Yum! Brands, Inc.
Q2 2018 Earnings Call Transcript

Published: 2 Aug 2018

[Operator:]

Good morning. My name is Athania, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Yum! Brands Second Quarter 2018 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to your host Mr. Keith Siegner, Vice President of Investor Relations, Corporate Strategy and Treasurer. Sir, you may begin.

[Keith R. Siegner:]

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

[Greg Creed:]

Thank you, Keith, and good morning, everyone. System sales growth for the second quarter was 4%, with 1% same-store sales growth and 4% net new unit growth. As we discussed on our earnings call last quarter, four items were expected to weigh on our second quarter core operating profit results. These included the timing mismatch between G&A savings and refranchising, the revenue recognition accounting standard change, the KFC distributor disruption in the UK and the lap of some one-time benefits at KFC. As a result, and consistent with our expectations for the quarter, core operating profit declined 6%. We are reiterating our 2018 full year guidance. However, given the strong unit development in the first half of the year, we expect net new unit growth to be at the high-end of our guidance of 3% to 4% and same-store sales growth, given the softer first half of the year, to be at the lower end of our guidance of 2% to 3%. It's also important to note that, excluding the KFC distributors' disruption in the UK, first half same-store sales growth would have been 2%, within the range of our full year guidance. As a reminder, our full year core operating profit guidance of approximately flat includes anticipated headwinds of 6 to 7 percentage points related to the timing mismatch between refranchising and the associated G&A savings, along with 2 to 3 percentage points related to revenue recognition accounting standard. Looking at the second half of the year, we're confident in our plans and are performing on track with those plans thus far through the third quarter. We are now a year and a half into our transformation and are continuing to execute on the key items designed to deliver accelerated growth. The foundation of this is our four key growth drivers, which David and I will talk to you about today. I'll provide an update on two of these drivers, our distinctive, relevant and easy brands and unrivaled culture and talent. Then David will discuss the next two, bold restaurant development and unmatched franchise operating capability, along with the details of our second quarter results. I'll start with our three distinctive, relevant and easy brands. Beginning with KFC Global, system sales grew 6% with same-store sales growth of 2% and net new unit growth of 5%. We continued to see strength in Australia, Russia & Eastern Europe, Latin America, the Middle East, including Turkey and North Africa and our India markets. The success in these markets was primarily a result of balancing the core, value, innovation, and also ensuring the operational basics are executed well. In particular, I want to highlight our KFC Australia market. Year-after-year, this market continues to deliver, posting 4% same-store sales growth year-to-date for a two-year stack of 11%, of which approximately 75% is transaction growth. They have wrapped the KFC brand within the lovable, larrikin Australian culture, distinguishing KFC and helping drive the consistently strong same-store sales growth. I'm proud of the fact that transactions have been driven by their focus on core products. We just celebrated 50 years in this market and I look forward to many more years of continued growth. Just last week, the KFC team from across the globe held their Annual Marketing Planning Meeting with record breaking attendance. The event focused on sharing know-how and facilitating collaboration by connecting our teams with each other. Themes centered around building sales overnight and brand over time with the objective of making KFC more distinctive, relevant and easy. The market teams bring so much passion for the brand and I love this way of bringing best practices to life around the globe. Shifting to the U.S., I'm proud that the innovation team has delivered with the Crispy Colonel Sandwich. Operational enhancements ensure the sandwich is delivered hot and fresh to each customer with options for a classic sandwich or one of the delicious flavor profiles of Nashville Hot, Georgia Gold or Smoky Mountain BBQ. As a bonus, we introduced a new pickle flavor, which could be added to any Extra Crispy product, including the Crispy Colonel Sandwich. This was a very limited-time offering, as each store was only shipped one case of the new cult favorite. Without any traditional commercials, Pickle Chicken spread by word of mouth and generated significant buzz for the brand. Before moving onto Pizza Hut, I want to provide an update on the KFC UK business, which suffered a setback as a result of disruptions in supply, when we changed distribution partners in the first quarter. As expected, all stores were fully up and running by mid-May. We've turned the national advertising back on and are seeing good customer response. I'm very thankful to and proud of the team who have worked tirelessly since the disruption began. It is because of their hard work, collaborative spirit and dedication that customers in the UK are now able to enjoy the KFC they love and missed. Now to Pizza Hut. In the U.S., system sales declined 1% with flat same-store sales and net new unit decline of 2%. During the second quarter, we launched an innovative product with our Double Cheesy Crust Pan Pizza that customers enjoy and mix well in our menu offerings. However, this campaign shifted marketing away from the value offering, which we believe weighed on same-store sales growth in the quarter. We know consistent value is of the utmost importance and at the core of our brands, and so we've adjusted our marketing for the balance of the year to remind customers we're a brand offering everyday compelling value. Regarding our Transformation Agreement investments, we continued to gain traction with our commitment to Hot, Fast and Reliable experience. Our investments in digital, delivery, operations, and loyalty are generating improvements in internal metrics. In fact, our delivery times have improved by three minutes versus prior delivery times to the Transformation Agreement. Customer satisfaction scores have also significantly increased as was recently reported by the American Customer Satisfaction Index. Pizza Hut customer satisfaction score increased 5%, the largest gain in the category making Pizza Hut tied for fourth amongst limited service restaurants. Lastly, we recently announced a new partnership with advertising agency, GSD&M and could not be more excited about the creative opportunities that await this powerful brand and look forward to an exciting activation of our football partnerships including our new NFL agreement and the extension of our NCAA agreement. We still believe that Pizza Hut U.S. turnaround will be a slow build, but we're encouraged by the foundation that's being put in place and continue to make significant strides to improve the brand's position. Internationally, system sales grew 1% with same-store sales decline of 2% and net new unit growth of 6%. The strong net new unit growth represents an acceleration over last year, as our Delcos continue to generate healthy unit level economics, keeping franchisees excited and motivated to continue building the footprint of our brand. Additionally, we were very excited to announce our landmark international growth alliance with Telepizza back in May. This alliance will double Pizza Hut's footprint in the regions covered, place Pizza Hut in the number one position in the category across Latin America and the Caribbean in terms of unit count and confirm Pizza Hut's position as the world's largest pizza restaurant company. Please note completion of the alliance is subject to certain conditions including regulatory approvals. Upon approval and deal closure, Telepizza units will be included in our unit count. Outside of unit development, we have significant work to do around same-store sales growth. Many markets are experiencing similar issues to those faced in the U.S. and we are taking the learnings from the U.S. market and applying them internationally. In particular, I want to elaborate on the three key steps I outlined last quarter, which are designed to reignite same-store sales growth. First is ensuring we have strong operations and digital execution in place to deliver on being the easiest, fastest, tastiest pizza. Secondly, is making sure we have compelling value in each of our markets with examples such as the 69 pesos Pan Pizza in Mexico, £5 Favorites value in the UK and medium two-topping online deal in Canada. Third, is a consistent communication about For The Love of Pizza brand positioning. Overall, we are utilizing the repeatable model to roll out these three key initiatives across each of our international markets and we'll continue to update you as we progress. Now to Taco Bell, where system sales grew 5% with same-store sales growth of 2% and net new unit growth of 3%. The quarter began with our $1 Nacho Fries followed by the $1 Triple Melt Burrito and Nachos. Also available in the $5 Box, the Triple Melt Burrito and Nachos featured a delicious blend of melted cheddar, mozzarella and pepper jack cheeses. We also brought back the Naked Chicken Chalupa, an innovative take on the taco shell made of fried chicken now in both a wild and mild flavor. And as we move into the third quarter, Nacho Fries are back for a sequel. The PR buzz around the follow-up faux movie trailer Web of Fries II

[David W. Gibbs:]

Thank you, Greg, and good morning everyone. Today, I'll discuss our second quarter results, progress towards our transformation initiatives, and two of our four growth capabilities

[Operator:]

And your first question comes from the line of Brian Bittner with Oppenheimer & Company.

[Brian Bittner:]

Thank you. Good morning. My one question is going to be on the unit growth, I know you just came into that (29

[David W. Gibbs:]

Hi. Yeah, great question Brian. I am really excited about what's going on in development. Just to put some numbers around it. Year-to-date we've opened 482 net new units versus 317 at this point last year. So we're up 165 units. As for the composition and what that might look like going forward, obviously, KFC and the level that they are performing on and the growth number of units that they're opening is fairly significant. But they still have enormous runway to keep going and take their numbers up. But Taco Bell and Pizza Hut starting from lower numbers I think can have even more room to improve their percentages in their growth rates. The Pizza Hut model with the Delcos, as we said, we're getting 90% of our growth through Delcos. It's a really efficient way to build new units with great returns for franchisees in most cases. So we see ramping that up fairly significantly and you're seeing that right now around the world. And then Taco Bell as we've said many, many times is really just scratching the surface internationally. So my guess is as we go forward you'll see the composition change a little bit with Pizza Hut and Taco Bell becoming a bigger and bigger part of unit growth and KFC taking their already very impressive numbers up further as well.

[Operator:]

Your next question comes from the line of David Palmer with RBC Capital Markets.

[David Palmer:]

Great, thanks. Good morning. Congrats on that move towards 4% unit growth. A question on delivery. With your investment in Grubhub, you're in a great position to see what's going on in U.S. delivery these days, obviously you have a big play there in Pizza and it looks like the big three pizza players in aggregate are weaker than they were in the past. Do you attribute this to non-pizza delivery hurting Pizza? And could you talk about your lift today, how delivery is going with KFC and Taco Bell and what you think that might be as you look ahead with Grubhub? Thanks.

[Greg Creed:]

Yeah, I think we're in obviously the early days of testing with Grubhub. I think that's – I think the key thing is that we've got the systems integrated. So we're in the very early days. We are seeing what you'd expect us to see, which is incremental transactions we're seeing higher check. We've not unleashed the marketing muscle behind it, so we think there's a lot more transaction growth to get. But the transactions appear to be incremental at a much higher check. So I think in that sense we feel good about delivery. And obviously, I think that we'll obviously work with Grubhub in order to grow this opportunity. Nothing better than a new occasion and a higher check that's all good for us and we'll obviously continue to support that and make that a big deal going forward.

[Operator:]

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

[John Glass:]

Thanks. Good morning. On the Pizza Hut business globally and you talked about some operational tweaks you need to make, some marketing. But there's also a fair proportion of stores that currently don't offer delivery. So is there some sort of unlock that you can achieve early on in terms of getting some of those dine in stores to deliver? Is that a key piece to driving incremental same-store sales? And I did want you maybe just to address the prior question about delivery maybe impacting particularly some of your global Pizza Hut markets (33

[David W. Gibbs:]

Yeah, I mean on the question of the dine-in stores at Pizza Hut and their ability to deliver, we actually do have some dine-in stores that deliver out of the dine-in stores, we call them restaurant-based delivery. And with aggregators it does make it easier to add dine-in stores to the delivery world and have the aggregators deliver from our dine-in stores. I think Yum! China has taken advantage of that opportunity. So for us, the dine-in asset base though is very different around the world for Pizza Hut. In some cases, it's nearly white tablecloth. In other cases, it might resemble more of a fast casual kind of asset and you have to take into account on the delivery side is the back of the restaurant actually set up to deliver? In some cases it is, in some cases it isn't. In some cases, the menu is something that could be delivered, in other cases it's more of a dine-in menu. So we are – where there are opportunities we are taking advantage of the ability to add delivery to our dine-in assets. And as I mentioned in the opening remarks, the vast majority of the stores we're building, the Telepizza stores that we are adding, they are all delivery capable stores. So you'll see our asset base become more and more delivery capable over time. As far as the trends on delivery...

[Greg Creed:]

Yeah, I think if you look at our international pizza business, there's a distinct difference between our performance in dine-in and our performance in off-premise. And so we feel good about our off-premise performance in our international Pizza Hut business. It's got some very good numbers and, as I said, there's quite a difference between that and our dine-in. We've still got some strong dine-in markets, Hong Kong, Indonesia that are performing well. But, clearly, as David said, we're building the future which is Delcos and we're still seeing good growth in international in our off-premise business.

[David W. Gibbs:]

Yeah. I mean, both U.S. and internationally, our delivery business is in growth mode. Our delivery carryout business is in growth mode. So back to the earlier question of, are we seeing other people getting into delivery impacting us, it would be hard for us to say that since we feel pretty good about our Pizza Hut delivery carryout business today.

[Operator:]

Your next question comes from the line of John Ivankoe with JPMorgan.

[John William Ivankoe:]

Yes. Hi. I was hoping to get an update on delivery specifically at KFC and Taco Bell in the U.S., how many units have been fully integrated into the GRUB platform from a delivery perspective on the front-end, but how much of that work is already been done on the backend as well, (36

[David W. Gibbs:]

Yeah, look, I think as we've said a couple of times, we're pleased with the initial results that we're seeing by adding delivery into Taco Bell and KFC. Remember, Taco Bell already had a decent sized pool of stores that they experimented with delivery with another aggregator partner. Behind the scenes, we're doing all the work to integrate the systems with Grubhub, so that we can make this the fastest most seamless process for consumers and for our store employees. And we feel good about how that work is going. We're not throwing out numbers and targets and when certain number of units are going to be opened because there are several milestones we have to get through as we go on this journey. In fact, we're still trying to finalize the specific terms of the agreements that our franchisees will sign with GRUB. And then until things like that happen, we don't have complete visibility to a timeline around certain units and when they'll all be on. But as far as initial results, I think we're pleased with how things have gone.

[Operator:]

Your next question comes from Karen Holthouse with Goldman Sachs.

[Karen Holthouse:]

Hi, another question on the delivery front, where you have been testing delivery, do you have any early data you can share in terms of delivery times that you're accomplishing or achieving?

[Greg Creed:]

Yes. I mean, look, I think the key is as we've been trying to say, this is very early. We're in test. We haven't unleashed the marketing muscle of each of the brands in order to drive it. So I think we're seeing times that we're really happy with. So we've obviously got a very big Pizza Hut delivery business. We know what the expectations of the customers are. So I think we feel good about the delivery times that we're delivering to the customers. The transactions per restaurant are still small, but I believe that with all the work we've got from our Pizza Hut knowledge on how to deliver, that we are meeting the customer's expectations. So I feel good about that. The tests are very early, small number of stores. And I think as David said correctly, getting both KFC and Taco Bell integrated in the POS system, we don't want to be going to a tablet to order, to place an order because then you get speed issues. You get accuracy issues. We know all of that. So we would rather get the integration done right, test the integration, then unleash the marketing dollars and then drive the incrementality that we know we'll get.

[David W. Gibbs:]

And in a good way I guess, we're fairly sophisticated when it comes to the subject of delivery. We know delivery well from our Pizza Hut business. So getting Taco Bell and KFC in, we have very high standards for where we want to ultimately get to. And while, as Greg said, we're pleased with where we're at right now in the journey, we know what ultimately the kinds of times and accuracy that you need to deliver in delivery. We're not there yet, but we're on that path to getting there with GRUB right now.

[Operator:]

Your next question comes from Matt McGinley with Evercore ISI.

[Matthew Robert McGinley:]

Good morning. My question is on the interplay of comp and unit growth. If over the long run, your units gravitate more towards that 4% unit growth range, why wouldn't your comp naturally gravitate more towards that 2% over the long run? Given you have 45,000 units around the world and growing at that higher rate just adds that many more units, you're going to have more cannibalization. It probably is a distraction to execution. I'm just kind of curious why the long run wouldn't look like your guidance for this year.

[Greg Creed:]

Look, I think that being at the low end of 2% to 3% is not where I want us to be. I think we have every capability to be closer to the high end of the range. And it's probably not a surprise to anybody that based on our first half performance even accounting for the KFC performance in the UK, we have strengthened the back half calendars on all the brands. We happen to have a thing called, as David said, the marketing planning meeting last week for KFC. I sat through every one of those brand presentations. I've seen the calendar adjustments. I think that there is still opportunity for us to grow closer to the 3% than the 2% we are delivering. And I can assure you we're very focused on, obviously, continuing to grow the net new units that David spoke about, and which we're obviously happy about. But I do believe we can still accelerate our growth closer to 3% than to 2%.

[David W. Gibbs:]

Yeah, on the specific question, it was a fair question though, as we expand will we end up with more and more cannibalization impacting same store sales growth? Actually if you think about where we're growing, mostly very much wide open spaces. We talked in our opening comments about how Pizza Hut's just entering Sub-Saharan Africa, there is new countries to enter, there's hundreds of units to build. I mean in many ways the units that you build start to produce more marketing dollars, which help you grow your topline more. Certainly at some point you'll get to saturation and you will deal with more of the impact issues that are little bit more common in the U.S. We have a very big presence in emerging markets where the markets are growing, where our unit counts are growing along with the population and with the purchasing power of the population and we really don't see a lot of concern about cannibalization from the development folks and where we're building stores.

[Operator:]

Your next question comes from Andrew Charles with Cowen.

[Andrew Charles:]

Great. Thanks. Dave you called out core operating profit growth in 2Q is expected to be the softest for the year, but you showed pretty good traction on G&A savings which at 1.8% of system sales in the quarter is brushing up against that 1.7% target as well as franchise and property expenses. Does the full year guidance for flat core operating profit embed accelerated levels of savings in these two line items as we look out to the back half of the year?

[David W. Gibbs:]

I wouldn't necessarily say accelerated, obviously, as we're getting towards the end of the refranchising and most of the – we have two kinds of G&A cuts, obviously, the organic cuts that were independent of refranchising and those related to our refranchising. The vast majority of the organic cuts were made early in this journey and then we're coming to the end of the G&A reduction coming from the refranchising. We do have some annualization of G&A savings, but you're absolutely right to point out, look, we're almost at the 1.7% target. You look at the first half number and sort of double that. You get a sense for where we can get to, where we want to go, we want to get to fairly comfortably as we keep growing the top line. So, yeah, we're in good shape on G&A and that's why we reiterated all the elements of the transformation in our commitment.

[Operator:]

Your next question comes from Jeffrey Bernstein with Barclays.

[Jeffrey A. Bernstein:]

Great. Thank you very much. My question is on Pizza Hut, I guess, specifically on the U.S., just seems like the comps maybe aren't yet seeing the acceleration you had anticipated. So I'm wondering maybe if you could talk a little bit about the challenges, I think you mentioned most recently the move away from value, may be with a more of a noticeable headwind or maybe you can share any metrics related to the loyalty program and membership, and how your $130 million contribution would – where it would see the greatest benefit? Just trying to see if there any laterals to the – maybe the relative weakness we're seeing in China or whether it's just more U.S. specific? Thanks.

[Greg Creed:]

Sure. I think there's no doubt that all three brands have to be on value, that's like given. And obviously getting back on value is critically important. I think the exciting opportunity for Pizza Hut in U.S. is to activate our NFL partnership. And obviously as we said, we renewed our NCAA partnership, and the way we look at it will be sort of owning football Thursday through Mondays. And I think there's nothing that brings America together more than football and pizza. So I think all – as we said, all the internal metrics which we talked about are improving; three minute speed if a speed improvement, obviously customer satisfaction improving. And I'm looking forward to us activating this partnership as football season gets underway. And obviously, hopefully using that to drive our brand to be more relevant, to be more distinct and then obviously the functional foundational stuff is helping us make this more easy. So, I think we're doing all the right things. We've got to deliver the results, it's sort of show-me time, but we feel good about what we've got for the back half of the year on Pizza Hut in the U.S.

[Operator:]

Your next question comes from Dennis Geiger with UBS.

[Dennis Geiger:]

Great. Good morning. Thanks for the question. Wondering if you could just talk a little bit more about the competitive environment you're seeing in the U.S. And I guess through that value lens specifically, and sort of what impact that it's having on the brands? Just following up on your commentary Greg, just Pizza Hut and the pivot towards value in the back half, just curious how easy it is to differentiate within the category on value, and if the combination of all the enhancements you're making to the brand right now can sort of enhance those benefits from pizza value. And then just on Taco Bell, just a bit more about how all the innovative and differentiated value items that you had in the quarter, how they performed relative to your expectations and how you see the back half shaping up given the calendar if this value cycle continues? Thanks.

[Greg Creed:]

Sure. Well, yeah, you're right. I mean value has become an important part of the industry. It's become an important part of every brand's positioning. As we talked about last week at the MPMs, I think there's also two ways to how you can communicate value

[Keith R. Siegner:]

Operator, we have time for one more question.

[Operator:]

Your final question comes from the line of Sara Senatore with Bernstein.

[Sara Harkavy Senatore:]

Yes. Thank you. Just a quick I guess two parter

[Greg Creed:]

Sure. Well, I think franchise economics are critical right? I like to say if you have great economics for the franchisee and great enthusiasm from the customer you've got a winning combination. So we're obviously very conscious of franchise economics. I think a good example would be Taco Bell took a la carte fries from $1 to $1.29 but they put them in the $5 box and we're going to sell a lot more $5 boxes. And so I think each of the brands has done a very good job of being conscious of the unit level economic impact. The other great thing is these businesses run off in a momentum and volume, and our ability with these disruptive value offers which are essentially protein only offers, example, in Australia which as I said earlier two year stack of 11, of which 7 or 8 is transaction growth. They run nine pizzas for $9.95 on a Tuesday because of the – and it's only chicken. So obviously all the sides are bought at full margin. So there's a lot of smart thinking that's gone into all of this. And obviously we've got our franchisees on board. We've got them supporting this, but we're very conscious of their economics. And I think you also saw in the quarter results that our Taco Bell margins improved despite the fact that we obviously were doubling down on $1 and $5 offering. So I think we've got a very good way of working with our franchise partners delivering great unit level economics for them and great customer enthusiasm. On your question on China, I think the way I want to think about it is that, obviously they talked last night, we listened to their call about their new unit growth which we're excited about, them continuing to grow new units and the returns that they're getting on those units, so I think it's two units on KFC and three to four on Pizza Hut, so that's exciting. And the other great thing is the KFC China team and the Pizza Hut team were at the MPMs last week. So they sat in for a whole week as every country shared what they're doing to drive same store sales growth. So the China team got to see what the Australia team is doing, and all those sort of things, and I think that's the beauty of a global business like Yum! which is we can share, we can cross collaborate. So I'm excited that they'll be able to take those learnings, go back, adjust their calendars just like we have adjusted the calendars in the rest of the business. And obviously hopefully deliver stronger same store sales growth in the back half of the year.

[Greg Creed:]

Okay, so let me just say, first of all, I want to thank everyone for taking their time to be on our call today. Like any business there are things that you're proud of and happy about, but there's always this unfinished business as we all know. I'm really proud of the entire organization's efforts and results on our transformation to be more focused, more franchised and more efficient. These were really bold goals and it's clear that we're going to achieve them. I'm also particularly proud of how we've step changed our new unit development, which we talked about today across the globe and across the three brands, and we've moved from consistently delivering 3% to now 4% net new unit growth. And I think David and I believe we have the opportunity to eventually even do better than that. So where do we have unfinished business? Same store sales growth obviously. If I take out the impact of the KFC distributor issue, our numbers aren't bad, but I have to be honest to say I'm not content. And I know we can and will do a lot better. The brands have all adjusted their back half calendars which I've seen and I know now we have to deliver, not just talk about it. That's my focus. It's our focus for the second half. So thanks again and I look forward to updating you on our journey to deliver a world with more Yum! Thank you.

[Operator:]

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