Washington, D. C. 20549
| (Mark One) | |
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 8, 2001 |
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
| North Carolina | 13-3951308 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer 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 × No
The number of shares outstanding of the Registrant's Common Stock as of October 15, 2001 was 145,849,571 shares
TRICON GLOBAL RESTAURANTS, INC.
INDEX
| Page No. | ||
| Part I. | Financial Information | |
| Financial Statements | ||
| Condensed Consolidated Statements of Income - 12 and 36 weeks ended September 8, 2001 and September 2, 2000 | 3 | |
| Condensed Consolidated Statements of Cash Flows - 36 weeks ended September 8, 2001 and September 2, 2000 | 4 | |
| Condensed Consolidated Balance Sheets - September 8, 2001 and December 30, 2000 | 5 | |
| Notes to Condensed Consolidated Financial Statements | 6 | |
| Management's Discussion and Analysis of Financial Condition and Results of Operations | 19 | |
| Independent Accountants' Review Report | 35 | |
| Part II. | Other Information and Signatures | |
| Item 1 - Legal Proceedings | 36 | |
| Item 6 - Exhibits and Reports on Form 8-K | 36 | |
| Signatures | 37 | |
2
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions, except per share data - unaudited)
12 Weeks Ended 36 Weeks Ended
------------------------- -------------------------
9/08/01 9/02/00 9/08/01 9/02/00
----------- ----------- ----------- -----------
Revenues
Company sales $ 1,449 $ 1,470 $ 4,191 $ 4,375
Franchise and license fees 191 188 560 536
----------- ----------- ----------- -----------
1,640 1,658 4,751 4,911
----------- ----------- ----------- -----------
Costs and Expenses, net
Company restaurants
Food and paper 457 455 1,309 1,345
Payroll and employee benefits 391 395 1,152 1,212
Occupancy and other operating expenses 388 393 1,125 1,153
----------- ----------- ----------- -----------
1,236 1,243 3,586 3,710
General and administrative expenses 188 200 585 576
Other (income) expense (6) (6) (15) (21)
Facility actions net (gain) (9) (3) (25) (116)
Unusual items - 92 (2) 168
----------- ----------- ----------- -----------
Total costs and expenses, net 1,409 1,526 4,129 4,317
----------- ----------- ----------- -----------
Operating Profit 231 132 622 594
Interest expense, net 36 39 112 121
----------- ----------- ----------- -----------
Income Before Income Taxes 195 93 510 473
Income Tax Provision 71 34 182 188
----------- ----------- ----------- -----------
Net Income $ 124 $ 59 $ 328 $ 285
=========== =========== =========== ===========
Basic Earnings Per Common Share $ 0.84 $ 0.41 $ 2.23 $ 1.94
=========== =========== =========== ===========
Diluted Earnings Per Common Share $ 0.81 $ 0.40 $ 2.16 $ 1.91
=========== =========== =========== ===========
See accompanying Notes to Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions - unaudited)
36 Weeks Ended
-----------------------
9/08/01 9/02/00
---------- ----------
Cash Flows - Operating Activities
Net Income $ 328 $ 285
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 243 245
Facility actions net (gain) (25) (116)
Unusual items (6) 148
Other liabilities and deferred credits (10) 6
Deferred income taxes (22) (37)
Other non-cash charges and credits, net 14 32
Changes in operating working capital, excluding
effects of acquisitions and dispositions:
Accounts and notes receivable 91 (238)
Inventories (5) (68)
Prepaid expenses and other current assets (5) (6)
Accounts payable and other current liabilities (55) 75
Income taxes payable 86 22
---------- ----------
Net change in operating working capital 112 (215)
---------- ----------
Net Cash Provided by Operating Activities 634 348
---------- ----------
Cash Flows - Investing Activities
Capital spending (360) (313)
Proceeds from refranchising of restaurants 73 240
Acquisition of restaurants (102) (27)
AmeriServe funding, net - (21)
Short-term investments (2) (17)
Sales of property, plant and equipment 15 35
Other, net 35 (8)
---------- ----------
Net Cash Used In Investing Activities (341) (111)
---------- ----------
Cash Flows - Financing Activities
Proceeds from Senior Unsecured Notes 842 -
Revolving Credit Facility activity, by original maturity
Three months or less, net (872) 45
Proceeds from long-term debt 1 3
Repayments of long-term debt (256) (72)
Short-term borrowings-three months or less, net 119 7
Repurchase shares of common stock (98) (216)
Other, net 22 24
---------- ----------
Net Cash Used In Financing Activities (242) (209)
---------- ----------
Effect of Exchange Rate on Cash and Cash Equivalents - (2)
---------- ----------
Net Increase in Cash and Cash Equivalents 51 26
Cash and Cash Equivalents - Beginning of Period 133 89
---------- ----------
Cash and Cash Equivalents - End of Period $ 184 $ 115
========== ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED BALANCE SHEETS
TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES
(in millions)
9/08/01 12/30/00
------------ -----------
(unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 184 $ 133
Short-term investments, at cost 65 63
Accounts and notes receivable, less allowance: $84
in 2001 and $82 in 2000 207 302
Inventories 54 47
Prepaid expenses and other current assets 92 68
Deferred income taxes 76 75
------------ -----------
Total Current Assets 678 688
Property, Plant and Equipment, net 2,665 2,540
Intangible Assets, net 474 419
Investments in Unconsolidated Affiliates 224 257
Other Assets 328 245
------------ -----------
Total Assets $ 4,369 $ 4,149
============ ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities
Accounts payable and other current liabilities $ 961 $ 978
Income taxes payable 233 148
Short-term borrowings 214 90
------------ -----------
Total Current Liabilities 1,408 1,216
Long-term Debt 2,159 2,397
Other Liabilities and Deferred Credits 863 848
Deferred Income Taxes - 10
------------ -----------
Total Liabilities 4,430 4,471
------------ -----------
Shareholders' Deficit
Preferred stock, no par value, 250 shares authorized;
no shares issued - -
Common stock, no par value, 750 shares authorized;
146 shares and 147 shares issued in 2001
and 2000, respectively 1,071 1,133
Accumulated deficit (950) (1,278)
Accumulated other comprehensive income (182) (177)
------------ -----------
Total Shareholders' Deficit (61) (322)
------------ -----------
Total Liabilities and Shareholders' Deficit $ 4,369 $ 4,149
============ ===========
See accompanying Notes to Condensed Consolidated Financial Statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in millions, except per share data)
(Unaudited)
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 accounting principles generally accepted in the U.S. 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/A for the fiscal year ended December 30, 2000 ("2000 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 2000 Form 10-K.
Our Financial Statements include TRICON Global Restaurants, Inc. and its wholly owned subsidiaries (collectively referred to as "TRICON" or the "Company"). 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," "us" or "our."
Our preparation of the Financial Statements in conformity with accounting principles generally accepted in the U.S. 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.
In our opinion, the accompanying Financial Statements include all adjustments considered necessary to present fairly, when read in conjunction with our 2000 Form 10-K, our financial position as of September 8, 2001, and the results of our operations for the 12 and 36 weeks ended September 8, 2001 and September 2, 2000 and cash flows for the 36 weeks ended September 8, 2001 and September 2, 2000. Our results of operations for these interim periods are not necessarily indicative of the results to be expected for the full year.
Effective December 31, 2000, we adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires that all derivative instruments be recorded on the balance sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument is dependent upon whether the derivative has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in the results of operations. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income ("OCI") and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Any ineffective portion of the gain or loss on the derivative instrument is recorded in the results of operations immediately. For derivative instruments not designated as hedging instruments, the gain or loss is also recognized in the results of operations immediately. The cumulative effect of adoption of SFAS 133 was insignificant.
6
Interest Rates
We enter into interest rate swaps, collars and forward rate agreements with the objective of reducing our exposure to interest rate risk for a portion of our debt. At September 8, 2001 and December 30, 2000 we had outstanding pay-variable interest rate swaps with notional amounts of $350 million. These swaps have been designated as fair value hedges of a portion of our fixed-rate debt and have been determined to be completely effective in offsetting the changes in the fair value of that debt due to interest rate fluctuations. The fair value of these swaps as of September 8, 2001 was approximately $43 million and has been included in Other Assets. The portion of this fair value which has not yet been recognized as a reduction to interest expense (approximately $35 million at September 8, 2001) has been included in Long-term Debt.
At September 8, 2001 and December 30, 2000, we also had outstanding pay-fixed interest rate swaps with notional amounts of $100 million and $450 million, respectively. These swaps have been designated as cash flow hedges of a portion of our variable-rate debt and have been determined to be completely effective in offsetting the variability in cash flows associated with interest payments on that debt due to interest rate fluctuations.
Foreign Exchange
We enter into foreign currency forward contracts with the objective of reducing our exposure to cash flow volatility arising from foreign currency fluctuations associated with certain foreign currency denominated financial instruments, the majority of which are intercompany short-term receivables and payables. The notional amount and maturity dates of these contracts match those of the underlying receivables or payables. We also enter into foreign currency forward contracts to reduce our cash flow volatility associated with certain forecasted foreign currency denominated royalties. These forward contracts have historically been short-term in nature, with termination dates matching forecasted settlement dates of the receivables or payables or cash receipts from royalties within the next twelve months. For those foreign currency exchange forward contracts that we have designated as cash flow hedges, we measure ineffectiveness by comparing the cumulative change in the forward contract with the cumulative change in the hedged item, both of which are based on forward rates. No ineffectiveness was recognized for the 12 and 36 weeks ended September 8, 2001 for those foreign currency forward contracts designated as cash flow hedges.
Commodities
We also utilize on a limited basis commodity futures and options contracts to mitigate our exposure to commodity price fluctuations over the next twelve months. Those contracts have not been designated as hedges under SFAS 133. Open commodity future and options contracts are not significant as of September 8, 2001, nor were they significant as of the adoption of SFAS 133 on December 31, 2000.
Deferred Amounts in Accumulated Other Comprehensive Income
As of September 8, 2001, we had a net deferred loss associated with cash flow hedges that was less than $1 million, net of tax. Of this amount, we estimate that a net after-tax gain of approximately $1 million will be reclassified into earnings through September 7, 2002. The remaining net after-tax loss of approximately $1 million, which arose from the settlement of treasury locks entered into prior to the issuance of certain amounts of our fixed rate debt, will be reclassified into earnings from September 8, 2002 through 2011 as an increase to interest expense on this debt.
7
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" ("SFAS 141") which supersedes Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations." SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations and modifies the application of the purchase accounting method. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported separately from goodwill. The provisions of SFAS 141 will be effective for transactions accounted for using the purchase method that are completed after June 30, 2001.
In July 2001, the FASB also issued SFAS No. 142, "Goodwill and Intangible Assets" ("SFAS 142") which supersedes APB Opinion No. 17, "Intangible Assets." SFAS 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. SFAS 142 will apply to goodwill and intangible assets arising from transactions completed before and after the effective date. SFAS 142 will be effective for the Company beginning fiscal year 2002.
The Company's business combinations have historically consisted primarily of acquiring restaurants from our franchisees and have been accounted for using the purchase method of accounting. The primary intangible asset to which we have generally allocated value in these business combinations is reacquired franchise rights. We have determined that reacquired franchise rights do not meet the criteria of SFAS 141 to be recognized as an asset apart from goodwill. However, we are evaluating the impact of SFAS 141 and SFAS 142 on our other intangibles and have also not yet determined whether any impairment of goodwill or other indefinite-lived intangibles is required under the provisions of SFAS 142. Until these determinations are made, it is not practicable to reasonably estimate the overall impact of adopting SFAS 141 and SFAS 142 on the Company's Financial Statements.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), which will be effective for the Company beginning fiscal year 2003. SFAS 143 addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121") and the accounting and reporting provisions of APB No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business. SFAS 144 retains many of the fundamental provisions of SFAS 121, but resolves certain implementation issues associated with that Statement. SFAS 144 will be effective for the Company for the fiscal year 2002. We have not yet determined the impact of adopting SFAS 143 or SFAS 144 on the Company's Financial Statements.
8
12 Weeks Ended 36 Weeks Ended
----------------------- -----------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ----------
Net income $ 124 $ 59 $ 328 $ 285
========== ========== ========== ==========
Basic EPS:
Weighted-average common shares outstanding 147 146 147 147
========== ========== ========== ==========
Basic EPS $ 0.84 $ 0.41 $ 2.23 $ 1.94
========== ========== ========== ==========
Diluted EPS:
Weighted-average common shares outstanding 147 146 147 147
Shares assumed issued on exercise of dilutive
share equivalents 27 14 27 18
Shares assumed purchased with proceeds of
dilutive share equivalents (21) (13) (22) (16)
---------- ---------- ---------- ----------
Shares applicable to diluted earnings 153 147 152 149
========== ========== ========== ==========
Diluted EPS $ 0.81 $ 0.40 $ 2.16 $ 1.91
========== ========== ========== ==========
Unexercised employee stock options to purchase approximately 3.1 million and 3.5 million shares of our Common Stock for the 12 and 36 weeks ended September 8, 2001, 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 36 weeks ended September 8, 2001.
Unexercised employee stock options to purchase approximately 16.2 million and 11.8 million shares of our Common Stock for the 12 and 36 weeks ended September 2, 2000, 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 36 weeks ended September 2, 2000.
Comprehensive income was as follows:
12 Weeks Ended 36 Weeks Ended
------------------------- -------------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ------------
Net income $ 124 $ 59 $ 328 $ 285
Foreign currency translation adjustment
arising during the period (3) (4) (8) (20)
Reclassification of foreign currency
translation adjustment - - 3 -
Changes in fair value of derivatives 2 - 7 -
Reclassification of derivative gains to net
income (2) - (7) -
---------- ---------- ---------- ------------
Total comprehensive income $ 121 $ 55 $ 323 $ 265
========== ========== ========== ============
9
Facility Actions Net (Gain)
Facility actions net (gain) consists of the following three components, which are described in our 2000 Form 10-K:
12 Weeks Ended 36 Weeks Ended
--------------------- -----------------------
9/08/01 9/02/00 9/08/01 9/02/00
--------- --------- --------- -----------
Refranchising (gains)losses(a)(b) $ (14) $ (5) $ (49) $ (126)
Store closure costs 4 1 10 4
Impairment charges for stores that will continue
to be used in the business - - 9 4
Impairment charges for stores to be closed 1 1 5 2
--------- --------- --------- -----------
Facility actions net (gain) $ (9) $ (3) $ (25) $ (116)
========= ========= ========= ===========
United States $ (9) $ (10) $ (25) $ (122)
International - 7 - 6
--------- --------- --------- -----------
$ (9) $ (3) $ (25) $ (116)
========= ========= ========= ===========
The following table summarizes Company sales and restaurant margin for the quarter and year-to-date related to stores held for disposal at September 8, 2001 or disposed of through refranchising or closure during 2001 and 2000. Restaurant margin represents Company sales less the cost of food and paper, payroll and employee benefits and occupancy and other operating expenses. These amounts do not include the impact of Company stores that have been contributed to unconsolidated affiliates.
12 Weeks Ended 36 Weeks Ended
--------------------- -----------------------
9/08/01 9/02/00 9/08/01 9/02/00
--------- --------- --------- -----------
Stores held for disposal at September 8, 2001 or
disposed of in 2001:
Sales $ 6 $ 64 $ 86 $ 192
Restaurant margin - 8 8 25
Stores disposed of in 2000:
Sales $ 66 $ 314
Restaurant margin 8 42
10
Unusual Items
Unusual net charges of $92 million and $168 million in the third quarter and year-to-date 2000, respectively, are primarily due to costs related to AmeriServe Food Distribution, Inc.'s ("AmeriServe") bankruptcy reorganization process, as more fully discussed in our 2000 Form 10-K, costs to defend certain wage and hour litigation and expenses related to the formation of a new unconsolidated affiliate in Canada.
Our primary bank credit agreement, as amended, is comprised of a senior unsecured Term Loan Facility and a $3 billion senior unsecured Revolving Credit Facility (collectively referred to as the "Credit Facilities") both of which mature on October 2, 2002. Amounts outstanding under our Revolving Credit Facility are expected to fluctuate, but reductions in our Term Loan Facility may not be reborrowed.
At September 8, 2001, we had unused Revolving Credit Facility borrowings available aggregating $2.6 billion, net of outstanding letters of credit of $0.2 billion. At September 8, 2001, the weighted average interest rate on our Credit Facilities was 5.2%, which included the effects of associated interest rate swaps.
At September 8, 2001, long-term debt included approximately $35 million resulting from SFAS 133 which is more fully discussed in Note 2.
Interest expense on short-term borrowings and long-term debt was $39 million and $42 million for the 12 weeks ended September 8, 2001 and September 2, 2000, respectively, and $123 million and $131 million for the 36 weeks ended September 8, 2001 and September 2, 2000, respectively. As more fully discussed in our 2000 Form 10-K, interest expense on incremental borrowings related to the AmeriServe bankruptcy reorganization process was included in unusual items for 2000.
In April 2001, we issued $200 million of 8.5% Senior Unsecured Notes due April 15, 2006 and $650 million of 8.875% Senior Unsecured Notes (collectively referred to as the "Notes") due April 15, 2011 under a shelf registration statement previously filed with the Securities and Exchange Commission. The net proceeds from the issuance of the Notes were used to reduce amounts outstanding under the Credit Facilities. Interest is payable April 15 and October 15 commencing on October 15, 2001.
11
Revenues
-------------------------------------------------
12 Weeks Ended 36 Weeks Ended
----------------------- ------------------------
9/08/01 9/02/00 9/08/01 9/02/00
----------- ---------- ---------- ------------
United States $ 1,126 $ 1,166 $ 3,320 $ 3,501
International 514 492 1,431 1,410
----------- ---------- ---------- ------------
$ 1,640 $ 1,658 $ 4,751 $ 4,911
=========== ========== ========== ============
Operating Profit; Interest Expense, Net;
and Income Before Income Taxes
-------------------------------------------------
12 Weeks Ended 36 Weeks Ended
----------------------- ------------------------
9/08/01 9/02/00 9/08/01 9/02/00
----------- ---------- ---------- ------------
United States $ 171 $ 191 $ 483 $ 537
International 82 76 214 219
Unallocated and corporate expenses (31) (45) (100) (110)
Foreign exchange net (loss) - (1) (2) -
Facility actions net gain 9 3 25 116
Unusual items - (92) 2 (168)
----------- ---------- ---------- ------------
Total operating profit 231 132 622 594
Interest expense, net (36) (39) (112) (121)
----------- ---------- ---------- ------------
Income before income taxes $ 195 $ 93 $ 510 $ 473
=========== ========== ========== ============
Identifiable Assets
-----------------------
9/08/01 12/30/00
----------- ----------
United States $ 2,492 $ 2,400
International 1,657 1,501
Corporate(a) 220 248
----------- ----------
$ 4,369 $ 4,149
=========== ==========
Long-Lived Assets(b)
-----------------------
9/08/01 12/30/00
----------- ----------
United States $ 2,181 $ 2,101
International 919 828
Corporate 39 30
----------- ----------
$ 3,139 $ 2,959
=========== ==========
In February 2001, our Board of Directors authorized a Share Repurchase Program, which authorizes us to repurchase, over a two-year period, up to $300 million, excluding applicable transaction fees, of our outstanding Common Stock. During the 36 weeks ended September 8, 2001, we repurchased approximately 2.3 million shares for approximately $98 million at an average price per share of approximately $42. Based on market conditions and other factors, additional repurchases may be made
12
from time to time in the open market or through privately negotiated transactions, at the discretion of the Company.
In 1999, our Board of Directors authorized the repurchase of up to $350 million, excluding applicable transaction fees, of our outstanding Common Stock. This Share Repurchase Program was completed in the second quarter of 2000. During the first and second quarters of 2000, we repurchased approximately 6.4 million shares for $216 million at an average price per share of approximately $34.
36 Weeks Ended
------------------------
9/08/01 9/02/00
---------- -----------
Cash Paid for:
Interest $ 95 $ 112
Income taxes 67 160
Significant Non-Cash Investing and Financing
Activities:
Issuance of promissory note to acquire an
unconsolidated affiliate $ - $ 25
Contribution of non-cash net assets to an
unconsolidated affiliate 21 70
Assumption of liabilities in connection with
an acquisition 36 -
Fair market value of non-cash assets received
in connection with an acquisition 9 -
Capital lease obligations incurred to acquire assets 14 -
AmeriServe Bankruptcy Reorganization Process
We and our franchisees and licensees are dependent on frequent replenishment of food and paper supplies required by our restaurants. We and a large number of our franchisees and licensees operate under multi-year contracts, which have now been assumed by McLane Company, Inc. ("McLane"), which required the use of AmeriServe to purchase and make deliveries of most of these supplies. AmeriServe filed for protection under Chapter 11 of the U.S. Bankruptcy Code on January 31, 2000. A plan of reorganization for AmeriServe (the "POR") was approved by the U.S. Bankruptcy Court on November 28, 2000.
During the AmeriServe bankruptcy reorganization process, we took a number of actions to ensure continued supply to our restaurant system. These actions resulted in a total net expense of $170 million in 2000, which was recorded as unusual items. We incurred no incremental net expense in connection with the AmeriServe bankruptcy reorganization process and POR during the third quarter or year-to-date 2001. Moreover, based upon the actions contemplated by the POR which have been completed to date and other currently available information, we believe the ultimate cost of the AmeriServe bankruptcy reorganization process will not materially exceed the amounts already provided through the end of 2000.
Under the terms of the POR, TRICON is entitled to proceeds from the liquidation of AmeriServe's remaining inventory, accounts receivable and certain other assets (the "Residual Assets"). We have currently estimated these proceeds, net of recoveries to date, to be approximately $24 million which we have recorded as a receivable from the AmeriServe bankruptcy estate. We expect that these proceeds will be primarily realized over the remainder of 2001.
13
The POR also grants TRICON a priority right to proceeds (up to a maximum of $220 million) from certain litigation claims and causes of action held by the AmeriServe bankruptcy estate, including certain avoidance and preference actions. We expect that any such proceeds, the ultimate potential amounts of which are not yet reasonably estimable, will be primarily realized over the next six to eighteen months. These recoveries will be recorded as unusual items as they are realized.
During the bankruptcy reorganization process, to help ensure that our supply chain remained open, we purchased supplies directly from suppliers for use in our restaurants, as well as for resale to our franchisees and licensees who previously purchased supplies from AmeriServe (the "Temporary Direct Purchase Program" or "TDPP"). Operations under the TDPP ceased on November 30, 2000, the date on which McLane purchased AmeriServe's U.S. distribution business. At September 8, 2001, our net remaining receivables from franchisees and licensees for sales of supplies under the TDPP were not significant. The Company intends to vigorously pursue collection of the remaining receivables.
Other Commitments and Contingencies
Contingent Liabilities
We were directly or indirectly contingently liable in the amounts of $385 million and $401 million at September 8, 2001 and December 30, 2000, respectively, for certain lease assignments and guarantees. At September 8, 2001, $295 million represented contingent liabilities to lessors as a result of assigning our interest in and obligations under real estate leases as a condition to the refranchising of certain Company restaurants and the contribution of certain Company restaurants to unconsolidated affiliates. The $295 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 $441 million. The remaining amounts of the contingent liabilities primarily relate to our guarantees to support financial arrangements of franchisees and certain unconsolidated affiliates. The contingent liabilities related to financial arrangements of franchisees include partial guarantees of franchisee loan pools originated primarily in connection with the Company's refranchising programs. In support of these guarantees, we have posted $32.4 million of letters of credit. Also, TRICON provides a standby letter of credit under which TRICON could potentially be required to fund a portion (up to $25 million) of one of the franchisee loan pools discussed above. Any such funding under these letters of credit would be secured by franchisee loan collateral. We believe that we have appropriately provided for our estimated probable exposures under these contingent liabilities. These provisions were primarily charged to refranchising (gains) losses.
Insurance Programs
We are currently self-insured for a portion of our current and prior years' losses related to workers' compensation, general liability and automobile liability insurance programs (collectively, "casualty loss(es)") as well as property losses and certain other insurable risks. To mitigate the cost of our exposures for certain property and casualty losses, we make annual decisions to either retain the risks of loss up to certain maximum per occurrence or aggregate loss limits negotiated with our insurance carriers or to fully insure those risks. For fiscal years 2001 and 2000, we have bundled our risks for casualty losses, property losses and various other insurable risks into one risk pool with a single maximum loss limit. Losses in excess of the single maximum loss limit are covered under reinsurance agreements. We are also self-insured for healthcare claims for eligible participating employees subject to certain deductibles and limitations. We have accounted for our retained liabilities for casualty losses and healthcare claims, including reported and incurred but not reported claims, based on information provided by our independent actuary.
14
Due to the inherent volatility of our property and actuarially determined casualty loss estimates, it is reasonably possible that we could experience changes in estimated losses which could be material to our growth in quarterly and annual net income. We believe that we have recorded our reserves for casualty losses at a level which has substantially mitigated the potential negative impact of adverse developments and/or volatility.
Change of Control Severance Agreements
In September 2000, the Compensation Committee of the Board of Directors approved renewing severance agreements with certain key executives (the "Agreements") that were set to expire on December 31, 2000. These Agreements are triggered by a termination, under certain conditions, of the executive's employment following a change in control of the Company, as defined in the Agreements. If triggered, the affected executives would generally receive twice the amount of both their annual base salary and their annual incentive in a lump sum, outplacement services and a tax gross-up for any excise taxes. These Agreements have a three-year term and automatically renew each January 1 for another three-year term unless the Company elects not to renew the Agreements. Since the timing of any payments under these Agreements cannot be anticipated, the amounts are not estimable. However, these payments, if made, could be substantial. In the event of a change of control, rabbi trusts would be established and used to provide payouts under existing deferred and incentive compensation plans.
Wage and Hour Litigation
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 certain other large retail employers, Pizza Hut and Taco Bell have been faced in certain 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, LLC. The lawsuit alleges violations of state wage and hour laws involving unpaid overtime wages and vacation pay and seeks an unspecified amount in damages. On January 12, 2000, the Court certified a class of approximately 1,300 current and former restaurant general managers. The Court amended the class on June 1, 2000 to include approximately 150 additional current and former restaurant general managers. On May 2, 2001, the parties reached an agreement to settle this matter and entered into a stipulation of discontinuance of the case. This settlement agreement is subject to approval by the court of the terms and conditions of the agreement and notice to the class with an opportunity to object and be heard. We have previously provided for the costs of this settlement as unusual items.
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 17,000 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 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. A trial date
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of November 2, 1999 was set. However, on November 1, 1999, the Court issued a proposed order postponing the trial and establishing a pre-trial claims process. The final order regarding the claims process was entered on January 14, 2000. Taco Bell moved for certification of an immediate appeal of the Court-ordered claims process and requested a stay of the proceedings. This motion was denied on February 8, 2000. Taco Bell appealed this decision to the Supreme Court of Oregon and the Court denied Taco Bell's Writ of Mandamus on March 21, 2000. A Court-approved notice and claim form was mailed to approximately 14,500 class members on January 31, 2000. A Court ordered pre-trial claims process went forward, and hearings were held to determine potential damages for claimants employed or previously employed in selected Taco Bell restaurants. After the initial hearings, the damage claims hearings were discontinued. Trial began on January 4, 2001. On March 9, 2001, the jury reached verdicts on the substantive issues in this matter. A number of these verdicts were in favor of the Taco Bell position; however, certain issues were decided in favor of the plaintiffs. The Court has scheduled a damages trial date of January 7, 2002. Taco Bell has filed several pre-trial motions relating to the form of trial and evidence to be admitted at the damages trial or trials. Hearings on these motions will be held in late October 2001. A number of procedural issues, including possible appeals, remain to determine the ultimate damages in this matter.
We have provided for the estimated costs of the Bravo litigation, based on a projection of eligible claims (including claims filed to date, where applicable), the cost of each eligible claim, the estimated legal fees incurred by plaintiffs and the results of settlement negotiations in these and other wage and hour litigation matters. Although the outcome of this case cannot be determined at this time, we believe the ultimate cost of this case in excess of the amounts already provided will not be material to our annual results of operations, financial condition or cash flows. Any provisions have been recorded as unusual items.
On October 2, 1996, a class action lawsuit against Taco Bell Corp., entitled Mynaf, et al. v. Taco Bell Corp., 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 alleged violations of California wage and hour laws involving unpaid overtime wages, and violations of the State Labor Code's record-keeping requirements. The complaint also included an unfair business practices claim. Plaintiffs claimed 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. Class notices were mailed on August 31, 1999 to over 3,400 class members. Trial began on January 29, 2001. Before conclusion of the trial, the parties reached an agreement to settle this matter, and entered into a stipulation of discontinuance of the case. This settlement agreement was approved by the court on September 21, 2001. We have previously provided for the costs of this settlement as unusual items.
Other Litigation
C&F Packing Co., Inc. v. Pizza Hut, Inc. This action was originally filed in 1993 by C&F Packing Co., Inc., a Chicago meat packing company ("C&F"), in the United States District court for the Northern District of Illinois. This lawsuit alleges that Pizza Hut misappropriated various trade secrets relating to C&F's alleged process for manufacturing a precooked Italian sausage pizza topping. C&F's trade secret claims against Pizza Hut were originally dismissed by the trial court on statute of limitations grounds. That ruling was later overturned by the U.S. Court of Appeals for the Federal Circuit in August 2000 and the case was remanded to the trial court for further proceedings. On remand, Pizza
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Hut moved for summary judgment on its statute of limitations defense. That motion was denied in January 2001. This lawsuit is in the discovery phase and no trial date has been set. Similar trade secret claims against another defendant were tried by a jury in late 1998 and the jury returned a verdict for C&F. Judgment on that verdict was affirmed by the U.S. Court of Appeals for the Federal Circuit in August 2000.
TRICON believes that C&F's claims are without merit and is vigorously defending the case. However, in view of the inherent uncertainties of litigation, the outcome of this case cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.
On January 16, 1998, a lawsuit against Taco Bell Corp., entitled Wrench LLC, Joseph Shields and Thomas Rinks v. Taco Bell Corp. ("Wrench") was filed in the United States District Court for the Western District of Michigan. The lawsuit alleges that Taco Bell Corp. misappropriated certain ideas and concepts used in its advertising featuring a Chihuahua. Plaintiffs seek to recover damages under several theories, including breach of implied-in-fact contract, idea misappropriation, conversion and unfair competition. On June 10, 1999, the District Court granted summary judgment in favor of Taco Bell Corp. Plaintiffs filed an appeal with the U.S. Court of Appeals for the Sixth Circuit (the "Court of Appeals"), and oral arguments were held on September 20, 2000. On July 6, 2001, the Court of Appeals reversed the District Court's judgment in favor of Taco Bell Corp. and remanded the case to the District Court. Taco Bell's petition to the Court of Appeals for a rehearing en banc was denied in early October, 2001, but the Court granted Taco Bell's motion to stay the remand to the District Court. Taco Bell intends to prepare and file a Petition for Certiorari with the United States Supreme Court. In the event that the ruling of the Court of Appeals stands, the Wrench plaintiffs will be allowed to bring their claims to trial.
TRICON believes that the Wrench plaintiffs' claims are without merit and is vigorously defending the case. However, in view of the inherent uncertainties of litigation, the outcome of the case cannot be predicted at this time. Likewise, the amount of any potential loss cannot be reasonably estimated.
Obligations to PepsiCo, Inc. After Spin-off
In connection with the October 6, 1997 Spin-off from PepsiCo, Inc. ("PepsiCo") (the "Spin-off") we entered into separation and other related agreements (the "Separation Agreements"), governing the Spin-off transaction and our subsequent relationship with PepsiCo. These agreements provide certain indemnities to PepsiCo.
The Separation Agreements provided for, among other things, our assumption of all liabilities relating to the restaurant businesses, including California Pizza Kitchen, Chevys Mexican Restaurant, D'Angelo's Sandwich Shops, East Side Mario's and Hot 'n Now (collectively the "Non-core Businesses"), and our indemnification of PepsiCo with respect to these liabilities. We have included our best estimates of these liabilities in the accompanying Financial Statements.
In addition, we have indemnified PepsiCo for any costs or losses it incurs with respect to all letters of credit, guarantees and contingent liabilities relating to our businesses under which PepsiCo remains liable. As of September 8, 2001, PepsiCo remains liable for approximately $111 million related to these contingencies. This obligation ends at the time PepsiCo is released, terminated or replaced by a qualified letter of credit. We have not been required to make any payments under this indemnity.
Under the Separation Agreements, PepsiCo maintains full control and absolute discretion with regard to any combined or consolidated tax filings for periods through October 6, 1997. PepsiCo also maintains full control and absolute discretion regarding any common tax audit issues. Although
17
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 made by PepsiCo would be the same as we would reach, acting on our own behalf. Through September 8, 2001, there have not been any determinations made by PepsiCo where we would have reached a different determination.
We also agreed to certain restrictions on our actions to help ensure that the Spin-off maintained its tax-free status. These restrictions, which were generally applicable to the two-year period following October 6, 1997, included among other things, limitations on any liquidation, merger or consolidation with another company, certain issuances and redemptions of our Common Stock, our granting of stock options and our sale, refranchising, distribution or other disposition of assets. If we failed 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 or are expected to be required. Additionally, 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. We expense the payroll taxes related to the exercise of these options as incurred.
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TRICON Global Restaurants, Inc. and Subsidiaries (collectively referred to as "TRICON," or the "Company") is comprised of the worldwide operations of KFC, Pizza Hut and Taco Bell (the "Concepts") and is the world's largest quick service restaurant ("QSR") company based on the number of system units. The following Management's Discussion and Analysis ("MD&A") should be read in conjunction with the unaudited Condensed Consolidated Financial Statements ("Financial Statements"), the Cautionary Statements and our annual report on Form 10-K/A for the fiscal year ended December 30, 2000 ("2000 Form 10-K"). All Note references herein refer to the accompanying notes to the Financial Statements.
Throughout MD&A, we make reference to ongoing operating profit which represents operating profit excluding the impact of facility actions net (gain) and unusual items. See Note 6 for a discussion of these exclusions. We use ongoing operating profit as a key performance measure of our results of operations for purposes of evaluating performance internally and as the base to forecast future performance. Ongoing operating profit is not a measure defined by accounting principles generally accepted in the U.S. and should not be considered in isolation or as a substitution for measures of performance in accordance with accounting principles generally accepted in the U.S.
See Note 3.
The following factors impacted comparability of operating performance for the quarter and year-to-date ended September 8, 2001 to the quarter and year-to-date ended September 2, 2000 or could impact comparisons for the remainder of 2001. Certain of these factors were previously discussed in our 2000 Form 10-K.
AmeriServe Bankruptcy Reorganization Process
See Note 11 and our 2000 Form 10-K for a discussion of the impact of the AmeriServe Food Distribution, Inc. ("AmeriServe") bankruptcy reorganization process on the Company.
Kraft Taco Shell Recall
In the fourth quarter of 2000, allegations were made by a public environmental advocacy group that testing of corn taco shells, sold by Kraft Foods, Inc. ("Kraft") in grocery stores under a license to use the Taco Bell brand name, had indicated the presence of genetically modified ("GM") corn which had only been approved by the applicable U.S. governmental agencies for animal consumption. In light of the allegations, Kraft recalled this product line. We are not aware of any evidence that suggests that the GM corn at issue presents any significant health risk to humans. Nonetheless, consistent with our overall quality assurance procedures, we have taken significant actions to ensure that our restaurant supply chain is free of products containing the GM corn in question, and we will continue to take whatever actions are prudent or appropriate in this regard.
Although we are unable to estimate the amount, we believe that our Taco Bell restaurants have experienced a negative impact on sales following the allegations and the Kraft recall. We do not currently believe this sales impact will be sustained over the long term.
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As previously disclosed, FRANMAC, an association representing U.S. Taco Bell franchisees, together with TRICON, reached an agreement with Taco Bell's taco shell suppliers under which those suppliers have provided $60 million to Taco Bell franchisees. These funds, which are intended to assist Taco Bell franchisees to partially recover lost sales in the wake of marketplace confusion following the Kraft taco shell recall described above, have been distributed on a pro rata basis to franchisee operators based on their number of restaurants. As part of the agreement, FRANMAC, TRICON and the taco shell suppliers intend to jointly seek damages from those parties responsible for the introduction of the GM corn into the U.S. supply chain.
Franchisee Financial Condition
Like others in the QSR industry, from time to time, some of our franchise operators experience financial difficulties with respect to their franchise operations. At present, certain of our franchise operators, principally in the Taco Bell system, are experiencing varying degrees of financial problems.
Depending upon the facts and circumstances of each situation, and in the absence of an improvement in business trends, there are a number of potential resolutions of these financial issues. These include a sale of some or all of the operator's restaurants to us or a third party, a restructuring of the operator's business and/or finances, or, in the more unusual cases, bankruptcy of the operator. It is our practice to proactively work with financially troubled franchise operators in an attempt to positively resolve their issues.
In the fourth quarter of 2000, Taco Bell established a $15 million loan program to assist certain franchisees. All fundings had been advanced by the end of the first quarter of 2001, and the resulting notes receivable are included in Other Assets. Additionally, Taco Bell is in various stages of discussions with a number of Taco Bell franchisees and their lenders. We believe that many of these franchisees will require various types of business and/or financial restructuring, which includes the purchase of some franchised restaurants by Taco Bell. Through September 2001, restructurings have been completed for approximately 700 restaurants. In addition, Taco Bell has acquired 120 restaurants through September 8, 2001 in connection with these restructurings.
The Company charged expenses of $3 million in the quarter and $16 million year-to-date to ongoing operating profit related to allowances for doubtful franchise and license fee receivables. These costs were reported as general and administrative expenses. On an ongoing basis, we assess our exposure from franchise-related risks, which include estimated uncollectibility of accounts receivable related to franchise and license fees, contingent lease liabilities, guarantees to support certain third party financial arrangements with franchisees and potential claims by franchisees. The contingent lease liabilities and guarantees are more fully discussed in the Contingent Liabilities section of Note 11. Although the ultimate impact of these franchise financial issues cannot be predicted with certainty at this time, we have provided for our current estimate of the probable exposure to the Company as of September 8, 2001. It is reasonably possible that there will be additional costs which could be material to quarterly or annual results of operations, financial condition or cash flows.
The Taco Bell franchise financial situation poses certain risks and uncertainties to us. The more significant of these risks and uncertainties are described below. Significant adverse developments in this situation, or in any of these risks or uncertainties, could have a material adverse impact on our quarterly or annual results of operations, financial condition or cash flows.
We intend to continue to proactively work with financially troubled franchise operators in an attempt to positively resolve their issues. However, there can be no assurance that the number of franchise operators or restaurants experiencing financial difficulties will not change from our current estimates. Nor can there be any assurance that we will be successful in resolving financial issues relating to any specific franchise operator.
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Additionally, there can be no assurance that resolution of these financial issues will not result in Taco Bell purchasing a significant number of restaurants from financially troubled Taco Bell franchise operators.
Unusual Items
We had unusual net charges of $92 million and $168 million in the quarter and year-to-date 2000, respectively. See Note 6 for a discussion of our unusual items.
Change in Casualty Loss Estimates
Due to the inherent volatility of our actuarially-determined casualty loss estimates, it is reasonably possible that we will experience changes in estimated losses which could be material to our growth in ongoing operating profit in 2001. See Note 11 for a discussion of our insurance programs.
Impact of New Unconsolidated Affiliates
Consistent with our strategy to focus our capital on key international markets, we formed new ventures in Canada and Poland with our largest franchisee in each market. The venture in Canada was formed in the third quarter of 2000 and the venture in Poland was effective in the first quarter of 2001. The Canadian venture operates over 650 stores and the Poland venture operates approximately 100 stores. We did not record any gain or loss on the transfer of assets to these new ventures.
Previously, the results from the restaurants we contributed to these ventures were consolidated. The impact of these transactions on operating results is similar to the impact of our refranchising activities, which is described in the Store Portfolio Strategy section below. Consequently, these transactions resulted in a decline in our Company sales, restaurant margin dollars and general and administrative expenses ("G&A") as well as higher franchise fees. We also record equity income (losses) from investments in unconsolidated affiliates ("equity income") and higher franchise fees in Canada since the royalty rate was increased for those stores contributed by our partner to the venture. The formation of these ventures did not have a significant net impact on ongoing operating profit in the quarter and year-to-date ended September 8, 2001.
Impact of the Consolidation of an Unconsolidated Affiliate
At the beginning of 2001, we consolidated a previously unconsolidated affiliate in our Financial Statements as a result of a change in our intent to temporarily retain control of this affiliate. This change resulted in higher Company sales, restaurant margin dollars and G&A as well as decreased franchise fees and equity income. This previously unconsolidated affiliate operates 116 stores.
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. Greece has since adopted the single currency on January 1, 2001, taking the total adopting countries to twelve. From January 1, 1999 through no later than February 28, 2002, all adopting countries will maintain a period of dual currency, where both legacy currencies and the Euro can be used in day-to-day credit transactions. Beginning January 1, 2002, new Euro-denominated bills and coins will be issued, and a transition period of up to two months will begin during which local currencies will be removed from circulation.
We have Company and franchised businesses in the adopting member countries, which are preparing for the conversion. To date, expenditures associated with our conversion efforts have been relatively insignificant, totaling approximately $2 million. These expenditures have been concentrated mainly on consulting expenses
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for initial impact studies and head office accounting systems. We currently estimate that the total spending over the transition period will be approximately $5 million related to the conversion in the EMU member countries in which we operate stores. Approximately 30% of these expenditures relate to capital expenditures for new point-of-sale and back-of-restaurant hardware and software to accommodate Euro-denominated transactions. We believe that adoption of the Euro by the United Kingdom 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.
The pace 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 anticipate that our suppliers and distributors will continue to invoice us in local currencies until late 2001. We expect to begin dual pricing in our restaurants in late 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 changes. 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.
Store Portfolio Strategy
Since 1995, we have been strategically reducing our share of total system units by selling Company restaurants to existing and new franchisees where their expertise can generally be leveraged to improve our overall operating performance, while retaining Company ownership of key U.S. and International markets. This portfolio-balancing activity has reduced our reported revenues and restaurant profits and has increased the importance of system sales as a key performance measure. We expect to substantially complete our refranchising program in 2001.
The following table summarizes our refranchising activities:
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ----------
Number of units refranchised 37 48 193 479
Refranchising proceeds, pre-tax $ 11 $ 30 $ 73 $ 240
Refranchising gains, pre-tax(a) $ 14 $ 5 $ 49 $ 126
In addition to our refranchising program, we have been closing restaurants over the past several years. Restaurants closed include poor performing restaurants, restaurants that are relocated to a new site within the same trade area or U.S. Pizza Hut delivery units consolidated with a new or existing dine-in traditional store within the same trade area.
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The following table summarizes Company store closure activities:
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ----------
Number of units closed 67 47 168 132
Store closure costs $ 4 $ 1 $ 10 $ 4
Impairment charges for stores to be closed $ 1 $ 1 $ 5 $ 2
The impact on ongoing operating profit arising from our refranchising and store closure initiatives as well as the contribution of Company stores to new unconsolidated affiliates as described in the Impact of New Unconsolidated Affiliates section, represents the net of (a) the estimated reduction in Company sales, restaurant margin and G&A; (b) the estimated increase in franchise fees; and (c) the increase or decrease in equity income. The amounts presented below reflect the estimated impact from stores that were operated by us for all or some portion of the comparable period in 2000 and are no longer operated by us as of September 8, 2001.
The following table summarizes the estimated impact on revenue of refranchising, store closures and the contribution of Company stores to unconsolidated affiliates:
12 Weeks Ended 9/08/01
-----------------------------------------
U.S. International Worldwide
----------- -------------- ------------
Reduced sales $ (98) $ (62) $ (160)
Increased franchise fees 5 3 8
----------- -------------- ------------
Reduction in total revenues $ (93) $ (59) $ (152)
=========== ============== ============
36 Weeks Ended 9/08/01
-----------------------------------------
U.S. International Worldwide
----------- -------------- ------------
Reduced sales $ (357) $ (201) $ (558)
Increased franchise fees 16 11 27
----------- -------------- ------------
Reduction in total revenues $ (341) $ (190) $ (531)
=========== ============== ============
The following table summarizes the estimated impact on ongoing operating profit of refranchising, store closures and the contribution of Company stores to unconsolidated affiliates:
12 Weeks Ended 9/08/01
-----------------------------------------
U.S. International Worldwide
----------- -------------- ------------
Decreased restaurant margin $ (14) $ (7) $ (21)
Increased franchise fees 5 3 8
Decreased G&A 1 4 5
Decreased equity income - (1) (1)
----------- -------------- ------------
Decrease in ongoing operating profit $ (8) $ (1) $ (9)
=========== ============== ============
36 Weeks Ended 9/08/01
-----------------------------------------
U.S. International Worldwide
----------- -------------- ------------
Decreased restaurant margin $ (51) $ (21) $ (72)
Increased franchise fees 16 11 27
Decreased G&A 5 11 16
Decreased equity income - (5) (5)
----------- -------------- ------------
Decrease in ongoing operating profit $ (30) $ (4) $ (34)
=========== ============== ============
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12 Weeks Ended 36 Weeks Ended
------------------------ -------------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
----------- ----------- ------------ ----------- ------------ ------------
System sales(a) $ 5,267 $ 5,225 1 $ 15,360 $ 15,165 1
=========== =========== =========== ============
Revenues
Company sales $ 1,449 $ 1,470 (1) $ 4,191 $ 4,375 (4)
Franchise and license fees 191 188 1 560 536 4
----------- ----------- ----------- ------------
Total revenues $ 1,640 $ 1,658 (1) $ 4,751 $ 4,911 (3)
=========== =========== =========== ============
Company restaurant margin $ 213 $ 227 (6) $ 605 $ 665 (9)
=========== =========== =========== ============
% of Company sales 14.7% 15.4% (0.7) ppts. 14.4% 15.2% (0.8) ppts.
=========== =========== =========== ============
Ongoing operating profit $ 222 $ 221 1 $ 595 $ 646 (8)
Facility actions net gain 9 3 NM 25 116 (78)
Unusual items - (92) NM 2 (168) NM
----------- ----------- ----------- ------------
Operating profit 231 132 75 622 594 5
Interest expense, net 36 39 5 112 121 7
Income tax provision 71 34 NM 182 188 3
----------- ----------- ----------- ------------
Net income $ 124 $ 59 NM $ 328 $ 285 15
=========== =========== =========== ============
Diluted earnings per share $ 0.81 $ 0.40 100 $ 2.16 $ 1.91 13
=========== =========== =========== ============
Unconsolidated
Company Affiliates Franchisees Licensees Total
----------- --------------- -------------- ---------- ---------
Balance at December 30, 2000 6,123 1,844 19,287 3,163 30,417
Openings 275 84 504 131 994
Acquisitions 328 (56) (267) (5) -
Refranchising (193) (9) 202 - -
Closures (168) (32) (514) (371) (1,085)
Other (a) (67) 93 (26) - -
----------- --------------- -------------- ---------- ---------
Balance at September 8, 2001 6,298 1,924 19,186 2,918 30,326
=========== =============== ============== ========== =========
% of Total 20.8% 6.3% 63.3% 9.6% 100.0%
System sales increased $42 million or 1% in the quarter and $195 million or 1% year-to-date, after a 3% unfavorable impact from foreign currency translation in both the quarter and year-to-date. The increases were driven by new unit development and franchisee same store sales growth partially offset by store closures.
Company sales decreased $21 million or 1% in the quarter, after a 1% unfavorable impact from foreign currency translation. The increase from new unit development and acquisitions of restaurants from franchisees was offset by refranchising, the contribution of Company stores to new unconsolidated affiliates and store closures.
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Company sales decreased $184 million or 4% year-to-date, after a 2% unfavorable impact from foreign currency translation. The decrease primarily resulted from refranchising, the contribution of Company stores to new unconsolidated affiliates and store closures. The decrease was partially offset by new unit development and acquisitions of restaurants from franchisees.
Franchise and license fees increased approximately $3 million or 1% in the quarter, after a 3% unfavorable impact from foreign currency translation. Franchise and license fees increased approximately $24 million or 4% year-to-date, after a 3% unfavorable impact from foreign currency translation. The increases were driven by new unit development, units acquired from us and units contributed to unconsolidated affiliates. These increases were partially offset by store closures and units acquired from franchisees. Same store sales growth also contributed to the year-to-date increase.
12 Weeks Ended 36 Weeks Ended
--------------------- ---------------------
9/08/01 9/02/00 9/08/01 9/02/00
--------- --------- --------- ---------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 31.6 30.9 31.2 30.7
Payroll and employee benefits 27.0 26.9 27.5 27.7
Occupancy and other operating expenses 26.7 26.8 26.9 26.4
--------- --------- --------- ---------
Company restaurant margin 14.7% 15.4% 14.4% 15.2%
========= ========= ========= =========
Restaurant margin as a percentage of sales decreased 70 basis points as compared to the third quarter of 2000. Both U.S. and International restaurant margin declined approximately 70 basis points.
Restaurant margin as a percentage of sales decreased 80 basis points year-to-date. U.S. restaurant margin declined approximately 50 basis points and International restaurant margin declined approximately 150 basis points.
G&A decreased $12 million or 6% in the quarter. The decrease was driven by lower corporate and project spending, the favorable impact from the formation of unconsolidated affiliates and refranchising. The decrease was partially offset by higher franchise support costs principally related to the financial restructuring of certain Taco Bell franchisees.
G&A increased $9 million or 2% year-to-date. The increase was driven by expenses related to the financial restructuring of certain Taco Bell franchisees, including franchise support costs and allowances for doubtful franchise and license fee receivables, and increased compensation costs. The increase was partially offset by the favorable impact from the formation of unconsolidated affiliates, refranchising and lower corporate and project spending.
12 Weeks Ended 36 Weeks Ended
-------------------- --------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
--------- --------- ---------- --------- --------- ---------
Equity income $ (6) $ (7) (12) $ (17) $ (21) (20)
Foreign exchange net loss - 1 NM 2 - NM
--------- --------- --------- ---------
Other (income) expense $ (6) $ (6) - $ (15) $ (21) (30)
========= ========= ========= =========
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Equity income declined $4 million or 20% year-to-date, after a 5% unfavorable impact from foreign currency translation. The decline was primarily due to equity losses in new unconsolidated affiliates and the consolidation of a previously unconsolidated affiliate. The decline was partially offset by improved operating results from our unconsolidated affiliate in the United Kingdom.
We recorded facility actions net gain of $9 million and $25 million for the 12 and 36 weeks ended September 8, 2001, respectively, and $3 million and $116 million for the 12 and 36 weeks ended September 2, 2000, respectively. See the Store Portfolio Strategy section for more detail of our refranchising and closure activities and Note 6 for a summary of facility actions net gain.
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
---------- ---------- --------- ---------- ---------- ---------
United States $ 171 $ 191 (11) $ 483 $ 537 (10)
International 82 76 6 214 219 (3)
Unallocated and corporate expenses (31) (45) (35) (100) (110) (9)
Foreign exchange net (loss) - (1) NM (2) - NM
---------- ---------- ---------- ----------
Ongoing operating profit $ 222 $ 221 1 $ 595 $ 646 (8)
========== ========== ========== ==========
Quarter and year-to-date U.S. and International ongoing operating profit are discussed in the respective sections.
Unallocated corporate expenses decreased $14 million or 35% in the quarter and $10 million or 9% year-to-date. The decrease was driven by lower corporate and project spending. Lower incentive and deferred compensation costs also contributed to the decline in the quarter.
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
---------- ---------- --------- ---------- ---------- ---------
Interest expense $ 39 $ 42 5 $ 123 $ 131 6
Interest income (3) (3) - (11) (10) 4
---------- ---------- ---------- ----------
Interest expense, net $ 36 $ 39 5 $ 112 $ 121 7
========== ========== ========== ==========
The decrease in our net interest expense in the quarter and year-to-date was primarily due to a decrease in our average interest rates. As discussed in our 2000 Form 10-K, the interest expense on incremental borrowings related to the AmeriServe bankruptcy reorganization process has been included in unusual items for 2000.
26
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ----------
Reported
Income taxes $ 71 $ 34 $ 182 $ 188
Effective tax rate 36.6% 36.2% 35.7% 39.7%
Ongoing(a)
Income taxes $ 61 $ 67 $ 158 $ 201
Effective tax rate 32.7% 37.0% 32.8% 38.3%
The decrease in our ongoing effective tax rate for the quarter and year-to-date was primarily attributable to a favorable change in the mix and timing of our earnings. Year-to-date, adjustments relating to prior years also contributed to the decrease.
The components of diluted earnings per common share were as follows:
12 Weeks Ended(a) 36 Weeks Ended(a)
---------------------- ----------------------
9/08/01 9/02/00 9/08/01 9/02/00
---------- ---------- ---------- ----------
Ongoing operating earnings $ 0.82 $ 0.77 $ 2.14 $ 2.17
Facility actions net gain (loss) (0.01) 0.02 0.02 0.45
Unusual items - (0.39) - (0.71)
---------- ---------- ---------- ----------
Net income $ 0.81 $ 0.40 $ 2.16 $ 1.91
========== ========== ========== ==========
12 Weeks Ended 36 Weeks Ended
------------------------ ------------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
----------- ----------- -------------- ---------- ----------- ------------
System sales $ 3,464 $ 3,441 1 $ 10,074 $ 9,917 2
=========== =========== =========== ===========
Revenues
Company sales $ 999 $ 1,039 (4) $ 2,948 $ 3,140 (6)
Franchise and license fees 127 127 - 372 361 3
----------- ----------- ----------- -----------
Total revenues $ 1,126 $ 1,166 (3) $ 3,320 $ 3,501 (5)
Company restaurant margin $ 147 $ 162 (8) $ 434 $ 478 (9)
=========== =========== =========== ===========
% of Company sales 14.8% 15.5% (0.7) ppts. 14.7% 15.2% (0.5) ppts.
=========== =========== =========== ===========
Ongoing operating profit $ 171 $ 191 (11) $ 483 $ 537 (10)
=========== =========== =========== ===========
27
Company Franchisees Licensees Total
------------ ------------ ----------- -------------
Balance at December 30, 2000 4,302 12,862 2,873 20,037
Openings 88 171 125 384
Acquisitions 133 (130) (3) -
Refranchising (115) 115 - -
Closures (118) (262) (328) (708)
------------ ------------ ----------- -------------
Balance at September 8, 2001 4,290 12,756 2,667 19,713
============ ============ =========== =============
% of Total 21.8% 64.7% 13.5% 100.0%
System sales increased $23 million or 1% in the quarter and $157 million or 2% year-to-date. The increases were driven by new unit development partially offset by store closures. Same store sales declines at Taco Bell also partially offset the increases.
Company sales decreased $40 million or 4% in the quarter and $192 million or 6% year-to-date. The decreases were primarily due to the impact of refranchising and store closures partially offset by new unit development and acquisitions of restaurants from franchisees.
Blended Company same store sales for our three Concepts were down 1% for the quarter. A decline in transactions was partially offset by an increase in the average guest check. Same store sales at Pizza Hut and KFC were flat. At Pizza Hut, a 2% increase in the average guest check was offset by transaction declines. At KFC, a 2% increase in transactions was offset by a lower average guest check. Same store sales at Taco Bell decreased 2%. Transaction declines of 4% were partially offset by an increase in the average guest check.
Year-to-date, blended Company same store sales for our three Concepts were flat. An increase in the average guest check was offset by transaction declines. Same store sales at Pizza Hut increased 2%, due to a higher average guest check. Same store sales at KFC increased 1%. Transaction increases of 2% were partially offset by a decrease in the average guest check. Same store sales at Taco Bell decreased 3%. Transaction declines of 6% were partially offset by an increase in the average guest check.
Franchise and license fees were flat in the third quarter. An increase from units acquired from us and new unit development was offset by store closures and Taco Bell same store sales declines.
Franchise and license fees grew $11 million or 3% year-to-date. The increase was driven by units acquired from us and new unit development. The increase was partially offset by store closures and Taco Bell same store sales declines.
12 Weeks Ended 36 Weeks Ended
--------------------- ---------------------
9/08/01 9/02/00 9/08/01 9/02/00
--------- --------- --------- ---------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 29.1 28.5 28.8 28.5
Payroll and employee benefits 30.8 30.1 30.9 30.8
Occupancy and other operating expenses 25.3 25.9 25.6 25.5
--------- --------- --------- ---------
Restaurant margin 14.8% 15.5% 14.7% 15.2%
========= ========= ========= =========
28
Restaurant margin as a percentage of sales declined 70 basis points in the quarter as compared to the third quarter of 2000. The decrease was primarily attributable to increased product costs, principally cheese, higher wage rates and the unfavorable impact of acquiring lower margin stores. The decrease was partially offset by lower occupancy and other costs and favorable pricing and product mix.
Restaurant margin as a percentage of sales declined 50 basis points year-to-date. The decrease was primarily due to increased product costs, principally cheese, and higher wage rates as well as the unfavorable impact of acquiring lower margin stores and Taco Bell volume declines. The decrease was partially offset by favorable pricing and product mix.
Ongoing operating profit decreased $20 million or 11% in the quarter. The decrease was primarily due to the unfavorable impact of refranchising and store closures, higher restaurant operating costs and higher franchise support costs principally related to the financial restructuring of certain Taco Bell franchisees. The decrease was partially offset by Company new unit development.
Ongoing operating profit decreased $54 million or 10% year-to-date. The decrease was primarily due to the unfavorable impact of refranchising and store closures, expenses related to the financial restructuring of certain Taco Bell franchisees, including franchise support costs and allowances for doubtful franchise and license receivables, and higher restaurant operating costs. The decrease was partially offset by Company new unit development.
12 Weeks Ended 36 Weeks Ended
---------------------- ----------------------
9/08/01 9/02/00 % B(W) 9/08/01 9/02/00 % B(W)
---------- ---------- -------------- ---------- ---------- -------------
System sales $ 1,803 $ 1,784 1 $ 5,286 $ 5,248 1
========== ========== ========== ==========
Revenues
Company sales $ 450 $ 431 4 $ 1,243 $ 1,235 1
Franchise and license fees 64 61 5 188 175 7
---------- ---------- ---------- ----------
Total revenues $ 514 $ 492 4 $ 1,431 $ 1,410 1
========== ========== ========== ==========
Company restaurant margin $ 66 $ 65 - $ 171 $ 187 (9)
========== ========== ========== ==========
% of Company sales 14.5% 15.2% (0.7) ppts. 13.7% 15.2% (1.5) ppts.
========== ========== ========== ==========
Ongoing operating profit $ 82 $ 76 6 $ 214 $ 219 (3)
========== ========== ========== ==========
Unconsolidated
Company Affiliates Franchisees Licensees Total
---------- -------------- ------------ --------- ----------
Balance at December 30, 2000 1,821 1,844 6,425 290 10,380
Openings 187 84 333 6 610
Acquisitions 195 (56) (137) (2) -
Refranchising (78) (9) 87 - -
Closures (50) (32) (252) (43) (377)
Other(a) (67) 93 (26) - -
---------- -------------- ------------ --------- ----------
Balance at September 8, 2001 2,008 1,924 6,430 251 10,613
========== ============== ============ ========= ==========
% of Total 18.9% 18.1% 60.6% 2.4% 100.0%
29
System sales increased $19 million or 1% in the quarter and $38 million or 1% year-to-date, after an 8% unfavorable impact from foreign currency translation in both the quarter and year-to-date. The increases were driven by new unit development and same store sales growth partially offset by store closures.
Company sales increased $19 million or 4% in the quarter, after a 6% unfavorable impact from foreign currency translation. Company sales increased $8 million or 1% year-to-date, after a 6% unfavorable impact from foreign currency translation. The increases primarily resulted from new unit development and acquisitions of restaurants from franchisees. These increases were partially offset by the contribution of Company stores to new unconsolidated affiliates and refranchising.
Franchise and license fees increased approximately $3 million or 5% in the quarter, after a 7% unfavorable impact from foreign currency translation. Franchise and license fees increased approximately $13 million or 7% year-to-date, after an 8% unfavorable impact from foreign currency translation. The increases were driven by new unit development, units contributed to unconsolidated affiliates, units acquired from us and same store sales growth. These increases were partially offset by store closures and units acquired from franchisees.
12 Weeks Ended 36 Weeks Ended
-------------------- --------------------
9/08/01 9/02/00 9/08/01 9/02/00
--------- --------- --------- ---------
Company sales 100.0% 100.0% 100.0% 100.0%
Food and paper 37.0 36.8 37.1 36.4
Payroll and employee benefits 18.5 19.1 19.4 19.9
Occupancy and other operating expenses 30.0 28.9 29.8 28.5
--------- --------- --------- ---------
Restaurant margin 14.5% 15.2% 13.7% 15.2%
========= ========= ========= =========
Restaurant margin as a percentage of sales decreased approximately 70 basis points in the quarter as compared to the third quarter of 2000. The decrease was primarily attributable to higher operating costs, unfavorable pricing and product mix and the acquisition of lower margin stores from franchisees. The decrease was partially offset by higher volumes.
Restaurant margin as a percentage of sales decreased approximately 150 basis points year-to-date. The decrease was primarily attributable to higher operating costs, product promotions and discounts and the acquisition of lower margin stores from franchisees. The decrease was partially offset by favorable pricing and product mix.
Ongoing operating profit increased $6 million or 6% in the quarter, after an 8% unfavorable impact from foreign currency translation. The increase in ongoing operating profit was driven by new unit development.
Year-to-date ongoing operating profit decreased $5 million or 3%, after a 9% unfavorable impact from foreign currency translation. Excluding the impact of foreign currency translation, the increase in ongoing operating profit was primarily attributable to new unit development and franchisee same store sales growth. The increase
30
was partially offset by higher restaurant operating costs and increased product promotions and discounts as well as lower operating profit in a market where we made an acquisition in 2001.
Net cash provided by operating activities was $634 million compared to $348 million in 2000. The increase of $286 million was driven by a $107 million source of working capital resulting primarily from a reduction in receivables related to the AmeriServe bankruptcy reorganization process versus a net use of $162 million of working capital related to the AmeriServe bankruptcy reorganization process last year. Excluding the impact of AmeriServe, our operating working capital reflects a net source of $5 million in 2001 compared to a net use of $53 million in 2000. The increase in cash provided by working capital was driven by timing of payments of income taxes.
Net cash used in investing activities was $341 million compared to net cash used of $111 million in 2000. The increase in cash used in investing activities was primarily due to lower gross refranchising proceeds as a result of selling fewer restaurants in 2001, the acquisition of 77 restaurants in Taiwan and the acquisition of 120 Taco Bell restaurants.
Net cash used in financing activities was $242 million in 2001 compared to $209 million in 2000.
As more fully discussed in Note 7, in April 2001 we issued $850 million of Senior Unsecured Notes. The net proceeds were used to reduce amounts outstanding under our Term Loan Facility and our Revolving Credit Facility.
During the 36 weeks ended September 8, 2001, we repurchased 2.3 million shares of our Common Stock for approximately $98 million under a Share Repurchase Program authorized by our Board of Directors in February 2001. Cumulatively, through October 15, 2001, we have repurchased approximately 2.4 million shares for approximately $100 million. During the first and second quarters of 2000, we repurchased 6.4 million shares for approximately $216 million, under the Share Repurchase Program authorized in 1999. This Program was completed in the second quarter of 2000. These Programs are more fully discussed in Note 9.
As more fully discussed in Note 7, our primary bank credit agreement, as amended, is comprised of a senior unsecured Term Loan Facility and a $3 billion senior unsecured Revolving Credit Facility (collectively referred to as the "Credit Facilities"), both of which mature on October 2, 2002. At September 8, 2001, we had unused Revolving Credit Facility borrowings available aggregating $2.6 billion, net of outstanding letters of credit of $0.2 billion. We believe we will be able to replace or refinance the remaining Credit Facilities prior to maturity with new borrowings which will reflect the market conditions and terms available at that time.
The Credit Facilities subject 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. Interest on the Credit Facilities is based principally on the London Interbank Offered Rate ("LIBOR") plus a variable margin factor as defined in the credit agreement. Therefore, our future borrowing costs may fluctuate depending upon the volatility in LIBOR.
As more fully discussed in Note 7, we issued $850 million of unsecured Notes in April 2001. The issuance included $200 million of 8.5% Senior Unsecured Notes due April 15, 2006 and $650 million of 8.875% Senior Unsecured Notes due April 15, 2011. We used the proceeds, net of issuance costs, to reduce amounts outstanding under the Credit Facilities. After the issuance of these Notes, $550 million is still available for
31
issuance under a $2 billion shelf registration statement previously filed with the Securities and Exchange Commission.
We use derivative financial instruments, including interest rate swaps, to manage our exposure to interest rate risk and lower interest expense. See Note 2 and our market risk disclosure for further discussion of our interest rate risk.
Assets increased $220 million, or 5%, to $4.4 billion. The increase is primarily attributable to the acquisition of restaurants and a net increase in property, plant and equipment driven by capital spending. The fair value of derivatives due to the adoption of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") also contributed to the increase. The increase was partially offset by a reduction in receivables related to the AmeriServe bankruptcy reorganization process. See Note 2 for a discussion of the adoption of SFAS 133.
Liabilities decreased $41 million, or 1%, to $4.4 billion. The impact from the adoption of SFAS 133 and increases in income taxes payable and short-term borrowings were offset by reductions in accounts payable and other accrued liabilities and long-term debt.
Excluding the impact of the AmeriServe bankruptcy reorganization process, our working capital deficit increased 3% to approximately $793 million at September 8, 2001 from $769 million at December 30, 2000. The increase from year-end 2000 was primarily due to the timing of income tax payments partially offset by an increase in accounts receivable and seasonal changes in accrued compensation.
We believe the Company has adequate financial resources to meet its requirements in 2001 and beyond.
The Company is exposed to financial market risks associated with interest rates, foreign currency exchange rates and commodity prices. In the normal course of business and in accordance with our policies, we manage these risks through a variety of strategies, which include the use of derivative financial and commodity instruments to hedge our underlying exposures. Our policies prohibit the use of derivative instruments for trading purposes, and we have procedures in place to monitor and control their use.
Interest Rate Risk
Our primary market risk exposure is to changes in interest rates, principally in the United States. We attempt to minimize this risk and lower our overall borrowing costs through the utilization of derivative financial instruments, primarily interest rate swaps. These swaps are entered into with financial institutions and have reset dates and critical terms that match those of the underlying debt. Accordingly, any change in market value associated with interest rate swaps is offset by the opposite market impact on the related debt.
At September 8, 2001 and December 30, 2000, a hypothetical 100 basis point increase in short-term interest rates would result in a reduction of $10 million and $19 million, respectively, in annual income before taxes. The estimated reductions are based upon the unhedged portion of our variable rate debt and assume no changes in the volume or composition of debt. In addition, the fair value of our derivative financial instruments at September 8, 2001 and December 30, 2000 would decrease approximately $12 million and $11 million, respectively. The fair value of our Senior Unsecured Notes at September 8, 2001 and December 30, 2000 would decrease approximately $73 million and $25 million, respectively. The significant change in the
32
decrease of the fair market value between current year and prior year was primarily due to additional Senior Unsecured Notes issued in April 2001. Fair value was determined by discounting the projected cash flows.
Foreign Currency Exchange Rate Risk
International ongoing operating profit constitutes approximately 31% of our year-to-date 2001 ongoing operating profit, excluding unallocated and corporate expenses. In addition, the Company's net asset exposure (defined as foreign currency assets less foreign currency liabilities) totaled approximately $840 million as of September 8, 2001. Operating in international markets exposes the Company to movements in foreign currency exchange rates. The Company's primary exposures result from our operations in Asia-Pacific and Europe. Changes in foreign currency exchange rates would impact the translation of our investments in foreign operations, the fair value of our foreign currency denominated financial instruments and our reported foreign currency denominated earnings and cash flows.
We attempt to minimize the exposure related to our investments in foreign operations by financing those investments with local currency debt when practical. In addition, we attempt to minimize the exposure related to foreign currency denominated financial instruments by purchasing goods and services from third parties in local currencies when practical. Foreign currency denominated financial instruments consist primarily of intercompany short-term receivables and payables. At times, we utilize forward contracts to reduce our risk exposure related to these foreign currency denominated financial instruments. The notional amount and maturity dates of these contracts match those of the underlying receivables or payables such that our foreign currency exchange risk related to these instruments is eliminated. On a limited basis, we utilize forward contracts in order to reduce our risk exposure related to certain foreign currency denominated cash flows from royalties. There were no such forward contracts outstanding as of September 8, 2001.
Commodity Price Risk
We are subject to volatility in food costs as a result of market risk associated with commodity prices. Our ability to recover increased costs through higher pricing is, at times, limited by the competitive environment in which we operate. We manage our exposure to this risk primarily through pricing agreements as well as, on a limited basis, commodity future and option contracts. Commodity future and option contracts outstanding at September 8, 2001, and December 30, 2000, were not material to the financial 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," "anticipate," "believe," "plan" and other similar terminology. These "forward-looking statements" reflect our current expectations regarding future events and operating and financial performance 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, potentially substantial tax contingencies related to the Spin-off, which, if they occur, require us to indemnify PepsiCo, Inc.; our substantial debt leverage and the attendant potential restriction on our ability to borrow in the future, as well as our substantial interest expense and principal repayment obligations; our ability to replace or refinance the Credit Facilities at reasonable rates; potential unfavorable variances between estimated and actual liabilities including the liabilities related to the sale of the non-core businesses; our ability to secure alternative distribution of products and equipment to our restaurants and our ability to ensure adequate supply of restaurant products and
33
equipment in our stores; our ability to complete our Euro conversion plans or the ability of our key suppliers to be Euro-compliant; the ongoing financial viability of our franchisees and licensees; volatility of actuarially determined losses and loss estimates and adoption of new or changes in accounting policies and practices including pronouncements promulgated by standard setting bodies.
Industry risks and uncertainties include, but are not limited to, global and local business, economic and political conditions; legislation and governmental regulation; competition; success of operating initiatives and advertising and promotional efforts; volatility of commodity costs; 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 changes in currency exchange and interest rates.
34
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 September 8, 2001 and the related condensed consolidated statements of income for the twelve and thirty-six weeks ended September 8, 2001 and September 2, 2000 and the condensed consolidated statements of cash flows for the thirty-six weeks ended September 8, 2001 and September 2, 2000. These condensed consolidated financial statements are the responsibility of TRICON's management.
We conducted our review 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 auditing standards generally accepted in the United States of America, 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 review, 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 accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of TRICON as of December 30, 2000, and the related consolidated statements of income, cash flows and shareholders' deficit and comprehensive income for the year then ended not presented herein; and in our report dated February 13, 2001, except as to Note 18 which is as of February 14, 2001 and Note 21 which is as of March 9, 2001, 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 30, 2000, is fairly presented, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
KPMG LLP
Louisville, Kentucky
October 12, 2001
35
| Item 1. | Legal Proceedings | Information regarding legal proceedings is incorporated by reference from Note 11 to the Company's Condensed Consolidated Financial Statements set forth in Part I of this report. | |
| 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) | ||
| (b) | Reports on Form 8-K | We filed a Current Report on Form 8-K dated July 30, 2001, attaching our second quarter ended June 16, 2001 earnings release dated July 26, 2001. | |
36
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: October 22, 2001 | /s/
Brent A. Woodford
Vice President and Controller (Principal Accounting Officer) |
37
EXHIBIT 12
TRICON Global Restaurants, Inc.
Ratio of Earnings to Fixed Charges Years Ended 2000-1996
and 36 Weeks Ended September 8, 2001 and September 2, 2000
(in millions except ratio amounts)
53
Weeks --------- 52 Weeks ---------- 36 Weeks Ended
------- ----------------------------------- ----------------
2000 1999 1998 1997 1996 9/08/01 9/02/00
------- -------- ------- ------- ------- ------- -------
Earnings:
Pretax income from continuing operations
before cumulative effect of accounting
changes(a) 684 1,038 756 (35) 72 510 473
Minorities interests in consolidated
subsidiaries - - - - (1) - -
Unconsolidated affiliates' interests,
net(a) (13) (12) (10) (3) (6) (4) (13)
Interest expense(a) 190 218 291 290 310 123 131
Interest portion of net rent expense(a) 87 90 105 118 116 64 57
------- -------- ------- ------- ------- ------- -------
Earnings available for fixed charges 948 1,334 1,142 370 491 693 648
======= ======== ======= ======= ======= ======= =======
Fixed Charges:
Interest expense(a) 190 218 291 290 310 123 131
Interest portion of net rent expense(a) 87 90 105 118 116 64 57
------- -------- ------- ------- ------- ------- -------
Total fixed charges 277 308 396 408 426 187 188
======= ======== ======= ======= ======= ======= =======
Ratio of earnings to fixed
charges(b)(c) 3.42x 4.33x 2.88x 0.91x 1.15x 3.71x 3.44x
EXHIBIT 15
Accountants' Acknowledgment
The Board of Directors
TRICON Global Restaurants, Inc.:
We hereby acknowledge our awareness of the use of our report dated October 12, 2001 included within the Quarterly Report on Form 10-Q of TRICON Global Restaurants, Inc. for the twelve and thirty-six weeks ended September 8, 2001, and incorporated by reference in the following Registration Statements:
| Description | Registration Statement Number |
||
Forms S-3 and S-3/A | |||
| YUM Direct Stock Purchase Program | 333-46242 | ||
| $2,000,000 Debt Securities | 333-42969 | ||
Form S-8s | |||
| Tricon Restaurants Puerto Rico, Inc. Save-Up Plan | 333-85069 | ||
| Restaurant Deferred Compensation Plan | 333-36877, 333-32050 | ||
| Executive Income Deferral Program | 333-36955 | ||
| TRICON Long-Term Incentive Plan | 333-36895, 333-85073, 333-32046 | ||
| SharePower Stock Option Plan | 333-36961 | ||
| TRICON Long-Term Savings Program | 333-36893, 333-32048 | ||
| Tricon Global Restaurants, Inc. Restaurant General Manager Stock Option Plan | 333-64547 | ||
| Tricon Global Restaurants, Inc. Long Term Incentive Plan | 333-32052 |
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.
KPMG LLP
Louisville, Kentucky
October 19, 2001