Edgar Filing: Wendy's Co

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



(X)		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018



( )		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _______________

Commission file number: 1-2207

THE WENDY’S COMPANY

(Exact name of registrants as specified in its charter)



Delaware		38-0471180
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

One Dave Thomas Blvd., Dublin, Ohio		43017
(Address of principal executive offices)		(Zip Code)

(614) 764-3100

(Registrant’s telephone number, including area code)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer [x]	Accelerated filer [ ]
Non-accelerated filer [ ]	Smaller reporting company [ ]
	Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [x]

There were 236,768,234 shares of The Wendy’s Company common stock outstanding as of October 31, 2018.

THE WENDY’S COMPANY AND SUBSIDIARIES

INDEX TO FORM 10-Q



	Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements	3
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017	3
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and October 1, 2017	4
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and October 1, 2017	5
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and October 1, 2017	6
Notes to Condensed Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3. Quantitative and Qualitative Disclosures about Market Risk	43
Item 4. Controls and Procedures	44

PART II: OTHER INFORMATION	45
Item 1. Legal Proceedings	47
Item 1A. Risk Factors	47
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 6. Exhibits	48
Signatures	49

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands Except Par Value)



	September 30, 2018			December 31, 2017
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$	634,751		$	171,447
Restricted cash	29,874			32,633
Accounts and notes receivable, net	100,148			114,390
Inventories	3,335			3,156
Prepaid expenses and other current assets	18,147			20,125
Advertising funds restricted assets	69,835			62,602
Total current assets	856,090			404,353
Properties	1,223,982			1,263,059
Goodwill	749,192			743,334
Other intangible assets	1,303,690			1,321,585
Investments	52,575			56,002
Net investment in direct financing leases	226,149			229,089
Other assets	95,754			79,516
Total assets	$	4,507,432		$	4,096,938

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	31,291		$	30,172
Accounts payable	24,061			22,764
Income taxes payable	84,623			1,115
Accrued expenses and other current liabilities	120,203			110,509
Advertising funds restricted liabilities	78,925			62,602
Total current liabilities	339,103			227,162
Long-term debt	2,759,766			2,724,230
Deferred income taxes	275,312			299,053
Deferred franchise fees	92,522			10,881
Other liabilities	257,411			262,409
Total liabilities	3,724,114			3,523,735
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.10 par value; 1,500,000 shares authorized; 470,424 shares issued; 238,318 and 240,512 shares outstanding, respectively	47,042			47,042
Additional paid-in capital	2,883,298			2,885,955
Retained earnings (accumulated deficit)	146,983			(163,289		)
Common stock held in treasury, at cost; 232,106 and 229,912 shares, respectively	(2,242,870		)	(2,150,307		)
Accumulated other comprehensive loss	(51,135		)	(46,198		)
Total stockholders’ equity	783,318			573,203
Total liabilities and stockholders’ equity	$	4,507,432		$	4,096,938

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Amounts)



	Three Months Ended						Nine Months Ended
	September 30, 2018			October 1, 2017			September 30, 2018			October 1, 2017
	(Unaudited)
Revenues:
Sales	$	165,323		$	158,843		$	486,316		$	467,914
Franchise royalty revenue and fees	103,212			98,882			308,679			306,120
Franchise rental income	50,474			50,275			152,110			140,127
Advertising funds revenue	81,541			—			245,011			—
	400,550			308,000			1,192,116			914,161
Costs and expenses:
Cost of sales	139,348			133,631			409,721			388,755
Franchise support and other costs	5,349			3,690			18,553			11,122
Franchise rental expense	22,260			24,076			69,829			64,841
Advertising funds expense	81,541			—			245,011			—
General and administrative	46,545			51,716			146,064			153,089
Depreciation and amortization	29,070			31,216			94,649			91,690
System optimization (gains) losses, net	(486		)	106			(8		)	39,749
Reorganization and realignment costs	941			2,888			6,691			20,768
Impairment of long-lived assets	347			1,041			2,156			1,804
Other operating income, net	(1,713		)	(2,021		)	(4,643		)	(5,828		)
	323,202			246,343			988,023			765,990
Operating profit	77,348			61,657			204,093			148,171
Interest expense, net	(29,625		)	(29,977		)	(89,939		)	(87,887		)
Loss on early extinguishment of debt	—			—			(11,475		)	—
Investment income (loss), net	450,133			(636		)	450,432			2,086
Other income, net	1,061			511			2,423			1,022
Income before income taxes	498,917			31,555			555,534			63,392
Provision for income taxes	(107,668		)	(17,298		)	(114,250		)	(28,639		)
Net income	$	391,249		$	14,257		$	441,284		$	34,753

Net income per share
Basic	$	1.65		$	.06		$	1.85		$	.14
Diluted	1.60			.06			1.79			.14

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands)



	Three Months Ended					Nine Months Ended
	September 30, 2018		October 1, 2017			September 30, 2018			October 1, 2017
	(Unaudited)
Net income	$	391,249	$	14,257		$	441,284		$	34,753
Other comprehensive income (loss), net:
Foreign currency translation adjustment	5,315		8,787			(5,054		)	16,797
Change in unrecognized pension loss:
Unrealized gains arising during the period	—		—			156			156
Income tax provision	—		—			(39		)	(60		)
	—		—			117			96
Effect of cash flow hedges:
Reclassification of losses into Net income	—		723			—			2,170
Income tax provision	—		(279		)	—			(838		)
	—		444			—			1,332
Other comprehensive income (loss), net	5,315		9,231			(4,937		)	18,225
Comprehensive income	$	396,564	$	23,488		$	436,347		$	52,978

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)



	Nine Months Ended
	September 30, 2018			October 1, 2017
	(Unaudited)
Cash flows from operating activities:
Net income	$	441,284		$	34,753
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	94,649			91,690
Share-based compensation	14,401			16,356
Impairment of long-lived assets	2,156			1,804
Deferred income tax	(1,527		)	945
Non-cash rental income, net	(10,868		)	(8,348		)
Net receipt of deferred vendor incentives	2,689			4,547
System optimization (gains) losses, net	(8		)	39,749
Gain on sale of investments, net	(450,000		)	(1,807		)
Distributions received from TimWen joint venture	9,060			5,524
Equity in earnings in joint ventures, net	(5,810		)	(6,113		)
Long-term debt-related activities, net (see below)	16,860			9,051
Other, net	4,596			2,023
Changes in operating assets and liabilities:
Accounts and notes receivable, net	11,382			(14,193		)
Inventories	(82		)	(44		)
Prepaid expenses and other current assets	2,754			(1,281		)
Advertising funds restricted assets and liabilities	8,879			(15,823		)
Accounts payable	(559		)	(1,557		)
Accrued expenses and other current liabilities	89,806			3,039
Net cash provided by operating activities	229,662			160,315
Cash flows from investing activities:
Capital expenditures	(39,717		)	(53,711		)
Acquisitions	(21,401		)	(86,788		)
Dispositions	2,863			80,058
Proceeds from sale of investments	450,000			3,282
Notes receivable, net	(283		)	(4,174		)
Payments for investments	(13		)	(375		)
Net cash provided by (used in) investing activities	391,449			(61,708		)
Cash flows from financing activities:
Proceeds from long-term debt	934,837			22,675
Repayments of long-term debt	(893,039		)	(42,966		)
Deferred financing costs	(17,340		)	(1,069		)
Repurchases of common stock	(140,199		)	(90,065		)
Dividends	(60,786		)	(51,464		)
Proceeds from stock option exercises	42,299			10,419
Payments related to tax withholding for share-based compensation	(10,464		)	(4,484		)
Contingent consideration payment	(6,269		)	—
Net cash used in financing activities	(150,961		)	(156,954		)
Net cash provided by (used in) operations before effect of exchange rate changes on cash	470,150			(58,347		)
Effect of exchange rate changes on cash	(2,195		)	6,910
Net increase (decrease) in cash, cash equivalents and restricted cash	467,955			(51,437		)
Cash, cash equivalents and restricted cash at beginning of period	212,824			275,949
Cash, cash equivalents and restricted cash at end of period	$	680,779		$	224,512

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—CONTINUED

(In Thousands)



	Nine Months Ended
	September 30, 2018		October 1, 2017
	(Unaudited)
Detail of cash flows from operating activities:
Long-term debt-related activities, net:
Loss on early extinguishment of debt	$	11,475	$	—
Accretion of long-term debt	940		927
Amortization of deferred financing costs	4,445		5,954
Reclassification of unrealized losses on cash flow hedges	—		2,170
	$	16,860	$	9,051

Supplemental cash flow information:
Cash paid for:
Interest	$	103,240	$	93,701
Income taxes, net of refunds	5,925		22,092

Supplemental non-cash investing and financing activities:
Capital expenditures included in accounts payable	$	9,588	$	9,621
Capitalized lease obligations	6,569		239,721
Accrued debt issuance costs	332		—

	September 30, 2018		December 31, 2017
Reconciliation of cash, cash equivalents and restricted cash at end of period:
Cash and cash equivalents	$	634,751	$	171,447
Restricted cash	29,874		32,633
Restricted cash, included in Advertising funds restricted assets	16,154		8,579
Restricted cash, included in Other assets	—		165
Total cash, cash equivalents and restricted cash	$	680,779	$	212,824

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements (the “Financial Statements”) of The Wendy’s Company (“The Wendy’s Company” and, together with its subsidiaries, the “Company,” “we,” “us” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and, therefore, do not include all information and footnotes required by GAAP for complete financial statements. In our opinion, the Financial Statements contain all adjustments of a normal recurring nature necessary to present fairly our financial position as of September 30, 2018, the results of our operations for the three and nine months ended September 30, 2018 and October 1, 2017 and cash flows for the nine months ended September 30, 2018 and October 1, 2017. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the full 2018 fiscal year. These Financial Statements should be read in conjunction with the audited consolidated financial statements for The Wendy’s Company and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “Form 10-K”).

The principal subsidiary of the Company is Wendy’s International, LLC and its subsidiaries (“Wendy’s”). The Company manages and internally reports its business geographically. The operation and franchising of Wendy’s^®restaurants in North America (defined as the United States of America (“U.S.”) and Canada) comprises virtually all of our current operations and represents a single reportable segment. The revenues and operating results of Wendy’s restaurants outside of North America are not material.

We report on a fiscal year consisting of 52 or 53 weeks ending on the Sunday closest to or on December 31. All three- and nine-month periods presented herein contain 13 weeks and 39 weeks, respectively. All references to years and quarters relate to fiscal periods rather than calendar periods.

Certain reclassifications have been made to the prior year presentation to conform to the current year presentation.

The Company has reclassified certain costs associated with the Company’s franchise operations to “Franchise support and other costs,” which were previously recorded to “Other operating expense (income), net.” The costs reclassified include costs incurred to provide direct support services to our franchisees, as well as certain other direct and incremental costs for the Company’s franchise operations. Also, the Company reclassified certain restaurant operational costs from “General and administrative” to “Cost of sales.” The Company believes this new presentation will aid users in understanding its results of operations. The prior periods reflect the reclassifications of these expenses to conform to the current year presentation. There was no impact to operating profit, income before income taxes or net income as a result of these reclassifications.

The following tables illustrate the expense reclassifications made to the condensed consolidated statements of operations for the three and nine months ended October 1, 2017:



	Three Months Ended
			Reclassifications
	As Previously Reported		Franchise support and other costs			Restaurant operational costs			As Currently Reported
Cost of sales	$	132,387	$	—		$	1,244		$	133,631
Franchise support and other costs	—		3,690			—			3,690
General and administrative	52,960		—			(1,244		)	51,716
Other operating expense (income), net	1,669		(3,690		)	—			(2,021		)
	$	187,016	$	—		$	—		$	187,016

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)



	Nine Months Ended
			Reclassifications
	As Previously Reported		Franchise support and other costs			Restaurant operational costs			As Currently Reported
Cost of sales	$	385,154	$	—		$	3,601		$	388,755
Franchise support and other costs	—		11,122			—			11,122
General and administrative	156,690		—			(3,601		)	153,089
Other operating expense (income), net	5,294		(11,122		)	—			(5,828		)
	$	547,138	$	—		$	—		$	547,138

(2) New Accounting Standards

New Accounting Standards

In August 2018, the Financial Accounting Standards Board (“FASB”) issued new guidance on accounting for implementation costs of a cloud computing arrangement that is a service contract. The new guidance aligns the accounting for such implementation costs of a cloud computing arrangement that is a service contract with the guidance on capitalizing costs associated with developing or obtaining internal-use software. The Company does not expect the amendment, which is effective beginning with our 2019 fiscal year, to have a material impact on our consolidated financial statements.

In August 2018, the FASB issued new guidance on disclosure requirements for fair value measurements. The objective of the new guidance, which is effective beginning with our 2020 fiscal year, is to provide additional information about assets and liabilities measured at fair value in the statement of financial position or disclosed in the notes to financial statements. New incremental disclosure requirements include the amount of fair value hierarchy level 3 changes in unrealized gains and losses and the range and weighted average used to develop significant unobservable inputs for level 3 fair value measurements. The Company does not expect the amendment to have a material impact on our consolidated financial statements.

In August 2018, the FASB issued new guidance on disclosure requirements for employer sponsored defined benefit plans. The amendments remove disclosure requirements that no longer are considered cost beneficial and add disclosure requirements that are identified as relevant. New incremental disclosure requirements include the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates as well as an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The Company does not expect the amendment, which is effective beginning with our 2020 fiscal year, to have a material impact on our consolidated financial statements.

In June 2018, the FASB issued new guidance on nonemployee share-based payment arrangements. The new guidance aligns the requirements for nonemployee share-based payments with the requirements for employee share-based payments. The Company does not expect the amendment, which is effective beginning with our 2019 fiscal year, to have a material impact on our consolidated financial statements.

In February 2016, the FASB issued new guidance on leases, which outlines principles for the recognition, measurement, presentation and disclosure of leases applicable to both lessors and lessees. The new guidance, which is effective beginning with our 2019 fiscal year, requires lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by finance and operating leases with lease terms of more than 12 months. The guidance allows for either (1) a modified retrospective transition method under which the standard is applied at the beginning of the earliest period presented in the financial statements or (2) an alternative transition method under which the standard is applied at the adoption date and a cumulative-effect adjustment to the opening balance of retained earnings is recognized in the period of adoption. The Company currently plans to adopt the standard using the alternative transition method. We are currently implementing a new lease management system to facilitate the adoption of this guidance. As shown in Note 14, there are $1,546,470 in future minimum rental payments for operating leases that are not currently on our balance sheet; therefore, we expect this will have a material impact on our consolidated balance sheets and related disclosures. We do not expect the adoption of this guidance to have a material impact on our consolidated statements of operations and statements of cash flows.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

New Accounting Standards Adopted

In May 2017, the FASB issued new guidance on the scope of modification accounting for share-based payment arrangements. The new guidance provides relief to entities that make non-substantive changes to their share-based payment arrangements. The Company adopted this amendment, prospectively, during the first quarter of 2018. The adoption of this guidance did not impact our condensed consolidated financial statements.

In January 2017, the FASB issued an amendment that clarifies the definition of a business in determining whether to account for a transaction as an asset acquisition or a business combination. The Company adopted this amendment, prospectively, during the first quarter of 2018. The adoption of this guidance did not impact our condensed consolidated financial statements.

In November 2016, the FASB issued an amendment that clarifies guidance for proper classification and presentation of restricted cash in the statement of cash flows. Accordingly, changes in restricted cash that have historically been included within operating, investing and financing activities have been eliminated, and restricted cash, including the restricted cash of the national advertising funds, is combined with cash and cash equivalents when reconciling the beginning and end of period balances for all periods presented. The Company adopted this amendment during the first quarter of 2018. The adoption of the amendment resulted in an increase in net cash used in investing activities of $23,624 during the nine months ended October 1, 2017. In addition, during the nine months ended October 1, 2017, net cash provided by operating activities decreased $16,428, primarily due to changes in restricted cash of the national advertising funds. Because of the inclusion of restricted cash in the beginning and end of period balances, our cash, cash equivalents and restricted cash as presented in the statement of cash flows increased $37,883 and $77,709 as of October 1, 2017 and January 1, 2017, respectively. This amendment did not impact the Company’s condensed consolidated statements of operations and condensed consolidated balance sheets.

In August 2016, the FASB issued an amendment that provides guidance for proper classification of certain cash receipts and payments in the statement of cash flows. Upon adoption in the first quarter of 2018, the Company elected to use the nature of distribution approach for all distributions it receives from its equity method investees. The adoption of this guidance did not impact our condensed consolidated financial statements.

In March 2016, the FASB issued an amendment that provides guidance on extinguishing financial liabilities for certain prepaid stored-value products. The Company adopted this amendment during the first quarter of 2018. The adoption of this guidance did not impact our condensed consolidated financial statements.

In January 2016, the FASB issued an amendment that revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The Company adopted this amendment during the first quarter of 2018. The adoption of this guidance did not impact our condensed consolidated financial statements.

Revenue Recognition

In May 2014, the FASB issued amended guidance for revenue recognition. The new guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of the guidance is that an entity should recognize revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Additionally, the guidance requires improved disclosure to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognized. The Company adopted the new guidance on January 1, 2018. As a result, the Company has changed its accounting policy for revenue recognition as detailed below.

The Company applied the new guidance using the modified retrospective method, whereby the cumulative effect of initially adopting the guidance was recognized as an adjustment to the opening balance of equity at January 1, 2018. Therefore, the comparative period has not been adjusted and continues to be reported under the previous revenue recognition guidance. The details of the significant changes and quantitative impact of the changes are discussed below. See Note 3 for further information regarding our revenue policies and disaggregation of our sources of revenue.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Franchise Fees

Under previous revenue recognition guidance, new build technical assistance fees and development fees were recognized as revenue when a franchised restaurant opened, as all material services and conditions related to the franchise fee had been substantially performed upon the restaurant opening. In addition, under previous guidance, technical assistance fees received in connection with sales of Company-operated restaurants to franchisees and facilitating franchisee-to-franchisee restaurant transfers (“Franchise Flips”), as well as renewal fees, were recognized as revenue when the license agreements were signed and the restaurant opened. Under the new guidance, these franchise fees are considered highly dependent upon and interrelated with the franchise right granted in the franchise agreement. As such, these franchise fees are recognized over the contractual term of the franchise agreement.

National Advertising Funds

The Company maintains two national advertising funds (the “Advertising Funds”) established to collect and administer funds contributed for use in advertising and promotional programs for Company-operated and franchised restaurants in the U.S. and Canada. Previously, the revenue, expenses and cash flows of such Advertising Funds were not included in the Company’s condensed consolidated statements of operations and statements of cash flows because the contributions to these Advertising Funds were designated for specific purposes and the Company acted as an agent, in substance, with regard to these contributions as a result of industry-specific guidance. Under the new guidance, which superseded the previous industry-specific guidance, the revenue, expenses and cash flows of the Advertising Funds are fully consolidated into the Company’s condensed consolidated statements of operations and statements of cash flows. In addition, the Company reclassified the total stockholders’ equity of the Advertising Funds from “Advertising funds restricted liabilities” to “Accumulated deficit” upon adoption of the guidance. Upon the full consolidation of the Advertising Funds, the Company also eliminated certain amounts due to and from affiliates from “Advertising funds restricted assets” and “Advertising funds restricted liabilities.” The Company allocates a portion of its advertising funds expense to “Cost of sales” based on a percentage of sales of Company-operated restaurants. Our significant interim accounting policies include the recognition of advertising funds expense in proportion to advertising funds revenue.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Impacts on Financial Statements

The following tables summarize the impacts of adopting the revenue recognition standard on the Company’s condensed consolidated financial statements:



				Adjustments
	As Reported			Franchise Fees			Advertising Funds			Balances Without Adoption
Condensed Consolidated Balance Sheet
September 30, 2018
Accrued expenses and other current liabilities	$	120,203		$	(1,664	)	$	—		$	118,539
Advertising funds restricted liabilities	78,925			—			(6,645		)	72,280
Total current liabilities	339,103			(1,664		)	(6,645		)	330,794
Deferred income taxes	275,312			21,463			—			296,775
Deferred franchise fees	92,522			(81,686		)	—			10,836
Total liabilities	3,724,114			(61,887		)	(6,645		)	3,655,582
Retained earnings	146,983			62,011			6,645			215,639
Accumulated other comprehensive loss	(51,135		)	(124		)	—			(51,259		)
Total stockholders’ equity	783,318			61,887			6,645			851,850

Condensed Consolidated Statements of Operations
Three Months Ended September 30, 2018
Franchise royalty revenue and fees (a)	$	103,212		$	(497	)	$	—		$	102,715
Advertising funds revenue	81,541			—			(81,541		)	—
Total revenues	400,550			(497		)	(81,541		)	318,512
Advertising funds expense	81,541			—			(81,541		)	—
Total costs and expenses	323,202			—			(81,541		)	241,661
Operating profit	77,348			(497		)	—			76,851
Income before income taxes	498,917			(497		)	—			498,420
Provision for income taxes	(107,668		)	124			—			(107,544		)
Net income	391,249			(373		)	—			390,876

Nine Months Ended September 30, 2018
Franchise royalty revenue and fees (a)	$	308,679		$	(2,087	)	$	—		$	306,592
Advertising funds revenue	245,011			—			(245,011		)	—
Total revenues	1,192,116			(2,087		)	(245,011		)	945,018
Advertising funds expense	245,011			—			(245,011		)	—
Total costs and expenses	988,023			—			(245,011		)	743,012
Operating profit	204,093			(2,087		)	—			202,006
Income before income taxes	555,534			(2,087		)	—			553,447
Provision for income taxes	(114,250		)	533			—			(113,717		)
Net income	441,284			(1,554		)	—			439,730

_______________

(a)

The adjustments for the three and nine months ended September 30, 2018 include the reversal of franchise fees recognized over time under the new revenue recognition guidance of $2,266 and $7,393, respectively, as well as franchisee fees that would have been recognized under the previous revenue recognition guidance when the license agreements were signed and the restaurant opened of $1,769 and $5,306, respectively. See Note 3 for further information.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)



				Adjustments
	As Reported			Franchise Fees			Advertising Funds		Balances Without Adoption
Condensed Consolidated Statement of Cash Flows
Nine Months Ended September 30, 2018
Cash flows from operating activities:
Net income	$	441,284		$	(1,554	)	$	—	$	439,730
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income tax	(1,527		)	(533		)	—		(2,060		)
Other, net	4,596			(219		)	—		4,377
Changes in operating assets and liabilities:
Accrued expenses and other current liabilities	89,806			2,306			—		92,112

(3) Revenue

Nature of Goods and Services

Wendy’s franchises and operates Wendy’s^® quick-service restaurants specializing in hamburger sandwiches throughout North America. Wendy’s also has franchised restaurants in 30 foreign countries and U.S. territories other than North America. At September 30, 2018, Wendy’s operated and franchised 350 and 6,319 restaurants, respectively. The Company generates revenues from sales at Company-operated restaurants and earns fees and rental income from franchised restaurants.

The rights and obligations governing franchised restaurants are set forth in the franchise agreement. The franchise agreement provides the franchisee the right to construct, own and operate a Wendy’s restaurant upon a site accepted by Wendy’s and to use the Wendy’s system in connection with the operation of the restaurant at that site. The franchise agreement generally provides for a 20-year term and a 10-year renewal subject to certain conditions. The initial term may be extended up to 25 years and the renewal extended up to 20 years for qualifying restaurants under certain new restaurant development programs.

The franchise agreement requires that the franchisee pay a royalty based on a percentage of sales of the franchised restaurant, as well as make contributions to the Advertising Funds based on a percentage of sales. The agreement also typically requires that the franchisee pay Wendy’s a technical assistance fee. The technical assistance fee is used to defray some of the costs to Wendy’s for training, start-up and transitional services related to new and existing franchisees acquiring restaurants and in the development and opening of new restaurants.

Wendy’s also enters into development agreements with certain franchisees. The development agreement provides the franchisee with the right to develop a specified number of new Wendy’s restaurants using the Image Activation design within a stated, non-exclusive territory for a specified period, subject to the franchisee meeting interim new restaurant development requirements.

Wendy’s owns and leases sites from third parties, which it leases and/or subleases to franchisees. Noncancelable lease terms are generally initially between 15 and 20 years and, in most cases, provide for rent escalations and renewal options. The lease term for properties leased or subleased to franchisees is determined based upon the economic detriment to the franchisee and includes consideration of the length of the franchise agreement, historical performance of the restaurant and the existence of bargain renewal options.

Royalties and contributions to the Advertising Funds are generally due within the month subsequent to which the revenue was generated through sales of the franchised restaurant. Technical assistance fees, renewal fees and development fees are generally due upon execution of the related franchise agreement. Rental income is due in accordance with the terms of each lease, which is generally at the beginning of each month.

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(In Thousands Except Per Share Amounts)

Significant Accounting Policy

“Sales” includes revenues recognized upon delivery of food to the customer at Company-operated restaurants. “Sales” excludes taxes collected from the Company’s customers. Revenue is recognized when the performance obligation is satisfied, which occurs upon delivery of food to the customer. “Sales” also includes income for gift cards. Gift card payments are recorded as deferred income when received and are recognized as revenue in proportion to actual gift card redemptions.

“Franchise royalty revenue and fees” includes royalties, new build technical assistance fees, renewal fees, Franchise Flip technical assistance fees, Franchise Flip advisory fees and development fees. Royalties from franchised restaurants are based on a percentage of sales of the franchised restaurant and are recognized as earned. New build technical assistance fees, renewal fees and Franchise Flip technical assistance fees are recorded as deferred revenue when received and recognized as revenue over the contractual term of the franchise agreements, once the restaurant has opened. Development fees are deferred when received, allocated to each agreed upon restaurant, and recognized as revenue over the contractual term of each respective franchise agreement, once the restaurant has opened. These franchise fees are considered highly dependent upon and interrelated with the franchise right granted in the franchise agreement. Franchise Flip advisory fees include valuation services and fees for selecting pre-approved buyers for Franchise Flips. Franchise Flip advisory fees are paid by the seller and are recognized as revenue at closing of the Franchise Flip transaction.

“Advertising funds revenue” includes contributions to the Advertising Funds by franchisees. Revenue related to these contributions is based on a percentage of sales of the franchised restaurants and is recognized as earned.

“Franchise rental income” includes rental income from properties owned and leased by the Company and leased or subleased to franchisees. Rental income is recognized on a straight-line basis over the respective operating lease terms. Favorable and unfavorable lease amounts related to the leased and/or subleased properties are amortized to rental income on a straight-line basis over the remaining term of the leases.

Disaggregation of Revenue

The following table disaggregates revenue by primary geographical market and source:



	Three Months Ended		Nine Months Ended
	September 30, 2018		September 30, 2018
Primary geographical markets
United States	$	375,938	$	1,121,518
Canada	19,738		56,156
International	4,874		14,442
Total revenue	$	400,550	$	1,192,116

Sources of revenue
Sales at Company-operated restaurants	$	165,323	$	486,316
Franchise royalty revenue	95,501		283,602
Franchise fees	7,711		25,077
Franchise rental income	50,474		152,110
Advertising funds revenue	81,541		245,011
Total revenue	$	400,550	$	1,192,116

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Contract Balances

The following table provides information about receivables and contract liabilities (deferred franchise fees) from contracts with customers:



	September 30, 2018 (a)
Receivables, which are included in “Accounts and notes receivable, net” (b)	$	39,281
Receivables, which are included in “Advertising funds restricted assets”	42,226
Deferred franchise fees (c)	103,012

_______________


(a)	Excludes funds collected from the sale of gift cards, which are primarily reimbursed to franchisees upon redemption at franchised restaurants and do not ultimately result in the recognition of revenue in the Company’s statement of operations.


(b)	Includes receivables related to “Sales” and “Franchise royalty revenue and fees.”


(c)	Deferred franchise fees of $10,490 and $92,522 are included in “Accrued expenses and other current liabilities” and “Deferred franchise fees,” respectively.

Significant changes in deferred franchise fees are as follows:



	Nine Months Ended
	September 30, 2018
Deferred franchise fees at beginning of period	$	102,492
Revenue recognized during the period	(7,393		)
New deferrals due to cash received and other	7,913
Deferred franchise fees at end of period	$	103,012

Anticipated Future Recognition of Deferred Franchise Fees

The following table reflects the estimated franchise fees to be recognized in the future related to performance obligations that are unsatisfied at the end of the period:



Estimate for fiscal year:
2018 (a)	$	2,445
2019	7,774
2020	6,282
2021	5,749
2022	5,559
Thereafter	75,203
	$	103,012

_______________


(a)	Represents franchise fees expected to be recognized for the remainder of the 2018 fiscal year, which includes development-related franchise fees expected to be recognized over a duration of one year or less.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(4) Acquisitions

During the nine months ended September 30, 2018, the Company acquired 16 restaurants from a franchisee for total net cash consideration of $21,401. The Company did not incur any material acquisition-related costs associated with the acquisition and such transaction was not significant to our condensed consolidated financial statements. The table below presents the allocation of the total purchase price to the fair value of assets acquired and liabilities assumed for restaurants acquired from the franchisee:



	Nine Months Ended
	September 30, 2018
Restaurants acquired from franchisee	16

Total consideration paid, net of cash received	$	21,401
Identifiable assets acquired and liabilities assumed:
Properties	4,363
Acquired franchise rights	10,127
Capital lease assets	5,360
Other assets	621
Capital lease obligations	(3,135		)
Unfavorable leases	(733		)
Other liabilities	(1,960		)
Total identifiable net assets	14,643
Goodwill	$	6,758

On May 31, 2017, the Company also entered into the DavCo and NPC Transactions. See Note 5 for further information.

(5) System Optimization (Gains) Losses, Net

The Company’s system optimization initiative includes a shift from Company-operated restaurants to franchised restaurants over time, through acquisitions and dispositions, as well as facilitating Franchise Flips. The Company completed its plan to reduce its ongoing Company-operated restaurant ownership to approximately 5% of the total system as of January 1, 2017. While the Company has no plans to reduce its ownership below the approximately 5% level, Wendy’s will continue to optimize its system through Franchise Flips, as well as evaluating strategic acquisitions of franchised restaurants and strategic dispositions of Company-operated restaurants to existing and new franchisees, to further strengthen the franchisee base and drive new restaurant development and accelerate reimages in the Image Activation format.

During the nine months ended September 30, 2018, the Company completed the sale of three Company-operated restaurants to a franchisee. In addition, the Company facilitated 73 and 270 Franchise Flips during the nine months ended September 30, 2018 and October 1, 2017, respectively (excluding the DavCo and NPC Transactions discussed below).

Gains and losses recognized on dispositions are recorded to “System optimization (gains) losses, net” in our condensed consolidated statements of operations. Costs related to acquisitions and dispositions under our system optimization initiative are recorded to “Reorganization and realignment costs,” which are further described in Note 6. All other costs incurred related to facilitating Franchise Flips are recorded to “Franchise support and other costs.”

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of the disposition activity recorded as a result of our system optimization initiative:



	Three Months Ended					Nine Months Ended
	September 30, 2018		October 1, 2017			September 30, 2018			October 1, 2017
Gain on sale of restaurants, net (a)	$	—	$	—		$	89		$	—
Post-closing adjustments on sales of restaurants (b)	279		418			54			1,345
Gain (loss) on sales of other assets, net (c)	207		(539		)	(135		)	2,040
Gain (loss) on DavCo and NPC Transactions (d)	—		15			—			(43,134		)
System optimization gains (losses), net	$	486	$	(106	)	$	8		$	(39,749	)

_______________


(a)	During the nine months ended September 30, 2018, the Company received cash proceeds of $1,436 from the sale of three Company-operated restaurants. Net assets sold totaled $1,139 and consisted primarily of equipment. In addition, goodwill of $208 was written off in connection with the sale.

(b)

The nine months ended September 30, 2018 includes cash proceeds, net of payments of $6. The three and nine months ended October 1, 2017 includes cash payments, net of proceeds received, of $333 and $33, respectively, related to post-closing reconciliations with franchisees. The three and nine months ended September 30, 2018 and the nine months ended October 1, 2017 include the recognition of deferred gains of $503 and $312, respectively, as a result of the resolution of certain contingencies related to the extension of lease terms for restaurants previously sold to franchisees.

(c)

During the three and nine months ended September 30, 2018, the Company received cash proceeds, primarily from the sale of surplus properties, of $1,049 and $1,421, respectively, and received cash proceeds of $2,411 and $9,403 during the three and nine months ended October 1, 2017, respectively. The nine months ended October 1, 2017 also includes the recognition of a deferred gain of $375 related to the sale of a share in an aircraft.

(d)

As part of our system optimization initiative, the Company acquired 140 Wendy’s restaurants on May 31, 2017 from DavCo Restaurants, LLC (“DavCo”) for total net cash consideration of $86,788, which were immediately sold to NPC International, Inc. (“NPC”), an existing franchisee of the Company, for cash proceeds of $70,688 (the “DavCo and NPC Transactions”). The acquisition of Wendy’s restaurants from DavCo was not contingent on executing the sale agreement with NPC; as such, the Company accounted for the transactions as an acquisition and subsequent disposition of a business. As part of the transactions, the Company retained leases for purposes of subleasing such properties to NPC.

The total consideration paid to DavCo was allocated to net tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. Refer to the Form 10-K for further information regarding the purchase price allocation. The Company finalized the purchase price allocation during 2018 with no differences from the provisional amounts previously reported. The gain on the DavCo and NPC Transactions during the three months ended October 1, 2017 was comprised of a decrease in goodwill of $27 related to adjustments in the fair value of deferred taxes and net unfavorable leases, partially offset by additional selling and other costs of $12. The loss on the DavCo and NPC Transactions during the nine months ended October 1, 2017 was comprised of the write-off of goodwill of $65,476 and selling and other costs of $1,692, partially offset by the recognition of net favorable leases of $24,034.

As part of the DavCo acquisition, the Company recognized a supplemental purchase price liability of $6,269, which was settled during the nine months ended September 30, 2018.

As of September 30, 2018 and December 31, 2017, the Company had assets held for sale of $2,519 and $2,235, respectively, primarily consisting of surplus properties. Assets held for sale are included in “Prepaid expenses and other current assets.”

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(6) Reorganization and Realignment Costs

The following is a summary of the initiatives included in “Reorganization and realignment costs:”



	Three Months Ended				Nine Months Ended
	September 30, 2018		October 1, 2017		September 30, 2018		October 1, 2017
G&A realignment	$	629	$	2,656	$	6,375	$	19,901
System optimization initiative	312		232		316		867
Reorganization and realignment costs	$	941	$	2,888	$	6,691	$	20,768

General and Administrative (“G&A”) Realignment

In May 2017, the Company initiated a plan to further reduce its G&A expenses. The Company expects to incur total costs aggregating approximately $30,000 to $33,000 related to the plan. The Company recognized costs totaling $6,375 during the nine months ended September 30, 2018, which primarily included severance and related employee costs and share-based compensation. The Company expects to incur additional costs aggregating approximately $4,500, comprised of (1) severance and related employee costs of approximately $1,000, (2) recruitment and relocation costs of approximately $2,000, (3) third-party and other costs of approximately $500 and (4) share-based compensation of approximately $1,000. The Company expects to continue to recognize costs associated with the plan into 2019.

The following is a summary of the activity recorded as a result of the G&A realignment plan:



	Three Months Ended				Nine Months Ended				Total Incurred Since Inception
	September 30, 2018		October 1, 2017		September 30, 2018		October 1, 2017		Total Incurred Since Inception
Severance and related employee costs	$	57	$	1,210	$	3,168	$	14,436	$	18,124
Recruitment and relocation costs	200		145		708		145		1,197
Third-party and other costs	39		496		971		821		2,062
	296		1,851		4,847		15,402		21,383
Share-based compensation (a)	333		805		1,528		4,499		6,655
Total G&A realignment	$	629	$	2,656	$	6,375	$	19,901	$	28,038

_______________


(a)	Primarily represents incremental share-based compensation resulting from the modification of stock options in connection with the termination of employees under our G&A realignment plan.

As of September 30, 2018, the accruals for our G&A realignment plan are included in “Accrued expenses and other current liabilities” and “Other liabilities” and totaled $6,817 and $1,432, respectively. The tables below present a rollforward of our accruals for the plan.



	Balance December 31, 2017		Charges		Payments			Balance September 30, 2018
Severance and related employee costs	$	12,093	$	3,168	$	(7,103	)	$	8,158
Recruitment and relocation costs	177		708		(794		)	91
Third-party and other costs	—		971		(971		)	—
	$	12,270	$	4,847	$	(8,868	)	$	8,249

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)



	Balance January 1, 2017		Charges		Payments			Balance October 1, 2017
Severance and related employee costs	$	—	$	14,436	$	(1,350	)	$	13,086
Recruitment and relocation costs	—		145		(36		)	109
Third-party and other costs	—		821		(821		)	—
	$	—	$	15,402	$	(2,207	)	$	13,195

System Optimization Initiative

The Company recognizes costs related to acquisitions and dispositions under its system optimization initiative. The Company has incurred costs of $72,225 under the initiative since inception. The Company does not expect to incur additional costs in 2018 in connection with acquisitions or dispositions under our system optimization initiative.

(7) Investments

Equity Investments

Wendy’s has a 50% share in a partnership in a Canadian restaurant real estate joint venture (“TimWen”) with a subsidiary of Restaurant Brands International Inc., a quick-service restaurant company that owns the Tim Hortons^® brand. (Tim Hortonsis a registered trademark of Tim Hortons USA Inc.) In addition, a wholly-owned subsidiary of Wendy’s has a 20% share in a joint venture for the operation of Wendy’s restaurants in Brazil (the “Brazil JV”). The Company has significant influence over these investees. Such investments are accounted for using the equity method of accounting, under which our results of operations include our share of the income (loss) of the investees in “Other operating income, net.”

Presented below is activity related to our investment in TimWen and the Brazil JV included in our condensed consolidated financial statements:



	Nine Months Ended
	September 30, 2018			October 1, 2017
Balance at beginning of period	$	55,363		$	54,545

Investment	13			375

Equity in earnings for the period	7,566			7,844
Amortization of purchase price adjustments (a)	(1,756		)	(1,731		)
	5,810			6,113
Distributions received (b)	(9,060		)	(8,128		)
Foreign currency translation adjustment included in “Other comprehensive income (loss), net” and other	(191		)	4,304
Balance at end of period	$	51,935		$	57,209

_______________


(a)	Purchase price adjustments that impacted the carrying value of the Company’s investment in TimWen are being amortized over the average original aggregate life of 21 years.


(b)	The nine months ended October 1, 2017 included a distribution receivable from TimWen of $2,604, which was included in “Accounts and notes receivable, net.”

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Indirect Investment in Inspire Brands

In connection with the sale of Arby’s Restaurant Group, Inc. (“Arby’s) during 2011, Wendy’s Restaurants, LLC (“Wendy’s Restaurants”) obtained an 18.5% equity interest in ARG Holding Corporation (“ARG Parent”) (through which Wendy’s Restaurants indirectly retained an 18.5% interest in Arby’s). The carrying value of our investment was reduced to zero during 2013 in connection with the receipt of a dividend.

Our 18.5% equity interest was diluted to 12.3% on February 5, 2018, when a subsidiary of ARG Parent acquired Buffalo Wild Wings, Inc. As a result, our diluted ownership interest included both the Arby’s and Buffalo Wild Wings brands under the newly formed combined company, Inspire Brands, Inc. (“Inspire Brands”). On August 16, 2018, the Company sold its remaining 12.3% ownership interest to Inspire Brands for $450,000 and incurred transaction costs of $79, which were recorded to “Investment income (loss), net.” The Company expects to pay income taxes on the transaction of approximately $95,000 during the fourth quarter of 2018.

(8) Long-Term Debt

Long-term debt consisted of the following:



	September 30, 2018			December 31, 2017
Series 2018-1 Class A-2 Notes:
3.573% Series 2018-1 Class A-2-I Notes, anticipated repayment date 2025	$	446,625		$	—
3.884% Series 2018-1 Class A-2-II Notes, anticipated repayment date 2028	471,438			—
Series 2015-1 Class A-2 Notes:
3.371% Series 2015-1 Class A-2-I Notes, repaid with 2018 refinancing	—			855,313
4.080% Series 2015-1 Class A-2-II Notes, anticipated repayment date 2022	873,000			879,750
4.497% Series 2015-1 Class A-2-III Notes, anticipated repayment date 2025	485,000			488,750
7% debentures, due in 2025	90,454			89,514
Capital lease obligations, due through 2045	458,347			467,964
Unamortized debt issuance costs	(33,807		)	(26,889		)
	2,791,057			2,754,402
Less amounts payable within one year	(31,291		)	(30,172		)
Total long-term debt	$	2,759,766		$	2,724,230

On January 17, 2018, Wendy’s Funding, LLC (the “Master Issuer”), a limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiary of the Company, completed a refinancing transaction under which the Master Issuer issued fixed rate senior secured notes in the following 2018-1 series: Class A-2-I with an initial principal amount of $450,000 and Class A-2-II with an initial principal amount of $475,000 (collectively, the “Series 2018-1 Class A-2 Notes”). Interest payments on the Series 2018-1 Class A-2 Notes are payable on a quarterly basis. The legal final maturity date of the Series 2018-1 Class A-2 Notes is in March 2048. If the Master Issuer has not repaid or redeemed the Series 2018-1 Class A-2 Notes prior to the respective anticipated repayment date, additional interest will accrue on these notes equal to the greater of (1) 5.00% per annum and (2) a per annum interest rate equal to the excess, if any, by which the sum of (a) the yield to maturity (adjusted to a quarterly bond-equivalent basis) on such anticipated repayment date of the United States Treasury Security having a term closest to 10 years, plus (b) 5.00%, plus (c) (i) with respect to the Series 2018-1 Class A-2-I Notes, 1.35%, and (ii) with respect to the Series 2018-1 Class A-2-II Notes, 1.58%, exceeds the original interest rate with respect to such tranche. The net proceeds from the sale of the Series 2018-1 Class A-2 Notes were used to redeem the Master Issuer’s outstanding Series 2015-1 Class A-2-I Notes, to pay prepayment and transaction costs, and for general corporate purposes. As a result, the Company recorded a loss on early extinguishment of debt of $11,475 during the nine months ended September 30, 2018, which was comprised of the write-off of certain deferred financing costs and a specified make-whole payment. The Series 2018-1 Class A-2 Notes have scheduled principal payments of $9,250 annually from 2018 through 2024, $423,250 in 2025, $4,750 in each 2026 through 2027 and $427,500 in 2028.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Concurrently, the Master Issuer entered into a revolving financing facility of Series 2018-1 Variable Funding Senior Secured Notes, Class A-1 (the “Series 2018-1 Class A-1 Notes” and, together with the Series 2018-1 Class A-2 Notes, the “Series 2018-1 Senior Notes”), which allows for the drawing of up to $150,000 using various credit instruments, including a letter of credit facility. No amounts were borrowed under the Series 2018-1 Class A-1 Notes during the nine months ended September 30, 2018. The Series 2015-1 Class A-1 Notes were canceled on the closing date and the letters of credit outstanding against the Series 2015-1 Class A-1 Notes were transferred to the Series 2018-1 Class A-1 Notes.

The Series 2018-1 Senior Notes are secured by substantially all of the assets of the Master Issuer and certain other limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiaries of the Company that act as guarantors (the “Guarantors”), excluding certain real estate assets and subject to certain limitations. The Series 2018-1 Senior Notes are subject to the same series of covenants and restrictions as the Series 2015-1 Senior Notes.

During the nine months ended September 30, 2018, the Company incurred debt issuance costs of $17,672 in connection with the issuance of the Series 2018-1 Senior Notes. The debt issuance costs are being amortized to “Interest expense, net” through the anticipated repayment dates of the Series 2018-1 Senior Notes utilizing the effective interest rate method.

Wendy’s U.S. advertising fund has a revolving line of credit of $25,000. Neither the Company, nor Wendy’s, is the guarantor of the debt. The advertising fund facility was established to fund the advertising fund operations. During the nine months ended September 30, 2018, the Company borrowed and repaid $9,837 and $11,124 under the line of credit, respectively. During the nine months ended October 1, 2017, the Company borrowed and repaid $22,675 under the line of credit.

(9) Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques under the accounting guidance related to fair value measurements are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. These inputs are classified into the following hierarchy:


•	Level 1 Inputs - Quoted prices for identical assets or liabilities in active markets.


•	Level 2 Inputs - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.


•	Level 3 Inputs - Pricing inputs are unobservable for the assets or liabilities and include situations where there is little, if any, market activity for the assets or liabilities. The inputs into the determination of fair value require significant management judgment or estimation.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Financial Instruments

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments:



	September 30, 2018				December 31, 2017
	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Fair Value Measurements
Financial assets
Cash equivalents	$	444,012	$	444,012	$	338	$	338	Level 1
Non-current cost method investments (a)	640		2,409		639		327,710		Level 3

Financial liabilities
Series 2018-1 Class A-2-I Notes (b)	446,625		425,678		—		—		Level 2
Series 2018-1 Class A-2-II Notes (b)	471,438		449,186		—		—		Level 2
Series 2015-1 Class A-2-I Notes (b)	—		—		855,313		856,510		Level 2
Series 2015-1 Class A-2-II Notes (b)	873,000		866,714		879,750		897,961		Level 2
Series 2015-1 Class A-2-III Notes (b)	485,000		481,654		488,750		513,188		Level 2
7% debentures, due in 2025 (b)	90,454		104,500		89,514		107,000		Level 2
Guarantees of franchisee loan obligations (c)	22		22		37		37		Level 3

_______________

(a)

The fair value of our indirect investment in Arby’s as of December 31, 2017 was based on applying a multiple to Arby’s adjusted earnings before income taxes, depreciation and amortization per its current unaudited financial information. The carrying value of our indirect investment in Arby’s was reduced to zero during 2013 in connection with the receipt of a dividend. On February 5, 2018, a subsidiary of ARG Parent acquired Buffalo Wild Wings, Inc. As a result, our ownership interest included both the Arby’s and Buffalo Wild Wings brands under the newly formed combined company, Inspire Brands. On August 16, 2018, the Company sold its remaining ownership interest to Inspire Brands for $450,000. See Note 7 for further information. The fair values of our remaining investments are not significant and are based on our review of information provided by the investment managers or investees which was based on (1) valuations performed by the investment managers or investees, (2) quoted market or broker/dealer prices for similar investments and (3) quoted market or broker/dealer prices adjusted by the investment managers for legal or contractual restrictions, risk of nonperformance or lack of marketability, depending upon the underlying investments.


(b)	The fair values were based on quoted market prices in markets that are not considered active markets.


(c)	Wendy’s has provided loan guarantees to various lenders on behalf of franchisees entering into debt arrangements for equipment financing. We have accrued a liability for the fair value of these guarantees, the calculation of which was based upon a weighted average risk percentage.

The carrying amounts of cash, accounts payable and accrued expenses approximated fair value due to the short-term nature of those items. The carrying amounts of accounts and notes receivable, net (both current and non-current) approximated fair value due to the effect of the related allowance for doubtful accounts. Our cash equivalents and guarantees are the only financial assets and liabilities measured and recorded at fair value on a recurring basis.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Non-Recurring Fair Value Measurements

Assets and liabilities remeasured to fair value on a non-recurring basis resulted in impairment that we have recorded to “Impairment of long-lived assets” in our condensed consolidated statements of operations.

Total impairment losses may reflect the impact of remeasuring long-lived assets held and used (including land, buildings, leasehold improvements and favorable lease assets) to fair value as a result of (1) declines in operating performance at Company-operated restaurants and (2) the Company’s decision to lease and/or sublease the land and/or buildings to franchisees in connection with the sale or anticipated sale of restaurants, including any subsequent lease modifications. The fair value of long-lived assets held and used presented in the tables below represents the remaining carrying value and was estimated based on either discounted cash flows of future anticipated lease and sublease income or discounted cash flows of future Company-operated restaurant performance.

Total impairment losses may also include the impact of remeasuring long-lived assets held for sale, which primarily include surplus properties. The fair values of long-lived assets held for sale presented in the tables below represents the remaining carrying value and were estimated based on current market values. See Note 10 for further information on impairment of our long-lived assets.



			Fair Value Measurements
	September 30, 2018		Level 1		Level 2		Level 3
Held and used	$	226	$	—	$	—	$	226
Held for sale	1,115		—		—		1,115
Total	$	1,341	$	—	$	—	$	1,341



			Fair Value Measurements
	December 31, 2017		Level 1		Level 2		Level 3
Held and used	$	757	$	—	$	—	$	757
Held for sale	1,560		—		—		1,560
Total	$	2,317	$	—	$	—	$	2,317

Total impairment losses for the three and nine months ended September 30, 2018 included remeasuring long-lived assets held and used of $118 and $1,886, respectively, and remeasuring long-lived assets held for sale of $229 and $270, respectively. Total impairment losses for the three and nine months ended October 1, 2017 included remeasuring long-lived assets held and used of $928 and $1,146, respectively, and remeasuring long-lived assets held for sale of $113 and $658, respectively.

(10) Impairment of Long-Lived Assets

During the three and nine months ended September 30, 2018 and October 1, 2017, the Company recorded impairment charges on long-lived assets as a result of (1) closing Company-operated restaurants and classifying such surplus properties as held for sale and (2) the Company’s decision to lease and/or sublease properties to franchisees in connection with the sale or anticipated sale of Company-operated restaurants, including any subsequent lease modifications. Additionally, during the nine months ended September 30, 2018 and the three and nine months ended October 1, 2017, the Company recorded impairment charges on long-lived assets as a result of the deterioration in operating performance of certain Company-operated restaurants and charges for capital improvements in previously impaired restaurants that did not subsequently recover.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of impairment losses recorded, which represent the excess of the carrying amount over the fair value of the affected assets and are included in “Impairment of long-lived assets.”



	Three Months Ended				Nine Months Ended
	September 30, 2018		October 1, 2017		September 30, 2018		October 1, 2017
Surplus properties	$	229	$	113	$	270	$	658
Restaurants leased or subleased to franchisees	118		95		283		95
Company-operated restaurants	—		833		1,603		1,051
	$	347	$	1,041	$	2,156	$	1,804

(11) Income Taxes

The Company’s effective tax rate for the three months ended September 30, 2018 and October 1, 2017 was 21.6% and 54.8% respectively. The Company’s effective tax rate varies from the U.S. federal statutory rate of 21% and 35% in the third quarter of 2018 and 2017, respectively, primarily due to (1) net excess tax benefits related to share-based payments, which resulted in a benefit of $5,251 in the third quarter of 2018, (2) the impact of the comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), (3) the system optimization initiative provision of $5,019 in 2017, reflecting goodwill adjustments, changes to valuation allowances on state net operating loss carryforwards and state deferred taxes, and (4) state income tax provision in 2017, including non-recurring changes to state deferred taxes net of federal benefits.

The Company’s effective tax rate for the nine months ended September 30, 2018 and October 1, 2017 was 20.6% and 45.2%, respectively. The Company’s effective tax rate varies from the U.S. federal statutory rate of 21% and 35% for the first nine months of 2018 and 2017, respectively, primarily due to (1) net excess tax benefits related to share-based payments, which resulted in a benefit of $12,142 in the first nine months of 2018, (2) state income taxes, (3) the impact of the Tax Act and (4) the system optimization initiative in 2017, reflecting goodwill adjustments, changes to valuation allowances on state net operating loss carryforwards and state deferred taxes.

On December 22, 2017, the U.S. government enacted the Tax Act. In our continued analysis of the impact of the Tax Act in the first nine months of 2018 under Staff Accounting Bulletin 118, we have adjusted our provisional amounts for a discrete net tax expense of $2,076. This includes a net expense of $2,426 related to the impact of the corporate rate reduction on our net deferred tax liabilities and a net expense of $991 related to limitations on the deductibility of certain executive compensation, partially offset by $1,341 for the tax benefit of foreign tax credits. The Company considers the impact of the Tax Act related to these items to be final. The impact of the Tax Act on the Company’s state income taxes is not yet final; however, we do not expect any material change to the provisional amounts made for state taxes.

Unrecognized tax benefits for the Company increased by $3,554 and $2,547 during the three and nine months ended September 30, 2018, respectively. The increase was primarily related to the sale of our ownership interest in Inspire Brands (see Note 7 for further information). During the next twelve months, we believe it is reasonably possible the Company will reduce unrecognized tax benefits by up to $11,241 due to the lapse of statutes of limitations and expected settlements with taxing authorities.

The current portion of refundable income taxes was $5,851 and $26,262 as of September 30, 2018 and December 31, 2017, respectively, and is included in “Accounts and notes receivable, net” in the condensed consolidated balance sheets. There were no long-term refundable income taxes as of September 30, 2018 and December 31, 2017.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(12) Net Income Per Share

Basic net income per share was computed by dividing net income amounts by the weighted average number of common shares outstanding.

The weighted average number of shares used to calculate basic and diluted net income per share were as follows:



	Three Months Ended		Nine Months Ended
	September 30, 2018	October 1, 2017	September 30, 2018	October 1, 2017
Common stock:
Weighted average basic shares outstanding	237,696	243,354	238,872	245,073
Dilutive effect of stock options and restricted shares	7,070	8,383	7,574	8,103
Weighted average diluted shares outstanding	244,766	251,737	246,446	253,176

Diluted net income per share for the three and nine months ended September 30, 2018 and October 1, 2017 was computed by dividing net income by the weighted average number of basic shares outstanding plus the potential common share effect of dilutive stock options and restricted shares. We excluded potential common shares of 1,121 and 1,287 for the three and nine months ended September 30, 2018, respectively, and 1,617 and 618 for the three and nine months ended October 1, 2017, respectively, from our diluted net income per share calculation as they would have had anti-dilutive effects.

(13) Stockholders’ Equity

Stockholders’ Equity

The following is a summary of the changes in stockholders’ equity:



	Three Months Ended						Nine Months Ended
	September 30, 2018			October 1, 2017			September 30, 2018			October 1, 2017
Balance at beginning of period	$	430,539		$	487,049		$	573,203		$	527,736
Comprehensive income	396,564			23,488			436,347			52,978
Cash dividends ($.085 and $.07 per share for the three months and $.255 and $.21 per share for the nine months ended September 30, 2018 and October 1, 2017, respectively)	(20,141		)	(17,017		)	(60,786		)	(51,464		)
Repurchases of common stock	(56,421		)	(38,463		)	(141,615		)	(90,964		)
Share-based compensation	4,810			4,984			14,401			16,356
Exercises of stock options	29,075			4,033			35,889			10,194
Vesting of restricted shares	(1,168		)	(1,528		)	(4,089		)	(4,260		)
Cumulative effect of change in accounting principle (a)	—			—			(70,210		)	1,880
Other	60			49			178			139
Balance at end of period	$	783,318		$	462,595		$	783,318		$	462,595

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(a)

During the nine months ended September 30, 2018, the Company recognized a net increase to “Accumulated deficit” of $70,210 as a result of adoption of amended guidance for revenue recognition. The net increase resulted from an increase to deferred franchise fees of $85,561 and a decrease to “Deferred income taxes” of $21,996 as a result of now deferring franchise fees over the contractual term of the franchise agreements. Additionally, an increase to “Advertising funds restricted liabilities” of $6,645 was recognized as a result of a reclassification of the total stockholders’ deficit of the Advertising Funds as of December 31, 2017. See Note 2 for further information.

During the nine months ended October 1, 2017, the Company recognized a tax benefit as a reduction to the Company’s deferred tax liability with an equal offsetting increase to “Accumulated deficit.” The adjustment was recognized as a result of adoption of an amendment to the accounting for employee share-based payment transactions.

Repurchases of Common Stock

In February 2018, our Board of Directors authorized a repurchase program for up to $175,000 of our common stock through March 3, 2019, when and if market conditions warrant and to the extent legally permissible. In August 2018, our Board of Directors authorized an additional share repurchase program for up to $100,000 of our common stock through December 27, 2019 with a portion of the proceeds obtained through the sale of our ownership interest in Inspire Brands, when and if market conditions warrant and to the extent legally permissible. During the nine months ended September 30, 2018, the Company repurchased 6,896 shares with an aggregate purchase price of $118,866, of which $2,675 was accrued at September 30, 2018, and excluding commissions of $97. As of September 30, 2018, the Company had $56,134 of availability remaining under its February 2018 authorization and $100,000 remaining under its August 2018 authorization. Subsequent to September 30, 2018 through October 31, 2018, the Company repurchased 1,596 shares under the February 2018 authorization with an aggregate purchase price of $27,288, excluding commissions of $22. In addition, subsequent to September 30, 2018, the Board of Directors approved an increase of $120,000 to the August 2018 authorization, which now totals $220,000 and expires on December 27, 2019.

In February 2017, our Board of Directors authorized a repurchase program for up to $150,000 of our common stock through March 4, 2018, when and if market conditions warranted and to the extent legally permissible. During the nine months ended September 30, 2018, the Company completed the $150,000 program with the repurchase of 1,385 shares with an aggregate purchase price of $22,633, excluding commissions of $19. During the nine months ended October 1, 2017, the Company repurchased 6,131 shares with an aggregate purchase price of $90,876, of which $899 was accrued at October 1, 2017, and excluding commissions of $88.

Accumulated Other Comprehensive Loss

The following table provides a rollforward of the components of accumulated other comprehensive loss, net of tax as applicable:



	Foreign Currency Translation			Cash Flow Hedges (a)			Pension			Total
Balance at December 31, 2017	$	(45,149	)	$	—		$	(1,049	)	$	(46,198	)
Current-period other comprehensive (loss) income	(5,054		)	—			117			(4,937		)
Balance at September 30, 2018	$	(50,203	)	$	—		$	(932	)	$	(51,135	)

Balance at January 1, 2017	$	(60,299	)	$	(1,797	)	$	(1,145	)	$	(63,241	)
Current-period other comprehensive income	16,797			1,332			96			18,225
Balance at October 1, 2017	$	(43,502	)	$	(465	)	$	(1,049	)	$	(45,016	)

_______________

(a)

Current-period other comprehensive income included the reclassification of unrealized losses on cash flow hedges from “Accumulated other comprehensive loss” to our condensed consolidated statements of operations of $444 and $1,332 for the three and nine months ended October 1, 2017, respectively. The reclassification of unrealized losses on cash flow hedges consisted of $723 and $2,170 for the three and nine months ended October 1, 2017, respectively, recorded to “Interest expense, net,” net of the related income tax benefit of $279 and $838 for the three and nine months ended October 1, 2017, respectively, recorded to “Provision for income taxes.”

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(14) Leases

At September 30, 2018, Wendy’s and its franchisees operated 6,669 Wendy’s restaurants. Of the 350 Company-operated Wendy’s restaurants, Wendy’s owned the land and building for 145 restaurants, owned the building and held long-term land leases for 141 restaurants and held leases covering land and building for 64 restaurants. Wendy’s also owned 519 and leased 1,281 properties that were either leased or subleased principally to franchisees.

Rental expense for operating leases consists of the following components:



	Three Months Ended				Nine Months Ended
	September 30, 2018		October 1, 2017		September 30, 2018		October 1, 2017
Rental expense:
Minimum rentals	$	22,814	$	23,997	$	72,738	$	66,701
Contingent rentals	5,061		5,395		14,522		14,405
Total rental expense (a) (b)	$	27,875	$	29,392	$	87,260	$	81,106

_______________


(a)	Amounts include rental expense related to (1) leases for Company-operated restaurants recorded to “Cost of sales,” (2) leased properties that are subsequently leased to franchisees recorded to “Franchise rental expense” and (3) leases for corporate offices and equipment recorded to “General and administrative.”


(b)	Amounts exclude sublease income of $34,097 and $103,353 recognized during the three and nine months ended September 30, 2018, respectively, and $35,022 and $92,434 recognized during the three and nine months ended October 1, 2017, respectively.

Rental income for operating leases and subleases consists of the following components:



	Three Months Ended				Nine Months Ended
	September 30, 2018		October 1, 2017		September 30, 2018		October 1, 2017
Rental income:
Minimum rentals	$	45,291	$	44,682	$	137,549	$	124,847
Contingent rentals	5,183		5,593		14,561		15,280
Total rental income	$	50,474	$	50,275	$	152,110	$	140,127

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following table illustrates the Company’s future minimum rental payments and rental receipts for non-cancelable leases and subleases, including rental receipts for direct financing leases as of September 30, 2018. Rental receipts below are presented separately for owned properties and for leased properties based on the classification of the underlying lease.



	Rental Payments				Rental Receipts
Fiscal Year	Capital Leases		Operating Leases		Capital Leases		Operating Leases		Owned Properties
2018 (a)	$	12,967	$	25,217	$	16,007	$	18,911	$	13,488
2019	45,323		95,216		64,376		76,044		54,736
2020	46,252		94,079		65,467		75,810		55,348
2021	47,849		93,580		67,267		75,771		56,943
2022	48,937		93,304		68,451		76,222		58,514
Thereafter	751,317		1,145,074		1,034,322		935,083		948,620
Total minimum payments	$	952,645	$	1,546,470	$	1,315,890	$	1,257,841	$	1,187,649
Less interest	(494,298