Industry News | July 27, 2001

Tricon Reports 2Q Results

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Tricon Global Restaurants, Inc. (NYSE: YUM) reported operating results for the second quarter, ended June 16, 2001, including:

• Ongoing operating EPS of $0.73

• Worldwide system sales increase of 5% prior to U.S. dollar conversion

• International up 8% prior to U.S. dollar conversion U.S. up 3%

• U.S. blended same-store sales increase of 1%

• A second-quarter record of international traditional restaurant openings (179) Franchise fees of $189 million, an increase of 10% prior to U.S. dollar conversion

Revenues were up 4% for the quarter, excluding the impact of refranchising, joint-venture formation and acquisitions.

Ongoing operating EPS does not include the impact of net facility actions or unusual items.

David C. Novak, Chairman and CEO said, "We're pleased to report second-quarter operating earnings were at the high end of the range we provided last quarter. Importantly, we are growing our global system sales in a tough macro environment. Better-than-expected control of our structural costs such as G&A, interest and tax were able to offset somewhat lower than expected U.S. blended same-store sales and higher than expected commodity costs. These structural-cost reductions will continue through the second half of the year.

"To achieve our full-year earnings target, we will continue to grow our system sales, and we will reap the benefits of acting with a sense of urgency to counteract the cost pressures of the industry, international strategic investments and foreign currency translation impact. As a result, we will drive earnings growth in the third and fourth quarters and expect to achieve our target of $3.18 per share for the full year. Tricon's second half plan is based on:

1. Continued momentum in international system unit and local currency same-store sales growth, combined with solid international profit performance despite adverse foreign currency impacts

2. Flat U.S. blended same-store sales in the third quarter and ending with our best performance of the year, 2% growth for the fourth quarter. This allows us to enter 2002 with momentum and results in about 1% full-year same-store sales growth.

Further aggressive reductions in our structural costs: G&A, interest and tax rate. We intend to drive these major costs to a new lower base.

"Overall, you can expect our international business to produce solid growth in sales, profits and returns well into the future. In the U.S, we are slugging it out in a highly competitive market and improving our customer proposition to enable consistent same-store sales growth going into 2002 and beyond. Running great restaurants, multibranding and more effectively differentiating our leading brands with innovative products, quality, service and marketing will continue to be our focus. And finally, by reducing our cost base to new best levels, we are establishing a much more productive and higher return base for our global business.

"During the first half of 2001, we made progress in all five key areas that we believe are long-term growth drivers and make us a unique restaurant company:

INTERNATIONAL EXPANSION continued as we set a record for first-half traditional restaurant openings (378), which makes us confident that we will set a new record for full-year openings, exceeding last year's level of 929. On the strength of new openings and system same-store sales growth, second-quarter and first-half system sales growth was 8% and 9% in local currency terms respectively.

U.S. BLENDED SAME-STORE SALES increased 1% for the quarter led by 3% growth at Pizza Hut and 2% at KFC, offsetting a 2% decline at Taco Bell. Both Pizza Hut and KFC experienced solid transaction growth. The decline of 2% at Taco Bell is clearly unacceptable and remains our Number 1 challenge. We believe improved operational execution and a number of key initiatives to be implemented throughout the second half are crucial to begin the turnaround. This should begin to build consistent, positive same-store sales growth during the fourth quarter and into 2002.

MULTIBRANDED RESTAURANT GROWTH is on track, with over 50 multibranded restaurants added this quarter and over 100, year to date. This concept provides a significant competitive advantage in the U.S., utilizing three category leaders, and expands avenues of U.S. system- sales growth through new-unit openings, asset upgrades, and conversions of existing single-brand restaurants. And long term, we see significant opportunity in international.

GLOBAL FRANCHISE FEES increased to $189 million, up 10% prior to U.S. dollar conversion in the second quarter. Additionally,we continued to make progress toward resolving Taco Bell franchise financial issues.

CASH GENERATION -- over $250 million in the quarter and over $400 million year to date -- is on track to reach over $1 billion for the year. We expect to maintain our return on invested capital of 18% in 2001."

1. INTERNATIONAL EXPANSION AND BUSINESS PERFORMANCE During the second quarter, a record 179 new traditional restaurants were opened outside the U.S., an increase of 13% over last year's second-quarter opening rate. Significantly, Tricon opened 378 new traditional restaurants year to date, which is over 40% higher versus last year's first half. For the full year, the company now expects that new traditional restaurant openings outside the U.S. will break the record of 929 recorded last year.

For the quarter, international system sales increased 8% before a 9% negative effect of translating foreign currency into U.S. dollars. For the second quarter, ongoing operating profit in U.S. dollars declined by 15% versus last year. The unfavorable impact of foreign currency conversion, higher operating costs, including utilities and promotion costs, and lower profits in recent acquisition markets offset the benefit from strong system-sales growth. Additionally, start-up costs related to accelerated openings of new restaurants and spending on strategic growth initiatives impacted profits. New restaurants typically experience higher expenses during the first 120 days of operation before reaching normal operating profitability.

Year to date, international system sales increased 9% before an 8% negative effect of translating foreign currency into U.S. dollars. Ongoing operating profit in U.S. dollars declined by 7% versus last year due to the factors cited, which affected second-quarter performance.

For the full year, we expect the international business to deliver continued strong system-sales growth prior to conversion to U.S. dollars. On a comparable 52-week basis, international ongoing operating profit is expected to grow at a double-digit rate prior to significant impacts from foreign currency conversion. This includes investment spending to drive long-term growth initiatives and improve the company's position in certain key markets. The investment spending on long-term growth initiatives will continue going forward.

2. U.S. BLENDED SAME-STORE SALES AND BUSINESS PERFORMANCE

For the second quarter, U.S. blended same-store sales increased by 1%. U.S. system sales, however, increased by more than 3% primarily as a result of system same-store sales growth and the benefit from opening new higher-volume, new-image restaurants and closing older restaurants with lower volumes and non-prime locations. KFC was the key driver to U.S. system-sales growth, combining strong franchise and company same-store sales growth with 2% growth in units versus a year ago and continued transformation and remodeling of system assets. Second-quarter system-sales growth at KFC was the best since the fourth quarter of 1998.

As expected, U.S. ongoing operating profit for the quarter declined by 9% primarily as a result of the dilutive operating-profit impact of refranchising, additional expenses related to the financial restructuring of certain Taco Bell franchise businesses and substantially higher cheese costs.

Year to date, U.S. blended same-store sales increased slightly due to 3% growth at Pizza Hut and 2% growth at KFC, which offset a 4% decline at Taco Bell. U.S. system sales growth of over 2% can be attributed to the same factors previously cited, which drove second-quarter performance. KFC led the year-to-date performance in system sales. U.S. ongoing operating profit declined 10% as a result of the same factors previously noted for second-quarter ongoing operating performance.

For the full year, we expect growth of about 1% in U.S. blended same-store sales. The company expects U.S. system sales to increase 2% to 3% on a comparable 52-week basis. U.S. ongoing operating profit is expected to decline slightly versus last year, primarily as a result of the dilutive operating-profit impact of refranchising.

3. MULTIBRANDED RESTAURANT GROWTH

The company now operates 1,300 multibranded restaurants globally, making Tricon the world's largest multibranded restaurant company. The system includes nearly 700 KFC/Taco Bell restaurants, nearly 450 Taco Bell/Pizza Hut Express restaurants, and over 100 KFC/Pizza Hut Express restaurants. For the full year, Tricon expects continued rapid expansion of the multibrand concept. The company expects to have approximately 1,600 multibrand restaurants in operation by year's end.

4. GLOBAL FRANCHISEE FEES AND BUSINESS PERFORMANCE

Franchise fees for Tricon's three global brands totaled $189 million for the quarter, an increase of 10% versus last year, prior to foreign currency conversion impact of negative 3 percentage points. Growth was driven by franchise new-unit expansion, the purchase of company operated restaurants by franchisees and global local currency same-store sales growth. Tricon expects continued franchise new-restaurant development, helping to drive global franchise fees of $815 million for the full year 2001.

5. CASH FLOW AND RETURNS Tricon generated over $250 million in cash in the second quarter and over $400 million year to date. This strong cash flow was invested in a number of growth areas, including international and multibranding expansion. Additionally, the company continued to invest in the transformation of existing U.S. assets primarily through remodel and replacement programs at KFC and Pizza Hut. Capital spending, including acquisitions of franchise restaurants, totaled $162 million in the second quarter and $305 million year to date.

At the end of the second quarter, the company had reduced debt by about $20 million from year's end and increased cash and short-term investments by over $60 million, which we intend to use for debt reduction in the near future. Additionally, the company purchased $11 million of its own shares during the second quarter, bringing year-to-date purchases to $21 million.

In 2001, the company expects cash generated will exceed $1 billion, allowing for approximately $725 million of capital to be invested in the business, $200 million to reduce debt and $100 million to repurchase shares.

Return on invested capital is expected to remain at 18% for the full year, significantly above Tricon's cost of capital and one of the best levels in the restaurant category. The company expects continued solid returns from international and multibranded investments combined with strong franchise business expansion, which requires virtually no capital investment by Tricon. At the end of the second quarter, over 21,000 franchise and joint-venture traditional restaurants were in operation worldwide versus 20,177 a year ago, an increase of 4%.

FINANCIAL PROGRESS

Restaurant margin of 14.5% was 1.5 percentage points below last year's second-quarter results. U.S. restaurant margin of 15.6% was down 0.8 percentage points from last year as substantially higher cheese costs and continued wage inflation were partially offset by favorable product mix and pricing. International restaurant margin of 12.1% declined 3.1 percentage points primarily due to lower volume in several markets, higher operating costs -- including promotion and utility costs -- the impact of acquiring lower-margin restaurants, and new-unit start-up costs as had been anticipated.

For the full year, the company expects restaurant margin to be down slightly versus last year's 15.1%. High levels of inflation in energy and cheese costs and the impact of acquiring lower-margin international restaurants will be nearly offset by positive local currency global same-store sales growth and the impact of refranchising. For 2001, it is expected that U.S. restaurant margin will be down slightly and international margin will be down more than 0.5 percentage points essentially due to second-quarter performance.

During 2001, Tricon will continue to invest in a number of customer-focused programs intended to enhance quality and customer experience and increase overall consumer ratings for each brand. These include quality upgrades at KFC with improved flavor of Extra Crispy® and Original Recipe® chicken, the new steak product and Grilled Stuft Burrito® at Taco Bell and systemwide facility upgrades. Overall, these initiatives will have a modest negative effect on margin. However, Tricon believes these are important investments to further strengthen its three leading brands and drive sustainable same-store sales going forward.

For 2001, Tricon will continue to aggressively pursue structural cost-saving opportunities such as overhead costs, interest expense and operating tax rate. As such, the company is targeting further reductions in each of these categories. It is expected that full-year overhead costs will reach the lowest level since Tricon became a public company, down more than 2% versus last year in dollar terms. With market reductions in interest rates and further debt reduction, interest expense should decline by 8% from last year's level. Tricon continues to pursue tax strategies to improve the ongoing operating tax rate involving both U.S. and international operations. This is expected to result in an ongoing operating tax rate in the range of 35% to 36%, which is the best level achieved since Tricon became a public company.

In the second quarter, Tricon experienced approximately three cents per share of unfavorable impact from the translation of foreign currencies to U.S. dollars. Year to date, the impact is six cents. The Australian dollar, British pound sterling, Canadian dollar, Japanese yen, Korean won, and Mexican peso are all significant currencies in the results of the company's international business. All these currencies, except the Mexican peso, were weaker versus the U.S. dollar, compared to the second quarter of 2000. Tricon expects a two-cent negative impact in both the third and fourth quarters, based on current foreign exchange rates.

THIRD-QUARTER OUTLOOK

The company's initial guidance for third-quarter ongoing operating EPS is in the range of $0.78 to $0.82, or between 1% and 6% higher than last year. Factors contributing to our expectations are

U.S. blended same-store sales even with last year International system sales growth of +8% to +9% prior to U.S. dollar conversion International ongoing operating profit growth of low-double digits, excluding foreign exchange conversion impact Adverse impact of foreign exchange conversion of roughly $0.02 per share, based on current exchange rates Global restaurant margin down about 0.7 percentage points versus last year: U.S. down 0.9 percentage points; International flat to slightly positive General and administrative expenses down more than 5% in dollar terms versus last year's quarter Ongoing operating tax rate roughly even with last year

TACO BELL FRANCHISE BUSINESS

As previously disclosed, certain of the company's Taco Bell franchise operators are experiencing varying degrees of financial difficulty with respect to their franchise operations.

Taco Bell is in various stages of discussion with a number of Taco Bell franchisees and their lenders, representing several hundred Taco Bell franchised restaurants. The company believes that many of these franchisees will require various types of business and/or financial restructuring, which could include the purchase of some franchised restaurants by Taco Bell. Taco Bell has been working diligently during the first half to resolve these issues. To date, the company has completed restructuring for approximately 500 of these restaurants, including the purchase of 125 Taco Bell franchise restaurants. A significant number remaining to be restructured are targeted for completion in the near term. It is anticipated that the vast majority will be completed in the third quarter.

During the second quarter of 2001, Tricon recorded an additional $5 million of expense related to allowances for doubtful franchise and license-fee receivables and $12 million year to date. These costs were reported as general and administrative expenses. Tricon intends to continually evaluate the appropriateness of estimated allowances and assess the need for any additional charges related to ongoing fees and other related financial contingencies.

During the second half of 2001, the company estimates than an additional $2 million to $5 million for allowances related to doubtful receivables is possible. This contingency, along with the financial effects that result from any foreseeable purchases of franchised restaurants by Taco Bell, have been included in the company's ongoing operating EPS and cash-flow estimates for the full year.

ONGOING RESULTS

Tricon's revenue declined in the second quarter of 2001. Revenue is expected to decline slightly for the third quarter and full year 2001 due to the company's refranchising program, which should be substantially completed in 2001. Based on currently available information, we expect revenues to be up slightly in the fourth quarter, the first quarter to show positive growth since Tricon became a public company. The effective tax rate on ongoing operating profit for the quarter was 28.8%, which was lower than last year's rate of 39.1%. The tax rate on reported earnings was 34.8% for the quarter versus 41.1% a year ago. Year to date, the tax rate on ongoing operating profit was 32.8%, and the reported rate was 35.2%. Depreciation and amortization was $85 million for the quarter and $158 million year to date. For the second quarter, average shares outstanding utilized in the diluted EPS calculation increased 2% to 152 million shares from 149 million last year. The increase was driven by the dilutive impact of a higher average share price in the first half of 2001, which more than offset the repurchase of over 500,000 common shares by the company.