Yum! Brands Q2 2024 Earnings Call Transcript

Thanks Zapper [Phonetic]. Good morning, everyone, and thank you for joining us. On our call today are David Gibbs, our CEO; Chris Turner, our CFO; and Dave Russell, our senior vice president and corporate controller. Following remarks from David and Chris, we'll open the call to questions.

Before we get started, please note that this call includes forward-looking statements that are subject to future events and uncertainties that could cause our actual results to differ materially from these statements. All forward-looking statements are made only as of the date of this call and 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 release and the relevant sections of our filings with the SEC to find disclosures, definitions, and reconciliations of non-GAAP financial measures and other metrics used on today's call. Please note that during today's call, all system sales growth and operating profit growth results exclude the impact of foreign currency.

As a reminder, several of Yum! Brands business units report on a period calendar basis, including all U.S. and Canada brands KFC U.K. and KFC Australia. When forecasting 2024, please keep in mind this year will include an extra week in the fourth quarter for those entities. For more information on our reporting calendar for each market, please visit the Financial Reports section of the IR website.

We are broadcasting this conference call via our website. This call is also being recorded and will be available for playback. We would like to make you aware of upcoming Yum! investor events and the following. Our third quarter earnings will be released on November 5 with a conference call on the same day.

Finally, on our last call, we shared the timing for our Taco Bell Consumer Day originally planned for December of this year, we are finalizing a revised date for early next year. Please stay tuned for more details and invitations to follow. Now, I'd like to turn the call over to David Gibbs.

Thank you, David, and good morning, everyone. Today, I'll discuss our financial results, our bold restaurant development and unmatched operating capability growth drivers, our balance sheet and capital strategy, and provide an update on our outlook for the remainder of the year.

Beginning with our second quarter results. System sales grew 3%, driven by 5% unit growth. Consumer sentiment relating to the conflict in the Middle East continued to pressure system sales growth in the quarter. The recovery trajectory we observed in Q1 for the Middle East, Malaysia and Indonesia, flattened in Q2. And while hard to precisely quantify, we continue to observe conflict-related impacts in a broader set of markets. Despite these pressures, Yum! delivered an impressive 10% core operating profit growth, reflecting the resilience of our scale, global, multi-brand business model, increasing benefits of our digital and technology strategy and the expert management of the business by our leaders around the globe.

A prime example of factors underpinning our resilience was profitability in our 488 company-owned Taco Bell stores in the U.S., our single largest estate of company-owned stores, representing approximately half of our total global company-owned store revenue. Store level margins were 25.6% with mature stores achieving over 27%, reflecting the strength of the Taco Bell business model and its magic formula, which enables the brand to simultaneously deliver an outstanding consumer experience, tremendous consumer value and exceptional store-level margins for our franchisees and Yum!

Importantly, Taco Bell operations leaders are taking advantage of the continued growth in digital sales mix, which is now 35% to further digitally enable our operations in ways that not only improve consumer and team experiences, but also improve labor productivity. Another contributor to profit growth was improved expense leverage. As we shared in January, we expected throughout the year to see the benefits of our ongoing resource optimization program, which strategically leverages our scale to free up general and administrative expense for reinvestment in future growth drivers such as AI, which will benefit both Yum! and our franchisees in addition to some beneficial onetime G&A expense overlaps.

Second quarter ex-special G&A expense was $256 million, down 9% year-over-year. Reported G&A was $281 million, reflecting $25 million of special expense related to our resource optimization program. We expect to generate additional savings on an ex-special basis from the resource optimization program in the second half of the year. Reported operating profit increased 6% as foreign currency translation continued to be a headwind with a $12 million negative impact in the quarter. Historically, given our global footprint, foreign currency translation has at times been a significant tailwind to our reported operating profit and at other times, a headwind. Since interest rates in the U.S. began to rise in Q1 2022, our current annual operating profit reflects a headwind of nearly $180 million in foreign currency, equivalent to roughly one year of operating profit growth under our long-term growth algorithm during that period.

Second quarter ex-special EPS was $1.35, reflecting a $0.20 negative impact from a higher year-over-year tax rate and lower year-over-year investment gains. Additionally, foreign currency translation unfavorably impacted Q2 EPS by $0.03.

Moving on to our bold restaurant development growth driver. Yum! opened 894 units, the second highest number of Q2 gross openings in Yum!'s history, leading to our unit count expanding 5% year-over-year, contributing 4 points to total system sales growth. In the quarter, we transferred certain rights related to the trademarks of the Gino's Pizza and Telepizza brands in Latin in Latin America to our local franchisee, enabling our teams and Latin America to focus exclusively on driving growth in the Pizza Hut brand. As a result, we removed 120 low volume and low royalty rate units associated with those brands from our store base in exchange for nominal compensation. Excluding the impact of this transfer, our unit growth was 6%. Our growth remains diversified across brands and countries with 195 brand country combinations contributing growth during the last 12 months.

Moving to brand-specific development. In the KFC division, we opened 598 units across 57 countries. This brings our year-to-date gross openings in KFC to 1,107 units, a new all-time record for KFC for the first half of the year. China, India, Thailand and Japan led development. Over the last year, we've seen positive development trends in South Africa, the Philippines and Brazil. In the quarter, we closed on the transaction to purchase 216 stores in the U.K. and Ireland, one of our highest average annual unit volume markets. Our total equity estate at KFC is now 434 stores, the majority of which are located in the U.K. market.

The Pizza Hut division opened 236 units across 30 countries. Pizza Hut's year-over-year unit growth is trending higher from this time last year for several of our largest markets, including China and Japan, which is offsetting closures in the U.S. and the conflict-related slowing of development in Indonesia and Malaysia.

At Taco Bell, we opened 56 units this quarter, including 17 new units in our international markets across 10 countries. Our U.S. gross openings are running higher year-over-year for the first half, and we expect international store growth to pick up in the second half of the year. Excluding China, Taco Bell international unit count was up 7% year-over-year.

Moving to our digital and technology initiatives. You will recall that on our last earnings call, David and I discussed our journey to become the leading global digital restaurant company. The first phase of this journey is focused on acquiring, building and scaling a comprehensive suite of owned platforms that enable ownership of our data, control the digital ecosystem, speed of innovation and cost advantages through scale leverage. Within this phase, we are accelerating deployment of our foundational platforms, such as the Poseidon POS system, Yum! e-commerce platform, Dragontail, SuperApp and our Global Data Hub. In the next phase, we are focused on maximizing the value creation potential of our platforms through AI and leveraging our extensive data assets.

Data is becoming a crucial differentiator, enabling us and our franchisees to generate better insights and make better decisions. We believe we are still only scratching the surface of the full value creation potential of our capabilities.

Let me now discuss additional digital and technology accomplishments for Q2 across our easy experiences, easy operations and easy insights pillars. I will begin with our easy experience pillar, focused on providing frictionless experiences to our consumers. As you recall, last quarter, we discussed plans to expand drive-through Voice AI technology to more Taco Bell stores.

I'm excited to announce that given our encouraging early results, the team has accelerated the rollout. And as of today, we now have this technology operational in over 100 Taco Bell stores. We plan to scale the technology to several hundred stores by year-end, while the pilot test is underway in KFC Australia. In our tests, we have witnessed consistent consumer experiences and higher team member productivity. This technology leverages digital menu boards, which will be a Taco Bell brand standard in 2025 and Yum!'s proprietary point-of-sale system, Poseidon.

On the e-commerce front, we have made significant progress in implementing the Yum! commerce platform at Pizza Hut U.S. We are currently transitioning to this platform at Pizza Hut in the U.K., which will be the second international Pizza Hut market to operate on the Yum! commerce platform with Pizza Hut Canada next in line.

Next, I'll discuss our easy operations pillar, where we continue to deploy our world-class technology to provide our franchisees and team members with the capabilities to operate their stores more effectively and efficiently. We have fully deployed our Poseidon point-of-sale system within Taco Bell U.S. and are in the early stages of incorporating this system into the KFC U.S. estate.

With respect to Dragontail, our AI-enabled restaurant management system, we plan to have the system rolled out to nearly the entire Pizza Hut U.S. system by year-end. As an example of Dragontail's impact, in the first 1,000 Pizza Hut U.S. stores to implement the technology, we have measured a 7% increase in overall consumer satisfaction due to hotter and fresher pizzas leading to improved consumer frequency.

Finally, we are in the process of scaling SuperApp, our restaurant General Manager support app at Pizza Hut U.S., and we plan to achieve the 10,000 store milestone across KFC globally by year-end.

Lastly, I'll discuss our easy insights pillar. We deepened our AI pursuits this quarter, taking steps to unlock the benefits of our R.E.D 360 database and engage with an innovative start-up in the AI-driven personalization space to leverage our massive first-party data assets. This partnership covers the application and integration of a deep learning AI approach known as reinforcement learning, which we expect to be broadly and easily scalable across brands. This partnership will focus on our basic CRM channels and in the future, may extend to our other consumer sales and communications channels, for instance, paid media.

Next, I'll provide an update on our balance sheet and liquidity position. As a reminder, our capital priorities are guided by maximizing shareholder value and include investing in the business, maintaining a resilient balance sheet, offering a competitive dividend and returning excess cash to our shareholders.

Net capital expenditures for the quarter were $31 million, reflecting $50 million in gross capex and $19 million in refranchising proceeds. Our net leverage ratio ended the quarter at 4.1 times. We have a strong balance sheet and no debt maturities until 2026.

During the second quarter, we are pleased to have resumed share repurchases by buying back $50 million in our stock, which for context is the same value of shares repurchased during the entire year of 2023. Going forward, absent any attractive investment opportunities like our recent acquisition of KFC U.K. restaurants, we plan to continue to return excess cash flow to shareholders through share repurchases.

Finally, I'll discuss our outlook on the balance of 2024. We remain on track to achieve 5% unit growth for the full year despite the extended impact the Middle East conflict. On a global basis, our planned number of gross unit openings for the full year is expected to be similar to our number of gross openings in 2023. We should also note some certainty on the future path in the Middle East markets.

For example, there are approximately 210 restaurants currently temporarily closed across the Middle East, Malaysia and Indonesia. While there are plans in place to reopen some of those restaurants starting later this month and throughout the second half of the year, there is risk that some could close permanently pending the future trajectory the conflict impact. These stores have not been producing royalties while temporarily closed, but our reported unit count would be negatively impacted if these stores were to permanently close.

With respect to company store profitability, we expect full year Taco Bell company-operated store margins to be in the range of 23% to 24%. Regarding G&A. Excluding 53rd week, we now expect ex-special G&A expense to be lower on a year-over-year basis by a low single-digit percentage. As for sequencing, Q3 G&A will be higher year-over-year as we lap last year's recovery of cyber-related insurance proceeds and as we incur costs relating to our Global Leadership Summit.

Finally, despite updating our balance of year sales outlook to reflect the continued softness we're seeing tied to the Middle East conflict, we remain confident that we will deliver at least 8% core operating profit growth on a full year basis excluding the benefit of the 53rd week. I'm very proud of the work our teams continue to do to position Yum! as a resilient growth business going forward and to further cement Yum! as the global franchisor of choice. We are making incredible strides toward our distinctive digital and technology ambitions, our 50% plus digital sales mix and our continued rollout of distinctive digital and AI technologies are testaments to that pursuit.

In markets around the world, we have the privilege of working with outstanding 3C that is capable, well-capitalized and committed franchisees who want to grow with our system and our iconic brands.

With that, operator, we are ready to take any questions.