Breakfast generates 6% of total sales mix at Taco Bell.


LOUISVILLE, KY. — Launching a national breakfast platform at Taco Bell this year has become a big success story for parent company Yum! Brands, Inc. In just over six months, the day part generates 6% of the chain’s sales mix.

“I would go so far as to say we are one of the very few companies in the history of the Q.S.R. industry to launch breakfast successfully and profitably in year one,” said David Novak, chairman and chief executive officer, during an Oct. 8 call with financial analysts to discuss third-quarter earnings. “Not only are breakfast sales largely incremental, but we are making money and sustaining it with margins of nearly 21% in the quarter.”

Negative publicity over a food safety scare in China weighed on third-quarter performance during what Yum! had previously called its comeback year. Net income in the quarter ended Sept. 6 increased 166% to $404 million, equal to 91c per share on the common stock, which compared with $152 million, or 33c per share, in the prior-year period. But revenues fell 3.2% to $3,354 million from $3,466 million in the comparable quarter.

While U.S. results were flat at KFC and declined at Pizza Hut, Taco Bell outpaced quick-service industry performance with a 3% increase in U.S. same-store sales. The morning meal platform has added “muscle” to the Mexican fast-food chain, Mr. Novak said.

“It has killed me for years driving by all those McDonald’s that are full and before we even open up our doors,” he said. “So I think this is like taking our awareness and taking our usage of breakfast up over time; it is like the biggest new product we could have ever introduced to grow the base business. The trade-off, the margin trade-off between lunch and dinner, isn’t that significant for us. So we are able to leverage the box, and that is the name of the game.”

Taco Bell also recently introduced its Dollar Cravings value menu with early positive results, and is set to launch mobile and digital ordering in the fourth quarter.

And recently the chain announced plans to expand its breakfast menu, which debuted in March with the Waffle Taco and A.M. Crunchwrap, by adding higher-protein items, including a Greek yogurt parfait, a steak and egg bowl and a steak and egg burrito.

“Everybody thinks Taco Bell has a great late-night business, Fourth Meal,” Mr. Novak said. “Our Sunday, Monday, Tuesday breakfast is higher than our late-night business. So, we are building a pretty damn good business that is only going to get better as we go forward, and I am glad that we have it in our arsenal.”

Lowering expectations

Operating profit for the KFC division increased 15% to $169 million, and revenues climbed 9.5% to $771 million, reflecting a 6% increase in system sales driven by strength in international markets and even performance in U.S. restaurants.

In the Pizza Hut division, operating profit dropped 4.2% to $68 million, and revenues remained flat at $264 million, as growth in emerging markets offset a 2% same-store sales decline in the United States.

“At Pizza Hut, while we are disappointed with the full-year operating profit and it will fall well short of our initial expectation, we are pleased with the progress we are making and expect this to continue into next year,” Mr. Novak said. “We have sharpened our focus on value in the United States and have leveraged more competitive offers to drive digital activations and consumers are responding. In fact, sales turned positive during the last two months of the quarter, and our digital mix is now over 40% on our delivery and carryout business, which represents a more than five-percentage-point increase over second quarter. Our system is now fully aligned around competing more effectively and winning in the digital and social world.”

The Taco Bell division posted a 14% increase in operating profit to $124 million. Revenues rose 1.8% to $443 million.

“Going forward, we will introduce mobile ordering and payments in the fourth quarter and we have significant innovation planned in our core business to drive growth balance of the year and beyond,” Mr. Novak said. “With strong unit level economics at Taco Bell, we are seeing an acceleration of development with over 100 net new units this year, which represents a 10-year high, and we have an even better development pipeline headed into 2015. We are confident we will ultimately achieve our goal of at least 8,000 Taco Bell restaurants in the United States.”

In China, operating profit fell 40% to $202 million, and revenues declined 10% to $1,840 million on the impact of negative publicity in July surrounding improper food handling by an ex-supplier. The India division reported operating loss of $3 million, up from a loss of $4 million in the prior year, and $36 million in total revenues, up 20% from the comparable quarter, as system sales increased 14% while same-store sales declined 4%.

With uncertainty in the trajectory of China sales, Yum! has lowered its full-year projection of earnings per share growth between 6% and 10%, down from a previous outlook of at least 20%.

“First half e.p.s. growth of 27% was driven by particularly strong results in China where system sales grew 19% and we delivered restaurant margins of nearly 20%,” Mr. Novak said. “However, our strong first-half results have been offset by an unexpected and highly publicized food supplier incident in China, which significantly impacted sales at both KFC and Pizza Hut.”

On July 20, an undercover investigation televised in China depicted alleged illegal actions of employees at Shanghai Husi, a division of OSI, which was a supplier to Yum!, representing only a relatively small percentage of the company’s sales at KFC and Pizza Hut in China.

“However, given our size and category-leading positions in China, our sales were disproportionately impacted because we were mentioned with the same media weight as our major competitor who was a large customer of OSI in China,” Mr. Novak said. “As we have said before, experience tells us it takes six to nine months to fully recover from these type of events and this will most likely be the case with this situation as well. But make no mistake, KFC and Pizza Hut are beloved brands in China and around the globe and have proven to be absolutely resilient. We have complete confidence in a full sales recovery and expect our bounce back to be strong.”