Yum! Brands Inc

NYSE:YUM

Earnings Call Transcript 2019-Q2

[Operator]

Good morning. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Yum! Brands Second Quarter 2019 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. [Operator Instructions]

I would now like to turn the conference over to Keith Siegner, Vice President, Investor Relations, Corporate Strategy and Treasurer. Sir, you may begin.

[Keith Siegner, VP, IR, Corporate Strategy & Treasurer]

Thank you, operator. Good morning, everyone, and thank you for joining us. On our call today are Greg Creed, our CEO; David Gibbs, our President, Chief Operating Officer, and Dave Russell, our Senior Vice President and Corporate Controller. Following remarks from Greg and David, we'll open the call to questions.

Before we get started, I'd 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 statements in our earnings release and the Risk Factors included in our filings with the SEC.

In addition, please refer to our earnings releases in relevant sections of our filings with the SEC to find disclosures and reconciliations of non-GAAP financial numbers that may be used on today's call.

Please note the following regarding our basis of presentation for today's call. First, all system sales results exclude the impact of foreign currency.

Second, Pizza Hut division and worldwide system sales and net new unit growth include the benefit of the increase in units in the fourth quarter of 2018 related to our strategic alliance with Telepizza. Same-store sales growth reflects the inclusion of Telepizza in the prior year base.

Third, core operating profit growth figures exclude the impact of foreign currency and special items.

Fourth, the lease accounting standard was prospectively adopted on January 1, 2019. As a reminder, this is a GAAP required change resulting in the recognition of operating lease assets and liabilities on the balance sheet. We did not expect to change in our income statement or cash flows as a result of this accounting change.

And last, please note that 2019 results will include a 53rd week. We are broadcasting this conference call via our website. This call is also being recorded and will be available for playback. Please be advised that if you ask a question it will be included in both our live conference and in any future use of the recording.

We'd like to make you aware of the following changes in upcoming Yum! Investor Events. Disclosures pertaining to outstanding debt in our restricted group capital structure will be provided at the time of the Form 10-Q filing. Third quarter 2019 earnings will be released on October 30, 2019, with the conference call on the same day.

Now, I'd like to turn the call over to Mr. Greg Creed.

[Greg Creed, Chief Executive Officer]

Thank you, Keith, and good morning, everyone. We are pleased to report another strong quarter with system sales growth of 10% including 5% same-store sales growth and 7% net new unit growth. Focus on our four growth drivers, increased collaboration and our unrivaled culture continues to fuel these results.

As usual, David and I will talk you through the lens of our four key growth drivers. I'll provide an update on our relevant, easy, and distinctive brands or RED for short, as well as unrivaled culture and talent. Then, David, will discuss bold restaurant developments, unmatched franchise operating capability and some additional and exciting news on talent.

I'll begin with our three RED brands. I am thrilled to report that KFC delivered its 16th consecutive quarter of positive same-store sales growth. Encouragingly, this global powerhouse is seeing broad based strength across the world with standout performances across many of our largest markets which translated into a truly impressive, global system sales growth of 10% with same-store sales growth and net new unit growth of 6% each.

Now, many of you have been asking, what’s fueling the recent broad based performance? Well, there are a number of factors including the consumer is healthy, KFC has a robust digital and delivery strategy globally with over 12,000 restaurants delivering on just one metric.

And broadly speaking, at Yum!, I’ll focus on being a world-class franchisor has led us becoming more intentional about fostering collaboration and leveraging the power of Yum!.

A perfect example of this is the KFC Annual Market Planning Meeting, which is one of the first global collaboration meetings we instituted and which continues to gain momentum and impact each year. In fact at our recent 2019 KFC AMPM had a record number of franchisee and team members in attendance.

We also attended the Pizza Hut AMPM earlier this week and I was impressed with how Vipul Chawla and teams are so focused on the things that matter most.

But again, AMPM is a just one example of fostering collaboration to drive results today and into the future. Without question, these forms of the collaboration are a unique competitive advantage for all our franchise partners and team members globally.

Now back to KFC’s quarter. Internationally, sales callouts include, Japan, Africa, Iberia, Indonesia, Germany, Australia, China, Latin America and the Caribbean. You’ll notice I included more markets than usual, but again strength was broad based with eight out of thirteen markets reporting at or above 6% same-store sales growth.

And while each market is unique, the recipe for success has a consistent theme. Its disruptive value coupled with amplified innovation, compounded by an effective digital and delivery strategy.

Specifically, Japan and Africa led the way each with double-digit same-store sales growth. Japan’s 18% same-store sales growth was driven by renewed focus on value and the well-received chicken pack and Peri Peri Chicken innovation.

Africa’s 10% same-store sales growth was backed by the Wrapstar Lunchbox value promotion and the innovative Crunch Double Down.

Iberia’s 11% same-store sales growth was driven by continued momentum from strong media campaigns and their third-party delivery partners.

Now, to KFC U.S., where same-store sales grew 2% in the quarter. Continued focus on the core menu items balanced with an accelerated pace of promotion. The quarter began with the innovation, first bringing back the very successful Chicken and Waffles and then introducing Cinnabon Biscuits. Value also remained a focus through launching a new channel for A La Carte menu items, a 2 for $6 Mix and Match.

Combined, our new value proposition drove transactions for the quarter and allowed customers’ flexibility to build their own meals. KFC continues to partner with Grubhub to add locations for delivery and click and collect throughout this year and also expects to launch a branded web experience by year end. We now have 2300 KFCs offering delivery and 3500 restaurants available for click and collect.

We are excited about the operational ease and the increased check through our franchisees and we look forward to updating you more throughout the year.

Moving on to our Pizza Hut division, in the U.S., system sales grew 4% with same-store sales growth of 2% and flat unit growth. We are happy to report that transactions for the quarter grew 3%, which is the result of continued compelling value, ops execution and our growing loyalty program Hut Rewards.

As you may have seen earlier this week, in partnership with our franchisees, we’ve updated the $5 line-up to the $5 and up line-up where we will continue to offer the same favorites at more flexible price points.

We expect this to be a win for franchisees by addressing local economic factors, particularly in high wage markets, while customers benefit from their balance of compelling every day value and unique only from Pizza Hut innovation.

While we are pleased with the positive transaction growth this quarter, we understand more clearly than ever that same-store sales growth in the U.S. will continue to be choppy without transforming the asset base.

And following the tremendous recent improvements in operations and technology led by Artie Starrs and the Pizza Hut leadership team, we plan to lean into accelerate the transition of our Pizza Hut U.S. style to a more modern delivery and carryout-focused asset base.

This will ultimately position the Pizza Hut brand for many years of faster growth in t he U.S. We are excited about collaborating with franchisees who are capable, well-capitalized, committed to the brand and who have the growth mindset to accelerate the closure of underperforming dining stores and replacement with new delivery of fast casual delivery assets.

By the same token, we also know we’ll need to directly address franchisees who are burdened with too much debt, don’t have access to capital or aren’t committed to the long-term. Thus, in a few cases, some of these businesses will need to be restructured in the near-term to address capital structure and leverage issues, particularly, those franchisees with greater dining exposure.

We view this as a positive move for the brand and David will provide more specifics in a few minutes. Before moving on to Pizza Hut International, I want to briefly update you on our excitement regarding our partnership with GrubHub and the opportunity to leverage it as an additional sales channel for Pizza Hut.

As a reminder, while customers are placing their orders on the GrubHub App or website, Pizza Hut drivers are completing the delivery to ensure a hot stuff and reliable experience. We ended the second quarter with over 300 locations on GrubHub and are planning on expanding the tips further in the third quarter.

While it’s still early days, we’ve found that the GrubHub customers are incremental and some customers are therefore trying our favorable products for the first time.

Pizza Hut International system sales grew 15% in the quarter, driven by a 10 point benefit from the addition of the Telepizza units in Q4 of last year, while same-store sales growth was 2%. We were pleased to see same-store sales growth in places like China, Europe, Brazil, Indonesia and Hong Kong.

I recently visited Latin America and got to see some of our newly converted Telepizza units. I am so impressed with the team and how they are executing at a high level to drive tremendous early results. Internationally, the same-store sales gap between the dining channel and off-premise sales was approximately three points this quarter.

Encouragingly, the smaller gap arose from an improvement in our international dining business as our two largest dining markets, China and the UK performed well. Pizza Hut continues to develop tailored actions planned for our largest dining markets, while at the same time transforming the state for a more compelling off-premise focused asset strategy.

Last, but definitely not least, Taco Bell where system sales grew 10% with same-store sales growth of 7% and net new unit growth of 3%. Taco Bell has now reported positive same-store sales growth in 17 of the last 18 quarters including 12 consecutively. So kudos to the entire team for such amazing results.

Starting with the U.S., we continue to have a focus on both value and innovation, starting Q2 with the $1 Loaded Nacho Taco, followed by the $5 Grande Nacho Box and the return of Nacho Fries. The Grande Nachos Box was a particular standout as the amount was extremely high a truly abundant value at just $5 with sales mix peaking at 10%.

We also welcome back Nacho Fries for our fourth faux movie trailer breaking weekly sales records twice during the promotion. The buzz worthy moment of the quarter was the announcement of the Bell Hotel in June. Reservations for a Taco Bell-inspired stay in Palm Springs sold out in two minutes.

Our ALL ACCESS strategy to create a frictionless customer experience is sharper than ever. Taco Bell now has kiosks in over 4900 restaurants and expects to have the full U.S. rollout completed this year. Delivery is now live in 4500 Taco Bell restaurants in the U.S. and opportunistic market expansion should increase restaurant coverage over time.

The customer experience has been positive with the number one reasons are getting Taco Bell Delivered! being the craving for the food. Mobile and online ordering continue to be a priority and we are seeing strong results with over 11 million registered users.

Additionally, click and collect functionality is a vital of the nationwide on Tacobell.com and the Taco Bell App.

Taco Bell International saw strong sales momentum around the world, driven by the focus on Cult Icons, Value Boxes at power price points and product innovation. Our value boxes introduced earlier this year continued to drive growth in India, the UK and Spain. India’s positive same-store sales growth was driven by the launch of their Big Bell Box and Quesalupa.

We continue to build global brand awareness by successfully incorporating U.S. programs into globally relevant promotions. For example, Canada participated in the Steal a Game, Steal a Taco NBA Finals promotion for the first time and saw fantastic results.

Now to unrivaled culture and talent. As you heard let me say before, we have two important assets, our brands, and our people. We feel great about the level of talent we have and have been very fortunate to be able to promote so many top leaders internally.

As we have mentioned on previous calls, we’ve made the decision to even further strengthen our bench and enhance talent as a competitive environment advantage by investing in new world-class talent.

I’d like to start with an enthusiastic thank you to David Gibbs for his incredible leadership as President and CFO over the last three years. He was a great partner to me as we spun-off Yum! China and adopted our financial and business strategy to be more focused, more franchise and more efficient, all with accelerated growth.

Since the beginning of the year, he has won three hats heading the Chief Operating Officer to his responsibilities and leading the brands to impressive results while we undertook a search for a new CFO.

And with that, I am excited to have Chris Turner join the Yum! family as Chief Financial Officer. Chris will begin reporting to me after the filing of our 10-Q on August 8 and will assume global responsibility for finance, corporate strategy, supply chain and information technology.

From his time at PepsiCo to his years at McKinsey & Company, Chris is a broad-thinking business leader who brings nearly 20 years of strategy, finance and operations experience.

His deep commercial experience in the quick service and retail sectors, a track record of growth leadership and commitment to culture and talent development make him a perfect fit for the CFO role.

He is also deeply knowledgeable about digital and technology solutions shaping the future of retail which will be valuable to Yum! given the role technology will play as we leverage our scale to improve franchise unit economics and accelerate same-store sales growth and net new unit growth. We’ve also finalized our roles for our brand CEOs as David will discuss in more detail in a few minutes.

And finally, we take our role as a global citizen and our impact on society and the environment very seriously. We have recently updated our Recipe for Good, which outlines our public commitments concerning food, planet and people. We’ve made tremendous progress over the past year when it comes to advancing our citizenship and sustainability agenda to drive socially responsible growth and manage risk better. From working to remove antibiotics in our protein supply chain to expanding our depot expansion commitments to progressing our work around diversity inclusion. I truly believe we are leveraging our scale to help address major global issues.

And with that, it gives me great pleasure to introduce our President and Chief Operating Officer, David Gibbs.

[David Gibbs]

Thank you, Greg and good morning, everyone. Today, I’ll discuss our second quarter results, our remaining transformation initiatives, bold restaurant development, unmatched franchise operating capability and some exciting news on unrivaled culture and talent.

To begin, our second quarter results, core operating profit growth increased 18%. And as Greg mentioned, we delivered system sales growth of 10%, same-store sales growth of 5%, and net new unit growth of 7%.

A major contributor to this success was KFC, our largest division in units and profit contribution with 6% growth in both same-store sales net new unit growth driving 10% system sales growth in the quarter.

Contribution to the KFC’s strength were again broad-based. Japan and Africa which together represent 8% of KFC’s system sales performed particularly well while easier laps at KFC UK were also beneficial. And not to be left out, Taco Bell had another tremendous quarter with 10% system sales growth driven by 7% same-store sales growth.

Our second quarter results are lapping the distribution disruptions in our KFC UK business in 2018. We estimated that 2018 same-store sales growth at KFC was negatively impacted by 1% in both Q1 and Q2 therefore having a full year negative impact of 50 basis points for KFC and 25 basis points for consolidated Yum!

Additionally, we estimated the negative impact on KFC’s 2018 core operating profit growth was 5% for the first quarter – for the first quarter, 3% for the second quarter, and 2% for the full year. For Yum! core operating profit, the impact was 3% for the first quarter, 1% for the second quarter, and 1% for the full year. Again, now that we have lapped the disruption, there will be no benefit from easier laps going forward.

I’ll now update you on our 2019 EPS outlook and the moving pieces that will impact our reported results versus adjusted EPS guidance, all of which is outlined in a table within our earnings release.

First, there is no change to our goal to deliver at least $3.75 in 2019 adjusted EPS, which we introduced in 2016.

Second, as a reminder, the $3.75 target excludes any benefit from the 53rd week in 2019, the impact of changes in FX rates, and any special items, or any gains or losses associated with our Grubhub investment. We estimate the benefit of the 53rd week to 2019 and on the $3.75 guidance to be approximately $0.06.

Our updated estimate of the impact of FX rate movements is now a $0.08 headwind to the $3.75 number. This is because rates have moved against us since we provided the original guidance in October of 2016. This estimated headwind is based on applying current forward rates to local currency forecasts, which will undoubtedly vary over time.

Year-to-date 2019 special items are a $0.01 headwind and year-to-date Grubhub mark-to-market adjustments are a $0.01 tailwind to the $3.75 figure respectively. Taking these items into account as outlined in our earnings release, the GAAP equivalent to our adjusted 2019 EPS guidance of at least $3.75 is at least $3.73.

Now turning to our transformation initiatives to be more focused, more franchise, and more efficient in order to deliver more growth to our shareholders. With our target franchise mix of at least 98% having been reached in the fourth quarter of 2018, and with focus on our four growth drivers consistently at the heart of everything we do, I'll update you on our plans to be more efficient.

In summary, we remain on track. G&A was 1.6% of system sales in the second quarter while 1.7% of system sales remains the appropriate target for full year 2019. Additionally, our CapEx guidance is unchanged from last quarter.

Our ex special items affected tax rate for the quarter was 23.7%, which is above the 20% to 22% range we gave at our Analyst Day last December, but follows a 12.2% rate in the first quarter. We are not changing our annual tax rate guidance at this time.

But we wanted to mention that it is difficult to forecast this rate with pinpoint accuracy in the near-term, given uncertainty of equity compensation payouts, as well as a continually changing tax landscape across the over 145 countries where our system sales are generated.

We will continue to update you as we progress through the back half of the year. As for our capital return plans, our goal to return $6.5 billion to $7 billion of capital to shareholders over the three-year period 2017 through 2019 remains firmly on track.

During the second quarter, we repurchased 1.9 million shares for $196 million at an average price per share of $104. When combined with dividends, we have already returned $5.7 billion to-date.

Now let's discuss our growth drivers, beginning with unmatched franchise operating capability. I'll start with Taco Bell. Its fast and friendly obsession helped our system and speed and break records in sales this quarter.

In fact, in the U.S., 6 million more cars drove through drive-throughs compared to 2Q 2018 and our guests received an experience that was on average seven seconds faster. This attention to improve speed, customer satisfaction and running great restaurants help the Taco Bell system break two weekly sales records just one week apart.

Internationally, it was my pleasure to visit Italy and Romania, where we spent time with our reigning KFC franchisee of the year, Sphera, a fantastic partner to us in both our KFC and Pizza Hut businesses who recently launched Taco Bell in Bucharest with encouraging early results. At Pizza Hut, we continue to execute on our hot, fast and reliable initiatives.

In the U.S., we’ve also perfected the original pan pizza, which is now baked in a newly engineered pan. The use of this new pan results in enhanced flavor, texture and improved customer feedback scores for this iconic fan favorite.

Internationally, we are continuing to run workshops on speed to taste with our franchise partners leading to overall customer satisfaction score improvements in markets including Malaysia, Kuwait and UAE. Pizza Hut digital ventures also expanded its Fast Casual Digital Store platform or FCDS to Japan and Mexico in 400 and 250 stores respectively bringing the total store count to over 2500.

Markets with FCDS with similar technology which also include India, France, Turkey and Malaysia have seen increased online transactions as a result.

At KFC, Greg and I had the pleasure of attending a Global Operations Meeting in Dallas in June, which had operators from the around the world in attendance along with both KFC and franchisee leaders represented. The key focus was aligning on strategy when it comes to empowering frontline leaders of our business, our restaurant general managers.

Topics were broad and included ideal equipment design and set up as well as technology options to make life easier for our team members. We were impressed and inspired by the passion of our operators have from improving the customer and team member experiences. It was a great example of how collaborations and leads of best-in-class solutions for our businesses across the globe.

Next to bold restaurant development. During the quarter, we opened 312 net new units bringing total net new units opened over the last four quarters to 1897 excluding the Telepizza units added in 4Q of last year.

At KFC, strong development trends continued with 232 net new units. We continue to see momentum in China, Asia, Russia, Thailand, Latin America, and the Caribbean. In the U.S., we continue to strive for positive net new unit growth while at the same time transforming our asset base to the American Showman image.

We closed out the quarter with over 1600 American Showman restaurants across the country as 104 remodels were completed. Taco Bell continued to grow in the U.S. with 18 net new units during the quarter.

Among those, two Urban Cantina restaurants opened in Manhattan where we are seeing strong cash-on-cash return with 46 Urban Cantina restaurants across the Taco Bell system at the end of the quarter, they represent a strong complement to our existing asset portfolio and will remain an important part of future development.

Internationally, Taco Bell opened 13 net new units in 11 countries and signed massive franchise agreements in India and Portugal. In particular, I am very excited to highlight India and our partnership with Burman Hospitality. This is our largest Taco Bell development agreement today with plans for 600 Taco Bell restaurants over the next ten years, which would make Burman Hospitality the largest Taco Bell franchisee globally.

We are confident in a long runway for growth for Taco Bell International and continue to garner interest from 3C partners around the globe.

At Pizza Hut, as Greg mentioned earlier, we are leaning in to accelerate the transition of our Pizza Hut U.S. asset base to truly modern delivery carryout assets. This will ultimately strengthen the Pizza Hut business in the U.S. and set it up for faster long-term growth.

During this transition, we expect a temporary deceleration in the pace of new unit developments for the Pizza Hut division as continued healthy international unit growth will be partially offset by a short-term decline in the absolute number of U.S. units.

As a result, our U.S. door count to drop to as low as 7,000 locations over the next 24 months primarily driven by closures of underperforming dine-in restaurants before rebounding to current levels and above in the future.

Further we believe that Yum! will still deliver 4% annual net new unit growth on average over the next several years. Although as mentioned, it will probably be a little bumpier than our original plan.

Importantly, the short-term financial impact should be minimal as the closures will be our lower volume stores and long-term that should improve our system sales and profitability as the closed units are replaced with higher volume stores.

Outside the U.S., Pizza Hut celebrated its 11,000 international restaurant opening alongside its franchise partner Americana, located at the waterfront development of Dubai Creek Harbor, this brand new fast casual delivery store is a great example of a truly modern asset resonating with customers and driving profitable unit development.

As for our strategic alliance, - our strategic growth alliance with Telepizza, the integration continues to go very well. Specifically, we are pleased Telepizza again reported positive net new unit growth and conversions of Telepizza units to the Pizza brand.

Next, unrivaled culture and talent. The Board of Directors, Greg, and I are excited to have finalized our roles for our brand CEOs. First, Mark King, former President of Adidas Group North America, will join the company as Taco Bell Division Chief Executive Officer reporting to me effective August 5th.

Mark brings to Taco Bell and Yum! extensive retail experience and an excellent track record driving growth, innovation, brand relevance and culture. His unique talents of rewriting the rules for brands to win and fiercely competitive markets will be central to Taco Bell's journey to become a $15 billion brand that transcends the quick service restaurant in retail category.

We are privileged to be in a position to add Mark’s high caliber talent to the strong and accomplished Taco Bell leadership team we have in place. Under the leadership of Julie Felss Masino, Taco Bell North American President; and Liz Williams, Taco Bell International President, the Taco Bell team has been delivering fantastic results and has reinforced Taco Bell's stronghold as a Category of One Brand in the U.S. and internationally. Both Julie and Liz will report to Mark going forward.

Second, Artie Starrs, President of Pizza Hut U.S. has been promoted to Pizza Hut division Chief Executive Officer. Artie is a talented growth leader who has made bold moves to galvanize Pizza Hut U.S. franchisees around the transformation agreement, strengthened the brand’s digital and e-commerce roadmap, improved operations and the customer strength and articulated clear path forward to drive Pizza Hut’s growth over the long-term.

I am confident Artie will help grow and continue to strengthen Pizza Hut’s competitive position globally and partnership with Vipul Chawla, President Pizza Hut International, who is off to a truly fantastic start and now reporting to Artie.

Third, and rounding up the Brand CEOs, I am pleased to report KFC division Chief Executive Officer, Tony Lowings has had an incredible start. Under Tony's leadership, the global KFC’s system has accelerated the envelope where highly accomplished world-class results across the board.

In summary, the first half of 2019 was a strong start to the year. We always expected a stronger first half owing to less challenging laps than the second half with this quarter’s results exceeded our already high expectations.

With three category-leading iconic brands, a uniquely diversified global business and over 48,000 restaurants, Yum! is well positioned to accelerate growth and improve franchise unit economics by leveraging our mass of scale and expanding digital technology and delivery.

We look forward to updating you throughout the remainder of 2019. Now, the team and I are happy to take your questions.

[Operator]

[Operator Instructions] Our first question will come from the line of David Palmer with Evercore ISI.

[David Palmer, Evercore ISI]

Thanks. Just a little bit of a longer-term question on Taco Bell and actually international development of Taco Bell. There is recently a podcast with Liz Williams who was interviewed by Novak and I listened to yours too, Greg.

But those are pretty good interviews and it reminded me that you have one of your better executives working on that and you just mentioned that 600 unit development deal. I am wondering if India was maybe uniquely fertile opportunity and there be that’s more unique or will there be other development deals around the corner. Thanks.

[Greg Creed, Chief Executive Officer]

Sure, David. I think, yes, obviously it was a great deal, 600 units in India and the business in India is doing incredibly well. It’s very relevant. We made it easier and it’s very distinct. I am also happy that, in the UK and Spain, we now have over 50 units in each of those. We have opened four units in Australia right now.

Those are off to a really good start and in fact, both our New Zealand franchisee and one of our Australian franchisees has announced that they will be expanding our presence in Australia. So, I do think we are at an inflection point. I think our plan is to open over a 100 units internationally. Taco Bell this year, which will be the first time are over a 100.

So we are seeing good progress. I think the brand is very relevant. It’s very distinct and I think it’s connecting with our millennial audience, not just in the U.S. but globally. So, David?

[David Gibbs]

Yes, I think, and one of the keys to India is, we have been in added in India for quite some time and we now have the perfect partner Burman Hospitality and given the fact that we've been building the brand over time and now we have the right party – partner with that’s ready for growth.

That’s going to always be our challenge around the world is establishing the brand and finding the right partners and as you say, Liz is doing a good job of going out and striking those deals with the right people on building the brands.

[Keith Siegner, VP, IR, Corporate Strategy & Treasurer]

Thank you. Next question please?

[Operator]

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

[John Ivankoe, JPMorgan]

Hi, thank you. A couple of different questions, I think, related, I mean, we’ve talked a lot about global scale and I just wanted to get a sense of how you view your current franchise community and one thing that we have seen is a fairly common theme is consolidating franchisees around the world, allowing franchisees themselves to have scale from every different perspectives.

How much more of that do you think should occur within the overall Yum! system? Is there still an opportunity from here to accelerate unit growth?

And I’d like to ask just because that there is an undercurrent that’s discussed about this, is how you are monitoring the leverage that the franchisees are taking giving you confidence that they can continue or maintain their development even when this cycle eventually comes to an end?

[David Gibbs]

It’s a good question, John. As you know, our franchise-base tends to have the larger typical franchisee has about 25 stores which is much bigger than most in the industry. And there are pockets around the world where we would be encouraging consolidation where we do have a more fragmented base in a country.

But in general, we like the model of having bigger, better capitalized, more capable franchisees. We view that as a competitive advantage that we have really professionally-run organizations helping us to build our brands. But I don’t think we have some – to answer your question, I don’t think we have some big strategy to consolidate. We already have a pretty large number of stores for a franchisee.

And then as far as monitoring leverage obviously, as part of being a world-class franchisor, we are putting the brands in the hands of our franchisees and we need to make sure that they are all in the best financial health and most capable to grow the brands. That’s a big part of what we do working with franchisees to make sure they have the right kind of financial structure to succeed.

And with 2000 franchisees, there will always be situations that we have to attend to. But in general, around the world across the three brands, we feel like our franchisees are generally in good health.

[Greg Creed, Chief Executive Officer]

I think they are also very engaged in their business right now. We had record attendance of the franchisees at the recent three brand AMPM. So, that’s really good to see when they coming to want to understand why the brand is performing well.

What we are doing on a global basis, so we can share best practice. So, I am very encouraged by, I guess, their energy and their commitment to growing our three iconic global brands.

[Operator]

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

[Sara Senatore, Bernstein]

Hi, thank you very much. I have a question about Pizza Hut and in particular, traffic versus ticket. You mentioned that traffic grew globally and ticket I guess, the implication was a bit negative. I think we saw this in China.

But are you seeing in other markets as well? In other words, maybe you could just talk about the puts and takes to that comp as you think about the shift towards delivery from dine-in and the impact of aggregators whether it’s just competitors or partners. And then just, a housekeeping, you are going to close some stores.

I know said that will have an impact on unit count in U.S., but shouldn’t that be a tailwind for same-store sales if those are some of the weaker performing stores? Thanks.

[Greg Creed, Chief Executive Officer]

Sure. Let me just – I’ll talk about Pizza Hut and all the brands. I think we had a good transaction quarter. Obviously, as you said, Pizza Hut U.S. trends were up 3, international trends were up run, Taco Bell trends were up 3, and our global KFC trends were also up 3. So, it was a strong quarter from a transaction point of view.

I do think, at the same time, value, even though the customer is in a healthy position, value remains a priority and making sure that we don't walk away from both everyday and disruptive value. So it's about finding that fine line between everyday and disruptive value, and obviously, driving transactions.

On the aggregator front, I think what we are clearly learning is that, there are people that are loyal to Pizza Hut. There are people that are loyal to GrubHub in our case. The way to grow our business is to increase reach and penetration.

And our ability, I think to partner with both GrubHub and as a party to the sort of Pizza Hut brand enabled just to get broader reach and with broader reach and penetration, we're going to get transaction and sales growth.

So, I hope that answers the question. But we are encouraged by our partnership with GrubHub. I think it's incremental. But at the same time, very focused on transaction growth for all three brands.

[Operator]

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

[John Glass, Morgan Stanley]

Thanks very much. Just following up on the transformation in the Pizza Hut US business, just first checking my math. I think it looks like you have got about 7,500 units in the US. So, a net closure of, say 500 over. I guess, the question is, what is that right? Two, over what period of time would you contemplate that?

And maybe most importantly, what do you think the company's role in this is, is there going to be direct assistance in the form of maybe taking ownership in some of the stores at some point in time or some other financial assistance or is this all go through the franchise system and you are just an advisor in that process?

[Greg Creed, Chief Executive Officer]

Yes, John, again your numbers are roughly right. I think we have as of the end of the quarter 7,449 Pizza Hut assets in the U.S. Just a clarifying comment on that, 6,100 of those are traditional restaurants and about 1,350 are express units.

I know sometimes, as we calculate percentages of dine-in and stuff, you could use either base, but within our traditional base of 6,100 close to half are dine-in, as obviously as part of the 7,449 it's a smaller percentage.

But, as far as the numbers and how the math works, it's hard to estimate how soon the timing of when a store will close and then, when the replaced unit will open. There will be gaps on some of those certainly. Our goal is to try to minimize those gaps.

So, it's a little hard to pinpoint an exact number, but - and that's why we provided the guidance of the store count at any point in time over the next few years could dip down close to that 7,000. But we ultimately – we know that the economics of building a modern delivery asset work quite well for us and that any – for the most part, any area, trade area where a store closes, there should be the opportunity to rebuild the store in that area or somewhere nearby.

As far as the capital required to do this, we are committed to the asset-light model at the 98% franchise and we think the economics of building a new unit stand on their own and we should have no trouble getting either existing or new franchisees ultimately to rebuild in these trade areas.

But, as we get into the specific situations and sort them out, there may be some situations where we deploy a little capital in the short-term to flip a market and get it in the hands of somebody else and take our capital back out. So we'll update you on that part of the journey as well.

[Operator]

Your next question comes from the line of David Tarantino with Baird.

[David Tarantino, Robert W. Baird & Co.]

Hi. Good morning. And congratulations on such a strong momentum. Maybe a follow-up, David, on that last point on Pizza Hut. Will the closings in the U.S. be in fact lower volume units? So, if there is a net reduction in the units, would that have a smaller impact on the system sales, than on the unit count?

And then, I guess secondly, a bigger picture question about KFC's momentum, which appeared very strong globally. So, just wondering how you are thinking about the sustainability of that trend, given all the drivers, you have in place across all those markets. Thanks.

[David Gibbs]

I'll let Greg comment on KFC and then I will talk about Pizza Hut.

[Greg Creed, Chief Executive Officer]

Yes, sure, obviously, David, as you saw the momentum was really broad probably the broadest momentum we've had in KFC. I think I give credit to Tony. We had probably been focused on driving what we call, one extra transaction, one extra occasion from a frequency point of view. And what Tony has got the business focused on, as I said earlier is driving reach and penetration, i.e. broadening the user base.

We know exactly what drives both reach and frequency and what I am really excited is that, he and Catherine Tan, the CMO have pivoted the brand to really helping us drive the reach. And so I think that's also the reason why the transaction growth was so strong in the quarter at plus 3 internationally, which is really half of our same-store sales growth.

So - and at the AMPMs last week, which we sat through, I think David and I was so impressed with the consistency of what we saw. People are focusing on a very clear, simple and aligned global brand positioning.

They are executing it and a lot of the tactics that we saw, I think even across markets developing where consistently strong and I think broad based. So, we feel really good about the leadership of the brand, we feel good about the positioning of the brand. And we feel good about this idea, I think of pivoting a little bit from just trying to drive frequency to driving reach and frequency.

[David Gibbs]

And on the Pizza Hut question David, your assumption is correct. The stores that we would be closing would be lower volume units. So we will have less of an impact on system sales. Just as a little bit more detail on that, if you think about it, we have a lot of stores that were built in the right spots 30 or 40 years ago in the trade area.

But that's not the right spot today to have a modern delivery asset and if we can get those stores closed and then put in the right spot in the trade area for delivery, obviously there is going to be upside to sales for those units and better economics for the franchisee, better system sales and a better image to our consumer.

[Keith Siegner, VP, IR, Corporate Strategy & Treasurer]

Thank you. Next question, please.

[Operator]

Your next question will come from the line of Dennis Geiger with UBS.

[Dennis Geiger, UBS]

Thanks for the question. Just wondering if you could talk a bit more about Taco Bell's strength including anything additional to share on what you are seeing with delivery? And maybe if there's anything to call out on potential share gains kind of in the lower price point ticket items where maybe some other brands seem to be a little bit softer?

And then, just to that point, looking ahead, any way to help kind of frame Taco Bell's back half of the year in light of the strength last year including any high-level thoughts, Greg, maybe on how you feel about the products and the marketing pipeline et cetera? Thank you.

[Greg Creed, Chief Executive Officer]

Sure. I think when you deliver a plus seven on 3 trends you are doing everything really well and I think that's very true of Taco Bell obviously delivery is helping the business. Value continued to help the business. The innovation is really spot on. They are doing great cultural icon things like the hotel, which sold out in two minutes.

I probably had more customer complaints about they couldn't get a room at the hotel than I've had on anything in Taco Bell in the last five years. So, I think they are doing very well. The calendar for the balance of the year looks strong. Obviously, we do start to roll out some pretty big numbers. Q3 and Q4 we are rolling out, I think plus 5 and plus 6.

But I hope, I think we feel good about two year trends hopefully can be, I guess, pretty much where we were - and maybe in the first half or just a little bit were softer, but just a little bit - a little bit softer maybe, yeah. But I still feel good that the brand is in a great shape, doing the right things and we feel good about the long, long-term for this brand.

[David Gibbs]

Yes, I mean just to comment on sales. Obviously, we had a very strong first half of the year. But we do expect trends to return to more of our long-term guidance range in Q3 and beyond as laps get tougher. But we are obviously pleased with the progress in the first half of the year.

[Keith Siegner, VP, IR, Corporate Strategy & Treasurer]

Next question please.

[Operator]

Your next question comes from the line of Andrew Charles with Cowen.

[Andrew Charles, Cowen and Company]

Great. Thanks and Greg please add me to the customer complaints about not getting hotel reservation. You know, just following up on Dennis’ questions, it's been pretty well publicized there is a partial shortfall in 10-inch tortilla at Taco Bell in the first week or two of July? And so, you alluded to the stunning 7% performance in 1Q.

Can you speak to the scope of the shortfall? And importantly the impact this had on July sales? Any residual drag we should think about as we head into August, just from consumer awareness, the replenishment is still potentially taking hold? Thanks.

[Greg Creed, Chief Executive Officer]

Yes. Sure, well, the supply issue was limited to 10-inch tortillas, so things like quesadillas and burritos. It was, it was also limited regionally. It wasn't across the whole system. It probably impacted us for about nine days and did it have an impact on sales? Yes. Was it material? No. What we clearly – was it clearly unacceptable to run out of the core menu item?

Yes. Have we taken them out with our supplier? Yes. So, but I think the key takeaway is, it had an impact, but we don't believe it was a material impact. And we, our objective is to make sure we don't obviously run out of core menu items going forward.

[Andrew Charles, Cowen and Company]

Thank you.

[Keith Siegner, VP, IR, Corporate Strategy & Treasurer]

We have time for one more question, please.

[Operator]

Our final question comes from the line of Brian Bittner with Oppenheimer & Company.

[Brian Bittner]

Thanks for sneaking me in. Can you just talk a little bit more about the accelerating unit openings we are seeing at KFC globally? I know China is helping here. But outside of China, it's really strengthening and you are growing that portfolio at a 6% clip now. And with the strength in comps, it's just hard to see KFC slowing its unit openings.

So, is this just a new normal for KFC? Is it going to be a system sales grower that's consistently above your overall kind of at least 7% trend you think about for your portfolio? Anything else you can say about that would be helpful?

[David Gibbs]

Yes, I think we're really pleased, obviously with the progress we've made on ramping up KFC development and as you know, it keeps getting stronger every quarter. It obviously helped China, as you saw just up their guidance for unit development and that China is having a lot of success with KFC.

We are not going to really provide guidance by brand, development and obviously some of the tailwinds we have going on at KFC from new unit development will help offset a little bit of the challenges that will have on unit count at Pizza Hut, which is why we think when you net it all out over the long-term, we will be able to continue to grow Yum! that's 4% rate on average.

As the base keeps getting larger, that means that unit counts will keep going up. But KFC is having widespread success. You can see it in the numbers. System sales growth all - and that leads to better unit economics and franchisees are putting their money behind those better unit economics and building more stores.

[Greg Creed, Chief Executive Officer]

Okay. Well, thank you everyone for being on the call today. I am thrilled to be able to share such strong Q2 results with you with obviously broad based contributions from each of our iconic brands driving impressive same-store and system sales growth.

And we have long expected and discussed a slower growth second half of 2019 owing to more challenging laps and the loss of some discrete benefits like lapping the UK, KFC UK distribution disruption.

However, I am confident that our enviable business, underpinned by unrivaled culture will deliver lasting growth that maximizes shareholder value in 2019 and beyond.

Thanks for being on the call. Appreciate it.

[Operator]

Ladies and gentlemen this concludes today's call. Thank you all for joining and you may now disconnect.