Keith R. Siegner - Yum! Brands, Inc. Greg Creed - Yum! Brands, Inc. David W. Gibbs - Yum! Brands, Inc..

John William Ivankoe - JPMorgan Securities LLC Matthew Robert McGinley - Evercore ISI Sara Harkavy Senatore - Sanford C. Bernstein & Co. LLC John Glass - Morgan Stanley & Co. LLC David Palmer - RBC Capital Markets LLC Dennis Geiger - UBS Securities LLC Jeffrey A. Bernstein - Barclays Capital, Inc. David E. Tarantino - Robert W. Baird & Co., Inc.

Chris O'Cull - Stifel, Nicolaus & Co., Inc. Brian Bittner - Oppenheimer & Co., Inc..

Ladies and gentlemen, thank you for standing by. And welcome to the Yum! Brands Third 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. Thank you. I will now turn the conference over to Mr.

Keith Siegner, Vice President of Investor Relations, Corporate Strategy and Treasurer. Please go ahead, sir..

Greg Creed, our CEO; David Gibbs, our President and CFO; 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 the Investors section of the Yum! Brands' website, www.yum.com, to find disclosures and reconciliations of non-GAAP financial measures that maybe used on today's call. Please note the following regarding our basis of presentation for today's call. First, system sales results exclude the impact of foreign currency.

Second, core operating profit growth figures exclude the impact of foreign currency and Special Items. And third, the revenue recognition accounting standard was prospectively adopted on January 1.

As a reminder, this is a GAAP required change adjusting the timing of recognition of upfront fees received from and incentive payments made to franchisees, the effects of which have no impact on cash. In addition, it requires the gross-up of revenues and offsetting expenses of advertising funds we consolidate within our income statement.

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.

First, disclosures pertaining to outstanding debt in our Restricted Group capital structure will be provided at the time of the third quarter Form 10-Q filing. Second, fourth quarter earnings will be released on February 07, 2018, with the conference call on the same day.

And finally, the Yum! Brands Investor and Analyst Day will be held on Wednesday, December 5, 2018 and will be available via webcast on our website at www.yum.com. Now, I'd like to turn the call over to Mr. Greg Creed..

Franchise Wars. Taco Bell also connected the Nacho Fries to the 25th anniversary of the cult classic Demolition Man. In case you didn't know, in the movie Demolition Man, the only remaining restaurant is Taco Bell, which the brand celebrated with a truly unique activation at Comic-Con.

Lastly, we want to send a big congratulations to the entire Taco Bell system for ranking as America's number one favorite Mexican restaurant in the distinguished Harris Poll. Taco Bell's ability to innovate and elevate around both their marketing and products highlights the fact that the brand proudly stands in a Category of One.

Internationally, this is only the beginning for Taco Bell and I'm excited to see the growth the brand grow and expand. We saw momentum and enthusiasm in India, Spain, the Philippines and Canada. Taco Bell India's year-to-date same-store sales growth is 10%, driven by the innovation such as the Naked Chicken Taco and Crispy Potaco.

In Spain, one of our more established international markets, year-to-date same-store sales growth of 6% was fueled by value innovation. Guatemala, Taco Bell's largest international market, continues to grow as it recently opened its 57th restaurant.

I'm proud of the work Taco Bell International is doing to lay the groundwork for exponential growth to feed people's lives with más.

Now to unrivaled culture and talent, part of our transformation is ensuring that we have diverse talent and an inclusive culture to achieve greater gender parity in senior leadership, which we know generates better growth.

This commitment aligns with the Paradigm for Parity coalition, to have an organization in which women and men have equal power, status and opportunity. Yum! is intentional about diversity and this is especially evident in the leadership teams of our brands.

This past month, Forbes released a series on Pizza Hut's female leaders, which highlighted the careers of five C-suite leaders. While the Forbes' article highlights Pizza Hut, we are proud of the focus on diversity and inclusion at all our brands. Here at Yum!, we are constantly cultivating great talent.

It is a true competitive advantage to have a deep bench of this quality.

In conclusion, I'm proud of the work we're doing around the world, focusing on our four key growth drivers to build a world with more Yum!. We remain confident as we lay the foundation of our transformation strategy to maximize shareholder value.

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

they are committed to providing consistently bold value and successfully expanding with a delivery-based development strategy; they are capable, able to deliver a great customer experience having earned a record in customer satisfaction including a plus nine-percentage-point improvement in Pan Pizza taste; and finally, they have capital both to grow new units and modernize existing assets.

I'd like to spend a minute discussing the challenge Pizza Hut faces given its large dine-in sales mix. Specifically, the drag dine-in is having on our reported same-store sales, which masks the relative health of our delivery and carryout business. You're all aware of this headwind in the U.S.

where dine-in sales are down to less than 10% of the total, but the same issue applies to our international business where dine-in sales represent approximately 50% of the total. The gap between dine-in sales and sales from delivery and carryout is significant with both the U.S. and international seeing a roughly ten-point differential.

Dine-in is waning in relevance in a lot of markets and importantly complicates pricing decisions in our ability to offer disruptive delivery value, especially in international markets with a high percentage of dine-in sales. We have a long way to go given some of the challenges in legacy dine-in markets such as Europe and China.

However, the good news is the estate is shifting towards delivery/carryout, given that 90% of net new unit openings and 80% of all replacement units are delivery/carryout-focused. At Taco Bell U.S., we have opened 59 net new units through the third quarter of 2018.

We recently opened our 30th domestic Urban Concept which includes walk-ups and Cantinas, and are excited about the opportunity to tap this near-greenfield market. This quarter we celebrated openings in New York, Chicago and Raleigh, and look forward to more high profile openings later this year, including our first company Cantina in Manhattan.

So, stay tuned. In becoming more franchised and more focused, our refranchising initiative has fueled bold development with nearly 220 new development commitments in the U.S. through the third quarter since 2016. In international markets, Taco Bell has developed 34 net new units in 2018, with a strong fourth quarter pipeline yet to come.

Lastly, as we know, unit-level economics are essential to stimulating development. I had the privilege of attending the Taco Bell Franchise Convention last month and there's a lot of excitement especially for our Urban and Cantina models where early returns have been encouraging and the development pipeline continues to build.

In aggregate, accelerating unit growth across our three brands is a driving factor as we strive for a bold aspiration of 7% system sales. Now onto our final growth driver, Unmatched Franchise Operating Capability. I'd like to spend a minute highlighting our partnership with Grubhub.

At the beginning of the year, we announced our partnership with Grubhub to drive sales to KFC and Taco Bell through online ordering for pickup and delivery. We are pleased to share that 1,200 KFC restaurants now will offer delivery through Grubhub covering 30% of the U.S. system in just seven months.

We are seeing above-average customer ratings on the Grubhub KFC experience and expect this to improve once POS integration is complete later this year.

As per Taco Bell, in September we launched a fully integrated solution between the Taco Bell POS and Grubhub marketplace, rolling out this integrated delivery solution to over 2,100 stores across the nation covering 30% of the U.S. market. We are adding stores at a rapid rate and expect to make healthy headway through the end of the year.

We have seen positive early results along with valuable operations learnings. Franchisees are very excited about delivery as an opportunity to drive incremental sales and are all in on delivery as a major brand initiative.

Wrapping up on Grubhub, while we are in very early stages of our partnership, the check growth and incrementality of sales that we see is encouraging and supporting expansion throughout the franchise systems. To wrap-up, our third quarter operating profit results were as we expected.

We remain confident in delivering on our transformation initiatives and while there may be noise between quarters, we are pleased with the progress to-date. Now, the team and I are happy to take your questions..

Our first question comes from the line of John Ivankoe with JPMorgan..

John, are you there? You might be on mute..

Yes. Sorry about that guys. The question was on Pizza Hut. Obviously, looking at the U.S. and the Transformation Agreement that's been put into place there, it does seem like you're identifying that many of your bigger international markets are having the similar type of issues that the U.S.

was having a year or so ago in terms of what products are promoted at what price and basically serving the dining store versus the Delco store. So, are we now beginning a position or are you alluding to that maybe some of the international markets need some of the capital and operating costs and attention that the U.S.

was really talked about about a year or so ago?.

Yeah, John, I think one important difference between the U.S. and international is our international dine-in stores are actually in fairly good shape. These are good assets in good locations and in many countries we actually have a very strong dine-in business that we have confidence in for the future. That's quite a contrast to the U.S.

where we have a lot of Red Roof restaurants that are in the wrong part of the trade area, haven't been remodeled and clearly need to go away. So there's a lot of capital required to get out of the Red Roof restaurants in the U.S. It's not a similar situation internationally.

So no, we don't anticipate any kind of capital investment needs from Yum! going into international dine-in business..

And is there – I mean, I guess, a similar type of conversion opportunity over time, even if the assets are in good shape that makes them actually easier to convert, to integrate some of the Delco or fast casual type developments within the existing Red Roof type or a full-service type of estate that exists internationally.

I mean, are we at the point where not just 90% of new units are Delcos but you need to begin to convert many of those legacy assets over to something that is more flexible for the overall business model?.

Yeah, that's exactly right. I think I shared 80% of the stores are – that are being replaced, so when we have a dine-in unit that does need to be replaced it is being replaced with one of the fast casual or Delco assets. We think this transition will occur, it won't happen overnight but it is planned to occur over time.

And with half of our sales coming – roughly half of our sales coming from dine-in today, we think that number will be closer to a quarter of our sales within three to four years, just from the natural shift of, for example, closing on the Telepizza deal, adding all of those delivery sales, building all these net new unit Delcos that are in the pipeline and then all the work that's being done to replace dine-in stores with delivery stores.

So we want to give everybody the clear signal that we do have a plan to migrate out of those dine-in stores, but we thought it was important to highlight frankly that the delivery carryout business at Pizza Hut International is actually fairly healthy.

That business is doing well, but the results we report don't show the success that we're having in that part of the business..

Thank you. Next question, please..

Our next question comes from the line of Matt McGinley with Evercore ISI..

Thank you. My question is on the core operating profit guide. I know the guidance update today was just based on 2018. As I look at the refranchising and the G&A savings benefit that's more of a timing mismatch that would have worked itself out anyway.

Are you concerned that the underlying issues of Pizza Hut International would impair the core operating profit growth over the longer term? Or do you think that those issues are more just isolated to this year?.

Yeah, I think the beauty of Yum! obviously is that we do have a diverse portfolio of brands and countries. And yes, the Pizza Hut business is underperforming our expectations when we started this transformation journey.

But obviously, we're also seeing great strength at the much bigger parts of our business at Taco Bell and KFC and we did reiterate our guidance for 2019 today. So I think you never get there the way you planned when you start the journey and we'll talk more about this when we get to December Analyst Day.

But we feel good about the state of the business. Obviously, the results this quarter and the fact that we are very demonstrably ramping up net new-unit development certainly helps this earnings model of ours. Just as another fact on that front, year-to-date now we have 892 net new units opened for the year compared to 2017.

At the same point, we had 677, so we're 215 units ahead of the pace we had last year. Remember last year we were well ahead of the pace from the prior year, so that's all quite positive and typically the fourth quarter of the year is the biggest year on development by far. So a good story on the development front that helps the earnings model..

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

Thank you. I'll ask my follow-up first and then I'll ask my question. The follow-up is on Pizza Hut U.S., I know you said the turnarounds are slow build, but I think this is the second quarter where you said maybe the messaging wasn't as effective even though you did pivot to value.

So, could you talk about what can be done here? Because as you noted this isn't a dine-in issue since that's such a small piece of the business in the U.S. at this point. So, I guess, what is the strategy from here if really the only issue is messaging? And then I have a second question..

Yeah, sure. Look if I answer it in its totality, we're now the NFL partner. It's with us and not a competitor. Is that a good thing? Yes it is. We know what the right price points are to be successful in the marketplace. Do we have all of our franchisees on those price points right yet? No, we don't.

But are the stores that are on the right price points doing better? Yes, they are. And as we said, I personally feel that we just got to do a better job of communicating this compelling value.

We've got a new agency, they're onboard, the team is all over it and I think you will see us going forward with what I'll call sharper and more distinctive advertising and communication around this compelling value that we offer..

Yeah, and just one thing to add on that although the dine-in sales in the Pizza Hut U.S. business are only 10% of the business or so, remember about half the assets are dine-in assets. Those assets are very often in the wrong part of the trade area to deliver, they're not set up in the back of house to deliver.

So, although the sales mix is now down to a much more manageable level, we still have work to do that should give you confidence over time. Once we move those assets we'll be in a much better shape..

Thanks David..

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

Thanks, good morning.

David just going back to the 2019 comments, do you believe 2019 is a year you can still deliver on the high single-digit operating profit growth? Are you signaling that there are different pieces you get to the EPS number, but maybe not the operating profit number you'd once envisioned? And related to that I think your G&A on a percentage of system sales is at your target rate of 1.7% this quarter, so is this the right sort of baseline to think about G&A and then it grows in line with system sales from here, are there additional opportunities you've identified as you've gone through this year?.

Look I think, we'll talk a lot more about 2019 guidance when we get to the December analyst event. But we weren't trying to imply that there was any change to our high single-digit core operating profit growth model in future years with any of the comments today.

The business and the models all generally remain intact, but we'll provide a lot more color on that when we get to the December event..

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

Thanks. Just a follow-up on Pizza Hut, since KFC and Taco Bell seem to be cranking along here. The U.S. business, you've invested a lot this year and obviously to this point you're going to have the big fall push here with the NFL. But to this point, the momentum has not been as strong.

You mention creative, but next year you're going to be lapping some of those investments. Do you feel like that this is in a fragile position where you really got to get brand momentum going here in the near-term to start to lap some of those investments? I mean, how should we think about the state of Pizza Hut U.S.

heading into the 2019 in particular?.

Dave, the way I think about it is that the foundations of Pizza Hut U.S. are in a much better place. I think our delivery times, the quality of the food we're delivering, the price points, all of those are fundamentally in a better place. So our foundations are definitely in a better place.

Have we made it easier for our customers to access? Yes, we have through both digital, through both our apps, through the pricing. The point I was making and I think it's one that the team is very aware of is that we have to bring that sort of sharpness of what we're now delivering and doing so we attract new customers.

I think our current customer base is very happy with the foundational improvements they're seeing in the brand. The opportunity for us is to bring in new customers by communicating and messaging better this compelling new proposition that Pizza Hut U.S. has to offer, which is an operating improvement, an ease improvement, a value improvement.

We just got to do a better job of communicating that and I'm confident that once we do do that and when customers have a new Pizza Hut experience they'll be very happy with the experience that they have.

And on that basis, I feel good about the momentum that the (37:06) as David said earlier, our performance in delivery and carryout is better than our overall performance. So have we got work to do? Yes. The foundation is in place? Yes. Can we do a better job of communicating? Yes.

And we know what the task is and when you know what the task is, you go chase it and you deliver it..

On the question of lapping, all of the transformation initiatives were really designed to help the business for the long-term. There really isn't a lapping issue. We invested in media. You'd think that could be a lapping issue, but that was done so that then the franchisees ongoing contribution in media would jump up.

So we will have that additional media in future years, so there's – it's not like that creates a lap issue and then the other investments in things like pouches, and different standards for the brands, launching the loyalty program, we should continue to reap the benefit of those investments over time..

Our next question comes from the line of Dennis Geiger with UBS..

Good morning and thanks for the question. David just wondering, if you could talk a bit more about the accelerated unit growth potential for the business going forward. Maybe following another strong quarter at KFC, maybe specifically about your confidence in the accelerated growth there, generally which reasons you see that coming from.

And just how you're thinking about the U.S. getting back to positive based on the strong returns that the franchisees are seeing? Thanks..

Yeah, look again, we'll go into a lot of the future guidance and we'll actually have the leaders from each of the brands talk about their development plans when we get to the December analyst event.

I think I want to celebrate the fact that we've made meaningful progress to-date during this transformation as we've been doing all these things like cutting G&A and getting the business more focused. We're starting to see the benefit from development. It's showing up in the numbers, which is why I'm trying to highlight that every quarter.

Do we think – and are we pushing to take the numbers higher from here? Yes. Do we think there are opportunities in almost every market whether they be the mature markets in the U.S. or the international markets? Yes. KFC U.S. is very focused on getting to be a positive net new unit grower. And just as a preview, I think we can get them there next year.

So, yeah, that is something that's really quite additive to the model, when you think about how many units they've been closing over time. But yes, we're excited about unit growth. We'll never stop pushing for more, because when the returns are healthy, you should be capitalizing that and building more and the franchisees love it.

It's a way for them to grow their business. But we'll give you even more color on that when we get to December..

Our next question comes from the line of Jeffrey Bernstein with Barclays..

Great. Thank you very much. Just a question broadly on the franchisee health and profitability, I'm not sure whether you can slice it U.S. versus international, but however you look at it.

I mean in the past you used to use restaurant margin as a proxy for the franchisees' health and profit, but obviously that margin is no longer representative as the base is so small.

So, just wondering if you can offer any directional thoughts on the franchisee health at each brand, maybe how you're suggesting they best manage through the labor cost headwinds they're presumably all facing, and whether or not any of them have concerns about access to capital with rising interest rates? Thank you..

Yeah, that's true Jeff that now we – you really can't judge the margins that we report and use that as a proxy for the franchise unit economics since we're down to some small numbers with a lot of noise in them.

I guess, a general comment on franchisee health is when you operate in as many different combinations of brands and countries as we do there are always pockets of issues. We got 2,000 franchisees.

There is always going to be some that are having challenges that we're working with, but the vast majority of our franchise system around the world is quite healthy. The areas where we would have more issues that you would expect would be in businesses where we're trying to transform the business a little bit like Pizza Hut U.S.

We're trying to make sure we have the healthiest system of franchisees that we can. Some of the stuff we did in the Transformation Agreement was designed to give us some strength to manage out our underperforming franchisees. And you may see some change in the franchise system there.

But in general, I think our franchise health around the world is quite good, and the unit returns that we're reporting are strong. You heard Yum! China yesterday on their earnings call talk about two-year cash paybacks on brand new KFC, so that kind of thing at least to help new franchisees..

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

Hi, good morning. My question is on Taco Bell, which did have impressive performance in Q3. And I just wanted to see if you would elaborate on the drivers of that and whether the reintroduction of Nacho Fries had a big impact on that or whether you think there's something more structural or sustainable that you have that's driving that trend? Thanks..

Yeah, I think Taco Bell is just doing everything really well. Obviously to report 5% system sales growth, the calendar was incredibly strong. The team adjusted the calendar, which I was really proud of. The fact that they weren't happy with how they got out of the gate, so they adjusted the calendar.

I think the product innovation continues to be world class. I still believe that there's no better product innovation that comes out – that doesn't come out from Taco Bell. The restaurants are being incredibly well-run. The value price points are spot on. The communication is distinctive and cut through.

And to the delivered system sales growth of 8%, that is really at the top end, definitely the top end of what happened in the Mexican category and I would argue at the top end of what's happened in QSR.

And then, I guess, to top it all off, the prestigious Harris Poll to make Taco Bell the number one Mexican brand in the country was I think just the icing on the cake. So I think this brand is set up for continued success..

Great. Thank you very much..

Our next question comes from the line of Chris O'Cull with Stifel..

Thanks. Good morning, guys. I had a follow-up to a prior question and then a second.

David just going back to your Pizza Hut comment, is there a compelling financial argument that could be made for the company to increase its support to accelerate the Pizza Hut conversions?.

I think we've done a lot to support the franchisees as we move out of the dine-in asset base into the delivery base. By compelling arguments, there are some incentives that we've done to do that, that we haven't talked about a lot on these calls.

So I think we've looked at those things and we've worked with the franchise community to help support them in that regard. Remember that, building a new delivery carryout unit is a very good economic proposition in general. It's a low-cost investment and it generates a three, four year cash payback in general.

So the economics are there to make it happen, but when you're dealing with over 3,000 dine-in restaurants it's just going to take some time..

Thanks, operator. We'll take one more question, please..

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

Thanks. Good morning. Just two questions, one on KFC and one on Pizza Hut. On KFC same-store sales accelerated there particularly on a two-year basis, so super strong performance there.

I know we had Yum! China's comps last night, but what's driving the improvement elsewhere at KFC? Is the momentum of delivery growth in some of these markets really gaining momentum? Or anything else you can point out there.

And just on Pizza Hut, the $5 lineup you announced, is this a sustainable value offering, are franchisees able to operate at this price point? Thanks..

great value, delivery, digital, very good execution and as we said in the commentary, it's widespread. We've had really good across-the-board performance in the quarter from KFC. So what I liked about it was geographically this was a really strong across-the-board sort of quarter. So I think they're doing all the things right.

Value is great, delivery, digital and really good execution focusing on the core, and they're doing that across a broad range of markets and we're seeing the benefit. And then on your question on the $5 lineup, yes, it is sustainable. It's been designed to be sustainable.

And even the things that, I'm not going to talk about that are coming out, that will go on the menu in the future are also designed to sustain the $5 price point. So I feel very good. We've got the right price points, we communicated in a compelling way and we will see an improvement in Pizza Hut U.S..

Okay. So first of all, I just want to thank everyone for being on the call today. We remain confident that we are going to deliver on our transformation to be more focused, more franchised and more efficient, all of which will deliver more growth. Q3 was a strong quarter.

We obviously have work to do on the top line at Pizza Hut International, but I am happy with their new-unit development. However, it is great that two of our brands which represent over 80% of our operating profits are delivering on all four of our key growth drivers.

The high single-digit system sales growth at both Taco Bell and KFC was impressive I think by any standard. And we look forward to discussing this more in December and thank you for being on the call with us today..

This concludes today's conference call. You may now disconnect and have a wonderful day..