| • 10-Q • EX-10.3 • EX-10.4 • EX-10.5 • EX-10.6 • EX-31.1 • EX-31.2 • EX-32.1 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q
For the quarterly period ended July 1, 2012 OR
For the transition period from ______________ to _______________ Commission file number: 1-2207 THE WENDY’S COMPANY (Exact name of registrants as specified in its charter)
(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, or a smaller reporting company. See the 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 [ ] Smaller reporting company [ ] Indicate by check mark whether either registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x] There were 390,735,791 shares of The Wendy’s Company common stock outstanding as of August 1, 2012. Explanatory Note Wendy’s Restaurants, LLC (“Wendy's Restaurants”) is a wholly-owned subsidiary of The Wendy’s Company. Wendy’s Restaurants was obligated to file periodic reports with the Securities and Exchange Commission (“SEC”) pursuant to the terms of the indenture governing the Wendy’s Restaurants’ 10.00% Senior Notes due 2016 (the “Senior Notes”). Following the redemption of the Senior Notes by Wendy’s Restaurants on July 16, 2012, there were no longer any Senior Notes outstanding. As a result of the redemption and the termination of the indenture governing the Senior Notes pursuant to its terms, Wendy’s Restaurants is no longer filing reports with the SEC. 2 THE WENDY’S COMPANY AND SUBSIDIARIES INDEX TO FORM 10-Q
3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements. THE WENDY’S COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
See accompanying notes to condensed consolidated financial statements. 4 THE WENDY’S COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands Except Per Share Amounts)
See accompanying notes to condensed consolidated financial statements. 5 THE WENDY’S COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (In Thousands)
See accompanying notes to condensed consolidated financial statements. 6 THE WENDY’S COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
7 THE WENDY’S COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED (In Thousands)
See accompanying notes to condensed consolidated financial statements. 8 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 necessary to present fairly our financial position as of July 1, 2012 and the results of our operations for the three and six months ended July 1, 2012 and July 3, 2011 and our cash flows for the six months ended July 1, 2012 and July 3, 2011. The results of operations for the three and six months ended July 1, 2012 are not necessarily indicative of the results to be expected for the full 2012 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 January 1, 2012 (the “Form 10-K”). The principal subsidiary of the Company is Wendy’s International, Inc. (“Wendy’s”) and its subsidiaries. The Company manages and internally reports its business geographically. The operation and franchising of Wendy’s® restaurants in North America (defined as the 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 (including through our joint venture in Japan (the “Japan JV”)) are not material. References herein to The Wendy’s Company corporate (“Corporate”) represent The Wendy’s Company parent company only functions and their effect on the Company’s consolidated results of operations and financial condition. We report on a fiscal year consisting of 52 or 53 weeks ending on the Sunday closest to December 31. All three month and six month periods presented herein contain 13 weeks and 26 weeks, respectively. All references to years and quarters relate to fiscal periods rather than calendar periods. (2) Discontinued Operations On July 4, 2011, Wendy’s Restaurants, LLC (“Wendy’s Restaurants”), a direct 100% owned subsidiary holding company of the Company, completed the sale of 100% of the common stock of its then wholly-owned subsidiary, Arby’s Restaurant Group, Inc. (“Arby’s”) (while indirectly retaining an 18.5% interest in Arby’s), as described in the Form 10-K. Information related to Arby’s has been reflected in the accompanying unaudited condensed consolidated financial statements as follows:
Our unaudited condensed consolidated statements of operations for the three months and six months ended July 3, 2011 (prior to the sale of Arby’s) includes certain indirect corporate overhead costs in “General and administrative,” which, for segment reporting purposes, had previously been allocated to Arby’s. These indirect corporate overhead costs do not qualify for classification within discontinued operations, and therefore are included in “General and administrative” in continuing operations. Interest expense on Arby’s debt that was assumed by the buyer in the sale has been included in discontinued operations; however, interest expense on Wendy’s Restaurants’ credit agreement, which was not required to be repaid as a result of the sale, continued to be included in “Interest expense” in continuing operations. We incurred “Transaction related costs” resulting from the sale of Arby’s of $562 and $1,174 during the three and six months ended July 1, 2012, respectively, and $5,039 and $6,923 during the three and six months ended July 3, 2011, respectively. 9 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) The following table details Arby’s revenues and income from operations for the three months and six months ended July 3, 2011, which have been reported in discontinued operations:
(3) Acquisitions and Other Dispositions On June 11, 2012, Wendy’s acquired 30 Wendy's franchised restaurants in the Austin, Texas area from Pisces Foods, L.P. (“Pisces”) and Near Holdings, L.P., pursuant to the terms of an Asset Purchase Agreement dated as of June 5, 2012 (the “Pisces Acquisition”). The purchase price was $19,243 in cash, including closing adjustments. Further adjustments will occur in the future as provided in the Asset Purchase Agreement. Wendy’s also agreed to lease the real estate, buildings and improvements related to 23 of the acquired restaurants from Pisces which were considered part of the purchase transaction and to assume ground leases for five of the acquired restaurants and building leases for two of the acquired restaurants. Wendy’s did not incur any material acquisition-related costs associated with the Pisces Acquisition. The operating results of the 30 Wendy’s franchised restaurants acquired have been included in our condensed consolidated financial statements beginning on the acquisition date. Such results were not material to our condensed consolidated financial statements. In accordance with GAAP, the Pisces Acquisition is being accounted for using the acquisition method. 10 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) The table below presents the preliminary computation of total purchase price and fair value of assets acquired and liabilities assumed at the acquisition date. The amounts remain subject to finalization during the measurement period, not to exceed one year.
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The preliminary fair values of the identifiable assets acquired were determined using one of the valuation approaches: market, income and cost. The selection of a particular method for a given asset depended on the reliability of available data and the nature of the asset. The pro forma revenue and earnings of the combined companies had the acquisition date been January 3, 2011 are as follows:
11 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts)
This As Adjusted data is presented for comparative purposes only and does not purport to be indicative of the Company’s actual results of operations had the Pisces Acquisition actually occurred as of January 3, 2011 or of the Company's future results of operations. Wendy’s did not have any material non-recurring adjustments associated with the Pisces Acquisition. Other acquisitions and other dispositions During the first quarter of 2012, the Company also acquired two Wendy’s franchised restaurants along with certain other equipment and franchise rights. The total net cash consideration for this acquisition was $2,594. The total consideration was allocated to net tangible and identifiable intangible assets acquired, primarily properties, and liabilities assumed based on their estimated fair values, with the excess of $485 recognized as goodwill. During the first half of 2011, the Company acquired nine Wendy’s franchised restaurants in three separate acquisitions. The total consideration for these acquisitions was $7,673, consisting of (1) $6,613 of cash, net of $55 of cash acquired, and (2) the issuance of a note payable of $1,060. The total consideration was allocated to net tangible and identifiable intangible assets acquired, primarily properties, and liabilities assumed based on their estimated fair values, with the excess of $3,689 recognized as goodwill. During the first half of 2012, one other restaurant disposition by the Company was not significant. During first half of 2011, two other restaurant acquisitions by the Company were not significant. (4) Investments Investment in Joint Venture with Tim Hortons Inc. Wendy’s is a partner in a Canadian restaurant real estate joint venture (“TimWen”) with Tim Hortons Inc. Wendy’s 50% share of the joint venture is accounted for using the equity method of accounting. Our equity in earnings from TimWen is included in “Other operating expense, net.” 12 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) Presented below is an unaudited summary of activity related to our investment in TimWen included in our condensed consolidated balance sheets and condensed consolidated statements of operations:
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Presented below is a summary of unaudited financial information of TimWen as of and for the six months ended July 1, 2012 and July 3, 2011, respectively, in Canadian dollars. The summary balance sheet financial information does not distinguish between current and long-term assets and liabilities.
13 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) Sale of Investment in Jurlique International Pty Ltd. On February 2, 2012, Jurl Holdings, LLC (“Jurl”), a 99.7% owned subsidiary, completed the sale of our investment in Jurlique International Pty Ltd. (“Jurlique”) for which we received proceeds of $27,287, net of the amount held in escrow. The amount held in escrow as of July 1, 2012 was $3,327, which was adjusted for foreign currency translation, and was included in “Deferred costs and other assets.” In connection with the anticipated proceeds of the sale and in order to protect ourselves from a decrease in the Australian dollar through the closing date, we entered into a foreign currency related derivative transaction for an equivalent notional amount in U.S. dollars of the expected proceeds of $28,500 Australian dollars. We recorded a “Gain on sale of investment, net” of $27,407, which included a loss of $2,913 on the settlement of the derivative transaction discussed above. We have reflected net income attributable to noncontrolling interests of $2,384, net of income tax benefit of $1,283, in the six months ended July 1, 2012 in connection with the equity and profit interests discussed below. The net assets and liabilities of the subsidiary that held the investment were not material to the consolidated financial statements. Therefore, the noncontrolling interest in those assets and liabilities was not previously reported separately. As a result of this sale and distributions to the minority shareholders, there are no remaining noncontrolling interests in this consolidated subsidiary. Prior to 2009 when our predecessor entity was a diversified company active in investments, we had provided our Chairman, who was also our then Chief Executive Officer, and our Vice Chairman, who was our then President and Chief Operating Officer (the “Former Executives”), and certain other former employees, equity and profits interests in Jurl. In connection with the gain on sale of Jurlique, we distributed, based on the related agreement, approximately $3,667 to Jurl’s minority shareholders, including approximately $2,296 to the Former Executives. (5) Long-Term Debt Long-term debt consisted of the following:
Except as described below, the Company did not have any significant changes to its long-term debt as disclosed in the notes to our consolidated financial statements included in the Form 10-K. 14 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) Credit Agreement On May 15, 2012, Wendy’s entered into a Credit Agreement (the “Credit Agreement”), which includes a senior secured term loan facility (the “Term Loan”) of $1,125,000 and a senior secured revolving credit facility of $200,000 and contains provisions for an uncommitted increase of up to $275,000 principal amount of the revolving credit facility and/or Term Loan subject to the satisfaction of certain conditions. The revolving credit facility includes a sub-facility for the issuance of up to $70,000 of letters of credit. The obligations under the Credit Agreement are secured by substantially all of the non-real estate assets and stock of Wendy’s and its domestic subsidiaries (other than certain unrestricted subsidiaries), and 65% of the stock of certain of its foreign subsidiaries in each case subject to certain limitations and exceptions. The Term Loan was issued at 99.0% of the principal amount, representing an original issue discount of 1.0% resulting in net proceeds of $1,113,750 with draws on May 15, 2012 and July 16, 2012 (subsequent to the end of our second quarter). The discount of $11,250 will be accreted and the related charge included in “Interest expense” through the maturity of the Term Loan. The net proceeds and respective discounts for draws under the Term Loan are as follows:
The Term Loan is due not later than May 15, 2019 and amortizes in an amount equal to 1% per annum of the total principal amount outstanding, payable in quarterly installments beginning in the fourth quarter of 2012, with the remaining balance payable on the maturity date. In addition, the Term Loan requires prepayments of principal amounts resulting from certain events and excess cash flow on an annual basis from Wendy’s as defined under the Credit Agreement. The revolving credit facility expires not later than May 15, 2017. An unused commitment fee of 50 basis points per annum is payable quarterly on the average unused amount of the revolving credit facility until the maturity date. As of July 1, 2012, there were no amounts outstanding under the revolving credit facility, except for $19,000 of letters of credit issued in the normal course of business. The interest rate on the Term Loan and amounts borrowed under the revolving credit facility is based on the Eurodollar Rate as defined in the Credit Agreement (but not less than 1.25%), plus 3.50%, or a Base Rate, as defined in the Credit Agreement plus 2.50%. Since the inception of the Term Loan, we have elected to use the Eurodollar Rate, which resulted in an interest rate on the Term Loan of 4.75% as of July 1, 2012. Wendy’s incurred $15,602 in costs related to the Credit Agreement, which are being amortized to “Interest expense” through the maturity of the Term Loan utilizing the effective interest rate method. No costs related to the Credit Agreement were incurred from the Term Loan draw on July 16, 2012. Proceeds from the Term Loan draw on May 15, 2012 were used (1) to repay all amounts outstanding under the prior credit agreement, (2) to purchase $124,225 aggregate principal amount of Wendy’s Restaurants’ 10.00% Senior Notes due 2016 (the “Senior Notes”) at a redemption price of 108.125% of the principal amount plus accrued and unpaid interest and (3) to pay fees and expenses. Proceeds from the Term Loan draw on July 16, 2012, subsequent to the end of our second quarter, were used to purchase $440,775 aggregate principal amount of remaining Senior Notes outstanding at a redemption price of 107.5% of the principal amount plus accrued and unpaid interest. 15 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) The Company incurred a loss on the early extinguishment of debt for the draws on the Term Loan, as described above, as follows:
The affirmative and negative covenants in the Credit Agreement include, among others, preservation of corporate existence; payment of taxes; maintenance of insurance; and limitations on: indebtedness (including guarantee obligations of other indebtedness); liens; mergers, consolidations, liquidations and dissolutions; sales of assets; dividends and other payments in respect of capital stock; investments; payments of certain indebtedness; transactions with affiliates; changes in fiscal year; negative pledge clauses and clauses restricting subsidiary distributions; and material changes in lines of business. The financial covenants contained in the Credit Agreement are (1) a consolidated interest coverage ratio and (2) a consolidated senior secured leverage ratio. Wendy’s was in compliance with all covenants of the Credit Agreement as of July 1, 2012. Aircraft Term Loan During the first quarter of 2012, the Company made a $3,911 prepayment on its aircraft financing facility to comply with a requirement that the outstanding principal balance be no more than 85% of the appraised value of the aircraft. On June 25, 2012, the Company voluntarily repaid the remaining outstanding principal, including accrued interest thereon related to this facility, totaling $6,656. (6) Fair Value of Financial Instruments 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. 16 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) As of July 1, 2012, the carrying amounts and estimated fair values of The Wendy’s Company’s financial instruments, for which the disclosure of fair values is required, are as follows:
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The carrying amounts of cash and cash equivalents, accounts payable and accrued expenses approximated fair value due to the short-term maturities of those items. The carrying amounts of accounts and notes receivable (both current and non-current) approximated fair value due to the effect of related allowances for doubtful accounts and notes receivable. 17 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) The following table presents the fair values for those assets and liabilities of continuing operations measured at fair value during the six months ended July 1, 2012 on a non-recurring basis. Total losses include losses recognized from all non-recurring fair value measurements during the six months ended July 1, 2012. See Note 7 for more information on the impairment of our long-lived assets.
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Interest rate swaps Our derivative instruments for the periods presented included interest rate swaps on our 6.20% senior notes with notional amounts totaling $225,000 that were all designated as fair value hedges. At July 1, 2012 and January 1, 2012, the fair value of these interest rate swaps of $10,254 and $11,695, respectively, was included in “Deferred costs and other assets” and as an adjustment to the carrying amount of our 6.20% senior notes. Interest income on the interest rate swaps was $1,404 and $2,730 for the three and six months ended July 1, 2012, respectively, and $1,435 and $2,848 for the three and six months ended July 3, 2011, respectively. (7) Impairment of Long-Lived Assets During the second quarter of 2012, we closed 15 company-owned restaurants in connection with our review of certain underperforming locations. The closing of these restaurants resulted in an impairment charge of $3,270. In addition, we incurred costs related to these restaurant closings of $1,477, primarily for continuing lease obligations, which are included in “Other operating expense, net.” Our company-owned restaurant impairment losses in the first quarter of 2012 and for the three and six months ended July 3, 2011, predominantly reflect impairment charges on restaurant-level assets resulting from the deterioration in operating performance of certain restaurants, and additional charges for capital improvements in restaurants impaired in prior years which did not subsequently recover. Also, during the second quarter of 2012, we reclassified our company-owned aircraft as held and used from its previous held-for-sale classification. In the first half of 2012, the Company recorded an impairment charge of $1,628 on the company-owned aircraft. As of July 1, 2012, the carrying value of the aircraft, which reflects current market conditions, approximated its fair value and is included in “Properties.” See Note 13 for information regarding an amended and restated lease agreement for the company-owned aircraft. 18 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) These impairment losses, as detailed in the following table, represented the excess of the carrying amount over the fair value of the affected assets and are included in “Impairment of long-lived assets.”
Arby’s impairment losses for the six months ended July 3, 2011 were not significant and are included in discontinued operations and are not included in the table above. See Note 2 for more information on discontinued operations. (8) Facilities Relocation and Other Transition Costs As announced in December 2011, we are relocating the Company’s Atlanta restaurant support center to Ohio. The Company expects to expense costs aggregating approximately $28,000 in 2012 and $2,600 in 2013 related to its relocation and other transition activities which are expected to be substantially completed during the third quarter of 2012. The costs expected to be expensed in 2013 primarily relate to severance and other costs for employees who will be assisting in the transition activities through the early part of 2013. The components of “Facilities relocation and other transition costs” for the three and six months ended July 1, 2012, as well as the total expected to be incurred and total incurred since inception are presented in the table below:
The increase in the Total Expected to be Incurred noted above as compared to our 2011 year end estimate relates primarily to additional professional fees that became determinable during our 2012 first quarter. 19 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) An analysis of related activity in the facilities relocation and other transition costs accrual which is included in “Accrued expenses and other current liabilities” is as follows:
(9) Income Taxes The Company’s effective tax rate benefit for the three months ended July 1, 2012 and effective tax rate for the three months ended July 3, 2011 was 61.2% and 42.2%, respectively, on (loss) income from continuing operations. The Company’s effective tax rate varies from the U.S. federal statutory rate of 35% due to the effect of (1) state income taxes, net of federal income tax benefit, (2) tax credits, (3) a net reduction in deferred state taxes related to the Company’s debt refinancing and related corporate activities, (4) adjustments related to prior year tax matters, and (5) changes in our estimated full year tax rates. The Company’s effective tax rate benefit for the six months ended July 1, 2012 and effective tax rate for the six months ended July 3, 2011 was 24.1% and 40.2%, respectively, on income from continuing operations. The Company’s effective tax rate varies from the U.S. federal statutory rate of 35% due to the effect of (1) state income taxes, net of federal income tax benefit, (2) tax credits, (3) a net reduction in deferred state taxes related to the Company’s debt refinancing and related corporate activities, and (4) adjustments related to prior year tax matters. There were no significant changes to unrecognized tax benefits or related interest and penalties for the Company for the six month periods ended July 1, 2012 and July 3, 2011. The Company participates in the Internal Revenue Service Compliance Assurance Process. During the six months ended July 1, 2012, we concluded without adjustment the examination of our tax year ended January 2, 2011. (10) (Loss) Income Per Share Basic (loss) income per share for the three and six months ended July 1, 2012 and July 3, 2011 was computed by dividing income amounts attributable to The Wendy’s Company by the weighted average number of common shares outstanding. (Loss)income amounts attributable to The Wendy’s Company used to calculate basic and diluted (loss) income per share were as follows:
20 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) The weighted average number of shares used to calculate basic and diluted (loss) income per share was as follows:
Diluted (loss) income per share for the three months and six months ended July 1, 2012 and July 3, 2011 was computed by dividing income by the weighted average number of basic shares outstanding plus the potential common share effect of dilutive stock options and restricted shares, computed using the treasury stock method. Diluted loss per share for the three months ended July 1, 2012 was the same as basic loss per share since the Company reported a loss from continuing operations and, therefore, the effect of all potentially dilutive securities would have been antidilutive. For the six months ended July 1, 2012, we excluded 19,541 of potential common shares from our diluted income per share calculation as they would have had anti-dilutive effects. For the three months and six months ended July 3, 2011, we excluded 15,250 and 18,295, respectively, of potential common shares from our diluted income per share calculation as they would have had anti-dilutive effects. (11) Equity Stockholders’ Equity The following is a summary of the changes in stockholders’ equity:
(12) Guarantees and Other Commitments and Contingencies Except as described below, the Company did not have any significant changes to its guarantees, other commitments and contingencies as disclosed in the notes to our consolidated financial statements included in the Form 10-K. Japan Joint Venture Guarantee In 2012, the Company (1) provided a guarantee to certain lenders to the Japan JV for which our joint venture partners have agreed, should it become necessary, to reimburse and otherwise indemnify us for their 51% share of the guarantee and (2) agreed to reimburse and otherwise indemnify our joint venture partners for our 49% share of the guarantee by our joint venture partners of a line of credit granted by a different lender to the Japan JV to fund working capital requirements. As of July 1, 2012, our portion of these contingent obligations totaled approximately $4,200 (¥350,100) based upon then current rates of exchange. The 21 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts) fair value of our guarantees is immaterial. The Company anticipates that our share of any additional guarantees, after the agreement of our joint venture partners to reimburse and otherwise indemnify us for their 51% share of the guarantee, of up to $3,300 may be necessary in 2012. Capital Expenditures Commitments As of July 1, 2012, the Company had approximately $7,422 of outstanding commitments for capital expenditures expected to be paid in the third quarter of 2012. (13) Transactions with Related Parties The following is a summary of ongoing transactions between the Company and its related parties, which are included in continuing operations and includes any updates and amendments since those reported in the Form 10-K:
___________________ Transactions with Purchasing Cooperatives
Transactions with the Management Company
22 THE WENDY’S COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands Except Per Share Amounts)
(14) Legal, Environmental and Other Matters We are involved in litigation and claims incidental to our current and prior businesses. We provide reserves for such litigation and claims when payment is probable and reasonably estimable. As of July 1, 2012, the Company had reserves for continuing operations for all of its legal and environmental matters aggregating $2,351. We cannot estimate the aggregate possible range of loss due to most proceedings being in preliminary stages, with various motions either yet to be submitted or pending, discovery yet to occur, and significant factual matters unresolved. In addition, most cases seek an indeterminate amount of damages and many involve multiple parties. Predicting the outcomes of settlement discussions or judicial or arbitral decisions is thus inherently difficult. Based on currently available information, including legal defenses available to us, and given the aforementioned reserves and our insurance coverage, we do not believe that the outcome of these legal and environmental matters will have a material effect on our consolidated financial position or results of operations. The Company had previously described a dispute between Wendy’s and Tim Hortons Inc. in the Form 10-K and in the Company’s Quarterly Report on Form 10-Q for the quarter ended April 1, 2012. There have been no material developments on this matter. (15) Multiemployer Pension Plan As further described in the Form 10-K, the unionized employees at The New Bakery Co. of Ohio, Inc. (the “Bakery”), a 100% owned subsidiary of Wendy’s, are covered by the Bakery and Confectionery Union and Industry International Pension Fund (the “Union Pension Fund”), a multiemployer pension plan with a plan year end of December 31 that provides defined benefits to certain employees covered by a collective bargaining agreement (the “CBA”) which expires on March 31, 2013. The cost of this pension plan is determined in accordance with the provisions of the CBA. As of January 1, 2012, the Union Pension Fund was in Green Zone Status, as defined in the Pension Protection Act of 2006 (the “PPA”) and had been operating under a Rehabilitation Plan. In April 2012, we received a Notice of Critical Status from the Union Pension Fund which sets forth that the plan was considered to be in Red Zone Status for the 2012 Plan Year due to funding problems. As the fund is in critical status, all contributing employers, including Wendy’s, will be required to pay a 5% surcharge on contributions for all hours worked from June 1, 2012 through December 31, 2012 and a 10% surcharge on contributions for all hours worked on and after January 1, 2013 until a contribution rate is negotiated at the expiration of the CBA that will be consistent with a revised Rehabilitation Plan which must be adopted by the Union Pension Fund in accordance with the provisions of the PPA. The surcharges and the possible effect of the revised Rehabilitation Plan to be adopted by the Union Pension Fund as described above are not anticipated to have a material effect on the Company's results of operations. (16) Accounting Standards Not Yet Adopted In July 2012, the Financial Accounting Standards Board (the “FASB”) issued an amendment that permits a company to make an assessment of whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 with early adoption permitted. 23 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of The Wendy’s Company (“The Wendy’s Company” and, together with its subsidiaries, the “Company”) should be read in conjunction with the accompanying unaudited condensed consolidated financial statements included elsewhere herein and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended January 1, 2012 (the “Form 10-K”). There have been no material changes as of July 1, 2012 to the application of our critical accounting policies as described in Item 7 of the Form 10-K. Certain statements we make under this Item 2 constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. See “Special Note Regarding Forward-Looking Statements and Projections” in “Part II - Other Information” preceding “Item 1.” You should consider our forward-looking statements in light of our unaudited condensed consolidated financial statements, related combined notes, and other financial information appearing elsewhere in this report, the Form 10-K and our other filings with the Securities and Exchange Commission. The Wendy’s Company is the parent company of its 100% owned subsidiary holding company, Wendy’s Restaurants, LLC (“Wendy's Restaurants”). On July 4, 2011, Wendy’s Restaurants completed the sale of 100% of the common stock of its then wholly-owned subsidiary, Arby’s Restaurant Group, Inc. (“Arby’s”) (while indirectly retaining an 18.5% interest in Arby’s), as described in the Form 10-K. Arby’s operating results for the three and six months ended July 3, 2011 are classified as discontinued operations in the accompanying unaudited condensed consolidated statements of operations. After this sale, the principal subsidiary of The Wendy’s Company is Wendy’s International, Inc. (“Wendy’s”) and its subsidiaries. Wendy’s franchises and operates company-owned Wendy’s® quick service restaurants throughout the United States of America (the “U.S.”). Wendy’s also has franchised restaurants in 27 foreign countries and U.S. territories. Wendy’s restaurants offer an extensive menu specializing in hamburger sandwiches and featuring filet of chicken breast sandwiches, chicken nuggets, chili, side dishes, freshly prepared salads, soft drinks, Frosty® desserts, and kids’ meals. In addition, the restaurants sell a variety of promotional products on a limited basis. The Company manages and internally reports its business geographically. The operation and franchising of Wendy’s restaurants in North America (defined as the 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 (including through our joint venture in Japan (the “Japan JV”) are not material. References herein to The Wendy’s Company corporate (“Corporate”) represent The Wendy’s Company parent company only functions and their effect on the Company’s consolidated results of operations and financial condition. The results of operations discussed below may not necessarily be indicative of future results. Executive Overview Our Continuing Business As of July 1, 2012, the Wendy’s restaurant system was comprised of 6,547 restaurants, of which 1,425 were owned and operated by the Company. Our company-owned restaurants are located principally in the U.S. and to a lesser extent in Canada. Wendy’s operating results have been impacted by a number of external factors, including high unemployment, negative general economic trends and intense price competition, as well as increased commodity costs in the first half of 2012. These increased costs negatively affected cost of sales and restaurant margins. Wendy’s long-term growth opportunities include (1) improving our North America business by elevating the total customer experience through core menu improvement, step-change product innovation and focused execution of operational excellence and brand positioning and which will be supported by (2) investing in an Image Activation program, which includes innovative exterior and interior restaurant designs, for our new and remodeled restaurants, (3) improving restaurant utilization through daypart expansion, (4) employing financial strategies to improve our net income and (5) building the brand worldwide. Wendy’s revenues for the first six months of 2012 include: (1) $1,049.7 million of sales at company-owned restaurants, (2) $36.3 million from the sale of bakery items, (3) $141.4 million of royalty income from franchisees, and (4) $11.7 million of other franchise-related revenue and other revenues. Substantially all of our Wendy’s royalty agreements provided for royalties of 4.0% of franchise revenues for the six months ended July 1, 2012. 24 Key Business Measures We track our results of operations and manage our business using the following key business measures:
Since the 2012 first quarter, we have been reporting Wendy’s same-store sales commencing after new restaurants have been open for at least 15 continuous months and after remodeled restaurants have been reopened for three continuous months (the “New Method”). Prior thereto, the calculation of same-store sales commenced after a restaurant had been open for at least 15 continuous months and as of the beginning of the previous fiscal year (the “Old Method”). The tables summarizing the results of operations below provide the same-store sales percent change using the New Method, as well as the Old Method. Same-store sales exclude the impact of currency translation.
We define restaurant margin as sales from company-owned restaurants less cost of sales divided by sales from company-owned restaurants. Cost of sales includes food and paper, restaurant labor, and occupancy, advertising and other operating costs. Sales and cost of sales exclude amounts related to bakery and other. Restaurant margin is influenced by factors such as restaurant openings and closures, price increases, the effectiveness of our advertising and marketing initiatives, featured products, product mix, the level of our fixed and semi-variable costs, and fluctuations in food and labor costs. Credit Agreement As further described in “Liquidity and Capital Resources - Credit Agreement,” below, on May 15, 2012, Wendy’s entered into a Credit Agreement (the “Credit Agreement”) which includes a senior secured term loan facility (the “Term Loan”) of $1,125.0 million and a senior secured revolving credit facility of $200.0 million. The Company recognized a loss on the early extinguishment of debt of $25.2 million in the second quarter of 2012 related to the use of proceeds from the Term Loan draw on May 15, 2012. Subsequent to the end of our second quarter and as a result of the use of proceeds from the Term Loan draw on July 16, 2012, the Company will recognize a loss on early extinguishment of debt of $49.8 million in the third quarter of 2012. Related Party Transactions The Company has entered into the following transactions with related parties since those reported in our Form 10-K: Noncontrolling Interests in Jurl Holdings, LLC Jurl Holdings, LLC’s (“Jurl”), a 99.7% owned subsidiary, completed the sale of our investment in Jurlique International Pty Ltd. (“Jurlique”) in February 2012. Prior to 2009 when our predecessor entity was a diversified company active in investments, we had provided our Chairman, who was also our then Chief Executive Officer, and our Vice Chairman, who was our then President and Chief Operating Officer (the “Former Executives”), and certain other former employees, equity and profits interests in Jurl. In connection with the sale of Jurlique, we distributed approximately $3.7 million to Jurl’s minority shareholders, including approximately $2.3 million to the Former Executives in the six months ended July 1, 2012. Aircraft Lease Agreement The company-owned aircraft was being leased under an aircraft lease agreement with TASCO, LLC (an affiliate of a company that was formed by the Former Executives and a director, who was our former Vice Chairman (the “Management Company”)) (“TASCO”), which expired on June 30, 2012. The Company and TASCO entered into an extension of that lease agreement that extended the lease term to July 31, 2012, and effective as of August 1, 2012, entered into an amended and restated lease agreement that will expire on January 5, 2014. Under the amended and restated lease agreement, TASCO will pay all costs associated with the operation, maintenance and insurance of the aircraft. At the expiration of the term of the amended and restated lease agreement, the Company will evaluate all options for the aircraft, including a possible sale. 25 Japan Joint Venture Guarantee In 2012, Wendy’s (1) provided a guarantee to certain lenders to the Japan JV for which our joint venture partners have agreed to reimburse and otherwise indemnify us for their 51% share of the guarantee and (2) agreed to reimburse and otherwise indemnify our joint venture partners for our 49% share of the guarantee by our joint venture partners of a line of credit granted by a different lender to the Japan JV to fund working capital requirements. As of July 1, 2012, our portion of these contingent obligations totaled approximately $4.2 million (¥350.1 million) based upon then current rates of exchange. The fair value of our guarantees is immaterial. The Company anticipates that our share of additional guarantees, after the agreement of our joint venture partners to reimburse and otherwise indemnify us for their 51% share of the guarantee, of up to $3.3 million may be necessary in 2012. Presentation of Financial Information The Company reports on a fiscal year consisting of 52 or 53 weeks ending on the Sunday closest to December 31. All quarters presented contain 13 weeks. All references to years and quarters relate to fiscal periods rather than calendar periods. Certain percent changes between these years are considered not measurable or not meaningful (“n/m”). As a result of the sale of Arby’s as discussed above in “Introduction,” Arby’s results of operations for the quarter ended July 3, 2011 have been included in “Income from discontinued operations, net of income taxes” in the tables below. 26 Results of Operations The following tables included throughout this Results of Operations set forth the Company’s consolidated results of operations for the three months ended July 1, 2012 and July 3, 2011 (dollars in millions):
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________________ (a) Includes international franchised restaurants same-store sales. 28
The increase in sales in the second quarter of 2012 was due in large part to an increase in our average per customer check amount, primarily due to strategic price increases taken on our menu items. Sales were also impacted by a $2.6 million decrease in the benefit from Canadian foreign currency rates. Wendy’s company-owned restaurants opened or acquired subsequent to the second quarter of 2011 resulted in incremental sales of $16.8 million in the second quarter of 2012, which were partially offset by a reduction in sales of $6.8 million from locations sold or closed after the second quarter of 2011.
As a percent of sales in the second quarter of 2012, increases in food and paper costs, which were primarily related to a 0.7% increase in commodity costs, and increased labor and controllable costs were more than offset by the effect of strategic price increases on our menu items as well as favorable impact of product mix.
The decrease in general and administrative expenses in the second quarter of 2012 was primarily due to decreases in professional fees primarily related to the design and implementation of our employee retention plan in the prior year quarter that did not recur and in contract services for information technology. These decreases were partially offset by an increase in legal fees related to certain legal matters during the second quarter of 2012. 29
The increase in restaurant depreciation and amortization in the second quarter of 2012 was primarily for (1) capital expenditures for operating initiatives, (2) new restaurants opened and restaurants acquired from franchisees subsequent to the second quarter of 2011, primarily related to equipment and leasehold improvements and (3) point-of-sale system hardware. In addition, depreciation increased as compared to the second quarter of 2011 as a result of the reclassification of the company-owned aircraft to held and used from its previous held-for-sale classification.
The increase in impairment was due to the closing of 15 company-owned restaurants during the second quarter of 2012 in connection with our review of certain underperforming locations, which resulted in an impairment charge of $3.3 million.
During the second quarter of 2012, the Company incurred “Facilities relocation and other transition costs” aggregating $9.4 million, which are related to the ongoing relocation of the Atlanta restaurant support center to Ohio which is expected to be substantially completed during the third quarter of 2012. Transaction Related Costs During the three months ended July 1, 2012 and July 3, 2011, we incurred “Transaction related costs” of $0.6 million and $5.0 million, respectively, resulting from the sale of Arby’s.
The decrease in interest expense during the second quarter of 2012 was primarily due to the redemption in May 2012 of a portion of the outstanding Wendy's Restaurants 10.00% Senior Notes due 2012 (the “Senior Notes”), as further discussed in “Liquidity and Capital Resources - Credit Agreement.” This decrease was partially offset by (1) an increase in interest expense related to the Credit Agreement Wendy’s entered into on May 15, 2012, as further discussed in “Liquidity and Capital Resources - Credit Agreement,” and (2) an increase in interest expense related to tax positions and other tax matters. 30 Loss on Early Extinguishment of Debt We incurred a loss on the early extinguishment of debt for the draw on the Term Loan on May 15, 2012, as described below in “Liquidity and Capital Resources - Credit Agreement,” as follows: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||