Yum Brands Makes Gains, Mostly In Sales At China Unit

Despite back-to-back public relations disasters — first an E. coli outbreak at its Taco Bell franchise, and then a widely publicized rat infestation at one of its restaurants in New York City — Yum Brands yesterday reported strong first-quarter earnings, as surging overseas sales and growth offset reduced business in the United States.

The restaurant chain, which operates KFC, Taco Bell and Pizza Hut, said that net income increased 14 percent in the first quarter, to $194 million, led by a 31 percent increase in operating profit in the China division and a 25 percent increase in other overseas markets.

In the United States, the story was different. Operating profit at the companys domestic restaurants declined by 11 percent in the quarter as company officials battled to restore consumer confidence. At Taco Bell, where both the E. coli and rat incidents occurred, same-store sales declined by 11 percent.

The first problem surfaced in December, when customers at Taco Bell stores in Long Island and New Jersey reported falling ill from E. coli poisoning after eating at the chain. The illnesses spread to Pennsylvania and Delaware, and the Centers for Disease Control confirmed more than 70 cases, though state officials suspected far more.

Preliminary tests by Taco Bell traced the E. coli to green onions, which are used as a garnish on some dishes. But further testing discounted green onions, and federal investigators eventually determined that the cause of the outbreak was lettuce, which is used in about 80 percent of Taco Bells dishes.

Taco Bell responded by temporarily closing and sanitizing the restaurants with the contaminated food and by switching produce suppliers. Taco Bell now requires the farmers who supply its lettuce to test the raw product at the farm for E. coli, in addition to tests already being conducted by the restaurants suppliers.

Our goal is to expand this farm-level testing to other produce as soon as possible, said Peter R. Hearl, Yums chief operating officer.

The second incident occurred in February, when a television news camera captured rats running rampant through a restaurant in Greenwich Village, which housed both a Taco Bell and a KFC. Not only was the videotape played repeatedly on television news shows, but it also became a popular video on the Internet, spreading word of the situation well beyond New York.

The owner of the restaurant had tried to address the rodent problem, hiring a construction crew and pest control experts. But when a construction crew failed to cover a gaping hole in the basement one evening, rats scampered into the restaurant.

A passer-by noticed the rodents in the middle of the night, contacted a television news tip line and touched off an embarrassing episode for Yum Brands, particularly given its proximity to the E. coli outbreak. Yum officials said the Greenwich Village restaurant would not be reopened.

Yum Brands hired a pest control expert to review its protocols and to recommend improvements.

The recent rodent infestation at a franchisees restaurant in New York City is simply unacceptable, and it shouldnt have happened, Mr. Hearl said in a statement.

But Yum Brands, which is based in Louisville, Ky., said yesterday that it was raising its predictions for full-year 2007 earnings on the strength of its international business. Yum Brands has added 351 restaurants in China in the last year, for a total of 2,202. Same-store sales in China increased by 9 percent in the first quarter of this year.

Joseph T. Buckley, an analyst at Bear Stearns, said he was surprised that the numbers in the United States were not worse. From an overall corporate standpoint, you would never know they had a problem, he said.

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