Our restaurant margin increased over 160 basis points in 1998. Excluding the negative impact of foreign currency translation, restaurant margin increased approximately 195 basis points. The increase was driven primarily by the suspension of depreciation and amortization relating to restaurants included in our 1997 fourth quarter charge, which contributed 110 basis points. The portfolio effect also contributed approximately 30 basis points to the improvement. The remaining margin improvement of approximately 55 basis points resulted from favorable effective net pricing in excess of costs in Mexico, Australia and Spain. Restaurant margin improvement was partially offset by volume declines in Asia, led by Korea. The economic turmoil throughout Asia resulted in an overall volume decline, even though we had volume increases in Mexico, Canada and Spain.

Our restaurant margin increased over 20 basis points in 1997. The increase was driven by effective net pricing in excess of cost increases, primarily labor, offset by volume declines. Foreign currency translation and the portfolio effect did not have a significant impact.

OPERATING PROFITS,   excluding facility actions net gain and unusual charges, increased $19 million or 11% in 1998. Excluding the negative impact of foreign currency translation, operating profits increased $43 million or 25% in 1998. The increase was driven by an increase in franchise fees and a decline in G&A. Operating profits included benefits related to our 1997 fourth quarter charge of approximately $29 million, of which $14 million related to the suspension of depreciation and amortization for the stores included in the charge. These benefits were fully offset by the decline in Asia operating profits and Year 2000 spending.

Operating profits, excluding the fourth quarter charge, other facility actions and unusual charges, increased $17 million or 11% in 1997. Excluding the negative impact of foreign currency translation, operating profits increased $23 million or 15%. The increase in 1997 was driven by higher franchise fees, new unit development and higher restaurant margin dollars. These increases were partially offset by an increase in G&A.



NET CASH PROVIDED BY OPERATING ACTIVITIES decreased $136 million or 17% to $674 million in 1998. Cash used for working capital was $106 million for 1998 compared to cash provided by working capital of $27 million in 1997. The 1998 use was primarily due to an increase in current deferred tax assets and reduced income taxes payable. Excluding net changes in working capital, net income before facility actions and all other non-cash charges was essentially unchanged despite the decline in the number of our restaurants in the current year relating to our portfolio activities.

Net cash provided by operating activities in 1997 increased $97 million or 14% to $810 million. This was driven by an increase in net income prior to facility actions net loss and unusual charges recorded in 1997 and an increase in our normal working capital deficit primarily related to higher income tax payables. These increases were partially offset by reduced depreciation and amortization in 1997. The decrease in depreciation and amortization related to refranchisings, store closures and impairment charges.

NET CASH PROVIDED BY INVESTING ACTIVITIES  decreased $164 million to $302 million in 1998 compared to $466 million in 1997. The 1998 decrease was primarily due to the prior year sale of the Non-core Businesses offset by increased proceeds from refranchising and the sales of property, plant and equipment. Capital spending decreased by $81 million or 15%.

The 1997 increase of $715 million was primarily attributable to an increase in proceeds from refranchising of restaurants of $415 million over 1996 and the proceeds from the sale of the Non-core Businesses of $186 million. Capital spending in 1997 decreased by $79 million or 13%.

NET CASH USED FOR FINANCING ACTIVITIES of $1.1 billion decreased slightly in 1998 compared to 1997. The 1998 use represents net debt repayments. During 1998, we issued Unsecured Notes resulting in proceeds of $604 million, including the settlement of our treasury lock agreements. These proceeds were used to reduce existing borrowings under our unsecured Term Loan Facility and unsecured Revolving Credit Facility.

Net cash used for financing activities almost tripled in 1997 to $1.1 billion, primarily reflecting the net payments to PepsiCo, partially offset by the bank borrowings in connection with the Spin-off.  This net use was partially offset by the increase in short-term borrowings of $83 million in 1997 versus a decrease of $80 million in 1996 and payments on the Revolving Credit Facility.

 


During 1998, we reduced our reliance on bank debt by over $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 operating cash flows. 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 SEC 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, under our shelf registration. 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 year ended December 26, 1998, we made net payments of $1.04 billion and $620 million under our unsecured bank Term Loan Facility and the unsecured Revolving Credit Facility, respectively. 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 December 26, 1998, to $926 million and $1.82 billion from $1.97 billion and $2.44 billion at year-end 1997, on the term facility and revolving facility, respectively. At December 26, 1998, we had unused revolving credit agreement borrowings available aggregating $1.3 billion, net of outstanding letters of credit of $173 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.

 

Since October 7, 1997, we have been 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.

We continue to 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. During 1998, we entered into treasury lock agreements to partially hedge the anticipated issuance of our senior debt securities discussed above. 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 December 26, 1998, the weighted average interest rate on our variable bank debt, including the effect of derivatives, was 6.2%. Other derivative instruments may be considered from time to time as well to manage our debt portfolio and to hedge foreign currency exchange exposures.

We anticipate that our 1999 combined cash flow from operating and refranchising activities will be lower than 1998 levels primarily because of our expectations of reduced refranchising activity. However, we believe it will be sufficient to support our expected capital spending and still allow us to make significant debt repayments.

ASSETS    decreased $583 million or 11% to $4.5 billion at year-end 1998. This decrease is primarily attributable to refranchising and store closures and a decrease in U.S. cash which was attributable to improved cash management.

LIABILITIES    decreased $1.0 billion or 15% to $5.7 billion primarily due to net debt repayments. Partially offsetting this decrease is an increase in other liabilities largely due to increased deferred compensation liabilities, pension liabilities and self-insured casualty claims. Additional salary and bonus deferrals and imputed earnings on deferrals under our compensation programs caused the deferred compensation liability to increase. The pension liability increased based on current actuarial valuations. The increase in casualty claims is due to the decision in the current year to effectively self-insure a portion of our 1998 exposure compared to a fully insured program in 1997.

 

Our operating working capital deficit, which excludes cash, short-term investments and short-term borrowings, is typical of restaurant operations where the vast majority of sales are for cash, and food and supply inventories are relatively small. Our terms of payment to suppliers generally range from 10-30 days. Our operating working capital deficit decreased $113 million to $960 million at year-end 1998. This decrease was primarily the result of a decrease in income taxes payable and an increase in deferred tax assets. Also contributing to this decrease was a reduction in the Core businesses' working capital deficit due to our reduced number of restaurants resulting from our portfolio activities and also due to increased inventories of promotional items. This decrease was partially offset by higher levels of above-store accounts payable and other current liabilities due to timing of payments as well as higher levels of outside services and an increase in total incentive compensation accruals.