SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 30, 2007
¨ | TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 1-8116
WENDYS INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
Ohio | 31-0785108 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
P.O. Box 256, 4288 West Dublin- Granville Road, Dublin, Ohio |
43017-0256 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code 614-764-3100
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Common Shares, $.10 stated value |
Name of each exchange on which registered New York Stock Exchange |
Preferred Stock Purchase Rights | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO ¨.
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x.
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 ¨.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company ¨.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x.
The aggregate market value of the voting stock held by non-affiliates of the Registrant computed by reference to the price, at which such voting stock was last sold, as of June 30, 2007, was $3,209,602,000.
Indicate the number of shares outstanding of each of the Registrants classes of common stock, as of February 14, 2008. 87,405,000
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrants 2008 Proxy Statement, or its Form 10-K/A, which will be filed no later than 120 days after December 30, 2007, are incorporated by reference into Part III hereof.
Exhibit index on pages 89-92.
2007 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Item 1. | Business |
The Company
Wendys International, Inc. was incorporated in 1969 under the laws of the State of Ohio. Wendys International, Inc. and its subsidiaries are collectively referred to herein as the Company or Wendys.
The Company is primarily engaged in the business of operating, developing and franchising a system of distinctive quick-service restaurants serving high quality food. At December 30, 2007, there were 6,645 Wendys restaurants in operation in the United States and in 19 other countries and territories. Of these restaurants, 1,414 were operated by the Company and 5,231 by the Companys franchisees.
On March 29, 2006, the Company completed its initial public offering (IPO) of Tim Hortons Inc. (THI). A total of 33.4 million shares of THI were offered at an initial per share price of $23.162 ($27.00 Canadian). The shares sold in the IPO represented 17.25% of total THI shares issued and outstanding and the Company retained the remaining 82.75%. On September 29, 2006, the Company completed the spin-off of its remaining 82.75% ownership in THI, the parent company of the business previously reported as the Hortons segment. Accordingly, the results of operations of THI are reflected as discontinued operations for all periods presented. On November 28, 2006 and July 29, 2007, the Company completed the sales of Baja Fresh and Cafe Express, respectively, and accordingly, the results of operations of Baja Fresh and Cafe Express are reflected as discontinued operations for all periods presented. The assets and liabilities of Cafe Express were held for sale at December 31, 2006 and are presented as current and non-current assets and liabilities from discontinued operations as of that date. Baja Fresh and Cafe Express were previously reported as the Developing Brands segment (see Note 10 of the Financial Statements and Supplementary Data included in Item 8 herein).
Operations
Each Wendys restaurant offers a relatively standard menu featuring hamburgers and filet of chicken breast sandwiches, which are prepared to order with the customers choice of condiments. Wendys menu also includes chicken nuggets, chili, baked and French fried potatoes, freshly prepared salads, soft drinks, milk, Frosty dessert, floats and kids meals. In addition, the restaurants sell a variety of promotional products on a limited basis.
The Company strives to maintain quality and uniformity throughout all restaurants by publishing detailed specifications for food products, preparation and service, by continual in-service training of employees, restaurant reviews and by field visits from Company supervisors. In the case of franchisees, field visits are made by Company personnel who review operations, including quality, service and cleanliness and make recommendations to assist in compliance with Company specifications.
Generally, the Company does not sell food or supplies, other than sandwich buns and kids meal toys, to its Wendys franchisees. However, the Company has arranged for volume purchases of many of these products. Under the purchasing arrangements, independent distributors purchase certain products directly from approved suppliers and then store and sell them to local company and franchised restaurants. These programs help assure availability of products and provide quantity discounts, quality control and efficient distribution. These advantages are available both to the Company and to its franchisees.
The New Bakery Co. of Ohio, Inc. (Bakery), a wholly-owned subsidiary of the Company, is a producer of buns for Wendys restaurants, and to a lesser extent for outside parties. At December 30, 2007, the Bakery supplied 637 restaurants operated by the Company and 2,366 restaurants operated by franchisees. At the present time, the Bakery does not manufacture or sell any other products.
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See Note 15 of the Financial Statements and Supplementary Data included in Item 8 herein, for financial information attributable to certain geographical areas.
Raw Materials
The Company and its franchisees have not experienced any material shortages of food, equipment, fixtures or other products which are necessary to restaurant operations. The Company anticipates no such shortages of products and alternate suppliers are available.
Trademarks and Service Marks of the Company
The Company has registered certain trademarks and service marks in the United States Patent and Trademark Office and in international jurisdictions, some of which include Wendys, Old Fashioned Hamburgers and Quality Is Our Recipe. The Company believes that these and other related marks are of material importance to the Companys business. Domestic trademarks and service marks expire at various times from 2008 to 2018, while international trademarks and service marks have various durations of five to 20 years. The Company generally intends to renew trademarks and service marks which are scheduled to expire.
The Company entered into an Assignment of Rights Agreement with the Companys Founder, R. David Thomas, and his wife dated as of November 5, 2000 (the Assignment). The Company has used Mr. Thomas, Wendys Founder and who was Senior Chairman of the Board until his death on January 8, 2002, as a spokesperson and focal point for its products and services for many years. With the efforts and attributes of Mr. Thomas, the Company has, through its extensive investment in the advertising and promotional use of Mr. Thomas name, likeness, image, voice, caricature, endorsement rights and photographs (the Thomas Persona), made the Thomas Persona well known in the U.S. and throughout North America and a valuable asset for both the Company and Mr. Thomas estate. Under the terms of the Assignment, the Company acquired the entire right, title, interest and ownership in and to the Thomas Persona, including the sole and exclusive right to commercially use the Thomas Persona.
Seasonality
The Companys business is moderately seasonal. Wendys average restaurant sales are normally higher during the summer months than during the winter months. Because the business is moderately seasonal, results for any quarter are not necessarily indicative of the results that may be achieved for any other quarter or for the full fiscal year.
Working Capital Practices
Cash flow from operations, cash and investments on hand, possible asset sales, and cash available through existing revolving credit agreements and through the possible issuance of securities should provide for the Companys projected short-term and long-term cash requirements, including cash for capital expenditures, potential share repurchases, dividends, repayment of debt, future acquisitions of restaurants from franchisees or other corporate purposes.
Competition
Each company and franchised restaurant is in competition with other food service operations within the same geographical area. The quick-service restaurant segment is highly competitive. The Company competes with other organizations primarily through the quality, variety and value perception of food products offered. The number and location of units, quality and speed of service, attractiveness of facilities, effectiveness of marketing and new product development by the Company and its competitors are also important factors. The price charged for each menu item may vary from market to market depending on competitive pricing and the local cost structure.
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The Companys competitive position at its Wendys restaurants is enhanced by its use of fresh, never frozen ground beef, its unique and diverse menu, promotional products, its wide choice of condiments and the atmosphere and decor of its restaurants.
Research and Development
The Company engages in research and development on an ongoing basis, testing new products and procedures for possible introduction into the Companys systems. While research and development operations are considered to be of prime importance to the Company, amounts expended for these activities are generally not deemed material.
Government Regulations
A number of states have enacted legislation which, together with rules promulgated by the Federal Trade Commission, affect companies involved in franchising. Much of the legislation and rules adopted have been aimed at requiring detailed disclosure to a prospective franchisee and periodic registration by the franchisor with state administrative agencies. Additionally, some states have enacted, and others have considered, legislation which governs the termination or non-renewal of a franchise agreement and other aspects of the franchise relationship. The United States Congress has also considered legislation of this nature. The Company has complied with requirements of this type in all applicable jurisdictions. The Company cannot predict the effect on its operations, particularly on its relationship with franchisees, of future enactment of additional legislation. Various other government initiatives such as minimum wage rates and taxes can all have a significant impact on the Companys performance.
Environment and Energy
Various federal, state and local regulations have been adopted which affect the discharge of materials into the environment or which otherwise relate to the protection of the environment. The Company does not believe that such regulations will have a material effect on its capital expenditures, earnings or competitive position. The Company cannot predict the effect of future environmental legislation or regulations.
The Companys principal sources of energy for its operations are electricity and natural gas. To date, the supply of energy available to the Company has been sufficient to maintain normal operations.
Acquisitions and Dispositions
The Company has from time to time acquired the interests of and sold Wendys restaurants to franchisees, and it is anticipated that the Company may have opportunities for such transactions in the future. The Company generally retains a right of first refusal in connection with any proposed sale of a franchisees interest. The Company will continue to sell and acquire Wendys restaurants in the future where prudent.
See Notes 7 and 8 of the Financial Statements and Supplementary Data included in Item 8 herein, and the information under Managements Outlook in Item 7 herein for further information regarding acquisitions and dispositions.
International Operations
The Company has both company owned and franchised restaurants in Canada and franchised restaurants in 19 other countries and territories. The Company is evaluating expansion into other international markets but to date has not made significant investments in these markets. The Company has granted development rights for the countries and territories listed under Item 2 of this Form 10-K.
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Franchised Restaurants
As of December 30, 2007, the Companys franchisees operated 5,231 Wendys restaurants in 50 states, Canada and 19 other countries and territories.
The rights and obligations governing the majority of franchised restaurants operating in the United States are set forth under Wendys Unit Franchise Agreement. This document provides the franchisee the right to construct, own and operate a Wendys restaurant upon a site accepted by Wendys and to use the Wendys system in connection with the operation of the restaurant at that site. The Unit Franchise Agreement provides for a 20-year term and a 10-year renewal subject to certain conditions. Wendys has in the past franchised under different agreements on a multi-unit basis; however, Wendys now generally grants new Wendys franchises on a unit-by-unit basis.
The Wendys Unit Franchise Agreement requires that the franchisee pay a royalty of 4% of gross sales, as defined in the agreement, from the operation of the restaurant. The agreement also typically requires that the franchisee pay the Company a technical assistance fee. In the United States, the standard technical assistance fee required under a newly executed Unit Franchise Agreement is currently $25,000 for each restaurant.
The technical assistance fee is used to defray some of the costs to the Company in providing technical assistance in the development of the Wendys restaurant, initial training of franchisees or their operator and in providing other assistance associated with the opening of the Wendys restaurant. In certain limited instances (like the regranting of franchise rights or the relocation of an existing restaurant), Wendys may charge a reduced technical assistance fee or may waive the technical assistance fee. The Company does not select or employ personnel on behalf of the franchisees.
Wendys has in certain instances in the past offered to qualified franchisees, pursuant to its Franchise Real Estate Development program, the option of Wendys locating and securing real estate for new store development and/or constructing a new store. Under this program, Wendys obtains all licenses and permits necessary to construct and operate the restaurant, with the franchisee having the option of building the restaurant or having Wendys construct it. The franchisee pays Wendys a fee for this service and reimburses Wendys for all out-of-pocket costs and expenses Wendys incurs in locating, securing, and/or constructing the new store. Wendys has announced that it does not intend to offer the Franchise Real Estate Development program in the future.
The rights and obligations governing franchisees who wish to develop internationally are currently contained in the Franchise Agreement and Services Agreement (the Agreements). The Agreements are for an initial term of 20 years or the term of the lease for the restaurant site, whichever is shorter. The Agreements license the franchisee to use the Companys trademarks and know-how in the operation of the restaurant. Upon execution of the Agreements, the franchisee is required to pay a technical assistance fee. Generally, the technical assistance fee is $25,000 for each restaurant. Currently, the franchisee is required to pay monthly fees, usually 4%, based on the monthly gross sales of the restaurant, as defined in the Agreements.
See Schedule II of this Form 10-K (the page following the signature page), and Managements Discussion and Analysis and Note 12 of the Financial Statements and Supplementary Data included in Item 8 herein for further information regarding reserves, commitments and contingencies involving franchisees.
Advertising and Promotions
The Company participates in two advertising funds established to collect and administer funds contributed for use in advertising through television, radio, newspapers, the internet and a variety of promotional campaigns. Separate advertising funds are administered for Wendys U.S and Wendys of Canada. Contributions to the advertising funds are required to be made from both company operated and franchise restaurants and are based on a percent of restaurant retail sales. In addition to the contributions to the various advertising funds, the
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Company, based on a system-wide vote, may require additional contributions to be made for both company operated and franchisee restaurants based on a percent of restaurant retail sales for the purpose of local and regional advertising programs. Required franchisee contributions to the advertising funds and for local and regional advertising programs are governed by the Wendys franchise agreement. Required contributions by company operated restaurants for advertising and promotional programs are at the same percent of retail sales as franchised restaurants within the Wendys system.
See Note 14 of the Financial Statements and Supplementary Data included in Item 8 herein, for further information regarding advertising.
Personnel
As of December 30, 2007, the Company employed approximately 44,000 people, of whom approximately 42,000 were employed in company operated restaurants. The total number of full-time employees at that date was approximately 6,000. The Company believes that its employee relations are satisfactory.
Availability of Information
The Company makes available through its internet website (www.wendys-invest.com) its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission (SEC). The reference to the Companys website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this document.
Item 1A. | Risk Factors |
This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. The Company is under no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements are all based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. The Companys actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below.
The quick- service restaurant segment is highly competitive, and that competition could lower revenues, margins and market share.
The quick-service restaurant segment of the foodservice industry is intensely competitive regarding price, service, location, personnel and type and quality of food. The Company and its franchisees compete with international, regional and local organizations primarily through the quality, variety and value perception of food products offered. Other key competitive factors include the number and location of restaurants, quality and speed of service, attractiveness of facilities, effectiveness of advertising and marketing programs, and new product development by the Company and its competitors. The Company anticipates intense competition will continue to focus on pricing. Some of the Companys competitors have substantially larger marketing budgets, which may provide them with a competitive advantage. In addition, the Companys system competes within the foodservice market and the quick-service restaurant segment not only for customers but also for management and hourly employees, suitable real estate sites and qualified franchisees. If the Company is unable to maintain its competitive position, it could experience downward pressure on prices, lower demand for products, reduced margins, the inability to take advantage of new business opportunities and the loss of market share.
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Changes in economic, market and other conditions could adversely affect the Company and its franchisees, and thereby the Companys operating results.
The quick-service restaurant industry is affected by changes in international, national, regional, and local economic conditions, consumer preferences and spending patterns, demographic trends, consumer perceptions of food safety, weather, traffic patterns, the type, number and location of competing restaurants, and the effects of war or terrorist activities and any governmental responses thereto. Factors such as inflation, food costs, labor and benefit costs, legal claims, and the availability of management and hourly employees also affect restaurant operations and administrative expenses. The ability of the Company and its franchisees to finance new restaurant development, improvements and additions to existing restaurants, and the acquisition of restaurants from, and sale of restaurants to, franchisees is affected by economic conditions, including interest rates and other government policies impacting land and construction costs and the cost and availability of borrowed funds.
Events reported in the media, such as incidents involving food-borne illnesses or food tampering, whether or not accurate, can cause damage to the Companys reputation and swiftly affect sales and profitability.
Reports, whether true or not, of food-borne illnesses (such as E. coli, avian flu, bovine spongiform encephalopathy, hepatitis A, trichinosis or salmonella) and food tampering have in the past severely injured the reputations of participants in the quick-service restaurant segment and could in the future affect the Company as well. The Companys reputation is an important asset to the business; as a result, anything that damages brand reputation could immediately and severely hurt systemwide sales and, accordingly, revenues and profits. If customers become ill from food-borne illnesses, the Company could also be forced to temporarily close some restaurants. In addition, instances of food-borne illnesses or food tampering, even those occurring solely at the restaurants of competitors, could, by resulting in negative publicity about the restaurant industry, adversely affect system sales on a local, regional or systemwide basis. A decrease in customer traffic as a result of these health concerns or negative publicity, or as a result of a temporary closure of any of the Companys restaurants, could materially harm the Companys business.
Failure to successfully implement the Companys growth strategy could reduce, or reduce the growth of, the Companys revenue and net income.
The Company plans to increase the number of Wendys restaurants over the next five years, but may not be able to achieve its growth objectives and any new restaurants may not be profitable. The opening and success of restaurants depends on various factors, including:
| competition from other quick-service restaurants in current and future markets; |
| the degree of saturation in existing markets; |
| the identification and availability of suitable and economically viable locations; |
| sales levels at existing restaurants; |
| the negotiation of acceptable lease or purchase terms for new locations; |
| permitting and regulatory compliance; |
| the ability to meet construction schedules; |
| the availability of qualified franchisees and their financial and other development capabilities (including their ability to obtain acceptable financing); |
| the ability to hire and train qualified management personnel; and |
| general economic and business conditions. |
If the Company is unable to open new restaurants as planned, if the stores are less profitable than anticipated or if the Company is otherwise unable to successfully implement its growth strategy, revenue and profitability may grow more slowly or even decrease, which could cause the Companys stock price to decrease.
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The Company continues to expand into the breakfast daypart, where competitive conditions are challenging, the Wendys brand is not well known in the breakfast daypart and markets may prove difficult to penetrate.
As of December 30, 2007, approximately 1,000 restaurants have expanded into the breakfast daypart. The Company plans to expand breakfast to more of its restaurants by late 2008. The roll out and expansion of breakfast has been accompanied by challenging competitive conditions, varied consumer tastes and discretionary spending patterns that differ from existing dayparts. In addition, breakfast sales could cannibalize sales during other parts of the day and may have negative implications on food and labor costs and restaurant margins. The Company will need to reinvest royalties earned and other amounts to build breakfast brand awareness through greater investments in advertising and promotional activities. Capital investments will also be required at company operated restaurants and franchised restaurants where breakfast will be served and franchisees could elect not to participate in the breakfast expansion. As a result of the foregoing, breakfast sales and profits therefrom may take longer to reach expected levels.
The Company and its franchisees are affected by commodity market fluctuations, which could reduce profitability or sales and shortages or interruptions in the supply or delivery of perishable food products could damage the Companys reputation and adversely affect its operating results.
The Company and its franchisees purchase large quantities of food and supplies, which can be subject to significant price fluctuations due to seasonal shifts, climate conditions, industry demand, changes in international commodity markets and other factors. The Company and its franchisees are dependent on frequent deliveries of perishable food products that meet certain specifications. Shortages or interruptions in the supply of perishable food products caused by unanticipated demand, problems in production or distribution, disease or food-borne illnesses, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients, which would likely lower revenues, damage the Companys reputation and otherwise harm its business.
Current restaurant locations may become unattractive, and attractive new locations may not be available for a reasonable price, if at all, which may cause the Companys growth strategy to be adversely affected.
The success of any restaurant depends in substantial part on its location. There can be no assurance that current locations will continue to be attractive as demographic patterns change. Neighborhood or economic conditions where restaurants are located could decline in the future, thus resulting in potentially reduced sales in those locations. If the Company and its franchisees cannot obtain desirable locations at reasonable prices the ability to affect the Companys growth strategy will be adversely affected.
Changing health or dietary preferences may cause consumers to avoid products offered by the Company in favor of alternative foods, which may result in the reduction of demand and adversely affect the financial performance of the Company.
The foodservice industry is affected by consumer preferences and perceptions. If prevailing health or dietary preferences and perceptions cause consumers to avoid the products offered by the Companys restaurants in favor of alternative or healthier foods, demand for the Companys products may be reduced and its business could be harmed.
The Company is subject to health, employment, environmental and other government regulations, and failure to comply with existing or future government regulations could expose the Company to litigation, damage the Companys reputation and lower profits.
The Company and its franchisees are subject to various federal, state and local laws affecting their businesses. The successful development and operation of restaurants depend to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use (including the placement of drive-thru
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windows), environmental (including litter), traffic and other regulations. Restaurant operations are also subject to licensing and regulation by state and local departments relating to health, food preparation, sanitation and safety standards, federal and state labor laws (including applicable minimum wage requirements, overtime, working and safety conditions and citizenship requirements), federal and state laws prohibiting discrimination and other laws regulating the design and operation of facilities, such as the Americans with Disabilities Act of 1990. If the Company fails to comply with any of these laws, it may be subject to governmental action or litigation, and its reputation could be accordingly harmed. Injury to the Companys reputation would, in turn, likely reduce revenues and profits.
In recent years, there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry, particularly among quick-service restaurants. As a result, the Company may become subject to regulatory initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of its food products, which could increase expenses. The operation of the Companys franchise system is also subject to franchise laws and regulations enacted by a number of states and rules promulgated by the U.S. Federal Trade Commission. Any future legislation regulating franchise relationships may negatively affect the Companys operations, particularly its relationship with its franchisees. Failure to comply with new or existing franchise laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales. Changes in applicable accounting rules imposed by governmental regulators or private governing bodies could also affect the Companys reported results of operations, and thus cause its stock price to fluctuate or decline.
Litigation from customers, franchisees, employees and others could harm the Companys reputation and impact operating results.
Claims of illness or injury relating to food quality or food handling are common in the food service industry. In addition, class action lawsuits have been filed, and may continue to be filed, against various quick-service restaurants alleging, among other things, that quick-service restaurants have failed to disclose the health risks associated with high-fat foods and that quick-service restaurants marketing practices have encouraged obesity. In addition to decreasing the Companys sales and profitability and diverting management resources, adverse publicity or a substantial judgment against the Company could negatively impact the Companys reputation, hindering the ability to attract and retain qualified franchisees and grow the business.
Further, the Company may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, including those relating to overtime compensation. These types of claims, as well as other types of lawsuits to which the Company is subject to from time to time, can distract managements attention from core business operations.
The Company may not be able to adequately protect its intellectual property, which could decrease the value of the Company and its products.
The success of the Companys business depends on the continued ability to use existing trademarks, service marks and other components of the Companys brand in order to increase brand awareness and further develop branded products. The Company may not be able to adequately protect its trademarks, and the use of these trademarks may result in liability for trademark infringement, trademark dilution or unfair competition. All of the steps the Company has taken to protect its intellectual property may not be adequate.
The Companys earnings and business growth strategy depends in large part on the success of its franchisees, and the Companys reputation and financial performance may be harmed by actions taken by franchisees that are outside of the Companys control.
A portion of the Companys earnings comes from royalties, rents and other amounts paid by the Companys franchisees. Franchisees are independent contractors, and their employees are not employees of the Company.
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The Company provides training and support to, and monitors the operations of, its franchisees, but the quality of their restaurant operations may be diminished by any number of factors beyond the Companys control. Consequently, franchisees may not successfully operate stores in a manner consistent with the Companys high standards and requirements and franchisees may not hire and train qualified managers and other restaurant personnel. Any operational shortcoming of a franchise restaurant is likely to be attributed by consumers to the Companys system, thus damaging the Companys reputation and potentially affecting revenues and profitability. Additionally, financial instability, bankruptcy or other financial conditions of franchisees may adversely impact the Companys results by lowering royalty revenue.
Ownership and leasing of significant amounts of real estate exposes the Company to possible liabilities and losses.
The Company owns the land and building, or leases the land and/or the building, for many system restaurants. Accordingly, the Company is subject to all of the risks associated with owning and leasing real estate. In particular, the value of the Companys assets could decrease, and its costs could increase, because of changes in the investment climate for real estate, demographic trends and supply or demand for the use of the restaurants, which may result from competition from similar restaurants in the area, as well as liability for environmental conditions. The Company generally cannot cancel these leases. If an existing or future store is not profitable, and the Company decides to close it, the Company may nonetheless be committed to perform its obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as each of the leases expires, the Company may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause the Company to close stores in desirable locations.
The Companys annual and quarterly financial results may fluctuate depending on various factors, many of which are beyond its control, which may adversely affect the Companys results of operations and its financial performance and result in the failure to meet the expectations of securities analysts or investors and the decline of the Companys share price.
The Companys sales and operating results can vary from quarter to quarter and year to year depending on various factors, many of which are beyond its control. Some of these events may directly and immediately decrease demand for the Companys products. These events and factors include:
| variations in the timing and volume of the Companys sales and franchisees sales; |
| sales promotions by the Company and its competitors; |
| changes in average same-store sales and customer visits; |
| variations in the price, availability and shipping costs of supplies; |
| seasonal effects on demand for the Companys products; |
| unexpected slowdowns in new store development efforts; |
| changes in competitive and economic conditions generally; |
| changes in the cost or availability of ingredients or labor; |
| weather and acts of God; |
| changes in the number of franchise agreement renewals; and |
| foreign currency exposure. |
One or more of these events may cause the Companys results of operations and financial performance to decline precipitously and result in the failure to meet expectations of securities analysts or investors and the decline of the Companys share price.
Catastrophic events may disrupt the Companys business, which may adversely affect growth in the United States or abroad, as well as profitability.
Unforeseen events, including war, terrorism and other international conflicts, public health issues, and natural disasters such as earthquakes, hurricanes or other adverse weather and climate conditions, whether occurring in
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the United States or abroad, could disrupt the Companys operations, disrupt the operations of franchisees, suppliers or customers, or result in political or economic instability. These events could reduce demand for the Companys products or make it difficult or impossible to receive products from suppliers.
The Companys international operations are subject to various factors of uncertainty and there is no assurance that international operations will be profitable.
The Companys business outside of the United States is subject to a number of additional factors, including international economic and political conditions, differing cultures and consumer preferences, currency regulations and fluctuations, diverse government regulations and tax systems, uncertain or differing interpretations of rights and obligations in connection with international franchise agreements and the collection of royalties from international franchisees, the availability and cost of land and construction costs, and the availability of experienced management, appropriate franchisees, and joint venture partners. Although the Company believes it has developed the support structure required for international growth, there is no assurance that such growth will occur or that international operations will be profitable.
The Company may from time to time sell real estate and company operated restaurants to its franchisees.
The disposition of company operated restaurants to new or existing franchisees is part of the Companys strategy to develop the overall health of the system by acquiring restaurants from, and disposing of restaurants to, franchisees where prudent. The realization of gains from future dispositions of restaurants depends in part on the ability of the Company to complete disposition transactions on acceptable terms. The sale of real estate previously leased to franchisees is generally part of the program to improve the Companys return on invested capital. There are various reasons why the program might be unsuccessful, including changes in economic, credit market, real estate market or other conditions, and the ability of the Company to complete sale transactions on acceptable terms and at or near the prices estimated as attainable by the Company.
The Company relies on computer systems and information technology to run its business. Any material failure, interruption or security breach of the Companys computer systems or information technology may adversely affect the operation of the companys business and results of operations.
The Company is significantly dependent upon its computer systems and information technology to properly conduct its business. A failure or interruption of the Companys computer systems or information technology could result in the loss of data, business interruptions or delays in the Companys operations. Also, despite the Companys considerable efforts and technological resources to secure its computer systems and information technology, security breaches, such as unauthorized access and computer viruses, may occur resulting in system disruptions, shutdowns or unauthorized disclosure of confidential information. Any security breach of the Companys computer systems or information technology may result in adverse publicity, loss of sales and profits, penalties or loss resulting from misappropriation of information.
Item 1B. | Unresolved Staff Comments |
None.
Item 2. | Properties |
Wendys uses outside contractors in the construction of its restaurants. The restaurants are built to Company specifications as to exterior style and interior decor. The majority are free-standing, one-story brick buildings, substantially uniform in design and appearance, constructed on sites of approximately 40,000 square feet, with parking for approximately 45 cars. Some restaurants, located in downtown areas or shopping malls, are of a store-front type and vary according to available locations but generally retain the standard sign and interior decor. The typical new free-standing restaurant contains approximately 2,900 square feet and has a food
10
preparation area, a dining room capacity for approximately 90 persons and a double pick-up window for drive-through service. The restaurants are generally located in urban or heavily populated suburban areas, and their success depends upon serving a large number of customers. Wendys provides a facility for rural and less populated areas that has a building size of approximately 2,100 square feet and approximately 60 seats. This unit provides full double drive-through capacity. Wendys also operates restaurants in special site locations such as travel centers, gas station/convenience stores, military bases, arenas, malls, hospitals, airports and college campuses.
There are a number of existing Wendys and THI concepts combined in single free-standing units which average about 5,780 square feet. These units in Canada are leased from the 50/50 Canadian restaurant real estate joint venture between Wendys and THI and share a common dining room seating from approximately 100 to 130 persons. The combined units in the U.S. are similar in design and are owned by THI, with the Wendys space leased from THI. Each unit has separate Wendys and THI food preparation and storage areas and most have separate pick-up windows for each concept. The Company does not intend to open a significant number of new combined units going forward.
The Company remodels its restaurants on a periodic basis to maintain a fresh image, providing convenience for its customers and increasing the overall efficiency of restaurant operations.
At December 30, 2007, the Company and its franchisees operated 6,645 Wendys restaurants. Of the 1,414 company operated Wendys restaurants, the Company owned the land and building for 632 restaurants, owned the building and held long-term land leases for 572 restaurants and held leases covering land and building for 210 restaurants. The Companys land and building leases are generally written for terms of 10 to 25 years with one or more five-year renewal options. In certain lease agreements the Company has the option to purchase the real estate. Certain leases require the payment of additional rent equal to a percentage, generally less than 6%, of annual sales in excess of specified amounts. Some of the real estate owned by the Company is subject to mortgages which mature over various terms. The Company also owned land and buildings for, or leased 265 Wendys restaurant locations which were leased or subleased to franchisees. Surplus land and buildings are generally held for sale.
The Bakery operates two facilities in Zanesville, Ohio that produce hamburger buns for Wendys restaurants. The hamburger buns are distributed to both company operated and franchisee restaurants using primarily the Bakerys fleet of trucks. As of December 30, 2007 the Bakery employed approximately 346 people at the two facilities that had a combined size of approximately 205,000 square feet.
11
The location of company and franchise restaurants is set forth below.
Wendys | ||||
State |
Company | Franchise | ||
Alabama |
| 96 | ||
Alaska |
| 7 | ||
Arizona |
49 | 54 | ||
Arkansas |
| 64 | ||
California |
63 | 223 | ||
Colorado |
47 | 80 | ||
Connecticut |
5 | 44 | ||
Delaware |
| 15 | ||
Florida |
200 | 304 | ||
Georgia |
53 | 243 | ||
Hawaii |
8 | | ||
Idaho |
| 29 | ||
Illinois |
94 | 91 | ||
Indiana |
5 | 172 | ||
Iowa |
| 47 | ||
Kansas |
11 | 62 | ||
Kentucky |
3 | 139 | ||
Louisiana |
62 | 64 | ||
Maine |
4 | 17 | ||
Maryland |
| 115 | ||
Massachusetts |
64 | 26 | ||
Michigan |
21 | 253 | ||
Minnesota |
| 70 | ||
Mississippi |
8 | 89 | ||
Missouri |
22 | 54 | ||
Montana |
| 16 | ||
Nebraska |
| 34 | ||
Nevada |
| 47 | ||
New Hampshire |
4 | 23 | ||
New Jersey |
17 | 125 | ||
New Mexico |
| 38 | ||
New York |
66 | 156 | ||
North Carolina |
41 | 209 | ||
North Dakota |
| 9 | ||
Ohio |
83 | 354 | ||
Oklahoma |
| 38 | ||
Oregon |
22 | 33 | ||
Pennsylvania |
79 | 182 | ||
Rhode Island |
9 | 11 | ||
South Carolina |
| 133 | ||
South Dakota |
| 9 | ||
Tennessee |
| 182 | ||
Texas |
77 | 323 | ||
Utah |
57 | 28 | ||
Vermont |
| 6 | ||
Virginia |
51 | 167 | ||
Washington |
27 | 47 | ||
West Virginia |
22 | 51 | ||
Wisconsin |
| 64 | ||
Wyoming |
| 14 | ||
District of Columbia |
| 5 | ||
Domestic Subtotal |
1,274 | 4,662 | ||
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Wendys | ||||
Country/Territory |
Company | Franchise | ||
Aruba |
| 3 | ||
Bahamas |
| 7 | ||
Canada |
140 | 236 | ||
Cayman Islands |
| 3 | ||
Costa Rica |
| 3 | ||
Dominican Republic |
| 2 | ||
El Salvador |
| 14 | ||
Guam |
| 2 | ||
Guatemala |
| 6 | ||
Honduras |
| 27 | ||
Indonesia |
| 22 | ||
Jamaica |
| 2 | ||
Japan |
| 71 | ||
Mexico |
| 13 | ||
New Zealand |
| 15 | ||
Panama |
| 5 | ||
Philippines |
| 32 | ||
Puerto Rico |
| 65 | ||
Venezuela |
| 39 | ||
Virgin Islands |
| 2 | ||
International Subtotal |
140 | 569 | ||
Grand Total |
1,414 | 5,231 | ||
Item 3. | Legal Proceedings |
The Company and its subsidiaries are parties to various legal actions and complaints arising in the ordinary course of business. Many of these are covered by the Companys self-insurance or other insurance programs. Reserves related to the resolution of legal proceedings are included on the Companys Consolidated Balance Sheets, as a liability in Accrued expensesOther. It is the opinion of the Company that the ultimate resolution of such matters will not materially affect the Companys financial condition or earnings.
Item 4. | Submission of Matters to a Vote of Security Holders |
None.
13
Item 5. | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities |
Wendys International, Inc. common shares are traded on the New York, Boston, Chicago, National and Philadelphia Stock Exchanges, as well as the NYSE Arca (trading symbol: WEN). Options in Wendys shares are traded on the American Stock Exchange, Chicago Board Options Exchange, International Securities Exchange, NYSE Arca and Philadelphia Stock Exchange.
Market Price of Common Stock
2007 | High | Low | Close | ||||||
First Quarter |
$ | 34.54 | $ | 30.29 | $ | 31.30 | |||
Second Quarter |
42.22 | 30.81 | 36.75 | ||||||
Third Quarter |
39.22 | 29.56 | 34.91 | ||||||
Fourth Quarter |
35.14 | 25.94 | 26.01 |
2006 | High | Low | Close | ||||||
First Quarter |
$ | 66.35 | $ | 53.90 | $ | 62.06 | |||
Second Quarter |
63.65 | 56.25 | 58.29 | ||||||
Third Quarter |
67.19 | 57.54 | 67.00 | ||||||
Fourth Quarter (1) |
35.95 | 31.75 | 33.09 |
(1) | On September 29, 2006, the Company distributed 1.3542759 shares of THI common stock for each outstanding share of Wendys common stock in the form of a pro rata stock dividend. After the distribution, the market price of the Companys stock reflected the value of the Company excluding THI. See Note 6 of the Financial Statements and Supplementary Data included in Item 8 herein for additional information on the THI distribution. |
At February 15, 2008, the Company had approximately 97,500 shareholders of record.
Dividends Declared and Paid Per Share
Quarter | 2007 | 2006 | ||||
First |
$ | .085 | $ | .17 | ||
Second |
.125 | .17 | ||||
Third |
.125 | .17 | ||||
Fourth (1) |
.125 | .085 |
(1) | On September 29, 2006, the Company distributed 1.3542759 shares of THI common stock for each outstanding share of Wendys common stock in the form of a pro rata stock dividend. After the distribution, the Company reduced its dividend to $0.085. The Companys annual dividend rate beginning in the fourth quarter of 2006 was $0.34. Beginning in the second quarter of 2007, the Company increased its quarterly dividend to $0.125, which is an annual rate of $0.50. See Note 6 of the Financial Statements and Supplementary Data included in Item 8 herein for additional information on the THI distribution. |
See Note 6 of the Financial Statements and Supplementary Data included in Item 8 herein for information on related stockholder matters.
14
The following table sets forth, as of the end of the Companys last fiscal year, (a) the number of securities that could be issued upon exercise of outstanding options and vesting of outstanding restricted stock units and restricted stock awards under the Companys equity compensation plans, (b) the weighted-average exercise price of outstanding options under such plans, and (c) the number of securities remaining available for future issuance under such plans, excluding securities that could be issued upon exercise of outstanding options.
EQUITY COMPENSATION PLAN INFORMATION | |||||||
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) |
Weighted- average exercise price of outstanding options, warrants and rights (b) |
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) | ||||
Equity compensation plans approved by security holders |
2,805,624 | $ | 25.8495 | 5,842,364 | |||
Equity compensation plans not approved by security holders |
272,866 | $ | 13.7537 | 532,681 | |||
Total |
3,078,490 | $ | 24.2868 | 6,375,045 |
Included in the 3,078,490 total number of securities in column (a) above are approximately 1.0 million restricted stock units, restricted stock awards and performance units. The weighted-average exercise price in column (b) is based only on stock options as restricted stock units, restricted stock awards and performance units have no exercise price.
On April 26, 2007, the Companys shareholders approved the 2007 Stock Incentive Plan (the 2007 Plan), which provides for equity compensation awards in the form of stock options, restricted stock, restricted stock units, stock appreciation rights, dividend equivalent rights, performance shares, performance units and share awards (collectively, Awards) to eligible employees and directors of the Company or its subsidiaries. The 2007 Plan authorizes up to 6 million common shares for grants of Awards. The common shares offered under the 2007 Plan may be authorized but unissued shares, treasury shares or any combination thereof. The Company has used the 2007 Plan to issue annual stock option grants and long-term performance unit awards. Based on the current compensation philosophy of the Companys Compensation Committee (the Committee), the Company expects that approximately 50% of the value of Awards made in subsequent years will be comprised of stock options, with the remaining 50% of the value comprised of performance units. This was the philosophy under which Awards for 2007 were made. However, this is subject to review and possible change by the Committee.
Stock option awards made by the Company in 2007 have a term of seven years from the date of grant and become exercisable in installments of 33 1/3% on each of the first three anniversaries of the grant date. Stock option awards granted in prior years generally have a term of 10 years from the grant date and become exercisable in installments of 25% on each of the first four anniversaries of the grant date.
The 2007 Plan contains provisions concerning the treatment of Awards upon termination of employment. These provisions apply unless the Committee determines otherwise in an applicable Award agreement. Under these provisions:
| In the event of a grantees death or disability, the grantees options will become immediately exercisable and may be exercised for a period of one year following death or disability (but in no event beyond the maximum term of the option). If the grantee dies within 90 days after termination of employment, or services as a non-employee director, the grantees options that were vested on the date of termination may be exercised for a period of one year following such termination (but in no event beyond the maximum term of the option). In the event of a grantees death or disability, the grantees performance units will remain outstanding and the grantee will be entitled to a pro rata portion of the payment otherwise payable in respect of the performance units on the date the performance units would have been paid if the grantee had remained employed with the Company or a subsidiary. |
15
| In the event that a grantee who is an employee of the Company or a subsidiary retires after attaining age 60 with at least ten years of service, or in the event that a grantee who is a non-employee director retires after attaining age 60 with at least three years of service as a Board member, the grantees options will remain outstanding for a period of 48 months (but in no event beyond the maximum term of the option), unvested options will continue to vest in accordance with the applicable vesting schedule, the grantees performance units will remain outstanding and the grantee will be entitled to a pro rata portion of the payment otherwise payable in respect of the performance units on the date the performance units would have been paid if the grantee had remained employed with the Company or a subsidiary. |
| In the event that a grantees employment with the Company is terminated without cause in connection with a disposition of one or more restaurants or other assets by the Company or its subsidiaries, or in connection with a sale or other disposition of a subsidiary, the grantees options will remain outstanding for one year, unvested options will continue to vest in accordance with the applicable vesting schedule, the grantees performance units will remain outstanding and the grantee will be entitled to a pro rata portion of the payment otherwise payable in respect of the performance units on the date the performance units would have been paid if the grantee had remained employed with the Company or a subsidiary. |
| In the event that a grantees service as a non-employee director or employment with the Company or its subsidiaries terminates for any reason other than those described above, all Awards that the grantee holds will be forfeited immediately unless otherwise determined by the Committee at any time prior to or after termination with the grantees consent, except that options which are vested and exercisable on the date of termination of employment or of service as a non-employee director will remain exercisable for a period of 90 days following the date of such termination. |
On August 2, 1990, the Board of Directors adopted the WeShare Stock Option Plan (the WeShare Plan), a non-qualified stock option plan that provided for grants of options equal to 10% of each eligible employees earnings, with a minimum of 20 options to be granted to each eligible employee annually. Beginning in 2002, options equal to 8 -12% of each eligible employees earnings could be granted annually under the WeShare Plan. The percentage of each eligible employees earnings was determined by the Companys annual performance as measured by earnings per share growth and the Companys three-year average total shareholder return relative to the Standard & Poors 500 Index. Most employees of the Company and its subsidiaries who were full-time employees on the grant date and on December 31 of the year preceding the grant date were eligible employees. On August 2, 1990, the Board of Directors adopted the 1990 Stock Option Plan (1990 Plan) for issuance of equity awards to key employees and outside directors. On April 22, 2004, the Companys shareholders approved the 2003 Stock Incentive Plan (2003 Plan) for issuance of equity awards to employees and non-employee directors. In aggregate 6.3 million shares are reserved under the WeShare Plan, the 1990 Plan the 2003 Plan and the 2007 Plan as of December 30, 2007.
Options granted under the WeShare Plan, 1990 Plan and 2003 Plan had a term of 10 years from the grant date and became exercisable in installments of 25% on each of the first four anniversaries of the grant date. Under the original terms of these grants, these exercise dates could be accelerated if the Company was involved in certain merger, consolidation, reclassification or exchange of securities transactions as specified in each of the respective plans. If an employees employment is terminated for any reason other than death, disability, termination without cause in connection with the disposition of one or more restaurants or retirement, the options will be canceled as of the date of such termination. If the employees employment is terminated by reason of his or her death, disability or termination without cause in connection with the disposition of one or more restaurants (disposition termination), the options will become immediately exercisable and may be exercised at any time during the 12-month period after his or her death, disposition termination or date of becoming disabled, subject to the stated term of the options. If the employees employment is terminated by reason of his or her retirement, the options may be exercised during the 48-month period after the retirement date, subject to the stated term of the options. The Company had granted options under the WeShare Plan annually to several thousand employees. However, the Company no longer makes grants of options under the WeShare Plan or the 1990 Plan and did not make any
16
option grants under the 2003 Plan in 2006. The WeShare Plan has not been submitted to the shareholders of the Company for approval as permitted under current New York Stock Exchange listing requirements.
Restricted stock unit grants under the 2003 Plan generally vest over a 30 month period for employees in Canada and over a four year period for U.S. employees.
On October 27, 2005, the Committee after discussion with the Board of Directors, approved accelerating the vesting, effective October 27, 2005, of approximately 3.2 million stock options, representing all then outstanding, unvested stock options granted under the Companys (i) 1990 Plan, as amended; (ii) WeShare Plan, as amended; and (iii) 2003 Plan, as amended (collectively, the Plans), that were held by then current employees, including all executive officers, and employees who retired with unvested stock options after having attained age 55 with at least 10 years of service with the Company or its subsidiaries. The vesting of stock options held by the independent directors of the Company was not changed by this action. Except as described below for executive officers, all other terms and conditions of each stock option award remain the same.
The Committees decision to accelerate the vesting of all then outstanding, unvested stock options granted under the Plans only affected stock option awards granted from October 31, 2001, through 2004. It did not affect stock option awards granted prior to October 31, 2001 since those options had already vested and no stock options were granted by the Company in 2005 as the Company transitioned from stock options to restricted stock and restricted stock unit awards. The Committees acceleration decision did not affect restricted stock unit awards. Of the total number of stock options accelerated, approximately 463,000 were held by executive officers at October 27, 2005.
The Committee imposed a holding period that will require all executive officers to refrain from selling shares acquired upon the exercise of these accelerated options (other than shares needed to cover the exercise price, applicable transaction fees and satisfying withholding taxes) until the date on which the exercise would have been permitted under the options original vesting terms or, if earlier, the executive officers death, disability or termination of employment. The decision to accelerate the vesting of these stock options was made primarily to reduce non-cash compensation expense that would have been recorded in future periods following the Companys adoption of Financial Accounting Standards Board Statement No. 123, Share Based Payment (revised 2004) (SFAS 123R). The acceleration of vesting did not alter the vesting of restricted stock, restricted stock units or performance shares held by directors, officers and employees of the Company. SFAS No. 123R: (i) generally requires recognizing compensation cost for the grant-date fair value of stock options and other equity-based compensation over the requisite service period; (ii) applies to all awards granted, modified, vesting, repurchased or cancelled after the required effective date; and (iii) was effective for the Company as of the beginning of its first quarter 2006. The future expense that was eliminated as a result of the acceleration of the vesting of these options is estimated to be approximately $8 million, $3 million and $1 million in 2006, 2007 and 2008, respectively. In 2005, as a result of modifying the vesting period of the options, the Companys continuing operations included $3.5 million in compensation expense in accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation. The expense represents the estimated number of stock options that would have been forfeited according to the original terms of the options that will no longer be forfeited due to the acceleration of the vesting, at the intrinsic value of the options on the date vesting was accelerated.
On September 29, 2006, the Company completed the spin-off of THI. The distribution took place in the form of a pro rata common stock dividend to the Companys shareholders of record as of Friday, September 15, 2006. Shareholders received 1.3542759 shares of THI common stock for each share of the Companys common stock held. Cash was paid for fractional share interests. In total, the Company distributed 159,952,977 shares of THI common stock to its shareholders, representing all of the shares of THI that Wendys owned as of September 29, 2006. In conjunction with the spin-off of THI, directors, officers and employees of the Company holding options, restricted stock units (including accrued dividend equivalent units) and performance shares did not receive shares of THI in the spin-off distribution on the common shares underlying those equity awards. Pursuant to the
17
provisions of the Plans, to preserve the economic value of those equity awards as they existed prior to the spin-off, the Committee approved an adjustment to all outstanding options, restricted stock units (including accrued dividend equivalent units) and performance shares. The equity award adjustment was effected by dividing the number of shares underlying the equity awards by 0.4828 and by multiplying the stock option exercise price by the same adjustment ratio. This adjustment ratio was obtained by dividing the ex-dividend opening price of the Companys common stock on the New York Stock Exchange on October 2, 2006 ($32.35), the first trading day after the spin-off, by the closing price of the Companys common stock in the regular way market on September 29, 2006 ($67.00). There was no compensation expense charge associated with this conversion.
ISSUER PURCHASES OF EQUITY SECURITIES: The Company did not repurchase any of its common stock in the fourth quarter ended December 30, 2007.
18
Item 6. | Selected Financial Data |
Selected Financial Data
(Information included below excludes amounts related to discontinued operations, except where otherwise noted)
Operations (in millions) |
2007 | 2006 | 2005 | 2004 | (1) | 2003 | |||||||
Revenues (2) |
$ | 2,450 | 2,439 | 2,455 | 2,502 | 2,252 | |||||||
Sales (2) |
$ | 2,160 | 2,155 | 2,138 | 2,194 | 1,960 | |||||||
Income from continuing operations before income taxes |
$ | 126 | 42 | 137 | 176 | 182 | |||||||
Income from continuing operations |
$ | 87 | 37 | 85 | 106 | 120 | |||||||
Income (loss) from discontinued operations (3) |
$ | 1 | 57 | 139 | (54 | ) | 116 | ||||||
Net income (3) |
$ | 88 | 94 | 224 | 52 | 236 | |||||||
Capital expenditures |
$ | 134 | 110 | 181 | 166 | 214 | |||||||
Per Share Data |
|||||||||||||
Diluted earnings per common share from continuing operations |
$ | .96 | .32 | .73 | .92 | 1.04 | |||||||
Diluted earnings (loss) per common share from discontinued operations |
$ | .01 | .50 | 1.19 | (.47 | ) | 1.01 | ||||||
Total diluted earnings per common share (including discontinued operations) |
$ | .97 | .82 | 1.92 | .45 | 2.05 | |||||||
Dividends declared and paid per common share (4) |
$ | .46 | .60 | .58 | .48 | .24 | |||||||
Market price at year-end (4) |
$ | 26.01 | 33.09 | 55.26 | 39.26 | 39.24 | |||||||
Financial Position (in millions) |
|||||||||||||
Total assets (including discontinued operations) |
$ | 1,789 | 2,060 | 3,440 | 3,198 | 3,133 | |||||||
Property and equipment, net |
$ | 1,247 | 1,226 | 1,348 | 1,512 | 1,462 | |||||||
Long-term obligations |
$ | 543 | 556 | 540 | 539 | 639 | |||||||
Shareholders equity (including discontinued operations) |
$ | 804 | 1,012 | 2,059 | 1,716 | 1,759 | |||||||
Ratios |
|||||||||||||
Company operated store margins (5) |
% | 10.7 | 8.9 | 8.6 | 10.9 | 13.1 | |||||||
Pretax profit margin (6) |
% | 5.1 | 1.7 | 5.6 | 7.0 | 8.1 | |||||||
Return on average assets (7) |
% | 4.9 | 2.8 | 7.0 | 1.7 | 8.4 | |||||||
Return on average equity (8) |
% | 10.7 | 4.7 | 11.9 | 2.9 | 14.9 | |||||||
Long-term debt to equity (9) |
% | 68 | 55 | 26 | 31 | 36 | |||||||
Debt to total capitalization (10) |
% | 40 | 34 | 21 | 23 | 26 | |||||||
Price to earnings (11) |
27 | 40 | 29 | 87 | 19 |
(1) | Fiscal year includes 53 weeks. |
(2) | During 2006, the Company revised its presentation of the sale of kids meal toys to reflect the sales on a gross versus net basis under the provisions of Emerging Issues Task Force (EITF) 99-19. Reporting Revenue Gross as a Principal versus Net as an Agent. The revised presentation had no impact on operating income or net income. Amounts related to the prior years were not material, but were revised for purposes of comparability. The revisions increased sales and cost of sales, $59.4 million, $61.6 million, $69.1 million and $61.0 million for fiscal years 2006, 2005, 2004 and 2003, respectively. |
(3) | Includes results of operations for THI, Baja Fresh and Cafe Express. |
(4) | On September 29, 2006, the Company distributed 1.3542759 shares of THI common stock for each outstanding share of Wendys common stock in the form of a pro rata stock dividend. After the distribution, the market price of the Companys stock reflected the value of the Company excluding THI. See Note 6 of the Financial Statements and Supplementary Data included in Item 8 herein for additional information on the THI distribution. After the spin-off of THI, the Company lowered its annual dividend rate to reflect the reduced earnings of the Company excluding THI. |
(5) | Company operated store margins are computed as store sales less store cost of sales and company restaurant operating costs, divided by store sales. |
(6) | Pretax profit margin is computed by dividing income from continuing operations before income taxes by revenues. |
(7) | Return on average assets is computed by dividing net income (including discontinued operations) by average assets over the previous five quarters, excluding advertising fund restricted assets. |
(8) | Return on average equity is computed by dividing net income (including discontinued operations) by average shareholders equity over the previous five quarters. |
(9) | Long-term debt to equity is computed by dividing long-term debt (excluding discontinued operations) by shareholders equity. |
(10) | Debt to total capitalization is computed by dividing long-term debt (excluding discontinued operations) by total capitalization. |
(11) | Price to earnings is computed using the year-end stock price divided by the diluted earnings per share for the year including discontinued operations. |
19
Other Information
Restaurant Data | 2007 | 2006 | 2005 | 2004* | 2003 | 2002 | 2001 | 2000 | 1999 | 1998* | 1997 | ||||||||||||
North American Wendys open at year-end |
|||||||||||||||||||||||
Company |
1,414 | 1,463 | 1,497 | 1,482 | 1,460 | 1,316 | 1,223 | 1,148 | 1,082 | 1,021 | 1,186 | ||||||||||||
Franchise |
4,898 | 4,869 | 4,898 | 4,837 | 4,668 | 4,587 | 4,431 | 4,271 | 4,079 | 3,922 | 3,634 | ||||||||||||
International Wendys open at year-end |
|||||||||||||||||||||||
Company |
0 | 2 | 5 | 5 | 5 | 4 | 5 | 5 | 30 | 15 | 16 | ||||||||||||
Franchise |
333 | 339 | 346 | 347 | 348 | 346 | 384 | 368 | 336 | 375 | 371 | ||||||||||||
Total Wendys |
6,645 | 6,673 | 6,746 | 6,671 | 6,481 | 6,253 | 6,043 | 5,792 | 5,527 | 5,333 | 5,207 | ||||||||||||
Average net sales per domestic Wendys restaurant (in thousands) |
|||||||||||||||||||||||
Company |
$ | 1,422 | 1,400 | 1,365 | 1,416 | 1,389 | 1,387 | 1,337 | 1,314 | 1,284 | 1,174 | 1,111 | |||||||||||
Franchise |
$ | 1,309 | 1,276 | 1,263 | 1,291 | 1,268 | 1,251 | 1,164 | 1,130 | 1,102 | 1,031 | 1,017 | |||||||||||
Total domestic |
$ | 1,333 | 1,303 | 1,286 | 1,319 | 1,294 | 1,280 | 1,199 | 1,167 | 1,138 | 1,062 | 1,042 | |||||||||||
Per Share Data |
|||||||||||||||||||||||
Dividends *** |
$ | .46 | .60 | .58 | .48 | .24 | .24 | .24 | .24 | .24 | .24 | .24 | |||||||||||
Market price at year-end ** |
$ | 26.01 | 33.09 | 55.26 | 39.26 | 39.24 | 27.07 | 29.17 | 26.25 | 20.81 | 21.81 | 22.88 |
* | Fiscal year includes 53 weeks. |
** | On September 29, 2006, the Company distributed 1.3542759 shares of THI common stock for each outstanding share of Wendys common stock in the form of a pro rata stock dividend. After the distribution, the market price of the Companys stock reflected the value of the Company excluding THI. See Note 6 of the Financial Statements and Supplementary Data included in Item 8 herein for additional information on the THI distribution. |
*** | After the spin-off of THI in 2006, the Company lowered its annual dividend rate to reflect the reduced earnings of the Company excluding THI. |
20
Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Executive Overview
Wendys International, Inc. and subsidiaries (the Company) completed the initial public offering (IPO) of Tim Hortons Inc. (THI) in March 2006, the spin-off of THI on September 29, 2006, the sale of Baja Fresh on November 28, 2006 and the sale of Cafe Express on July 29, 2007. Accordingly, the after-tax operating results of THI, Baja Fresh and Cafe Express appear in the Income from discontinued operations line on the Consolidated Statements of Income for all years presented.
The Companys reported net income was $87.9 million in 2007 compared to $94.3 million in 2006. The 2007 reported net income declined because THI results were included in the Companys 2006 results as part of income from discontinued operations, but are not included in the Companys 2007 results. Income from continuing operations improved $49.6 million, or 134%, from $37.0 million in 2006 to $86.6 million in 2007. The year over year improvement was driven primarily by stronger operating income, which improved $116.7 million, or 289%, over 2006, partially offset by lower interest income of $24.1 million due to lower average cash balances in 2007 compared to 2006 and higher interest expense of $9.3 million on debt associated with the sale of a portion of the Companys royalty revenues. Both 2007 and 2006 results were impacted by restructuring charges and 2007 results were impacted by costs associated with the Board of Directors Special Committee, which was formed to investigate strategic options for the Company (see Managements Outlook section below). Excluding the restructuring charges in 2007 and 2006 and Special Committee related charges in 2007 as shown on the Consolidated Statements of Income, 2007 adjusted operating income of $191.4 million was higher than 2006 adjusted operating of $79.2 million by $112.2 million, or 142%. The Company uses adjusted operating income as an internal measure of operating performance. Management believes adjusted operating income provides a meaningful perspective of the underlying operating performance of the business.
The 2007 improved operating income results from continuing operations over 2006 were driven by higher company operated restaurant margins (see below), reduced general and administrative costs of $25.2 million, resulting primarily from the Companys 2006 cost reduction efforts and lower insurance costs, the absence of 2006 incremental advertising contributions of $25.0 million to the Wendys National Advertising Program (WNAP) that did not recur in 2007 and gains from insurance recoveries of $9.0 million in 2007. Company operated restaurant margins in 2007 improved by 180 basis points over 2006 primarily reflecting positive sales, including menu price increases tied to the Companys market based pricing strategy, and labor efficiencies. U.S. company operated restaurant margins in 2007 improved by 210 basis points over 2006. The reported company operated restaurant margin basis point improvement would have been higher without the impact of rising commodity prices which negatively impacted U.S. company operated store margins 90 basis points in 2007 compared to 2006.
Other factors that favorably impacted 2007 results compared to 2006 included 2007 store closure charges of $7.3 million, compared to 2006 store closure charges of $16.7 million and a $5.7 million gain related to a 2007 amendment of the Tax Sharing Agreement with THI. These favorable variances in 2007 were partially offset by higher 2007 remodel incentives provided to franchisees of $5.4 million and a 2007 $5.0 million impairment of the Companys investment in Pasta Pomodoro. In addition, operating income was $7.2 million lower in 2007 because the Companys 50/50 Canadian restaurant real estate joint venture with THI is no longer consolidated since the spin-off of THI in September 2006. If adjusted operating income did not include the amounts discussed in this paragraph and the incremental advertising contributions to WNAP and gains from insurance recoveries discussed in the previous paragraph, 2007 adjusted operating income of $191.4 million would have been higher by $10.2 million, or $201.6 million, and 2006 adjusted operating income of $79.2 million would have been higher by $41.7 million, or $120.9 million.
One of the key indicators in the restaurant industry that management monitors to assess the health of the Company is average same-store sales. This metric provides information on total sales at restaurants operating
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during the relevant period and provides a useful comparison between periods. Average same-store sales results for U.S. company operated and U.S. franchised restaurants are listed in the table below. Franchisee operations are not included in the Companys financial statements; however, franchisee sales result in royalties and rental income which are included in the Companys franchise revenues.
For comparative purposes, average same-store sales changes at U.S. company operated and U.S. franchised restaurants for 2007 are shown in the table below.
2007 Average Same-Store Sales Increases/(Decreases) | ||||||||||
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | 2007 | ||||||
U.S. company restaurants |
3.8% | 0.7% | 0.2% | (0.8)% | 0.9% | |||||
U.S. franchise restaurants |
3.7% | 0.4% | 1.3% | 0.2 % | 1.4% | |||||
For comparative purposes, average same-store sales changes at U.S. company operated and U.S. franchised restaurants for 2006 are shown in the table below.
| ||||||||||
2006 Average Same-Store Sales Increases/(Decreases) | ||||||||||
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | 2006 | ||||||
U.S. company restaurants |
(4.8)% | 0.7% | 4.1% | 3.1% | 0.8% | |||||
U.S. franchise restaurants |
(5.2)% | 1.0% | 3.9% | 2.7% | 0.6% |
Other financial and operating highlights include:
n | The Company and its franchisees opened a total of 92 new restaurants during 2007, including 16 company operated restaurants and 76 franchised restaurants. This reflects the slowing of store development as the Company focuses on improving store margins. Company operated stores closed in 2007 totaled 22 and franchisees closed a total of 98 restaurants in 2007. |
n | In the first quarter of 2007, the Company completed an accelerated share repurchase (ASR) of 9.0 million shares for $298.0 million. |
A summary of systemwide restaurants is included on page 38.
Company Operated Restaurant Margins
The Companys restaurant margins are computed as store sales less store cost of sales and company restaurant operating costs, divided by store sales. Depreciation is not included in the calculation of company operated restaurant margins. Company operated restaurant margins improved to 10.7% in 2007 compared to 8.9% in 2006 primarily reflecting positive sales, including menu price increases tied to the Companys market based pricing strategy, and labor efficiencies. The 2006 company operated restaurant margins improved to 8.9% from 8.6% in 2005, primarily reflecting improvements in cost of sales.
Sales
The Companys sales are comprised of sales from company operated restaurants, sales of kids meal toys to franchisees and sales of sandwich buns from the Companys bun baking facilities to franchisees. Franchisee sales are not included in reported sales. Of total sales, domestic company store sales comprised approximately 85% in each period presented, while the remainder primarily represented Canadian company store sales.
The $5.4 million increase in sales in 2007 versus 2006 primarily included the impact from a strengthening Canadian dollar of approximately $12 million and the impact of slightly higher average same-store sales at U.S.
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company operated restaurants, offset by fewer U.S. company operated restaurants open during the year, as the Company closed 22 underperforming company operated restaurants in 2007 and sold a net 45 restaurants to franchisees in 2007. The U.S. sales benefited from menu price increases and additional sales derived from the Companys new breakfast program.
The $16.2 million increase in sales in 2006 versus 2005 primarily included the impact from a strengthening Canadian dollar of approximately $13 million and the impact of higher average same-store sales at company operated restaurants, offset by fewer U.S. company operated restaurants open during the year, as the Company closed 29 underperforming company operated restaurants in 2006. Total company operated restaurants open at year-end 2007 were 1,414 versus 1,465 at year-end 2006 and 1,502 at year-end 2005.
The following table summarizes various restaurant statistics for U.S. company operated restaurants for the years indicated:
2007 | 2006 | 2005 | |||||||
Average U.S. company same-store sales increase (decrease) |
0.9% | 0.8% | (3.7)% | ||||||
U.S. company operated restaurants open at year-end |
1,274 | 1,317 | 1,345 | ||||||
U.S. average unit volumes |
$ | 1,422,000 | $ | 1,400,000 | $ | 1,365,000 |
Franchise Revenues
The Companys franchise revenues include royalty income from franchisees, rental income from properties leased to franchisees, gains from the sales of properties to franchisees and franchise fees. Franchise fees cover charges for various costs and expenses related to establishing a franchisees business.
The $5.5 million increase in franchise revenues in 2007 versus 2006 primarily reflects higher royalties of $6.5 million, due primarily to growth in U.S. franchisee average same-store sales of 1.4% and a stronger Canadian dollar, and $1.0 million in higher gains on sales of stores to franchisees in 2007, partially offset by $3.2 million in lower rental income due primarily to the change in accounting for the Companys 50/50 Canadian restaurant real estate joint venture with THI. This 50/50 joint venture is no longer consolidated since the spin-off of THI. As a result, rental income received by the joint venture is no longer reflected on the Companys Consolidated Statements of Income and the Companys 50% share of the joint ventures income is recorded under the equity method of accounting in other (income) expense, net.
The $32.4 million decrease in franchise revenues in 2006 versus 2005 primarily reflects $16.8 million in lower rental income due to the sale of sites previously leased to franchisees during 2005 and early 2006. The decrease also reflects the absence of $16.3 million in gains on sales of properties leased to franchisees that occurred in 2005.
The following table summarizes various restaurant statistics for U.S. franchised restaurants for the years indicated:
2007 | 2006 | 2005 | |||||||
U.S. average franchise same-store sales increase (decrease) |
1.4% | 0.6% | (3.1)% | ||||||
Franchise restaurants open at year-end |
4,662 | 4,638 | 4,673 | ||||||
Average unit volumes |
$ | 1,309,000 | $ | 1,276,000 | $ | 1,263,000 |
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Cost of Sales
Cost of sales includes food, paper and labor costs for company operated restaurants, and the cost of goods sold to franchisees related to kids meal toys and from the Companys bun baking facilities. Of the total cost of sales, U.S. company operated restaurant cost of sales comprised approximately 84% in each period presented, while the remainder primarily represented Canadian company operated restaurants. Overall, cost of sales as a percent of sales was 61.2% in 2007, 62.7% in 2006 and 63.7% in 2005.
U.S. company operated restaurant cost of sales were 59.9% of U.S. company operated restaurant sales in 2007, compared with 61.5% in 2006 and 62.5% in 2005. U.S. food and paper costs were 32.5% of U.S. company operated restaurant sales in 2007, compared with 33.7% in 2006 and 34.7% in 2005. The decrease in 2007 versus 2006 primarily reflects menu price increases tied to the Companys market based pricing strategy, partially offset by higher commodity costs. The decrease in 2006 versus 2005 primarily reflects lower commodity costs, including an approximate 8% decline in beef, and improved menu management, with the introduction of higher-margin products.
U.S. labor costs were 27.4% of U.S. company operated restaurant sales in 2007, compared with 27.8% in 2006 and 27.8% in 2005. The decrease in 2007 versus 2006 primarily reflects menu price increases and labor cost savings initiatives, offset by an average labor rate increase of 3.3%. The increase in 2006 versus 2005 primarily reflects an average labor rate increase of 2.3%, partially offset by the favorable impact from the closure of lower volume stores in 2005, an average same-store sales increase in company operated restaurants and productivity improvements.
Company Restaurant Operating Costs
Company restaurant operating costs include costs necessary to manage and operate company restaurants, except cost of sales and depreciation. Of the total company restaurant operating costs, U.S. company stores comprised approximately 90% in each period presented, while the remainder primarily represented Canadian company stores.
As a percent of company operated restaurant sales, company restaurant operating costs were 27.7% in 2007, 28.5% in 2006 and 27.8% in 2005. The 2007 decrease versus 2006 primarily reflects lower costs as a result of the Companys 2006 cost saving initiatives and lower bonuses of $4.0 million. The 2006 increase versus 2005 primarily reflects higher utilities of $6.6 million, higher performance-based incentive compensation of $4.4 million, as well as higher costs for property management, insurance and supplies. These 2006 increases were partially offset by lower group insurance reserves of $4.1 million due to favorable claims experience.
Operating Costs
Operating costs include rent expense and other costs related to properties subleased to franchisees, other franchisee related costs and costs related to operating and maintaining the Companys bun baking facilities.
The $23.9 million decrease in operating costs in 2007 versus 2006 reflects $25.0 million in special contributions to the WNAP in 2006 and a $5.7 million decline in rent expense related to the change in accounting for the Companys 50/50 Canadian restaurant real estate joint venture which is no longer consolidated, partially offset by higher franchisee remodel incentives of $5.4 million. The $26.3 million increase in operating costs in 2006 versus 2005 primarily reflects the $25.0 million in special contributions to the WNAP in 2006, as well as $3.4 million in payments related to a distributor commitment and $1.1 million in 2006 for franchise remodel incentives. These 2006 increases were partially offset by lower rent expense due to the fact that the Companys 50/50 Canadian restaurant joint venture with THI is no longer consolidated as a result of the spin-off of THI in September 2006, and therefore, this rent is no longer included in operating costs. For the first nine months of 2006, this rent totaled approximately $6 million.
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Depreciation of Property and Equipment
Depreciation of property and equipment decreased $9.5 million in 2007 and decreased $5.4 million in 2006. The decrease in 2007 versus 2006 reflects the lack of $2.9 million of depreciation from the Companys 50/50 Canadian restaurant real estate joint venture with THI that is no longer consolidated, a reduction in the number of company operated restaurants and other asset dispositions. The decrease in 2006 versus 2005 primarily reflects a reduction in the number of company operated restaurants.
General and Administrative Expenses
General and administrative expenses decreased $25.2 million, or 10.6%, in 2007 versus 2006. As a percent of revenues, general and administrative expenses were lower in 2007 at 8.7% versus 9.7% in 2006. The dollar and percentage decrease in 2007 reflects lower salaries and benefits of $15.7 million, lower performance-based incentive compensation of $6.8 million, lower insurance cost of $8.0 million due to lower claims and lower professional fees of $4.9 million. These improvements were partially offset by higher equity-based compensation of $3.9 million and higher marketing related expenses of $2.3 million for new product testing.
In 2006, general and administrative expenses increased $16.7 million, or 7.6%, to $237.6 million versus 2005. As a percent of revenues, general and administrative expenses were higher in 2006 at 9.7% versus 9.0% in 2005. The dollar and percent increase in 2006 includes incremental expense for performance-based incentive compensation of $10.9 million, $9.2 million in incremental consulting and professional fees and $7.4 million in higher costs related to breakfast. These increases were partially offset by lower salary and benefit costs of $14.8 million.
Restructuring and Special Committee Related Charges
In 2007 and 2006, the Company accrued restructuring costs of $9.7 million and $38.9 million, respectively, related to its voluntary enhanced retirement plan, reduction in force and professional fees as part of a cost reduction plan. The restructuring charges included $7.4 million and $3.9 million of non-cash pension settlement charges in 2007 and 2006, respectively.
In 2007, the Company recorded $24.7 million of primarily financial and legal advisory fees related to the activities to the Special Committee formed by the Companys Board of Directors (see Managements Outlook section for a further description). No Special Committee costs were recorded in 2006 or 2005.
Other (Income) Expense, Net
Other (income) expense, net includes amounts that are not directly derived from the Companys primary business. These include amounts related to store closures, sales of properties to non-franchisees and equity investment income.
The following is a summary of other (income) expense, net for each of the years indicated:
(In thousands) | 2007 | 2006 | 2005 | ||||||||
Store closing costs |
7,266 | 16,737 | 24,696 | ||||||||
Rent revenue |
0 | (14,021 | ) | (16,359 | ) | ||||||
Gain from property dispositions |
(4,956 | ) | (6,833 | ) | (46,855 | ) | |||||
Equity investment (income) loss |
(9,424 | ) | (2,962 | ) | 2,046 | ||||||
Impairment of equity investment |
5,000 | 0 | 0 | ||||||||
Gain from insurance recoveries |
(9,018 | ) | 0 | 0 | |||||||
THI tax sharing amendment |
(5,698 | ) | 0 | 0 | |||||||
Other, net |
7,824 | 5,633 | 2,209 | ||||||||
Other (income) expense, net |
$ | (9,006 | ) | $(1,446 | ) | $ | (34,263 | ) |
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Store closing costs
Store closure charges include asset impairments and lease termination costs.
Rent revenue
Rent revenue included in other (income) expense, net represents rent paid by THI to the Companys 50/50 Canadian restaurant real estate joint venture with THI. After the spin-off of THI on September 29, 2006, this joint venture was no longer consolidated in the Companys financial statements and only Wendys 50% share of the joint venture income is included in other (income) expense, net, under the equity accounting method.
Gain from property dispositions
The 2007 gain from property dispositions reflects the sale of 21 properties and includes $3.2 million of gains related to properties held for sale and also reflects the sale of an additional 40 properties for a gain of $1.8 million. The 2006 gain from property dispositions reflects the sale of 70 properties and includes $5.5 million of gains related to properties held for sale. The 2005 gain from property dispositions includes a gain of $46.2 million related to the sale of 130 Wendys real estate properties to a third party for $119.1 million.
Equity investment (income) loss
Equity investment income in 2007 primarily includes income from the Companys 50/50 Canadian restaurant real estate joint venture with THI. Prior to the fourth quarter of 2006, this joint venture was consolidated. Equity income prior to the fourth quarter of 2006 includes equity (income) losses from other equity investments held by the Company.
Impairment of equity investment
Based on a decline in Pasta Pomodoro operating results, in the fourth quarter of 2007 the Company recorded a $5.0 million impairment of its equity investment in Pasta Pomodoro to reflect an other then temporary decline in the value of the Companys investment in its Pasta Pomodoro investment in accordance with APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. As of December 30, 2007, the Companys recorded equity investment value in Pasta Pomodoro was $5.8 million and is classified as Other assets in the Companys Consolidated Balance Sheet.
Gain from Insurance Recoveries
Gain from insurance recoveries reflects insurance recoveries for Hurricane Katrina property damages.
THI tax sharing amendment
In November 2007, the Company executed an amendment to its tax sharing agreement with THI which reduced the Companys liability to THI by $5.7 million.
Other, net
Other, net in 2007 primarily includes store-level asset write-offs of $5.4 million and severance costs of $1.9 million. Other, net in 2006 primarily includes store-level asset write-offs of $5.5 million and severance costs of $2.4 million, partially offset by favorable legal reserve settlements of $1.5 million.
Interest Expense
The $9.3 million increase in interest expense in 2007 versus 2006, primarily reflects interest on debt that was incurred in the fourth quarter of 2006 as a result of the sale of a portion of the Companys 2007 royalty revenues.
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In the fourth quarter of 2006, the Company entered into an agreement to sell approximately 40% of the Companys U.S. royalties for a 14-month period to a third party in return for a cash payment in 2006 of $94.0 million. When received, the $94.0 million was recorded as debt (see also the Liquidity and Capital Resources section below). Also, the Company recorded a pretax fourth quarter 2007 adjustment of $1.7 million ($1.1 million after tax) as a cumulative correction of the accounting for a capital lease with a bargain purchase option. The adjustment represents a cumulative catch-up of the lease entered into in 1995 and was not material to the current year or prior years.
The $7.4 million decrease in interest expense in 2006 versus 2005 primarily reflects the repayment of the Companys $100 million, 6.35% Notes in December 2005.
Interest Income
The $24.1 million decrease in interest income in 2007 versus 2006 primarily reflects reduction in cash balances as a result of the completion of a modified Dutch Auction tender offer in the fourth quarter of 2006, using approximately $800 million of cash, and the completion of an ASR using approximately $298 million of cash in the first quarter of 2007.
The $33.9 million increase in interest income in 2006 versus 2005, primarily reflects interest earned on the funds received from THI after its IPO in March 2006, which also included borrowings by THI paid to the Company.
Income Taxes
The effective income tax rate for 2007 was 31.1% compared to 12.8% for 2006 and 37.8% for 2005. The rate for 2007 was favorably impacted by the resolution of the 2005 IRS audit, settlement of a Competent Authority matter as well as audits for various states. These benefits were partially offset by the recording of a valuation allowance (expense) associated with the book/tax basis difference on the Pasta Pomodoro investment. In 2007, the Company deducted fees to certain advisors to the Special Committee of the Board of Directors. In the event a transaction (i.e. sale, merger or other transaction related to the Companys Special Committee process) takes place, these 2007 fees may be deemed as non-deductible resulting in up to approximately $9 million in additional tax expense for the period in which the transaction would occur. The rate for 2006 was favorably impacted by the resolution of the IRS audit for 2001 through 2004 along with audits for various states. Additionally, the rate in 2006 benefited from federal tax credits earned throughout the year for hiring employees in the Gulf Zone subsequent to Hurricane Katrina.
Income from Discontinued Operations
The Company completed its spin-off of THI on September 29, 2006, completed its sale of Baja Fresh on November 28, 2006 and completed the sale of Cafe Express on July 29, 2007. Accordingly, the after-tax operating results of THI, Baja Fresh and Cafe Express appear in the Income from discontinued operations line on the Consolidated Statements of Income for all years presented. Income from discontinued operations, net of tax, was $1.3 million, $57.3 million and $139.0 million in 2007, 2006 and 2005, respectively. The results for 2006 include a Baja Fresh $46.9 million pretax goodwill impairment charge, $84.5 million and $9.2 million of Baja Fresh and Cafe Express pretax intangible and fixed asset impairment charges, respectively, and a tax benefit of $11.5 million to recognize the outside book versus tax basis differential on the sale of the stock of Baja Fresh. Also, the results from discontinued operations included only nine months of THI results in 2006 compared to a full year of THI results in 2005. The results for 2005 include $25.4 million and $10.7 million of THI and Cafe Express pretax goodwill impairment charges, respectively, and $18.5 million and $4.0 million of pretax asset impairment charges of THI and Cafe Express, respectively.
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Comprehensive Income
Comprehensive income was higher than net income by $23.4 million in 2007, lower than net income by $16.0 million in 2006 and higher than net income by $12.1 million in 2005. The increase in comprehensive income in 2007 is due to favorable translation adjustments of $19.8 million and a pension liability adjustment of $3.6 million. The decrease in comprehensive income in 2006 is primarily due to a pension liability adjustment of $21.5 million, partially offset by $5.4 million in favorable translation adjustments. The increase in comprehensive income over net income in 2005 primarily reflects favorable translation adjustments.
FINANCIAL POSITION
Overview
The Company generates considerable cash flow each year from operating income excluding depreciation and amortization. The sale of properties has also provided significant cash to continuing operations over the last three years. The main recurring requirement for cash is capital expenditures. The Company generally generates cash from continuing operating activities in excess of capital expenditure spending. Share repurchases are part of the ongoing financial strategy utilized by the Company, and normally these repurchases have come from cash on hand, including the cash provided by option exercises. In the first quarter of 2007, the Company used a portion of the funds received from THI after its initial public offering (IPO) to repurchase 9.0 million shares in an ASR for a total purchase price of $298.0 million, including a $15.5 million price adjustment in the second quarter of 2007. In the fourth quarter of 2006, the Company also used approximately $800 million of funds received from THI after its IPO to complete a Dutch Auction tender offer share repurchase of 22.4 million common shares. In the short term, the Company expects cash provided from option exercises should decrease because, until 2007 when the Company granted 0.9 million options, the Company had not granted options over the previous two years. At December 30, 2007 there were approximately 2 million options outstanding. In February 2007, the Company announced an increase in its annual cash dividend from $0.34 per share to $0.50 per share beginning with the quarterly dividend paid May 2007.
The Company currently has a $500 million shelf registration and $200 million revolving credit facility which are unused as of December 30, 2007. The revolving credit facility expires in March 2008 and the Company is currently negotiating a renewal of this agreement. The Company did not borrow under its revolving credit facility during the year ended December 30, 2007.
The Company maintains a strong balance sheet. Standard & Poors and Moodys rate the Companys senior unsecured debt BB- and Ba3, respectively. Standard & Poors has stated that the Companys debt ratings remain on credit watch with negative implications. Moodys has stated that it has placed the Companys debt ratings on review for possible downgrade (see discussion under Liquidity and Capital Resources below). The long-term debt-to-total equity ratio for the Companys continuing operations increased to approximately 68% at year-end 2007 from approximately 55% at year-end 2006, primarily reflecting a $207.5 million decline in equity in 2007 due primarily to common share repurchases of $298.0 million.
Total assets decreased $270.9 million in 2007 to $1.8 billion primarily due to a $246.4 million reduction in cash, due in large part to common share repurchases of $298.0 million. Return on average assets was 4.9% in 2007 and 2.8% in 2006. The increase primarily reflects an increase in income from continuing operations. Return on average assets is computed as net income divided by average assets over the previous five quarters, excluding advertising fund restricted assets. Current advertising fund restricted assets are separately presented on the Companys Consolidated Balance Sheets. The Company is restricted from utilizing these assets for its own purposes. See also Note 14 of the Financial Statements and Supplementary Data included in Item 8 herein for further information.
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Total shareholders equity decreased $207.5 million in 2007 due to common share repurchases. Return on average equity, defined as net income divided by average equity over the previous five quarters, was 10.7% in 2007 and 4.7% in 2006.
Comparative Cash Flows
Cash flows from operations provided by continuing operations were $255.2 million, $143.9 million and $190.8 million for 2007, 2006 and 2005, respectively. The 2007 increase was primarily due to higher income from continuing operations and lower tax payments, resulting primarily from the timing between 2006 and 2007 of tax benefits associated with the sale of 40% of the Companys U.S. royalties in 2006. The 2006 decrease compared to 2005 was primarily due to tax benefits of $29.2 million related to equity award grants which were classified as a financing activity cash inflow for the first time in 2006 in accordance with Statement of Financial Accounting Standards (SFAS) No. 123R Share Based Payment and higher working capital cash outflows in 2006 versus 2005. Prior to 2006, tax benefits related to equity award grants were classified as an operating activity cash inflow.
Cash flows from operations (used) provided by discontinued operations were $(1.7) million, $127.5 million and $286.5 million for 2007, 2006 and 2005, respectively. The 2007 decrease was primarily due to the spin-off of THI in 2006. The 2006 decrease was primarily due to the spin-off of THI in September 2006, higher tax and interest payments of $30.1 million, 2006 foreign currency hedge payments of $28.0 million and higher working capital cash outflows in 2006 versus 2005.
Net cash used in investing activities from continuing operations totaled $99.8 million in 2007 compared to $62.6 million in 2006 and cash provided of $3.7 million in 2005. The $37.2 million difference between 2007 and 2006 primarily reflects a decrease in proceeds from property dispositions of $31.1 million and higher 2007 capital expenditures of $20.6 million. Capital expenditures increased in 2007 due to a higher number of store remodels and a $12.4 million purchase of 18 properties pursuant to a previously granted put option that was exercised by the landlord on properties previously leased to the Company. Other differences between 2007 and 2006 include the receipt in 2007 of $8.4 million of insurance proceeds related to property losses incurred as a result of hurricanes Katrina and Wilma and lower 2007 expenditures for franchisee acquisitions.
The $66.3 million higher cash used in investing activities from continuing operations in 2006 compared to 2005 primarily reflects a decrease in 2006 proceeds from property dispositions of $133.2 million primarily due to the 2005 sale of properties previously leased to franchisees, partially offset by lower 2006 capital expenditures of $71.8 million. Capital expenditures are the largest ongoing component of the Companys investing activities and include expenditures for new restaurants, improvements to existing restaurants and other capital needs. A summary of continuing operations capital expenditures for the last three years follows.
(In millions) | 2007 | 2006 | 2005 | ||||||
New restaurants |
$ | 28 | $ | 44 | $ | 101 | |||
Restaurant improvements |
79 | 56 | 56 | ||||||
Other capital needs |
27 | 10 | 24 | ||||||
Total capital expenditures |
$ | 134 | $ | 110 | $ | 181 |
Net cash used in investing activities from discontinued operations was $.2 million in 2007 compared to $88.3 million in 2006 and $190.9 million in 2005. The decrease in net cash used in 2007 compared to 2006 is due to the spin-off of THI in 2006. The decrease in net cash used in 2006 compared to 2005 primarily reflects a $76.5 million decrease in capital expenditures for new store development and higher development costs in 2005 for THIs new distribution center and $25.0 million in net proceeds from the sale of Baja Fresh in 2006.
Net cash used in financing activities from continuing operations totaled $405.6 million in 2007 compared to $854.9 million in 2006 and $77.4 million in 2005. The $449.3 million decrease in net cash used from continuing
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operations in 2007 compared to 2006 primarily reflects fewer share repurchases of $726.9 million and lower 2007 dividends of $28.8 million, offset by $113.2 million in lower 2007 proceeds from employee exercises of stock options, and $78.3 million of 2007 debt repayments compared to net borrowing proceeds in 2006 of $90.7 million. The $777.5 million increase in net cash used from continuing operations in 2006 compared to 2005 primarily reflects higher 2006 share repurchases of $925.4 million and $96.1 million in lower 2006 proceeds from employee exercises of stock options, partially offset by $94.0 million in proceeds from debt established through the sale of a portion of the Companys royalty revenues and 2005 net debt repayments of $124.3 million. Dividends paid in 2007 decreased $28.8 million as the Company adjusted its annual dividend rate subsequent to the spin-off of THI to reflect the reduced earnings of the Company excluding THI.
Financing activities from discontinued operations provided no cash in 2007 and $796.9 million in 2006, compared to a cash use of $0.1 million in 2005. The 2006 amount primarily reflects net proceeds of $716.8 million related to the THI IPO and THI proceeds from the issuance of debt. Offsetting these amounts were 2006 net principal payments on debt obligations of $183.1 million, primarily reflecting THIs repayment of its $200 million Canadian bridge facility in May 2006 and the elimination of $170.6 million of THI cash.
Liquidity and Capital Resources
Cash flow from continuing operations, cash and investments on hand, possible asset sales, cash available through existing revolving credit agreements and the possible issuance of securities should provide for the Companys projected short-term and long-term cash requirements, including cash for capital expenditures, authorized share repurchases, dividends, repayment of debt, future acquisitions of restaurants from franchisees and other corporate purposes. The Company is currently negotiating a renewal of its revolving credit facility which expires in March 2008. In the past three years, cash provided by operating activities, borrowings, proceeds from stock options and other sources was used to primarily fund continued growth in restaurants, other capital expenditures, investments, dividend payments and repurchases of shares of common stock. As of December 30, 2007, the Company had $211.2 million of cash on its balance sheet.
In the first quarter of 2007, the Company completed an ASR of 9.0 million shares for $282.5 million at an initial price of $31.33 plus certain other costs. The repurchased shares were also subject to a purchase price adjustment based upon the weighted average price during the period from the repurchase date until settlement, which occurred in May 2007. The price adjustment increased the per share cost at settlement date to $33.05, resulting in an additional cost of $15.5 million.
In November 2006, the Company purchased 22.4 million of its common shares at a purchase price of $35.75 per share, for a total cost of $804.4 million by conducting a modified Dutch Auction tender offer. In the first quarter of 2006, the Company acquired 3.75 million shares in an ASR for a total cost of $220.1 million or $58.64 per share (prior to the spin-off of THI). Cash used to acquire the shares in November 2006 was received from THI after its IPO in late March and included borrowings by THI paid to the Company.
The Company expects 2008 capital expenditures to be in the range of approximately $110 million to $130 million for new restaurant development, remodeling, maintenance and technology initiatives. In 2008, the Company plans to open new company operated and franchised restaurants which, in the aggregate, would total between 70 and 90 compared to 92 in 2007. Development in 2008 is expected to be concentrated in North America.
The Company used cash totaling $298.0 million, $1.0 billion and $99.5 million in 2007, 2006 and 2005, respectively, to repurchase common shares. Generally, the Companys objective in its share repurchase program is to enhance shareholder value and offset the dilution impact of the Companys equity compensation program. Since 1998 through the end of 2007, the Company has repurchased 77.6 million common and other shares exchangeable into common shares for $2.4 billion.
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In the fourth quarter of 2006, the Company entered into an agreement to sell approximately 40% of the Companys U.S. royalties for a 14-month period to a third party in return for a cash payment in 2006 of $94.0 million. Royalties subject to the agreement relate to royalties payable to a subsidiary of the Company for both company operated and franchised stores. The cash received in 2006 was classified as debt and, as of December 30, 2007, the recorded debt was $18.8 million. This recorded debt amount is expected to be repaid through May 2008 as royalties are received. The agreement related to this transaction will conclude in May 2008, unless terminated earlier by agreement of the parties.
In February 2007, the Company announced that based on its strong cash position and strategic direction, it intended to increase its common stock dividend by 47%, from the annual $0.34 rate established in the fourth quarter of 2006 to $0.50, beginning with the May 2007 payment. The $0.50 annual dividend rate was established with an intended dividend yield of 1.4% to 1.6%. Prior to the spin-off of THI in the third quarter of 2006, the Companys annual dividend rate was $0.68. The Company adjusted its annual dividend rate subsequent to the spin-off of THI to reflect the reduced earnings of the Company excluding THI.
In 2006 and 2005, the Company issued only restricted stock, restricted stock units and performance shares (together with performance units, the restricted shares) under its existing equity plans. The issuance of restricted shares combined with significant option exercises over the last two years have reduced overhang (all approved but unexercised options and restricted shares divided by shares outstanding plus all approved but unexercised options and restricted shares). The Company obtained shareholder approval for the 2007 Stock Incentive Plan (the 2007 Plan) at its shareholders meeting on April 26, 2007. The 2007 Plan provides for equity compensation awards in the form of stock options, restricted stock, restricted stock units, stock appreciation rights, dividend equivalent rights, performance shares, performance units and share awards (collectively, Awards) to eligible employees and directors of the Company or its subsidiaries. The Company began using the 2007 Plan to issue annual stock option grants and long-term performance unit awards in 2007. The 2007 Plan authorizes up to 6 million common shares for grants of Awards. The common shares offered under the 2007 Plan may be authorized but unissued shares, treasury shares or any combination thereof. Based on the current compensation philosophy of the Companys Compensation Committee (the Committee), the Company expects that approximately 50% of the value of Awards made in subsequent years will be comprised of stock options, with the remaining 50% of the value comprised of performance awards. This was the philosophy under which Awards for 2007 were made. However, this is subject to review and possible change by the Committee.
In 2003, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (SEC) to issue up to $500 million of securities. As of December 30, 2007 and throughout the year, the Company was in compliance with its covenants under its $200 million revolving credit facility and the limits of its Senior Notes and debentures. As of December 30, 2007, no amounts under the $200 million credit facility were drawn and all of the $500 million of securities available under the above-mentioned Form S-3 filing remained unused. The $200 million credit facility expires March 2008 and the Company is currently negotiating a renewal of this agreement.
Standard & Poors and Moodys rate the Companys senior unsecured debt as BB- and Ba3, respectively. The ratings were downgraded in the second quarter of 2007 and are considered below investment grade. Following the Companys announcement on June 18, 2007 that the Special Committee of its Board of Directors had decided to explore a possible sale of the Company and was evaluating a possible securitization financing that could be used by a potential acquirer or in a recapitalization of the Company, Standard & Poors reduced its rating and issued a statement that the Companys debt ratings remained on credit watch with negative implications. Moodys also reduced its rating and issued a statement that it had placed the Companys debt ratings on review for possible downgrade. As a result of the lower debt ratings, the Company could incur an increase in borrowing costs if it were to enter into new borrowing arrangements and can no longer access the capital markets through its commercial paper program. If the ratings should continue to decline, it is possible that the Company would not be able to borrow on acceptable terms. Factors that could be significant to the determination of the Companys credit ratings include, among other things, sales and cost trends, the Companys cash position, cash flow, capital
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expenditures, stability of earnings, the possible non-renewal of the Companys revolving credit facility and transactions implemented in connection with the strategic alternatives being considered by the Special Committee.
The Company does not have significant term-debt maturities until 2011. The Company believes it will be able to pay or refinance its debt obligations as they become due based on its strong financial condition and sources of cash described above. The Companys significant contractual obligations and commitments as of December 30, 2007 are shown in the following table. Purchase obligations primarily include commitments for advertising expenditures and purchases for certain food-related ingredients.
Payments Due by Period | |||||||||||||||
Contractual Obligations(1) (In thousands) |
Less Than 1 Year |
1-3 Years | 3-5 Years | After 5 Years |
Total | ||||||||||
Long-term debt, including interest and current maturities |
$ | 59,473 | $ | 66,929 | $ | 252,479 | $ | 432,725 | $ | 811,606 | |||||
Capital leases |
2,048 | 15,994 | 3,290 | 13,705 | 35,037 | ||||||||||
Operating leases |
62,289 | 118,172 | 92,795 | 723,724 | 996,980 | ||||||||||
Purchase obligations |
166,220 | 2,823 | 1,111 | 0 | 170,154 | ||||||||||
Total Contractual Obligations |
$ | 290,030 | $ | 203,918 | $ | 349,675 | $ | 1,170,154 | $ | 2,013,777 |
(1) | As of December 30, 2007, the Companys pension assets are approximately $7.3 million less than the projected benefit obligation. In the fourth quarter of 2006, the Company decided to terminate its two defined benefit pension plans and has filed with the Internal Revenue Service to distribute the amounts due to plan participants. The Company believes these plan termination payments will be made in 2008 or 2009, but there are no assurances as to the ultimate timing. Estimates of reasonably likely future pension contributions by the Company in order to make the plans termination payments are heavily dependent on expectations about future events outside of the pension plans, such as future pension asset performance, future interest rates, future tax law changes and future changes in regulatory funding requirements. The Company currently estimates that contributions to its pension plans to make the plans termination payments will not exceed $20 million, but this estimate is subject to changes in factors outside the Companys control. Certain executive employees are also eligible to participate in one or more of the Companys supplemental executive retirement plans. Under these plans, each participating employees account reflects amounts credited by the Company based on the employees earnings plus or minus investment gains and losses of specified investments in which amounts credited by the Company are deemed to be invested. The supplemental executive retirement plans are not funded, but account balances of approximately $9 million, which are included in other long-term liabilities on the Consolidated Balance Sheet as of December 30, 2007, are payable to participating employees when they retire or otherwise are no longer employed by the Company. Estimates of reasonably likely future payments by the Company under the supplemental executive retirement plans are heavily dependent on future events outside of these plans, such as the timing of participating employees leaving the Company, the performance of the deemed investments and the time period over which employees elect to receive distributions from the supplemental executive retirement plans. Due to the significant uncertainties regarding future pension fund contributions and payments under the Companys supplemental executive retirement plans, no pension fund contributions or supplemental executive retirement plan payments are included in the table. In addition, the Company also has liabilities for income taxes, however the timing or amounts for periods beyond 2007 cannot be determined. |
Other Commercial Commitments (In thousands) |
As of December 30, 2007 | ||
Franchisee lease and loan guarantees |
$ | 168,956 | |
Contingent rent on leases |
19,356 | ||
Letters of credit |
6,514 | ||
Total Other Commercial Commitments |
$ | 194,826 |
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The Company has guaranteed certain leases and debt payments, primarily related to franchisees, amounting to $169.0 million. In the event of default by a franchise owner, the Company generally retains the right to acquire possession of the related restaurants. The Company is contingently liable for certain other leases amounting to an additional $19.4 million. These leases have been assigned to unrelated third parties, who have agreed to indemnify the Company against future liabilities arising under the leases. These leases expire on various dates through 2022. The Company is also the guarantor on $6.5 million in letters of credit with various parties, however, management does not expect any material loss to result from these letters of credit because it does not believe performance will be required. The length of the lease, loan and other arrangements guaranteed by the Company or for which the Company is contingently liable varies, but generally does not exceed 20 years.
In accordance with Financial Accounting Standards Board Interpretation (FIN) 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and based on available information, the Company has accrued for certain guarantees and indemnities as of December 30, 2007 and December 31, 2006, in amounts which, in total, are not material.
At December 30, 2007 and December 31, 2006, the Companys reserves established for doubtful royalty receivables were $2.5 million and $3.1 million, respectively. Reserves related to possible losses on notes receivable, real estate, guarantees, claims and contingencies involving franchisees totaled $9.0 million and $7.4 million at December 30, 2007 and December 31, 2006, respectively. These reserves are included in accounts receivable, notes receivable and other accrued expenses.
MANAGEMENTS OUTLOOK
Comprehensive Plan
In October 2006, the Company announced a new plan to drive restaurant-level economic performance focused on product innovation, targeted marketing and operations excellence. Components include:
| Revitalize Wendys Core BrandThe Company will focus on its brand essence, Quality Made Fresh, centered on Wendys core strength, its hamburger business. |
| Streamline and improve operationsIncludes a new restaurant services group to improve system-wide restaurant operations performance, while driving improved store profits and operating margins. |
| Reclaim Innovation LeadershipDevelopment of new products that reinforce Wendys Quality Made Fresh brand essence and drive new consumers to its restaurants. The Company believes its new product pipeline is now robust. |
| Investingapproximately $60 million per year over the next five years into the upgrade and renovation of its company operated restaurants. |
| Strengthen Franchisee CommitmentProviding up to $25 million per year of incentives to franchisees for reinvestments in their restaurants over the next four years, and require franchisees to meet store remodel standards. The Company anticipates spending significantly less than $25 million in 2008. |
| Franchising of RestaurantsThe Company also intends to sell up to approximately 300 400 of its company operated restaurants to franchisees beginning in 2008, but focusing on improving store level profitability first. |
| Capture New OpportunitiesSeeking to drive growth beyond its existing business. The Company is expanding breakfast and is following a disciplined process for product development and operations, as well as analyzing consumer feedback. With the quick-service restaurant breakfast market estimated at $30 billion, breakfast is a priority for the Company that could generate significant long-term sales and profits. Also, the Company believes it has considerable opportunity to expand in the U.S. over the long-term and is making infrastructure investments to grow its international business. The Company will continue to moderate its short-term North American development until restaurant revenues and operating cash flows improve. |
| Embrace a Performance-Driven CultureThe Company is executing a redesigned incentive compensation plan to drive future performance to better reward individual employee performance and to better align compensation with business performance in the short and longer term. |
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| The Company is also prioritizing its strong culture based on the values established by Wendys founder Dave Thomas. |
As part of its comprehensive plan, in the fourth quarter of 2007 the Company renewed its commitment to quality and innovation in all that it does and announced specific initiatives which focus on driving growth, creating efficiencies and improving returns. These initiatives include:
| Core HamburgerContinuing to improve the Companys premium hamburger market share by increasing consumer appeal and building transactions. The Company intends to build on its core strength with distinctive national advertising, by leveraging the success of the Baconator and indulgent sandwiches and by emphasizing the brands unique competitive advantage of fresh, never frozen beef. |
| Value Menu propositionIntroducing an updated and effective value strategy to capture a growing share of the critical 18-34 year-old customer. |
| Beverage PlanEstablishing beverages as a destination, as well as a meal accompaniment. There are plans to expand several beverage programs. |
| Late Night / SnackingRe-energizing the Companys Late Night business and capturing afternoon and evening snack opportunities. Introducing innovative products that will appeal to frequent users of snack items. |
| BreakfastContinuing to leverage the Companys brand and optimize its facilities by offering a new daypart to consumers who exhibit a demand for a better, high quality breakfast. This component meets consumer needs in the fast-growing breakfast market and is focused on improving store margins. |
| Customer ServiceIntroducing a total customer feedback system for improved customer service. |
| ReinvestmentRe-imaging restaurants by using a systematic capital reinvestment process and a disciplined approach. Reinvesting is critical to meeting consumer needs and driving long-term sales improvement. |
| People QualityElevating the customer experience by improving the hiring and retention of the Companys employees while reducing turnover, improving training and generating savings at the store level. |
| Re-franchisingImproving the overall health of the Companys system by re-franchising, as well as acquiring and re-imaging franchise restaurants with potential for future re-franchising. |
| Store MarginsFocusing on food, labor, paper, general and administrative and indirect costs to achieve store margin objectives. |
Authorization of 4 million shares remaining for repurchase
In October 2006, the Companys Board of Directors approved a share repurchase program of up to 35.4 million shares to be implemented over the next 18 to 24 months. The Company utilized the majority of this authorization by conducting a modified Dutch Auction tender offer under which in the fourth quarter of 2006 it purchased 22.4 million common shares at a purchase price of $35.75. The Company purchased the shares tendered in the offer using existing cash on its balance sheet. In the first quarter of 2007, the Company purchased 9.0 million common shares in an ASR transaction at a final price of $33.05 per share plus certain other costs. As a result, as of December 30, 2007 4.0 million shares remained under the Board of Directors authorization.
Stock Ownership Guidelines
The stock ownership guidelines were revised by the Committee in April 2007, and call for officers to hold Company stock, in-the-money vested stock options and other vested equity awards in the following amounts:
Position | Multiple of Annual Base Salary | |
Chief Executive Officer |
5X | |
Chief Operations Officer and Executive Vice Presidents |
3X | |
Other Officers |
1X |
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Formation of Special Committee
In April 2007, the Company announced that its Board of Directors, acting unanimously, had formed a Special Committee of independent directors to investigate strategic options for Wendys. These options, among other things, included revisions to the Companys strategic plan, changes to its capital structure, or a possible sale, merger or other business combination. In June 2007, the Company announced that the Special Committee had decided to explore a more thorough examination of a possible sale of the Company and that the Special Committee was also evaluating a possible securitization financing. There is no specific timeframe to complete the review and there is no assurance that the process will result in any changes to the Companys current plans. In January 2008, the Special Committee announced it believed it was in the final stages of its review process. The Company is presently unable to predict whether the Special Committee will recommend implementation of any transaction in connection with its review, or whether any such transaction would materially adversely affect the ratings for the Companys debt securities, increase its borrowing costs, affect its ability to borrow money or raise capital by the issuance of equity, affect its strategic plan or result in materially increased expenses (such as if such transaction is a change in control under the terms of various plans and agreements to which the Company is a party).
Ongoing Initiatives
The Company continues to implement its strategic initiatives. These initiatives include leveraging the Companys core assets, growing average same-store sales, improving store-level productivity to enhance margins, improving underperforming operations, developing profitable new restaurants and implementing new technology initiatives. Management intends to allocate resources to improve returns on assets and invested capital, and monitor its progress by tracking various metrics, including return on average assets, return on average equity and return on invested capital, as well as comparing to historical performance, the Companys peers and other leading companies. The Company also continues to focus on its dividend policy, continued share repurchases and an equity-based compensation program for employees and directors.
New restaurant development will continue to be an important opportunity for the Company. The Company intends to grow responsibly, focusing on the markets with the best potential for sales and return on investment. A total of 92 new restaurants were opened in 2007. Current plans call for a total of 70 to 90 new company and franchise restaurant units to open in 2008. The primary focus will be in North America, with the majority of units being standard sites.
Another element of the Companys strategic plan is the evaluation of potential acquisitions of franchised restaurants and the sale of company stores to franchisees.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements as of December 30, 2007 and December 31, 2006 as that term is described by the SEC, other than those described in Note 12 to the Consolidated Financial Statements.
Revenue Recognition
Wendys has a significant number of company operated restaurants at which revenue is recognized as customers pay for products at the time of sale. Franchise revenues consist of royalties, rents, gains from the sales of properties to franchisees, and various franchise fees. Royalty revenues are due 15 days after a month ends and are normally collected within two months after a period ends. The timing of revenue recognition for both retail sales and franchise revenues does not involve significant contingencies and judgments other than providing adequate reserves against collections of franchise-related revenues.
The Application of Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that can have a material impact on
35
the results of operations of the Company. The earnings reporting process is covered by the Companys system of internal controls, and generally does not require significant management estimates and judgments. However, estimates and judgments are inherent in the calculations of royalty and other franchise-related revenue collections, legal obligations, pension and other postretirement benefits, income taxes, insurance liabilities, various other commitments and contingencies, valuations used when assessing potential impairment of goodwill, other intangibles and other long lived assets and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions.
The Company collects royalties, and in some cases rent, from franchisees. The Company provides for estimated losses for revenues that are not likely to be collected. Although the Company generally enjoys a good relationship with franchisees, and collection rates are currently very high, if average sales or the financial health of franchisees were to deteriorate, the Company might have to increase reserves against collection of franchise revenues.
The Company is self-insured for most domestic workers compensation, health care claims, general liability and automotive liability losses. The Company records its insurance liabilities based on historical and industry trends, which are continually monitored, and accruals are adjusted when warranted by changing circumstances. Outside actuaries are used to assist in estimating casualty insurance obligations. Since there are many estimates and assumptions involved in recording insurance liabilities, differences between actual future events and prior estimates and assumptions could result in adjustments to these liabilities. Workers compensation insurance can particularly involve significant time before the ultimate resolution of claims. Wendys had accrued $46.3 million and $47.3 million at year-end 2007 and 2006, respectively, for U.S. workers compensation liabilities, domestic general liability, domestic automotive liability and other property liabilities. In Canada, workers compensation benefits are part of a government-sponsored plan and although the Company and its employees make contributions to that plan, management is not involved in determining these amounts.
Pension and other retirement benefits, including all relevant assumptions required by generally accepted accounting principles, are evaluated each year with the oversight of the Companys retirement committee. Due to the technical nature of retirement accounting, outside actuaries are used to calculate the estimated future obligations. Market interest rates are reviewed to establish pension plan discount rates and expected returns on plan assets are based on the mix of investments and expected market returns. Since there are many estimates and assumptions involved in retirement benefits, differences between actual future events and prior estimates and assumptions could result in adjustments to pension expenses and obligations. If the Company were to change its discount rate by 0.25%, this would change annual pension costs by $0.3 million. If the Company were to change its long-term return on assets rate by 0.25%, this would change annual pension costs by $0.2 million. If the lump sum conversion rate used to calculate lump sum payments of participant liabilities were to change by 0.2%, this would increase the amount of contributions required to settle participant liabilities by approximately $4 million.
In the normal course of business, the Company must make continuing estimates of potential future legal obligations and liabilities, which requires the use of managements judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required.
The Company records income tax liabilities utilizing known obligations and estimates of potential obligations pursuant to SFAS No. 109 and FIN 48. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. When considered necessary, the Company records a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. Management must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to
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determine the proper valuation allowance. When the Company determines that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are involved in determining the proper tax valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance. The Company uses an estimate of its annual effective tax rate at each interim period based on the facts and circumstances available at that time while the actual effective tax rate is calculated at year-end.
Depreciation and amortization are recognized using the straight-line method in amounts adequate to amortize costs over the following estimated useful lives: buildings and leasehold improvements and property under capital leases, the lesser of the useful life of the asset (up to 40 years) or the lease term, as that term is defined in SFAS No. 13, Accounting for Leases, as amended; restaurant equipment, up to 15 years; and other equipment, up to 10 years. The Company estimates useful lives on buildings and equipment based on historical data and industry trends. The Company capitalizes certain internally developed software costs which are amortized over a period of up to 10 years. The Company monitors its capitalization and amortization policies to ensure they remain appropriate. Intangibles separate from goodwill are amortized on a straight-line basis over periods of generally up to 15 years. Lives may be related to legal or contractual lives, or must be estimated by management based on specific circumstances.
Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates that an impairment may exist. The Company tests for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing. If an impairment is indicated, the fair value of the fixed assets is estimated using the discounted cash flows or with the assistance of third party appraisals of the operating market. The interest rate used in preparing discounted cash flows is managements estimate of the weighted average cost of capital. The Company tests goodwill for impairment annually (or in interim periods if events or changes in circumstances indicate that its carrying amount may not be recoverable) by comparing the fair value of each reporting unit, as measured by discounted cash flows and market multiples based on earnings, to the carrying value to determine if there is an indication that a potential impairment may exist. One of the most significant assumptions is the projection of future sales. The Company reviews its assumptions each time goodwill is tested for impairment and makes appropriate adjustments, if any, based on facts and circumstances available at that time. In the fourth quarter of 2007, the Company tested goodwill for impairment and determined that no impairment was required.
Prior to January 2, 2006, the Company used the intrinsic value method to account for stock-based employee compensation as defined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, because stock options granted prior to January 2, 2006 had no intrinsic value at date of grant, compensation expense related to stock options was recognized using the Black-Scholes method only when stock option awards were modified after the grant date. During the fourth quarter of 2005, the Company accelerated the vesting of all outstanding options, excluding those held by outside directors of the Company. Prior to January 2, 2006, compensation expense recognized related to restricted shares was measured based on the market value of the Companys common stock on the date of grant. The Company generally satisfies share-based exercises and vesting through the issuance of authorized but previously unissued shares of Company stock. Restricted shares are generally net-settled with new Company shares withheld, and not issued, to meet the employees minimum statutory withholding tax requirements.
On January 2, 2006, the Company adopted SFAS No. 123R Share-Based Payment, which requires share-based compensation cost to be recognized based on the grant date estimated fair value of each award, net of estimated cancellations, over the employees requisite service period, which is generally the vesting period of the equity grant. The Company elected to adopt SFAS No. 123R using the modified prospective method, which requires compensation expense to be recorded for all unvested share-based awards beginning in the first quarter of adoption. Accordingly, the prior periods presented in this Form 10-K have not been restated to reflect the fair value method of expensing stock options. Also, because the value used to measure compensation expense for
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restricted shares is the same for APB Opinion No. 25 and SFAS No. 123R and because substantially all of the Companys stock option grants were fully vested prior to January 2, 2006, the adoption of SFAS No. 123R did not have a material impact on the Companys operating income, pretax income or net income. The adoption did require the Company to classify tax benefits as a financing activity versus an operating activity in the Consolidated Statements of Cash Flows.
SYSTEMWIDE RESTAURANTS
As of December 30, 2007 |
As of September 30, 2007 |
Increase/ (Decrease) From Prior Quarter |
As of December 31, 2006 |
Increase/ (Decrease) From Prior Year |
||||||||
U.S. |
||||||||||||
Company |
1,274 | 1,288 | (14 | ) | 1,317 | (43 | ) | |||||
Franchise |
4,662 | 4,644 | 18 | 4,638 | 24 | |||||||
5,936 | 5,932 | 4 | 5,955 | (19 | ) | |||||||
Canada |
||||||||||||
Company |
140 | 141 | (1 | ) | 146 | (6 | ) | |||||
Franchise |
236 | 235 | 1 | 231 | 5 | |||||||
376 | 376 | 0 | 377 | (1 | ) | |||||||
Other International |
||||||||||||
Company |
0 | 2 | (2 | ) | 2 | (2 | ) | |||||
Franchise |
333 | 323 | 10 | 339 | (6 | ) | ||||||
333 | 325 | 8 | 341 | (8 | ) | |||||||
Total |
||||||||||||
Company |
1,414 | 1,431 | (17 | ) | 1,465 | (51 | ) | |||||
Franchise |
5,231 | 5,202 | 29 | 5,208 | 23 | |||||||
6,645 | 6,633 | 12 | 6,673 | (28 | ) |
Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157 Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 creates consistency and comparability in fair value measurements among the many accounting pronouncements that require fair value measurements but does not require any new fair value measurements. This statement is effective for fiscal years beginning after November 15, 2007 except for nonfinancial assets and nonfinancial liabilities, for which the effective date is fiscal years beginning after November 15, 2008. The adoption of SFAS No. 157 is not expected to have a material impact on the Companys financial statements.
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS No. 115. This statement allows entities to measure certain assets and liabilities at fair value, with changes in the fair value recognized in earnings. The statements objective is to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently, without applying complex hedge accounting provisions. This statement is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of the adoption of SFAS No. 159.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. This Statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This Statement changes the accounting for acquisition-related costs and restructuring costs, now requiring those costs to be recognized separately from the
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acquisition. This Statement also makes various other amendments to the authoritative literature intended to provide additional guidance or to conform the guidance in that literature to that provided in this Statement. SFAS No. 141(R) shall be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and early adoption is prohibited. The Company is currently evaluating the impact of the adoption of SFAS No. 141 (R).
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary (previously referred to as minority interest) and for the deconsolidation of a subsidiary. This Statement shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. The Company is currently evaluating the impact of the adoption of SFAS No. 160.
Safe Harbor Statement
Certain information contained in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, particularly information regarding future economic performance and finances, plans and objectives of management, is forward looking. In some cases, information regarding certain important factors that could cause actual results to differ materially from any such forward-looking statement appears together with such statement. In addition, the following factors, in addition to other possible factors not listed, could affect the Companys actual results and cause such results to differ materially from those expressed in forward-looking statements. These factors include: competition within the quick-service restaurant industry, which remains extremely intense, both domestically and internationally, with many competitors pursuing heavy price discounting; changes in economic conditions; changes in consumer perceptions of food safety; harsh weather, particularly in the first and fourth quarters; changes in consumer tastes; labor and benefit costs; legal claims; risk inherent to international development (including currency fluctuations); the continued ability of the Company and its franchisees to obtain suitable locations and financing for new restaurant development; governmental initiatives such as minimum wage rates, taxes and possible franchise legislation; changes in applicable accounting rules; the ability of the Company to successfully complete transactions designed to improve its return on investment; or other factors set forth in this Form 10-K, including (in addition to other sections) Item 1A and Exhibit 99 hereto.
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Inflation
Financial statements determined on a historical cost basis may not accurately reflect all the effects of changing prices on an enterprise. Several factors tend to reduce the impact of inflation for the Company. Inventories approximate current market prices. There is some ability to adjust menu prices and liabilities are repaid with dollars of reduced purchasing power.
Foreign Exchange Risk
The Companys exposure to foreign exchange risk is primarily related to fluctuations in the Canadian dollar relative to the U.S. dollar for the Canadian operations. Exposure outside of North America is limited to royalties paid by franchisees. The exposure to Canadian dollar exchange rates on the Companys 2007 cash flows primarily includes imports paid for by Canadian operations in U.S. dollars and payments from the Companys Canadian operations to the Companys U.S. operations. After the spin-off of THI, the Companys exposure to Canadian dollar foreign currency risk is not material.
39
The Company seeks to manage its cash flows and balance sheet exposure to changes in the value of foreign currencies. The Company may use derivative products to reduce the risk of a significant negative impact on its U.S. dollar cash flows or income. The Company does not hedge foreign currency exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates on net income and cash flows. The Company has a policy forbidding trading or speculating in foreign currency and does not hedge foreign currency translation. In accordance with SFAS No. 133, the Company defers unrealized gains and losses arising from foreign currency derivatives until the impact of the related transactions occur. Fair values are determined from quoted market prices. Since the spin-off of THI in 2006, the Company has not entered into any foreign currency hedges.
At the 2007 level of annual operating income generated from Canada, if the Canadian currency rate changes U.S. $0.05, or 5% compared to the average 2007 exchange rate, for an entire year, the annual impact on the Companys diluted EPS would be approximately one cent per share. At current royalty levels outside of North America, if all foreign currencies moved 10% during each royalty collection period in the same direction, at the same time, the annual impact on the Companys diluted EPS would be less than one cent per share. The Company has not hedged its exposure to currency fluctuations related to royalty collections outside North America because it does not believe the risk is material.
Interest Rate Risk
The Companys debt is denominated in U.S. dollars, at fixed interest rates. The Company is exposed to interest rate risk impacting its net borrowing costs. The Company may seek to manage its exposure to interest rate risk and to lower its net borrowing costs by managing the mix of fixed and floating rate instruments based on capital markets and business conditions.
To manage interest rate risk, the Company entered into an interest rate swap in 2003, effectively converting some of its fixed interest rate debt to variable interest rates. By entering into the interest rate swap, the Company agreed, at specified intervals, to receive interest at a fixed rate of 6.35% and pay interest based on the floating LIBOR-BBA interest rate, both of which were computed based on the agreed-upon notional principal amount of $100.0 million. The Company does not enter into speculative swaps or other financial contracts. The interest rate swap matured in December 2005 and met specific conditions of SFAS No. 133 to be considered a highly effective fair value hedge of a portion of the Companys long-term debt. Accordingly, gains and losses arising from the swap were completely offset against gains or losses of the underlying debt obligation. Since the spin-off of THI, the Company has not entered into an interest rate hedge.
Commodity Risk
The Company purchases certain products in the normal course of business which are affected by commodity prices. Therefore, the Company is exposed to some price volatility related to weather and various other market conditions outside the Companys control. However, the Company employs various purchasing and pricing contract techniques in an effort to minimize volatility. Generally these techniques can include setting fixed prices with suppliers generally for one year or less, setting in advance the price for products to be delivered in the future (sometimes referred to as buying forward), and unit pricing based on an average of commodity prices on indexes over a period of time. The Company has not used financial instruments to hedge commodity prices, partly because of the contract pricing utilized. While price volatility can occur, which would impact profit margins, there are generally alternative suppliers available and, if the pricing problem is prolonged, the Company has some ability to increase selling prices to offset a rise in commodity price increases.
In instances such as reported cases of mad cow disease and illnesses from the E. coli bacteria, it is possible the Company may be exposed to commodity risks other than price risk. Reported cases over the past several years of mad cow disease and illnesses from the E. coli bacteria in North America, however, did not significantly
40
impact the Companys sales or earnings. There can be no assurance, however, that a future case of mad cow disease or illness from the E. coli bacteria or another food-borne illness would not have a significant impact on the Companys sales and earnings.
Concentration of Credit Risk
The Company has cash balances in various domestic bank accounts above the Federal Deposit Insurance Corporation (FDIC) guarantee limits. The Company subscribes to a bank rating system and only utilizes high-grade banks for accounts that might exceed these limits. At year-end 2007, the amount in domestic bank accounts above FDIC limits was approximately $25 million. The Company also has cash in various Canadian bank accounts above amounts guaranteed by the Canadian Deposit Insurance Corporation of Canada (CDIC). At year-end 2007, the amount in Canadian banks above CDIC limits was approximately $25 million dollars equivalent. The Company utilizes only high-grade banks in Canada for accounts that might exceed CDIC limits.
Item 8. | Financial Statements and Supplementary Data |
Managements Statement of Responsibility for Financial Statements and Report on Internal Control Over Financial Reporting
Financial Statements
Management is responsible for preparation of the consolidated financial statements and other related financial information included in this annual report on Form 10-K. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, incorporating managements reasonable estimates and judgments, where applicable.
Managements Report on Internal Control Over Financial Reporting
This report is provided by management pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and the SEC rules promulgated thereunder. Management is responsible for establishing and maintaining adequate internal control over financial reporting and for assessing the effectiveness of internal control over financial reporting.
The Companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use, or disposition of the Companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
41
Management has assessed the Companys internal control over financial reporting as of December 30, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the assessment of the Companys internal control over financial reporting, management has concluded that, as of December 30, 2007, the Companys internal control over financial reporting was effective.
The effectiveness of the Companys internal control over financial reporting as of December 30, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
42
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Wendys International, Inc.:
In our opinion, the consolidated financial statements listed in the index appearing under item 15(a) (1) and (2) present fairly, in all material respects, the financial position of Wendys International, Inc. and its subsidiaries at December 30, 2007 and December 31, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 30, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Companys internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 1 to the consolidated financial statements, effective January 2, 2006 the Company changed the manner in which it accounts for share-based compensation. As discussed in Note 13, the Company changed the manner in which it records the funded status of its defined benefit pension plans in 2006. As discussed in Note 5 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes in 2007.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Columbus, Ohio
February 27, 2008
43
Wendys International, Inc. and SubsidiariesConsolidated Statements of Income
Years ended December 30, 2007, December 31, 2006 and January 1, 2006 | ||||||||||||
(In thousands, except per share data) | 2007 | 2006 | 2005 | |||||||||
Revenues |
||||||||||||
Sales |
$ | 2,160,025 | $ | 2,154,607 | $ | 2,138,365 | ||||||
Franchise revenues |
290,219 | 284,670 | 317,053 | |||||||||
Total revenues |
2,450,244 | 2,439,277 | 2,455,418 | |||||||||
Costs and expenses |
||||||||||||
Cost of sales |
1,322,264 | 1,352,312 | 1,362,631 | |||||||||
Company restaurant operating costs |
597,285 | 602,298 | 581,869 | |||||||||
Operating costs |
22,725 | 46,674 | 20,419 | |||||||||
Depreciation of property and equipment |
113,127 | 122,636 | 127,998 | |||||||||
General and administrative expenses |
212,425 | 237,575 | 220,891 | |||||||||
Restructuring and Special Committee related charges |
34,427 | 38,914 | 0 | |||||||||
Other (income) expense, net |
(9,006 | ) | (1,446 | ) | (34,263 | ) | ||||||
Total costs and expenses |
2,293,247 | 2,398,963 | 2,279,545 | |||||||||
Operating income |
156,997 | 40,314 | 175,873 | |||||||||
Interest expense |
(45,010 | ) | (35,711 | ) | (43,076 | ) | ||||||
Interest income |
13,769 | 37,876 | 3,987 | |||||||||
Income from continuing operations before income taxes |
125,756 | 42,479 | 136,784 | |||||||||
Income taxes |
39,131 | 5,433 | 51,689 | |||||||||
Income from continuing operations |
86,625 | 37,046 | 85,095 | |||||||||
Income from discontinued operations |
1,271 | 57,266 | 138,972 | |||||||||
Net income |
$ | 87,896 | $ | 94,312 | $ | 224,067 | ||||||
Basic earnings per common share from continuing operations |
$ | 0.97 | $ | 0.33 | $ | 0.74 | ||||||
Diluted earnings per common share from continuing operations |
$ | 0.96 | $ | 0.32 | $ | 0.73 | ||||||
Basic earnings per common share from discontinued operations |
$ | 0.02 | $ | 0.50 | $ | 1.21 | ||||||
Diluted earnings per common share from discontinued operations |
$ | 0.01 | $ | 0.50 | $ | 1.19 | ||||||
Basic earnings per common share |
$ | 0.99 | $ | 0.83 | $ | 1.95 | ||||||
Diluted earnings per common share |
$ | 0.97 | $ | 0.82 | $ | 1.92 | ||||||
Dividends declared and paid per common share |
$ | 0.46 | $ | 0.60 | $ | 0.58 | ||||||
Basic shares |
89,143 | 114,244 | 114,945 | |||||||||
Diluted shares |
90,190 | 115,325 | 116,819 |
See accompanying Notes to the Consolidated Financial Statements.
44
Wendys International, Inc. and SubsidiariesConsolidated Balance Sheets
December 30, 2007 and December 31, 2006 | ||||||||
(Dollars in thousands) | 2007 | 2006 | ||||||
Assets |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 211,200 | $ | 457,614 | ||||
Accounts receivable, net |
72,069 | 84,841 | ||||||
Deferred income taxes |
7,304 | 29,651 | ||||||
Inventories and other |
29,590 | 30,252 | ||||||
Advertising fund restricted assets |
42,665 | 36,207 | ||||||
Assets held for disposition |
3,338 | 15,455 | ||||||
Current assets of discontinued operations |
0 | 2,712 | ||||||
Total current assets |
366,166 | 656,732 | ||||||
Property and equipment, net |
1,246,885 | 1,226,328 | ||||||
Goodwill |
84,001 | 85,353 | ||||||
Deferred income taxes |
4,899 | 4,316 | ||||||
Intangible assets, net |
2,704 | 3,855 | ||||||
Other assets |
84,742 | 82,738 | ||||||
Non current assets of discontinued operations |
0 | 1,025 | ||||||
Total assets |
$ | 1,789,397 | $ | 2,060,347 | ||||
Liabilities and Shareholders Equity |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 85,662 | $ | 93,465 | ||||
Accrued expenses |
||||||||
Salaries and wages |
39,157 | 47,329 | ||||||
Taxes |
31,033 | 46,138 | ||||||
Insurance |
57,190 | 57,353 | ||||||
Other |
45,612 | 32,199 | ||||||
Advertising fund restricted liabilities |
35,760 | 28,568 | ||||||
Current portion of long-term obligations |
26,591 | 87,396 | ||||||
Current liabilities of discontinued operations |
0 | 2,218 | ||||||
Total current liabilities |
321,005 | 394,666 | ||||||
Long-term obligations |
||||||||
Term debt |
521,343 | 537,139 | ||||||
Capital leases |
21,680 | 18,963 | ||||||
Total long-term obligations |
543,023 | 556,102 | ||||||
Deferred income taxes |
45,351 | 30,220 | ||||||
Other long-term liabilities |
75,887 | 66,163 | ||||||
Non current liabilities of discontinued operations |
0 | 1,519 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity |
||||||||
Preferred stock, Authorized: 250,000 shares |
||||||||
Common stock, $.10 stated value per share, Authorized: 200,000,000 shares, Issued: 130,241,000 and 129,548,000 shares, respectively |
13,024 | 12,955 | ||||||
Capital in excess of stated value |
1,110,363 | 1,089,825 | ||||||
Retained earnings |
1,287,963 | 1,241,489 | ||||||
Accumulated other comprehensive income (expense): |
||||||||
Cumulative translation adjustments |
28,949 | 9,100 | ||||||
Pension liability |
(18,990 | ) | (22,546 | ) | ||||
2,421,309 | 2,330,823 | |||||||
Treasury stock, at cost: 42,844,000 and 33,844,000 shares, respectively |
(1,617,178 | ) | (1,319,146 | ) | ||||
Total shareholders equity |
804,131 | 1,011,677 | ||||||
Total liabilities and shareholders equity |
$ | 1,789,397 | $ | 2,060,347 |
See accompanying Notes to the Consolidated Financial Statements.
45
Wendys International, Inc. and SubsidiariesConsolidated Statements of Cash Flows
Years ended December 30, 2007, December 31, 2006 and January 1, 2006 |
||||||||||||
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Cash flows from operating activities |
||||||||||||
Net income |
$ | 87,896 | $ | 94,312 | $ | 224,067 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities |
||||||||||||
Income from discontinued operations |
(1,271 | ) | (57,266 | ) | (138,972 | ) | ||||||
Depreciation and amortization |
115,339 | 123,700 | 129,000 | |||||||||
Deferred income taxes |
37,647 | (31,781 | ) | (12,475 | ) | |||||||
(Gain) loss from property dispositions, net |
2,880 | 14,800 | (48,060 | ) | ||||||||
Equity based compensation expense |
12,342 | 11,413 | 16,194 | |||||||||
Tax benefit on the exercise of stock options |
5,006 | 29,189 | 37,872 | |||||||||
Excess stock-based compensation tax benefits |
(5,006 | ) | (29,189 | ) | 0 | |||||||
Net reserves for receivables and other contingencies |
758 | 635 | (81 | ) | ||||||||
Changes in operating assets and liabilities, net of effects of acquisitions and dispositions of restaurants |
||||||||||||
Accounts and notes receivable |
13,356 | (23,386 | ) | (1,984 | ) | |||||||
Inventories and other |
613 | (2,000 | ) | (4,607 | ) | |||||||
Accounts payable and accrued expenses |
(18,149 | ) | (3,710 | ) | (15,956 | ) | ||||||
Other, net |
3,834 | 17,189 | 5,819 | |||||||||
Net cash provided by operating activities from continuing operations |
255,245 | 143,906 | 190,817 | |||||||||
Net cash (used in) provided by operating activities from discontinued operations |
(1,710 | ) | 127,473 | 286,460 | ||||||||
Net cash provided by operating activities |
253,535 | 271,379 | 477,277 | |||||||||
Cash flows from investing activities |
||||||||||||
Proceeds from property dispositions |
31,771 | 62,885 | 196,036 | |||||||||
Capital expenditures |
(130,102 | ) | (109,533 | ) | (181,302 | ) | ||||||
Acquisition of franchises |
(9,586 | ) | (13,263 | ) | (13,251 | ) | ||||||
Proceeds from insurance settlements |
8,389 | 0 | 0 | |||||||||
Principal payments on notes receivable |
608 | 514 | 9,838 | |||||||||
Investments in joint ventures and other investments |
(911 | ) | (1,701 | ) | (2,420 | ) | ||||||
Other investing activities |
0 | (1,540 | ) | (5,216 | ) | |||||||
Net cash provided by (used in) investing activities from continuing operations |
(99,831 | ) | (62,638 | ) | 3,685 | |||||||
Net cash used in investing activities from discontinued operations |
(174 | ) | (88,279 | ) | (190,898 | ) | ||||||
Net cash used in investing activities |
(100,005 | ) | (150,917 | ) | (187,213 | ) | ||||||
Cash flows from financing activities |
||||||||||||
Proceeds from issuance of debt |
0 | 127,973 | 0 | |||||||||
Proceeds from employee stock options exercised |
6,621 | 119,846 | 215,938 | |||||||||
Excess stock-based compensation tax benefits |
5,006 | 29,189 | 0 | |||||||||
Repurchase of common stock |
(298,032 | ) | (1,024,963 | ) | (99,545 | ) | ||||||
Principal payments on debt |
(78,304 | ) | (37,306 | ) | (127,675 | ) | ||||||
Dividends paid on common shares |
(40,885 | ) | (69,667 | ) | (66,137 | ) | ||||||
Net cash used in financing activities from continuing operations |
(405,594 | ) | (854,928 | ) | (77,419 | ) | ||||||
Net cash provided by (used in) financing activities from discontinued operations |
0 | 796,946 | (94 | ) | ||||||||
Net cash used in financing activities |
(405,594 | ) | (57,982 | ) | (77,513 | ) | ||||||
Effect of exchange rate changes on cashcontinuing operations |
3,377 | (246 | ) | 265 | ||||||||
Effect of exchange rate changes on cashdiscontinued operations |
0 | 4,412 | 3,676 | |||||||||
Net increase in cash and cash equivalents |
(248,687 | ) | 66,646 | 216,492 | ||||||||
Cash and cash equivalents at beginning of period |
457,614 | 230,560 | 64,679 | |||||||||
Add: Cash and cash equivalents of discontinued operations at beginning of period |
2,273 | 162,681 | 112,070 | |||||||||
Net increase (decrease) in cash and cash equivalents |
(248,687 | ) | 66,646 | 216,492 | ||||||||
Less: Cash and cash equivalents of discontinued operations at end of period |
0 | (2,273 | ) | (162,681 | ) | |||||||
Cash and cash equivalents at end of period |
$ | 211,200 | $ | 457,614 | $ | 230,560 | ||||||
Supplemental disclosures of cash flow information: |
||||||||||||
Interest paid from continuing operations |
$ | 41,881 | $ | 35,369 | $ | 43,167 | ||||||
Interest paid from discontinued operations |
0 | 16,783 | 6,675 | |||||||||
Income taxes (refunded) paid |
(9,738 | ) | 110,453 | 88,845 | ||||||||
Dividend of THI net assets in conjunction with THI spin-off, including cash of $166.0 million |
0 | 638,858 | 0 | |||||||||
Non-cash investing and financing activities: |
||||||||||||
Capital lease obligations incurred from continuing operations |
$ | 2,046 | $ | 1,432 | $ | 3,852 | ||||||
Capital lease obligations incurred from discontinued operations |
0 | 3,854 | 3,871 |
See accompanying Notes to the Consolidated Financial Statements.
46
Wendys International, Inc. and SubsidiariesConsolidated Statements of Shareholders Equity
Years ended December 30, 2007, December 31, 2006 and January 1, 2006 | ||||||||||||
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Common stock at stated value |
||||||||||||
Balance at beginning of period |
$ | 12,955 | $ | 12,549 | $ | 11,809 | ||||||
Exercise of options and restricted stock vesting |
69 | 406 | 740 | |||||||||
Balance at end of period |
13,024 | 12,955 | 12,549 | |||||||||
Capital in excess of stated value |
||||||||||||
Balance at beginning of period |
1,089,825 | 405,588 | 111,286 | |||||||||
Exercise of options, including tax benefits of $2,707, $25,440, and $37,816 |
9,282 | 145,049 | 257,589 | |||||||||
Initial Public Offering of THI |
0 | 716,680 | 0 | |||||||||
THI Minority Interest |
0 | (140,288 | ) | 0 | ||||||||
Unearned compensationrestricted stock |
0 | (37,778 | ) | 0 | ||||||||
Restricted stock awards and other equity-based compensation |
11,256 | 8,282 | 36,713 | |||||||||
Tax adjustments related to the THI spin-off |
0 | (7,708 | ) | 0 | ||||||||
Balance at end of period |
1,110,363 | 1,089,825 | 405,588 | |||||||||
Retained earnings |
||||||||||||
Balance at beginning of period |
1,241,489 | 1,858,743 | 1,700,813 | |||||||||
Net income |
87,896 | 94,312 | 224,067 | |||||||||
Dividends |
(41,422 | ) | (72,708 | ) | (66,137 | ) | ||||||
Spin-off of THI |
0 | (638,858 | ) | 0 | ||||||||
Balance at end of period |
1,287,963 | 1,241,489 | 1,858,743 | |||||||||
Accumulated other comprehensive income |
9,959 | (13,446 | ) | 114,156 | ||||||||
Treasury stock, at cost |
||||||||||||
Balance at beginning of period |
(1,319,146 | ) | (294,669 | ) | (195,124 | ) | ||||||
Purchase of common stock |
(298,032 | ) | (1,024,477 | ) | (99,545 | ) | ||||||
Balance at end of period |
(1,617,178 | ) | (1,319,146 | ) | (294,669 | ) | ||||||
Unearned compensationrestricted stock |
0 | 0 | (37,778 | ) | ||||||||
Shareholders equity |
$ | 804,131 | $ | 1,011,677 | $ | 2,058,589 | ||||||
Common shares |
||||||||||||
Balance issued at beginning of period |
129,548 | 125,490 | 118,090 | |||||||||
Exercise of options and restricted stock vesting |
693 | 4,058 | 7,400 | |||||||||
Balance issued at end of period |
130,241 | 129,548 | 125,490 | |||||||||
Treasury shares |
||||||||||||
Balance at beginning of period |
(33,844 | ) | (7,681 | ) | (5,681 | ) | ||||||
Purchase of common stock |
(9,000 | ) | (26,163 | ) | (2,000 | ) | ||||||
Balance at end of period |
(42,844 | ) | (33,844 | ) | (7,681 | ) | ||||||
Common shares outstanding |
87,397 | 95,704 | 117,809 |
See accompanying Notes to the Consolidated Financial Statements.
47
Wendys International, Inc. and SubsidiariesConsolidated Statements of Comprehensive Income
Years ended December 30, 2007, December 31, 2006 and January 1, 2006 | |||||||||||
(In thousands) | 2007 | 2006 | 2005 | ||||||||
Net income |
$ | 87,896 | $ | 94,312 | $ | 224,067 | |||||
Other comprehensive income (expense) |
|||||||||||
Translation adjustments, net of tax of $3,071 for the year ended December 31, 2006 |
19,849 | 5,402 | 10,820 | ||||||||
Cash flow hedges: |
|||||||||||
Net change in fair value of derivatives, net of tax |
0 | (7,705 | ) | (3,289 | ) | ||||||
Amounts realized in earnings during the period, net of tax |
0 | 7,758 | 4,771 | ||||||||
Total cash flow hedges |
0 | 53 | 1,482 | ||||||||
Pension liability (net of tax benefit of $2,161 for the year ended December 30, 2007 and tax expense of $13,033 and $100 for the years ended December 31, 2006 and January 1, 2006, respectively) |
3,556 | (21,450 | ) | (183 | ) | ||||||
Total other comprehensive income (expense) (1) |
23,405 | (15,995 | ) | 12,119 | |||||||
Comprehensive income |
$ | 111,301 | $ | 78,317 | $ | 236,186 |
(1) | In addition to the amounts presented for 2006 above, accumulated other comprehensive income on the Consolidated Balance Sheets reflects the distribution of $112.2 million of accumulated translation adjustments as part of the spin-off of THI (see Note 6 to the Consolidated Financial Statements). |
See accompanying Notes to the Consolidated Financial Statements.
48
Wendys International, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
NOTE 1 | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Description of business
The principal business of Wendys International, Inc. and Subsidiaries (the Company) is the operation, development and franchising of quick-service restaurants serving high-quality food. At year-end 2007, the Company and its franchise owners operated 6,645 restaurants under the name Wendys in 50 states and in 19 other countries and territories. As of December 30, 2007, total systemwide restaurants included 1,414 company operated restaurants and 5,231 franchise restaurants.
On March 29, 2006, the Company completed its initial public offering (IPO) of Tim Hortons Inc. (THI). A total of 33.4 million shares of THI were offered at an initial per share price of $23.162 ($27.00 Canadian). The shares sold in the IPO represented 17.25% of total THI shares issued and outstanding and the Company retained the remaining 82.75%. On September 29, 2006, the Company completed the spin-off of its remaining 82.75% ownership in THI, the parent company of the business previously reported as the Hortons segment. Accordingly, the results of operations of THI are reflected as discontinued operations for all periods presented. On November 28, 2006 and July 29, 2007, the Company completed the sales of Baja Fresh and Cafe Express, respectively, and accordingly, the results of operations of Baja Fresh and Cafe Express are reflected as discontinued operations for all periods presented. The assets and liabilities of Cafe Express were held for sale at December 31, 2006 and are presented as current and non-current assets and liabilities from discontinued operations as of that date (see Note 10 to the Consolidated Financial Statements). Baja Fresh and Cafe Express historically comprised the Developing Brands segment.
Fiscal year
The Companys fiscal year ends on the Sunday nearest to December 31. The 2007, 2006 and 2005 fiscal years each consisted of 52 weeks.
Basis of presentation
The Consolidated Financial Statements include the results and balances of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation (see also Note 14 to the Consolidated Financial Statements for consolidation of the Companys advertising funds).
Investments in unconsolidated affiliates over which the Company exercises significant influence but is not the primary beneficiary and does not have control are accounted for using the equity method. The Companys share of the net income or loss of these unconsolidated affiliates is included in Other (income) expense, net. The Company is a partner in a 50/50 Canadian restaurant real estate joint venture with THI. After the spin-off of THI on September 29, 2006, this joint venture is no longer consolidated in the Companys financial statements and Wendys 50% share of the joint venture is accounted for using the equity method. The income from this joint venture is included in Other (income) expense, net on the Consolidated Statements of Income as it is directly related to the operations of the Company.
In 2007, the Company added the Restructuring and Special Committee related charges line to the Consolidated Statements of Income, which required the reclassification of $38.9 million of restructuring costs out of Other (income) expense, net in 2006 for purposes of comparability. There were no restructuring charges in 2005.
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Cash and cash equivalents
The Company considers short-term investments with original maturities of three months or less as cash equivalents. Cash overdrafts, which occur on bank accounts that do not have a right of offset and that are not funded until issued checks are presented for payment, are recorded within Accounts payable and totaled $16.0 million and $14.0 million at December 30, 2007 and December 31, 2006, respectively.
Accounting estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates. These affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates and judgments are inherent in the calculations of royalty and other franchise-related revenue collections, legal obligations, pension and other postretirement benefits, income taxes, insurance liabilities, various other commitments and contingencies, valuations used when assessing potential impairment of goodwill, other intangibles and fixed assets and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions.
In the normal course of business, the Company must make continuing estimates of potential future legal obligations and liabilities, which requires the use of managements judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required.
Inventories
Inventories, amounting to $12.6 million and $17.2 million at December 30, 2007 and December 31, 2006, respectively, are stated at the lower of cost (first-in, first-out) or market, and consist primarily of restaurant food items, kids meal toys, and parts and paper supplies.
Property and equipment
Depreciation and amortization are recognized using the straight-line method in amounts adequate to amortize costs over the following estimated useful lives: buildings and leasehold improvements and property under capital leases, the lesser of the useful life of the asset (up to 40 years) or the lease term as that term is defined in Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases, as amended; restaurant equipment, up to 15 years; computer hardware, up to 5 years; computer software, up to 10 years; vehicles, up to 7 years; and other equipment, up to 10 years. Interest associated with the construction of new restaurants is capitalized. Rent during the construction of a restaurant is expensed as incurred. Major improvements are capitalized, while maintenance and repairs are expensed when incurred. Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates an impairment may exist. The Company tests for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing (see also Note 8 to the Consolidated Financial Statements). Gains and losses on the disposition of fixed assets not sold to franchisees are classified in Other (income) expense, net. Gains and losses on the disposition of fixed assets sold to franchisees are classified in Franchise revenues.
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Property and equipment, at cost, at each year-end consisted of the following:
(In thousands) | 2007 | 2006 | ||||||
Land |
$ | 263,658 | $ | 259,303 | ||||
Buildings and leasehold improvements |
1,043,609 | 994,874 | ||||||
Restaurant equipment |
592,449 | 564,371 | ||||||
Capital leases |
22,668 | 22,746 | ||||||
Computer hardware and software |
115,145 | 114,842 | ||||||
Vehicles |
23,452 | 23,190 | ||||||
Other |
19,644 | 20,074 | ||||||
Construction in progress |
38,515 | 25,315 | ||||||
2,119,140 | 2,024,715 | |||||||
Accumulated depreciation and amortization |
(872,255 | ) | (798,387 | ) | ||||
$ | 1,246,885 | $ | 1,226,328 |
In accordance with American Institute of Certified Public Accountants Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes certain internally developed software costs which are amortized over a period of up to 10 years. At December 30, 2007 and December 31, 2006, capitalized software development costs amounted to $66.4 million and $66.8 million, respectively, which amounts are included in Computer hardware and software above.
Leases
For operating leases, minimum lease payments, including minimum scheduled rent increases, are recognized as rent expense on a straight line basis over the lease term as that term is defined in SFAS No. 13, as amended, including any option periods considered in the lease term and any periods during which the Company has use of the property but is not charged rent by a landlord (rent holiday). Contingent rentals are generally based on either a percentage of restaurant sales or as a percentage of restaurant sales in excess of stipulated amounts, and thus are not included in minimum lease payments but are included in rent expense when incurred. Rent is expensed during the construction of a restaurant. Leasehold improvement incentives paid to the Company by a landlord are recorded as a liability and amortized as a reduction of rent expense over the lease term. No individual lease is material to the Company.
When determining the lease term for purposes of recording depreciation and rent or for evaluating whether a lease is capital or operating, the Company includes option periods for which failure to renew the lease imposes an economic penalty on the Company of such an amount that a renewal appears, at the inception of the lease, to be reasonably assured. For example, such an economic penalty would generally exist if the Company were to choose not to exercise an option on leased land upon which the Company had constructed a restaurant and, as a result, the Company would lose the ability to use the restaurant if the lease was not renewed.
Goodwill and other intangibles
Goodwill is the excess of the cost of an acquired entity over the fair value of acquired net assets. For purposes of testing goodwill for impairment, the Company has determined that its reporting units are Wendys U.S. and Wendys Canada. Each constitutes a business and has discrete financial information available which is regularly reviewed by management. The Company tests goodwill for impairment at least annually by comparing the fair value of each reporting unit, using discounted cash flows or market multiples based on earnings, to the carrying value to determine if there is an indication that a potential impairment may exist (see also Note 2 to the Consolidated Financial Statements).
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Definite-lived intangibles separate from goodwill are amortized on a straight-line basis over periods of generally up to 15 years. Lives are generally related to legal or contractual lives, but in some cases must be estimated by management based on specific circumstances. The Company tests intangible assets for impairment whenever events or circumstances indicate that an impairment may exist.
Accounts and notes receivable, net
Notes receivable arise primarily from agreements by the Company, under certain circumstances, to a structured repayment plan for past due franchisee obligations. The need for a reserve for uncollectible amounts is reviewed on a specific franchisee basis using information available to the Company, including past due balances and the financial strength of the franchisee. Notes receivable, net were $8.5 million and $8.9 million at December 30, 2007 and December 31, 2006, respectively, of which $0.4 million and $0.5 million, respectively, are classified in Inventories and other on the Consolidated Balance Sheets. The reserve for uncollectible notes receivable was $5.4 million and $5.2 million at December 30, 2007 and December 31, 2006, respectively. The remaining long-term portion of the notes is classified in Other assets on the Consolidated Balance Sheets. The need for a reserve for uncollectible accounts receivable is reviewed on a specific franchisee basis using information available to the Company, including past due balances and the financial strength of the franchisee. The reserve for uncollectible accounts receivable was $5.4 million and $4.8 million at December 30, 2007 and December 31, 2006, respectively.
Revenue and incentive recognition
The Company has a significant number of company operated restaurants at which revenue is recognized as customers pay for products at the time of sale. Franchise revenues consist of royalties, rents, gains from the sales of properties to franchisees, and various franchise fees. Royalty revenues are normally collected within two months after a period ends. The timing of revenue recognition for both retail sales and franchise revenues does not involve significant contingencies and judgments other than providing adequate reserves against collections of franchise-related revenues. Also, see discussion of Franchise operations below for further information regarding franchise revenues.
The Company receives incentives from its vendors. These incentives are recognized as earned and in accordance with Emerging Issues Task Force Issue 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor, have been classified as a reduction of Cost of sales in the Consolidated Statements of Income.
Franchise operations
The Company grants franchises to independent operators who in turn pay a technical assistance fee, royalties, and in some cases, rents for each restaurant opened (see Note 4 to the Consolidated Financial Statements for the amount of rent revenue included in franchise revenue for each of the last three years). A technical assistance fee is recorded as income when each restaurant commences operations. Royalties, based upon a percent of monthly sales, are recognized as income on the accrual basis. The Company has established reserves related to the collection of franchise royalties and other franchise-related receivables and commitments (see Note 12 to the Consolidated Financial Statements).
Franchise owners receive assistance in such areas as real estate site selection, construction consulting, purchasing and marketing from company personnel who also furnish these services to company operated restaurants. These franchise expenses are included in general and administrative expenses.
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The following are changes in the Companys franchised locations for each of the fiscal years 2007 through 2005:
Franchise restaurant progression | 2007 | 2006 | 2005 | ||||||
Franchise restaurants in operationbeginning of year |
5,208 | 5,244 | 5,184 | ||||||
Franchises opened |
76 | 96 | 155 | ||||||
Franchises closed |
(98 | ) | (162 | ) | (89 | ) | |||
Net transfers within the system |
45 | 30 | (6 | ) | |||||
Franchise restaurants in operationend of year |
5,231 | 5,208 | 5,244 | ||||||
Company-owned restaurantsend of year |
1,414 | 1,465 | 1,502 | ||||||
Total system-wide restaurantsend of year |
6,645 | 6,673 | 6,746 |
Advertising costs
The Company expenses advertising costs as incurred with the exception of media development costs that are expensed beginning in the month that the advertisement is first communicated (see Note 14 to the Consolidated Financial Statements).
Foreign operations
At December 30, 2007, the Company and its franchise owners operated 376 Wendys restaurants in Canada. Additionally, there are 333 Wendys restaurants in other foreign countries and territories, operated solely by franchisees. The functional currency of each foreign subsidiary is the respective local currency. Assets and liabilities are translated at the year-end exchange rates and revenues and expenses are translated at average exchange rates for the period. Resulting translation adjustments are recorded as a component of shareholders equity and in other comprehensive income (expense). Total translation adjustments included in Accumulated other comprehensive income (expense) at December 30, 2007 and December 31, 2006 were $28.9 million and $9.1 million, respectively. Total transaction gains and losses included in other (income) expense, net are not material.
Derivative instruments
The Companys exposure to foreign exchange risk is primarily related to fluctuations between the Canadian dollar and the U.S. dollar. The Company seeks to manage significant cash flow and income statement exposures arising from these fluctuations and may use derivative products to reduce the risk of a significant impact on its cash flows or income. Foreign exchange risks have included imports paid for by Canadian operations in U.S. dollars and certain Canadian dollar intercompany payments ultimately transferred to U.S. entities as part of the Companys centralized approach to cash management. Historically, forward currency contracts have been entered into as cash flow hedges primarily for the benefit of THI relative to foreign currency risks related to the THI Canadian operations prior to the spin-off of THI in 2006. The Company has investments in foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in currency exchange rates. The Company may use derivative financial instruments to hedge this exposure. The Company does not hedge foreign currency exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates on net income and cash flows. The Company has a policy forbidding trading or speculating in foreign currency. Derivative fair values used by the Company are based on quoted market prices. Since the spin-off of THI in 2006, the Company has not entered into any foreign currency hedges.
The Company may also seek to manage its exposure to interest rate risk and to lower its net borrowing costs by managing the mix of fixed and floating rate instruments. The Company entered into an interest rate swap in 2003 for the notional amount of $100.0 million, which matured in December 2005 and met specific conditions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to be considered a highly effective fair value hedge of a portion of the Companys long-term debt. Accordingly, gains and losses arising from the swap were completely offset against gains or losses of the underlying debt obligation until the interest rate swap matured. The Company has not entered into an interest rate hedge since the spin-off of THI (see Note 10 to the Consolidated Financial Statements).
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Other (income) expense, net
The following represents the components of Other (income) expense, net as presented on the Consolidated Statements of Income for each of the periods presented:
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Store closing costs |
$ | 7,266 | $ | 16,737 | $ | 24,696 | ||||||
Rent revenue |
0 | (14,021 | ) | (16,359 | ) | |||||||
Gains from property dispositions |
(4,956 | ) | (6,833 | ) | (46,855 | ) | ||||||
Equity investment (income) loss |
(9,424 | ) | (2,962 | ) | 2,046 | |||||||
Impairment of equity investment |
5,000 | 0 | 0 | |||||||||
Gain from insurance recoveries |
(9,018 | ) | 0 | 0 | ||||||||
THI tax sharing adjustment |
(5,698 | ) | 0 | 0 | ||||||||
Other, net |
7,824 | 5,633 | 2,209 | |||||||||
Other (income) expense, net |
$ | (9,006 | ) | $(1,446 | ) | $ | (34,263 | ) |
Rent revenue shown above represents rent paid by THI to a 50/50 Canadian restaurant real estate joint venture between Wendys and THI. Since the spin-off of THI, this joint venture is no longer consolidated in the Companys financial statements and only the Companys 50% equity share of the joint venture income is included above in equity investment (income) loss under the equity method of accounting. See Note 8 to the Consolidated Financial Statements for discussion of store closing costs and gains from property dispositions. See Note 7 to the Consolidated Financial Statements for discussion of the impairment of equity investment. In November 2007, the Company executed an amendment to its tax sharing agreement with THI which reduced the Companys liability to THI by $5.7 million. See Note 5 to the Consolidated Financial Statements for discussion of the THI tax sharing agreement. The gains from insurance recoveries represent reimbursements related to property damage during Hurricane Katrina and are recognized when all significant contingencies are resolved. Other, net in 2007 primarily includes store-level asset write-offs of $5.4 million and severance costs of $1.9 million. Other, net in 2006 primarily includes store-level asset write-offs of $5.5 million and severance costs of $2.4 million, partially offset by favorable legal reserve settlements of $1.5 million.
Net income per share
Basic earnings per common share are computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding. Diluted computations are based on the treasury stock method and include assumed conversions of stock options, restricted stock and restricted stock units, when outstanding and dilutive.
The computation of diluted earnings per common share excludes options to purchase 0.9 million and 0.3 million shares in 2007 and 2005, respectively, because the exercise price of these options was greater than the average market price of the common shares in the respective periods and therefore, they were antidilutive. There were no options excluded from the computation of diluted earnings per common share in 2006 as they were all dilutive. The computations of basic and diluted earnings per common share for each year are shown in the following table:
(In thousands except per share amounts) | 2007 | 2006 | 2005 | ||||||
Income from continuing operations for the computation of basic earnings per common share |
$ | 86,625 | $ | 37,046 | $ | 85,095 | |||
Income from discontinued operations for the computation of basic earnings per common share |
1,271 | 57,266 | 138,972 | ||||||
Net income for the computation of basic earnings per common share |
$ | 87,896 | $ | 94,312 | $ | 224,067 | |||
Weighted average shares for computation of basic earnings per common share |
89,143 | 114,244 | 114,945 | ||||||
Effect of dilutive stock options and restricted stock |
1,047 | 1,081 | 1,874 | ||||||
Weighted average shares for computation of diluted earnings per common share |
90,190 | 115,325 | 116,819 | ||||||
Basic earnings per common share from continuing operations |
$ | 0.97 | $ | 0.33 | $ | 0.74 | |||
Basic earnings per common share from discontinued operations |
$ | 0.02 | $ | 0.50 | $ | 1.21 | |||
Total basic earnings per common share |
$ | 0.99 | $ | 0.83 | $ | 1.95 | |||
Diluted earnings per common share from continuing operations |
$ | 0.96 | $ | 0.32 | $ | 0.73 | |||
Diluted earnings per common share from discontinued operations |
$ | 0.01 | $ | 0.50 | $ | 1.19 | |||
Total diluted earnings per common share |
$ | 0.97 | $ | 0.82 | $ | 1.92 |
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Stock options and other equity-based compensation
The Company has various plans which provide stock options and, beginning in 2004, restricted stock, restricted stock units, performance shares and performance units (together restricted shares), for certain employees and non-employee directors to acquire common shares of the Company. Grants of stock options and restricted shares to employees and the periods during which such stock options can be exercised are at the discretion of the Companys Compensation Committee (the Committee). Grants of stock options and restricted shares to non-employee directors and the periods during which such options can be exercised are specified in the plan applicable to directors and did not involve discretionary authority of the Board. All options expire at the end of the exercise period. Options are granted with exercise prices equal to the fair market value of the Companys common shares on the date of grant.
Prior to January 2, 2006, the Company used the intrinsic value method to account for stock-based employee compensation as defined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, because stock options granted prior to January 2, 2006 had no intrinsic value at date of grant, compensation expense related to stock options was recognized using the Black-Scholes method only when stock option awards were modified after the grant date. During the fourth quarter of 2005, the Company accelerated the vesting of all outstanding options, excluding those held by outside directors of the Company. As a result of modifying the vesting period of the options, the Company recorded $3.5 million pretax in compensation expense in continuing operations in accordance with Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 44, Accounting for Certain Transactions Involving Stock Compensation. The expense represents the intrinsic value, on the date vesting was accelerated, for the estimated number of stock options that would have been forfeited according to the original terms of the options that will not be forfeited due to the acceleration of the vesting. The decision to accelerate vesting of stock options was made primarily to reduce non-cash expense in 2006, 2007 and 2008 by approximately $8 million, $3 million and $1 million, respectively. The Committee imposed a holding period that will require all executive officers to refrain from selling net shares acquired upon any exercise of these accelerated options, until the date on which the exercise would have been permitted under the options original vesting terms or, if earlier, the executive officers death, disability or termination of employment. Prior to January 2, 2006, compensation expense recognized related to restricted shares was measured based on the market value of the Companys common stock on the date of grant. The Company generally satisfies share-based exercises and vesting through the issuance of authorized but previously unissued shares of Company stock. Restricted shares are generally net-settled with new Company shares withheld, and not issued, to meet the employees minimum statutory withholding tax requirements.
On January 2, 2006, the Company adopted SFAS No. 123R Share-Based Payment, which requires share-based compensation cost to be recognized based on the grant date estimated fair value of each award, net of estimated cancellations, over the employees requisite service period, which is generally the vesting period of the equity grant. The Company elected to adopt SFAS No. 123R using the modified prospective method, which requires compensation expense to be recorded for all unvested share-based awards beginning in the first quarter of adoption. Accordingly, the prior periods presented in this Form 10-K have not been restated to reflect the fair value method of expensing stock options. Also, because the value used to measure compensation expense for restricted shares is the same for APB Opinion No. 25 and SFAS No. 123R and because substantially all of the Companys stock option grants were fully vested prior to January 2, 2006, the adoption of SFAS No. 123R did not have a material impact on the Companys operating income, pretax income or net income. In accordance with SFAS No. 123R, tax benefits received of $5.0 million in 2007 and $29.2 million in continuing operations and $0.4 million in discontinued operations in 2006 related to equity award grants that are in excess of the tax benefits recorded on the Companys Consolidated Statements of Income are classified as a cash inflow in the financing section of the Companys Consolidated Statements of Cash Flows. Also in accordance with SFAS No. 123R, the unearned compensation amount previously separately displayed under shareholders equity was reclassified during the first quarter of 2006 to Capital in excess of stated value on the Companys Consolidated Balance Sheets. In March 2005, the Securities and Exchange Commission (the SEC) issued Staff Accounting Bulletin (SAB) No. 107 regarding the SECs interpretation of SFAS No. 123R. The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123R.
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The Company recorded stock compensation expense for each year as follows:
(In thousands) | 2007 | 2006 | 2005 | ||||||
Continuing operations: |
|||||||||
Before-tax |
$ | 12,342 | $ | 11,413 | $ | 16,194 | |||
After-tax |
7,959 | 7,240 | 10,531 | ||||||
Discontinued operations: |
|||||||||
Before-tax |
254 | 10,383 | 4,072 | ||||||
After-tax |
161 | 6,587 | 2,648 | ||||||
Total: |
|||||||||
Before-tax |
12,596 | 21,796 | 20,266 | ||||||
After-tax |
$ | 8,120 | $ | 13,827 | $ | 13,179 |
The increase in stock compensation expense recognized in continuing operations in 2007 from 2006 is primarily attributed to the 2007 stock option, performance share and restricted stock awards granted partially offset by the impact of higher cancellations in 2007. The decrease in stock compensation expense recognized in discontinued operations in 2007 compared to 2006 is due to the absence of expense for THI and Baja Fresh in 2007 due the spin-off of THI and sale of Baja Fresh in 2006 as well as the sale of Cafe Express in July 2007. The decrease in stock compensation expense recognized in continuing operations in 2006 from 2005 is primarily attributed to higher cancellations in 2006 as a result of the reduction in force in the second half (see Note 9 to the Consolidated Financial Statements) and the impact of the stock option acceleration charge in 2005. In the first quarter of 2006, the Company recorded a pretax adjustment of $1.7 million ($1.1 million net of tax) to correct cumulative compensation expense. The adjustment was not material to 2006 or to prior years. The increase in stock compensation expense recognized in discontinued operations in 2006 compared to 2005 is primarily attributed to the acceleration of expense due to the THI spin-off, sale of Baja Fresh and additional 2006 grants awarded by THI.
Included in the continuing operations amounts above for 2006 is $2.5 million ($1.6 million after-tax) in additional stock compensation expense recognized in connection with the Companys voluntary enhanced retirement plan (see Note 9 to the Consolidated Financial Statements). This expense is included in Restructuring and Special Committee related charges line of the Consolidated Statements of Income.
In calculating the fair value of options issued to employees that received grants in 2007, the Company used the following assumptions. There were no option grants in 2006 or 2005.
Assumption | 2007 | |
Dividend yield |
1.3% | |
Expected volatility |
25% | |
Risk-free interest rate |
4.55% | |
Expected lives |
4.3 years | |
Per share weighted average fair value of options granted |
$9.23 |
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The pro-forma disclosures for 2005 below are provided as if the Company had adopted the cost recognition requirements under SFAS No. 123 Accounting for Stock-Based Compensation. Under SFAS No. 123, the fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model. This model requires the use of subjective assumptions that can materially affect fair value estimates, and therefore, this model does not necessarily provide a reliable single measure of the fair value of the Companys stock options. Had compensation expense been recognized for stock-based compensation plans in accordance with provisions of SFAS No. 123 in 2005, the Company would have recorded net income and earnings per share as follows:
(In thousands, except per share data) | 2005 | |||
Net income, as reported |
$ | 224,067 | ||
Add: Stock compensation cost recorded under APB Opinion No. 25, net of tax |
13,179 | |||
Deduct: Stock compensation cost calculated under SFAS No. 123, net of tax |
(47,283 | ) | ||
Pro-forma net income |
$ | 189,963 | ||
Basic as reported |
$ | 1.95 | ||
Basic pro-forma |
$ | 1.65 | ||
Diluted as reported |
$ | 1.92 | ||
Diluted pro-forma |
$ | 1.63 |
The above stock compensation cost calculated under SFAS No. 123, net of tax, was based on costs generally computed over the vesting period of the awards. Upon adoption, SFAS No. 123R required compensation cost for stock-based compensation awards to be recognized immediately for retirement eligible employees and over the period from the grant date to the date retirement eligibility is achieved, if that period is shorter than the normal vesting period. The table below shows the impact on the Companys reported diluted earnings per share and the above pro-forma diluted earnings per share as if the SFAS No. 123R guidance on recognition of stock compensation expense for retirement eligible employees was applied to the periods reflected in the financial statements.
2007 | 2006 | 2005 | ||||||||
Impact on: |
||||||||||
Diluted as reported |
$ | 0.97 | $ | 0.06 | $ | (0.05 | ) | |||
Diluted pro-forma |
N/A | N/A | $ | 0.03 |
The impact of applying SFAS No. 123R in these pro-forma disclosures is not necessarily indicative of future results.
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NOTE 2 | GOODWILL AND OTHER INTANGIBLE ASSETS |
The table below presents amortizable intangible assets as of December 30, 2007 and December 31, 2006:
(In thousands) | Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount | |||||||
2007 |
||||||||||
Amortizable intangible assets: |
||||||||||
Patents and trademarks |
$ | 452 | $ | (452 | ) | $ | 0 | |||
Other |
4,985 | (2,281 | ) | 2,704 | ||||||
$ | 5,437 | $ | (2,733 | ) | $ | 2,704 | ||||
2006 |
||||||||||
Amortizable intangible assets: |
||||||||||
Patents and trademarks |
$ | 452 | $ | (424 | ) | $ | 28 | |||
Purchase options |
7,500 | (6,680 | ) | 820 | ||||||
Other |
4,956 | (1,949 | ) | 3,007 | ||||||
$ | 12,908 | $ | (9,053 | ) | $ | 3,855 |
Included in other above is $2.6 million and $2.9 million as of December 30, 2007 and December 31, 2006, respectively, net of accumulated amortization of $2.2 million and $1.9 million, primarily related to the use of the name and likeness of Dave Thomas, the late founder of Wendys. The change in the gross carrying amount and accumulated amortization related to purchase options primarily reflects the expiration of a $5.0 million option to purchase properties in Utah.
Total intangibles amortization expense was $0.8 million for the year ended December 30, 2007 and $1.1 million for the year ended December 31, 2006. The estimated annual intangibles amortization expense for the years 2008 through 2012 is approximately $0.3 million.
The changes in the carrying amount of goodwill for the year ended December 30, 2007 are as follows:
(In thousands) | ||||
Balance as of December 31, 2006 |
$ | 85,353 | ||
Goodwill related to dispositions |
(1,899 | ) | ||
Translation adjustments |
547 | |||
Balance as of December 30, 2007 |
$ | 84,001 |
The changes in the carrying amount of goodwill for the year ended December 31, 2006, are as follows:
(In thousands) | ||||
Balance as of January 1, 2006 |
$ | 81,875 | ||
Goodwill recorded in connection with acquisitions |
3,486 | |||
Translation adjustments |
(8 | ) | ||
Balance as of December 31, 2006 |
$ | 85,353 |
Under SFAS No. 142, Goodwill and Other Intangibles, goodwill and other indefinite-lived intangibles must be tested for impairment annually (or in interim periods if events indicate possible impairment). The Company tested goodwill for impairment as of year-end 2007 and 2006 and no impairment was indicated.
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NOTE 3 | TERM DEBT |
Term debt at each year-end consisted of the following:
(In thousands) | 2007 | 2006 | ||||||
Notes, unsecured, and mortgages payable with a weighted average interest rate of 10%, due in installments through 2009 |
$ | 74 | $ | 883 | ||||
6.25% Senior Notes, due November 15, 2011 |
199,641 | 199,562 | ||||||
6.20% Senior Notes, due June 15, 2014 |
224,600 | 224,551 | ||||||
7% Debentures, due December 15, 2025 |
97,073 | 96,996 | ||||||
Other, with an effective interest rate of 8.5%, due May 2008 |
18,781 | 93,977 | ||||||
Advertising fund debt at an interest rate of 6.1% due September 30, 2008 |
6,904 | 7,639 | ||||||
547,073 | 623,608 | |||||||
Current portion of term debt |
(25,730 | ) | (86,469 | ) | ||||
$ | 521,343 | $ | 537,139 |
The U.S. advertising fund has a revolving line of credit of $25.0 million with a fee of 0.2% on the unused portion. The Company is not the guarantor of the debt. The advertising fund debt was incurred to fund the advertising fund operations (see Note 14 to the Consolidated Financial Statements).
The 6.25% Senior Notes were issued in 2001 in connection with the Companys share repurchases (see Note 6 to the Consolidated Financial Statements). The 6.20% Senior Notes were issued in 2002 in connection with the Companys purchase of Baja Fresh. The 6.25% and 6.20% Senior Notes are redeemable prior to maturity at the option of the Company. The 7% Debentures are not redeemable by the Company prior to maturity. All of the Companys notes and debentures are unsecured.
In the fourth quarter of 2006, the Company entered into an agreement to sell approximately 40% of the Companys U.S. royalties for a 14-month period to a third party in return for a cash payment in 2006 of $94.0 million. Royalties subject to the agreement relate to royalties payable to a subsidiary of the Company for both company operated and franchised stores. In accordance with EITF 88-18 Sales of Future Revenues, the Company classified as debt the $94.0 million of cash received in 2006 and the $18.8 million balance remaining at December 30, 2007. These amounts are reflected as other debt in the table above. The debt is being amortized using the interest method over the life of the agreement, which concludes in May 2008. Changes in estimated cash flows to be paid to the third party are reflected prospectively in Interest expense.
Based on future cash flows and current interest rates for all term debt, the fair value of the Companys term debt was approximately $546 million and $612 million at December 30, 2007 and December 31, 2006, respectively.
Future maturities for all term debt are as follows:
(In thousands) | |||
2008 |
$ | 25,730 | |
2009 |
29 | ||
2010 |
0 | ||
2011 |
199,641 | ||
2012 |
0 | ||
Later years |
321,673 | ||
$ | 547,073 |
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The Companys debt agreements contain covenants that specify limits on the amount of indebtedness secured by liens and the maximum aggregate value of restaurant property as to which the Company could enter into sale-leaseback transactions. The Company was in compliance with these covenants as of December 30, 2007 and throughout 2007, and will continue to monitor these on a regular basis.
The Company currently has a shelf registration statement which would enable the Company to issue securities up to $500 million. As of December 30, 2007 and December 31, 2006, no securities under this shelf registration statement had been issued.
On March 1, 2006, the Company entered into a new $200 million unsecured revolving credit facility, which expires on March 1, 2008 and which replaced the Companys previous $200 million revolving credit facility entered into in 2003. The current revolving credit facility contains various covenants which, among other things, require the maintenance of certain ratios, including indebtedness to total capitalization and a fixed charge coverage ratio, and limits on the amount of assets that can be sold and liens that can be placed on the Companys assets. The Company was in compliance with these covenants as of December 30, 2007 and throughout 2007. The Company is charged interest on advances that varies based on the type of advance utilized by the Company, which is either an alternate base rate (greater of prime or Federal funds plus 0.5%) or a rate based on LIBOR plus a margin that varies based on the Companys debt rating at the time of the advance. The Company is also charged a facility fee based on the total credit facility. This fee varies from 0.07% to 0.20% based on the Companys debt rating. The Company did not borrow under its revolving credit facility during the year ended December 30, 2007. The Company is currently negotiating a renewal of its current revolving credit facility.
In the first quarter of 2006, $35.0 million in commercial paper was issued for general corporate purposes and repaid. Due to the Companys current debt ratings, the Company does not currently have access to a commercial paper program.
At December 30, 2007, the Companys Canadian subsidiary had a revolving credit facility with approximately $6 million Canadian available at December 30, 2007. This facility bears interest at a rate of 6.0%, has no financial covenants and no amounts under the facility were outstanding at December 30, 2007.
NOTE 4 | LEASES |
The Company occupies land and buildings and uses equipment under terms of numerous lease agreements, substantially all of which expire on various dates through 2047. Lease terms of land and building leases are generally equal to the initial lease period of 10 to 20 years, while land only lease terms can extend up to 40 years. Many of these leases provide for future rent escalations and renewal options. Certain leases require contingent rent, determined as a percentage of sales, generally when annual sales exceed specified levels. Most leases also obligate the Company to pay the cost of maintenance, insurance and property taxes.
At each year-end, assets leased under capital leases with the Company as the lessee consisted of the following:
(In thousands) | 2007 | 2006 | ||||||
Land and Buildings |
$ | 22,667 | $ | 22,746 | ||||
Accumulated depreciation |
(7,056 | ) | (8,889 | ) | ||||
$ | 15,611 | $ | 13,857 |
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At December 30, 2007, future minimum lease payments to be made by the Company for all leases, and the present value of the net minimum lease payments for capital leases, were as follows:
(In thousands) | Capital Leases |
Operating Leases | |||||
2008 |
$ | 2,048 | $ | 62,289 | |||
2009 |
14,086 | 63,399 | |||||
2010 |
1,908 | 54,773 | |||||
2011 |
1,804 | 50,720 | |||||
2012 |
1,486 | 42,075 | |||||
Later years |
13,705 | 723,724 | |||||
Total minimum lease payments |
35,037 | $ | 996,980 | ||||
Amount representing interest |
(12,496 | ) | |||||
Present value of net minimum lease payments |
22,541 | ||||||
Current portion |
(861 | ) | |||||
$ | 21,680 |
Total minimum lease payments have not been reduced by minimum sublease rentals of $5.7 million under capital leases, and $24.4 million under operating leases payable to the Company in the future under non-cancelable subleases.
Rent expense for each year is included in Company restaurant operating costs, Operating costs and General and administrative expenses and amounted to:
(In thousands) | 2007 | 2006 | 2005 | ||||||
Minimum rents |
$ | 72,832 | $ | 75,663 | $ | 76,974 | |||
Contingent rents |
16,909 | 9,937 | 10,277 | ||||||
$ | 89,741 | $ | 85,600 | $ | 87,251 |
In connection with the franchising of certain restaurants, the Company has leased or subleased land, buildings and equipment to the related franchise owners. Most leases to franchisees provide for monthly rentals based on a percentage of sales, while others provide for fixed payments with contingent rent when sales exceed certain levels. Lease terms are approximately 10 to 20 years with one or more five-year renewal options. The franchise owners bear the cost of maintenance, insurance and property taxes.
The Company leases, as lessor, some building and equipment under fixed payment terms that are accounted for as direct financing leases. The land portion of leases and leases with rents based on a percentage of sales are accounted for as operating leases. At each year-end, the net investment in direct financing leases, included in other assets, consisted of the following:
(In thousands) | 2007 | 2006 | ||||||
Total minimum lease receipts |
$ | 22,312 | $ | 10,087 | ||||
Estimated unguaranteed residual value |
669 | 117 | ||||||
Amount representing unearned interest |
(16,002 | ) | (5,086 | ) | ||||
Current portion, included in accounts receivable |
(96 | ) | (142 | ) | ||||
$ | 6,883 | $ | 4,976 |
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At each year-end, company assets leased under operating leases with the Company as lessor is shown below.
(In thousands) | 2007 | 2006 | ||||||
Land |
$ | 14,744 | $ | 13,015 | ||||
Buildings and leasehold improvements |
62,326 | 51,619 | ||||||
Equipment |
9,787 | 8,383 | ||||||
86,857 | 73,017 | |||||||
Accumulated depreciation |
(40,092 | ) | (32,909 | ) | ||||
$ | 46,765 | $ | 40,108 |
At December 30, 2007, future minimum lease receipts were as follows:
(In thousands) | Direct Financing Leases |
Operating Leases | ||||
2008 |
$ | 1,011 | $ | 6,773 | ||
2009 |
1,226 | 6,924 | ||||
2010 |
1,205 | 6,278 | ||||
2011 |
1,223 | 5,528 | ||||
2012 |
1,162 | 4,685 | ||||
Later years |
16,485 | 45,736 | ||||
$ | 22,312 | $ | 75,924 |
Rental income for each year is included in Franchise revenues and amounted to:
(In thousands) | 2007 | 2006 | 2005 | ||||||
Minimum rents |
$ | 4,966 | $ | 3,360 | $ | 5,023 | |||
Contingent rents |
12,803 | 17,581 | 32,755 | ||||||
$ | 17,769 | $ | 20,941 | $ | 37,778 |
In addition to the rental income in the table above, there is rent revenue included in Other (income) expense, net, which represents rent paid by THI to a 50/50 Canadian restaurant real estate joint venture between Wendys and THI. After the spin-off of THI on September 29, 2006, this joint venture is no longer consolidated in the Companys financial statements.
NOTE 5 | INCOME TAXES |
Earnings from continuing operations before taxes were as follows:
(In thousands) | 2007 | 2006 | 2005 | ||||||
Domestic |
$ | 115,599 | $ | 32,173 | $ | 133,996 | |||
Foreign |
10,157 | 10,306 | 2,788 | ||||||
Total |
$ | 125,756 | $ | 42,479 | $ | 136,784 |
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The provision for income taxes on earnings from continuing operations consisted of the following:
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Current |
||||||||||||
Federal |
$ | (1,287 | ) | $ | 27,315 | $ | 52,316 | |||||
State and local |
(3,608 | ) | 2,923 | 6,649 | ||||||||
Foreign |
6,379 | 6,976 | 5,199 | |||||||||
1,484 | 37,214 | 64,164 | ||||||||||
Deferred |
||||||||||||
Federal |
33,439 | (28,547 | ) | (8,703 | ) | |||||||
State and local |
4,560 | (1,698 | ) | (2,602 | ) | |||||||
Foreign |
(352 | ) | (1,536 | ) | (1,170 | ) | ||||||
37,647 | (31,781 | ) | (12,475 | ) | ||||||||
$ | 39,131 | $ | 5,433 | $ | 51,689 |
The provision for foreign taxes includes withholding taxes.
The temporary differences which give rise to deferred tax assets and liabilities each year-end consisted of the following:
(In thousands) | 2007 | 2006 | ||||||
Deferred tax assets: |
||||||||
Lease transactions |
$ | 18,971 | $ | 14,323 | ||||
Property and equipment basis differences |
3,839 | 3,426 | ||||||
Intangible assets basis differences |
6,460 | 14,327 | ||||||
Benefit plans transactions |
14,469 | 14,922 | ||||||
Reserves not currently deductible |
21,520 | 21,361 | ||||||
Deferred income |
2,056 | 35,092 | ||||||
Capital loss carryforward |
77,881 | 81,000 | ||||||
Other tax benefits available to carryforward |
5,522 | 0 | ||||||
All other |
142 | 640 | ||||||
$ | 150,860 | $ | 185,091 | |||||
Valuation allowance |
(81,839 | ) | (81,000 | ) | ||||
$ | 69,021 | $ | 104,091 |
(In thousands) | 2007 | 2006 | ||||
Deferred tax liabilities: |
||||||
Lease transactions |
$ | 2,638 | $ | 1,934 | ||
Property and equipment basis differences |
80,996 | 77,039 | ||||
Intangible assets basis differences |
9,848 | 10,611 | ||||
Capitalized expenses deducted for tax |
6,527 | 9,250 | ||||
All other |
2,160 | 1,510 | ||||
$ | 102,169 | $ | 100,344 |
The pension liability expense adjustment appearing in the Shareholders equity section of the Consolidated Balance Sheets under Accumulated other comprehensive income is shown net of deferred taxes of $11.5 million and $13.7 million in 2007 and 2006, respectively. Accordingly, these deferred taxes are not reflected in the table above.
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A deferred tax asset has been established for the capital loss carryforward resulting from the sale of Baja Fresh in 2006. Federal capital losses may be carried forward for five years. Additionally, the Company has a deferred tax asset associated with the difference between the book and tax basis of its investment in Pasta Pomodoro. The Company has reviewed various SFAS No. 109 tax planning strategies, including sale and leasebacks, which might be used to realize the benefit of these loss carryforwards. These strategies, as of December 30, 2007, do not meet the prudent and feasible criteria of SFAS No. 109 and accordingly the valuation allowance in the amount of $81.8 million has been recorded as a result of managements determination that it is more likely than not these capital losses or basis differences will not be used. The net increase in the valuation allowance from year-end 2006 to 2007 of $0.8 million is composed of an increase of $3.9 million related to the Pasta Pomodoro basis difference (including the state tax impact) offset by a reduction of $3.1 million due to changes in estimates on the actual capital loss from the sale of Baja Fresh and capital gains resulting from miscellaneous property dispositions.
A reconciliation of the statutory U.S. federal income tax rate of 35% to the Companys effective tax rate for each year is shown below:
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Income taxes at statutory rate |
$ | 44,015 | $ | 14,868 | $ | 47,874 | ||||||
State and local taxes, net of federal benefit |
2,788 | 78 | 3,434 | |||||||||
Tax on foreign earnings, net of foreign tax credits |
115 | (361 | ) | (430 | ) | |||||||
Work opportunity and jobs tax credits |
(2,746 | ) | (2,223 | ) | (1,709 | ) | ||||||
Impairment of investment in Pasta Pomodoro |
3,665 | 0 | 0 | |||||||||
Prior year tax adjustments |
(6,134 | ) | (6,846 | ) | 2,332 | |||||||
Other |
(2,572 | ) | (83 | ) | 188 | |||||||
Income taxes at effective rate |
$ | 39,131 | $ | 5,433 | $ | 51,689 |
The prior year tax adjustments line item in the rate reconciliation above includes the effects of federal and state tax exam settlements, statute of limitations lapses, changes in estimates and book-to-return adjustments, used in calculating the income tax provision.
The determination of annual income tax expense takes into consideration amounts including interest and penalties which may be needed to cover exposures for open tax years. The Internal Revenue Service (IRS) is currently conducting an examination of the Companys U.S. federal income tax return for the 2007 year as part of the IRSs Compliance Assurance Process program. State income tax returns are generally subject to examination for a period of 3-5 years after filing of the respective return. The Company has various state income tax returns in the process of examination or administrative appeals. The Company does not expect any material impact on earnings to result from the resolution of matters related to open tax years; however actual settlements may differ from amounts accrued. Amounts related to IRS examinations of federal income tax returns for 2006 and prior years have been settled and paid. The Company settled the matter concerning transfer pricing on royalties and fees between the U.S. and Canada for the years 1999 through 2001 which was before the U.S. Competent Authority. The Company has a refund claim pending which is accounted for as an unrecognized tax benefit under FIN 48 related to work opportunity tax credits for the years 1998-2004.
U.S. income taxes and foreign withholding taxes are not provided on undistributed earnings of foreign subsidiaries which are considered to be indefinitely reinvested in the operations of such subsidiaries. The amount of these earnings was approximately $0.8 million at December 30, 2007.
The Company is a party to a Tax Sharing Agreement (TSA) dated March 29, 2006 with THI, its former subsidiary, which governs the allocation of tax liabilities between the two companies. The income tax provision reflects this agreement. Certain terms of the TSA were adjusted and clarified as part of a Supplemental Tax Agreement which was negotiated with THI and executed as of November 7, 2007.
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109, Accounting for Income Taxes (FIN 48). The Interpretation addresses the
64
determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.
The Company adopted the provisions of FIN 48 on January 1, 2007. There was no material effect on the financial statements or a cumulative effect to retained earnings related to the adoption of FIN 48. However, certain amounts have been reclassified in the Consolidated Balance Sheets in order to comply with the requirements of the Interpretation. The amount of unrecognized tax benefits at January 1, 2007 was approximately $23.1 million, all of which would impact the Companys effective tax rate, if recognized.
The Company recognizes accrued interest and penalties associated with uncertain tax positions as part of the income tax provision. The benefit for interest and penalties reflected in the income tax provision for the year ended December 30, 2007 was approximately $1.3 million (net of related tax impact). As of January 1, 2007 and December 30, 2007, the Company had approximately $7.1 million and $2.6 million, respectively, of accrued interest and penalties liability on its Consolidated Balance Sheets.
The amount of unrecognized tax benefits at December 30, 2007 was approximately $17.0 million, all of which would impact the Companys effective tax rate, if recognized. The Company expects it is reasonably possible that approximately $10.3 million of its liability for unrecognized tax benefits will be settled or refund claims will be received in the next 12 months.
Below is the tabular reconciliation of the amounts of unrecognized tax benefits at the beginning and end of the 2007 reporting period.
(In thousands) | 2007 | |||
Unrecognized tax benefits, 1/1/2007 |
$ | 23,084 | ||
Gross increasestax positions in prior period |
728 | |||
Gross decreasestax positions in prior period |
(4,819 | ) | ||
Gross increasescurrent-period tax positions |
608 | |||
Settlements |
(2,445 | ) | ||
Lapse of statute of limitations |
(192 | ) | ||
Unrecognized tax benefits, 12/30/2007 |
$ | 16,964 |
NOTE 6 | SHAREHOLDERS EQUITY |
On September 29, 2006, the Company completed its spin-off of THI, the parent company of the business formerly reported as the Hortons segment. The net assets of THI of $638.9 million (including accumulated translation adjustments of $112.2 million and a hedge fair value loss of $0.6 million in Other comprehensive income) have been reflected as a dividend paid out of Retained earnings in 2006.
On March 29, 2006, the Company completed its IPO of THI. A total of 33.4 million shares were offered at an initial per share price of $23.162 ($27.00 Canadian). The gross proceeds of $769.2 million were offset by $52.4 million in underwriter and other third party costs. As a result of the IPO, the Company recorded a $716.8 million increase to Capital in excess of stated value. The shares sold in the IPO represented 17.25% of total THI shares issued and outstanding and the Company retained the remaining 82.75% of THI shares until it completed the spin-off described above. The IPO was reflected as an increase to Capital in excess of stated value in accordance with SAB No. 51, Accounting for Sales of Stock of a Subsidiary, because the Company expected to spin-off the remaining THI shares it held.
65
In 2005, the Board of Directors approved an increase in the common share repurchase program of up to an additional $1 billion. On October 9, 2006 the Companys Board of Directors authorized the repurchase of up to 35.4 million common shares of the Company. The October 9, 2006 authorization replaced all prior authorizations. During 2007, 2006 and 2005, 9.0 million, 26.2 million and 2.0 million common shares were repurchased and cash disbursements related to share repurchases totaled approximately $300 million, $1 billion and $100 million, respectively. At December 30, 2007, approximately 4 million shares remained under the October 9, 2006 share repurchase authorization.
In March 2007, 9.0 million common shares were repurchased under an accelerated share repurchase (ASR) transaction for an initial value of $282.5 million. The initial price paid as part of the ASR transaction was $31.33 per share plus certain other costs. The repurchased shares were also subject to a future contingent purchase price adjustment based upon the weighted average price during the period from the repurchase date until settlement, which occurred in May 2007. The price adjustment was $15.5 million and was paid by the Company. The ASR agreement included the option to settle the contract in cash or shares of the Companys common stock and, accordingly, the contract was treated as an equity transaction. The total purchase price of $298.0 million was reflected in the Treasury stock component of shareholders equity.
On October 18, 2006, the Company commenced a modified Dutch Auction tender offer to purchase up to approximately 22 million of its outstanding common shares in a price range of $33.00 to $36.00 per share. The shares sought represented approximately 19% of the Companys shares outstanding as of October 12, 2006. The tender offer expired on November 16, 2006. As a result of the tender offer, the Company purchased 22.4 million common shares at a price of $35.75, for a total purchase price of $804.4 million, which was reflected in the Treasury stock component of shareholders equity, including $3.1 million of transaction costs.
In January 2006, 3.75 million common shares of the Company were repurchased under an ASR transaction for an initial value of $207.0 million. The initial price paid per share as part of the ASR transaction was $55.21 (prior to the spin-off of THI). The repurchased shares were also subject to a future contingent purchase price adjustment based upon the weighted average repurchase price during the period through March 23, 2006. The ASR agreement included the option to settle the contract in cash or shares of the Companys common stock and, accordingly, the contract was treated as an equity transaction. In March 2006, the contingent purchase price adjustment was determined to be $13.1 million and was paid by the Company. The total purchase price of $220.1 million was reflected in the Treasury stock component of shareholders equity in the first quarter of 2006.
In 2005, 2.0 million common shares were repurchased under an ASR transaction for an initial value of approximately $98 million. The initial price paid per share as part of the ASR transaction was $49.10. The repurchased shares were also subject to a future contingent purchase price adjustment based upon the weighted average repurchase price during the period from August 16, 2005 through September 16, 2005. The ASR agreement included the option to settle the contract in cash or shares of the Companys common stock and, accordingly, the contract was classified in equity. In September 2005, the contingent purchase price adjustment was determined to be $0.5 million and was paid to the Company. The purchase price adjustment was reflected in the Treasury stock component of shareholders equity in the third quarter of 2005.
In accordance with SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132R, the Company has recorded the following amounts in Accumulated other comprehensive income of $30.5 million ($19.0 million after tax) and $36.2 million ($22.5 million after tax) as of December 30, 2007 and December 31, 2006, respectively (See also Note 13 to the Consolidated Financial Statements).
On April 26, 2007, the Companys shareholders approved the 2007 Stock Incentive Plan (the 2007 Plan), which provides for equity compensation awards in the form of stock options, restricted stock, restricted stock units, stock appreciation rights, dividend equivalent rights, performance shares, performance units and share awards (collectively, Awards) to eligible employees and directors of the Company or its subsidiaries. The 2007 Plan authorizes up to 6 million common shares for grants of Awards. The common shares offered under the 2007 Plan may be authorized but unissued shares, treasury shares or any combination thereof. The Company began issuing Awards under the 2007 Plan in 2007. Based on the current compensation philosophy of the Committee, the Company expects that approximately 50% of the value of Awards made in subsequent years will be
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comprised of stock options, with the remaining 50% of the value comprised of performance units. This was the philosophy under which the Awards for 2007 were made. However, this is subject to review and possible change by the Committee.
Stock option awards made by the Company in 2007 have a term of seven years from the date of grant and become exercisable in installments of 33 1/3% on each of the first three anniversaries of the grant date. Stock option awards granted in prior years generally have a term of 10 years from the grant date and become exercisable in installments of 25% on each of the first four anniversaries of the grant date. Restricted share grants made by the Company generally vest in increments of 25% on each of the first four anniversaries of the grant date. Restricted share grants to Canadian employees vest over a 30 month period. As discussed in Note 1, during the fourth quarter of 2005 the Company accelerated the vesting of all then outstanding options, excluding those held by non-employee directors. No stock options were granted in 2006 or 2005.
In 2007, the Company granted 0.2 million long-term performance units that cliff vest on May 1, 2010 and settle in common shares of the Company. The number of common shares to be issued on the May 1, 2010 vesting date will depend upon the Companys results relative to performance objectives for the three-year period ending January 3, 2010, including earnings before interest, taxes, depreciation and amortization (EBITDA) and return on average net working assets. The Company granted 0.1 million performance shares in 2006 to certain key employees based on achieving Company earnings targets. The performance shares granted in 2006 settle in restricted shares based on specified performance criteria and the earned restricted shares then generally vest over the following four years in installments of 25% each year.
In accordance with the Companys 2003 Stock Incentive Plan, with respect to the disposition of a subsidiary, outstanding restricted shares granted to Baja Fresh and U.S. THI employees vested at the time of the sale and spin-off, respectively. The Companys restricted shares granted to Canadian THI employees were cancelled in May and August 2006 and the Canadian THI employees were granted THI restricted shares. The THI restricted share grants immediately vested and THI common shares were distributed to these THI employees under the THI 2006 Stock Incentive Plan. Restricted shares generally have dividend participation rights under which dividends are reinvested in additional shares.
In accordance with the anti-dilution provisions in the Companys equity plans, upon the spin-off of THI, all stock options, restricted stock units and performance shares were adjusted in order to retain the equivalent value to employees. The adjustment reflected the impact of the conversion of the number of restricted shares based on the adjusted market price of the Companys stock after the spin-off of THI. In accordance with SFAS No. 123R, no compensation cost was recorded as a result of this adjustment. This adjustment is reflected in the following schedules. Restricted stock awards received the dividend of THI shares and therefore were not adjusted. The THI shares distributed to participants holding restricted stock awards are being held for the benefit of these participants and will be issued to participants in accordance with the normal vesting period of the underlying restricted stock awards.
The number of remaining shares authorized under all of the Companys equity plans, including awards granted but not yet vested or exercised, totaled 9.5 million as of December 30, 2007.
As of December 30, 2007, total unrecognized compensation cost related to nonvested share-based compensation was $22.8 million and is expected to be recognized over a weighted-average period of 1.8 years. The Company expects substantially all of its restricted shares and options to vest.
Restricted shares
The following is a summary of unvested restricted share activity for 2007:
(Shares in thousands) | Restricted Shares |
Weighted Average Fair Value | ||||
Balance at December 31, 2006 |
1,029 | $ | 29.02 | |||
Granted |
429 | 36.28 | ||||
Vested |
(411 | ) | 27.76 | |||
Canceled |
(81 | ) | 28.55 | |||
Balance at December 30, 2007 |
966 | $ | 32.38 |
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The total fair value of restricted shares vested in 2007, 2006 and 2005 was $11.4 million, $20.5 million and $4.7 million, respectively. Approximately 0.4 million and 0.9 million restricted shares were granted in 2007 and 2006, respectively, at a weighted-average grant date fair value of $36.28 and $42.97, respectively.
The tax benefit realized for tax deductions on restricted shares vested in 2007 and 2006 was $2.3 million and $3.8 million, respectively. There were no tax benefits realized in 2005.
Stock options
In 2007, the Company granted 0.9 million stock options to key employees at a weighted average price of $37.52. The options granted in 2007 vest 33 1/3% on each of the first three anniversaries of the grant date. No stock options were granted in 2006 or 2005. Approximately 0.9 million stock options were unvested as of December 30, 2007.
The following is a summary of stock option activity for 2007:
(Shares and aggregate intrinsic value in thousands) | Shares Under Option |
Weighted Average Price Per Share |
Weighted Average Remaining Contractual Life |
Aggregate Intrinsic Value | |||||||
Balance at December 31, 2006 |
1,773 | $ | 15.23 | 5.4 | |||||||
Granted |
886 | 37.52 | |||||||||
Exercised |
(449 | ) | 14.75 | ||||||||
Canceled |
(98 | ) | 23.75 | ||||||||
Outstanding at December 30, 2007 |
2,112 | $ | 24.29 | 6.6 | $ | 3,640 | |||||
Exercisable at December 30, 2007 |
1,262 | $ | 15.36 | 4.7 | $ | 13,434 |
The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The total intrinsic value of stock options exercised was $9.5 million, $99.6 million and $129.4 million for 2007, 2006 and 2005, respectively. Proceeds from stock options exercised were $6.6 million, $119.8 million and $215.9 million for 2007, 2006 and 2005, respectively, and the tax benefit realized for tax deductions from stock options exercised totaled $2.7 million, $25.4 million and $37.8 million for 2007, 2006 and 2005, respectively.
The Company has a Shareholder Rights Plan (Rights Plan) under which one preferred stock purchase right (Right) was distributed as a dividend for each outstanding common share. Each Right entitles a shareholder to buy one ten-thousandth of a share of a new series of preferred stock for $100 upon the occurrence of certain events. Rights would be exercisable once a person or group acquires 15% or more of the Companys common shares, or 10 days after a tender offer for 15% or more of the common shares is announced. No certificates will be issued unless the Rights Plan is activated.
Under certain circumstances, all Rights holders, except the person or company holding 15% or more of the Companys common shares, will be entitled to purchase common shares at about half the price that such shares traded for prior to the announcement of the acquisition. Alternatively, if the Company is acquired after the Rights Plan is activated, the Rights will entitle the holder to buy the acquiring companys shares at a similar discount. The Company can redeem the Rights for one cent per Right under certain circumstances. If not redeemed, the Rights will expire on August 10, 2008.
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NOTE 7 | ACQUISITIONS AND INVESTMENTS |
In 2007, the Company acquired 10 restaurants for $9.6 million and in 2006, the Company acquired 12 restaurants for $13.3 million in various markets from franchisees. In 2005, the Company acquired 15 restaurants for $13.3 million in various markets from franchisees. No goodwill was acquired in connection to the 2007 acquisitions. Goodwill acquired in connection with the Companys acquisition of restaurants totaled $3.5 million and $5.5 million for 2006 and 2005, respectively.
Based on a decline in Pasta Pomodoro operating results, in the fourth quarter of 2007 the Company recorded a $5.0 million impairment of its equity investment in Pasta Pomodoro to reflect an other than temporary decline in the value of the Companys investment in Pasta Pomodoro in accordance with APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. As of December 30, 2007, the Companys recorded equity investment value in Pasta Pomodoro, including manditorily redeemable preferred shares, was $5.8 million and is classified as Other assets in the Companys Consolidated Balance Sheet.
NOTE 8 | FIXED ASSET DISPOSITIONS AND IMPAIRMENTS |
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company has classified assets with a net book value of $3.3 million and $15.5 million as Assets held for disposition in the Consolidated Balance Sheets as of December 30, 2007 and December 31, 2006, respectively. Assets classified as held for disposition are no longer depreciated and are classified as held for disposition based on the Companys intention to sell these assets within 12 months.
The following is a progression of assets held for disposition over the past two years.
(In thousands, except number of sites) | Number of Sites | Net Book Value | Gain on Sale | |||||||
Balance at January 1, 2006 |
110 | $ | 65,693 | |||||||
Sold |
(70 | ) | (49,785 | ) | $ | 8,247 | ||||
Transferred to property, plant and equipment |
(31 | ) | (23,548 | ) | ||||||
Transferred from property, plant and equipment |
27 | 31,057 | ||||||||
Impairments recorded |
(7,962 | ) | ||||||||
Balance at December 31, 2006 |
36 | 15,455 | ||||||||
Sold |
(21 | ) | (10,188 | ) | $ | 3,477 | ||||
Transferred to property, plant and equipment |
(15 | ) | (5,618 | ) | ||||||
Transferred from property, plant and equipment |
7 | 5,438 | ||||||||
Impairments recorded |
(1,749 | ) | ||||||||
Balance at December 30, 2007 |
7 | $ | 3,338 |
Of the 2007 net gain of $3.5 million, $3.2 million is classified as Other (income) expense, net and $0.3 million is classified as Franchise revenue. Of the 2006 net gain of $8.2 million, $5.5 million is classified as Other (income) expense, net and $2.7 million is classified as Franchise revenue.
As shown above, 15 sites in 2007 and 31 sites in 2006 which were previously classified as held for disposition were reclassified from Assets held for disposition to Property and equipment, net because these sites are no longer being actively marketed for sale. The effect on the Consolidated Statements of Income related to the reclassification of these sites from Assets held for disposition was limited to depreciation expense and was not material. At December 30, 2007, the net book value of Assets held for disposition includes $2.7 million of land and $0.6 million of buildings and leasehold improvements.
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Also during 2007, the Company sold 40 sites not classified as held for disposition with a net book value of $11.2 million. The Company recognized a gain of $4.8 million from the sale of these sites, of which $1.8 million is classified as Other (income) expense, net and $3.0 million is classified as Franchise revenues on the Consolidated Statements of Income.
In the fourth quarter of 2005, the Company completed the sale of 130 Wendys real estate properties to a third party for $119.1 million, resulting in a pretax gain of $46.2 million, which is included in Other (income) expense, net on the Consolidated Statements of Income. The Company also sold 37 real estate properties in 2005 to existing franchisees for $42.0 million, resulting in a pretax gain of $16.4 million, which is included in Franchise revenues on the Consolidated Statements of Income.
In 2007, 2006 and 2005, the Company incurred $7.3 million, $16.7 million and $24.7 million, respectively, of store closing and asset impairment charges, which are included in Other (income) expense, net on the Consolidated Statements of Income. Total store closing costs included asset write-offs and lease termination costs.
NOTE 9 | RESTRUCTURING RESERVES |
As part of a cost reduction program, in 2006 the Company offered a voluntary enhanced retirement plan to certain full-time employees who were 55 years of age and had at least 10 years of service. Benefits primarily included severance and healthcare coverage. In accordance with SFAS No. 88, Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, in 2006 the Company recorded $16.5 million in charges related to individuals that accepted the offer. This amount included $2.5 million of additional stock compensation expense for unvested restricted stock units resulting from the acceleration of vesting to the employees retirement dates, in accordance with the Companys 2003 Stock Incentive Plan. In 2007 and 2006, the Company recognized $7.4 million and $3.9 million, respectively, of settlement charges as a result of distributions from the Companys defined benefit pension plan, primarily related to those individuals who participated in the voluntary enhanced retirement plan (see also Note 13 to the Consolidated Financial Statements).
In 2006, the Company also initiated a reduction in force and in accordance with SFAS No. 112, Employers Accounting for Postemployment Benefits, recognized severance and associated benefit costs of $1.7 million and $13.3 million in 2007 and 2006, respectively. The costs recognized in 2006 included $4.1 million related to certain senior executives who left the Company in 2006 and also included approximately $1.0 million of additional stock compensation expense related to the modification of stock-based equity awards.
In addition to the employee related costs above, the Company incurred professional fees and employee benefit costs of $0.7 million and $5.5 million in 2007 and 2006.
The table below presents a reconciliation of the beginning and ending restructuring liabilities (included in Accrued expensesOther) at January 1, 2006, December 31, 2006 and December 30, 2007, respectively:
(In thousands) | Enhanced Retirement |
Reduction in Force |
Professional Fees and Other |
Total | ||||||||||||
Balance at January 1, 2006 |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||
Expensed during the year |
14,179 | 11,386 | 5,601 | 31,166 | ||||||||||||
Paid during the year |
(13,925 | ) | (3,035 | ) | (5,460 | ) | (22,420 | ) | ||||||||
Adjustments |
(236 | ) | (1,853 | ) | 0 | (2,089 | ) | |||||||||
Balance at December 31, 2006 |
18 | 6,498 | 141 | 6,657 | ||||||||||||
Expensed during the year |
0 | 2,721 | 711 | 3,432 | ||||||||||||
Paid during the year |
0 | (8,569 | ) | (811 | ) | (9,380 | ) | |||||||||
Adjustments |
(18 | ) | 51 | (31 | ) | 2 | ||||||||||
Balance at December 30, 2007 |
$ | 0 | $ | 701 | $ | 10 | $ | 711 |
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The adjustments in the table above for 2007 and 2006 primarily reflect revised estimates related to the expected payout for certain employees included in the reduction in force. The 2007 adjustments also reflect the reclassification of $1.3 million of severance liabilities from long-term to current liabilities. As of December 30, 2007, all amounts related to this cost reduction plan are classified as current liabilities.
The Company expects to pay all remaining restructuring liabilities in 2008. All of the above restructuring costs are included in the Restructuring and Special Committee related charges line on the Consolidated Statements of Income.
The Restructuring and Special Committee related charges line on the Consolidated Statements of Income for 2007 also includes $24.7 million of primarily financial and legal advisory fees related to the activities of the Special Committee formed by the Companys Board of Directors. The Special Committee was formed to investigate strategic options including, among other things, revisions to the Companys strategic plan, changes to its capital structure, or a possible sale, merger or other business combination. No Special Committee costs were recorded in 2006.
NOTE 10 | DISCONTINUED OPERATIONS |
THI
On September 29, 2006, the Company completed the distribution of its remaining 82.75% ownership in THI. The distribution took place in the form of a pro rata common stock dividend to Wendys shareholders whereby each shareholder received 1.3542759 shares of THI common stock for each share of Wendys common stock held (see also Note 6 to the Consolidated Financial Statements).
The table below presents the significant components of THI operating results included in Income from discontinued operations for 2006 and 2005. THI represented the Hortons segment prior to the spin-off.
(In thousands) | 2006 | 2005 | ||||
Revenues |
$ | 1,040,945 | $ | 1,185,264 | ||
Income before income taxes |
$ | 232,692 | $ | 242,405 | ||
Income tax expense |
48,605 | 75,060 | ||||
Minority interest expense |
23,603 | 0 | ||||
Income from discontinued operations, net of tax |
$ | 160,484 | $ | 167,345 |
Impairment Charges
Under SFAS No. 142, goodwill and other indefinite-lived intangibles must be tested for impairment annually (or in interim periods if events indicate possible impairment). In the fourth quarter of 2005, the Company tested goodwill for impairment and recorded an impairment charge of $25.4 million related to the THI U.S. business. The Company determined the amount of the charge based on an estimate of the fair market value of the reporting unit based on historical performance and discounted cash flow projections. Lower than anticipated sales levels and lower store development expectations were the primary considerations in the determination that the recorded goodwill value was impaired. The impairment charges fully eliminated the balance of goodwill related to THI.
In 2005, a pretax asset impairment charge of $18.5 million was recorded related to two THI markets in New England that were acquired in 2004 as part of the Bess Eaton acquisition. These markets were underperforming despite various strategies employed to improve performance. The fair value of this market was determined based on the estimated realizable value of the fixed assets using third party appraisals.
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Derivatives
In the third quarter of 2005, THI entered into forward currency contracts that matured in March 2006 to sell Canadian dollars and buy $427.4 million U.S. dollars to hedge the repayment of cross-border intercompany notes being marked-to-market beginning in the third quarter of 2005. Previously, the translation of these intercompany notes was recorded in comprehensive income (expense), rather than in the Consolidated Statements of Income, in accordance with SFAS No. 52, Foreign Currency Translation. The fair value unrealized loss on these contracts as of January 1, 2006 was $3.2 million. On the maturity date of March 3, 2006, THI received $427.4 million from the counterparties and disbursed to the counterparties the U.S. dollar equivalent of $500.0 million Canadian, resulting in a net U.S. dollar cash flow of $13.1 million to the counterparties. Per SFAS No. 95, Statement of Cash Flows, the net U.S. dollar cash flow is reported in the Net cash provided by operating activities from discontinued operations line of the Consolidated Statements of Cash Flows. These forward currency contracts remained highly effective cash flow hedges and qualified for hedge accounting treatment through their maturity. As a result, changes in the fair value of the effective portion of these foreign currency contracts offset changes in the cross-border intercompany notes and a $0.8 million gain was recognized as the ineffective portion of the foreign currency contracts in Income from discontinued operations in the Consolidated Statements of Income.
In the fourth quarter of 2005, THI entered into forward currency contracts to sell Canadian dollars and buy $490.5 million U.S. dollars in order to hedge certain net investment positions in Canadian subsidiaries. On the maturity dates in April 2006, THI received $490.5 million U.S. from the counterparties and disbursed to the counterparties the U.S. dollar equivalent of $578.0 million Canadian, resulting in a net U.S. dollar cash flow of $14.9 million to the counterparties. Per SFAS No. 95, the net U.S. dollar cash flow is reported in the Net cash provided by operating activities from discontinued operations line of the Consolidated Statements of Cash Flows. The fair value unrealized loss on these contracts was $5.0 million, net of taxes of $3.0 million, as of January 1, 2006. Changes in the fair value of these foreign currency net investment hedges are included in the translation adjustments line of Other comprehensive income. These forward contracts remained highly effective hedges and qualified for hedge accounting treatment through their maturity. No amounts related to these net investment hedges were reclassified into earnings.
Debt
On February 28, 2006, THI entered into an unsecured five-year senior bank facility with a syndicate of Canadian and U.S. financial institutions that comprises a $300 million Canadian dollar term-loan facility; a $200 million Canadian dollar revolving credit facility (which includes $15 million in overdraft availability); and a $100 million U.S. dollar revolving credit facility (together referred to as the senior bank facility). The senior bank facility is an obligation of THI only, and not of the Company. The term loan facility bears interest at a variable rate per annum equal to Canadian prime rate or alternatively, THI may elect to borrow by way of Bankers Acceptances (or loans equivalent thereto) plus a margin. On February 28, 2006, THI also entered into an unsecured non-revolving $200 million Canadian dollar bridge loan facility. The bridge loan facility had interest at Bankers Acceptances plus a margin. Outstanding borrowings of $200 million Canadian at April 2, 2006 were repaid on May 3, 2006 and the bridge facility was terminated as a result of the voluntary prepayment. In connection with the term-loan facility, THI entered into a $100 million Canadian dollar interest rate swap on March 1, 2006 to help manage its exposure to interest rate volatility. The interest rate swap essentially fixed the interest rate on one third of the $300 million Canadian dollar term loan facility to 5.175% and matures on February 28, 2011.
Income Taxes
The decrease in 2006 tax expense as a percent of pretax income primarily reflects the resolution of certain THI tax audits in the second quarter 2006.
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Developing Brands
On November 28, 2006, the Company completed the sale of Baja Fresh, and on July 29, 2007, the Company completed the sale of Cafe Express. Accordingly, the results of operations of Baja Fresh and Cafe Express are reflected as discontinued operations for all periods presented. Both of these businesses historically comprised the Developing Brands segment. The assets and liabilities of Cafe Express were held for sale at December 31, 2006 and were presented as current and non-current assets and liabilities from discontinued operations. On February 28, 2007, in accordance with the terms of the partnership agreement, Wendys acquired, at no cost, the remaining 30% of equity of Cafe Express. The Company owned 100% of Cafe Express until it was sold on July 29, 2007. The income statement impact of the sale of Cafe Express was not material. The Company sold Baja Fresh for net cash proceeds of $25.0 million, net of costs associated with the sale, resulting in a $2.1 million loss, which is included in Income from discontinued operations on the Consolidated Statements of Income. According to the terms of the sale agreements, the dispositions of Baja Fresh and Cafe Express were subject to certain working capital and other adjustments, which have not been finalized. The impact of any such adjustments is not expected to have a material impact on the results of operations of the Company.
The table below presents the significant components of Baja Fresh and Cafe Express operating results included in Income from discontinued operations for 2007, 2006 and 2005.
(In thousands) | 2007 | 2006 | 2005 | |||||||||
Revenues |
$ | 19,687 | $ | 180,063 | $ | 204,091 | ||||||
Loss before income taxes |
$ | (379 | ) | $ | (161,112 | ) | $ | (41,125 | ) | |||
Income tax benefit |
(1,650 | ) | (57,894 | ) | (12,752 | ) | ||||||
Income (loss) from discontinued operations, net of tax |
$ | 1,271 | $ | (103,218 | ) | $ | (28,373 | ) |
The assets and liabilities of Cafe Express are reflected as discontinued operations in the Consolidated Balance Sheet as of December 31, 2006 and are comprised of the following:
(In thousands) | December 31, 2006 | ||
Cash |
$ | 2,273 | |
Accounts receivable, net |
124 | ||
Inventories and other |
315 | ||
Total current assets |
$ | 2,712 | |
Property and equipment, net |
$ | 350 | |
Intangible assets, net |
180 | ||
Other non current assets |
495 | ||
Total non current assets |
$ | 1,025 | |
Accounts payable |
$ | 1,476 | |
Accrued liabilities |