================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[|X|]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the quarterly period ended June 12, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _________________
Commission file number 1-13163
TRICON GLOBAL RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
North Carolina 13-3951308
- -------------- -----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1441 Gardiner Lane, Louisville, Kentucky 40213
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 874-8300
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
The number of shares outstanding of the Registrant's Common Stock as of
July 19, 1999 was 153,887,742 shares.
================================================================================
<PAGE>
TRICON GLOBAL RESTAURANTS, INC.
INDEX
Page No.
------------
Part I. Financial Information
Condensed Consolidated Statement of Income -
12 and 24 weeks ended June 12, 1999 and
June 13, 1998 3
Condensed Consolidated Statement of Cash Flows -
24 weeks ended June 12, 1999 and June 13, 1998 4
Condensed Consolidated Balance Sheet - June 12,
1999 and December 26, 1998 5
Notes to Condensed Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations
14
Independent Accountants' Review Report 37
Part II. Other Information and Signatures 38
2
<PAGE>
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions, except per share data - unaudited)
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
-------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues
Company sales $ 1,723 $ 1,867 $ 3,385 $ 3,657
Franchise and license fees 163 140 314 272
--------- --------- --------- ---------
1,886 2,007 3,699 3,929
--------- --------- --------- ---------
Costs and Expenses, net
Company restaurants
Food and paper 534 591 1,062 1,170
Payroll and employee benefits 481 545 944 1,083
Occupancy and other operating expenses 437 469 849 941
--------- --------- --------- ---------
1,452 1,605 2,855 3,194
General, administrative and other expenses 214 213 422 407
Facility actions net gain (133) (73) (167) (102)
Unusual charges 4 - 4 -
--------- --------- --------- ---------
Total costs and expenses, net 1,537 1,745 3,114 3,499
--------- --------- --------- ---------
Operating Profit 349 262 585 430
Interest expense, net 51 67 103 136
--------- --------- --------- ---------
Income Before Income Taxes 298 195 482 294
Income Tax Provision 119 83 197 128
--------- --------- --------- ---------
Net Income $ 179 $ 112 $ 285 $ 166
========= ========= ========= =========
Basic Earnings Per Common Share $ 1.16 $ 0.74 $ 1.86 $ 1.09
========= ========= ========= =========
Diluted Earnings Per Common Share $ 1.10 $ 0.72 $ 1.76 $ 1.07
========= ========= ========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions - unaudited)
<TABLE>
<CAPTION>
24 Weeks Ended
-----------------
6/12/99 6/13/98
-------- -------
<S> <C> <C>
Cash Flows - Operating Activities
Net Income $ 285 $ 166
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 183 201
Facility actions net gain (167) (102)
Non-cash unusual charges 1 -
Deferred income taxes (18) (15)
Other non-cash charges and credits, net 31 49
Changes in operating working capital, excluding effects
of acquisitions and dispositions:
Accounts and notes receivable (50) (14)
Inventories - 4
Prepaid expenses and other current assets (22) (21)
Deferred income taxes - (11)
Accounts payable and other current liabilities (178) (48)
Income taxes payable 122 67
-------- -------
Net change in operating working capital (128) (23)
-------- -------
Net Cash Provided by Operating Activities 187 276
-------- -------
Cash Flows - Investing Activities
Capital spending (152) (157)
Refranchising of restaurants 397 290
Acquisition of restaurants (6) -
Sales of property, plant and equipment 18 22
Other, net (12) (48)
-------- -------
Net Cash Provided by Investing Activities 245 107
-------- -------
Cash Flows - Financing Activities
Proceeds from Notes - 604
Revolving Credit Facility activity, by original maturity
More than three months - proceeds - 400
More than three months - payments - (500)
Three months or less, net (314) (312)
Proceeds from long-term debt 3 1
Payments of long-term debt (84) (599)
Short-term borrowings-three months or less, net 1 (39)
Other, net 6 (1)
-------- -------
Net Cash Used for Financing Activities (388) (446)
-------- -------
Effect of Exchange Rate Changes on Cash and Cash Equivalents 1 (3)
-------- -------
Net Increase (Decrease) in Cash and Cash Equivalents 45 (66)
Cash and Cash Equivalents - Beginning of period 121 268
-------- -------
Cash and Cash Equivalents - End of period $ 166 $ 202
======== =======
- ---------------------------------------------------------------------------------------
Supplemental Cash Flow Information
Interest paid $ 116 $ 153
Income taxes paid 95 57
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
CONDENSED CONSOLIDATED BALANCE SHEET
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions)
<TABLE>
<CAPTION>
6/12/99 12/26/98
---------- ----------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 166 $ 121
Short-term investments, at cost 119 87
Accounts and notes receivable, less allowance: $21 in 1999
and $17 in 1998 214 155
Inventories 68 68
Prepaid expenses and other current assets 80 57
Deferred income taxes 137 137
---------- ----------
Total Current Assets 784 625
Property, Plant and Equipment, net 2,695 2,896
Intangible Assets, net 599 651
Investments in Unconsolidated Affiliates 157 159
Other Assets 184 200
---------- ----------
Total Assets $ 4,419 $ 4,531
========== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities
Accounts payable and other current liabilities $ 1,123 $ 1,283
Income taxes payable 217 94
Short-term borrowings 88 96
---------- ----------
Total Current Liabilities 1,428 1,473
Long-term Debt 3,045 3,436
Other Liabilities and Deferred Credits 767 785
---------- ----------
Total Liabilities 5,240 5,694
---------- ----------
Shareholders' Deficit
Preferred stock, no par value, 250 shares authorized;
no shares issued - -
Common stock, no par value, 750 shares authorized; 154
and 153 shares issued and
outstanding in 1999 and 1998, respectively 1,356 1,305
Accumulated deficit (2,033) (2,318)
Accumulated other comprehensive income (144) (150)
---------- ----------
Total Shareholders' Deficit (821) (1,163)
---------- ----------
Total Liabilities and Shareholders' Deficit $ 4,419 $ 4,531
========== ==========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in millions, except per share data)
(Unaudited)
1. Financial Statement Presentation
We have prepared our accompanying unaudited Condensed Consolidated
Financial Statements ("Financial Statements") in accordance with the rules
and regulations of the Securities and Exchange Commission for interim
financial information. Accordingly, they do not include all the information
and footnotes required by generally accepted accounting principles for
complete financial statements. Therefore, we suggest that the accompanying
Financial Statements be read in conjunction with the Consolidated Financial
Statements and notes thereto included in our annual report on Form 10-K for
the fiscal year ended December 26, 1998 ("1998 Form 10-K"). Except as
disclosed herein, there has been no material change in the information
disclosed in the notes to our Consolidated Financial Statements included in
the 1998 Form 10-K.
Our Financial Statements include TRICON Global Restaurants, Inc. and its
wholly owned subsidiaries ("TRICON"). The Financial Statements include our
worldwide operations of KFC, Pizza Hut and Taco Bell. References to TRICON
throughout these notes to Financial Statements are made using the first
person notations of "we" or "us."
Our preparation of the Financial Statements in conformity with generally
accepted accounting principles requires us to make estimates and
assumptions that affect our reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
Financial Statements and our reported amounts of revenues and expenses
during the reporting period. Actual results could differ from our
estimates.
We have reclassified certain items in the accompanying unaudited Financial
Statements for prior periods to be comparable with the classification
adopted for the 12 and 24 weeks ended June 12, 1999. These
reclassifications had no effect on previously reported net income.
In our opinion, the accompanying unaudited Financial Statements include all
adjustments considered necessary to present fairly, when read in
conjunction with the 1998 Form 10-K, our financial position as of June 12,
1999, the results of our operations for the 12 and 24 weeks ended June 12,
1999 and June 13, 1998 and our cash flows for the 24 weeks ended June 12,
1999 and June 13, 1998. The results of operations for these interim periods
are not necessarily indicative of the results to be expected for the full
year.
6
<PAGE>
2. Earnings Per Common Share ("EPS")
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
------------------ ------------------
6/12/99 6/13/98 6/12/99 6/13/98
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 179 $ 112 $ 285 $ 166
======== ======== ======== ========
Basic EPS:
----------
Weighted-average common shares outstanding 154 152 153 152
======== ======== ======== ========
Basic EPS $ 1.16 $ 0.74 $ 1.86 $ 1.09
======== ======== ======== ========
Diluted EPS:
------------
Weighted-average common shares outstanding 154 152 153 152
Shares assumed issued on exercise of dilutive share
equivalents 26 19 27 19
Shares assumed purchased with proceeds of dilutive
share equivalents (17) (16) (18) (16)
-------- -------- -------- --------
Shares applicable to diluted earnings 163 155 162 155
======== ======== ======== ========
Diluted EPS $ 1.10 $ 0.72 $ 1.76 $ 1.07
======== ======== ======== ========
</TABLE>
Unexercised employee stock options to purchase 379,000 and 190,000 shares
of our Common Stock for the 12 and 24 weeks ended June 12, 1999,
respectively, were not included in the computation of diluted EPS because
their exercise prices were greater than the average market price of our
Common Stock during the 12 and 24 weeks ended June 12, 1999.
Unexercised employee stock options to purchase 1.9 million and 2.1 million
shares of our Common Stock for the 12 and 24 weeks ended June 13, 1998,
respectively, were not included in the computation of diluted EPS because
their exercise prices were greater than the average market price of our
Common Stock during the 12 and 24 weeks ended June 13, 1998.
3. Items Affecting Comparability of Net Income
The following table summarizes Company sales and restaurant margin for
stores held for disposal at June 12, 1999 or disposed of in 1999 and 1998:
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
---------------- ----------------
6/12/99 6/13/98 6/12/99 6/13/98
------- ------- ------- -------
<S> <C> <C> <C> <C>
Stores held for disposal at June 12, 1999 or
disposed of in 1999:
Sales $ 112 $ 169 $ 264 $ 327
Restaurant Margin 10 21 25 35
Stores disposed of in 1998:
Sales $ - $ 193 $ - $ 430
Restaurant Margin - 20 - 37
</TABLE>
We expect that the loss of restaurant level profits from the disposal of
these stores will be mitigated by the increased royalty fees for stores
refranchised, lower general and administrative expenses and reduced
interest costs due to the reduction of debt from the after-tax cash
proceeds from our refranchising activities. The combined restaurant margin
reported above includes the benefit from the suspension of depreciation and
amortization of approximately $4 million ($3 million in the U.S. and $1
7
<PAGE>
million in International) and $10 million ($6 million in the U.S. and $4
million in International) for the 12 weeks ended June 12, 1999 and June 13,
1998, respectively, and $8 million ($5 million in the U.S. and $3 million
in International) and $20 million ($13 million in the U.S. and $7 million
in International) for the 24 weeks ended June 12, 1999 and June 13, 1998,
respectively.
4. Changes In Accounting Principles and New Accounting Pronouncement
a. Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use
Effective December 27, 1998, we adopted Statement of Position 98-1 ("SOP
98-1"), "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 identifies the characteristics of
internal-use software and specifies that once the preliminary project stage
is complete, external direct costs, certain direct internal payroll and
payroll-related costs and interest costs incurred during the development of
computer software for internal use should be capitalized and amortized.
Previously, we expensed all these costs as incurred. For the 12 and 24
weeks ended June 12, 1999, we capitalized approximately $3 million and $5
million, respectively, of internally developed software costs and third
party software purchases incurred in 1999 associated with all active
projects, including those that were in process at December 27, 1998. We
amortize capitalized software costs on a straight-line basis over useful
lives of 3 to 7 years dependent on facts and circumstances. The majority of
the software being developed is not yet ready for use and, therefore, is
not currently being amortized.
b. Self-Insurance Actuarial Methodology
In 1999, the methodology used by our independent actuary was refined and
enhanced to provide a more reliable estimate of the self-insured portion of
our current and prior years' ultimate loss projections related to workers'
compensation, general liability and automobile liability insurance programs
(collectively "casualty losses"). Our prior practice was to apply a fixed
factor to increase our independent actuary's ultimate loss projections
which was at the 51% confidence level for each year to approximate our
targeted 75% confidence level. Confidence level means the likelihood that
our actual casualty losses will be equal to or below those estimates. Based
on our independent actuary's opinion, our prior practice produced a very
conservative confidence factor at a level higher than our target of 75%.
Our actuary now provides an actuarial estimate at our targeted 75%
confidence level for each self-insured year. This change in methodology
resulted in a one-time increase to our first quarter 1999 operating profit
of $8 million.
c. Change in Pension Discount Rate Methodology
In 1999, we changed our method of determining the pension discount rate to
better reflect the assumed investment strategies we would most likely use
to invest any short-term cash surpluses. Accounting for pensions requires
us to develop an assumed interest rate on securities with which the pension
liabilities could be effectively settled. In estimating this discount rate,
we look at rates of return on high-quality corporate fixed income
securities currently available and expected to be available during the
period to the maturity of the pension benefits. As it is impractical to
find an investment portfolio which exactly matches the estimated payment
stream of the pension benefits, we often have projected short-term cash
surpluses. Previously, we assumed that all short-term cash surpluses would
be invested in U.S. government securities. Our new methodology assumes that
our investment strategies would be equally divided between U.S. government
securities and high-quality corporate fixed income securities. The change
in methodology favorably increased our second quarter and year-to-date 1999
operating profit by approximately $1.5 million and $3 million,
respectively.
8
<PAGE>
d. Accounting for Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). This Statement
establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. This Statement requires that changes
in the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset the
related change in fair value on the hedged item in the income statement,
and requires that a company must formally document, designate and assess
the effectiveness of transactions that receive hedge accounting.
In June 1999, the FASB amended SFAS 133 to extend the required adoption
date from fiscal years beginning after June 15, 1999 to fiscal years
beginning after June 15, 2000. The amendment was in response to issues
identified by FASB constituents regarding implementation difficulties. A
company may implement the Statement as of the beginning of any fiscal
quarter after issuance, (that is, fiscal quarters beginning June 16, 1998
and thereafter). SFAS 133 cannot be applied retroactively. When adopted,
SFAS 133 must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued,
acquired, or substantively modified after December 31, 1998 (and, at the
company's election, before January 1, 1999).
We have not yet quantified the effects of adopting SFAS 133 on our
financial statements or determined the timing or method of our adoption of
SFAS 133. However, the adoption of the Statement could increase volatility
in our earnings and other comprehensive income.
5. Long-term Debt
During the 24 weeks ended June 12, 1999, we have made net payments of
approximately $380 million under our unsecured Term Loan Facility and our
unsecured Revolving Credit Facility (the "Facilities"). As discussed in our
1998 Form 10-K, amounts outstanding under the Revolving Credit Facility are
expected to fluctuate from time to time, but reductions to our unsecured
Term Loan Facility cannot be reborrowed. These payments reduced amounts
outstanding under our Revolving Credit Facility at June 12, 1999 to $1.50
billion from $1.81 billion at year-end 1998. We reduced amounts outstanding
under our Term Loan Facility at June 12, 1999 to $859 million from $926
million at year-end 1998. In addition, we had unused Revolving Credit
Facility borrowings available aggregating $1.36 billion, net of outstanding
letters of credit of $138 million. At June 12, 1999, the weighted average
interest rate on our variable rate debt was 6.0%, which included the
effects of the associated interest rate swaps and collars.
Interest expense on the short-term borrowings and long-term debt was $53
million and $71 million for the 12 weeks ended June 12, 1999 and June 13,
1998, respectively, and $109 million and $144 million for the 24 weeks
ended June 12, 1999 and June 13, 1998, respectively.
On March 24, 1999, we entered into an agreement to amend certain terms of
the Facilities. This amendment gives us additional flexibility with respect
to acquisitions and other investments, permitted investments and the
repurchase of Common Stock. In addition, we voluntarily reduced our maximum
borrowings under the Revolving Credit Facility from $3.25 billion to $3.00
billion. As a result of this amendment, we capitalized debt costs of
approximately $2.5 million. These costs are being amortized over the
remaining life of the Facilities. Additionally, an insignificant amount of
our previously deferred debt costs were written off in the second quarter
of 1999 as a result of this amendment.
9
<PAGE>
6. Comprehensive Income
Our quarterly total comprehensive income was as follows:
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
--------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income $ 179 $ 112 $ 285 $ 166
Currency translation adjustment 1 3 6 (34)
--------- --------- --------- ---------
Total comprehensive income $ 180 $ 115 $ 291 $ 132
========= ========= ========= =========
</TABLE>
7. Reportable Business Segments
<TABLE>
<CAPTION>
Revenues
--------------------------------------------
12 Weeks Ended 24 Weeks Ended
--------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
U.S. $ 1,395 $ 1,530 $ 2,761 $ 2,998
International 491 477 938 931
--------- --------- --------- ---------
$ 1,886 $ 2,007 $ 3,699 $ 3,929
========= ========= ========= =========
Operating Profit; Interest Expense, Net;
and Income Before Income Taxes
--------------------------------------------
12 Weeks Ended 24 Weeks Ended
--------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- --------- --------- ----------
U.S. $ 207 $ 190 $ 391 $ 316
International 57 35 112 77
Foreign exchange net loss (2) - (3) -
Unallocated and corporate expenses (42) (36) (78) (65)
Facility actions net gain 133 73 167 102
Unusual charges (4) - (4) -
--------- --------- --------- ---------
Total Operating Profit 349 262 585 430
Interest expense, net (51) (67) (103) (136)
--------- --------- --------- ---------
Income Before Income Taxes $ 298 $ 195 $ 482 $ 294
========= ========= ========= =========
Identifiable Assets
---------------------
6/12/99 12/26/98
--------- ---------
U.S. $ 2,723 $ 2,942
International 1,479 1,447
Corporate 217 142
--------- ---------
$ 4,419 $ 4,531
========= =========
Long-Lived Assets(a)
---------------------
6/12/99 12/26/98
--------- ---------
U.S. $ 2,386 $ 2,616
International 1,027 1,054
Corporate 38 36
--------- ---------
$ 3,451 $ 3,706
========= =========
</TABLE>
(a) Represents Property, Plant and Equipment, net, Intangible Assets, net
and Investments in Unconsolidated Affiliates.
10
<PAGE>
8. Commitments And Contingencies
Relationship with Former Parent After Spin-off
As disclosed in our 1998 Form 10-K, in connection with the October 6, 1997
spin-off from PepsiCo, Inc. ("PepsiCo") (the "Spin-off"), separation and
other related agreements (collectively, "the Separation Agreement") were
entered into which contain certain indemnities to the parties and provide
for the allocation of tax and other assets, liabilities and obligations
arising from periods prior to the Spin-off. The Separation Agreement
provided for, among other things, our assumption of all liabilities
relating to the restaurant businesses, inclusive of our non-core
businesses, and our indemnification of PepsiCo with respect to these
liabilities. The non-core businesses were disposed of in 1997 and consisted
of California Pizza Kitchen, Chevys Mexican Restaurant, D'Angelo's Sandwich
Shops, East Side Mario's and Hot `n Now (collectively the "Non-core
Businesses"). Subsequent to Spin-off, claims have been made by certain
Non-core Business franchisees and a purchaser of one of the businesses.
Certain of these claims have been settled and we are disputing the validity
of the remaining claims. We believe that any settlement of these claims at
amounts in excess of previously recorded liabilities is not likely to have
a material adverse effect on our results of operations, financial condition
or cash flows.
In addition, we must pay a fee to PepsiCo for all letters of credit,
guarantees and contingent liabilities relating to our businesses under
which PepsiCo remains liable. This obligation ends at the time the
instruments are released, terminated or replaced by a qualified letter of
credit covering the full amount of contingencies under the letters of
credit, guarantees and contingent liabilities. Our fee payments to PepsiCo
during the second quarter of 1999 were immaterial. We have also indemnified
PepsiCo for any costs or losses it incurs with respect to these letters of
credit, guarantees and contingent liabilities. We have not been required to
make any payments under these indemnities.
Under the Separation Agreement, PepsiCo maintains full control and absolute
discretion with regard to any combined or consolidated tax filings for
periods through the Spin-off date. PepsiCo also maintains full control and
absolute discretion regarding common tax audit issues. Although PepsiCo has
contractually agreed to, in good faith, use its best efforts to settle all
joint interests in any common audit issue on a basis consistent with prior
practice, there can be no assurance that determinations so made by PepsiCo
would be the same as we would reach, acting on our own behalf.
We have agreed to certain restrictions on future actions to help ensure
that the Spin-off maintains its tax-free status. Restrictions include,
among other things, limitations on the liquidation, merger or consolidation
with another company, certain issuances and redemptions of our Common
Stock, the granting of stock options and our sale, refranchising,
distribution or other disposition of assets. If we fail to abide by these
restrictions or to obtain waivers from PepsiCo and, as a result, the
Spin-off fails to qualify as a tax-free reorganization, we will be
obligated to indemnify PepsiCo for any resulting tax liability, which could
be substantial. No payments under these indemnities have been required
through the second quarter of 1999. Additionally, under the terms of the
tax separation agreement, PepsiCo is entitled to the federal income tax
benefits related to the exercise after the Spin-off of vested PepsiCo
options held by our employees.
11
<PAGE>
Other Commitments and Contingencies
-----------------------------------
We were directly or indirectly contingently liable in the amounts of $347
million and $327 million at June 12, 1999 and December 26, 1998,
respectively, for certain lease assignments and guarantees. In connection
with these contingent liabilities, after the Spin-off we were required to
maintain cash collateral balances at certain institutions of approximately
$30 million, which are included in Other Assets in the accompanying
Condensed Consolidated Balance Sheet. At June 12, 1999, $269 million
represented contingent liabilities to lessors as a result of our assigning
our interest in and obligations under real estate leases as a condition to
the refranchising of Company restaurants. The $269 million represented the
present value of the minimum payments of the assigned leases, excluding any
renewal option periods, discounted at our pre-tax cost of debt. On a
nominal basis, the contingent liability resulting from the assigned leases
was $405 million. The balance of the contingent liabilities primarily
reflected our guarantees to support financial arrangements of certain
unconsolidated affiliates and restaurant franchisees.
During 1999, and for a significant portion of the three years ended
December 26, 1998, we have been effectively self-insured for most of our
casualty losses, subject to per occurrence and aggregate annual liability
limitations. We determine our liabilities for casualty claims reported and
for casualty claims incurred but not reported based on information provided
by our independent actuaries. Prior to the Spin-off, we participated with
PepsiCo in a guaranteed cost program for certain casualty loss coverages in
1997. Currently, we are self-insured up to a $5 million aggregate retention
for property losses in excess of applicable per occurrence deductibles.
In July 1998, we entered into severance agreements with certain key
executives which are triggered by a termination, under certain conditions,
of the executive following a change in control of the Company, as defined
in the agreements. Once triggered, the affected executives would receive
twice the amount of their annual base salary and their annual incentive in
a lump sum, outplacement services and a tax gross-up for any excise taxes.
The agreements expire December 31, 2000. Since the timing of any payments
under these agreements cannot be anticipated, the amounts are not
estimable. However, these payments, if required, could be substantial. In
connection with the execution of these agreements, the Compensation
Committee of our Board of Directors has authorized amendment of the
deferred and incentive compensation plans and, following a change in
control, an establishment of rabbi trusts which will be used to provide
payouts under these deferred compensation plans.
We are subject to various claims and contingencies related to lawsuits,
taxes, environmental and other matters arising out of the normal course of
business. Like some other large retail employers, Pizza Hut and Taco Bell
recently have been faced in a few states with allegations of purported
class-wide wage and hour violations.
On May 11, 1998, a purported class action lawsuit against Pizza Hut, Inc.,
and one of its franchisees, PacPizza, LLC, entitled Aguardo, et al. v.
Pizza Hut, Inc., et al. ("Aguardo"), was filed in the Superior Court of the
State of California of the County of San Francisco. The lawsuit was filed
by three former Pizza Hut restaurant general managers purporting to
represent approximately 1,300 current and former California restaurant
general managers of Pizza Hut and PacPizza. The lawsuit alleges violations
of state wage and hour laws involving unpaid overtime wages and vacation
pay and seeks an unspecified amount in damages. This lawsuit is in the
early discovery phase. A trial date of October 28, 1999 has been set.
12
<PAGE>
On October 2, 1996, a class action lawsuit against Taco Bell Corp.,
entitled Mynaf, et al. v. Taco Bell Corp. ("Mynaf"), was filed in the
Superior Court of the State of California of the County of Santa Clara. The
lawsuit was filed by two former restaurant general managers and two former
assistant restaurant general managers purporting to represent all current
and former Taco Bell restaurant general managers and assistant restaurant
general managers in California. The lawsuit alleges violations of
California wage and hour laws involving unpaid overtime wages. The
complaint also includes an unfair business practices claim. The four named
plaintiffs claim individual damages ranging from $10,000 to $100,000 each.
On September 17, 1998, the court certified a class of approximately 3,000
current and former assistant restaurant general managers and restaurant
general managers. Taco Bell petitioned the appellate court to review the
trial court's certification order. The petition was denied on December 31,
1998. Taco Bell then filed a petition for review with the California
Supreme Court, and the petition was subsequently denied. The parties are
scheduled for a case management conference on September 7, 1999, at which
time a trial date will likely be set.
Plaintiffs in the Aguardo and Mynaf lawsuits seek damages, penalties and
costs of litigation, including attorneys' fees, and also seek declaratory
and injunctive relief. We intend to vigorously defend these lawsuits.
However, the outcome of these lawsuits cannot be predicted at this time. We
believe that the ultimate liability, if any, arising from these claims or
contingencies is not likely to have a material adverse effect on our annual
results of operations, financial condition or cash flows. It is, however,
reasonably possible that if an unfavorable ruling were to occur in any
specific period it could be material to our year-over-year growth in
earnings in the quarter and year recorded.
On August 29, 1997, a class action lawsuit against Taco Bell Corp.,
entitled Bravo, et al. v. Taco Bell Corp. ("Bravo"), was filed in the
Circuit Court of the State of Oregon of the County of Multnomah. The
lawsuit was filed by two former Taco Bell shift managers purporting to
represent approximately 16,000 current and former hourly employees
statewide. The lawsuit alleges violations of state wage and hour laws,
principally involving unpaid wages including overtime, and rest and meal
period violations, and seeks an unspecified amount in damages. Under Oregon
class action procedures, Taco Bell was allowed an opportunity to "cure" the
unpaid wage and hour allegations by opening a claims process to all
putative class members prior to certification of the class. In this cure
process, Taco Bell has currently paid out less than $1 million. On January
26, 1999, the Court certified a class of all current and former shift
managers and crew members who claim one or more of the alleged violations.
The lawsuit is in the early discovery phase. A trial date of November 2,
1999 has been set.
On February 10, 1995, a class action lawsuit, entitled Ryder, et al. v.
Taco Bell Corp. ("Ryder"), was filed in the Superior Court of the State of
Washington for King County on behalf of approximately 16,000 current and
former Taco Bell employees claiming unpaid wages resulting from alleged
uniform, rest and meal period violations and unpaid overtime. In April
1996, the Court certified the class for purposes of injunctive relief and a
finding on the issue of liability. The trial was held during the first
quarter of 1997 and resulted in a liability finding. In August 1997, the
Court certified the class for purposes of damages as well. Prior to the
damages phase of the trial, the parties reached a court-approved settlement
process in April 1998.
We have provided for the estimated costs of the Bravo and Ryder
litigations, based on a projection of eligible claims (including claims
filed to date, where applicable), the cost of each eligible claim and the
estimated legal fees incurred by plaintiffs. Although the outcome of this
litigation cannot be determined at this time, we believe the ultimate cost
of the Bravo and Ryder cases in excess of the amounts already provided will
not be material to our annual results of operations, financial condition or
cash flows.
13
<PAGE>
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Introduction
TRICON Global Restaurants, Inc. and Subsidiaries (collectively referred to
as "TRICON," the "Company," "we" or "us") became an independent, publicly owned
company on October 6, 1997 (the "Spin-off Date") via a tax free distribution of
our Common Stock (the "Distribution" or "Spin-off") to the shareholders of our
former parent, PepsiCo, Inc. ("PepsiCo"). TRICON is comprised of the worldwide
operations of KFC, Pizza Hut and Taco Bell. The Spin-off marked our beginning as
a company focused solely on the restaurant business and our three
well-recognized concepts, which together have more retail units worldwide than
any other single quick service restaurant ("QSR") company. The following
Management's Discussion and Analysis should be read in conjunction with the
unaudited Condensed Consolidated Financial Statements which begin on page 3, the
Cautionary Statements on page 36 and our 1998 Form 10-K for the year ended
December 26, 1998 ("1998 Form 10-K"). All Note references herein refer to the
accompanying notes to the Condensed Consolidated Financial Statements.
In our discussion volume is the estimated dollar effect of the
year-over-year change in customer transaction counts from existing and new
products. Effective net pricing includes the estimated increases/decreases in
price and the effect of changes in product mix. Portfolio effect represents the
estimated impact on revenue, restaurant margin or operating profit related to
our refranchising initiative and closure of stores. System sales represents our
combined sales of Company, joint ventured, franchised and licensed units. Where
actual sales data is not reported, our franchised and licensed unit sales are
estimated. Ongoing operating profit represents our operating profit excluding
facility actions net gain, unusual charges and the impact of accounting changes.
NM in any table indicates that the percentage is not considered meaningful. B(W)
in any table means % better (worse). Tabular amounts are displayed in millions
except per share and unit count amounts, or as specifically identified. In
addition, throughout our discussion, we use the terms restaurants, units and
stores interchangeably.
The following factors impacted comparability of operating performance in
the quarter and year-to-date ended June 12, 1999 and could impact the remainder
of 1999. Certain of these factors were previously discussed in our 1998 Form
10-K.
Euro Conversion
---------------
On January 1, 1999, eleven of the fifteen member countries of the European
Economic and Monetary Union ("EMU") adopted the Euro as a common legal currency
and fixed conversion rates were established. From that date through June 30,
2002, participating countries will maintain both legacy currencies and the Euro
as legal tender. Beginning January 1, 2002, new Euro-denominated bills and coins
will be issued and a transition period of up to six months will begin during
which legacy currencies will be removed from circulation.
As disclosed in our 1998 Form 10-K, we have Company and franchised
businesses in the adopting member countries, which are preparing for the
conversion. Expenditures associated with conversion efforts to date have been
insignificant. We currently estimate that our spending over the ensuing
three-year transition period will be approximately $16 million, related to the
conversion in the EMU member countries in which we operate stores. These
expenditures primarily relate to capital expenditures for new point-of-sale and
back-of-house hardware and software to accommodate Euro-denominated
transactions. We expect that adoption of the Euro by the U.K. would
significantly increase this estimate due to the size of our businesses there
relative to our aggregate businesses in the adopting member countries in which
we operate.
14
<PAGE>
The speed of ultimate consumer acceptance of and our competitors' responses
to the Euro are currently unknown and may impact our existing plans. However, we
know that, from a competitive perspective, we will be required to assess the
impacts of product price transparency, potentially revise product bundling
strategies and create Euro-friendly price points prior to 2002. We do not
believe that these activities will have sustained adverse impacts on our
businesses. Although the Euro does offer certain benefits to our treasury and
procurement activities, these are not currently anticipated to be significant.
We currently anticipate that our suppliers and distributors will continue
to invoice us in legacy currencies until late 2001. We expect to begin dual
pricing in our restaurants in 2001. We expect to compensate employees in Euros
beginning in 2002. We believe that the most critical activity regarding the
conversion for our businesses is the completion of the rollout of Euro-ready
point-of-sale equipment and software by the end of 2001. Our current plans
should enable us to be Euro-compliant prior to the requirements for these
activities. Any delays in our ability to complete our plans, or in the ability
of our key suppliers to be Euro-compliant, could have a material adverse impact
on our results of operations, financial condition or cash flows.
Year 2000
---------
We have established an enterprise-wide plan to prepare our information
technology systems (IT) and non-information technology systems with embedded
technology applications (ET) for the Year 2000 issue, to reasonably assure that
our critical business partners are prepared and to plan for business continuity
as we enter the coming millennium.
Our plan encompasses the use of both internal and external resources to
identify, correct and test systems for Year 2000 readiness. External resources
include nationally recognized consulting firms and other contract resources to
supplement available internal resources.
The phases of our plan - awareness, assessment, remediation, testing and
implementation - are currently expected to cost approximately $68 to $71 million
from 1997 through completion in 2000. As discussed in our first quarter 1999
Form 10-Q, this estimate is higher than our estimate of $62 to $65 million
disclosed in our 1998 Form 10-K. Our estimate was increased by the cost of
additional resources needed in the remediation and testing phases and higher
than estimated personnel costs, including retention incentives for critical
personnel. Our plan contemplates our own IT/ET as well as assessment and
contingency planning relative to Year 2000 business risks inherent in our
material third party relationships. The total cost represents less than 20% of
our total estimated information technology related expenses over the plan
period. We have incurred approximately $53 million from inception of planned
actions through June 12, 1999 of which approximately $18 million has been
incurred during 1999 ($10 million in the second quarter). We expect to incur
approximately $31 million in 1999 with some additional problem resolution
spending in 2000. We expect to fund all costs related to our Year 2000 plan
through cash flows from operations.
IT/ET State of Readiness - We have completed our inventory process of
hardware (including desktops), software (third party and internally developed)
and embedded technology applications (collectively "IT/ET applications" as
defined below). However, as we progress through the phases of our plan, we will
continue to refine and improve our process to track the status and
classification of our new and existing IT/ET applications. As a result of these
refinements, we have modified the amounts presented in the application tables
presented below. In addition, we have implemented monitoring procedures designed
to insure that new IT/ET investments are Year 2000 compliant.
Based on this inventory, we identified the critical IT/ET applications and
are in the process of determining the Year 2000 compliance status of these
applications through third party vendor inquiry or internal processes. We have
substantially completed the conversion (which includes replacement and
remediation) and unit testing
15
<PAGE>
of the majority of critical U.S. systems. As disclosed in our 1998 Form 10-K, we
extended our original timeline to late summer for approximately ten critical
applications. However, we have now completed remediation and unit testing on six
of these applications. We still expect to be able to convert, consolidate or
replace three of the remaining applications by late summer, with completion of
the fourth and final application in the fall. This timetable reflects certain
delays attributable to identified incremental complexities of the remediation
processes as well as slippage in the execution of our remediation plan. Further
delays on these efforts or additional slippage could be detrimental to our
overall state of readiness. We have made considerable progress on our
international IT/ET conversion efforts of critical applications during the first
half of 1999. Our current plans call for timely conversion of critical
international systems primarily to compliant versions of unmodified third party
applications which are predominant in our international business. We will
continue to closely monitor international progress. We expect to continue
integration testing on remediated, replaced and consolidated U.S. and
international systems throughout 1999.
The following table identifies by category and status the major identified
IT/ET applications at June 12, 1999:
Remediated/ Not
Category Compliant In-Process Compliant
------------------------------ --------- ----------- ---------
Third Party Developed Software 715 441 593
Internally Developed Software 382 560 152
Desktop 1,279 1,015 955
Hardware 1,034 642 267
ET 1,892 819 211
Other 98 90 27
--------- ----------- ---------
5,400 3,567 2,205
========= =========== =========
Note: We have defined the term applications (as used in this Year 2000
discussion) to describe separately identifiable groups of
programs, hardware or ET which can be both logically segregated
by business purpose and separately unit tested as to performance
of a single business function. We will continue to either replace
or retire "Not Compliant" applications before January 1, 2000.
"Compliant" applications include only those applications that are
Year 2000 compliant and currently in production. Applications
have been prioritized and are being remediated based on expected
impact of non-remediation. Of the remaining 560
"Remediated/In-Process" applications in the Internally Developed
Software category, which by definition require internal
remediation, less than half have been identified as critical. As
we have anticipated, approximately 80% of these remaining
critical applications are smaller international applications used
within individual countries. The remediation of these
applications is on track and is being addressed by multiple teams
in those countries which should result in the completion of a
substantial number of these applications during the third
quarter. Overall, total applications considered "Compliant"
increased approximately 12% in the quarter to 48%.
Material Third Party Relationships - We are dependent in part on the
abilities of many third parties, particularly our suppliers and franchisees, to
be Year 2000 compliant. We have taken what we believe are prudent actions
described below to address third party risk, however, we are not able to require
compliance actions by these parties. While we believe our actions should
mitigate the third party Year 2000 risks, we are unable to eliminate the risks
or to estimate the ultimate impact, if any, on our operating results for 2000.
16
<PAGE>
We believe that our critical third party relationships can be subdivided
generally into suppliers, banks, franchisees and other service providers
(primarily data exchange partners). We completed an inventory of U.S. and
international restaurant suppliers and have mailed letters requesting
information regarding their Year 2000 status. We have collected the responses
from the suppliers and have assessed their Year 2000 risks. Of approximately 550
suppliers considered critical, approximately 13% are high risk based on their
responses and approximately 7% have not yet responded to inquiries to date. In
partnership with a newly formed systemwide U.S. purchasing cooperative ("Unified
Co-op"), which was described in our 1998 Form 10-K, we are planning to conduct
site visits of select critical suppliers during the next few months to further
assess their Year 2000 readiness. With the assistance of the Unified Co-op, we
are developing contingency plans for those U.S. suppliers that are not deemed
Year 2000 compliant. These contingency plans, which we expect to be completed by
late summer 1999, include sourcing by the Unified Co-op from alternate compliant
suppliers where possible. By late summer 1999, we also expect to develop
contingency plans for the international suppliers that we believe have
substantial Year 2000 operational risks.
In the first part of 1999, we completed the identification of our U.S.
depository banks and the international banks responsible for processing
restaurant deposits and disbursements ("Depository Banks"). We have sent letters
or obtained other information regarding Year 2000 compliance information from
our primary lending and cash management banks ("Relationship Banks") and our
Depository Banks. We have obtained compliance information from substantially all
of our Relationship Banks and critical Depository Banks. We are in the process
of following up with the banks that have not responded to the request. In
addition, we intend to develop contingency plans during the latter part of the
year for all critical banks we believe have substantial Year 2000 operational
risks.
We have almost 1,200 U.S. and approximately 950 international franchisees.
We have sent information to all U.S. and international franchisees regarding the
business risks associated with Year 2000. In addition, we provided sample IT/ET
project plans and a report of the compliance status of Company restaurants to
the U.S. franchisees. At the end of the first quarter of 1999, we mailed letters
to all U.S. franchisees requesting information regarding their Year 2000 status.
During the second quarter, we obtained compliance information, including an
inventory of their point-of-sale hardware and software, from approximately 75%
of our U.S. franchisees. As a result of this survey, we are holding regional
workshops and meetings during the third quarter to provide interested
franchisees with additional information regarding general and specific Year 2000
readiness programs. In addition, we are contacting the major identified
point-of-sale vendors to assist the franchise community in determining Year 2000
compliance of their in-store applications. Outside the U.S., our regional
franchise offices are soliciting compliance information using surveys either by
written request or by direct contact with all franchisees. During the second
quarter, we have obtained compliance information from approximately 40% of our
international franchisees. In the third quarter, we will conduct workshops or
on-site meetings based on surveys received to provide interested international
franchisees with additional information regarding general and specific Year 2000
readiness programs.
We have identified third party companies that provide critical data
exchange services and mailed letters to these companies requesting Year 2000
status. We will develop contingency plans for companies that we believe have
significant Year 2000 operational risks. Additionally, we are in the process of
identifying all other third party companies that provide business critical
services. We are planning to follow the same process used for the data exchange
service providers.
17
<PAGE>
The following table indicates by type of third party risk the status of the
readiness process:
Information Information Not Yet
Received Received
----------- -------------------
Suppliers 505 38
Relationship Banks 68 8
Depository Banks 608 208
Data Exchange Service Providers 93 47
----------- -------------------
1,274 301
=========== ===================
Note: During the first quarter, we increased the number of Data Exchange
Service Providers to include additional service providers that
were identified as critical. The letters for these providers were
mailed at the beginning of the second quarter.
The forward-looking nature and lack of historical precedent for Year 2000
issues present a difficult disclosure challenge. Only one thing is certain about
the impact of Year 2000 - it is difficult to predict with certainty what truly
will happen after December 31, 1999. We have based our Year 2000 costs and
timetables on our best current estimates, which we derived using numerous
assumptions of future events including the continued availability of certain
resources and other factors. However, we cannot guarantee that these estimates
will be achieved and actual results could differ materially from our plans.
Given our best efforts and execution of remediation, replacement and testing, it
is still possible that there will be disruptions and unexpected business
problems during the early months of 2000. We anticipate making diligent,
reasonable efforts to assess Year 2000 readiness of our critical business
partners and will ultimately develop contingency plans for business critical
systems prior to the end of 1999. However, we are heavily dependent on the
continued normal operations of not only our key suppliers of chicken, cheese,
beef, tortillas and other raw materials and our major food and supplies
distributor, but also on other entities such as lending, depository and
disbursement banks and third party administrators of our benefit plans. Despite
our diligent preparation, unanticipated third party failures, general public
infrastructure failures, or our failure to successfully conclude our remediation
efforts as planned could have a material adverse impact on our results of
operations, financial condition or cash flows in 1999 and beyond. Inability of
our larger franchisees to remit franchise fees on a timely basis or lack of
publicly available hard currency or credit card processing capability supporting
our retail sales stream could also have material adverse impact on our results
of operations, financial condition or cash flows.
Other Factors Affecting Comparability
Accounting Changes
------------------
In our 1998 Form 10-K, we discussed several accounting and human resource
policy changes (collectively, the "accounting changes") that would impact our
1999 operating profit. These changes, which we believe are material in the
aggregate, fall into three categories:
o required changes in Generally Accepted Accounting Principles ("GAAP"),
o discretionary methodology changes implemented to more accurately measure
certain liabilities and
o policy changes driven by our human resource and accounting standardization
programs.
18
<PAGE>
Required Changes in GAAP- As more fully described in Note 4, we adopted
Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." For the quarter and
year-to-date, we capitalized approximately $3 million and $5 million,
respectively, of internal software development costs and of third party software
costs that we would have previously expensed. The majority of the software being
developed is not yet ready for use and, therefore, is not currently being
amortized. We previously estimated for the full year 1999 we would capitalize
approximately $12 million of internal software development and third party
software costs previously expensed. We have revised our estimate for the full
year to $15 million to reflect additional software costs related to new projects
not included in our original estimate. The remaining impact of this change will
be recognized over the balance of the year.
In addition, we adopted Emerging Issues Task Force Issue No. 97-11 ("EITF
97-11"), "Accounting for Internal Costs Relating to Real Estate Property
Acquisitions," upon its issuance in March 1998. In the first quarter of 1999, we
also made a discretionary policy change limiting the types of costs eligible for
capitalization to those direct cost types described as capitalizable under SOP
98-1. As noted in our 1998 Form 10-K, we estimate the full year impact on our
1999 operating profit for the application of EITF 97-11 and the policy change
will result in approximately $4 million of additional expense. For the second
quarter and year-to-date, this change unfavorably impacted operating profit by
approximately $1 million and $3 million, respectively. The estimated remaining
impact, which is related only to the discretionary policy change, will be
recognized over the balance of 1999.
To conform to the Securities and Exchange Commission's April 23, 1998
letter interpretation of Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," our store closure accounting policy was changed in 1998. Prior
to April 23, 1998, we recognized store closure costs and generally suspended
depreciation and amortization when we decided to close a restaurant within the
next twelve months. Effective for closure decisions made on or subsequent to
April 23, 1998, we recognize store closure costs when we have closed the
restaurant within the same quarter the closure decision is made. When we decide
to close a restaurant beyond the quarter in which the closure decision is made,
it is reviewed for impairment. The impairment evaluation is based on the
estimated cash flows from continuing use until the expected date of disposal
plus the expected terminal value. This change in accounting resulted in
additional depreciation and amortization in the second quarter and year-to-date
of approximately $2 million and $3 million, respectively. The estimated full
year impact of this change to operating profit excluding facility actions net
gain is approximately $6 million.
The changes to our policy and practice regarding the timing of recognition
of our relocation expense had a favorable impact on our second quarter and
year-to-date operating profit of approximately $1 million and $2 million,
respectively. We currently estimate this change will have an insignificant
impact on a full year basis.
Discretionary Methodology Changes- As more fully described in Note 4, the
methodology used by our independent actuary was refined and enhanced to provide
a more reliable estimate of the self-insured portion of our current and prior
years' ultimate loss projections related to workers' compensation, general
liability and automobile liability insurance programs (collectively "casualty
loss(es)"). Our first quarter operating profit included a one-time favorable
increase of over $8 million relating to this change in methodology. In our 1998
Form 10-K, we estimated the impact of the change to be approximately $5 million.
In addition, as more fully described in Note 4, we changed our method of
determining the pension discount rate to better reflect the assumed investment
strategies we would most likely use to invest any short-term cash surpluses. The
pension discount methodology change resulted in a favorable impact of
approximately $1.5 million and $3 million to quarter and year-to-date operating
profit, respectively. Consistent with our 1998 Form 10-K estimate, the change in
methodology will favorably impact 1999 operating profit by approximately $6
million. The remaining impact of $3 million will be recognized over the balance
of 1999.
19
<PAGE>
Human Resource and Accounting Standardization Programs - In the first
quarter of 1999, we began the standardization of our U.S. personnel practices.
As noted in our 1998 Form 10-K, most of these changes are not expected to have a
significant impact on our operating profit. Over a two-year implementation
period, our vacation policy is being conformed to a fiscal-year based,
earn-as-you-go, use-or-lose policy. We now estimate the 1999 reduction of our
accrued vacation liabilities to be approximately $7 million. We previously
disclosed the reduction could have been as much as $20 million; however, due to
the adoption in the current year of a new transitional policy relating to buyout
provisions and extended carryover elections for certain employees, this estimate
has been reduced to $7 million. At this time, the number of employees to be
offered buyout or extension has been estimated; a final determination will be
made later this year. The increase in our second quarter and year-to-date
operating profit related to this change was approximately $3 million and $4
million, respectively. The estimated remaining impact of approximately $3
million will be recognized over the balance of 1999.
At the beginning of 1999, we began the standardization of accounting
practices in our U.S. operating companies. The increase in operating profit
related to these changes for the quarter was approximately $1 million and on a
year-to-date basis was immaterial. We currently estimate that standardizing our
accounting practices, which includes our vacation policy change, will favorably
impact our 1999 operating profit by approximately $5 million.
The estimated impact of these accounting changes are summarized below:
12 Weeks 24 Weeks
Ended Ended Full Year
6/12/99 6/12/99 Estimate
-------- --------- ----------
GAAP $ 1 $ 1 $ 6
Methodology 1 11 14
Standardization 4 4 5
-------- --------- ----------
Pre-tax $ 6 16 $ 25
======== ========= ==========
After-tax $ 4 10 $ 16(a)
======== ========= ==========
Per diluted share $ 0.02 $ 0.06 $ 0.10(a)
======== ========= ==========
(a) On a pro forma basis; the after-tax and per diluted share amounts were
calculated assuming the same effective tax rate and diluted shares in
use as of June 12, 1999.
Additional Factors Disclosed in our 1998 Form 10-K Expected to Impact 1999
Comparisons with 1998
---------------------------------------------------------------------------
In the fourth quarter of 1998, we incurred severance and other exit costs
related to strategic decisions to streamline the infrastructure of our
international businesses. We disclosed in our 1998 Form 10-K that we expected to
incur approximately $5 million of additional costs related to this initiative in
1999. We currently estimate we will incur approximately $8 million throughout
1999. Our estimate has been revised to include additional severance. For the
second quarter and year-to-date, we incurred $2 million related to these planned
actions.
As disclosed in our 1998 Form 10-K, certain cost recovery agreements with
Ameriserve and PepsiCo were terminated in the latter part of 1998. As a result,
our general, administrative and other expenses increased $1 million and $5
million in the quarter and year-to-date, respectively. The remaining impact on
the year-over-year change in general, administrative and other expenses
resulting from the termination of these contracts of approximately $3 million
will be reflected throughout the remainder of 1999.
20
<PAGE>
We are phasing in certain structural changes to our Executive Income
Deferral Program ("EID") during 1999 and 2000. One such 1999 change requires all
payouts under the plan to be made only in our Common Stock versus payouts in
cash or Common Stock at our option. For 1999, this restriction applies only if
the participant's original deferrals were invested in discounted stock units of
our Common Stock. Previously, for accounting purposes, we were required to
assume the payment was to be made in cash. As a result of this change, we no
longer expense the appreciation, if any, attributable to the investments in
these discounted stock units. We expensed approximately $2 million and $10
million in appreciation for the 24 weeks ended June 13, 1998 and the full year
1998, respectively. The amount expensed in the second quarter of 1998 was
immaterial.
Additional Factors Affecting 1999 Comparisons with 1998
-------------------------------------------------------
During 1999, and for a significant portion of the three years ended
December 26, 1998, we have been effectively self-insured for most of our
casualty losses, subject to per occurrence and aggregate annual liability
limitations. We determine our liabilities for casualty claims reported and for
casualty claims incurred but not reported based on information provided by our
independent actuaries. Prior to the Spin-off, we participated with PepsiCo in a
guaranteed cost program for certain casualty loss coverages in 1997. Currently,
we are self-insured up to a $5 million aggregate retention for property losses
in excess of applicable per occurrence deductibles.
Prior to our Spin-off from PepsiCo, we had our actuary perform valuations
two times a year. However, given the complexities of the Spin-off, we had only
one 1998 valuation, based on information through June 30, 1998, which we
received and recognized in the fourth quarter of that year. In the first quarter
of 1999, we received a valuation from the actuary based on information through
December 31, 1998. As a result, we have a timing difference in our actuarial
adjustments, from recognizing the entire 1998 adjustment in the fourth quarter
of 1998 to recognizing another adjustment in the first quarter of 1999. We
expect that, beginning in 2000, valuations will be received and required
adjustments will be made in the second and fourth quarters of each year.
Based on our independent actuary's valuation received in the first quarter
of 1999, we recognized approximately $21 million in the first quarter of
favorable adjustments to our self-insured casualty loss reserves. These
adjustments resulted primarily from improved loss trends related to our 1998
casualty losses across all three of our U.S. operating companies. We believe the
favorable adjustments are a direct result of our investment in safety and
security programs to better manage risk at the store level. We are unable to
reliably estimate the impact of our second 1999 actuarial valuation, which we
expect to receive in the fourth quarter. We recognized $23 million of favorable
casualty-related adjustments in 1998, all of which were recorded in the fourth
quarter. In 1997, we recognized favorable adjustments of approximately $18
million to our casualty loss expense, primarily in the second quarter. The 1998
and 1997 favorable adjustments included both actuarial and insurance-related
components. We are prospectively reducing our 1999 casualty loss estimates to
the actuary's last estimate, which reflected our improved loss trends.
We will continue to make adjustments both based on our actuary's periodic
valuations as well as whenever there are significant changes in the expected
costs of settling large claims not contemplated by the actuary. Due to the
inherent volatility of our actuarially-determined casualty loss estimates,
future adjustments are not reliably estimable and may vary in magnitude with
each valuation. If these adjustments significantly impact our margin growth
trends, they will be disclosed.
During the third quarter, we expect to make changes to our U.S. and
portions of our International property and casualty loss programs which we
believe will reduce our annual property and casualty costs. Under the new
program, we will bundle our risks for casualty losses, property losses and most
other insurable risks into one risk pool with a single large retention limit. In
aggregate, the annual risk we are retaining will still be
21
<PAGE>
approximately equal to the sum of the estimated annual self-insured retention
amounts under the per occurrence limits of our existing insurance agreements.
Based on our history of property and casualty losses, the new program should
result in lower annual costs in most years due to lower premium costs. However,
since all of these risks have been pooled and there are no per occurrence limits
for individual claims, it is possible that we may experience increased
volatility in property and casualty losses on a quarter to quarter basis. This
would occur if an individual large loss is incurred either early in a program
year or when the latest actuarial projection of losses for a program year is
significantly below our aggregate loss retention. A large loss is defined as a
loss in excess of $2 million which is our current per occurrence casualty loss
limit.
Our quarter and year-to-date operating profit, compared to 1998, were
favorably impacted by an increase in rebates from our suppliers of beverage
products ("beverage rebates"). These increased beverage rebates reflect new
contracts, more favorable contract terms, higher volumes and retroactive
beverage rebates recognized and recorded in 1999 of approximately $1 million and
$6 million in the quarter and year-to-date, respectively, relating to 1998.
1997 Fourth Quarter Charge
--------------------------
In the fourth quarter of 1997, we recorded a $530 million unusual charge
($425 million after-tax). The charge included estimates for (1) costs of closing
stores, primarily at Pizza Hut and internationally; (2) reduction to fair market
value, less costs to sell, of the carrying amounts of certain restaurants we
intended to refranchise; (3) impairment of certain restaurants intended to be
used in the business; (4) impairment of certain joint venture investments to be
retained; and (5) costs of related personnel reductions. Of the $530 million
charge, approximately $401 million related to asset writedowns and approximately
$129 million related to liabilities, primarily occupancy-related costs and, to a
much lesser extent, severance. The liabilities were expected to be settled from
cash flows provided by operations. Through June 12, 1999, the amounts utilized
apply only to the actions covered by the charge. As indicated in our first
quarter 1999 Form 10-Q, we will continue to re-evaluate our prior estimates of
fair market value of units to be refranchised or closed throughout 1999. Based
on decisions to retain stores originally expected to be disposed of and
better-than-expected proceeds from refranchisings, we reversed $3 million ($2
million after-tax) and $4 million ($3 million after-tax) in the second quarter
and year-to-date, respectively, of the charge. These reversals increased our
facility actions net gain for both the quarter and year-to-date. Largely as a
result of decisions to retain certain stores originally expected to be disposed
of, better-than-expected proceeds from refranchising and favorable lease
settlements on certain closed store leases, we have reversed $69 million of the
charge during 1998 and through the second quarter of 1999.
Although we originally expected to refranchise or close all 1,392 units
included in the original charge by year-end 1998, the disposal of 531 units was
delayed. We expect to dispose of the remaining units during 1999. Below is a
summary of activity through the second quarter of 1999 related to the remaining
units from the 1997 fourth quarter charge:
Total Units
Units Expected to be Included in
Closed Refranchised the Charge
-------- -------------- ------------
Units at December 26, 1998 123 408 531
Units disposed of (65) (108) (173)
Units retained (14) (10) (24)
Change in method of disposal (11) 11 -
Other 5 (1) 4
-------- -------------- ------------
Units at June 12, 1999 38 300 338
======== ============== ============
22
<PAGE>
Of the original $530 million charge, approximately $140 million represented
impairment charges for certain restaurants intended to be used in the business
and for certain joint venture investments to be retained, which were recorded as
permanent reductions of the carrying value of those assets.
Below is a summary of the 1999 activity related to our asset valuation
allowances and liabilities recognized as a result of the 1997 fourth quarter
charge:
Asset
Valuation
Allowances Liabilities Total
---------- ----------- --------
Remaining balance at December 26, 1998 $ 97 $ 44 $ 141
Utilizations (33) (14) (47)
(Income) expense impacts:
Completed transactions(a) (1) 1 -
Decision changes(a) (3) (1) (4)
Other 3 - 3
---------- ----------- --------
Remaining balance at June 12, 1999 $ 63 $ 30 $ 93
========== =========== ========
(a) Favorable adjustments to our 1997 fourth quarter charge of
approximately $3 million and $4 million for the quarter and
year-to-date, respectively, were related to decisions to retain
certain stores originally expected to be refranchised or closed and
better-than-expected proceeds from refranchising.
We believe that the remaining amounts are adequate to complete our current
plan of disposal. However, actual results could differ from our estimates.
In addition, we believe our worldwide business, upon completion of the
actions covered by the charge, will be significantly more focused and
better-positioned to deliver consistent growth in operating profit before
facility actions net gain. We estimate that the favorable impact on ongoing
operating profit related to the 1997 fourth quarter charge for the 12 weeks
ended June 12, 1999 and June 13, 1998 was approximately $5 million ($5 million
after-tax) and $17 million ($12 million after-tax), respectively. The benefits
include $3 million ($2 million after-tax) and $9 million ($6 million after-tax)
from the suspension of depreciation and amortization in the second quarter of
1999 and 1998, respectively, for the stores included in the charge that were
operating at the end of the respective periods. The favorable impact on ongoing
operating profit related to the 1997 fourth quarter charge for the 24 weeks
ended June 12, 1999 and June 13, 1998 was approximately $11 million ($9 million
after-tax) and $30 million ($21 million after-tax), respectively. These benefits
include approximately $6 million ($4 million after-tax) and $17 million ($11
million after-tax) from the suspension of depreciation and amortization for the
year-to-date 1999 and 1998, respectively, for the stores included in the charge.
The short-term benefits from depreciation and amortization suspension
related to stores that were operating at the end of the respective periods will
cease when the stores are refranchised or closed.
23
<PAGE>
Store Portfolio Perspectives
----------------------------
For the last several years, we have been strategically reducing our share
of total system units by selling Company restaurants to existing and new
franchisees where their expertise can be leveraged to improve our overall
operating performance, while retaining Company ownership of key markets. This
portfolio-balancing activity has reduced, and will continue to reduce, our
reported revenues and restaurant profits and increase the importance of system
sales as a key performance measure. We expect that the loss of restaurant level
profits from the disposal of these stores will be mitigated by the increased
royalty fees for stores refranchised, lower general and administrative expenses
and reduced interest costs due to the reduction of debt from the after-tax cash
proceeds from our refranchising activities. We currently estimate we will be
able to refranchise approximately 1,300 stores in 1999, and our refranchising
gains will approximate our prior year gains. However, if market conditions are
favorable, we may sell more than the 1,300 units we have currently forecasted
for 1999. We expect the impact of refranchising gains to decrease over time as
we approach a Company/franchise ratio more consistent with that of our major
competitors.
The following table summarizes the refranchising activities for the quarter
and year-to-date 1999 and 1998:
12 Weeks Ended 24 Weeks Ended
---------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
-------- ---------- ------- ---------
Number of units refranchised(a) 450 417(b) 671 603(b)
Refranchising proceeds, pre-tax $ 276 $ 169 $ 397 $ 290
Refranchising net gain, pre-tax $ 141 $ 79 $ 178 $ 108
The following table summarizes store closure activities for the quarter and
year-to-date 1999 and 1998:
12 Weeks Ended 24 Weeks Ended
---------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
-------- ---------- ------- ---------
Number of units closed(c)(d) 64 90(b) 146 327(b)
Store closure cost reductions $ 1 $ 2 $ - $ 2
(a) Excludes joint venture units refranchised of 2 in the second quarter of
1999. Excludes joint venture units refranchised of 5 and 6 for year-to-date
1999 and 1998, respectively.
(b) Reporting errors by certain of our international operating companies
resulted in overstatements in our prior year reported unit activity. These
reporting errors had no effect on the beginning or ending unit count. The
correct 1998 unit activity will be reported in future filings where
appropriate.
(c) Includes units closed due to poor performance, high-performing stores that
are relocated to a new site within the same trade area or Pizza Hut
delivery units consolidated with a new or existing dine-in traditional
store which has been remodeled to provide dine-in, carry-out and delivery
services within the same trade area.
(d) Excludes joint venture unit closures of 5 and 3 in the second quarter of
1999 and 1998, respectively. Excludes joint venture unit closures of 10 and
7 for year-to-date 1999 and 1998, respectively.
Our overall Company ownership percentage (including joint ventured units)
of our total system units decreased by 2 percentage points from year-end 1998
and by 8 percentage points from year-end 1997 to 30% at June 12, 1999.
24
<PAGE>
Worldwide Results of Operations
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
----------------------------- -------------------------
6/12/99 6/13/98 % B(W) 6/12/99 6/13/98 % B(W)
------------- ------------ -------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C>
SYSTEM SALES $ 5,002 $ 4,736 6 $ 9,808 $ 9,293 6
============= ============ ============ =========
REVENUES
Company sales $ 1,723 $ 1,867 (8) $ 3,385 $ 3,657 (7)
Franchise and license fees 163 140 16 314 272 15
------------- ------------ ------------ ---------
Total Revenues $ 1,886 $ 2,007 (6) $ 3,699 $ 3,929 (6)
============= ============ ============ =========
COMPANY RESTAURANT MARGIN $ 271 $ 262 4 $ 530 $ 463 15
============= ============ ============ =========
% of Company sales 15.7% 14.0% 1.7 ppts. 15.7% 12.7% 3.0 ppts.
============= ============ ============ =========
Operating profit before facility
actions net gain and unusual charges $ 220(a) $ 189 16 $ 422(a) $ 328 29
Facility actions net gain 133 73 82 167 102 64
Unusual charges (4) - NM (4) - NM
------------- ------------ ------------ ---------
Operating profit 349(a) 262 33 585(a) 430 36
Interest expense, net 51 67 25 103 136 24
Income tax provision 119 83 (43) 197 128 (54)
------------- ------------ ------------ ---------
Net Income $ 179 $ 112 59 $ 285 $ 166 71
============= ============ ============
Diluted earnings per share $ 1.10 $ .72 52 $ 1.76 $ 1.07 64
============= ============ ============ =========
</TABLE>
(a) Includes favorable accounting changes of approximately $6 million and $16
million in the quarter and year-to-date, respectively.
Worldwide Restaurant Unit Activity
<TABLE>
<CAPTION>
Joint
Company Ventured Franchised Licensed Total
--------------- ------------ --------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 26, 1998 8,397 1,120 16,650 3,596 29,763
New Openings & Acquisitions(a) 150 29 372 215 766
Refranchising & Licensing (671) (5) 679 (3) -
Closures and Divestitures(a) (146) (10) (306) (309) (771)
--------------- ------------ --------------- ----------- -----------
Balance at June 12, 1999 7,730(b) 1,134(b) 17,395 3,499 29,758
=============== ============ =============== =========== ===========
</TABLE>
(a) Company new openings and acquisitions and franchise closures and
divestitures include 9 International stores acquired by the Company from
franchisees.
(b) Includes 57 Company and 4 Joint Ventured units approved for closure, but
not yet closed at June 12, 1999 of which 38 were included in our 1997
fourth quarter charge.
- --------------------------------------------------------------------------------
25
<PAGE>
Worldwide System Sales and Revenues
System sales increased $266 million or 6% and $515 million or 6% in the
quarter and year-to-date, respectively. The increase was driven by new unit
development, led by TRICON Restaurants International ("TRI") and U.S. Taco Bell
franchisees and same store sales growth. The increase was partially offset by
store closures, primarily at TRI and Pizza Hut.
Revenues decreased $121 million or 6% and $230 million or 6% in the quarter
and year-to-date, respectively. As expected, Company sales decreased $144
million or 8% and $272 million or 7% in the quarter and year-to-date,
respectively, primarily due to the portfolio effect. The decrease was partially
offset by favorable effective net pricing, new unit development and volume
increases led by Pizza Hut's new product, "The Big New Yorker." Franchise and
license fees increased $23 million or 16% and $42 million or 15% in the quarter
and year-to-date, respectively. The increase for both the quarter and
year-to-date was driven by units acquired from us, new unit development and same
store sales growth, partially offset by store closures.
Worldwide Company Restaurant Margin
12 Weeks Ended 24 Weeks Ended
---------------- -----------------
6/12/99 6/13/98 6/12/99 6/13/98
------- ------- ------- --------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 31.0 31.7 31.3 32.0
Payroll and employee benefits 27.9 29.2 27.9 29.6
Occupancy and other operating expenses 25.4 25.1 25.1 25.7
------- ------- ------- --------
Company restaurant margin 15.7% 14.0% 15.7% 12.7%
======= ======= ======= ========
Our restaurant margin as a percentage of sales grew approximately 170 basis
points in the second quarter as compared to the same period in 1998. Portfolio
effect contributed approximately 30 basis points to our improvement. The
previously disclosed accounting changes were insignificant to our second quarter
growth. Excluding the portfolio effect and accounting changes, our second
quarter restaurant margin grew approximately 140 basis points. The improvement
was largely due to two factors. First, effective net pricing in excess of cost
increases, primarily labor. Increased labor costs in the quarter were the result
of higher wage rates across all three U.S. concepts, labor inefficiencies
primarily associated with our Star Wars promotional tie-in and increased
training costs related to new customer service initiatives that were implemented
by KFC. The increase in certain commodity costs, primarily cheese, chicken and
pizza dough costs, was fully offset by increased beverage rebates and declines
in other commodity costs. Second, we had strong margin improvement in Asia,
primarily in China and Korea, and in Puerto Rico.
Our restaurant margin as a percentage of sales grew approximately 300 basis
points year-to-date as compared to the same period in 1998. Portfolio effect
contributed approximately 35 basis points and accounting changes contributed
approximately 20 basis points. Excluding the portfolio effect and accounting
changes, our year-to-date restaurant margin grew approximately 245 basis points.
In addition to the factors affecting our quarterly comparison, our year-to-date
restaurant margin included approximately 60 basis points related to favorable
actuarial adjustments, primarily for 1998 casualty losses, arising from improved
casualty loss trends across all three of our U.S. operating companies. See pages
21-22 for additional information regarding the actuarial adjustments. The
year-to-date improvement was also due to retroactive beverage rebates related to
1998 recognized in 1999 which contributed 20 basis points and increased volume
in the U.S., primarily driven by Pizza Hut's new product, "The Big New Yorker."
26
<PAGE>
Worldwide General, Administrative and Other Expenses ("G&A")
G&A increased $1 million or 1% and $15 million or 4% in the quarter and
year-to-date, respectively, and included the following:
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
---------------- ----------------
6/12/99 6/13/98 % B(W) 6/12/99 6/13/98 % B(W)
------- ------- ------ ------- ------- ------
<S> <C> <C> <C> <C> <C>
General & administrative expenses $ 215 $ 216 - $ 428 $ 416 (3)
Equity income from investments in
unconsolidated affiliates (3) (3) 3 (9) (9) 3
Foreign exchange net loss 2 - NM 3 - NM
------- ------- ------- -------
$ 214 $ 213 (1) $ 422 $ 407 (4)
======= ======= ======= =======
</TABLE>
For the quarter, increased compensation and other operating costs were
largely offset by the favorable impacts of previously disclosed accounting
changes of $4 million, our fourth quarter 1998 decision to streamline our
international business and our portfolio effect. Year-to-date, higher spending
on biennial meetings to support our corporate culture initiatives and on Y2K
issues, in addition to the above items, drove the increase in G&A. Year-to-date,
accounting changes reduced our G&A by $8 million.
Worldwide Facility Actions Net Gain
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
------------------ ------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- ------- --------- -------
<S> <C> <C> <C> <C>
Refranchising gains, net $ 141 $ 79 $ 178 $ 108
Store closure cost reductions 1 2 - 2
Impairment charges for stores that will
continue to be used in the business (7) (8) (7) (8)
Impairment charge for stores to be closed
in the future (2) - (4) -
--------- ------- --------- -------
Facility actions net gain $ 133(a) $ 73 $ 167(a) $ 102
========= ======= ========= =======
</TABLE>
(a) Includes favorable adjustments to our 1997 fourth quarter charge of
approximately $3 million and $4 million for the quarter and year-to-date,
respectively, relating to decisions to retain certain stores originally
expected to be closed or refranchised and better-than-expected proceeds
from refranchising.
Refranchising net gain included initial franchise fees of $12 million for
both the 12 weeks ended June 12, 1999 and June 13, 1998, and $19 million for
both the 24 weeks ended June 12, 1999 and June 13, 1998. The refranchising net
gain arose from refranchising 450 and 417 units in the second quarter of 1999
and 1998, respectively, and 671 and 603 units for year-to-date 1999 and 1998,
respectively. See page 24 for more details regarding our refranchising
activities.
Impairment resulted from our semi-annual evaluation of stores that will
continue to be used in the business and evaluations of stores to be closed
beyond the quarter in which the closure decision is made. Future impairment
charges depend on facts and circumstances at each future evaluation date, so our
current impairment is not necessarily indicative of future impairment.
27
<PAGE>
Worldwide Operating Profit
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
---------------- ----------------
6/12/99 6/13/98 % B(W) 6/12/99 6/13/98 % B(W)
------- ------- ------ ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
U.S. $ 207 $ 190 9 $ 391 $ 316 24
International 57 35 59 112 77 44
Foreign exchange net loss (2) - NM (3) - NM
Unallocated and corporate expenses (42) (36) (14) (78) (65) (20)
------- ------- ------- -------
Operating profit before facility actions
net gain and unusual charges 220 189 16 422 328 29
Facility actions net gain 133 73 82 167 102 64
Unusual charges (4) - NM (4) - NM
------- ------- ------- -------
Operating profit $ 349 $ 262 33 $ 585 $ 430 36
======= ======= ======= =======
</TABLE>
Operating profit before facility actions net gain and unusual charges
increased $31 million or 16% in the quarter and $94 million or 29% year-to-date.
Our 1999 operating profit included favorable accounting changes of approximately
$6 million and $16 million in the quarter and year-to-date, respectively, as
described on pages 18-20. Our ongoing operating profit, which excludes
accounting changes, grew $25 million or 13% and $78 million or 24% in the
quarter and year-to-date, respectively. The increase in the quarter was driven
by higher franchise fees and restaurant margin improvement. The increase
year-to-date was driven by restaurant margin improvement and higher franchise
fees partially offset by increased G&A spending. Ongoing operating profit in
1999 includes benefits related to our 1997 fourth quarter charge of
approximately $5 million and $11 million in the quarter and year-to-date,
respectively, compared to benefits of approximately $17 million and $30 million
in the quarter and year-to-date, respectively, in the prior year. Benefits in
1999 include depreciation and amortization suspended of approximately $3 million
and $6 million for the quarter and year-to-date, respectively, compared to
approximately $9 million and $17 million in the quarter and year-to-date,
respectively, in the prior year. In addition, the quarter and year-to-date 1999
include estimated savings of approximately $5 million and $9 million,
respectively, related to our 1998 strategic decision to streamline our
international business and other actions.
Unallocated and corporate expenses increased $6 million or 14% in the
quarter and $13 million or 20% year-to-date. Unallocated corporate expenses
include favorable accounting changes of approximately $4 million and $5 million
in the quarter and year-to-date, respectively, primarily related to the
capitalization of internal use software costs. The increase in the quarter was
driven by higher compensation expense. In addition to higher compensation
expenses, the increase year-to-date was driven by higher Year 2000 and system
standardization investment spending and the absence of cost recovery agreements
from Ameriserve and PepsiCo that were terminated in 1998.
Worldwide Interest Expense, Net
12 Weeks Ended 24 Weeks Ended
---------------- ----------------
6/12/99 6/13/98 % B/(W) 6/12/99 6/13/98 % B/(W)
------- ------- ------- ------- ------- -------
Interest expense $ 53 $ 71 26 $ 109 $ 144 25
Interest income (2) (4) (51) (6) (8) (29)
------- ------- ------- -------
Interest expense, net $ 51 $ 67 25 $ 103 $ 136 24
======= ======= ======= =======
Our net interest expense decreased $16 million or 25% in the quarter and
$33 million or 24% year-to-date. The decrease in the quarter and year-to-date
was primarily due to a significant decline in our outstanding debt levels in
1999 as compared to 1998.
28
<PAGE>
Worldwide Income Taxes
12 Weeks Ended 24 Weeks Ended
------------------- -------------------
6/12/99 6/13/98 6/12/99 6/13/98
--------- -------- --------- --------
Income taxes $ 119 $ 83 $ 197 $ 128
Effective tax rate 40.0% 42.6% 40.9% 43.5%
The decrease in our year-to-date effective tax rate compared to 1998 is
primarily due to the reduction in the tax rate on foreign operations, the
favorable shift in the mix of the components of our taxable income and a
decrease in state income taxes, partially offset by a reduction in the favorable
impact of adjustments related to prior years.
Diluted Earnings Per Share
The components of diluted earnings per common share ("EPS") were as follows:
12 Weeks Ended(a) 24 Weeks Ended(a)
--------------------- --------------------
6/12/99 6/13/98 6/12/99 6/13/98
----------- -------- ----------- -------
Operating earnings excluding
accounting changes $ 0.60 $ 0.45 $ 1.10 $ 0.70
Accounting changes 0.02(b) - 0.06(b) -
Facility actions net gain 0.49 0.27 0.61 0.37
Unusual charges (0.01) - (0.01) -
----------- -------- ----------- -------
Net income $ 1.10 $ 0.72 $ 1.76 $ 1.07
=========== ======== =========== =======
(a) All computations based on diluted shares of 163 million and 155 million for
the 12 weeks ended June 12, 1999 and June 13, 1998, respectively, and 162
million and 155 million shares for the 24 weeks ended June 12, 1999 and
June 13, 1998, respectively.
(b) Includes the impact of required changes in GAAP, discretionary methodology
changes and our accounting and human resources policy standardization
programs previously discussed.
U.S. Results of Operations
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
------------------ -------------------
6/12/99 6/13/98 % B(W) 6/12/99 6/13/98 % B(W)
-------- -------- --------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
SYSTEM SALES $ 3,389 $ 3,239 5 $ 6,609 $ 6,296 5
======== ======== ======== =========
REVENUES
Company sales $ 1,282 $ 1,435 (11) $ 2,546 $ 2,816 (10)
Franchise and license fees 113 95 19 215 182 18
-------- -------- -------- ---------
Total Revenues $ 1,395 $ 1,530 (9) $ 2,761 $ 2,998 (8)
======== ======== ======== =========
COMPANY RESTAURANT MARGIN $ 208 $ 211 (1) $ 412 $ 361 14
======== ======== ======== =========
% of Company sales 16.3% 14.7% 1.6 ppts. 16.2% 12.8% 3.4 ppts.
======== ======== ======== =========
OPERATING PROFIT(a) $ 207 $ 190 9 $ 391 $ 316 24
======== ======== ======== =========
</TABLE>
(a) Includes favorable impact of accounting changes of approximately $3
million and $13 million for the quarter and year-to-date 1999,
respectively, and excludes facility actions net gain and unusual charges.
- --------------------------------------------------------------------------------
29
<PAGE>
U.S. Restaurant Unit Activity
Company Franchised Licensed Total
--------- ---------- -------- -------
Balance at December 26, 1998(a) 6,232 10,862 3,275 20,369
New Openings & Acquisitions 83 174 197 454
Refranchising & Licensing (496) 493 3 -
Closures and Divestitures (120) (212) (282) (614)
--------- ---------- -------- -------
Balance at June 12, 1999 5,699(b) 11,317 3,193 20,209
========= ========== ======== =======
(a) A total of 114 units have been reclassified from U.S. to International to
reflect the transfer of management responsibility.
(b) Includes 49 Company units approved for closure, but not yet closed at June
12, 1999, of which 38 units were included in the 1997 fourth quarter
charge.
- --------------------------------------------------------------------------------
U.S. System Sales and Revenues
System sales increased $150 million or 5% and $313 million or 5% in the
quarter and year-to-date, respectively. The improvement in the quarter and
year-to-date was driven by new unit development, led by Taco Bell franchisees,
and same store sales growth. The increase in same store sales was primarily due
to favorable effective net pricing and volume increases led by Pizza Hut's new
product, "The Big New Yorker." The increase was partially reduced by store
closures.
Revenues decreased $135 million or 9% and $237 million or 8% in the quarter
and year-to-date, respectively. As expected, Company sales decreased $153
million or 11% and $270 million or 10% in the quarter and year-to-date,
respectively. The decline in Company sales for the quarter and year-to-date was
primarily due to the portfolio effect, partially offset by favorable effective
net pricing and new unit development. In addition, year-to-date revenues were
favorably impacted by volume increases led by "The Big New Yorker." Franchise
and license fees increased $18 million or 19% and $33 million or 18% in the
quarter and year-to-date, respectively. The increase in the quarter and
year-to-date was driven by units acquired from us, new unit development and same
store sales growth, partially offset by store closures.
We measure same store sales only for our U.S. Company units. Despite the
fact that our disappointing Star Wars promotion in the later part of the quarter
actually slowed our sales momentum, all U.S. concepts experienced same store
sales growth in the quarter. Same store sales at Pizza Hut increased 9% and 12%
in the quarter and year-to-date, respectively. The improvement was primarily
driven by increased volume resulting from the launch of "The Big New Yorker."
Same store sales at KFC grew 2% in the quarter and 3% year-to-date. The increase
in the quarter and year-to-date was largely due to favorable effective net
pricing. Additionally, year-to-date same store sales growth was aided by
successful promotions of "Honey Bar-B-Que Wings", a combination of "Extra Crispy
Chicken" and "Honey Bar-B-Que Wings" and "Popcorn Chicken." Same store sales at
Taco Bell increased 1% and 2% in the quarter and year-to-date, respectively. The
improvement for the quarter and year-to-date was primarily due to favorable
effective net pricing, which was largely offset by volume declines.
30
<PAGE>
U.S. Company Restaurant Margin
12 Weeks Ended 24 Weeks Ended
----------------- ----------------
6/12/99 6/13/98 6/12/99 6/13/98
------- ------- ------- -------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 29.3 30.5 29.9 30.9
Payroll and employee benefits 30.0 30.7 29.8 31.3
Occupancy and other operating expenses 24.4 24.1 24.1 25.0
------- ------- ------- -------
Company restaurant margin 16.3% 14.7% 16.2% 12.8%
======= ======= ======= =======
Our restaurant margin as a percentage of sales grew approximately 160 basis
points in the second quarter as compared to the same period in 1998. Portfolio
effect contributed approximately 30 basis points and the previously disclosed
accounting changes contributed approximately 15 basis points to our second
quarter improvement. Excluding the portfolio effect and accounting changes, our
second quarter restaurant margin grew approximately 115 basis points. The
improvement was largely due to effective net pricing in excess of cost
increases, primarily labor. Increased labor costs in the quarter were the result
of higher wage rates across all three U.S. brands, labor inefficiencies
primarily associated with our Star Wars promotional tie-in and increased
training costs related to new customer service initiatives that were implemented
by KFC. Commodity cost increases, primarily cheese, chicken and pizza dough
costs, were fully offset by higher beverage rebates and declines in other
commodity costs.
Our restaurant margin as a percentage of sales grew approximately 340 basis
points year-to-date as compared to the same period in 1998. Portfolio effect
contributed approximately 35 basis points and accounting changes, which were
primarily driven by our actuarial methodology change, contributed approximately
30 basis points to our improvement. Excluding the portfolio effect and
accounting changes, our year-to-date restaurant margin grew approximately 275
basis points. In addition to the factors affecting our quarterly comparison, our
year-to-date restaurant margin included approximately 80 basis points related to
favorable actuarial adjustments, primarily for 1998 casualty losses, arising
from improved casualty loss trends across all three of our U.S. operating
companies. See pages 21-22 for additional information regarding our actuarial
adjustments. Our year-to-date improvement was also due to volume increases,
primarily driven by "The Big New Yorker" and retroactive beverage rebates
related to 1998 recognized in 1999 which contributed approximately 25 basis
points.
U.S. operating profit, excluding facility actions net gain and unusual
charges, grew $17 million or 9% in the quarter and $75 million or 24%
year-to-date. Our 1999 operating profit included favorable accounting changes of
approximately $3 million and $13 million in the quarter and year-to-date,
respectively, as described on pages 18-20. Our ongoing operating profit, which
excludes accounting changes, grew $14 million or 7% and $62 million or 20% in
the quarter and year-to-date, respectively. The increase in the quarter was due
to higher franchise and license fees, partially offset by lower restaurant
margin dollars. On a year-to-date basis, the increase in our ongoing operating
profit was driven by restaurant margin improvement and higher franchise and
license fees, partially offset by increased G&A. The increase in G&A was largely
due to higher spending at Pizza Hut and Taco Bell on biennial conferences to
support our corporate culture initiatives. Operating profit included benefits
related to our 1997 fourth quarter charge of approximately $1 million and $3
million in the quarter and year-to-date, respectively, compared to approximately
$8 million and $15 million in the quarter and year-to-date in the prior year.
The benefits included in 1999 of approximately $1 million and $3 million in the
quarter and year-to-date, respectively, related to the suspension of
depreciation and amortization for the stores included in the charge compared to
approximately $5 million and $10 million for the quarter and year-to-date,
respectively, in the prior year.
31
<PAGE>
International Results of Operations
<TABLE>
<CAPTION>
12 Weeks Ended 24 Weeks Ended
--------------------- ---------------------
6/12/99 6/13/98 % B(W) 6/12/99 6/13/98 % B(W)
--------- --------- -------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
SYSTEM SALES $ 1,613 $ 1,497 8 $ 3,199 $ 2,997 7
========= ========= ========= ==========
REVENUES
Company sales $ 441 $ 432 2 $ 839 $ 841 -
Franchise and license fees 50 45 10 99 90 10
--------- --------- --------- ----------
Total Revenues $ 491 $ 477 3 $ 938 $ 931 1
========= ========= ========= ==========
COMPANY RESTAURANT MARGIN $ 63 $ 51 24 $ 118 $ 102 16
========= ========= ========= ==========
% of Company sales 14.2% 11.8% 2.4 ppts. 14.0% 12.1% 1.9 ppts.
========= ========= ========= ==========
OPERATING PROFIT(a) $ 57 $ 35 59 $ 112 $ 77 44
========= ========= ========= ==========
</TABLE>
(a) Excludes facility action net gain and unusual charges.
- --------------------------------------------------------------------------------
International Restaurant Unit Activity
<TABLE>
<CAPTION>
Joint
Company Ventured Franchised Licensed Total
--------- ---------- ---------- --------- -------
<S> <C> <C> <C> <C> <C>
Balance at December 26, 1998(a) 2,165 1,120 5,788 321 9,394
New Openings & Acquisitions(b) 67 29 198 18 312
Refranchising & Licensing (175) (5) 186 (6) -
Closures and Divestitures(b) (26) (10) (94) (27) (157)
--------- ---------- ---------- --------- -------
Balance at June 12, 1999 2,031(c) 1,134(c) 6,078 306 9,549
========= ========== ========== ========= =======
</TABLE>
(a) A total of 114 units have been reclassified from U.S. to International to
reflect the transfer of management responsibility.
(b) Company new openings and acquisitions and franchise closures and
divestitures include 9 International stores acquired by the Company from
franchisees.
(c) Includes 8 Company and 4 Joint Ventured units approved for closure, but not
yet closed at June 12, 1999.
- --------------------------------------------------------------------------------
International System Sales and Revenues
System sales increased $116 million or 8% in the quarter and $202 million
or 7% year-to-date. The improvement in the quarter and year-to-date was driven
by new unit development by franchisees and same store sales growth, partially
offset by store closures. Foreign currency translation did not have a
significant impact on the growth of international system sales in the quarter or
year-to-date.
Revenues grew $14 million or 3% and $7 million or 1% for the quarter and
year-to-date, respectively. Company sales increased $9 million or 2% in the
quarter. The increase in company sales for the quarter was driven by new unit
development, volume increases and favorable effective net pricing, partially
offset by the portfolio effect. As expected, Company sales decreased $2 million
or less than 1% year-to-date primarily due to the portfolio effect which was
largely offset by new unit development, volume increases and favorable effective
net pricing. Franchise and license fees rose $5 million or 10% and $9 million or
10% in the quarter and year-to-date, respectively, driven by new unit
development, same store sales increases and units acquired from us, partially
offset by store closures. Foreign currency translation did not have a
significant impact on the growth of international revenues.
32
<PAGE>
International Company Restaurant Margin
12 Weeks Ended 24 Weeks Ended
---------------- ----------------
6/12/99 6/13/98 6/12/99 6/13/98
------- ------- ------- -------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 35.8 35.7 35.8 35.8
Payroll and employee benefits 21.7 24.0 22.0 24.0
Occupancy and other operating expenses 28.3 28.5 28.2 28.1
------- ------- ------- -------
Company restaurant margin 14.2% 11.8% 14.0% 12.1%
======= ======= ======= =======
Our restaurant margin as a percentage of sales grew approximately 245 basis
points in the quarter and 190 basis points year-to-date as compared to the same
periods in 1998. Portfolio effect contributed approximately 35 basis points for
the quarter and 40 basis points year-to-date to our improvement. Excluding the
portfolio effect, restaurant margin grew approximately 210 and 150 basis points,
for the quarter and year-to-date, respectively. The improvement in the quarter
and year-to-date was primarily driven by volume increases and new unit
development in China and favorable effective net pricing in excess of cost
increases in Puerto Rico, Korea and Thailand. Accounting changes and the impact
of foreign currency translation in the quarter and year-to-date were
insignificant.
International operating profit grew $22 million or 59% in the quarter and
$35 million or 44% year-to-date. The improvement in the quarter and year-to-date
was largely driven by an increase in restaurant margin primarily in Asia and
Puerto Rico, higher franchise fees and a decline in G&A. Operating profit
includes savings of approximately $5 million and $9 million for the quarter and
year-to-date, respectively, associated with our 1998 fourth quarter strategic
decision to streamline our international business and other actions. In
addition, operating profit includes benefits related to our 1997 fourth quarter
charge of approximately $4 million and $8 million in the quarter and
year-to-date, respectively, compared to benefits of approximately $9 million and
$15 million in the quarter and year-to-date, respectively, in the prior year.
Our 1997 fourth quarter charge benefits in 1999 include suspended depreciation
and amortization of approximately $1 million and $3 million in the quarter and
year-to-date, respectively, compared to approximately $4 million and $7 million
in the quarter and year-to-date, respectively, in the prior year. Accounting
changes and the impact of foreign currency translation in the quarter and
year-to-date were insignificant.
Consolidated Cash Flows
Net cash provided by operating activities decreased $89 million to $187
million year-to-date. Excluding net changes in working capital, net income
before facility actions and all other non-cash charges grew $16 million from
$299 million to $315 million, despite the over 1,500 unit decline in Company
restaurants due to our portfolio activities since the same quarter last year.
This increase was more than offset by a decrease in our working capital deficit.
Working capital deficits are typical in the restaurant industry. The decline in
our working capital deficit was the result of decreased accounts payable and
other current liabilities and increased accounts receivable, partially off-set
by increased income taxes payable. The decline in accounts payable is a result
of seasonal timing as well as the reduction in the number of our restaurants.
Other current liabilities mainly declined due to lower bonus accruals due to
timing of payments and deferrals, lower casualty loss reserves based on actuary
reports and lower advertising accruals. As expected, the refranchising of our
restaurants and the related increase in franchised units have caused accounts
receivable for franchise fees to increase. Also contributing to the increase in
accounts receivable were higher balances due to us from our primary U.S.
distributor related to both sales of premium items (primarily Star Wars items)
imported by us and price reductions under our 1999 contract. We also have higher
beverage rebate receivables. The increase in income taxes payable is based on
the current quarter's tax provision versus the timing of payments.
33
<PAGE>
Cash provided by investing activities increased $138 million to $245
million year-to-date. The majority of the increase is due to higher
refranchising proceeds and lower cash used for other investing activities.
Refranchising proceeds increased over the same period last year due to the
greater number of restaurants sold as well as the mix of units sold. The decline
in cash used for other investing is primarily driven by short-term investment
activities.
Net cash used for financing activities decreased $58 million to $388
million year-to-date. The decline was primarily due to the fluctuation in net
short-term borrowing activity and lower net payments on debt. These changes are
primarily due to lower repayment requirements on refranchising attributable to
our lower debt level. Cash from operations and refranchising proceeds has
enabled us to pay down almost $1.7 billion of debt since the Spin-off.
Financing Activities
During the 24 weeks ended June 12, 1999, we have made net payments of
approximately $380 million under our unsecured Term Loan Facility and our
unsecured Revolving Credit Facility (the "Facilities"). As discussed in our 1998
Form 10-K, amounts outstanding under the unsecured Term Loan Facility and our
Revolving Credit Facility are expected to fluctuate from time to time, but Term
Loan Facility reductions cannot be reborrowed. These payments reduced amounts
outstanding under our Revolving Credit Facility at June 12, 1999 to $1.50
billion from $1.81 billion at year-end 1998 and amounts outstanding under our
Term Loan Facility to $859 million from $926 million at year-end 1998. In
addition, we had unused revolving credit agreement borrowings available
aggregating $1.36 billion, net of outstanding letters of credit of $138 million.
The credit facilities are subject to various affirmative and negative covenants
including financial covenants as well as limitations on additional indebtedness
including guarantees of indebtedness, cash dividends, aggregate non-U.S.
investments, among other things, as defined in the credit agreement.
On March 24, 1999, we entered into an agreement to amend certain terms of
the Facilities. This amendment gives us additional flexibility with respect to
acquisitions and other investments, permitted investments and repurchase of
Common Shares. In addition, we voluntarily reduced our maximum borrowings under
the Revolving Credit Facility from $3.25 billion to $3.00 billion. As a result
of this amendment, we capitalized debt costs of approximately $2.5 million.
These costs are being amortized over the remaining life of the Facilities.
Additionally, an insignificant amount of our previously deferred debt costs was
written off in the second quarter of 1999 as a result of this amendment.
This substantial indebtedness subjects us to significant interest expense
and principal repayment obligations which are limited, in the near term, to
prepayment events as defined in the credit agreement. Our highly leveraged
capital structure could also adversely affect our ability to obtain additional
financing in the future or to undertake refinancings on terms and subject to
conditions that are acceptable to us.
At the end of the second quarter of 1999, we were in compliance with these
covenants, and we will continue to closely monitor on an ongoing basis the
various operating issues that could, in aggregate, affect our ability to comply
with our financial covenant requirements.
We use various derivative instruments with the objective of reducing
volatility in our borrowing costs. We have utilized interest rate swap
agreements to effectively convert a portion of our variable rate (LIBOR) bank
debt to fixed rate. We previously entered into treasury lock agreements to
partially hedge the anticipated issuance of our senior Unsecured Notes which
occurred in May 1998. We have also entered into interest rate arrangements to
limit the range of effective interest rates on a portion of our variable rate
bank debt. Other derivative instruments may be considered from time to time as
well to manage our debt portfolio and to hedge foreign currency exchange
exposures. At June 12, 1999, our weighted average interest rate on our variable
rate debt was 6.0% which included the effects of the associated interest rate
swaps and collars.
34
<PAGE>
Though we anticipate that cash flows from both operating and refranchising
activities will be lower than prior year levels, we believe they will be
sufficient to support our expected capital spending and still allow us to make
significant debt repayments.
Consolidated Financial Condition
Our operating working capital deficit, which excludes cash, short-term
investments and short-term borrowings, is typical of restaurant operations where
the majority of sales are for cash and food and supply inventories are
relatively small. Our terms of payment to suppliers generally range from 10-30
days. Our operating working capital deficit declined 12% to $841 million at June
12, 1999 from $960 million at December 26, 1998. This decline primarily
reflected a decrease in accounts payable and other current liabilities due to
both seasonal fluctuations and fewer Company restaurants resulting from our
portfolio initiatives and increased accounts receivable due to higher franchise
fees. Also contributing to the increase in accounts receivable were higher
balances due to us from our primary U.S. distributor related to both sales of
premium items (primarily Star Wars items) imported by us and price reductions
under our 1999 contract. We also have higher beverage rebate receivables. These
increases were partially offset by higher income taxes payable.
Quantitative and Qualitative Disclosures About Market Risk
Market Risk of Financial Instruments
Our primary market risk exposure with regard to financial instruments is to
changes in interest rates, principally in the United States. In addition, an
immaterial portion of our debt is denominated in foreign currencies which
exposes us to market risk associated with exchange rate movements. Historically,
we have not used derivative financial instruments to manage our exposure to
foreign currency rate fluctuations since the market risk associated with our
foreign currency denominated debt was not considered significant.
At June 12, 1999, a hypothetical 100 basis point increase in short-term
interest rates would result in a reduction of $15 million in annual pre-tax
earnings. The estimated reduction is based upon the unhedged portion of our
variable rate debt and assumes no change in the volume or composition of debt at
June 12, 1999. In addition, the fair value of our interest rate derivative
contracts would increase approximately $13 million in value to us , and the fair
value of our unsecured Notes would decrease approximately $31 million. Fair
value was determined by discounting the projected cash flows.
35
<PAGE>
Cautionary Statements
From time to time, in both written reports and oral statements, we present
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. The statements include those identified by such words as "may,"
"will," "expect," "believe," "plan" and other similar terminology. These
"forward-looking statements" reflect our current expectations and are based upon
data available at the time of the statements. Actual results involve risks and
uncertainties, including both those specific to the Company and those specific
to the industry, and could differ materially from expectations.
Company risks and uncertainties include, but are not limited to, the
limited experience of our management group in operating the Company as an
independent, publicly owned business; potentially substantial tax contingencies
related to the Spin-off, which, if they occur, require us to indemnify PepsiCo;
our substantial debt leverage and the attendant potential restriction on our
ability to borrow in the future, as well as the substantial interest expense and
principal repayment obligations; potential unfavorable variances between
estimated and actual liabilities including accruals for wage and hour litigation
and the liabilities related to the sale of the Non-core Businesses; our failure
or the failure of critical business partners to achieve timely, effective Year
2000 remediation; our ability to complete our conversion plans or the ability of
our key suppliers to be Euro-compliant; our potential inability to identify
qualified franchisees to purchase the 338 Company units remaining from the
fourth quarter 1997 charge as well as other units at prices we consider
appropriate under our strategy to reduce the percentage of system units we
operate; volatility of actuarially determined casualty loss estimates and
adoption of new or changes in accounting policies and practices.
Industry risks and uncertainties include, but are not limited to, global
and local business and economic and political conditions; legislation and
governmental regulation; competition; success of operating initiatives and
advertising and promotional efforts; volatility of commodity costs and increases
in minimum wage and other operating costs; availability and cost of land and
construction; consumer preferences, spending patterns and demographic trends;
political or economic instability in local markets; and currency exchange rates.
36
<PAGE>
Independent Accountants' Review Report
--------------------------------------
The Board of Directors
TRICON Global Restaurants, Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of TRICON
Global Restaurants, Inc. and Subsidiaries ("TRICON") as of June 12, 1999 and the
related condensed consolidated statement of income for the twelve and
twenty-four weeks ended June 12, 1999 and June 13, 1998 and the condensed
consolidated statement of cash flows for the twenty-four weeks ended June 12,
1999 and June 13, 1998. These financial statements are the responsibility of
TRICON's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of TRICON as of December 26, 1998, and
the related consolidated statements of operations, cash flows and shareholders'
deficit and comprehensive income for the year then ended not presented herein;
and in our report dated February 10, 1999, we expressed an unqualified opinion
on those consolidated financial statements. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheet as of December
26, 1998, is fairly presented, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/ KPMG LLP
KPMG LLP
Louisville, Kentucky
July 19, 1999
37
<PAGE>
PART II - OTHER INFORMATION AND SIGNATAURES
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Our Annual Meeting of Shareholders was held on May 20, 1999. At the
meeting, shareholders elected four directors, approved our Long Term
Incentive Plan and Executive Incentive Compensation Plan and ratified
the appointment of KPMG LLP as our independent auditors.
Results of the voting in connection with each item were as follows:
Election of Directors For Withheld
--------------------------- ------------- -------------
James Dimon 115,867,258 19,212,214
Massimo Ferragamo 115,873,179 19,206,293
Robert J. Ulrich 98,048,305 37,031,167
Jeanette S. Wagner 115,801,471 19,278,001
The following directors were not required to stand for reelection at
the meeting (the year in which each director's term expires is
indicated in parenthesis):
D. Ronald Daniel (2000), Robert Holland, Jr. (2001), Sidney Kohl
(2001), Kenneth G. Langone (2000), David C. Novak (2001), Andrall E.
Pearson (2000), Jackie Trujillo (2001) and John L. Weinberg (2000).
<TABLE>
<CAPTION>
For Against Abstain
------------ ----------- ---------
<S> <C> <C> <C>
Long Term Incentive Plan 97,286,764 36,873,960 914,148
Executive Incentive Compensation Plan 130,494,204 3,540,534 1,043,833
Ratification of Independent Auditors 134,387,046 180,106 512,320
</TABLE>
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibit Index
EXHIBITS
--------
Exhibit 12 Computation of Ratio of Earnings to Fixed Charges
Exhibit 15 Letter from KPMG LLP regarding Unaudited Interim
Financial Information (Accountants' Acknowledgment)
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K dated April 28, 1999
attaching our first quarter 1999 earnings release of April 28,
1999.
38
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, duly authorized officer of the registrant.
TRICON GLOBAL RESTAURANTS, INC.
--------------------------------------
(Registrant)
Date: July 26, 1999 /s/ Robert L. Carleton
------------------------------------
Senior Vice President and Controller
(Principal Accounting Officer)
39
<PAGE>
EXHIBIT 12
TRICON Global Restaurants, Inc.
Ratio of Earnings to Fixed Charges Years Ended 1998-1994
and 24 Weeks Ended June 12, 1999 and June 13, 1998
(in millions except ratio amounts)
<TABLE>
<CAPTION>
53
52 Weeks Weeks 24 Weeks
------------------------------------ ------- ------------------
1998 1997 1996 1995 1994 6/12/99 6/13/98
------- ------ ------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Earnings:
Income from continuing operations before
income taxes and cumulative effect of
accounting changes 756 (35) 72 (103) 241 482 294
Unconsolidated affiliates' interests,
net (a) 1 (1) (6) - (1) (2) -
Interest expense (a) 291 290 310 368 349 109 144
Interest portion of net rent expense (a) 105 118 116 109 108 42 48
------- ------ ------- ------- ------- -------- --------
Earnings available for fixed charges 1,153 372 492 374 697 631 486
======= ====== ======= ======= ======= ======== ========
Fixed Charges:
Interest Expense (a) 291 290 310 368 349 109 144
Interest portion of net rent expense (a) 105 118 116 109 108 42 48
------- ------ ------- ------- ------- -------- --------
Total Fixed Charges 396 408 426 477 457 151 192
======= ====== ======= ======= ======= ======== ========
Ratio of Earnings to Fixed
Charges (b) (c) (d) 2.91x .91x 1.15x 0.78x 1.53x 4.18x 2.53x
</TABLE>
(a) Included in earnings for the years 1994 through 1997 are certain
allocations related to overhead costs and interest expense from PepsiCo.
For purposes of these ratios, earnings are calculated by adding to
(subtracting from) income from continuing operations before income taxes
and cumulative effect of accounting changes the following: fixed charges,
excluding capitalized interest; and losses and (undistributed earnings)
recognized with respect to less than 50% owned equity investments. Fixed
charges consist of interest on borrowings, the allocation of PepsiCo's
interest expense for years 1994-1997 and that portion of rental expense
that approximates interest. For a description of the PepsiCo allocations,
see the Notes to the Consolidated Financial Statements included in our 1998
Form 10-K.
(b) Included the impact of unusual, disposal and other charges of $4 million
($2 million after-tax) for the 24 weeks ended June 12, 1999, $15 million
($3 million after-tax) in 1998, $184 million ($165 million after tax) in
1997, $246 million ($189 million after tax) in 1996 and $457 million ($324
million after tax) in 1995. Excluding the impact of such charges, the ratio
of earnings to fixed charges would have been 4.20x, 2.95x, 1.36x, 1.73x and
1.74x for the 24 weeks ended June 12, 1999 and fiscal years ended 1999,
1998, 1997, 1996 and 1995, respectively.
(c) The Company is contingently liable for obligations of certain franchisees
and other unaffiliated parties. Fixed charges associated with such
obligations aggregated approximately $17 million during the fiscal year
1998. Such fixed charges, which are contingent, have not been included in
the computation of the ratios.
(d) For the fiscal years December 27, 1997 and December 30, 1995, earnings were
insufficient to cover fixed charges by approximately $36 million and $103
million, respectively. Earnings in 1997 includes a charge of $530 million
($425 million after-tax) taken in the fourth quarter to refocus our
business. Earnings in 1995 included the noncash charge of $457 million
($324 million after-tax) for the initial adoption of Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of."
<PAGE>
EXHIBIT 15
Accountants' Acknowledgment
---------------------------
The Board of Directors
TRICON Global Restaurants, Inc.:
We hereby acknowledge our awareness of the use of our report dated July 19, 1999
included within the Quarterly Report on Form 10-Q of TRICON Global Restaurants,
Inc. for the twelve and twenty-four weeks ended June 12, 1999, and incorporated
by reference in the following Registration Statements:
Description Registration Statement Number
- ----------- -----------------------------
Form S-3
- --------
Initial Public Offering of Debt Securities 333-42969
Form S-8s
- ---------
Restaurant Deferred Compensation Plan 333-36877
Executive Income Deferral Program 333-36955
TRICON Long-Term Incentive Plan 333-36895
SharePower Stock Option Plan 333-36961
TRICON Long-Term Savings Program 333-36893
Restaurant General Manager Stock Option Plan 333-64547
Pursuant to Rule 436(c) of the Securities Act of 1933, such report is not
considered a part of a registration statement prepared or certified by an
accountant or a report prepared or certified by an accountant within the meaning
of Sections 7 and 11 of the Act.
/s/ KPMG LLP
KPMG LLP
Louisville, Kentucky
July 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from TRICON
Global Restaurants, Inc. Condensed Consolidated Financial Statements for the 12
and 24 Weeks Ended June 12, 1999 and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<CIK> 0001041061
<NAME> TRICON Global Restaurants, Inc.
<MULTIPLIER> 1,000,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 6-mos
<FISCAL-YEAR-END> Dec-25-1999
<PERIOD-START> Dec-27-1998
<PERIOD-END> Jun-12-1999
<EXCHANGE-RATE> 1.000
<CASH> 166
<SECURITIES> 119
<RECEIVABLES> 235
<ALLOWANCES> 21
<INVENTORY> 68
<CURRENT-ASSETS> 784
<PP&E> 5,207
<DEPRECIATION> 2,512
<TOTAL-ASSETS> 4,419
<CURRENT-LIABILITIES> 1,428
<BONDS> 3,045
0
0
<COMMON> 1,356
<OTHER-SE> (2,177)
<TOTAL-LIABILITY-AND-EQUITY> 4,419
<SALES> 3,385
<TOTAL-REVENUES> 3,699
<CGS> 2,006
<TOTAL-COSTS> 2,855
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4
<INTEREST-EXPENSE> 103
<INCOME-PRETAX> 482
<INCOME-TAX> 197
<INCOME-CONTINUING> 285
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 285
<EPS-BASIC> 1.86
<EPS-DILUTED> 1.76
</TABLE>
