gibbs:]

Maybe as we get to the end of the year, we might start talking about guidance for future years. Certainly it's our hope that we keep ramping up development, but one thing to note is that as we've done the refranchising in the markets where we have equity stores, we've continued to build up our own equity pipeline and then we hand that pipeline to the franchisees. So we didn't want to have the situation where somebody would buy a market and there would be no development at that point in time. So we've tried to avoid any lulls in development caused by the hand-off of units. But certainly very optimistic about development. It's an area that we're leaning in hard and really proud of the work that the teams in the field are doing to build a stronger and stronger pipeline.

[David E. Tarantino:]

Great. Thank you.

[Greg Creed:]

Okay. So first of all, I want to thank you all for being on the call. I guess just a few thoughts in closing. I think a solid start to the year, after adjusting for the impact of KFC UK. It's clear we need to stay focused on making the brands more relevant, distinct and easy to drive even stronger same-store sales performance. And as suggested, we're obviously pleased with the strongest net new unit openings in Q1 in recent history. Thanks, again, and we look forward to speaking to you in August.

[Operator:]

This concludes today's conference call. You may now disconnect.