Yum's U.S. Sales, Profit Take Beating in Second Quarter

Strong International Business Bolsters Overall Results; CEO Pins Troubles on Taco Bell

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Yum Brands CEO David Novak couldn't have picked a better time to ask agencies to pony up ideas to build its business: Yum Brands' U.S. sales have taken a beating in the second quarter. While the company's non-U.S. results were up considerably, Yum's domestic same-store sales for the period were down 4%, and operating profit was down 28%, worse than what analysts predicted.

"Year-to-date U.S. results have taken some of the luster away from what otherwise would be a great year," Chairman-CEO and President David Novak said in an earnings call this morning. "Our international business is clearly the growth engine that drives our company. Through the first half of this year, nearly 75% of our operating profit has come from China and Yum Restaurants International."

Overall, same-store sales were down 4% in the U.S. for Yum, the parent of chains Taco Bell, Pizza Hut and KFC. For those units, domestic same-store sales for Taco Bell were down 5%, down 2% at Pizza Hut, and down 5% at KFC. Operating profit in the U.S. tumbled 28%. For the quarter, Yum posted net income of $316 million, up 10% from the same period in the prior year.

Mr. Novak said during the earnings call that the decline in the U.S. was "primarily due to Taco Bell, our most profitable U.S. brand," adding that the company "had higher than normal commodity inflation."

But same-store sales in China jumped 18% and operating profit spiked 25% for the quarter, and year-to-date, the division's same-store sales are up 16%. Yum's international division had same-store sales up 2%.

Baird Equity Research analyst David Tarantino said in a note regarding Yum's results: "Even though China/international are increasingly becoming larger profit drivers for the overall company, Q2 results demonstrate that [the U.S.] segment still influences the company's overall performance. Taco Bell has been the biggest driver of the recent decline in the U.S., and when combined with sluggish performance for the other brands, visibility into core operating profit improvement is limited."

When discussing Taco Bell's poor performance, Mr. Novak was quick to bring up a lawsuit filed against the company back in January, which he called "meritless." "At the time of our first-quarter call, I thought we would be positive at Taco Bell by now and we're not," he said. "The remainder of 2011 will be challenging from a sales standpoint, but we expect slow improvement from the low point in the second quarter."

The suit, which charged that Taco Bell was advertising its ground beef deceptively because it is made up mostly of substances other than beef, prompted Taco Bell to act quickly and launch an aggressive campaign to fend off the charges. The suit was withdrawn in April, and Taco Bell launched another campaign in response.

During the same week of the campaign launch surrounding the lawsuit's withdrawal, a letter from the Franchise Management Advisory Council (Franmac) surfaced. The letter included a series of beefs the franchise council had with Taco Bell, including the council's desire to re-examine the DraftFCB agency relationship. Taco Bell has since stood by the Interpublic Group of Cos. agency.

Yesterday, Ad Age reported that Mr. Novak called on Yum's ad agencies -- WPP's Ogilvy & Mather and Interpublic siblings DraftFCB and the Martin Agency -- for a brainstorming session to help boost the company's U.S. sales. The company said that the session was not an agency review.

Mr. Novak said that in 2012 Taco Bell will have "significant category innovation in the pipeline that will re-energize the brand." He added, "We're working hard to make our advertising more insight driven and more compelling."

Although KFC's same-store sales were also down 5%, not much discussion was dedicated to the brand's U.S. performance during the earnings call. KFC in June relaunched its grilled chicken with an ad campaign in an effort to appeal to customers not interested in fried chicken, and its same-store sales in China were up 17% in the second quarter.

Mr. Novak said that the company felt "fairly good about the Pizza Hut performance."

Yum in January made a prescient move to put A&W and Long John Silver's up for sale, in an play to focus on aggressively growing overseas as well as improving sales in the U.S. on KFC, Pizza Hut and Taco Bell. A buyer has yet to come forward on the two lagging brands.

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