Tricon Global Restaurants, Inc. (NYSE:YUM) reported first quarter ongoing operating earnings of $96 million, or $0.64 per share, a 28 percent increase for the quarter ended March 18, 2000.
Tricon’s strongest performance in the quarter came from its international business, which now represents over one-third of the company’s worldwide system sales. Ongoing operating profits were up a solid 33%, on top of 34% growth last year. Ongoing operating profit increases were driven primarily by a strong top-line, with system sales up 9%. General and administrative costs were down significantly and restaurant margins increased 140 basis points primarily from improved base operations. Same store sales continue to be strong in key countries, including China, Australia, the United Kingdom, and Mexico. Tricon’s international strategy to focus company ownership in key countries, while expanding elsewhere around the globe with growth-ready franchisees, is paying dividends.
In the U.S., Pizza Hut continues to deliver excellent results. While same store sales in the quarter declined 2%, this was better than expected as it overlapped the launch of the highly successful Big New Yorker pizza, which drove same store sales up 14% in the quarter last year. The Big New Yorker launch has added another concept sales layer to Pizza Hut, as sales and mix of the product continue to be strong. Pizza Hut has solid momentum going forward.
Taco Bell’s same store sales were slightly positive, with transactions up for the quarter for the first time since late 1998. This transaction growth reflects Taco Bell’s renewed focus on great tasting Mexican food and value leadership with products like Chalupas and the recently reintroduced popular Enchiritos.
As expected, KFC‘s same store sales in the quarter were down 3%, overlapping its strongest quarter in 1999. Sales from KFC’s popular chicken sandwiches continue to annualize at roughly $130,000 per company restaurant, adding a new concept sales layer. KFC’s challenge going forward is to make sandwich sales incremental to the base business. The KFC system remains firmly committed to sandwiches as a long-term strategy, given consumer trends toward portable food and the strong sales success KFC has experienced with chicken sandwiches around the world. During the second quarter KFC will continue to build and invest in the all-important chicken sandwich segment.
Tricon continued to drive operational progress in the quarter. Ongoing operating profit increased 3%, driven by a 16% decline in ongoing G, and a 13% increase in franchise fees, offset partially by a 110 basis point decline in ongoing restaurant level margins. The margin decline is primarily a result of overlapping a 125 basis point margin gain in Q1 ’99 from $21 million in self-insurance favorability. Margins were favorably affected by portfolio benefits, lower cheese costs and improved product cost management. This was offset by the impact of sales deleverage and higher labor rates.
Tricon also continued to make substantial progress executing its financial strategies, refranchising 183 restaurants in the quarter. In addition, Tricon invested over $135 million in the first quarter to buy back 3.9 million of its shares under a $350 million share repurchase program announced in September 1999. Since the share repurchase program was initiated, Tricon has invested over $270 million in buying back 7.2 million of its shares.
“We are on track to deliver 23% to 27% growth in ongoing operating EPS by continuing to deliver on our operational and financial strategies, before the impact, if any, from the bankruptcy filing by AmeriServe,” said David Deno, CFO. “For the quarter, our ongoing operating EPS was stronger than previously expected primarily because we made considerable progress in reducing our general and administrative costs. We are on track to reduce general and administrative costs by about $50 million in 2000.
“Our Q1 year over year reductions in ongoing general and administrative costs totaled $36 million, and we expect most of the remaining planned reduction will be realized by the end of the second quarter. It is clear we have made excellent progress growing our international business, sustaining the progress we have made at Pizza Hut since mid-1997, and reducing our interest cost and income tax burdens. Restaurant margins were below our expectations due in part to timing, and we have the programs in place to improve our full year margins by 40 to 50 basis points.”
Tricon has been working closely with AmeriServe, its suppliers and the purchasing cooperative for the Tricon system to ensure that restaurants continue to receive supplies in a timely and cost effective manner. To date, Tricon has not experienced any significant service interruptions. Tricon is directly purchasing store level inventory for the system, while AmeriServe continues to distribute products to stores and provide ordering, inventory, billing and collection services to the Company for the same fee in effect prior to the bankruptcy filing.
Tricon remains committed to AmeriServe as it is reorganized through the bankruptcy process-whether in the form of a restructured company or through the sale of the business to another distributor that is acceptable to the Tricon system. However, Tricon has also undertaken contingency planning and believes that sufficient capacity exists at competitive rates with alternative distributors in the event AmeriServe is no longer able to meet its distribution needs. The term “ongoing” in the following section excludes the impact of facility actions net gain, unusual items, and last year’s accounting changes.
Ongoing operating profit was up 3%. The rate of growth was negatively impacted by portfolio actions, primarily refranchising, as company restaurants were sold to franchisees. This negatively impacted year-over-year growth in ongoing operating profit by about 6%. Within operating profits, restaurant profits decreased as we sold restaurants which was partially offset by higher franchisee fees and lower general and administrative expenses. Additionally, refranchising proceeds reduced debt and lowered our year-over-year interest expense. System sales grew over 2% to over $4.9 billion, driven by the opening of new restaurants.
U.S. system sales declined slightly. International system sales increased 9%. Excluding the favorable impact of currency translation, international system sales grew 8%.
As expected, Tricon’s refranchising efforts drove a decline in worldwide company revenues despite adding new restaurants. The impact of refranchising on revenue will continue throughout the year. U.S. revenues declined 15%. International revenues decreased 3%. Franchise and license fees increased 13% driven by existing company restaurants acquired by franchisees from Tricon and opening new restaurants. Company restaurant level margins as a percent of sales decreased 110 basis points. Base company restaurant level margins were down about 160 basis points. Excluding the overlap impact of 125 basis points from favorable self-insurance adjustments in 1999, base restaurant margins were down 35 basis points driven by the impact of sales deleverage on labor and occupancy and other costs, labor rate increases and delayed timing of a new beverage contract, partially offset by favorable cheese costs.
General and administrative expenses declined 16%. The reduction of spending on conferences, lower stock based compensation costs and Y2K spending along with savings from Tricon’s refranchising actions drove the decline. Net interest expense declined 22%. This was primarily due to free cash flow generated from refranchising over the past 12 months, which was used to significantly reduce debt. As expected, the effective tax rate on ongoing operating income for the quarter was 39.0%. This compares to a 42.6% rate last year. The decrease is primarily attributable to a reduction in the tax on our international operations.
“Tricon is on its way to achieving another outstanding year of operating and financial results,” said David C. Novak, chief executive officer. “Ongoing operating earnings per share were up 28%, and we view this as one of the best overall indicators of our progress along with free cash flow generation and return on investment. In fact, this is the seventh straight quarter of over 20% growth in ongoing operating EPS.
“This quarter’s results were fueled by the continued strength of our large and rapidly growing international business, significant reductions in the general and administrative costs, and the ongoing successful execution of our financial strategies. In addition we are very pleased with Pizza Hut’s strong sales and we are optimistic it is well positioned to have a better-than-expected 2000. Based on the progress Tricon is making, we are pleased to reaffirm our full-year commitment of 2% to 3% U.S. blended same store sales growth and ongoing operating EPS growth of 23% to 27%, before the impact, if any, from the bankruptcy filing by AmeriServe. This continued strong performance in ongoing operating EPS for 2000 builds on last year’s 41% growth.”
For 2000, Tricon currently anticipates an ongoing operating effective tax rate in the range of 38% to 39%. Tricon repurchased 3.9 million shares costing over $135 million in the quarter under its $350 million share repurchase program announced in September 1999. Since the share repurchase program was initiated, Tricon has invested over $270 million in buying back 7.2 million of its shares. Since year-end, net debt increased by over $190 million as Tricon opportunistically repurchased shares and, because of the AmeriServe situation, funded the direct purchase of inventory for the U.S. system and carried the receivables from U.S. franchisees related to the sale of this inventory.
Normally, free cash flow is seasonally skewed to the last three quarters of the year. This trend is expected to continue this year.