-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LF3jcPWpfCZohUDlQvhZx4RmN7iwUJuCjPxklYp6HHaEtr8gwcpazKKg+Yodua7L bFQibgohDdn0wy6HX63pWw== 0001041061-98-000018.txt : 19981020 0001041061-98-000018.hdr.sgml : 19981020 ACCESSION NUMBER: 0001041061-98-000018 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980905 FILED AS OF DATE: 19981019 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRICON GLOBAL RESTAURANTS INC CENTRAL INDEX KEY: 0001041061 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 933951308 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13163 FILM NUMBER: 98727619 BUSINESS ADDRESS: STREET 1: 1900 COLONEL SANDERS LANE CITY: LOUISVILLE STATE: KY ZIP: 40213 BUSINESS PHONE: 5028748300 MAIL ADDRESS: STREET 1: 1900 COLONEL SANDERS LANE CITY: LOUISVILLE STATE: KY ZIP: 40213 FORMER COMPANY: FORMER CONFORMED NAME: GREAT AMERICAN RESTAURANT CO DATE OF NAME CHANGE: 19970618 10-Q 1 TRICON GLOBAL RESTAURANTS, INC. FORM 10-Q 9/5/98 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (MarkOne) [|X|]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 5, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _________________ Commission file number 1-13163 TRICON GLOBAL RESTAURANTS, INC. (Exact name of registrant as specified in its charter) North Carolina 13-3951308 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1441 Gardiner Lane, Louisville, Kentucky 40213 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (502) 874-8300 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No The number of shares outstanding of the Registrant's Common Stock as of October 15, 1998 was 152,850,836 shares. ================================================================================ TRICON GLOBAL RESTAURANTS, INC. INDEX
Page No. ----------------- Part I. Financial Information Condensed Consolidated Statement of Income (Unaudited) - 12 and 36 weeks ended September 3 5, 1998 and September 6, 1997 Condensed Consolidated Statement of Cash Flows (Unaudited) - 36 weeks ended 4 September 5, 1998 and September 6, 1997 Condensed Consolidated Balance Sheet - September 5, 1998 (Unaudited) and December 27, 5 1997 Notes to Condensed Consolidated Financial Statements (Unaudited) 6 Management's Discussion and Analysis 14 Independent Accountants' Review Report 34 Part II. Other Information and Signatures 35
2 PART I - FINANCIAL INFORMATION TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF INCOME (in millions, except per share data - unaudited)
12 Weeks Ended 36 Weeks Ended ------------------------- --------------------------- 9/5/98 9/6/97 9/5/98 9/6/97 ----------- ---------- ----------- ------------ REVENUES Company restaurants $ 1,869 $ 2,162 $ 5,526 $ 6,499 Franchise and license fees 148 138 416 392 ----------- ---------- ----------- ------------ 2,017 2,300 5,942 6,891 ----------- ---------- ----------- ------------ Costs and Expenses, net Company restaurants Food and paper 592 698 1,762 2,102 Payroll and employee benefits 524 615 1,607 1,870 Occupancy and other operating expenses 477 592 1,420 1,754 ----------- ---------- ----------- ------------ 1,593 1,905 4,789 5,726 General, administrative and other expenses 204 236 605 658 Facility actions net gain (54) (51) (156) (136) Unusual (credits) charges (5) 15 (5) 54 ----------- ---------- ----------- ------------ Total costs and expenses, net 1,738 2,105 5,233 6,302 ----------- ---------- ----------- ------------ Operating Profit 279 195 709 589 Interest expense, net 62 57 198 188 ----------- ---------- ----------- ------------ Income Before Income Taxes 217 138 511 401 Income Tax Provision 89 59 217 149 ----------- ---------- ----------- ------------ Net Income $ 128 $ 79 $ 294 $ 252 =========== ========== =========== ============ Basic Earnings Per Common Share $ .84 $ 1.93 =========== =========== Diluted Earnings Per Common Share $ .82 $ 1.89 =========== ===========
See accompanying Notes to Condensed Consolidated Financial Statements. 3 TRICON GLOBAL RESTAURANTS, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (in millions - unaudited)
36 Weeks Ended ---------------------------- 9/5/98 9/6/97 ------------ ----------- Cash Flows - Operating Activities Net Income $ 294 $ 252 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 298 379 Facility actions net gain (156) (136) Unusual (credits) charges (5) 54 Deferred income taxes (28) (21) Other noncash charges and credits, net 74 42 Changes in operating working capital, excluding working capital acquired and disposed: Accounts and notes receivable 3 (21) Inventories 5 4 Prepaid expenses, deferred income taxes and other current assets (43) (74) Accounts payable and other current liabilities (33) (101) Income taxes payable 94 95 ------------ ----------- Net change in operating working capital 26 (97) ------------ ----------- Net Cash Provided by Operating Activities 503 473 ------------ ----------- Cash Flows - Investing Activities Capital spending (252) (288) Refranchising of restaurants 508 534 Sale of non-core businesses - 91 Sales of property, plant and equipment 34 88 Other, net (83) (58) ------------ ----------- Net Cash Provided by Investing Activities 207 367 ------------ ----------- Cash Flows - Financing Activities Proceeds from Notes 604 - Proceeds from long-term debt, net 1 - Payments of Revolving Credit Facility (760) - Payments of long-term debt (659) (9) Short-term borrowings-three months or less, net (17) 71 Decrease in investments by and advances from PepsiCo - (898) Other, net 2 - ------------ ----------- Net Cash Used for Financing Activities (829) (836) ------------ ----------- Effect of Exchange Rate Changes on Cash and Cash Equivalents (4) (6) ------------ ----------- Net Decrease in Cash and Cash Equivalents (123) (2) Cash and Cash Equivalents - Beginning of year 268 137 ------------ ----------- Cash and Cash Equivalents - End of period $ 145 $ 135 ============ =========== - --------------------------------------------------------------------------------------------------------------------------- Supplemental Cash Flow Information Interest paid $ 214 $ 21 Income taxes paid 144 146
See accompanying Notes to Condensed Consolidated Financial Statements. 4 TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (in millions)
9/5/98 12/27/97 --------------- -------------- (unaudited) ASSETS Current Assets Cash and cash equivalents $ 145 $ 268 Short-term investments, at cost 94 33 Accounts and notes receivable, less allowance: $17 in 1998 and $20 in 1997 148 149 Inventories 66 73 Prepaid expenses, deferred income taxes and other current assets 189 160 --------------- -------------- Total Current Assets 642 683 Property, Plant and Equipment, net 2,952 3,261 Intangibles Assets, net 679 812 Investments in Unconsolidated Affiliates 130 143 Other Assets 213 199 --------------- -------------- Total Assets $ 4,616 $ 5,098 =============== ============== LIABILITIES AND SHAREHOLDERS' DEFICIT Current Liabilities Accounts payable and other current liabilities $ 1,226 $ 1,260 Income taxes payable 285 195 Short-term borrowings 109 124 --------------- -------------- Total Current Liabilities 1,620 1,579 Long-term Debt 3,725 4,551 Other Liabilities and Deferred Credits 646 588 --------------- -------------- Total Liabilities 5,991 6,718 --------------- -------------- Shareholders' Deficit Preferred stock, no par value, 250 shares authorized; no shares issued - - Common stock, no par value, 750 shares authorized; 153 and 152 shares issued and outstanding in 1998 and 1997, respectively 1,281 1,271 Accumulated deficit (2,469) (2,763) Accumulated other comprehensive income - currency translation adjustment (187) (128) --------------- -------------- Total Shareholders' Deficit (1,375) (1,620) --------------- -------------- Total Liabilities and Shareholders' Deficit $ 4,616 $ 5,098 =============== ==============
See accompanying Notes to Condensed Consolidated Financial Statements. 5 TRICON GLOBAL RESTAURANTS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular amounts in millions, except per share data) (Unaudited) 1. FINANCIAL STATEMENT PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, we suggest that the accompanying financial statements be read in conjunction with the financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 27, 1997 ("10-K"). Except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in the 10-K. Forward looking statements contained herein should be read in conjunction with the cautionary statements contained on page 33. The condensed consolidated financial statements include TRICON Global Restaurants, Inc. and its wholly owned subsidiaries. The statements include the worldwide operations of KFC, Pizza Hut and Taco Bell and, through their respective disposal dates, our U.S. non-core businesses disposed of in 1997. These non-core businesses consist of California Pizza Kitchen, Chevys Mexican Restaurant, D'Angelo Sandwich Shop, East Side Mario's and Hot 'n Now (collectively, the "Non-core Businesses"). References to TRICON throughout these notes to condensed consolidated financial statements are made using the first person notations of "we" or "our." All significant intercompany accounts and transactions have been eliminated. For all periods presented prior to the Spin-off from PepsiCo, Inc. ("PepsiCo") on October 6, 1997, the accompanying unaudited condensed consolidated financial statements present our financial position, results of operations and cash flows as if we had been an independent, publicly owned company. Certain allocations in 1997 of previously unallocated PepsiCo interest of $53 million and $171 million and general and administrative expenses of $10 million and $34 million for the 12 and 36 weeks ended September 6, 1997, respectively, as well as computations of separate 1997 tax provisions, have been made to facilitate such presentation. We believe that the bases of allocation of interest and general and administrative expenses were reasonable based on the facts available at the date of their allocation. However, based on current information, such amounts are not indicative of amounts which we would have incurred if we had been an independent, publicly owned company for 1997. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain items have been reclassified in the accompanying unaudited condensed consolidated financial statements for prior periods to be comparable with the classification adopted for the 12 and 36 weeks ended September 5, 1998. Such reclassifications had no effect on previously reported net income. In our opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments considered necessary to present fairly, when read in conjunction with the 10-K, our financial position as of September 5, 1998, and the results of our operations for the 12 and 36 weeks ended September 5, 1998 and September 6, 1997 and cash flows for the 36 weeks ended September 5, 1998 and September 6, 1997. The results of operations for such interim periods are not necessarily indicative of the results to be expected for the full year. 2. EARNINGS PER COMMON SHARE ("EPS")
12 Weeks 36 Weeks Ended 9/5/98 Ended 9/5/98 -------------- ------------- Net income $ 128 $ 294 ============== ============= Basic EPS: Weighted-average common shares outstanding 153 152 ============== ============= Basic EPS $ .84 $ 1.93 ============== ============= Diluted EPS: Weighted-average common shares outstanding 153 152 Shares assumed issued on exercise of dilutive options 24 21 Shares assumed purchased with proceeds of dilutive options (20) (18) -------------- ------------- Shares applicable to diluted earnings 157 155 ============== ============= Diluted EPS $ .82 $ 1.89 ============== =============
Unexercised employee stock options to purchase 190,000 and 1.5 million shares of our common stock for the 12 and 36 weeks ended September 5, 1998, respectively, were not included in the computation of diluted EPS because their exercise prices were greater than the average market price of our common stock during the 12 and 36 weeks ended September 5, 1998. Basic and diluted EPS data has been omitted for the 12 and 36 weeks ended September 6, 1997 since we were not an independent, publicly owned company with a capital structure of our own during that period. 3. CHANGES IN ACCOUNTING PRINCIPLES a. Reporting Comprehensive Income Effective December 28, 1997, we adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This Statement requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual financial statement that is displayed with the same prominence as our other annual financial statements. This Statement also requires that we classify items of other comprehensive earnings by their nature in an annual financial statement. For example, other comprehensive earnings may include foreign currency translation adjustments, minimum pension liability adjustments, and unrealized gains and losses on certain investments in debt and equity securities. Our annual financial statements for prior periods will be reclassified, as required. 7 Our quarterly total comprehensive income was as follows:
12 Weeks Ended 36 Weeks Ended -------------------------- ------------------------ 9/5/98 9/6/97 9/5/98 9/6/97 ---------- ----------- ---------- ---------- Net income $ 128 $ 79 $ 294 $ 252 Currency translation adjustment (25) (9) (59) (49) ---------- ----------- ---------- ---------- Total comprehensive income $ 103 $ 70 $ 235 $ 203 ========== =========== ========== ==========
b. Accounting for the Costs of Computer Software Developed or Obtained for Internal Use Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," was issued in March 1998. SOP 98-1 identifies the characteristics of internal-use software and specifies that once the preliminary project stage is complete, certain external direct costs, certain direct internal payroll and payroll-related costs and interest costs incurred during the development of computer software for internal use should be capitalized and amortized. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998, with earlier application encouraged, and must be applied to internal-use computer software costs incurred in those fiscal years for all projects, including those projects in progress upon initial application of this SOP. We currently expense all such costs as incurred. We have not yet quantified the dollar impact of adopting SOP 98-1; however, when implemented in 1999, it will result in the capitalization of costs which would have been previously expensed. c. Disclosures About Segments of an Enterprise and Related Information Effective December 28, 1997, we adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." This Statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise" and requires that a public company report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This Statement allows aggregation of similar operating segments into a single operating segment, in general, if the businesses are considered similar under the criteria of this Statement. For purposes of applying this Statement, we consider our domestic businesses similar so they have been aggregated. Generally, financial information is required to be reported on the basis that we use it internally for evaluating segment performance and deciding how to allocate resources to segments. Our adoption of this Statement had no impact on our reportable segments as disclosed in our 10-K. Following are the disclosures recommended by the new standard on an interim basis: 8 GEOGRAPHIC AREAS
Revenues ----------------------------------------------------------- 12 Weeks Ended 36 Weeks Ended 9/5/98 9/6/97 (1) 9/5/98 9/6/97 (1) --------------------------------------------------------------------------------------------------------------- United States $ 1,529 $ 1,752 $ 4,523 $ 5,269 International 488 548 1,419 1,622 ---------- ----------- ---------- ---------- $ 2,017 $ 2,300 $ 5,942 $ 6,891 ========== =========== ========== ========== Operating Profit, Interest Expense, Net and Income Before Income Taxes ----------------------------------------------------------- 12 Weeks Ended 36 Weeks Ended 9/5/98 9/6/97 (1) 9/5/98 9/6/97 (1) --------------------------------------------------------------------------------------------------------------- Operating profit United States $ 266 $ 172 (2) $ 672 (2) $ 452 (2) International 53 54 142 198 Foreign exchange net gains (losses) 2 (7) 2 (15) Unallocated corporate expenses (42) (24) (107) (46) ---------- ----------- ---------- ---------- 279 195 709 589 ---------- ----------- ---------- ---------- Interest expense, net United States 1 2 7 12 International (1) 2 (2) 5 Unallocated corporate expenses 62 53 193 171 ---------- ----------- ---------- ---------- 62 57 198 188 ---------- ----------- ---------- ---------- Income before income taxes United States 265 170 (2) 665 440 (2) International 54 52 144 193 Foreign exchange net losses 2 (7) 2 (15) Unallocated corporate expenses (104) (77) (300) (217) ---------- ----------- ---------- ---------- $ 217 $ 138 $ 511 $ 401 ========== =========== ========== ==========
(1) Results from the United States included the Non-core Businesses disposed of in 1997. Excluding the unusual charges, the Non-core Businesses contributed the following: 12 Weeks Ended 36 Weeks Ended 9/6/97 9/6/97 ---------------- --------------- Revenues $ 62 $ 253 Operating profit 5 15 Interest expense, net (1) (3) Income before income taxes 4 12 Net income 4 10 9 (2) 1998 includes reversal of certain charges of $5 million relating to better-than-expected proceeds from the sale of properties and settlement of lease liabilities associated with properties retained upon sale of the Non-core Businesses. 1997 includes unusual charges related to the disposal of the Non-core Businesses of $15 million for the quarter and $54 million year-to-date. Identifiable Assets --------------------------- 9/5/98 12/27/97 --------------------------------------------------------------- United States $ 3,200 $ 3,637 International 1,416 1,461 ---------- ------------- $ 4,616 $ 5,098 ========== ============= d. Accounting for Derivative Instruments and Hedging Activities In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. This Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. A company may also implement the Statement as of the beginning of any fiscal quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and thereafter). SFAS No. 133 cannot be applied retroactively. When adopted, SFAS No. 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1997 (and, at the company's election, before January 1, 1998). We have not yet quantified the impacts of adopting SFAS No. 133 on our financial statements and have not determined the timing of or method of our adoption of SFAS No. 133. However, the Statement could increase volatility in earnings and other comprehensive income. 4. LONG-TERM DEBT During the 36 weeks ended September 5, 1998, we made net payments of $640 million and $760 million under our unsecured bank Term Loan Facility and the unsecured Revolving Credit Facility, respectively. As discussed in our 10-K, amounts outstanding under the revolving credit facility are expected to fluctuate from time to time, but term loan reductions cannot be reborrowed. Such payments reduced amounts outstanding at September 5, 1998 to $1.33 billion and $1.68 billion from $1.97 billion and $2.44 billion at year-end 1997, on the term facility and revolving facility, respectively. At September 5, 1998, we had unused revolving credit agreement lines available aggregating $1.43 billion, net of outstanding letters of credit of $147 million. 10 In fiscal 1997, we filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 with respect to offerings of up to $2 billion of senior unsecured debt. In early May 1998, we issued $350 million 7.45% Unsecured Notes due May 15, 2005 and $250 million 7.65% Unsecured Notes due May 15, 2008 (collectively referred to as the "Notes"). The proceeds, net of issuance costs, were used to reduce existing borrowings under our unsecured term facility and revolving facility. The Notes are carried net of related discounts which are being amortized over the life of the Notes. The unamortized discount for both issues was approximately $1.1 million at September 5, 1998 and the amount of amortization in the quarter or year-to-date was not significant. Interest is payable May 15 and November 15 commencing on November 15, 1998. In anticipation of the issuance of the Notes, we entered into $600 million in treasury locks to eliminate interest rate sensitivity in pricing of the Notes. Concurrent with the issuance of the Notes, the locks were settled at a gain which will be amortized to interest expense over the life of the Notes. 5. COMMITMENTS AND CONTINGENCIES Relationship with Former Parent After Spin-off As disclosed in our 1997 10-K, in connection with the October 6, 1997 spin-off from PepsiCo (the "Spin-off"), separation and other related agreements (the "Separation Agreement") were entered into which contain certain indemnities to the parties and provide for the allocation of tax and other assets, liabilities and obligations arising from periods prior to the Spin-off. The Separation Agreement provided for, among other things, our assumption of all liabilities relating to the restaurant businesses, inclusive of the Non-core Businesses disposed of in 1997, and the indemnification of PepsiCo with respect to such liabilities. Our best estimates of all such liabilities have been included in the accompanying condensed consolidated financial statements. Subsequent to Spin-off, claims have been made by certain Non-core Business franchisees and a purchaser of one of the businesses. We are disputing the validity of such claims; however, we believe that any settlement of these claims at amounts in excess of previously recorded liabilities is not likely to have a material adverse effect on our results of operations, financial condition or cash flows. Under the Separation Agreement, PepsiCo maintains full control and absolute discretion with regard to any combined or consolidated tax filings for periods through the Spin-off Date. PepsiCo also maintains full control and absolute discretion regarding common tax audit issues. Although PepsiCo has contractually agreed to, in good faith, use its best efforts to settle all joint interests in any common audit issue on a consistent basis with prior practice, there can be no assurance that determinations so made by PepsiCo would be the same as we would reach, acting on our own behalf. We have agreed to certain restrictions on future actions to help ensure that the Spin-off maintains its tax-free status. Restrictions include, among other things, limitations on the liquidation, merger or consolidation with another company, certain issuances and redemptions of our Common Stock, the granting of stock options and certain sales, refranchisings, distributions or other dispositions of assets. If we fail to abide by such 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. Additionally, we are obligated to indemnify PepsiCo in certain circumstances with respect to any employer payroll tax it incurs related to the exercise of vested PepsiCo options held by our employees after the Spin-off. No payments under these indemnities have been required through the third quarter of 1998. 11 Other Commitments and Contingencies We were directly or indirectly contingently liable in the amounts of $310 million and $302 million at September 5, 1998 and December 27, 1997, respectively, for certain lease assignments and guarantees. In connection with these contingent liabilities, after the Spin-off, we were required to maintain cash collateral balances at certain institutions of approximately $30 million, which are included in Other Assets in the accompanying condensed consolidated balance sheet. At September 5, 1998, $215 million represented contingent liabilities to lessors as a result of our assigning our interest in and obligations under real estate leases as a condition to the refranchising our restaurants. The $215 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 $320 million. The balance of the contingent liabilities primarily reflected guarantees to support financial arrangements of certain unconsolidated affiliates and restaurant franchisees. We are currently and, for certain prior years were, primarily self-insured for most workers' compensation, general liability and automotive liability losses, subject to per occurrence and aggregate annual liability limitations. During the first two quarters of 1997, we participated with PepsiCo in a guaranteed cost program for certain coverages. We are also primarily self-insured for health care claims for eligible participating employees, subject to certain deductibles and limitations. We determine our liability for claims reported and for claims incurred but not reported on an actuarial basis. In July 1998, we entered into severance agreements with certain key executives which are triggered by a termination, under certain conditions, of the executive following a change in control of the Company, as defined in the agreements. Once triggered, the affected executives would receive twice the amount of their annual base salary and their annual incentive in a lump sum, outplacement services and a tax gross-up for any excise taxes. The agreements expire December 31, 2000. In connection with the execution of these agreements, the Compensation Committee of our Board of Directors has authorized amendment of the deferred and incentive compensation plans and, following a change in control, an establishment of rabbi trusts which will be used to provide payouts under these deferred compensation plans following a change in control. We are subject to various claims and contingencies related to lawsuits, taxes, environmental and other matters arising out of the normal course of business. Like some other large retail employers, Pizza Hut and Taco Bell recently have been faced in a few states with allegations of purported class-wide wage and hour violations. We believe that the ultimate liability, if any, in excess of amounts already recognized arising from such claims or contingencies is not likely to have a material adverse effect on our results of operations, financial condition or cash flows. 6. SHAREHOLDERS' RIGHTS PLAN On July 21, 1998, our Board of Directors declared a dividend distribution of one right for each share of common stock outstanding as of August 3, 1998 (the "Record Date"). Each right initially entitles the registered holder to purchase a unit consisting of one one-thousandth of a share (a "Unit") of Series A Junior Participating Preferred Stock, without par value, at a purchase price of $130 per Unit, subject to adjustment. The rights, which do not have voting rights, will become exercisable for TRICON common stock ten business days following a public announcement that a person or group has acquired, or has commenced or intends to commence a tender offer for, 15% or more, or 20% or more if such person or group owned 10% or more on the adoption date of this plan, of our common stock. In the event the rights become exercisable for common stock, each right will entitle its holder (other than the 12 Acquiring Person as defined in the Agreement) to purchase, at the right's then-current exercise price, TRICON common stock having a value of twice the exercise price of the right. In the event the rights become exercisable for common stock and thereafter we are acquired in a merger or other business combination, each right will entitle its holder to purchase, at the right's then-current exercise price, common stock of the acquiring company having a value of twice the exercise price of the right. The rights are redeemable in their entirety, prior to becoming exercisable, at $.01 per right under certain specified conditions. The rights expire on July 21, 2008, unless such date is extended or the rights are earlier redeemed or exchanged as provided in the Agreement. The foregoing description of the rights is qualified in its entirety by reference to the Rights Agreement between TRICON and BankBoston, N.A., as Rights Agent, dated as of July 21, 1998 (including the exhibits thereto). 13 Management's Discussion and Analysis for the 12 and 36 Weeks Ended September 5, 1998 Introduction On October 6, 1997 (the "Spin-off Date"), the worldwide operations of KFC, Pizza Hut and Taco Bell (the "Core Business(es)") became an independent, publicly owned restaurant Company known as TRICON Global Restaurants, Inc. through a Spin-off from our former parent, PepsiCo, Inc. (the "Spin-off"). The following Management's Discussion and Analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements on pages 3 - 12 and the Cautionary Statements on page 33 and our filing on Form 10-K for the year ended December 27, 1997 ("10-K"). For purposes of this Management's Discussion and Analysis, we include the worldwide operations of the Core Businesses and, through their respective dates of disposal in 1997, the Non-core Businesses. Where significant to the discussion, the impact of the Non-core Businesses has been separately identified. In the following discussion, volume is the estimated dollar effect of the year-over-year change in customer transaction counts. Effective net pricing includes price increases/decreases and the effect of changes in product mix. Portfolio effect includes the impact on operating results related to our refranchising initiative and closure of underperforming stores. System sales represents the Core Business' combined sales of the Company, joint venture, franchised and licensed units. Franchised and licensed unit sales are estimated based on remitted and accrued royalties. Tabular amounts are displayed in millions except per share and unit count amounts, or as specifically identified. Percentages may not recompute due to rounding of reported numbers. Comparability Certain factors impacting comparability of operating performance in the quarter ended September 5, 1998 were anticipated at the prior fiscal year end and are more fully discussed in the 10-K. Updated information is provided below. The 1998 full-year benefits of the fourth quarter 1997 unusual charge, discussed below, have been and are expected to be significant. Based on the year-to-date actuals and our fourth quarter estimates, we now expect that they will be offset in the near term by the year-to-year decline in Asia operating profits and spending related to Year 2000 issues as discussed below. Asian Economic Events The overall economic turmoil and weakening of local currencies throughout much of Asia against the U.S. dollar beginning in late 1997 continues to present, in the near term, a challenging retail environment. The difficult economic conditions have continued through the third quarter of this year and have adversely affected the U.S. dollar value of our foreign currency denominated sales ("translation") and consumer demand as seen in reduced transaction counts, both of which continue to impact our consolidated results of operations. Asian operations in such countries as China, Japan, Korea, Singapore, Taiwan and Thailand, among others, comprised approximately 35% and 33% of our international system U.S. dollar translated sales in the quarter and year-to-date, respectively, versus 40% and 37% for the quarter and year-to-date 1997, respectively. Asian system sales declined 17% and 14% for the quarter and year-to-date, respectively. Declines in system sales in Japan, Korea, and Thailand have been mitigated by system sales increases in China and Taiwan primarily due to new unit development. Excluding the impact of foreign currency translation, Asian system sales increased 4% for both the quarter and year-to-date. 14 Total revenues from Asia declined 5% for the quarter and 6% year-to-date. Included in total revenues are franchise fees which decreased $5 million, or 25%, for the quarter and $10 million, or 20%, year-to-date. Excluding the negative impacts of foreign currency translation, total revenues from Asia increased approximately 16% for both the quarter and year-to-date. New unit development in China, Taiwan and Korea led the increase, partially offset by volume declines both in the quarter and year-to-date. Operating profits from Asia declined 28% and 40% for the quarter and year-to-date, respectively. Excluding the impact of foreign currency translation, operating profits increased 13% in the quarter and decreased 6% year-to-date. New unit growth as well as increased store margins in China were partially offset in the quarter by lower margins in Korea and volume declines in both Korea and China. Year-to-date, the lower margins in Korea and volume declines in both Korea and China were partially offset by new unit growth and increased store margins in China. While we continue to work with our suppliers to reduce food costs and focus on increasing our everyday value offerings, the challenges continue. We expect to continue to cautiously seek out investment opportunities in Asia, drawing on lessons learned there, and from our experience in other countries which have faced similar problems in the past such as Mexico and Poland. The complexities of the international environment in which we operate make it difficult to accurately predict the ongoing effect of currency movements and continuing economic turmoil on our results of operations. Related effects will be reported in our financial statements as they become known and estimable. Selected highlights of our recent operating results in Asia are as follows:
12 Weeks Ended 36 Weeks Ended ---------------------------------------- ---------------------------------------- % B(W) % B(W) 9/5/98 9/6/97 vs. 1997 9/5/98 9/6/97 vs. 1997 ---------- ---------- ----------- ---------- ---------- ------------ Systems Sales $ 549 $ 659 (17) $ 1,509 $ 1,765 (14) % of International System Sales 35% 40% 33% 37% Revenues $ 126 $ 133 (5) $ 318 $ 338 (6) % of International Revenues 26% 24% 22% 21% Operating Profit, excluding facility actions $ 18 $ 24 (28) $ 41 $ 67 (40) % of Total International Operating Profit, excluding facility actions 33% 55% 31% 55%
Note: A summary of total International results is located on page 28. Year 2000 We have established an enterprise-wide plan to prepare our information technology systems (IT) and non-information technology systems with embedded technology applications (ET) for the Year 2000 issue as well as to reasonably assure that our critical business partners are prepared and to plan for business continuity as we enter the coming millennium. Our plan encompasses the use of both internal and external resources to identify, correct and test systems for Year 2000 readiness. External resources include nationally recognized consulting firms and other contract resources to supplement available internal resources. 15 The phases of our plan - awareness, assessment, remediation, testing and implementation - are currently expected to cost $55 to $65 million from their inception through the end of 1999. This estimate includes costs related to accelerated implementation of replacement systems. Our plan contemplates our own IT/ET as well as assessment and contingency planning relative to potential Year 2000 business risks inherent in our material third party relationships. The total cost represents less than 20% of our total estimated information technology related expenses through the end of 1999. Approximately $23 million has been incurred from inception of planned actions through September 5, 1998 of which $19 million has been incurred during 1998 ($6 million in the third quarter). Approximately $31 million is expected to be incurred during the current year. All costs are expected to be funded by cash flow from operations. a. TRICON IT/ET State of Readiness We have substantially completed our inventory process of hardware (including desktops), software (third party and internally developed) and embedded technology applications and have implemented monitoring procedures designed to insure that new IT/ET investment is Year 2000 compliant. Based on this inventory, we are prioritizing critical IT/ET applications and determining the Year 2000 compliance status of the IT/ET through third party vendor inquiry or internal processes. All identified critical internally developed IT is in the process of remediation, replacement or retirement. Multiple phases of our Year 2000 project are occurring at the same time and some phases will require repetition. However, the majority of remediation and unit testing is expected to be completed in early 1999. Integration testing of remediated, replaced and consolidated systems is expected to continue throughout 1999. International IT/ET efforts are expected to lag domestic efforts, however, we believe that business risk is minimized by the predominant use of unmodified third party IT in our international business for which Year 2000 compliant versions already exist. The following table identifies by category and status the major identified IT/ET applications. Remediation Category Compliant In Process Not Compliant - ------------------------------- ------------ -------------- -------------- Third Party Developed Software 321 916 133 Internally Developed Software 19 420 92 Desktop 169 497 87 Hardware 268 1,062 74 ET 189 497 12 Other 24 394 2 ------------ -------------- -------------- 990 3,786 400 ============ ============== ============== Note: Tabulations based on currently available inventory of identified "applications." We have defined this term (as used in this Year 2000 discussion) to describe separately identifiable groups of program, hardware or ET which can be both logically segregated by business purpose and separately unit tested as to performance of a single business function. "Not compliant" applications will be either retired or replaced before the end of 1999. 16 b. Material Third Party Relationships We believe that our critical third party relationships can be subdivided generally into Suppliers, Banks, and Franchisees. An initial inventory of domestic restaurant suppliers and distributors is complete, and letters have been mailed requesting information regarding their Year 2000 status. Contingency plans will be developed by early 1999 for suppliers that we believe have substantial Year 2000 operational risks. An inventory is in process for international suppliers with a target for late 1998 completion after which we anticipate following the domestic process described above. Letters requesting compliance information have been or are being sent to relationship banks. Contingency plans will be developed by early 1999 for all banks that have not submitted written representation of Year 2000 readiness. An inventory of international banks responsible for processing deposits and payroll is in process with a late 1998 target for completion. The international banks will then be mailed letters following the same process to be used for domestic banks. We have approximately 1,200 domestic and 950 international franchisees. Information has been sent to all domestic franchisees regarding the business risks associated with Year 2000. Sample IT/ET project plans and a report of the compliance status in Company-owned restaurants will be made available to the franchisees by year-end. Our plan includes similar steps beginning in the fourth quarter for all international franchisees. Additionally, we are in the process of identifying all other third party companies that provide business critical services by late 1998 after which project plans will be developed to assess their Year 2000 readiness and develop contingency plans, as appropriate. The following table indicates by type of third party risk the status of the readiness process. Responses Received Responses Not Yet Received ------------------- ---------------------------- Suppliers 12 91 Banks 34 77 ------------------- ---------------------------- 46 168 =================== ============================ Note: Suppliers tabulations consist primarily of existing electronic data exchange partners, including our largest suppliers, distributors and third party administrators. Due to the forward-looking nature and lack of historical precedent for Year 2000 issues, it is a difficult disclosure challenge. Only one thing is certain about the impact of Year 2000 - it is difficult to predict with certainty what truly will happen after December 31, 1999. Given our best efforts and execution of remediation, replacement and testing, it is probable that there will be disruptions and unexpected business problems during the early months of 2000. Our plans anticipate making diligent, reasonable efforts to assess Year 2000 readiness of our critical business partners and will ultimately yield contingency plans for business critical systems prior to the end of 1999. However, we are heavily dependent on the continued normal operations of not only our key suppliers of chicken, cheese, beef, tortillas and other raw materials and our major food and supplies distributor, but also on other entities such as lending, depository and disbursement banks and third party administrators of our benefit plans. Despite diligent preparation, unanticipated third party failures, more general public infrastructure failures, or failure to successfully conclude our remediation efforts as planned could have a material adverse impact on our results of operations, financial condition and/or cash flows in 1999 and beyond. Inability of our franchisees to remit franchise fees on a timely basis or lack of publicly available hard currency or credit card processing capability supporting our retail sales stream could also have material adverse impact on our results of operations, financial condition and/or cash flows. 17 Other Factors Affecting Comparability In addition to the above identified near-term risks in our Asian businesses and costs related to Year 2000 issues, we believe that certain items included in 1997 results of operations will not recur in 1998 or will recur in significantly different magnitudes, thereby affecting comparability of results. These items include $4 million in the quarter and $23 million year-to-date in special KFC franchise contract renewal fees primarily from renewals in the second and third quarters of 1997 which did not recur in 1998 and the income included in 1997 results attributable to the Non-core Businesses sold in 1997. Excluding unusual disposal charges, the Non-core Businesses had income of $4 million ($4 million after-tax) in the third quarter of 1997 and $12 million ($10 million after-tax)year-to-date 1997. In the fourth quarter of 1997, the Non-core Businesses had income of $2 million ($1 million after-tax). Unusual disposal charges related to the Non-core Businesses were $15 million and $54 million in the quarter and year-to-date, respectively. In addition, 1998 total facility actions net gain after-tax is currently expected to decline less than 20% compared to the after-tax net gain recognized in 1997, excluding the fourth quarter 1997 charge. 1997 total facility actions net gain after-tax, excluding the fourth quarter 1997 charge, included a tax-free gain of approximately $100 million related to the refranchising of our restaurants in New Zealand through an initial public offering. In our 1997 10-K, we stated that we believed our 1998 net interest expense would be $40 million to $50 million higher than the interest allocated to us by PepsiCo for 1997, driven by the higher outstanding debt levels and higher expected weighted average interest rates. However, the better-than-expected proceeds from our refranchising activities and cash flows from operations have allowed us to reduce our outstanding debt at a faster pace than previously anticipated. In addition, overall borrowing rates have been lower than expected. Therefore, we now expect that our full-year 1998 net interest expense will approximate 1997 levels. As disclosed in the 10-K, we are proceeding with the relocation of our Wichita, Kansas, operations to other facilities. Through September 5, 1998, we have incurred approximately $12 million ($7 million in the third quarter) of termination benefits, relocation costs, early retirement and other expenses related to this relocation. We currently expect to incur the remaining relocation costs of approximately $2.5 million in the fourth quarter. These charges were expected to be substantially offset by the anticipated gain on the sale of the facility in the fourth quarter. However, due to contractual disputes with the proposed buyer, the sale of this processing center is not expected to close in the fourth quarter of 1998. Store Portfolio Perspectives In the fourth quarter of 1997, we announced a $530 million unusual charge ($425 million after-tax). The charge included (1) costs of closing underperforming stores during 1998, primarily at Pizza Hut and internationally; (2) reduction to fair market value, less costs to sell, of the carrying amounts of certain restaurants we intended to refranchise in 1998; (3) impairment of certain restaurants intended to be used in the business; (4) impairment of certain joint venture investments; and (5) costs of related personnel reductions. Of the $530 million charge, approximately $405 million related to asset writedowns and approximately $125 million related to liabilities, primarily occupancy-related costs and severance. While the total charge is unchanged, the component amounts have been revised from our prior disclosures to reflect better information. The liabilities are expected to be settled from cash flow from operations. Through September 5, 1998, the amounts utilized to date apply only to the actions covered by the charge. Based on better-than-expected lease settlements with certain lessors, we have reversed $.7 million of the charge in the quarter and $1.7 million year-to-date. These reversals have been included in and have increased reported Facility Actions Net Gain. The charge included reserves related to 1,392 units expected to be refranchised (652 units) or closed (740 units). Our prior disclosure of 1,407 has been revised to eliminate a duplication in the unit count of 15 units to be refranchised. As of September 5, 1998, 417 units have been closed and 97 units have been refranchised. In addition, during the quarter, we decided to continue to operate 15 units we had planned to refranchise. 18 Although we expected to refranchise or close all units by year-end 1998, we now forecast that we will not complete the refranchising of approximately 350 units and the closure of approximately 100 units until 1999. This delay is primarily due to operational issues such as longer than expected periods to locate qualified buyers, particularly for International units, extended negotiations with some lessors, and execution delays in consolidating the operations of certain units to be closed with other units that will continue to operate. We intend to refranchise or close these 450 units. The charge is expected to have a favorable impact on future cash flows and operating profits. We believe our worldwide business, upon completion of the actions covered by the charge, will be significantly more focused and better positioned to deliver consistent growth in operating earnings before facility actions. We estimate that the favorable impact on operating profit related to the 1997 fourth quarter charge was approximately $16 million in the third quarter of 1998 and approximately $46 million year-to-date resulting primarily from the absence of depreciation in 1998 for stores included in the charge. Based primarily on the improved performance of Pizza Hut in the U.S., we are currently re-evaluating our prior estimates of the fair market values of units to be refranchised and whether to close certain other units originally expected to be closed. We expect this re-evaluation to be completed in the fourth quarter of 1998. For the last few years, we have been working to reduce our share of total system units by selling Company restaurants to existing and new franchisees where their expertise can be leveraged to improve our concepts' overall operational performance, while retaining Company ownership of key markets. This portfolio-balancing activity has reduced, and will continue to reduce, our reported revenues and increase the importance of system sales as a key performance measure. Refranchising frees up invested capital while continuing to generate franchise fees, thereby improving returns. The impact of refranchising gains is expected to decrease over time. The following table summarizes the refranchising activities for the quarter and year-to-date 1998 and 1997.
12 Weeks Ended 36 Weeks Ended ------------------------------- ------------------------------ 9/5/98 9/6/97 9/5/98 9/6/97 -------------- ------------- -------------- ------------ Number of units refranchised 328 441 913 920 Refranchising proceeds, pre-tax $ 218 $ 150 $ 508 $ 534 Refranchising net gain, pre-tax 64 50 172 203
Our overall Company ownership percentage (including joint venture units) of our Core Businesses' total system units decreased by almost 4 percentage points from year-end 1997 and by 10 percentage points from year-end 1996 to 34% at September 5, 1998. This reduction was a result of our portfolio initiatives and the relative number of new points of distribution added and units closed by our franchisees and licensees and by us. As we approach a Company/franchise balance more consistent with our major competitors, refranchising activity is expected to substantially decrease. 19 Results of Operations Worldwide
12 Weeks Ended 36 Weeks Ended ------------------------------------------ ---------------------------------------- 9/5/98 9/6/97 % B(W) 9/5/98 9/6/97 % B(W) ------------ ----------- ----------- ---------- ---------- ----------- SYSTEM SALES - CORE ONLY $ 4,905 $ 4,987 (2) $14,198 $ 14,107 1 ============ =========== ========== ========== REVENUES Company sales $ 1,869 $ 2,162 (14) $ 5,526 $ 6,499 (15) Franchise and license fees (1) 148 138 7 416 392 6 ------------ ----------- ---------- ---------- Total Revenues $ 2,017 $ 2,300 (12) $ 5,942 $ 6,891 (14) ============ =========== ========== ========== COMPANY RESTAURANT MARGINS Domestic $ 214 $ 196 9 $ 573 $ 602 (5) International 62 61 2 164 171 (4) ------------ ----------- ---------- ---------- Total $ 276 $ 257 8 $ 737 $ 773 (5) ============ =========== ========== ========== % of sales 14.8% 11.9% 2.9 points 13.3% 11.9% 1.4 points Ongoing operating profit $ 220 $ 159 38 $ 548 $ 507 8 Facility actions net gain (54) (51) 5 (156) (136) 14 Unusual (credits) charges (5) 15 NM (5) 54 NM ------------ ----------- ---------- ---------- Operating profit 279 195 43 709 589 20 Interest expense, net 62 57 (10) 198 188 (5) Income tax provision 89 59 (50) 217 149 (46) ------------- ----------- ---------- ---------- Net Income $ 128 $ 79 60 $ 294 $ 252 17 ============ =========== ========== ========== Diluted earnings per share $ .82 $ 1.89 ============ ========== Pro forma diluted earnings per share (2) $ .50 $ 1.62 ========== ==========
(1) Excluding the 1997 KFC renewal fees, quarter and year-to-date increased 11% and 13% over the prior year, respectively. (2) The shares used to compute pro forma diluted earnings per common share for the 12 and 36 weeks ended September 6, 1997 are the same as those used in 1998, as our capital structure as an independent publicly owned Company did not exist during the first three quarters of 1997. NM - Not Meaningful - -------------------------------------------------------------------------------- 20 WORLDWIDE RESTAURANT UNIT ACTIVITY
Joint Company Venture Franchised Licensed Total ------------- ------------ -------------- ------------ ------------ Balance at December 27, 1997 10,117 1,090 15,097 3,408 29,712 New Builds & Acquisitions 161 60 530 384 1,135 Refranchising & Licensing (913) (6) 834 85 - Closures (421) (39) (476) (311) (1,247) ------------- ------------ -------------- ------------ Balance at September 5, 1998 (a) 8,944 1,105 15,985 3,566 29,600 ============= ============ ============== ============ ============ % of Total 30.2% 3.7% 54.0% 12.1% 100.0% ============= ============ ============== ============ ============
(a) Includes 314 Company and joint venture units approved for closure, but not yet closed at September 5, 1998. - -------------------------------------------------------------------------------- System sales decreased $82 million, or 2%, in the quarter and increased $91 million, or 1%, year-to-date. Excluding the negative impact of foreign currency translation, system sales increased $121 million, or 2%, in the quarter and $594 million, or 4%, year-to-date. The increase in both the quarter and year-to-date resulted primarily from new unit development during the last twelve months which exceeded sales declines due to closure of lower volume units. New unit development was predominantly by franchisees and licensees. Domestically, development during 1998 was principally at Pizza Hut and Taco Bell with international development largely in China, Taiwan and Korea. Revenues decreased $283 million, or 12%, in the quarter and $949 million, or 14%, year-to-date. Company restaurant sales decreased $293 million, or 14%, in the quarter and $973 million, or 15%, year-to-date. The Non-core Businesses had revenues of $62 million and $253 million in last year's quarter and year-to-date, respectively. Excluding the negative impact of foreign currency translation and revenues from the Non-core Businesses, total revenues decreased $236 million, or 10%, in the quarter and $797 million, or 12%, year-to-date and Company restaurant sales decreased $251 million, or 12%, in the quarter and $836 million, or 13%, year-to-date. This decrease in Company restaurant sales for both the quarter and year-to-date was primarily due to portfolio actions, partially offset by new unit development and growth in same store sales. Franchise and license fees increased $10 million, or 7%, and $24 million, or 6%, for the quarter and year-to-date, respectively. Excluding the negative impact of foreign currency translation and the 1997 KFC renewal fees of $4 million in the quarter and $23 million year-to-date, franchise and license fees increased $21 million, or 16%, and $62 million, or 17%, for the quarter and year-to-date, respectively. The increase in franchise and license fees reflected the increase in continuing fees from units acquired from us and new unit development, partially offset by store closures. Company Restaurant Margins - Worldwide
12 Weeks Ended 36 Weeks Ended ------------------------ ---------------------------- 9/5/98 9/6/97 9/5/98 9/6/97 ---------- ---------- ----------- ------------ Company sales 100.0% 100.0% 100.0% 100.0% Food and paper 31.6 32.3 31.9 32.3 Payroll and employee benefits 28.0 28.4 29.1 28.8 Occupancy and other operating expenses 25.6 27.4 25.7 27.0 ---------- ---------- ----------- ------------ Company restaurant margins 14.8% 11.9% 13.3% 11.9% ========== ========== =========== ============
21 Company restaurant margins as a percent of sales increased 290 basis points for the third quarter of 1998 and 140 basis points year-to-date as compared to the same periods in 1997. The portfolio effect contributed approximately 80 basis points and 70 basis points for the quarter and year-to-date, respectively, to this improvement. In addition, the absence in 1998 of depreciation and amortization relating to stores included in the 1997 fourth quarter charge contributed approximately 60 basis points for both the quarter and year-to-date. Margins, excluding the portfolio effect and the benefits of the fourth quarter charge, increased 150 basis points in the quarter and increased slightly year-to-date. In the quarter, favorable effective net pricing in excess of cost increases, primarily labor, was partially offset by volume declines in the U.S. and internationally, driven by Asia. Labor increases were driven by higher wage rates primarily related to the September 1997 minimum wage increase in the U.S. and higher incentive compensation accruals. The decrease in occupancy and other operating expenses in the quarter related primarily to store condition and quality initiatives at Taco Bell in 1997 partially offset by increased 1998 store refurbishment expenses at KFC. In addition to the factors affecting the quarterly comparison, the year-to-date results were also unfavorably impacted by an increase in the management complement in our Taco Bell restaurants and by the absence of favorable insurance actuarial adjustments which occurred in the prior year. General, Administrative and Other Expenses General, administrative and other expenses ("G&A") decreased $32 million in the quarter, or 13%, and $53 million, or 8%, year-to-date and includes the following:
12 Weeks Ended 36 Weeks Ended ------------------------ ---------------------- % B(W) vs. % B(W) 9/5/98 9/6/97 1997 9/5/98 9/6/97 vs. 1997 ---------- ---------- ------------ --------- --------- ----------- G&A - Core $ 210 $ 225 6 $ 620 $ 628 1 G&A - Non-Core - 5 NM - 20 NM Equity (income) loss from investments in unconsolidated affiliates (4) (1) NM (13) (5) NM Foreign exchange (gains) losses (2) 7 NM (2) 15 NM ---------- ---------- --------- --------- $ 204 $ 236 13 $ 605 $ 658 8 ========== ========== ========= =========
Included in the 1997 core G&A was a PepsiCo allocation amount of $10 million in the quarter and $34 million year-to-date, reflecting a portion of PepsiCo's shared administrative expenses. The allocated PepsiCo administrative expenses were based on PepsiCo's total corporate administrative expenses using a ratio of our revenues to PepsiCo's revenues. We believe that this basis of allocation was reasonable based on the facts available at the date of such allocation. However, based on current information, such amounts are not indicative of amounts which we would have incurred if we had been an independent, publicly owned entity for all periods presented. We now estimate that our ongoing corporate annual general and administrative expenses as an independent, publicly owned entity will exceed the annualized amount of the PepsiCo allocation by approximately $26 million in 1998. This expected increase will be partially offset by non-recurring TRICON start-up costs of approximately $14 million which were incurred in the last three quarters of 1997. This is higher than the estimate reported in the 1998 second quarter Form 10-Q primarily due to increased estimates of performance and stock-based compensation due to better-than-expected operating results, partially offset by delays in staffing positions at Tricon corporate. 22 Core G&A decreased $15 million, or 6%, in the quarter and $8 million, or 1%, year-to-date. Excluding the impact of foreign currency translation, core G&A decreased $12 million, or 5%, in the quarter and increased $1 million, or 1%, year-to-date. The favorable impact of stores sold or closed and decreased Restaurant Support Center and field overhead expenses were partially offset in the quarter and fully offset year-to-date by increased investment spending. Investment spending consisted primarily of costs related to our Year 2000 compliance and remediation efforts ($6 million in the quarter and $19 million year-to-date - see page 15) and costs to relocate certain support operations from Wichita, Kansas, to Louisville, Kentucky, and Dallas, Texas ($7 million in the quarter and $12 million year-to-date see page 18). Additionally, we experienced increased administrative expenses as an independent publicly owned company and incurred additional expenses related to the continued efforts to improve and consolidate administrative and accounting systems. Facility Actions Net Gain
12 Weeks Ended 36 Weeks Ended -------------------------------- ------------------------------- 9/5/98 9/6/97 9/5/98 9/6/97 ----------- ------------- -------------- ------------ Refranchising net gain $ 64 $ 50 $ 172 $ 203 Store closure costs, net (10) 1 (8) (28) Recurring impairment - - (8) (39) ----------- ------------- -------------- ------------ Facility actions net gain $ 54 $ 51 $ 156 $ 136 =========== ============= ============== ============
Refranchising net gain included initial franchise fees of $10 million and $13 million for the 12 weeks ended September 5, 1998 and September 6, 1997, respectively, and $29 million and $25 million for the 36 Weeks ended September 5, 1998 and September 6, 1997, respectively. The refranchising net gain arose from refranchising 913 and 920 units in 1998 and 1997, respectively. See page 19 for more details regarding refranchising activities. Additionally, 1998 store closure costs, net includes the reversal of $.7 million and $1.7 million in the quarter and year-to-date, respectively, of a portion of the 1997 fourth quarter charge related to better-than-expected lease settlements with certain lessors. Impairment resulted from our normal recurring evaluation of stores held for use. The lower amount in 1998 was primarily driven by 1997 decisions to dispose of certain stores which may have otherwise been impaired in the current evaluation. Future impairment charges depend on the facts and circumstances at each future evaluation date, so current impairment is not necessarily indicative of future impairment. Unusual (Credits) Charges Unusual credits in 1998 includes the reversal of certain reserves relating to better-than-expected proceeds from the sale of properties and settlement of lease liabilities associated with properties retained upon the sale of the Non-core Businesses. Unusual charges of $15 million in the third quarter of 1997 and $54 million year-to-date resulted from our 1996 decision to dispose of our remaining Non-core Businesses. These disposal charges represented a further reduction of the carrying amounts of the Non-core Businesses to their estimated or actual fair market value, less costs to sell. 23 Operating Profits
12 Weeks Ended 36 Weeks Ended ---------------------------------------- --------------------------------------- 9/5/98 9/6/97 % B(W) 9/5/98 9/6/97 % B(W) ---------- ----------- ----------- ---------- ---------- ----------- Domestic - Core $ 207 $ 140 47 $ 523 $ 429 22 Domestic - Non-core - 5 NM - 15 NM International 53 45 20 130 124 5 Foreign exchange gain (losses) 2 (7) NM 2 (15) NM Unallocated expenses (42) (24) (77) (107) (46) NM ---------- ----------- ---------- ---------- Ongoing operating profit 220 159 38 548 507 8 Facility actions net gain (54) (51) 5 (156) (136) 14 Unusual (credits) charges (5) 15 NM (5) 54 NM ---------- ----------- ---------- ---------- Reported operating profit $ 279 $ 195 43 $ 709 $ 589 20 ========== =========== ========== ==========
Excluding facility actions net gain and the unusual (credits) charges related to the Non-core Businesses, ongoing operating profits increased $61 million, or 38%, for the quarter and $41 million, or 8%, year-to-date. Excluding the negative impact of currency translation the increase in ongoing operating profits was $66 million, or 42%, and $56 million, or 11%, for the quarter and year-to-date, respectively. This increase in the quarter was driven by reduced G&A, restaurant margin improvements and higher franchise fees, partially offset by the absence in 1998 of the operating profits from the Non-core Businesses and the 1997 KFC renewal fees. The increase year-to-date was driven by reduced G&A and higher franchise fees, partially offset by lower restaurant margin dollars, the absence of the 1997 KFC renewal fees and the disposal of the Non-core Businesses. Ongoing operating profits included benefits related to our 1997 fourth quarter charge of $16 million and $46 million in the quarter and year-to-date, respectively. These benefits were fully offset year-to-date and partially offset in the quarter by the year-to-year decline in Asia profits and Year 2000 spending. Interest Expense, Net Prior to the Spin-off, our operations were financed through operating cash flows, proceeds from refranchising activities and investments by and advances from PepsiCo. Our 1997 interest expense includes an allocation of $53 million and $171 million for the 12 and 36 Weeks ended September 6, 1997, respectively, by PepsiCo of its interest expense (PepsiCo's weighted average interest rate applied to the average balance of investments by and advances from PepsiCo) and interest on our external debt for periods prior to the Spin-off. We believe such allocated interest expense is not indicative of the interest expense that we would have incurred as an independent, publicly owned Company or will incur in future periods. Interest expense increased $5 million, or 10% and $10 million, or 5% for the quarter and year-to-date, respectively. This increase is primarily due to the higher interest rate on our outstanding debt, as compared to the PepsiCo rate used in the allocation process prior to the Spin-off, and also higher average outstanding debt levels. 24 Income Taxes
12 Weeks Ended 36 Weeks Ended -------------------------------- ------------------------------- 9/5/98 9/6/97 9/5/98 9/6/97 ------------- ----------- ----------- -------------- Income taxes $ 89 $ 59 $ 217 $ 149 Reported effective tax rate 40.7 42.5 42.3 37.1 Ongoing effective tax rate* 40.7 50.7 42.3 45.9
* 1997 adjusted to exclude the effects of the tax-free New Zealand gain of $7 million and $100 million and the unusual charges of $15 million and $54 million for the quarter and year-to-date, respectively. The decrease in the ongoing 1998 year-to-date effective tax rate as compared to 1997 is primarily attributable to adjustments related to prior years and a decrease in foreign taxes, partially offset by an increase in state taxes. The ongoing 1998 year-to-date effective tax rate is lower than the year-to-date rate in the second quarter of 1998 due to the favorable shift in the mix of the components of our taxable income. Diluted Earnings Per Share The components of diluted earnings per common share ("EPS") were as follows:
12 Weeks Ended 36 Weeks Ended ----------------------------- ---------------------------- 9/5/98 9/6/97 (a) 9/5/98 9/6/97(a) ---------- -------------- ---------- -------------- Operating earnings - Core Businesses (b) $ .58 $ .28 $ 1.28 $ 1.05 Facility actions net gain .22 .27 .59 .73 ---------- -------------- ---------- -------------- Net income - Core Businesses .80 .55 1.87 1.78 Operating earnings - Non-core Businesses - .03 - .06 Unusual credits (charges) .02 (.08) .02 (.22) ---------- -------------- ---------- -------------- Net income $ .82 $ .50 $ 1.89 $ 1.62 ========== ============== ========== ==============
(a) The shares used to compute pro forma diluted earnings per common share for the 12 and 36 weeks ended September 6, 1997 are the same as those used in 1998, as our capital structure as an independent publicly owned Company did not exist during the first three quarters of 1997. (b) 1997 operating earnings from Core Businesses include KFC renewal fees of $4 million ($3 million after-tax or $.02 per pro forma diluted share) and $23 million ($14 million after-tax or $.09 per pro forma diluted share) in the quarter and year-to-date, respectively. 25 Domestic
12 Weeks Ended 36 Weeks Ended --------------------------------------- ----------------------------------- % B(W) % B(W) 9/5/98 9/6/97 9/5/98 9/6/97 ------------ ----------- --------- ---------- ---------- --------- SYSTEM SALES - CORE ONLY $ 3,351 $ 3,321 1 $ 9,647 $ 9,339 3 ============ =========== ========== ========== REVENUES Company sales $ 1,428 $ 1,664 (14) $ 4,244 $ 5,014 (15) Franchise and license fees (1) 101 88 14 279 255 9 ------------ ----------- ---------- ---------- Total Revenues $ 1,529 $ 1,752 (13) $ 4,523 $ 5,269 (14) ============ =========== ========== ========== COMPANY RESTAURANT MARGINS $ 214 $ 196 9 $ 573 $ 602 (5) % of sales 15.0% 11.8% 3.2 points 13.5% 12.0% 1.5 points OPERATING PROFITS, EXCLUDING FACILITY ACTIONS NET GAIN AND UNUSUAL (CREDITS) CHARGES Core Businesses $ 207 $ 140 47 $ 523 $ 429 22 Non-core Businesses - 5 NM - 15 NM ------------ ----------- ---------- ---------- $ 207 $ 145 41 $ 523 $ 444 18 ============ =========== ========== ==========
(1) Excluding the 1997 KFC renewal fees, quarter and year-to-date increased 19% and 20% over the prior year, respectively. - -------------------------------------------------------------------------------- U.S. RESTAURANT UNIT ACTIVITY
Company Franchised Licensed Total --------------- -------------- ----------- ------------ Balance at December 27, 1997 7,822 9,597 3,167 20,586 New Builds & Acquisitions 38 172 342 552 Refranchising & Licensing (835) 827 8 - Closures (318) (151) (272) (741) --------------- -------------- ----------- ------------ Balance at September 5, 1998 (a) 6,707 10,445 3,245 20,397 =============== ============== =========== ============ % of Total 32.9% 51.2% 15.9% 100.0% =============== ============== =========== ============
(a) Includes 242 Company and joint venture units approved for closure, but not yet closed at September 5, 1998. - -------------------------------------------------------------------------------- System sales increased $30 million, or 1%, in the quarter and $308 million, or 3%, year-to-date. The increase in the quarter and year-to-date is attributable to new unit development during the last twelve months predominately by franchisees and licensees of Taco Bell and Pizza Hut, partially offset by store closures. In addition, year-to-date was positively impacted by same store sales growth, led by Pizza Hut. Revenues decreased $223 million, or 13%, in the quarter and $746 million, or 14%, year-to-date. Company restaurant sales decreased $236 million, or 14%, in the quarter and $770 million, or 15%, year-to-date. Excluding the effect of the Non-core Businesses, Company restaurant sales declined $175 million, or 11%, in the quarter and $519 million, or 11%, year-to-date. The decrease in the quarter and year-to-date was driven by the portfolio effect. Positive same store sales growth at all three of our brands in the quarter and year-to-date partially offset this decrease. 26 Franchise and license fees increased $13 million, or 14%, in the quarter and $24 million, or 9%, year-to-date. Excluding the 1997 KFC contract renewal fees, franchise and license fees increased $17 million, or 19%, and $47 million, or 20%, in the quarter and year-to-date, respectively. The increase in the quarter and year-to-date is primarily due to the increase in continuing fees from refranchising and new unit development primarily by Pizza Hut and Taco Bell franchisees, partially offset by store closures. Same store sales are measured for our U.S. Company units. Same store sales at KFC increased 5% in the quarter and 3% year-to-date. The increase in the quarter was primarily driven by the successful promotion of crispier "Extra Crispy" chicken and "Honey Barbecue" wings compared to soft sales from "Twister" in the prior year. The increase year-to-date was primarily driven by favorable effective net pricing and strong product promotions, such as "Honey Barbecue" wings and "Original Recipe." Same store sales at Pizza Hut increased 4% for the quarter and 6% year-to-date. The increase in the quarter and year-to-date reflects a higher average guest check at traditional and delivery units driven by the new product offerings of "The Edge" and the "Sicilian" pizzas. In addition, year-to-date reflects the positive impact of increased volume. Taco Bell same store sales increased 2% in the quarter and 1% year-to-date. The increase in the quarter and year-to-date was driven by an increase in the average guest check resulting primarily from favorable effective net pricing. Same store sales also benefited from the introduction of "Gorditas," a higher priced menu item. The increase in the quarter and year-to-date was partially offset by volume declines. Company Restaurant Margins - Domestic
12 Weeks Ended 36 Weeks Ended ------------------------------- ------------------------------ 9/5/98 9/6/97 9/5/98 9/6/97 -------------- ------------ ------------- ------------- Company sales 100.0% 100.0% 100.0% 100.0% Food and paper 30.5 31.2 30.7 31.0 Payroll and employee benefits 29.7 30.2 30.8 30.5 Occupancy and other operating expenses 24.8 26.8 25.0 26.5 -------------- ------------ ------------- ------------- Company restaurant margins 15.0% 11.8% 13.5% 12.0% ============== ============ ============= =============
Company restaurant margins as a percent of sales increased 320 basis points in quarter and 150 basis points year-to-date as compared to the same periods in 1997. The portfolio effect contributed approximately 90 basis points in both the quarter and year-to-date to this improvement. In addition, benefits from the fourth quarter charge contributed approximately 50 basis points in both the quarter and year-to-date. Margins, excluding the portfolio effect and benefits from the 1997 fourth quarter charge, increased approximately 180 basis points in the quarter and increased slightly year-to-date. The quarter and year-to-date benefited from favorable effective net pricing in excess of cost increases, primarily labor. This improvement was partially offset in the quarter and largely offset year-to-date by volume declines. Labor increases in the both the quarter and year-to-date were driven by higher wage rates primarily related to the September 1997 minimum wage increase and higher incentive compensation accruals. Labor was also unfavorably impacted on a year-to-date basis by increases in the management complement at our Taco Bell restaurants and by the absence of favorable insurance actuarial adjustments which occurred in the prior year. The decreases in occupancy and other expenses related primarily to store condition and quality initiatives at Pizza Hut and Taco Bell in 1997 offset by 1998 store refurbishment expenses at KFC. 27 Operating profits from Core Businesses, excluding facilities action net gain, increased $67 million, or 47%, in the quarter and $94 million, or 22%, year-to-date. This increase in the quarter was driven by reduced G&A, restaurant margin improvements and higher franchise fees, partially offset by the absence of the 1997 KFC renewal fees. The increase year-to-date was driven by reduced G&A and higher franchise fees, partially offset by lower restaurant margin dollars and the absence of the 1997 KFC renewal fees. Operating profits included the benefits related to our 1997 fourth quarter charge of $9 million and $24 million in the quarter and year-to-date, respectively. These benefits were partially offset in the quarter and year-to-date by Year 2000 spending. International
12 Weeks Ended 36 Weeks Ended -------------------------------------- ------------------------------------- 9/5/98 9/6/97 % B(W) 9/5/98 9/6/97 % B(W) ---------- ----------- ----------- ---------- ---------- ----------- SYSTEM SALES $ 1,554 $ 1,666 (7) $ 4,551 $ 4,768 (5) ========== =========== ========== ========== REVENUES Company sales $ 441 $ 499 (12) $ 1,282 $ 1,485 (14) Franchise and license fees 47 49 (4) 137 137 - ---------- ----------- ---------- ---------- Total Revenues $ 488 $ 548 (11) $ 1,419 $ 1,622 (12) ========== =========== ========== ========== COMPANY RESTAURANT MARGINS $ 62 $ 61 2 $ 164 $ 171 (4) % of sales 14.0% 12.2% 1.8 points 12.8% 11.5% 1.3 points OPERATING PROFIT, EXCLUDING FACILITY ACTIONS NET GAIN $ 53 $ 45 20 $ 130 $ 124 5 -----------------------------------------------------------------------------------------------------------------
INTERNATIONAL RESTAURANT UNIT ACTIVITY
Joint Company Venture Franchised Licensed Total ------------- ----------- -------------- ------------ ------------ Balance at December 27, 1997 2,295 1,090 5,500 241 9,126 New Builds & Acquisitions 123 60 358 42 583 Refranchising & Licensing (78) (6) 7 77 - Closures (103) (39) (325) (39) (506) ------------- ----------- -------------- ------------ ------------ Balance at September 5, 1998 (a) 2,237 1,105 5,540 321 9,203 ============= =========== ============== ============ ============ % of Total 24.3% 12.0% 60.2% 3.5% 100.0% ============= =========== ============== ============ ============
(a) Includes 72 Company and joint venture units approved for closure, but not yet closed at September 5, 1998. - -------------------------------------------------------------------------------- System sales decreased $112 million, or 7%, in the quarter and $217 million, or 5%, year-to-date. Excluding the impact of foreign currency translation, system sales increased $91 million, or 5% and $286 million, or 6% in the quarter and year-to-date, respectively. The increase was primarily due to new unit development primarily in China, Taiwan and Korea, partially offset by store closures in other countries/markets. Revenues decreased $60 million, or 11%, in the quarter and $203 million, or 12%, year-to-date. Excluding the negative impact of foreign currency translation, revenues decreased $12 million, or 2%, and $51 million, or 3%, for the quarter and year-to-date, respectively. The decrease in the quarter and year-to-date reflects the absence of revenues due to portfolio actions partially offset by new unit development and effective net pricing. Franchise and license fees decreased $2 million, or 4%, for the quarter and were unchanged year-to-date. 28 Excluding the negative impact of foreign currency translation, franchise and license fees increased $5 million, or 9%, in the quarter and $15 million, or 11%, year-to-date. Fees from franchisee and licensee unit development and units acquired from us were partially offset by store closures. Company restaurant sales decreased $58 million, or 12% in the quarter and $203 million, or 14%, year-to-date. Excluding the impact of foreign currency translation, company restaurant sales decreased $11 million, or 2%, and $65 million, or 4%, for the quarter and year-to-date, respectively. The decrease in the quarter was driven by portfolio actions and volume declines, primarily in Asia. Declines in the quarter were partially offset by new unit development, effective net pricing and transaction increases in Mexico, Puerto Rico and Poland. Year-to-date, sales declines due to portfolio actions, driven by the refranchising of our restaurants in New Zealand in the second quarter of 1997, and volume declines were partially offset by effective net pricing and volume increases in several countries led by in Mexico, Puerto Rico and Poland. Company Restaurant Margins - International
12 Weeks Ended 36 Weeks Ended ------------------------------ ---------------------------- 9/5/98 9/6/97 9/5/98 9/6/97 ------------- ------------- ------------- ----------- Company sales 100.0% 100.0% 100.0% 100.0% Food and paper 35.3 35.9 35.6 36.6 Payroll and employee benefits 22.6 22.5 23.5 23.0 Occupancy and other operating expenses 28.1 29.4 28.1 28.9 ------------- ------------- ------------- ----------- Company restaurant margins 14.0% 12.2% 12.8% 11.5% ============= ============= ============= ===========
Restaurant margins increased 180 basis points in the quarter and 130 basis points year-to-date. Excluding the impact of foreign currency translation, restaurant margins increased 215 basis points in the quarter and 160 basis points year-to-date. This increase was driven primarily by the absence of depreciation relating to stores included in the 1997 fourth quarter charge which contributed approximately 130 basis points and 125 basis points in the quarter and year-to-date, respectively. The remaining 85 basis point improvement in the quarter and 35 basis point improvement year-to-date reflected favorable effective net pricing in excess of cost increases, partially offset by volume declines. The continuing economic turmoil throughout much of Asia resulted in an overall volume decline, even though we had volume increases in several countries led by Mexico, Puerto Rico and Poland. Operating profits, excluding facility actions net gain, increased $8 million, or 20% in the quarter and $6 million, or 5%, year-to-date. Excluding the negative impact of foreign currency translation, operating profits increased $13 million, or 29%, and $23 million, or 19%, in the quarter and year-to-date, respectively. The increase in the quarter and year-to-date reflected a decline in G&A, partially offset by lower franchise fees in the quarter and lower restaurant margin dollars year-to-date. Operating profits included benefits related to our 1997 fourth quarter charge of $7 million and $22 million in the quarter and year-to-date, respectively. These benefits were fully offset in the quarter and more than offset year-to-date by the year-to-year decline in Asia operating profits and Year 2000 spending. Consolidated Cash Flows Net cash provided by operating activities increased $30 million, or 6%, to $503 million year-to-date. Excluding net changes in working capital, net cash provided by operating activities declined $93 million due primarily to the decline in the number of Company restaurants in operation in the current year relating to our refranchising initiative. 29 Cash provided from working capital was $26 million this year compared to a $97 million use of cash last year. This swing was primarily due to the change in accounts payable balances which decreased $94 million in 1997 versus a decrease of $47 million in 1998. In addition, an increase in accrued casualty claims liabilities of approximately $44 million in 1998 reflecting a change to self-insurance from the previous insured programs also contributed to the swing. Net cash provided by investing activities decreased by $160 million to $207 million year-to-date, primarily due to the prior year sale of the Non-core Businesses and lower proceeds from the sales of property, plant and equipment. Net cash used for financing activities decreased by $7 million to $829 million year-to-date. The slightly larger net debt repayments in 1997 include amounts paid to PepsiCo. Financing Activities Through September 1998, we reduced our reliance on bank debt by $1 billion by reducing term debt. Term debt was reduced through a combination of proceeds from the debt securities offered under our shelf registration discussed below, proceeds from refranchising activities and a draw against the Revolving Credit Facility. A key component of our financing philosophy is to build balance sheet liquidity and to diversify sources of funding. Consistent with that philosophy, we have taken steps to refinance a portion of our existing bank credit facility referred to below. In 1997 we filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 with respect to offerings of up to $2 billion of senior unsecured debt. In early May 1998, under our shelf registration, we issued $350 million 7.45% unsecured Notes due May 15, 2005 and $250 million 7.65% unsecured Notes due May 15, 2008. The proceeds were used to reduce existing borrowings under our unsecured Term Loan Facility and unsecured Revolving Credit Facility. We may offer and sell from time to time additional debt securities in one or more series, in amounts, at prices and on terms we determine based on market conditions at the time of sale, as discussed in more detail in the registration statement. To fund the Spin-off, we negotiated a $5.25 billion bank credit agreement comprised of a $2 billion senior, unsecured Term Loan Facility and a $3.25 billion senior, unsecured Revolving Credit Facility which mature on October 2, 2002. Interest is based principally on the London Interbank Offered Rate ("LIBOR") plus a variable margin as defined in the credit agreement. During the 36 weeks ended September 5, 1998, we made net payments of $640 million and $760 million under our unsecured bank Term Loan Facility and the unsecured Revolving Credit Facility, respectively. As discussed in our 10-K, amounts outstanding under the revolving credit facility are expected to fluctuate from time to time, but term loan reductions cannot be reborrowed. Such payments reduced amounts outstanding at September 5, 1998 to $1.33 billion and $1.68 billion from $1.97 billion and $2.44 billion at year end 1997, on the term facility and revolving facility, respectively. At September 5, 1998, we had unused revolving credit agreement borrowings available aggregating $1.43 billion, net of outstanding letters of credit of $147 million. The credit facilities are subject to various affirmative and negative covenants including financial covenants as well as limitations on additional indebtedness including guarantees of indebtedness, cash dividends, aggregate non-U.S. investments, among other things, as defined in the credit agreement. This substantial indebtedness subjects us to significant interest expense and principal repayment obligations which are limited, in the near term, to prepayment events as defined in the credit agreement. Our highly leveraged capital structure could also adversely affect our ability to obtain additional financing in the future or to undertake refinancings on terms and subject to conditions that are acceptable to us. 30 At the end of the third quarter of 1998, we were in compliance with the bank covenants. We will continue to closely monitor on an ongoing basis the various operating issues that could, in aggregate, affect our ability to comply with financial covenant requirements. Such issues include, among other things, the ongoing economic turmoil faced by much of Asia as well as the intensely competitive nature of the quick service restaurant industry. We use various derivative instruments with the objective of reducing volatility in our borrowing costs. We have utilized interest rate swap agreements to effectively convert a portion of our variable rate (LIBOR) bank debt to fixed rate. We have also entered into interest rate arrangements to limit the range of effective interest rates on a portion of our variable rate bank debt. At September 5, 1998, the weighted average interest rate on our variable bank debt, including the effect of derivatives, was 6.4%. Other derivative instruments may be considered from time to time as well to manage our debt portfolio and to hedge foreign currency exchange exposures. Though we anticipate that cash flows from both operating and refranchising activities will be lower than prior year levels, we believe they will be sufficient to support our expected capital spending and still allow us to make significant debt repayments. Consolidated Financial Condition Our working capital deficit, which excludes short-term investments and short-term borrowings, is typical of restaurant operations where the vast majority of company sales are for cash and food and supply inventories are relatively small. The terms of payment to suppliers generally range from 10-30 days. Our working capital deficit increased 20% to $963 million at September 5, 1998 from $805 million at December 27, 1997. This increase primarily reflected a decrease in cash and cash equivalents which were at higher than normal levels at year end due to less flexible debt repayment terms than exist today. It also reflects an increase in income taxes payable due to timing of estimated tax payments offset by a decrease in accounts payable, also due to timing of payments and a lower number of Company-operated restaurants. As expected, we are continuing to experience reductions in most of our asset and liability accounts as we continue our initiatives to reduce the number of Company-operated restaurants to a level more consistent with our major competitors. An exception to these reductions is Other Liabilities and Deferred Credits which increased by $58 million, or 10%. The primary driver of this increase was pension and deferred compensation accruals. Euro Conversion The Single European Currency (euro) will be introduced on January 1, 1999. Complete transition is required by June 2002. We have completed an assessment of the impact of the introduction of the euro on our European businesses. This process, supported by outside consultants, will now move into implementing all necessary actions to accommodate the introduction of the euro, including inquiries of key suppliers as to their euro readiness. The conclusion of the euro assessment process is that we face a number of strategic and operational issues. The impact, if any, of these strategic and operational issues on our results of operation, financial condition and cash flows is not presently determinable. The key strategic issues include the as yet unknown competitor response and the effect of price transparency on the European quick service restaurant market-place. The key operational issues include the introduction of a euro marketing and pricing policy and the transition to the euro currency in both front and back-of-house IT systems. There will be costs associated with these and other IT changes but we currently estimate they will not be material. The euro offers benefits on the Treasury and Procurement side of our European businesses and policies are being developed for migrating to euro-purchasing over the three year 31 transition period. We plan to be euro compliant before the introduction of euro notes and coins in 2002. Any delays in our ability to be euro complaint, or in our key suppliers to be euro compliant, could have a material adverse impact on our results of operations, financial condition and/or cash flows. Quantitative and Qualitative Disclosures About Market Risk Market Risk Our primary market risk exposure with regard to financial instruments is to changes in interest rates, principally in the United States. In addition, an immaterial portion of our debt is denominated in a currency other than the functional currency of the respective country which exposes us to market risk associated with exchange rate movements. Historically, we have not used derivative financial instruments to manage our exposure to foreign currency rate fluctuations since the market risk associated with our foreign currency denominated debt was not considered significant. At September 5, 1998, a hypothetical 100 basis point increase in short-term interest rates would result in a reduction of $13 million in annual pre-tax earnings. The estimated reduction is based upon the unhedged portion of our variable rate debt and assumes no change in the volume or composition of debt at September 5, 1998. In addition, the fair value to us of our interest rate derivative contracts hedging the remaining portion of our variable rate bank debt would increase approximately $30 million. Fair value was determined by discounting the projected interest rate swap and collar cash flows. 32 Cautionary Statements From time to time, in both written reports and oral statements, we present "forward-looking statements" within the meaning of Federal and state securities laws, including those identified by such words as "may," "will," "expect," "believe," "plan" and other similar terminology. These "forward-looking statements" reflect our current expectations and are based upon data available at the time of the statements. Actual results involve risks and uncertainties, including both those specific to the Company and those specific to the industry, and could differ materially from expectations. Company risks and uncertainties include but are not limited to the lack of experience of our management group in operating the Company as an independent, publicly owned business; potentially substantial tax contingencies related to the Spin-off, which, if they occur, require us to indemnify PepsiCo; our substantial debt leverage and the attendant potential restriction on our ability to borrow in the future, as well as the substantial interest expense and principal repayment obligations; potential unfavorable variances between estimated and actual liabilities including those related to the sale of the Non-core Businesses; failures to achieve timely, effective Year 2000 remediation; and the potential inability to identify qualified franchisees to purchase Company restaurants at prices we consider appropriate under our strategy to reduce the percentage of system units we operate. Industry risks and uncertainties include, but are not limited to, global and local business and economic and political conditions; legislation and governmental regulation; competition; success of operating initiatives and advertising and promotional efforts; volatility of commodity costs and increases in minimum wage and other operating costs; availability and cost of land and construction; adoption of new or changes in accounting policies and practices; consumer preferences, spending patterns and demographic trends; political or economic instability in local markets; and currency exchange rates. 33 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 5, 1998 and the related condensed consolidated statement of income for the twelve and thirty-six weeks ended September 5, 1998 and September 6, 1997 and the condensed consolidated statement of cash flows for the thirty-six weeks ended September 5, 1998 and September 6, 1997. These financial statements are the responsibility of TRICON's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical review procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of TRICON as of December 27, 1997, and the related consolidated statements of operations, cash flows and shareholders' (deficit) equity for the year then ended not presented herein; and in our report dated February 12, 1998, 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 27, 1997, is fairly presented, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Our report, referred to above, contains an explanatory paragraph that states that TRICON in 1995 adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." KPMG Peat Marwick LLP Louisville, Kentucky October 14, 1998 34 PART II - OTHER INFORMATION AND SIGNATURES Item 6. Exhibits and Reports on Form 8-K (a) Exhibit Index EXHIBITS Exhibit 10.18+ Form of Severance Agreement (in the event of a change in control) Exhibit 12 Computation of Ratio of Earnings to Fixed Charges Exhibit 15 Letter from KPMG Peat Marwick LLP regarding Unaudited Interim Financial Information (Accountants' Acknowledgment) Exhibit 27 Financial Data Schedule + Indicates a management contract or compensatory plan. (b) Reports on Form 8-K We filed a Current Report on Form 8-K dated August 19, 1998 attaching a press release of August 19, 1998 announcing anticipated third quarter operating and financial trends. 35 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 19, 1998 /s/ Robert L. Carleton ------------------------------------------ Senior Vice President and Controller and Chief Accounting Officer (Principal Accounting Officer) 36 EXHIBIT 10.18 SEVERANCE AGREEMENT THIS AGREEMENT, dated , 1998, is made by and between Tricon Global Restaurants, Inc., a North Carolina corporation (the "Company"), and ______________(the "Executive"). WHEREAS, the Company considers it essential to the best interests of its shareholders to foster the continued employment of key management personnel; and WHEREAS, the Board recognizes that, as is the case with many publicly held corporations, the possibility of a Change in Control exists and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders; and WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control; NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and the Executive hereby agree as follows: 1 1. Defined Terms. The definitions of capitalized terms used in this Agreement are provided in the last Section hereof. 2. Term of Agreement. The Term of this Agreement shall commence on the date hereof and shall continue in effect through December 31, 2000; provided, however, that if a Change in Control shall have occurred during the Term, the Term shall expire no earlier than the second anniversary of the date of such Change in Control. 3. Company's Covenants Summarized. In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive's covenants set forth in Section 4 hereof, the Company agrees, under the conditions described herein, to pay the Executive the Severance Payments and the other payments and benefits described herein. Except as provided in Section 9.1 hereof, no Severance Payments shall be payable under this Agreement unless there shall have been (or, under the terms of the second sentence of Section 6.1 hereof, there shall be deemed to have been) a termination of the Executive's employment with the Company following a Change in Control and during the Term. This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any right to be retained in the employ of the Company. 4. The Executive's Covenants. The Executive agrees that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control during the Term, the Executive will remain in the employ of the Company until the earliest of (i) a date which is six (6) months from the date of such Potential Change in Control, (ii) the date of a Change in Control, (iii) the date of termination by the Executive of the Executive's employment for Good Reason or by reason of death or Disability, or (iv) the termination by the Company of the Executive's employment for any reason. 5. Compensation Other Than Severance Payments. 5.1 Following a Change in Control and during the Term, and during any period that the Executive fails to perform the Executive's full-time duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive's full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits 2 payable to the Executive under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period, until the Executive's employment is terminated by the Company for Disability. 5.2 If the Executive's employment shall be terminated for any reason following a Change in Control and during the Term, the Company shall pay the Executive's full salary to the Executive through the Date of Termination at the rate in effect immediately prior to the Date of Termination or, if higher, the rate in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason, together with all compensation and benefits payable to the Executive through the Date of Termination under the terms of the Company's compensation and benefit plans, programs or arrangements as in effect immediately prior to the Date of Termination or, if more favorable to the Executive, as in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason. 5.3 If the Executive's employment shall be terminated for any reason following a Change in Control and during the Term, the Company shall pay to the Executive the Executive's normal post-termination compensation and benefits as such payments become due. Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company's retirement, insurance and other compensation or benefit plans, programs and arrangements as in effect immediately prior to the Date of Termination or, if more favorable to the Executive, as in effect immediately prior to the occurrence of the first event or circumstance constituting Good Reason. 6. Severance Payments. 6.1 Subject to Section 6.2 hereof, if (i) the Executive's employment is terminated following a Change in Control and during the Term, other than (A) by the Company for Cause, (B) by reason of death or Disability, or (C) by the Executive without Good Reason, the Company shall pay the Executive the amounts, and provide the Executive the benefits, described in this Section 6.1 ("Severance Payments") and Section 6.2, in addition to any payments and benefits to which the Executive is entitled under Section 5 hereof. For purposes of this Agreement, the Executive's employment shall be deemed to have been terminated following a Change in Control by the Company 3 without Cause or by the Executive with Good Reason, if (i) the Executive's employment is terminated by the Company without Cause after the occurrence of a Potential Change in Control and prior to a Change in Control (whether or not a Change in Control ever occurs) and such termination was at the request or direction of a Person who has entered into an agreement with the Company the consummation of which would constitute a Change in Control, (ii) the Executive terminates his employment for Good Reason after the occurrence of a Potential Change in Control and prior to a Change in Control (whether or not a Change in Control ever occurs) and the circumstance or event which constitutes Good Reason occurs at the request or direction of such Person, or (iii) the Executive's employment is terminated by the Company without Cause or by the Executive for Good Reason after the occurrence of a Potential Change in Control and such termination or the circumstance or event which constitutes Good Reason is otherwise in connection with or in anticipation of a Change in Control (whether or not a Change in Control ever occurs). For purposes of any determination regarding the applicability of the immediately preceding sentence, any position taken by the Executive shall be presumed to be correct unless the Company establishes by clear and convincing evidence that such position is not correct. (A) In lieu of any further salary payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to two times the sum of (i) the Executive's base salary as in effect immediately prior to the Date of Termination or, if higher, in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason and (ii) the target annual incentive compensation for the Executive in respect of the fiscal year in which the Change in Control occurred, or, if higher, the actual incentive compensation the Executive earned for the fiscal year preceding the year in which the Executive's employment is terminated. (B) Notwithstanding any provision of any annual or long-term incentive plan to the contrary, the Company shall pay to the Executive a lump sum amount, in cash, equal to the sum of (i) any unpaid incentive compensation which has been allocated or awarded to the Executive for a completed fiscal year or other measuring period preceding the Date of 4 Termination under any such plan and which has not yet been paid or deferred pursuant to a deferral plan maintained by the Company, and (ii) and, notwithstanding any provision of the Company's annual incentive plan to the contrary, a cash lump sum amount equal to a pro rata portion to the Date of Termination of the aggregate value of the annual incentive compensation award to the Executive for the then uncompleted fiscal year under such plan, assuming achievement of performance goals at the target level, or, if higher, assuming continued achievement of such performance goals at the level achieved through the Date of Termination. (C) The Company shall provide the Executive with outplacement services suitable to the Executive's position for a period of one year or, if earlier, until the first acceptance by the Executive of an offer of employment. 6.2 (A) Whether or not the Executive becomes entitled to the Severance Payments, if any payment or benefit received or to be received by the Executive in connection with a Change in Control or the termination of the Executive's employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any Person whose actions result in a Change in Control or any Person affiliated with the Company or such Person) (all such payments and benefits, excluding the Gross-Up Payment, being hereinafter called "Total Payments") will be subject (in whole or part) to the Excise Tax, then, subject to the provisions of subsection (B) of this Section 6.2, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Total Payments and any federal, state and local income and employment taxes and Excise Tax upon the Gross-Up Payment, shall be equal to the Total Payments. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the Date of Termination (or if there is no Date of Termination, then the date on which the Gross-up Payment is calculated for purposes of this Section 6.2), net of the maximum reduction in federal income tax which could be obtained from deduction of such state and local taxes. 5 (B) In the event that, after giving effect to any redeterminations described in subsection (D) of this Section 6.2, the Total Payments do not exceed by more than ten percent (10%) the largest amount that would result in no portion of the Total Payments being subject to the Excise Tax, then subsection (A) of this Section 6.2 shall not apply and Severance Payments shall first be reduced (if necessary, to zero) in the manner elected by the Executive to the extent necessary so that no portion of the Total Payments will be subject to the Excise Tax. (C) For purposes of determining whether any of the Total Payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) all of the Total Payments shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, unless in the opinion of tax counsel ("Tax Counsel") reasonably acceptable to the Executive and selected by the accounting firm which was, immediately prior to the Change in Control, the Company's independent auditor (the "Auditor"), such other payments or benefits (in whole or in part) do not constitute parachute payments, including by reason of section 280G(b)(4)(A) of the Code, (ii) all "excess parachute payments" within the meaning of section 280G(b)(l) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered, within the meaning of section 280G(b)(4)(B) of the Code, in excess of the Base Amount allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of sections 280G(d)(3) and (4) of the Code. Prior to the payment date set forth in Section 6.3 hereof, the Company shall provide the Executive with its calculation of the amounts referred to in this Section 6.2(C) and such supporting materials as are reasonably necessary for the Executive to evaluate the Company's calculations. If the Executive disputes the Company's calculations (in whole or in part), the reasonable opinion of Tax Counsel with respect to the matter in dispute shall prevail. (D) In the event that (i) amounts are paid to the Executive pursuant to subsection (A) of this Section 6.2, (ii) the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, and (iii) after giving effect to such redetermination, the 6 Total Payments are to be reduced pursuant to subsection (B) of this Section 6.2, the Executive shall repay to the Company, within ten (10) business days following the time that the amount of such reduction in Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive), to the extent that such repayment results in (i) no portion of the Total Payments being subject to the Excise Tax and (ii) a dollar-for-dollar reduction in the Executive's taxable income and wages for purposes of federal, state and local income and employment taxes) plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code. In the event that (x) the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the termination of the Executive's employment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment) and (y) after giving effect to such redetermination, the Total Payments should not have been reduced pursuant to subsection (B) of this Section 6.2, the Company shall make an additional Gross-Up Payment in respect of such excess and in respect of any portion of the Excise Tax with respect to which the Company had not previously made a Gross-Up Payment (plus any interest, penalties or additions payable by the Executive with respect to such excess and such portion) within ten (10) business days following the time that the amount of such excess is finally determined. 6.3 The payments provided in subsections (A), (C) and (D) of Section 6.1 hereof and in Section 6.2 hereof shall be made not later than the tenth day following the Date of Termination; provided, however, that if the amounts of such payments, and the limitation on such payments set forth in Section 6.2 hereof, cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Executive or, in the case of payments under Section 6.2 hereof, in accordance with Section 6.2 hereof, of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments (together with interest on the unpaid remainder (or on all such payments to the extent the Company fails to make such payments when due) at 120% of the rate provided in section 1274(b)(2)(B) of the Code) as soon as the 7 amount thereof can be determined but in no event later than the thirtieth (30th) day after the Date of Termination. In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the tenth (10th) business day after demand by the Company (together with interest at 120% of the rate provided in section 1274(b)(2)(B) of the Code). At the time that payments are made under this Agreement, the Company shall provide the Executive with a written statement setting forth the manner in which such payments were calculated and the basis for such calculations including, without limitation, any opinions or other advice the Company has received from Tax Counsel, the Auditor or other advisors or consultants (and any such opinions or advice which are in writing shall be attached to the statement). The Company shall bear the entire cost of any opinions, advice or similar expenses associated with Sections 6.2 or 6.3 hereof. 6.4 The Company also shall pay to the Executive all legal fees and expenses incurred by the Executive in disputing in good faith any issue hereunder relating to the termination of the Executive's employment, in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder. Such payments shall be made within ten (10) business days after delivery of the Executive's written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require. 7. Termination Procedures and Compensation During Dispute. 7.1 Notice of Termination. After a Change in Control and during the Term (or under the circumstances described in the second sentence of section 6.1 hereof), any purported termination of the Executive's employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 10 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under 8 the provision so indicated. Further, a Notice of Termination for Cause is required to include a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3/4) of the entire membership of the Board at a meeting of the Board which was called and held for the purpose of considering such termination (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's counsel, to be heard before the Board) finding that, in the good faith opinion of the Board, the Executive was guilty of conduct set forth in clause (i) or (ii) of the definition of Cause herein, and specifying the particulars thereof in detail. 7.2 Date of Termination. "Date of Termination," with respect to any purported termination of the Executive's employment after a Change in Control and during the Term, shall mean (i) if the Executive's employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive's duties during such thirty (30) day period), and (ii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company, shall not be less than thirty (30) days (except in the case of a termination for Cause) and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given). 7.3 Dispute Concerning Termination. If within fifteen (15) days after any Notice of Termination is given, or, if later, prior to the Date of Termination (as determined without regard to this Section 7.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the earlier of (i) the date on which the Term ends or (ii) the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of an arbitrator or a court of competent jurisdiction (which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided, however, that the Date of Termination shall be extended by a notice of dispute given by the Executive only if such notice is given in good faith and the Executive pursues the resolution of such dispute with reasonable diligence. 9 7.4 Compensation During Dispute. If a purported termination occurs following a Change in Control and during the Term and the Date of Termination is extended in accordance with Section 7.3 hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, salary) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the Date of Termination, as determined in accordance with Section 7.3 hereof. Amounts paid under this Section 7.4 are in addition to all other amounts due under this Agreement (other than those due under Section 5.2 hereof) and shall not be offset against or reduce any other amounts due under this Agreement. 8. No Mitigation. The Company agrees that, if the Executive's employment with the Company terminates during the Term, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Section 6 hereof or Section 7.4 hereof. Further, the amount of any payment or benefit provided for in this Agreement shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise. 9. Successors; Binding Agreement. 9.1 In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive's employment for Good Reason after a Change in Control, 10 except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. 9.2 This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive's estate. 10. Notices. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed, if to the Executive, to the address inserted below the Executive's signature on the final page hereof and, if to the Company, to the address set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt: To the Company: Tricon Global Restaurants, Inc. 1441 Gardiner Lane Louisville, KY 40213 Attention: General Counsel 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Board. No waiver by either party hereto at any time of any breach by the other party hereto of, or of any lack of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. This Agreement supersedes any other agreements or representations, oral or otherwise, express or implied, 11 with respect to the subject matter hereof which have been made by either party; provided, however, that this Agreement shall supersede any agreement setting forth the terms and conditions of the Executive's employment with the Company only in the event that the Executive's employment with the Company is terminated on or following a Change in Control, by the Company other than for Cause or by the Executive for Good Reason. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Kentucky, without reference to its principles of conflicts of law. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed. The obligations of the Company and the Executive under this Agreement which by their nature may require either partial or total performance after the expiration of the Term (including, without limitation, those under Sections 6 and 7 hereof) shall survive such expiration. 12. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 13. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 14. Settlement of Disputes; Arbitration. 14.1 All claims by the Executive for benefits under this Agreement shall be directed to and determined by the Board and shall be in writing. Any denial by the Board of a claim for benefits under this Agreement shall be delivered to the Executive in writing and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon. The Board shall afford a reasonable opportunity to the Executive for a review of the decision denying a claim and shall further allow the Executive to appeal to the Board a decision of the Board within sixty (60) days after notification by the Board that the Executive's claim has been denied. 14.2 Any further dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Louisville, Kentucky in accordance with the rules of the American Arbitration Association then in effect; provided, however, that the evidentiary standards set forth in this Agreement shall apply. Judgment may be entered on the arbitrator's award in any court having jurisdiction. Notwithstanding any provision of this Agreement to the contrary, the Executive shall be entitled to seek specific performance of the Executive's right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 15. Definitions. For purposes of this Agreement, the following terms shall have the meanings indicated below: (A) "Affiliate" shall have the meaning set forth in Rule 12b-2 promulgated under Section 12 of the Exchange Act. (B) "Auditor" shall have the meaning set forth in Section 6.2 hereof. (C) "Base Amount" shall have the meaning set forth in section 280G(b)(3) of the Code. (D) "Beneficial Owner" shall have the meaning set forth in Rule 13d-3 under the Exchange Act. (E) "Board" shall mean the Board of Directors of the Company. (F) "Cause" for termination by the Company of the Executive's employment shall mean (i) the willful and continued failure by the Executive to substantially perform the Executive's duties with the Company (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or any such actual or anticipated failure after the issuance of a Notice of Termination for Good Reason by the Executive pursuant to Section 7.1 hereof) after a written demand for substantial performance is delivered to the Executive by the Board, which demand specifically identifies the manner in which the Board believes that the Executive has not substantially performed the Executive's duties, or (ii) the willful engaging by the Executive in conduct which is demonstrably and materially injurious to the Company or its subsidiaries, monetarily or otherwise. For purposes of clauses (i) and (ii) of this definition, (x) no act, or failure to act, on the Executive's part shall be deemed "willful" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that the Executive's 13 act, or failure to act, was in the best interest of the Company and (y) in the event of a dispute concerning the application of this provision, no claim by the Company that Cause exists shall be given effect unless the Company establishes to the Board by clear and convincing evidence that Cause exists. (G) A "Change in Control" shall be deemed to have occurred if the event set forth in any one of the following paragraphs shall have occurred: (I) any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates) representing 20% or more of the combined voting power of the Company's then outstanding securities, excluding any Person who becomes such a Beneficial Owner in connection with a transaction described in clause (i) of paragraph (III) below; or 14 (II) the following individuals cease for any reason to constitute a majority of the number of directors then serving: individuals who, on the date hereof, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of the Company) whose appointment or election by the Board or nomination for election by the Company's shareholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the date hereof or whose appointment, election or nomination for election was previously so approved or recommended; or (III) there is consummated a merger or consolidation of the Company or any direct or indirect subsidiary of the Company with any other corporation, other than (i) a merger or consolidation immediately following which those individuals who, immediately prior to the consummation of such merger or consolidation, constituted the Board, constitute a majority of the board of directors of the Company or the surviving or resulting entity or any parent thereof, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its Affiliates) representing 20% or more of the combined voting power of the Company's then outstanding securities, Notwithstanding the foregoing, a "Change in Control" shall not be deemed to have occurred by virtue of the consummation of any transaction or series of integrated transactions immediately following which the record holders of the common stock of the Company immediately prior to such transaction or series of transactions continue to have substantially the same proportionate 15 ownership in an entity which owns all or substantially all of the assets of the Company immediately following such transaction or series of transactions. (H) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time. (I) "Company" shall mean Tricon Global Restaurants, Inc. and, except in determining under Section 15(G) hereof whether or not any Change in Control of the Company has occurred, shall include any successor to its business and/or assets which assumes and agrees to perform this Agreement by operation of law, or otherwise. (J) "Date of Termination" shall have the meaning set forth in Section 7.2 hereof. (K) "Disability" shall be deemed the reason for the termination by the Company of the Executive's employment, if, as a result of the Executive's incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive's duties with the Company for a period of six (6) consecutive months, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive's duties. (L) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended from time to time. (M) "Excise Tax" shall mean any excise tax imposed under section 4999 of the Code. (N) "Executive" shall mean the individual named in the first paragraph of this Agreement. (O) "Good Reason" for termination by the Executive of the Executive's employment shall mean the occurrence (without the Executive's express written consent) after any Change in Control, or prior to a Change in Control under the circumstances described in clauses (ii) and (iii) of the second sentence of Section 6.1 hereof (treating all references in paragraphs (I) through (VII) below to a "Change in Control" as references to a "Potential Change 16 in Control"), of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (I), (V), (VI) or (VII) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof: (I) the assignment to the Executive of any duties inconsistent with the Executive's status as an executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities from those in effect immediately prior to the Change in Control; (II) a reduction by the Company in the Executive's annual base salary or target incentive award or incentive award opportunity as in effect on the date hereof or as the same may be increased from time to time; (III) the relocation of the Executive's principal place of employment to a location more than 50 miles from the Executive's principal place of employment immediately prior to the Change in Control or the Company's requiring the Executive to be based anywhere other than such principal place of employment (or permitted relocation thereof) except for required travel on the Company's business to an extent substantially consistent with the Executive's present business travel obligations; (IV) the failure by the Company to pay to the Executive any portion of the Executive's current compensation, or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due; (V) the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to 17 the Change in Control which is material to the Executive's total compensation, including but not limited to the Company's or any substitute plans adopted prior to the Change in Control, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive's participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount or timing of payment of benefits provided and the level of the Executive's participation relative to other participants, as existed immediately prior to the Change in Control; (VI) the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by the Executive under any of the Company's pension, savings, life insurance, medical, health and accident, or disability plans in which the Executive was participating immediately prior to the Change in Control (except for across the board changes similarly affecting all executives of the Company and all executives of any Person in control of the Company), the taking of any other action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in accordance with the Company's normal vacation policy in effect at the time of the Change in Control; or (VII) any purported termination of the Executive's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 7.1 hereof; for purposes of this Agreement, no such purported termination shall be effective. The Executive's right to terminate the Executive's employment for Good Reason shall not be affected by the Executive's incapacity due to physical or mental illness. The 18 Executive's continued employment shall not constitute consent to, or a waiver of rights with respect to, any act or failure to act constituting Good Reason hereunder. For purposes of any determination regarding the existence of Good Reason, any claim by the Executive that Good Reason exists shall be presumed to be correct unless the Company establishes to the Board by clear and convincing evidence that Good Reason does not exist. (P) "Gross-Up Payment" shall have the meaning set forth in Section 6.2 hereof. (Q) "Notice of Termination" shall have the meaning set forth in Section 7.1 hereof. (R) "Pension Plan" shall mean any tax-qualified, supplemental or excess benefit pension plan maintained by the Company and any other plan or agreement entered into between the Executive and the Company which is designed to provide the Executive with supplemental retirement benefits. (S) "Person" shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof, except that such term shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its Affiliates, (iii) an underwriter temporarily holding securities pursuant to an offering of such securities, or (iv) a corporation owned, directly or indirectly, by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company. (T) "Potential Change in Control" shall be deemed to have occurred if the event set forth in any one of the following paragraphs shall have occurred: (I) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control; (II) the Company or any Person publicly announces an intention to take or to consider taking actions which, if consummated, would constitute a Change in Control; 19 (III) any Person becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 15% or more of either the then outstanding shares of common stock of the Company or the combined voting power of the Company's then outstanding securities (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates), excluding, however, any entity or group which, as of July 21, 1998, has on file with the Securities and Exchange Commission a Form 13D or 13G indicating ownership aggregating 10% or more of the then outstanding shares of common stock of the Company or the combined voting power of the Company's then outstanding securities; or (IV) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. (U) "Severance Payments" shall have the meaning set forth in Section 6.1 hereof. (V) "Tax Counsel" shall have the meaning set forth in Section 6.2 hereof. (W) "Term" shall mean the period of time described in Section 2 hereof (including any extension, continuation or termination described therein). (X) "Total Payments" shall mean those payments so described in Section 6.2 hereof. TRICON GLOBAL RESTAURANTS, INC. By: ----------------------------------- Name: Title: ----------------------------------- Executive Address: 20
EXHIBIT 12 TRICON Global Restaurants, Inc. Ratio of Earnings to Fixed Charges Years Ended 1997-1993 and 36 Weeks Ended September 5, 1998 and September 6, 1997 (in millions except ratio amounts) 53 Weeks 52 Weeks 52 Weeks 36 Weeks ------------------------------- ------------ ---------- ----------------------- 1997 1996 1995 1994 1993 9/5/98 9/6/97 -------- -------- -------- ------------ ---------- ---------- ---------- Earnings: Income from continuing operations before income taxes and cumulative effect of accounting changes (35) 72 (103) 241 416 511 401 Unconsolidated affiliates' interests, net (a) (1) (6) - (1) (3) (1) (2) Interest expense, net (a) 290 310 368 349 238 212 195 Interest portion of net rent expense (a) 109 109 109 108 87 63 70 -------- -------- -------- ------------ ---------- ---------- ---------- Earnings available for fixed charges 363 485 374 697 738 785 664 ======== ======== ======== ============ ========== ========== ========== Fixed Charges: Interest Expense (a) 290 310 368 349 238 212 195 Interest portion of net rent expense (a) 109 109 109 108 87 63 70 -------- -------- -------- ------------ ---------- ---------- ---------- Total Fixed Charges 399 419 477 457 325 275 265 ======== ======== ======== ============ ========== ========== ========== Ratio of Earnings to Fixed Charges (b) (c) (d) .91x 1.16x .78x 1.53x 2.27x 2.86x 2.51x
(a) Included in earnings for the years 1993 through 1997 are certain allocations related to overhead costs and interest expense from PepsiCo. For purposes of these ratios, earnings are calculated by adding to (subtracting from) income from continuing operations before income taxes and cumulative effect of accounting changes the following: fixed charges, excluding capitalized interest; and losses and (undistributed earnings) recognized with respect to less than 50% owned equity investments. Fixed charges consist of interest on borrowings, the allocation of PepsiCo's interest expense and that portion of rental expense that approximates interest. For a description of the PepsiCo allocations, see the notes to the consolidated financial statements included in the 10-K. (b) Included the impact of unusual, disposal and other charges of $174 million ($159 million after tax) in 1997, $246 million ($189 million after tax) in 1996, $457 million ($324 million after tax) in 1995 and $54 million ($34 million after tax) for the 36 weeks ended September 6, 1997. Also included in the 36 weeks ended September 5, 1998 are unusual credits of $5 million ($3 million after tax). Excluding the impact of such charges and credits, the ratio of earnings to fixed charges would have been 1.35x, 1.74x, 1.74x, 2.71x and 2.84x for the fiscal years ended 1997, 1996 and 1995, respectively and the 36 weeks ended September 6, 1997 and September 5, 1998, respectively. (c) The Company is contingently liable for obligations of certain franchisees and other unaffiliated parties. Fixed charges associated with such obligations aggregated approximately $17 million during the fiscal year 1997. Such fixed charges, which are contingent, have not been included in the computation of the ratios. (d) For the fiscal years ending December 27, 1997 and December 30, 1995, earnings were insufficient to cover fixed charges by approximately $36 million and $103 million, respectively. Earnings in 1997 includes a charge of $530 million ($425 million after-tax) taken in the fourth quarter to refocus our business. Earnings in 1995 included the noncash charge of $457 million ($324 million after-tax) for the initial adoption of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." 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 14, 1998 included within the Quarterly Report on Form 10-Q of TRICON Global Restaurants, Inc. for the twelve and thirty-six weeks ended September 5, 1998, and incorporated by reference in the following Registration Statements: Description Registration Statement Number Form S-3 Initial Public Offering of Debt Securities 333-42969 Form S-8s Restaurant Deferred Compensation Plan 333-36877 Executive Income Deferral Program 333-36955 TRICON Long-Term Incentive Plan 333-36895 Share Power Stock Option Plan 333-36961 TRICON Long-Term Savings Program 333-36893 Restaurant General Manager Stock Option Plan 333-64547 Pursuant to Rule 436(c) of the Securities Act of 1933, such report is not considered a part of a registration statement prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of the Act. KPMG Peat Marwick LLP Louisville, Kentucky October 19, 1998 EX-27 2 FDS --
5 This schedule contains summary financial information extracted from TIRCON Global Restaurants, Inc. Condensed Consolidated Financial Statements for the 12 and 36 weeks ended September 5, 1998 and is qualified in its entirety by reference to such financial statements. 0001041061 TRICON Global Restaurants, Inc. 1,000,000 U.S. Dollars 9-mos Dec-27-1997 Dec-28-1998 Sep-5-1998 1.000 145 94 165 17 66 642 5,650 2,998 4,616 1,620 3,725 0 0 1,281 (2,656) 4,616 5,526 5,942 3,369 4,789 0 3 198 511 217 294 0 0 0 294 1.93 1.89
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