XNYS:THI Tim Hortons Inc Annual Report 10-K Filing - 1/1/2012

Effective Date 1/1/2012

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Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended January 1, 2012

 

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

For the transition period from              to             

Commission File Number: 001-32843

TIM HORTONS INC.

(Exact name of Registrant as specified in its charter)

 

Canada   98-0641955

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

874 Sinclair Road, Oakville, ON, Canada   L6K 2Y1
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code 905-845-6511

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Shares, without par value   New York Stock Exchange
Associated Share Purchase Rights   Toronto Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  x    NO  ¨.

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x.

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨.

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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  ¨
(Do not check if a smaller reporting company)

   Smaller reporting company  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x.

The aggregate market value of the common shares held by non-affiliates of the Registrant computed by reference to the price at which such shares were last sold, as of July 1, 2011, was Cdn.$ 7,681,493,043 (US$7,994,892,843).

Number of common shares outstanding as of February 21, 2012: 157,414,012

DOCUMENTS INCORPORATED BY REFERENCE:

Exhibit index on pages 168-171.

 

 

 


Table of Contents

EXPLANATORY NOTE

Tim Hortons Inc., a corporation incorporated under the Canada Business Corporations Act (the “Company”), qualifies as a foreign private issuer in the U.S. for purposes of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Although as a foreign private issuer the Company is no longer required to do so, the Company currently continues to file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K with the Securities and Exchange Commission (“SEC”) instead of filing the reporting forms available to foreign private issuers.

The Company prepares and files a management proxy circular and related material under Canadian requirements. As the Company’s management proxy circular is not filed pursuant to Regulation 14A, the Company may not incorporate by reference information required by Part III of this Form 10-K from its management proxy circular. Accordingly, in reliance upon and as permitted by Instruction G(3) to Form 10-K, the Company will be filing an amendment to this Form 10-K containing the Part III information no later than 120 days after the end of the fiscal year covered by this Form 10-K.

All references to our websites contained herein do not constitute incorporation by reference for information contained on the website and such information should not be considered part of this document.

 

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TIM HORTONS INC.

2011 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 

          Page  
   PART I   

Item 1.

   Business      4   

Item 1A.

   Risk Factors      23   

Item 1B.

   Unresolved Staff Comments      37   

Item 2.

   Properties      38   

Item 3.

   Legal Proceedings      40   

Item 4.

   Mine Safety Disclosures      41   
   PART II   

Item 5.

   Market for the Registrant’s Common Equity Related Stockholder Matters and Issuer Purchases of Equity Securities      42   

Item 6.

   Selected Financial Data      47   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      51   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      99   

Item 8.

   Financial Statements and Supplementary Data      100   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      160   

Item 9A.

   Controls and Procedures      160   

Item 9B.

   Other Information      161   
   PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance      162   

Item 11.

   Executive Compensation      165   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      165   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      165   

Item 14.

   Principal Accounting Fees and Services      165   
   PART IV   

Item 15.

   Exhibits and Financial Statement Schedules      166   

SIGNATURES

     167   

 

 

The noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York, were:

 

(US$)

   At End of
Fiscal Year
     Year
Average
     High      Low  

December 30, 2007

     1.0221         0.9419         1.0908         0.8437   

December 28, 2008

     0.8192         0.9399         1.0291         0.7710   

January 3, 2010

     0.9559         0.8834         0.9719         0.7695   

January 2, 2011

     0.9991         0.9663         1.0040         0.9280   

January 1, 2012

     0.9835         1.0151         1.0584         0.9480   

On February 17, 2012, the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York was US$1.0030 for Cdn.$1.00.

 

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PART I

 

 

Item 1. Business

 

 

The Company

We are one of the largest publicly-traded quick service restaurant chains in North America based on market capitalization and the largest in Canada based on systemwide sales and number of locations. We appeal to a broad range of consumer tastes, with a menu that includes premium coffee, espresso-based hot and cold specialty drinks, including lattes, cappuccinos and espresso shots, specialty teas, fruit smoothies, home-style soups, fresh sandwiches, wraps, hot breakfast sandwiches and fresh baked goods, including our trademark donuts.

The first Tim Hortons® was opened in May 1964 by Tim Horton, a National Hockey League All-Star defenseman. In 1967, Ron Joyce, then the operator of 3 Tim Hortons restaurants, became partners with Tim Horton and together they opened 37 restaurants over the next 7 years. After Tim Horton’s death in 1974, Mr. Joyce continued to expand the chain, becoming its sole owner in 1975. In the early 1990s, Tim Hortons and Wendy’s International, Inc., now wholly-owned by The Wendy’s Company (“Wendy’s”), entered into a partnership to develop real estate and combination restaurant sites with Wendy’s® and Tim Hortons restaurants under the same roof. In 1995, Wendy’s purchased Mr. Joyce’s interest in the Tim Hortons system and incorporated the company known as Tim Hortons Inc., a Delaware corporation (“THI USA”), as a wholly-owned subsidiary. In 2006, we became a standalone public company pursuant to an initial public offering and a subsequent spin-off of our common stock to Wendy’s stockholders through a stock dividend on September 29, 2006.

At a special meeting of stockholders held on September 22, 2009, THI USA’s stockholders voted to approve the reorganization of THI USA. As a result of the reorganization, Tim Hortons Inc., a corporation incorporated under the Canada Business Corporations Act (the “Company”), became the publicly held parent company of the group of companies previously controlled by THI USA, and each outstanding share of THI USA’s common stock automatically converted into 1 common share of the Canadian public company. The issuance of common shares (and the associated share purchase rights) of the Canadian public company was registered under the Securities Act of 1933, as amended (the “Securities Act”). The common shares of the Canadian public company, like the common stock of THI USA previously, are traded on both the Toronto Stock Exchange and the New York Stock Exchange under the symbol “THI.”

In 2010, we sold our 50% joint-venture interest in Maidstone Bakeries, which provides certain bread, pastries, donuts and Timbits™ to our system restaurants. Pursuant to our supply agreement with Maidstone Bakeries, our obligation to purchase donuts and Timbits extends until early 2016, and we have supply rights until late 2017, at our option, allowing us sufficient flexibility to secure alternative means of supply, if necessary.

Our primary business model is to identify potential restaurant locations, develop suitable sites, and make these new restaurants available to approved restaurant owners. As of January 1, 2012, restaurant owners operated 99.6% of our systemwide restaurants. We directly own and operate (without restaurant owners) only a small number of company restaurants in Canada and the U.S. We also have warehouse and distribution operations that supply paper and dry goods to a substantial majority of our Canadian restaurants, and supply frozen baked goods and some refrigerated products to most of our Ontario restaurants and Quebec restaurants. In the U.S., we supply similar products to system restaurants through third-party distributors. Our operations also include coffee roasting plants in Rochester, New York, and Hamilton, Ontario, and a fondant and fills manufacturing facility in Oakville, Ontario. See “Manufacturing” below. These vertically integrated manufacturing and distribution capabilities provide important benefits to our restaurant owners and systemwide restaurants, while allowing us to: improve product quality and consistency; protect proprietary interests; facilitate the expansion of our product offerings; control availability and timely delivery of products; provide economies of scale and labour efficiencies; and generate additional sources of income and financial returns for the Company’s investments.

 

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Our business model results in several distinct sources of revenues and corresponding income, consisting of distribution sales, franchise rent and royalties revenues, manufacturing income, and, to a much lesser extent, equity income, and sales from Company-operated restaurants. Franchise royalties are typically collected weekly based on a percentage of gross sales. Rental income results from our controlling interest (i.e., lease or ownership) in the real estate for approximately 83% of full-serve system restaurants, generating base rent and percentage rent in Canada, and percentage rent only in the U.S., which results in higher rental income as same-store sales increase. Historically, as we have opened new restaurants and made them available to restaurant owners, our operating income base has expanded. In addition, our product distribution and warehouse operations have generated consistent positive operating income.

Our segments, for financial reporting purposes, are Canada and the U.S. Financial information about these segments is set forth in Items 6 and 7 and Note 22 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K (“Annual Report”). Operating results from our international operations are currently insignificant and will continue to be included in Corporate charges in our segmented operating results. In addition, reference should be made to the Consolidated Financial Statements and Supplementary Data in Item 8 of this Annual Report for further information regarding revenues, segment operating profit and loss, total assets attributable to our segments, and for financial information attributable to certain geographic areas.

References to “we,” “our,” “us” or the “Company” refer to THI USA and its subsidiaries for periods on or before September 27, 2009 and to Tim Hortons Inc., a corporation incorporated under the Canada Business Corporations Act and its subsidiaries, for periods on or after September 28, 2009, unless specifically noted otherwise.

All dollar amounts referenced in this Annual Report are in Canadian dollars, unless otherwise expressly stated.

 

 

Business Overview

We have a strategic plan themed “More than a Great Brand” which charts strategic and operational initiatives designed to help us achieve both annual and longer-term goals (see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations) that strengthen our business and create shareholder value. We have a unique, layered business model that we believe adds to the scale and success of our system.

Unique business model

Key aspects of our business model include:

 

   

franchising in more than 99% of our restaurant system. We have a long-standing history of collaborating with our restaurant owners to grow our collective business and build positive relationships. Our restaurant owners typically operate an average of 3 to 4 restaurants and have a significant stake in the success of the restaurants they operate;

 

   

maintaining a controlling interest in a significant majority of the real estate in our full-serve restaurant system in North America to ensure brand integrity and control of development;

 

   

operating with a “we fit anywhere” concept that allows us to adapt our brand presence to take advantage of both standard and non-standard development opportunities; and

 

   

leveraging significant levels of vertical integration that exist in our system and continuing to explore additional system benefits through further vertical integration opportunities.

Increasing same-store sales through daypart, marketing and menu opportunities

Increasing same-store sales is an important measure of success in the restaurant sector. Our Company has a positive same-store sales growth record that extends two decades. We view same-store sales growth as vital to the ongoing health of our franchise system and our Company.

 

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Our strategies to increase same-store sales include:

 

   

leveraging our research and development capabilities to create menu and product innovation to respond to guest needs and trends, designed to expand our category and daypart traffic, average cheque and overall market share;

 

   

introducing product and category extensions as well as new product platforms such as chilled drinks and espresso-based beverages. We believe we have opportunities to extend market share across multiple dayparts;

 

   

enhancing our brand identity positioning efforts in the U.S. as a unique cafe and bake shop destination focused on freshness and value;

 

   

leveraging our marketing strengths and advantages. In Canada, we will leverage our scale as one of the country’s largest advertisers and marketers to reinforce our attractive price to value position, menu innovation and to reinforce our brand equity and coffee leadership;

 

   

increasing capacity at our existing Canadian restaurants through the design and implementation of a combination of drive-thru activities, including order station relocations, double-order stations and, in certain locations, double-lane drive-thrus. In addition, we will continue to evolve our in-restaurant guest queuing systems; and

 

   

sustaining increased marketing and advertising spending across our U.S. business with a focus on our core growth markets to increase awareness of our brand. In addition, we will continue to seek other marketing means, such as community involvement, sponsorships, event site product agreements and other forms of communication, to supplement traditional advertising to reinforce our brand position with customers and to broaden our brand awareness as a cafe and bake shop destination.

Investing to build our scale and brand in new and existing markets

Restaurant development in new and existing markets has historically contributed significantly to the Company’s growth. Our specific development plans include:

 

   

continued active development of both standard and non-standard restaurants in Canadian growth markets;

 

   

focusing Canadian development primarily in Quebec, western Canada, Ontario and major urban markets;

 

   

applying successful elements of our newest restaurant designs, including exterior and interior design treatments, menu items, equipment and fixtures, in new restaurants in both Canada and the U.S., and seeking opportunities to introduce these elements in renovations and continuing to evolve and evaluate flexible new restaurant designs to respond to consumer trends and interests including, in Canada, designs tailored to urban and rural markets;

 

   

working to accelerate the time it takes to create critical mass for convenience and advertising scale in our most developed U.S. markets, primarily through deployment of the substantial majority of our U.S. restaurant development capital into core growth markets which are most developed; and

 

   

actively seeking to complement our U.S. standard format restaurant development activity with non-standard formats and locations through strategic partnerships and relationships.

 

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Growing differently in ways we have not grown before

Our strategic growth plan includes initiatives that are designed to complement our core growth strategies with additional opportunities to grow our business. These initiatives include:

 

   

extending our competitive advantage for service excellence through our ongoing hospitality strategy and initiatives;

 

   

opportunistically pursuing strategic alliances and partnerships to take our brand to markets where we have not yet established a presence, to complement our existing presence, or to increase average unit volumes in existing locations. This may include further expanding the Cold Stone Creamery® co-branding concept in Canada, where we have exclusive development rights, and to a lesser extent in the U.S., where we already have a strong co-branded presence, or other initiatives; and

 

   

pursuing, as part of a broader international restaurant development strategy, development of restaurants in the Gulf Cooperation Council (“GCC”) markets through master licensee, Apparel FZCO (“Apparel”), based in Dubai.

Leveraging our core business strengths and franchise system

As one of the most franchised systems in the restaurant industry, we focus extensively on our relationships with our restaurant owners and the success of our system. We also seek to leverage our strengths and capabilities to grow our business in ways that benefit us and our system restaurant owners. Our focus includes:

 

   

continuing to work collaboratively with our restaurant owners across a wide range of initiatives and business matters;

 

   

pursuing additional vertical integration and supply chain opportunities to create value for our restaurant owners and shareholders; and

 

   

selectively assessing acquisition opportunities that leverage our core strengths and capabilities.

Operations

Restaurant formats. Tim Hortons restaurants operate in a variety of formats. From start to finish, the development process for each individual standard restaurant location, typically averaging 1,000 to 3,080 square feet, usually takes between 12 to 18 months. Development of non-standard sites and self-serve kiosks typically requires much less time. See Item 2. Properties of this Annual Report for additional information regarding our restaurants.

 

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Our non-standard restaurant development growth includes small, full-service restaurants and/or self-serve kiosks in offices, hospitals, colleges, airports, grocery stores, gas and convenience locations and drive-thru-only units on smaller pieces of property, including full-serve event sites located in sports arenas and stadiums that operate only during events with a limited product offering. Our self-serve kiosks also typically have a limited product offering and typically generate much smaller average unit volumes compared to non-standard, full-serve restaurants in their respective markets that have staff, larger locations, and more expansive beverage and food product offerings. Average unit volumes at self-serve kiosks are highly variable, depending upon the location, size of the site, product offerings, and hours of operation. In the U.S., self-serve kiosks only contribute nominal amounts to our distribution sales, royalty revenues and consolidated operating income at this time. Self-serve kiosks, however, complement our core growth strategy by increasing guest convenience and frequency of visits and allowing for additional market penetration of our brand, including in areas where we may not be as well known or where an alternative model for unit growth and development is appropriate. Additionally, in Canada, we have used self-serve kiosks in locations where existing full-service locations are at full capacity.

The development of co-branded locations is also increasing in our system. We are party to an agreement with Kahala Franchise Corp., the franchisor of the Cold Stone Creamery brand, pursuant to which we have exclusive development rights in Canada. During 2011, we opened 44 and closed 2 co-branded restaurants in Canada. In the U.S., we opened 19 Cold Stone Creamery co-branded restaurants in 2011. In addition, we opened 1 Tim Hortons restaurant in a Cold Stone Creamery.

See also “Combination restaurants, an ongoing relationship with Wendy’s” below for information regarding restaurants that offer Tim Hortons and Wendy’s products at a single location.

Restaurant development. We typically oversee and direct all aspects of restaurant development for system restaurants, from an initial review of a location’s demographics, site access, visibility, traffic counts, mix of residential/retail/commercial surroundings, competitive activity, and proposed rental/ownership structure, to considerations of the performance of nearby Tim Hortons locations, projections of the selected location’s ability to meet financial return targets, restaurant owner identification, and physical land development and restaurant construction costs. We typically retain a controlling interest in the real estate for full service system restaurants by either owning the land and building, leasing the land and owning the building, or leasing both the land and building. While we have a highly recognizable standard, standalone restaurant design, we may vary the design to fit into local architecture and municipal requirements. Ultimately, we control the design and building of our restaurants to cater to the market and the neighbourhood in which the restaurants are located.

In Canada, we believe we have opportunity for development for at least 4,000 locations. In 2011, we continued active development of both standard and non-standard restaurants in Canadian growth markets by focusing development primarily in Quebec, western Canada, Ontario and major urban markets; evaluating flexible new restaurant designs tailored to urban and rural markets; and, based on results from our initial pilot of a new restaurant format for standard restaurants, we began implementing flexible new and more contemporary restaurant designs in Canada in certain regions and incorporated various elements from our test results.

During 2011, we worked to accelerate the time it takes to create critical mass for convenience and advertising scale in our most developed U.S. markets by prioritizing and accelerating our U.S. restaurant development capital to our core growth markets, while continuing to develop, to a lesser extent, in other emerging markets for longer-term growth; and applying successful elements of our cafe and bake shop design, including exterior and interior design treatments, menu items, equipment and fixtures, in new restaurants in the U.S. and seeking opportunities to introduce these elements in renovations. We also supported our development through additional marketing and advertising investments in our growth and core markets designed to increase awareness.

 

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In addition, at the end of 2011, we opened 5 international locations in the GCC under our master license agreement with Apparel, pursuant to which up to 120 multi-format restaurants are expected to be developed over a 5-year period starting in 2011. See “Franchise and Other Arrangements—Master License Agreements” and “International Operations” below.

As of January 1, 2012, the number of Tim Hortons restaurants across Canada, both standard and non-standard locations, which for this purpose includes self-serve kiosks, totaled 3,295. Standard restaurants constitute approximately 72% of this total. Also as of January 1, 2012, our restaurant owners operated substantially all of our Canadian restaurants. In the U.S., as of January 1, 2012, we have a strong regional presence with 714 restaurants, including self-serve kiosks, in 10 states, concentrated in the Northeast in New York and Maine, and in the Midwest in Michigan and Ohio with standard full-serve restaurants representing approximately 61% of all U.S. restaurants. We own, rather than lease, the land underlying a higher percentage of our standard system restaurants in the U.S. than in Canada. As of January 1, 2012, restaurant owners (See “Franchise and Other Arrangements—Other Arrangements” below for a description of “operators”) operated substantially all of our restaurants in the U.S. See Item 2. Properties of this Annual Report for a description of the number and type of restaurants by province/territory in Canada and by state in the U.S. owned or operated by our restaurant owners and owned by the Company.

Our development strategy in Canada includes focusing development primarily in Quebec, western Canada, Ontario and major urban markets, evaluating flexible new restaurant designs tailored to urban and rural markets, and adding capacity at our existing restaurants through the design and implementation of a combination of activities, including selectively implementing drive-thru order station relocations, double order stations and double-lane drive-thrus, and through continued evolution of our in-restaurant guest queuing systems. In the U.S., our development strategy will focus on working to establish a greater density of restaurants in our most developed markets to accelerate the time it takes to create critical mass for convenience and advertising scale in those markets, while continuing to develop other emerging markets for long-term growth. We will also continue to evolve restaurant design in both Canada and the U.S. to respond to consumer trends and interests and apply successful elements of our newest restaurant designs, including exterior and interior design treatments, menu items, equipment and fixtures, in new restaurants and to introduce these elements in renovations.

The importance of restaurant owners and their teams. Finding exceptional restaurant owner candidates is critical to the system’s successful growth and development, and we have implemented a comprehensive restaurant owner screening and recruitment process that employs multi-level interviews with our senior operations management and requires candidates to work 2 to 3 different shifts in an existing restaurant owner’s restaurant. Each new restaurant owner typically participates in a mandatory 7-week intensive training program to learn all aspects of operating a Tim Hortons restaurant in accordance with our standards. Management-level employees of restaurant owners have the opportunity to become certified at our training centre after completion of a 7-week training program. We also provide ongoing training and education to restaurant owners and their staff after completion of the initial training programs. To further assist restaurant owners, we have standardized our restaurant management software with an application service provider to give our restaurants the ability to manage a variety of day-to-day operations and management functions.

Restaurant owner financing. Despite the challenging economic climate and credit conditions, our restaurant owners continue to have access to lending programs with third-party lenders, although processing may take longer and costs may be higher, consistent with prevailing market conditions. Currently, a significant portion of the notes under our franchise incentive program are past due. In many cases, we have also chosen to hold the note beyond the initial term to assist a restaurant owner in achieving certain profitability targets, or to accommodate a restaurant owner seeking to obtain third-party financing. In the event a restaurant owner does not repay the note, we may take back ownership of the restaurant and equipment based on the underlying franchise agreement, which collateralizes the note and, therefore, minimizes our credit risk. For most restaurant owners new to the system, we will enter into more operator agreements than full franchise agreements, and once the

 

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restaurant is established and reaches certain profitability measures, we may convert it to a full franchise agreement. See “Franchise and Other Arrangements” below for additional information regarding the franchise incentive program.

Distribution. The Company is a distributor to Tim Hortons restaurants. We have 5 distribution centres located in Langley, British Columbia; Calgary, Alberta; Kingston, Ontario; Guelph, Ontario; and Debert, Nova Scotia. The Guelph and the replacement Kingston facilities distribute frozen and refrigerated products in addition to dry goods and shelf-stable products. The replacement distribution centre in Kingston, Ontario became operational during the second half of 2011 and was servicing approximately 530 restaurants in eastern Ontario and Quebec by the end of 2011. The Guelph and Kingston facilities serve approximately 60% of restaurants in Canada, which are situated in Ontario and Quebec. As with other vertical integration initiatives, we believe that our distribution centres deliver important system benefits, including improved efficiency and cost-effective service for our restaurant owners, as well as providing a reasonable return for the Company. Under the franchise arrangements with our Canadian restaurant owners, each restaurant owner is required to purchase substantially all products, such as coffee, sugar, and restaurant supplies, from us. Canadian and U.S. restaurant owners are also required to purchase par-baked Maidstone Bakeries products from either us or an outside distributor, depending upon the restaurant location. We own or lease a significant number of trucks and trailers that deliver to most of our Canadian restaurants on a regular basis. We use third-party distributors to deliver all products to our U.S. restaurants and to deliver to certain limited geographic areas of Canada. Our international licensee, Apparel, is responsible for local delivery of all products in its market.

Supply chain is a critical element of our business model as it allows us to control costs to our restaurant owners and to service restaurants efficiently and reliably, while contributing positively to our profitability. The Guelph and Kingston facilities, in particular, further these objectives of timely and efficient service for our restaurant owners, despite the lower profitability to us of frozen and refrigerated distribution. We continue to consider expansion of our distribution business, including frozen and refrigerated distribution, to areas in Canada not supplied by the Guelph and Kingston facilities, if there are sufficient system benefits to do so.

We offer home-brew coffee through various lines of distribution in Canada and the U.S., including certain grocery stores. Home-brew coffee, other hot beverages and various accessories are also offered and distributed through TimShopTM. See “E-commerce Platform” below.

Menu items and new product innovation. Each Tim Hortons restaurant offers a relatively standard menu that spans a broad range of categories designed to appeal to guests throughout the day. While the largest portion of systemwide sales is generated in the morning, we generate significant sales across all of our dayparts. A substantial majority of Tim Hortons restaurants are open 24 hours. Our average cheque size for both Canada and the U.S. is in the range of approximately $3.00 to $3.75 (includes both standard and non-standard locations); however, the average cheque sizes in some regions may be higher or lower than this range.

The Tim Hortons menu consists of products such as our premium blend coffee, espresso-based hot and cold specialty drinks, including lattes, cappuccinos and espresso shots, iced cappuccinos, specialty and steeped teas, cold beverages, fruit smoothies, home-style soups, chili, lasagna casserole, freshly prepared sandwiches, wraps, yogurt and berries, oatmeal and freshly baked goods, including donuts, Timbits, bagels, muffins, cookies, croissants, Danishes, pastries and more. We also offer a variety of breakfast sandwiches in both Canada and the U.S., including the sausage/bacon and egg on a biscuit, bagel or an English muffin, as well as a variety of breakfast wraps. New product offerings have historically contributed significantly to same-store sales growth. In 2011, we continued to reinforce our commitment to providing guests with value by focusing advertising and promotions on product-specific items and combos. In addition to food items, Tim Hortons restaurants sell a variety of promotional products on a seasonal basis and also sell home coffee brewers, home-brew coffee, boxed teas, and other products throughout the year. Although the key menu offerings have remained substantially the same, we also tailored our menu offerings to meet the needs of our international guests in connection with our international expansion into the GCC.

 

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Quality controls. Our quality control programs focus on maintaining product quality, freshness, and availability, as well as speed of service, cleanliness, security, and employment standards. These programs are implemented by our restaurant owners (and the Company for Company-operated restaurants), with assistance from our field management. In addition, because the Tim Hortons brand is so closely linked to the public’s perception of our food quality and safety, we require our restaurant owners, as well as their managers and operations personnel, to complete the Advanced.fst® food safety program for our Canadian restaurants and the ServSafe® program for our U.S. restaurants. These programs must be completed with a passing grade and participants must be re-certified every 5 years. We also conduct site visits on a regular basis and, twice a year at a minimum, we perform unscheduled food safety audits. In addition, all restaurant staff must complete a multi-level food safety training module as part of their mandatory training. We also have a comprehensive supplier quality approval process, which requires all suppliers’ products to be pre-approved to our quality standards. Part of this process requires the supplier to pass on-site food safety inspections for the supplier’s manufacturing process and facilities.

Manufacturing. We have 2 wholly-owned coffee roasting facilities. Our Maidstone Coffee facility, located in Rochester, New York and, therefore, part of our U.S. segment for financial reporting purposes, was acquired in 2001 as part of our U.S. expansion activities. Our coffee roasting facility in Hamilton, Ontario was constructed in 2009. Together, our coffee roasting plants have the capacity to produce at least 75% of our total coffee requirements. We blend all our restaurant use coffee to protect the proprietary nature of our restaurant coffee and, where practical, our take home packaged coffee. We also own a fondant and fills manufacturing facility that was acquired in 2003 and produces fondants, fills, and ready-to-use glaze, which is used in connection with a number of the products produced in the Always Fresh baking system.

In 2001, a subsidiary of the Company formed CillRyan’s Bakery Limited (“CillRyan’s” or “Maidstone Bakeries”), a 50/50 joint venture with IAWS Group Ltd. (now owned by Aryzta AG) (“Aryzta”), to commission the construction of the Maidstone Bakeries facility, a 400,000 square foot joint venture par-baking facility located in Brantford, Ontario. This facility manufactures all par-baked donuts, Timbits and selected breads, following traditional Tim Hortons recipes, as well as European pastries, including Danishes, croissants, and puff pastry. Those products are partially baked and then flash frozen and delivered to system restaurants, most of which have an Always Fresh oven with the Company’s proprietary technology. The restaurant completes the baking process with this oven and adds final finishing such as glazing and fondant, allowing the product to be served warm to the guest within a few minutes of baking. The limited space required for an Always Fresh oven allows most non-standard restaurant locations (other than self-serve and certain other non-standard kiosk locations) to provide products baked fresh on-site. The Company sold its 50% joint-venture interest in Maidstone Bakeries for gross cash proceeds of $475 million in October 2010. For additional information regarding Maidstone Bakeries, see “Source and Availability of Raw Materials” below.

Combination restaurants, an ongoing relationship with Wendy’s. Since the early 1990s, TIMWEN Partnership, owned on a 50/50 basis by the Company and Wendy’s, jointly developed the real estate underlying “combination restaurants” in Canada that offer Tim Hortons and Wendy’s products at the same location, typically with separate restaurant owners operating the Tim Hortons and the Wendy’s portions of the restaurant. The combination restaurants have separate drive-thrus, if the site allows for drive-thrus, but share a common entrance way, seating areas and restrooms. Separate front counters and food preparation areas are also in place for each of the 2 restaurant concepts. TIMWEN Partnership owns or leases the underlying real estate from a third party, and leases, or subleases, as applicable, a portion of the location to the Company (for the Tim Hortons restaurant) and to Wendy’s (for the Wendy’s restaurant).

As of January 1, 2012, there were 101 combination restaurants in the TIMWEN Partnership, all of which were in Canada, and all of which were franchised. We also have a small number of combination restaurants that are not held by the TIMWEN Partnership. At January 1, 2012, there were 20 such restaurants in Canada, all of which were franchised, and 30 such restaurants in the U.S., all of which were franchised. For the U.S. combination restaurants, we generally own or lease the land, and typically own the building and lease or

 

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sublease, as applicable, a portion of the location to the Tim Hortons restaurant owner (for the Tim Hortons restaurant) and to Wendy’s (for the Wendy’s restaurant). We do not intend to actively open combination restaurants with Wendy’s in future years, nor has there been significant development of these restaurants in recent years.

Credit, Debit and Cash Card Arrangements. By the end of December 2011, electronic payment capabilities (including our Tim Card®, see below) were in place at approximately 2,979 locations in Canada and 486 locations in the U.S. We also have a Tim Card quick-pay cash card program. The Tim Card is a reloadable cash card that can be used by guests for purchases at system restaurants. Guests can reload the Tim Card online at www.timhortons.com. Our electronic payment systems provide guests with more payment options. As of January 1, 2012, “Restricted cash and cash equivalents,” which approximately represent outstanding guest deposits on Tim Cards, totaled $130.6 million. As of January 2, 2011, “Restricted cash and cash equivalents” and “Restricted Investments,” which approximately represented outstanding guest deposits on Tim Cards, totaled $105.1 million.

E-commerce Platform. TimShop®, an e-commerce platform, serves Canadian and U.S. residents. Canadian guests may order a range of items online such as gift baskets, coffee brewers, travel mugs, and our full canned beverage line-up of coffee, teas, cappuccinos and hot chocolate, at shop.timhortons.com. U.S. guests may also order products online, including ground coffee, hot chocolate, cappuccinos, boxed tea, various travel mugs and insulated coffee carriers, at shopus.timhortons.com. Although TimShop only contributes nominal amounts to consolidated operating income at this time, we believe this platform increases guest convenience and allows for additional market penetration of our brand.

 

 

Source and Availability of Raw Materials

Our food products are sourced from a combination of third-party suppliers and our own manufacturing facilities. We and our restaurant owners have not experienced any material shortages of food, equipment, fixtures, or other products that are necessary to restaurant operations. We currently do not anticipate any shortages of products. Alternative suppliers are available for most of our products, although we currently source some of our beverage and food offerings from a single supplier. As described below, in the event of an interruption in supply from any of these sources, our restaurants could experience shortages of certain products. While guests might purchase other products when a desired menu item is unavailable, this might not entirely offset the loss of revenue from the unavailable products.

While we have multiple suppliers for coffee from various coffee-producing regions, the available supply and price for high-quality coffee beans can fluctuate dramatically. Accordingly, we monitor world market conditions for green (unroasted) coffee and contract for future supply volumes to obtain expected requirements of high quality coffee beans at acceptable prices. It may be necessary for us to adjust our sources of supply or carry more inventory from time-to-time to achieve the desired blend, and we expect that we will continue to be able to do so.

In 2010, we sold our 50% joint-venture interest in Maidstone Bakeries to Aryzta, our former joint venture partner. See “Operations—Manufacturing” above. In connection with the sale of Maidstone Bakeries, our obligations to purchase donuts and Timbits extend until early 2016, and we have supply rights until late 2017, at our option, allowing us sufficient flexibility to secure alternative means of supply, if necessary. Our rights to purchase, which generally extend for 7 years from the termination of the joint venture agreements, could expire before the expiration of 7 years if a triggering event occurs with respect to the Company, such as if we breach our obligation to purchase all of our donuts and Timbits from Maidstone Bakeries until early 2016 or if we fail to cooperate in estimating the supply needs of our system, and Aryzta takes action to terminate our supply agreement with Maidstone Bakeries. All triggering events which may terminate our right to continue to purchase products from Maidstone Bakeries until late 2017 are within our ability to control.

 

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As a result of our exit from the Maidstone Bakeries joint venture, under certain circumstances, we may be required to purchase products currently sourced from Maidstone Bakeries at a higher cost, build our own facility to manufacture these products, or find alternative products and/or production methods, any of which would cause us to incur significant start-up and other costs. Also, if Maidstone Bakeries’ operations were negatively impacted by an unexpected event, our restaurants could experience shortages of donuts, Timbits, European pastries, and other bread products sourced from Maidstone Bakeries. We expect that any such shortage for most products would be for a limited period of time, until such products could be sourced from alternate suppliers, except for certain par-baked donuts and Timbits, for which alternate suppliers would require lead-time for equipment necessary to manufacture donuts and Timbits. Any product shortages, however, even of a limited duration, could negatively affect our sales as well as injure our relationships with restaurant owners and our guests’ perception of Tim Hortons and our brand.

Commencing in 2009 with the addition of our second coffee roasting plant in Hamilton, Ontario, a larger percentage of Tim Hortons system restaurants purchased coffee that is blended and roasted at our 2 Maidstone Coffee facilities, although we have third-party suppliers as well. Our fondant and fills manufacturing facility produces and is the sole supplier of ready-to-use glaze and certain fondants and fills which are used on a number of the products produced using the Always Fresh baking system. However, should our facility be unable to supply ready-to-use glaze, it may be replicated by restaurant-level operations, and should our facility be unable to supply fondants and fills for an extended period, we believe substitute fondants and fills could be supplied by third parties. We sell most other raw materials and supplies, including coffee, sugar, paper goods and other restaurant supplies, to system restaurants. We purchase those raw materials and supplies from multiple suppliers and generally have alternative sources of supply for each.

World markets for some of the commodities that we use in our business (such as coffee, wheat, edible oils and sugar) have experienced high volatility, including a number of commodities which experienced elevated spot market prices relative to historic prices. We currently have purchase contracts in place covering key commodities such as coffee, wheat, sugar, and cooking oils that generally extend to the third quarter of 2012 at prices which are in some cases higher than those secured for 2011. The continued relative strength of the Canadian dollar against the U.S. dollar, and our policy of hedging foreign currency exposure through forward foreign currency contracts, may help to mitigate some, but not all, of these price increases as certain of these commodities are sourced in U.S. dollars. Also, we may be subject to higher commodity prices depending upon prevailing market conditions at the time we make purchases beyond our current commitments.

Our business will continue to be subject to changes related to the underlying costs of key commodities. These cost changes can impact revenues, costs and margins, and can create volatility quarter-over-quarter and year-over-year. Increases and decreases in commodity costs are largely passed through to restaurant owners, resulting in higher or lower revenues and higher or lower cost of sales from our business. These changes may impact margins as many of these products are typically priced based on a fixed-dollar mark-up. Although we have implemented purchasing practices that mitigate our exposure to volatility to a certain extent, as mentioned above, if costs increased to a greater degree for 2012 purchases, we and our restaurant owners have some ability to increase product pricing to offset a rise in commodity prices, but these price increases could negatively affect our transactions.

In addition, we purchase certain products, such as coffee, in U.S. dollars. As the Canadian dollar strengthens against the U.S. dollar, these products become less expensive for us and, therefore, our Canadian restaurant owners. For our U.S. restaurant owners, as the U.S. dollar weakens against the Canadian dollar, certain other products become more expensive for them. As a result, although world commodity prices have increased, in a rising Canadian dollar environment, the positive impact of foreign exchange partially offsets the overall effect to us and our Canadian restaurant owners of such price increases. Conversely, if the U.S. dollar were to strengthen against the Canadian dollar, the negative impact of foreign exchange may impact products we purchase in U.S. dollars and, therefore, our Canadian restaurant owners. For our U.S. restaurant owners, as the U.S. dollar

 

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strengthens against the Canadian dollar, certain products become less expensive for them. See Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Foreign Exchange Risk and Commodity Risk.

 

 

Franchise and Other Arrangements

Restaurant owners. Our objective is to have restaurant owners own substantially all Tim Hortons restaurants and to maintain a small number of Company-operated restaurants primarily for restaurant owner training. As of January 1, 2012, restaurant owners owned or operated 99.7% of our Canadian restaurants and 98.9% of our U.S. restaurants.

Our restaurant owners operate under several types of license agreements, with a typical term for a standard restaurant of ten years plus aggregate renewal period(s) of approximately 10 years. For restaurant owners who lease land and/or buildings from the Company, for new arrangements and renewals, the license agreement typically requires a royalty payment of 3.0% to 4.5% of weekly gross sales of the restaurant, as defined in the license agreement. Under a separate lease or sublease, restaurant owners typically pay monthly rent based on a percentage (usually 8.5% to 10.0%) of monthly gross sales, as defined in the license agreement. Where the restaurant owner either owns the premises or leases it from a third party, the royalty is typically increased. Under the license agreement, each restaurant owner is required to make contributions to an advertising fund based on a percentage of restaurant gross sales, further described under “Advertising and Promotions,” below.

Generally, we retain the right to reacquire a restaurant owner’s interest in a restaurant under certain circumstances. To keep system restaurants up-to-date, both aesthetically and operationally, our license agreements require a full-scale renovation of each system restaurant by the restaurant owner, including our non-standard restaurants, approximately every 10 years. We typically, but are not required to, contribute up to 50% of the funding required for certain front-of-restaurant construction costs incurred in connection with renovations on properties that we own or lease. In 2012, we are planning to make investments to accelerate renovations in Canada, which will feature more contemporary design elements similar to our new restaurant sites and to increase drive-thru capacity in Canada, including initiatives such as order station relocations, double-order stations and, in certain locations, double-lane drive-thrus. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—2012 Performance Targets.

In Canada, and generally to-date in the U.S., we have not granted exclusive or protected areas or territories to restaurant owners. The license is a “location” license only, and we reserve the right to grant additional licenses for Tim Hortons restaurants at any other location. In addition, the royalty rates under license agreements entered into in connection with non-standard restaurants, including self-serve kiosks and strategic alliances with third parties, may vary from those described above for standard restaurants and are negotiated on a case-by-case basis.

The Company reserves the right to terminate the license agreement for a variety of reasons described in the underlying agreement.

Other Arrangements. For most restaurant owners new to the system, we will enter into arrangements, typically called operator agreements, in which the operator acquires the right to operate a Tim Hortons restaurant, but we continue to be the owner of the equipment, signage and trade fixtures. These are not typical franchise relationships. Such arrangements usually require the operator to pay approximately 20% of the restaurant’s weekly gross sales, as described in the operator agreement, to the Company. Additionally, the operator will be responsible for paying all trade debts, wages and salary expenses, maintenance and repair costs, taxes, and any other expenses incurred in connection with the operation of the restaurant. These operators also make the required contributions to our advertising funds, described below. In any such arrangement, the Company and the operator each have the option of terminating the agreement upon 30 days notice. Although we do not consider our operators to be typical restaurant owners, for purposes of this Form 10-K, references to restaurant owners include these operators, and references to license agreements include these operator agreements, unless otherwise

 

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indicated. Under Financial Accounting Standards Board Accounting Standards Codification™ 810— Consolidation, we are required to consolidate the financial results of certain of these operators. Additional detail regarding these arrangements for operators that are consolidated, as well as additional detail regarding the consolidation is set forth in Notes 1 and 21 to the Consolidated Financial Statements.

We have a franchise incentive program (“FIP”) for certain of our U.S. restaurant owners, which provides interest-free financing (“FIP Note”) for the purchase of certain restaurant equipment, furniture, trade fixtures, and signage (the “equipment package”). In fiscal 2011, we generally transitioned from this arrangement to using our operating agreement model with new restaurant owners. Under the FIP arrangement, payment for the equipment package is deferred for a period of 104 weeks from the date of opening (the “prescribed period”). The restaurant owner has the option to pay the initial franchise fee, including interest thereon, over the prescribed period on a weekly basis, or upfront. Payment for the equipment package is due and owing at the end of the prescribed period. The FIP is not available to restaurant owners governed by an operator agreement. Currently, the royalty rate and rent rate under this program are consistent with the standard rates referred to above for U.S. restaurants, although some restaurant owners were on an earlier program in prior years, under which the royalty and rental rates were reduced. In addition, at the conclusion of the prescribed period, if our restaurant owners are unable to secure financing for the equipment package, we may extend the maturity date of the FIP Note to these restaurant owners on a case-by-case basis. If the restaurant owner does not make required payments, the Company is able to take back ownership of the restaurant and equipment based on the underlying franchise agreement. See Notes 1 and 6 to the Consolidated Financial Statements for additional details regarding the FIP and related notes receivable.

To supplement the FIP, at our discretion, we may offer additional relief to restaurant owners primarily in developing markets in the U.S. where the brand is not yet established and the restaurants are underperforming. The terms of this additional relief vary depending on the circumstances, but may include assistance with costs of supplies; certain operating expenses, including rent and royalties; and, in certain markets, labour and other costs. These “support costs” decrease the Company’s rents and royalties revenue. As we develop more restaurants in the U.S., our relief costs may increase. We anticipate this will continue as we expand our developing markets in the U.S. We also provide limited relief to Canadian restaurant owners in certain circumstances.

Master License Agreements. We are party to a master licensing arrangement with Kahala Franchise Corp., the franchisor of the Cold Stone Creamery brand, in Canada, and a separate master licensing arrangement with Kahala Franchising, L.L.C. in the U.S. The nature and purpose of the arrangements are to expand the parties’ co-branding initiatives. We have exclusive development rights in Canada, and certain rights to use licenses within the U.S., in both cases to operate ice cream and frozen confections retail outlets and/or product offerings. We are also party to a master license agreement with Apparel to develop Tim Hortons restaurants in the GCC States of the United Arab Emirates, Qatar, Bahrain, Kuwait and Oman. See “Trademarks and Service Marks” and “International Operations” below.

 

 

Advertising and Promotions

Our marketing is designed to focus on “It’s Time for Tims”™ and to create and extend our brand image as “your neighbourhood Tims” that offers “quality products at reasonable prices.” We use radio, television, print, online advertising, and event sponsorship, as well as our highly visible community caring programs, and our Tim Card, to reinforce this brand image with our guests. We also host a website at www.everycup.ca and www.everycup.com which invites guests from Canada and the U.S. to share their stories and experiences with Tim Hortons as well as Facebook pages and Twitter accounts.

National Marketing Program. Restaurant owners fund substantially all of our national marketing programs by making contributions to our Canadian or U.S. advertising funds, which were established to collect and administer contributions for advertising efforts. In fiscal 2011, restaurant owners and Company-operated

 

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restaurants in Canada contributed approximately $191.5 million (approximately 3.5% of their sales) to the Canadian advertising fund. Although the franchise or license agreement requires contributions of up to 4.0% of sales, we have voluntarily reduced the current contribution to 3.5%, but retained the right to increase the contribution at any time. Restaurant owners and Company-operated restaurants in the U.S. contributed approximately $18.1 million (approximately 4.0% of their sales) to the U.S. advertising fund. We have national advisory boards of elected restaurant owners. The mandate for these boards includes responsibility for matters related to the Canadian and U.S. advertising funds, respectively, including promotions, operations, and research and development. In addition, we also have a guiding coalition for Cold Stone Creamery in Canada that provides feedback on promotions, operations and research and development.

Our current strategy is to increase same-store sales by leveraging our marketing strengths and advantages. In Canada, we leveraged our scale as one of the country’s largest advertisers to reinforce our attractive price to value position and to reinforce our brand equity, and continued to focus on our hospitality initiatives. In the United States, we have increased our marketing and advertising spending in all markets over historical contribution levels and, in particular, in our core, more developed growth markets, to increase awareness of our brand. In addition, we continue to use other marketing means, such as community involvement, sponsorships, and other forms of communication, to supplement traditional advertising to reinforce our brand position with guests and to broaden our brand awareness as a cafe and bake shop destination.

In fiscal 2012, our Canadian advertising fund will be investing up to $100 million to expand the use of digital menu boards in our Canadian restaurants along with new drive-thru rotating menu boards. These expenditures will be funded primarily through third-party financing which will be secured by the Canadian advertising fund’s assets. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—2012 Performance Targets.

Regional Marketing Programs. Part of the national marketing program contribution is allocated to regional marketing groups (approximately 335 in Canada and 30 in the U.S.). The regional marketing groups sponsor and support locally targeted marketing programs. We also support these regional marketing groups with market strategy and regional plans and programs.

Required restaurant owner contributions to the advertising funds, and the allocation to local and regional advertising programs, are governed by the respective franchise agreements between the Company and its restaurant owners. Contributions by Company-operated restaurants for advertising and promotional programs are at the same percentage of retail sales as those made by franchised restaurants.

See Note 21 to the Consolidated Financial Statements for further information regarding our advertising funds.

 

 

Competition

We compete in the quick service restaurant segment in Canada and the U.S. We face significant competition with a wide variety of restaurants on a national, regional, and local level, including quick service restaurants and fast-casual restaurants focused on specialty coffee, baked goods, and sandwiches, as well as gas and other convenience locations that sell food and beverages. The size and strength of our competitors vary by region, and there are numerous competitors in nearly every market in which we conduct business or expect to enter.

We believe competition within the quick service restaurant segment is based on, among other things, product quality, concept, atmosphere, guest service, operational excellence, convenience and price. The number and location of units, quality and speed of service, attractiveness of facilities, effectiveness of marketing, general brand acceptance, and new product development by us and our competitors are also important factors. The prices charged by us for menu items may vary from market to market depending on competitive pricing and the local cost structure. Additionally, we compete with quick service restaurants and other specialty restaurants for personnel, suitable restaurant locations, and qualified restaurant owners.

 

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In Canada, we have the leading market position in this segment, based on systemwide sales and number of restaurants, with a strong presence in every province. According to industry market studies, based on transactions, our system restaurants represented 41% of the Canadian quick service restaurant sector for the 12 months ended November 2011 and 78% of the brewed coffee sector of the Canadian quick service restaurant sector for the same period, in each case based on number of guests served. Our brand convenience and our ability to leverage our scale in advertising are designed to help support our goal of maintaining and building upon our leadership position in Canada over 2012.

In the U.S., we have developed a regional presence in certain markets in the Northeast and Midwest, but we still have limited brand awareness, even in many areas where we have a presence. Our competitors in the U.S. range from small local independent operators to well-capitalized national and regional chains, such as McDonald’s®, Wendy’s, Starbucks®, Subway® and Dunkin’ Donuts®. Many of our competitors in the U.S. are significantly larger than us, based on total systemwide sales and number of restaurants and, therefore, have substantially greater financial and other resources, including personnel and larger marketing budgets and greater leverage from marketing spending, which may provide them with a competitive advantage.

Competition in both Canada and the U.S. continues to intensify as new players enter the coffee market, and quick service restaurants have increasingly focused efforts on specialty coffee and other coffee-based beverages and baked goods. Also, our competitors in the coffee and baked goods sector are continuing to expand their food offerings, particularly during breakfast, which is a key daypart for us. A number of our competitors also engage in discounting (heightened by the continuing economic challenges in North America) and “combo” or value-pricing practices, as well as free product promotions. This cross-over of brands and menu offerings, and general increased competition on price and other factors, continued through 2011. In 2011, we continued to offer targeted value-priced food and beverage programs, in addition to the launch of new products at a variety of everyday value price points, with the intent to strengthen and build on our price/value position and to enhance this message with our guests in a tangible way. In the U.S., we also used coupons as a vehicle to attract new guests and introduce them to our brand and new product offerings. While we do not intend to stray from our core everyday positioning of quality food at reasonable prices, we are working with our restaurant owners to communicate and interact with guests in a manner that responds to their current situation and the economic environment. We believe that continued business refinements will help, over time, position our U.S. business to defend aggressive competitive discounting activity, while also creating sales momentum.

We plan to continue expanding in the U.S., including potentially into areas where guests are unfamiliar with our brand. We will likely need to build brand awareness in those markets through advertising and promotional activity. We do not get the same leverage from our television marketing activities in the U.S. as we do in Canada because our restaurants are spread across numerous distinct markets that require local purchases for television advertising, as opposed to leveraging local or regional advertising across larger marketing areas that are more highly penetrated with our restaurants. See “Advertising and Promotions” above. Many of the U.S. markets into which we may expand have competitive conditions, consumer tastes and discretionary spending patterns that may differ from our existing markets. We may need to adapt our brand and our restaurants to those markets. In addition, our position as a new entrant in certain U.S. regional markets makes us more vulnerable to competitive promotional activity from other more established brands in those markets and to increased competition for restaurant locations, guests, and restaurant owners. In certain markets in the U.S., we open restaurants that are less successful and may adversely impact surrounding locations for a period of time, and we may provide greater levels of relief to U.S. restaurant owners as a result. Such decisions are based on a long-term view of strengthening and expanding our business in the U.S. See “Operations—Restaurant development” above.

 

 

 

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Trademarks and Service Marks

We have registered various trademarks and service marks in Canada, the U.S. and certain other jurisdictions. We have also registered various internet domain names, including www.timhortons.com, www.rolluptherimtowin.com, www.timcard.ca, shop.timhortons.com, www.everycup.ca and www.everycup.com. Some of our most recognizable registered marks include:

 

   

Tim Hortons signature;

 

   

Tim Hortons and Always Fresh Oval Background Design;

 

   

Roll Up The Rim To Win;

 

   

Timbits;

 

   

Tim Card; and

 

   

TimShop.

We believe our trademarks, service marks and other proprietary rights have significant value and are important to our brand-building efforts and the marketing of our restaurant system. We generally intend to renew trademarks and service marks that are scheduled to expire and to otherwise protect and vigorously defend and enforce our rights to this intellectual property. See also Item 1A. Risk Factors.

We are party to 2 separate master license agreements with Kahala Franchise Corp. and Kahala Franchising, L.L.C. in Canada and the U.S., respectively. One such agreement provides us with the exclusive right to use the Cold Stone Creamery trademarks in Canada together with the right to sub-franchise said marks on an exclusive basis and the other agreement provides us with the right to use the Cold Stone Creamery trademarks in the United States, together with the right to sublicense said marks.

In 2011, the Company entered into a master license agreement with Apparel, pursuant to which Apparel has the right to use the Tim Hortons trademarks in Oman, Bahrain, Qatar, Kuwait and the United Arab Emirates.

 

 

Sustainability and Responsibility

Sustainability and responsibility at Tim Hortons is integrated through our “Making a True Difference”TM framework which is divided into 3 core pillars—Individuals, Communities and the Planet. Within each pillar are a number of key issues determined to be of importance to our stakeholders such as nutrition, food safety and employees, children, community giving, environmental stewardship, climate change and sustainable supply chain practices. We have developed a number of commitments and goals with respect to each of these areas of focus, and have reported our performance against these goals in our annual Sustainability and Responsibility Report, which adheres to the Global Reporting Initiative’s (“GRI”) G3.1 Guidelines and is available online at http://sustainabilityreport.timhortons.com.

Governance and Accountability for Sustainability and Responsibility. Our Sustainability and Responsibility Policy includes a structure and supporting processes for effective sustainability and responsibility governance and accountability, and is reviewed regularly. The Tim Hortons Board of Directors governs sustainability and responsibility through the Nominating and Corporate Governance Committee of the Board. Oversight activities include review of: policy development; sustainability and responsibility strategies, including mitigation of risks; and organizational sustainability and responsibility commitments, goals and external reporting. Management accountability for sustainability and responsibility resides within the Tim Hortons Executive Team.

Management of Sustainability Risks and Opportunities. The assessment and management of sustainability related risks and opportunities are embedded as part of our governance framework, and our sustainability and responsibility strategy and its supporting implementation plan. Key aspects of our approach include: the

 

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assessment of sustainability and responsibility impacts of major business decisions; the integration of sustainability and responsibility into the Company’s Enterprise Risk Management Program, as applicable; the development of internal performance scorecards; monitoring our relations with our stakeholders; the assessment of sustainability and responsibility trends; and, consideration of public policy, consumer, corporate, general public trends, issues, and developments that may impact the Company.

 

 

Environmental Matters

Our operations, including our distribution and manufacturing operations, supply chain, restaurant site selection and development, and other aspects of our business, are subject to complex environmental, health, and safety regulatory regimes, and involve the risk of environmental liability. There are also potential risks for road and on-site releases of hazardous substances and accidents that could result in environmental contamination that are not within our control.

Our restaurants have not been the subject of any material environmental investigations or claims of which we are aware. Our current practice is to conduct environmental due diligence when considering potential new restaurant locations or other company-owned facilities. This due diligence typically includes a Phase I Environmental Site Assessment, which will not necessarily identify all environmental conditions associated with a property and, if warranted, a Phase II Environmental Site Assessment to further investigate any areas of potential environmental concern. Action is taken, as needed, to appropriately resolve any issues.

Certain municipal governments and environmental advocacy groups have begun to focus on the level of emissions from vehicles idling in drive-thrus. Some of these municipalities have implemented a moratorium on drive-thru development along with considering implementing a restriction on drive-thru operations on smog-alert days. Anti-idling by-laws are also being considered in various communities, on both public and private lands. If such restrictions, moratoriums and/or by-laws are imposed, they could have a substantial negative impact on our business and would limit our ability to develop restaurants with drive-thrus.

Variations in weather in the short-term, and climate change in the long-term, have the potential to impact growing conditions in regions where we source our agricultural commodities, including coffee, wheat, sugar and other products. Over time, climate change may result in changes in sea levels, weather and temperature change, disease and pest levels, drought and fires, and resource availability. On a year-to-year basis, agricultural production can be negatively affected by weather variations and resulting physical impacts to the environment. The overall supply and demand of agricultural commodities and the price we pay for these commodities on the world market can therefore be impacted. At this time, we are unable to predict the effect on our operations, revenues, expenditures, cash flows, financial condition and liquidity due to the potential impacts of climate change. Proposed cap and trade systems and/or new carbon taxation may present risks or opportunities that will likely be unique to every business sector. We are unable to predict the effect on our operations of possible future environmental legislation or regulation in these areas.

Stewardship fee programs require all industry stewards with branded packaging, such as Tim Hortons, to contribute to a fund that subsidizes a portion of the annual costs of municipal recycling programs. Volumes of designated packaging are enumerated by the industry steward and fees are paid regardless of whether the designated materials are managed in municipal recycling programs. Stewardship programs for packaging currently exist in Ontario, Quebec and Manitoba. The Canadian Council of Ministers of the Environment’s (“CCME”) Canada-Wide Action Plan for Extended Producer Responsibility (“EPR”) has recommended that all Canadian jurisdictions (with the exception of the Territories) develop and implement EPR legislation for packaging (and other designated materials) by 2015. Some provinces have begun this process. For example, the implementation of 100% producer funding for packaging and printed matter in Quebec is set to take effect on materials generated in 2013. In British Columbia, 100% extended producer responsibility for packaging and printed matter will be in place no later than May 2014. A change in EPR programs involves a shift towards

 

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paying 100% of the fees associated with managing packaging waste at the end of the product life cycle. As the CCME recommendations are only guidelines, there is no certainty regarding future fees. In 2011, our stewardship fees were not financially material.

 

 

Acquisitions and Dispositions

We have from time to time acquired the interests of, and sold Tim Hortons restaurants to, restaurant owners, and we expect to continue to do so from time to time in the future, where prudent. We generally retain a right of first refusal in connection with any proposed sale of a restaurant owner’s interest. In 2011, we sold substantially all of the Company-owned properties in the Providence, Rhode Island and Hartford, Connecticut markets in connection with the closures of underperforming restaurants in these New England regions in late 2010.

In October 2010, we sold our 50% joint-venture interest in Maidstone Bakeries to our former joint venture partner. See “Operations—Manufacturing” above and Note 4 to the Consolidated Financial Statements included in Item 8 of this Annual Report.

We intend to evaluate other potential mergers, acquisitions, joint ventures, investments, strategic initiatives, alliances, vertical integration opportunities and divestitures when opportunities arise or our business warrants evaluation of such strategies. See “Business Overview” above and Item 1A. Risk Factors.

 

 

International Operations

We have granted a master license to Apparel, pursuant to which Apparel is expected to develop up to 120 multi-format restaurants over a 5-year period in markets in the United Arab Emirates, Qatar, Bahrain, Kuwait and Oman. In 2011, Apparel developed and operated 5 Tim Hortons restaurants. The master license agreement with Apparel is primarily a royalty-based model, together with ongoing supply chain margin, and also includes an upfront license fee. Apparel is responsible for capital spending and real estate development to open restaurants, along with operations and marketing. As a result, this arrangement minimizes our capital requirements, while still allowing us to pursue identified international growth opportunities. Based on the results of our initial market entry into the GCC region, we will evaluate potential entry into additional international markets.

We have primarily self-serve kiosks in the Republic of Ireland through offerings at gas and other convenience locations, primarily under the Tim Hortons brand, but also under another brand owned by Tim Hortons. These kiosks offer our premium coffee, tea, specialty hot beverages and a selection of donuts and muffins. As of January 1, 2012, there were a total of 189 kiosks in the Republic of Ireland, 186 of which were self-serve and 3 of which were full-serve, licensed as Tim Hortons locations. We also have licensed self-serve kiosks at gas and other convenience locations in the United Kingdom, where we had 72 kiosks as of January 1, 2012. In addition, we have begun to experiment with larger footprints at certain of these sites.

In November 2011, we closed our temporary location in Kandahar, Afghanistan, which was a full-serve location, in connection with the withdrawal of Canadian troops from the area.

See Item 2. Properties for a listing of our international locations by country. The self-serve kiosks and full-serve restaurants in the Republic of Ireland and the United Kingdom are described separately by country under Item 2, and are not included in our Canadian, U.S. or GCC restaurant counts.

Our financial and other business arrangements for international locations (and for international development in general) are likely to differ from our traditional development models. These arrangements have not contributed significantly to financial results historically; consequently, operating results from our GCC, Republic of

 

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Ireland and United Kingdom operations are currently included in Corporate charges in our segmented operating results. We believe these international activities (and others we may test or undertake in the future) provide us with opportunities to evaluate a variety of new strategies for the development of our brand, which, if successful, may be adapted to existing markets as well as other new markets.

 

 

Seasonality

Our business is moderately seasonal. Revenues and operating income are generally lower in the first quarter due, in part, to a lower number of new restaurant openings and consumer post-holiday spending patterns. First quarter revenues and operating income may also be affected by severe winter weather conditions, which can limit our guests’ ability to visit our restaurants and, therefore, reduce sales. Revenues and operating income generally build over the second, third, and fourth quarters and are typically higher in the third and fourth quarters due, in part, to a higher number of restaurant openings having occurred year-to-date, cooler weather potentially increasing sales of certain products, such as hot coffee, and, in the fourth quarter, sales of holiday-packaged coffee and other merchandise. Because our business is moderately seasonal, results for any quarter are not necessarily indicative of the results that may be achieved for any other quarter or for the full fiscal year.

 

 

Employees

Our principal office locations are in Oakville, Ontario (Canada) and Dublin, Ohio (U.S.). We have 10 other regional offices, including our 5 distribution centres. Our manufacturing facilities are located in Rochester, New York; Hamilton, Ontario; and Oakville, Ontario. Our distribution centres are located in Guelph and Kingston, Ontario; Langley, British Columbia; Calgary, Alberta; and Debert, Nova Scotia. Our other regional offices (other than our distribution and manufacturing facilities) are located in Lachine, Quebec; Brighton, Michigan; and Williamsville, New York. As at January 1, 2012, we had approximately 2,023 employees in our principal offices, regional offices, distribution centres, and manufacturing facilities. We also had 3 employees that work on international activities in the Republic of Ireland and the U.K. and 2 employees that work on international activities in the GCC.

As at January 1, 2012, the Company operated directly (without restaurant owners) 10 restaurants in Canada and 8 restaurants in the U.S. The total number of full-time employees working in these corporate restaurants at January 1, 2012 was approximately 260, with another approximately 202 employees working part-time, bringing the total number of our restaurant employees to approximately 462. None of our employees are covered by a collective bargaining agreement. At franchised locations, employees are hired and managed by the restaurant owners and not by the Company.

We believe in creating and fostering a positive work environment that drives high levels of performance and engagement. The work environment is a direct result of our strong commitment to employee development and career progression, our philosophy and focus on competitive total rewards, and our commitment to recognizing strong performance. Our corporate values evidence our commitment to our strong “people” focus and the other critical elements of our culture.

 

 

Government Regulations and Affairs

The successful development and operation of restaurants depend to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use (including the placement of drive-thrus), environmental (including litter and drive-thru emissions), traffic and transportation, land transfer tax, and other regulations. Restaurant operations, including our restaurants and our manufacturing and distribution facilities, are also subject to licensing and regulation by federal, state, provincial, and/or municipal departments relating to the environment, health, food preparation, sanitation and safety standards and, for our distribution business, traffic

 

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and transportation regulations; federal, provincial, and state labour laws (including applicable minimum wage requirements, overtime, working and safety conditions and citizenship requirements); federal, provincial, and state laws prohibiting discrimination; federal, provincial, state and local tax laws and regulations; and, other laws regulating the design and operation of facilities, such as the Americans with Disabilities Act of 1990 and similar Canadian federal and provincial legislation that can have a significant impact on our restaurant owners and our performance. See also “Environmental Matters” above regarding environmental regulations affecting our Company.

A number of states in the U.S., and the provinces of Ontario, Alberta, Prince Edward Island, Manitoba and New Brunswick, have enacted or are in the final stages of enacting legislation that affects companies involved in franchising. Franchising activity in the U.S. is also regulated by the U.S. Federal Trade Commission. Much of the legislation and rules adopted have been aimed at providing detailed disclosure to a prospective restaurant owner, duties of good faith as between the franchisor and the restaurant owner, and/or periodic registration by the franchisor with applicable regulatory agencies. Additionally, some U.S. states have enacted legislation that governs the termination or non-renewal of a franchise agreement and other aspects of the franchise relationship. Certain other U.S. states, as well as the U.S. Congress, have also considered or are considering legislation of this nature. We have complied with regulatory requirements of this type in all applicable jurisdictions. We cannot predict the effect on our operations, particularly on our relationship with restaurant owners, of the future enactment of additional legislation or modifications of existing legislation.

Governments and consumer advocacy groups are encouraging alternative food processing methods to reduce trans fatty acids (“TFA”). During 2006, significant progress was made to reduce trans fat in most of our products to at or below acceptable levels in Canada and the U.S. As required by Canadian and U.S. legislation, we comply with nutritional labeling for foods, including those that contain TFA. Certain municipal governmental authorities, such as New York City, have banned TFA. We continue to research approaches so that we do not exceed acceptable levels of TFA in our products, while still maintaining the taste and quality that guests desire.

The Canadian government continues to work with members of the quick service restaurants sector to reduce sodium intake among consumers. The Sodium Working Group, which consists of members from the manufacturing, health advocacy group, health professional organizations, and food service groups, agreed on a three pronged approach that includes: voluntary reduction of sodium levels in processed goods sold in food service establishments; education and awareness of consumers; and, research. We continue to work with suppliers to reduce the amount of sodium in our products. We have gradually reduced sodium by approximately 29% across our soup offerings. Our main objective is to continue to provide our guests with the same great tasting, quality products, without sacrificing flavour and freshness. With respect to awareness, we have voluntarily posted the sodium content of our products in our on-line and printed nutrition guides for a number of years as part of our commitment to providing our guests with up-to-date nutritional information. We also have a nutritional app with the latest nutritional information which may be downloaded onto any hand held mobile device.

Legislation has been enacted in the U.S. requiring restaurants to post calorie count information on menu boards. We will monitor and comply with all regulations to be enacted by the U.S. Food and Drug Administration in connection with such calorie count posting requirements. Certain provinces of Canada are also considering similar laws that would require the posting of calorie count information on menu boards. National restaurant chains in Canada, including our Company, are engaged in the Federal, Provincial, Territorial Task Group on the provision of nutrition information in restaurants.

 

 

Availability of Information

We currently qualify as a foreign private issuer in the U.S. for purposes of the Exchange Act. Although as a foreign private issuer we are no longer required to do so, we currently continue to file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K with the Securities and Exchange

 

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Commission (“SEC”) instead of filing the reporting forms available to foreign private issuers. We make available, through our internet website for investors (www.timhortons-invest.com), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the SEC and with the Canadian Securities Administrators. The foregoing reference to our website address does not constitute incorporation by reference of the information contained on the website, and such information should not be considered part of this document.

As a Canadian corporation and foreign private issuer in the U.S. that is not subject to the requirements of Section 14(a) of the Exchange Act or Regulation 14A, our management proxy circular (the “proxy circular”) and related materials are prepared in accordance with Canadian corporate and securities law requirements. As a result, for example, our officers and directors are required to file reports of equity ownership and changes in equity ownership with the Canadian Securities Administrators and do not file such reports under Section 16 of the Exchange Act.

 

 

 

Item 1A. Risk Factors

Certain information contained in this Annual Report on Form 10-K (the “Report”), including information regarding future financial performance and plans, expectations, and objectives of management, constitute forward-looking information within the meaning of Canadian securities laws and forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We refer to all of these as forward-looking statements. A forward-looking statement is not a guarantee of the occurrence of future events or circumstances, and such future events or circumstances may not occur. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “seeks,” “outlook,” “forecast” or words of similar meaning, or future or conditional verbs, such as “will,” “should,” “could” or “may.” Examples of forward-looking statements that may be contained in our public disclosure from time to time include, but are not limited to, statements concerning management’s expectations relating to possible or assumed future results, our strategic goals and our priorities, and the economic and business outlook for us, for each of our business segments, and for the economy generally. The forward-looking statements contained in this Report are based on currently available information and are subject to various risks and uncertainties, including, but not limited to, the risks and uncertainties discussed below and in Item 1. Business and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Report, that could materially and adversely impact our business, financial condition and results of operations (i.e., the “risk factors”). Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial may also materially adversely affect our business, financial condition, and/or operating results. Forward-looking information and statements are based on a number of assumptions which may prove to be incorrect, including, but not limited to, assumptions about: the absence of an adverse event or condition that damages our strong brand position and reputation; the absence of a material increase in competition within the quick service restaurant segment of the food service industry; cost and availability of commodities; continuing positive working relationships with the majority of the Company’s restaurant owners; the absence of any material adverse effects arising as a result of litigation; there being no significant change in the Company’s ability to comply with current or future regulatory requirements; and general worldwide economic conditions. We are presenting this information for the purpose of informing you of management’s current expectations regarding these matters, and this information may not be appropriate for any other purpose.

Many of the factors that could determine our future performance are beyond our ability to control or predict. Investors should carefully consider our risk factors and the other information set forth in this Report and are further cautioned not to place undue reliance on the forward-looking statements contained in this Report, which speak only as of the date of this Report. The events and uncertainties outlined in the risk factors, as well as other events and uncertainties not set forth below, could cause our actual results to differ materially from the expectation(s) included in the forward-looking statement, and if significant, could materially affect the

 

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Company’s business, revenue, stock price, financial condition, and/or future results, including, but not limited to, causing the Company to: (i) close restaurants, (ii) fail to realize our same-store sales growth targets, which are critical to achieving our financial targets, (iii) fail to meet the expectations of securities analysts or investors, or otherwise fail to perform as expected, (iv) have insufficient cash to engage in or fund expansion activities, dividends, or share repurchase programs, or (v) increase costs, corporately or at restaurant level, which may result in increased restaurant-level pricing, which, in turn, may result in decreased guest demand for our products resulting in lower systemwide sales, revenue, and earnings. We assume no obligation to update or alter any forward-looking statements after they are made, whether as a result of new information, future events, or otherwise, except as required by applicable law.

Throughout these risk factors, the words “include,” “including” or words of similar effect mean “include, without limitation” or “including, without limitation,” as applicable.

Our growth strategy and other important strategic initiatives may not be successful and may expose us to additional risk.

Our growth strategy to a large extent depends on our ability to increase the number of Tim Hortons restaurants through internal growth and potentially through strategic initiatives (such as acquisitions, joint ventures, and alternative business models, such as self-serve kiosks and co-branding). There is no assurance that we will be able to achieve our growth objectives, new restaurants may not be profitable, and strategic initiatives may not be successful and may expose us to various risks.

The addition of new restaurants in a market may negatively impact the same-store sales growth and profitability of restaurants already existing in the market. If our new restaurants are not profitable or if new restaurants negatively affect the profitability of existing restaurants, we may be limited or unable to carry out our business model of franchising new or existing restaurants, or we may be delayed in doing so, as we could have difficulty finding qualified restaurant owners willing to participate in our expansion or we may desire that the restaurant reach minimum profitability levels before franchising the restaurant. This could limit our ability to expand or make it harder for us to find qualified restaurant owners, either of which would likely hurt revenue growth and operating results. We may also need to provide relief and support programs for our restaurant owners in developing markets as well as expand our financing support programs or extend financing on more generous terms than would be available from third parties, either of which could increase our costs and thus decrease net income. Alternatively, if we have interested restaurant owners, we may offer the restaurant to a restaurant owner on an operator or other agreement, which may also result in an increase in restaurant owner relief and support costs. Initially, after conversion, we generally provide additional relief to the operator, and we may be required to consolidate some of these restaurants in accordance with variable interest entity accounting rules for consolidations.

We may also enter markets where our brand is not well known and where we have little or no operating experience. New markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets; as a result, new restaurants in those markets may be less successful than restaurants in existing markets. When we enter new regions and markets, we will need to build brand awareness in those markets through advertising and promotional activity, and those activities may not promote our brand as effectively as intended, if at all.

Restaurants opened in new markets may also have lower average restaurant sales than restaurants opened in existing markets, and may have higher construction, occupancy, and operating costs than restaurants in existing markets. Sales at restaurants opened in new markets may take longer to reach expected sales and profit levels, and may never do so, thereby affecting our overall financial condition and/or financial results. Our failure to successfully implement growth and various other business strategies and initiatives related to international development may have a negative impact on the overall operation of our business and may result in increased costs or inefficiencies that we cannot currently anticipate.

 

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From time to time, we may rationalize and close underperforming restaurants in order to improve overall profitability. Such closures, however, may be accompanied by impairment charges and/or valuation allowances that may have a negative impact on our earnings. We may also deliberately slow the development of new restaurants in some markets, depending on various factors, including the sales growth of existing restaurants in such markets. Same-store sales growth is a milestone we monitor, and, among other things, if sales growth falls below our expectations for a prolonged period of time, if we have significant negative cash flows in a market for several years, or if we close restaurants out of the ordinary course, we may be forced to impair assets in affected markets, which could have a negative effect on our earnings.

The success of any restaurant depends in substantial part on its location. There can be no assurance that current locations will continue to be attractive as demographic patterns change. Neighbourhood or economic conditions where restaurants are located could decline in the future, thus resulting in potentially reduced sales in those locations. Competition for restaurant locations can also be intense, and may be exacerbated by any sluggishness in commercial real estate or credit markets. If we cannot obtain desirable locations for our restaurants at reasonable prices or are subject to onerous zoning restrictions, our ability to execute our growth strategy will be adversely affected.

We also intend to continue to evaluate potential mergers, acquisitions, joint venture investments, alliances, vertical integration opportunities, which are subject to many of the same risks that also affect new restaurant development. In addition, these transactions involve various other financial and tax, managerial and operational risks, including accurately assessing the value, future growth potential, strengths, weaknesses, contingent and other liabilities and potential profitability of acquisition candidates; the potential loss of key personnel of an acquired business; the Company’s ability to achieve projected economic and operating synergies; difficulties successfully integrating, operating, maintaining and managing newly acquired operations or employees; difficulties maintaining uniform standards, controls, procedures and policies; the possibility the Company could incur impairment charges if an acquired business performs below expectations; unanticipated changes in business and economic conditions affecting the acquired business; ramp-up costs, whether anticipated or not; the potential for the unauthorized use of the Company’s trademarks and brand name by third parties; the possibility of a breach of contract or spoliation of the business relationship with a third party; the potential negative effects such transactions may have on the Company’s relationship with restaurant owners and existing business relationships with suppliers; the potential exposure to restaurant owners and others arising from the Company’s reliance on and dissemination of information provided by third parties; and diversion of management’s and restaurant owners’ attention from the demands of the existing business. In addition, there can be no assurance that the Company will be able to complete the desirable transactions, for reasons including restrictive covenants in debt instruments or other agreements with third parties, or a failure to secure financing in a tight credit market. Strategic alliances have been and will continue to be an integral part of our strategic plan to “grow in ways we have not grown before.” There can be no assurance that: significant value will be recognized through such strategic alliances; we will be able to maintain our existing strategic alliances; or, we will be able to enter into new strategic relationships in the future. While we believe we could ultimately take action to terminate any alliances that prove to be unsuccessful, we may not be able to identify problems and take action quickly enough and, as a result, our brand image and reputation may suffer, or we may suffer increased liabilities, costs and other financial burdens. Entry into and the subsequent unwinding of strategic alliances may expose us to additional risks which may adversely affect our brand and business and decrease our revenue and growth prospects.

We developed and began implementing various strategic plans and initiatives commencing in 2010. Our financial outlook and long-range aspirational EPS targets through the end of 2013, as previously announced, are based on the successful implementation, execution, and guest acceptance of such plans and initiatives. These strategic plans are also designed to improve our results of operations and drive long-term shareholder value. There can be no assurance that we will be able to implement our strategic plans and initiatives or that such plans and initiatives will yield the expected results, either of which could cause us to fall short of achievement of our financial objectives and long-range aspirational goals.

 

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Our success depends substantially on the value of the Tim Hortons brand and our Canadian segment performance.

Our success is dependent to a large part upon our ability to maintain and enhance the value of our brand, our guests’ connection to and perception of our brand, and a positive relationship with our restaurant owners. Brand value can be severely damaged even by isolated incidents, such as contaminated food, particularly if the incidents receive considerable negative publicity or result in litigation. Some of these incidents may relate to the way we manage our relationship with our restaurant owners, our growth strategies, our relationships with third parties with whom we enter into strategic alliances, our development efforts in domestic and foreign markets, land use and site and building development for our restaurants (including equipment, environment, and health and safety issues), sustainability or the ordinary course of our or our restaurant owners’ business. Other incidents may arise from events that are or may be beyond our ability to control and may damage our brand, such as: actions taken (or not taken) by 1 or more restaurant owners or their employees relating to health, safety, environmental, welfare, labour matters, public policy or social issues, or otherwise; litigation and claims; failure of, security breaches or other fraudulent activities associated with our networks and systems; illegal activity targeted at us; and negative incidents occurring at or affecting our strategic business partners, affiliates, or corporate social responsibility programs. Our brand could also be damaged by falsified claims or the quality of products from vertically integrated manufacturing facilities and potentially negative publicity from various sources, including social media sites on a variety of topics and issues, whether true or not, which are beyond our control. Guest demand for our products and our brand value could diminish significantly if any such incidents or other matters erode guest confidence in us or our products, which would likely result in lower sales and, ultimately, lower earnings and profits.

In addition, the Tim Hortons brand is synonymous with our ability to deliver quality food products at value prices. If we are unable to maintain in Canada, or unable to maintain and/or achieve in other markets, an appropriate price to value relationship for our products in the minds of guests, our ability, by and through our restaurant owners and independently, to increase or maintain same-store sales may be affected. Our ability to maintain or achieve the appropriate price to value relationship also may be affected by discounting or other promotional activity of competitors, which can be very aggressive.

Our financial performance is highly dependent on our Canadian operating segment, which accounted for approximately 93.9% of our reportable segment revenues, and 97.6% of our reportable segment operating income in 2011. Any substantial or sustained decline in our Canadian business would materially and adversely affect our financial performance.

The quick service restaurant segment is highly competitive, and competition could lower our revenues, margins, and market share.

The quick service restaurant segment of the food service industry is intensely competitive. Tim Hortons restaurants compete with international, regional, and local organizations primarily through the quality, variety, and value perception of food products offered. Other key competitive factors include: the number and location of restaurants; quality and speed of service; attractiveness of facilities; effectiveness and magnitude of advertising, marketing, promotional, and operational programs; price; changing demographic patterns and trends; changing consumer preferences and spending patterns, including weaker consumer spending in difficult economic times, or a desire for a more diversified menu; changing health or dietary preferences; and, perceptions and new product development. If we are unable to maintain our competitive position, we could experience lower demand for products, downward pressure on prices, reduced margins, an inability to take advantage of new business opportunities, the loss of market share, and the inability to attract qualified restaurant owners in the future. See additional disclosure under “Competition” in Item 1 of this Report that is incorporated herein by reference.

 

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Our financial results and achievement of our same-store sales growth strategy is dependent on our continued innovation and the successful development and launch of new products and product extensions.

Achievement of our same-store sales growth strategy is dependent, among other things, on our ability to extend the product offerings of our existing brands and introduce innovative new products. Although we devote significant focus to the development of new products, we may not be successful in developing innovative new products or our new products may not be commercially successful. Our financial results and our ability to maintain or improve our competitive position will depend on our ability to effectively gauge the direction of market and consumer trends and initiatives and successfully identify, develop, manufacture, market and sell new or improved products in response to such trends. In addition, our introduction of new products or product extensions may generate litigation or other legal proceedings against us by competitors claiming infringement of their intellectual property or other rights, which could negatively impact our results of operations.

Increases in the cost of commodities or decreases in the availability of commodities could have an adverse impact on our restaurant owners and on our business and financial results.

Our restaurant system is exposed to price volatility in connection with certain key commodities that we purchase in the ordinary course of business such as coffee, wheat, edible oil and sugar, which can impact revenues, costs and margins. Although we monitor our exposure to commodity prices and our forward hedging program (of varied duration, depending upon the type of underlying commodity) partially mitigates the negative impact of any cost increases, price volatility for commodities we purchase has increased due to conditions beyond our control, including economic and political conditions, currency fluctuations, availability of supply, weather conditions, pest damage and changing global consumer demand and consumption patterns. Increases and decreases in commodity costs are largely passed through to restaurant owners, and we and our restaurant owners have some ability to increase product pricing to offset a rise in commodity prices, subject to restaurant owner and guest acceptance, respectively. Notwithstanding the foregoing, while it is not our operating practice, we may choose not to pass along all price increases to our restaurant owners. As a result, commodity cost increases could have a more significant effect on our business and results of operations than if we had passed along all increases to our restaurant owners. Price fluctuations may also impact margins as many of these commodities are typically priced based on a fixed-dollar mark-up. A number of commodities have recently experienced elevated prices relative to historic prices. Although we have secured commitments for most of our key commodities that generally extend to the third quarter of 2012 in anticipation of continued high prices in 2012, these are at higher prices than our previous commitments. In addition, if further escalation in prices continues, we may be forced to purchase commodities at higher prices at the end of the respective terms of our current commitments. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Commodity Risk of this Report.

If the supply of commodities, including coffee, fail to meet demand, our restaurant owners may experience reduced sales which in turn, would reduce our rents and royalty income as well as distribution income. Such a reduction in our rents and royalty income and distribution income may adversely impact our business and financial results.

Food safety and health concerns may have an adverse effect on our business.

Incidents or reports, whether true or not, of unclean water supply; food-borne illness (including e-coli, listeria, hepatitis A or salmonella); injuries caused by or claims of food tampering, food contamination, employee hygiene and cleanliness failures or impropriety at Tim Hortons or other quick service restaurants unrelated to Tim Hortons; and, the potential health impacts of consuming certain of our products, could result in negative publicity, damage our brand value, and potentially lead to product liability or other claims. Any decrease in guest traffic or temporary closure of any of our restaurants as a result of such incidents or negative publicity may have a material adverse effect on our business and results of operations. Food-borne illness or food safety issues may also adversely affect the availability and price of ingredients, which could result in disruptions in our supply chain and/or negatively impact our restaurant owners and us.

 

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Our distribution operations and supply chain are subject to pressures and risks, many of which are outside our control, that could reduce the profitability of our operations.

Our distribution operations and supply chain may be impacted by various factors, some of which are beyond our control, that could injure our brand and negatively affect our results of operations and our ability to generate expected earnings and/or increase costs, including: increased transportation, shipping, food and other supply costs; inclement weather; the risks of having a single source of supply for certain of our food products; shortages or interruptions in the availability or supply of perishable food products and/or their ingredients; potential negative impacts on our relationship with our restaurant owners associated with an increase of required purchases, or prices, of products purchased from our distribution business; and political, physical, environmental, labour, or technological disruptions in our own or our suppliers’ manufacturing and/or warehouse plants, facilities, or equipment.

See additional disclosure under “Sources and Availability of Raw Materials” in Item 1 of this Report that is incorporated in this section by reference.

Because we do not provide distribution services to our restaurant owners in certain geographic areas, our restaurant owners in such areas may not receive the same level of service and reliability as we are able to provide through our own distribution channels.

Our earnings and business growth strategy depends in large part on the success of our restaurant owners; actions taken by our restaurant owners and changes in franchise laws and regulations may harm our business.

A substantial portion of our earnings come from royalties, rents, and other amounts paid by restaurant owners, who operated 99.6% of the Tim Hortons restaurants as of January 1, 2012. Accordingly, our financial results are to a large extent dependent upon the operational and financial success of our restaurant owners. There can be no assurance that we will be able to maintain positive relationships with our existing, higher performing restaurant owners or that we will be able to continue to attract, retain, and motivate sufficient numbers of restaurant owners of the same caliber, either of which could materially and adversely affect our business and operating results. Our restaurant owners are independent contractors and, as a result, the quality of their operations may be diminished by factors beyond our control. Some restaurant owners may not successfully operate restaurants in a manner consistent with our standards and requirements and may not be able to hire, train and retain qualified managers and other restaurant personnel. Any operational shortcoming of a franchised restaurant is likely to be attributed by guests to our entire system, thus damaging our brand reputation and potentially affecting revenues and profitability. Our principal competitors that have a significantly higher percentage of company-operated restaurants than we do may have greater control over their respective restaurant systems and have greater flexibility to implement operational initiatives and business strategies.

Since we receive revenues in the form of rents, royalties, and franchise fees from our restaurant owners, our revenues and profits would decline and our brand reputation could also be harmed if a significant number of restaurant owners were to: experience operational failures, including health and safety exposures; experience financial difficulty (including bankruptcy); be unwilling or unable to pay us for food and supplies, or for royalties, rent or other fees; fail to enter into renewals of franchise or license agreements; or experience any labour shortages or significant increases in labour or other costs of running their businesses. Our advertising levies may also be at risk, which could impact the magnitude and extent of our marketing initiatives. In addition, the ability of restaurant owners to finance the equipment and renovation costs or improvements and additions to existing restaurants, and our sale of restaurants to restaurant owners, are affected by economic conditions, including interest rates and the cost and availability of borrowed funds. A weakening in restaurant owner financial stability would have a negative impact on our business and may cause us to finance such purchases for our restaurant owners or, if we elect not to do so or we are unable to do so, our ability to grow our business in the way we would like may be adversely impacted.

 

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Although we generally enjoy a positive working relationship with the vast majority of our restaurant owners, active and/or potential disputes with one or more restaurant owners could damage our brand reputation and/or our relationships with the broader restaurant owner group. See also, risk factor “Our business activities subject us to litigation risk that could affect us adversely by subjecting us to significant money damages and other remedies or by increasing our litigation expense” below.

Our business activities subject us to litigation risk that could affect us adversely by subjecting us to significant monetary damages and other remedies or by increasing our litigation expense.

From time to time, we are subject to claims incidental to our business, such as illness or injury relating to food quality or food handling. In addition, class action lawsuits have been filed in the past, and may continue to be filed, against quick service restaurants alleging, among other things, that quick service restaurants have failed to disclose the health risks associated with their products or that certain food products contribute to obesity. These types of claims could also harm our brand reputation, making it more difficult to attract and retain qualified restaurant owners and grow the business. We may also be subject to claims from employees, guests, and others relating to health and safety risks and conditions of our restaurants associated with design, construction, site location and development, indoor or airborne contaminants and/or certain equipment utilized in operations. In addition, from time to time, we face claims from: our employees relating to employment or labour matters, including potentially class action suits, regarding wages, discrimination, unfair or unequal treatment, harassment, wrongful termination, or overtime compensation; our restaurant owners and/or operators regarding their profitability (which is a present claim against us), wrongful termination of their franchise or operating (license) agreement, as the case may be, or other restaurant owner relationship matters; taxation authorities regarding certain tax disputes; patent infringement claims from patent-holding companies; or, other stakeholders or business partners. We are also exposed to a wide variety of falsified claims due to our size and brand recognition. All of these types of matters have the potential to unduly distract management attention and increase costs, including costs associated with defending such claims. Any negative publicity resulting from these claims may adversely affect our reputation. Our current exposure with respect to legal matters pending against us could change if determinations by judges and other finders of fact are not in accordance with management’s evaluation of the claims. Should management’s evaluations prove incorrect, our exposure could exceed expectations and have a material adverse effect on our financial condition and results of operations. If successful, any such claims could adversely affect our business, financial condition, and financial results. A judgment significantly in excess of our insurance coverage for any claims could materially and adversely affect our consolidated financial condition or results of operations.

In June 2008, a claim was filed against the corporation and certain of its affiliates alleging that the corporation’s Always Fresh baking system and expansion of lunch offerings have led to lower restaurant owner profitability. On February 24, 2012, the Ontario Superior Court of Justice (the “Court”) granted our motion for summary judgment and dismissed the plaintiffs’ claims in their entirety. The Court also found that certain aspects of the test for certification of the action as a class proceeding had been met, but all of the underlying claims were nonetheless dismissed as part of the aforementioned summary judgment decision. While the Court found in our favour on all claims, if the matter is appealed and if the appeal is determined adversely to us, the effect would be that the matters would ultimately proceed to trial. We remain of the view that we would have good and tenable defences at any such trial however, if the matters were determined adversely to us at trial and that determination was upheld by final order after appeals, it is possible that the claims could have a material adverse impact on our financial position or liquidity. See Item 3. Legal Proceedings of this Report.

Our business is subject to various laws and regulations and changes in such laws and regulations and/or failure to comply with existing or future laws and regulations, or our planning initiatives related to such laws and regulations, could adversely affect us and our shareholders and expose us to litigation, damage our brand reputation or lower profits.

We and our restaurant owners are subject to various international, federal, state, provincial and local laws, treaties and regulations affecting our and their businesses. These laws and regulations include those regarding or relating to: zoning, land use (including the development and/or operation of drive-thru windows), and traffic;

 

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health, food, sanitation and safety; privacy laws, including the collection, retention, sharing and security of data; immigration, employment and labour laws (such as the U.S. Fair Labor Standards Act and similar Canadian legislation), including some increases in minimum wage requirements that were implemented in certain provinces in Canada in 2010 and in 2011, that have increased our and our restaurant owners’ labour costs in those provinces; laws preventing discrimination and harassment in the workplace and providing certain civil rights to individuals with disabilities; laws affecting the design of facilities (such as the Americans with Disabilities Act of 1990 and similar Canadian legislation), including accessibility; tax laws affecting our restaurant owners’ businesses; environmental matters; product safety; nutritional disclosure and regulations regarding nutritional content, including menu labeling; advertising and marketing; record keeping and document retention procedures; and new and/or additional franchise legislation. We are also subject to applicable accounting and reporting requirements and regulations, including those imposed by Canadian and U.S. securities regulatory authorities, the NYSE and the TSX. The complexity of the regulatory environment in which we operate and the related costs of compliance are both increasing due to additional legal and regulatory requirements.

With respect to environmental laws and regulations, our operations are governed and impacted by laws, regulations, local by-laws or limitations regarding climate change, energy consumption and our management, handling and/or disposal of water resources, air resources, toxic substances, solid waste and other environmental matters, including:

 

   

regulations regarding drive-thrus, including banning or imposing idling restrictions in drive-thrus, which could limit our ability to develop restaurants with drive-thrus in certain locations and/or affect the efficiency of drive-thru locations; local building codes, which may require more expensive building materials or restaurant types as well as programs requiring greater use of recyclable materials that can be processed by the waste management industry and/or requiring contributions to residential blue box programs in Ontario and other provinces in Canada, or similar programs in the U.S. that result in increased costs because certain municipalities do not accept our recyclable packaging; and

 

   

regulations relating to the discharge, storage, handling, release and/or disposal of hazardous or toxic substances, particularly with respect to: certain of our operations (e.g., distribution and manufacturing); restaurant locations that were formerly gas stations or that are adjacent to gas stations; septic systems with insufficient capacity; and treatment of well water.

In addition, third parties may make claims against owners or operators of properties for personal injuries or property damage associated with releases of hazardous or toxic substances. See additional disclosure under “Environmental Matters” in Item 1 of this Report that is incorporated into this section by reference.

As “sustainability” issues become more prevalent and accepted, there may be increased governmental, shareholder, and other stakeholder awareness and sentiment for more regulation as well as voluntarily adopted programs relating to reduction and mitigation of environmental or other impacts. There is a possibility that, when and if enacted, the final form of such legislation or any voluntary actions taken by us in this regard would impose stricter requirements or alternative modes of conducting business, which could lead to the need for significant capital expenditures in order to meet those requirements and/or higher ongoing compliance and operating costs. Our participation in or implementation of, or our decision not to participate in or implement, certain types of programs also may have an adverse impact on our brand due to potentially negative publicity or the negative perception of stakeholders regarding our business practices and lack of willingness to demonstrate environmental leadership. Such injury to our brand and reputation may, in turn, also reduce revenues and profits. See also our disclosure under “Sustainability and Responsibility” in Item 1 of this Report regarding our planned activities with respect to sustainability and corporate responsibility initiatives.

We continue to review the implications on us of a comprehensive U.S. health care reform law regarding government-mandated health benefits that was enacted in 2010, as well as the new U.S. food safety modernization law that was enacted in January 2011. We cannot currently determine with certainty the financial

 

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and operational impact that the laws will have on us, our restaurant owners and/or our third-party suppliers and distributors. Any significant increased costs associated with compliance with such laws could adversely affect our financial results and our restaurant owners’ profitability.

Additionally, we must, or may become required to, comply with a number of anti-corruption laws, including the U.S. Foreign Corrupt Practices Act, the Corruption of Foreign Public Officials Act (Canada) and The Bribery Act of 2010 (U.K.), which prohibit improper payments to foreign officials for the purpose of obtaining or retaining business. The scope and enforcement of anti-corruption laws and regulations may vary. There can be no assurance that our employees, contractors, licensees or agents will not violate these laws and regulations. Violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our business and operations. We may also be subject to competitive disadvantages to the extent that our competitors are able to secure business, licenses or other preferential treatment by making payments to government officials and others in positions of influence or using other methods that are prohibited by federal and international laws and regulations.

Existing, new, or future changes in tax laws, regulations, and treaties, or the interpretation or enforcement thereof, may adversely impact: our anticipated effective tax rate, tax liabilities and/or reserves; the benefits that we expected to achieve from certain of our completed or planned public or internal corporate reorganizations; ongoing tax disputes or realization of our tax assets; disclosure of tax-related matters; and/or the expansion of our business into new territories through our strategic initiatives, joint ventures, or other types of programs, projects or activities. In addition, incremental sales taxes at the federal, provincial, state or local level on products sold by our restaurants resulting from, without limitation, increased sales tax rates, changes to the taxability of our products sold at retail, changes to tax rules applicable to our restaurants, introduction of new tax systems such as value-added taxes and the harmonization of federal and provincial sales tax systems in Canada, may all result in increased sales taxes collected at retail. Any of these changes, if enacted, could have a material adverse impact on us, including by resulting in higher total costs of our products to our guests.

It is not possible for us to predict what laws or regulations will be enacted in the future, how existing or future laws and regulations will be administered or interpreted. Changes in our business operations may be negatively impacted by current laws or amended laws resulting in a material adverse impact to us. Compliance with these laws and regulations and planning initiatives undertaken in connection with such laws and regulations could increase our cost of doing business; reduce operational efficiencies; and, depending upon the nature of our and our restaurant owners’ responsive actions to or planning in connection with such laws, regulations, and other matters, damage our reputation. Increases in costs impact our profitability and the profitability of our restaurant owners. Failure to comply with such laws or regulations on a timely basis may lead to civil and criminal liability, cancellation of licenses, fines, and other corrective action, any of which could adversely affect our business and future financial results and have an adverse impact on our brand due to potentially negative publicity regarding our business practices.

See additional disclosure under “Government Regulations and Affairs” in Item 1 of this Report that is incorporated into this section by reference.

Tax regulatory authorities may disagree with our positions and conclusions regarding certain tax attributes and treatment, including relating to certain of our corporate reorganizations, resulting in unanticipated costs or non-realization of expected benefits.

A taxation authority may disagree with certain views of the Company, including, for example, the allocation of profits by tax jurisdiction, and may take the position that material income tax liabilities, interests, penalties or amounts are payable by us, in which case, we expect that we would contest such assessment. Contesting such an assessment may be lengthy and costly and if we were unsuccessful in disputing the assessment, the implications could be materially adverse to us and affect our anticipated effective tax rate or operating income, where applicable.

 

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Based on the provisions of the Income Tax Act (Canada), the U.S. Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder at the time of completing certain of our public or internal company corporate reorganizations (the “Reorganizations”), we anticipated that the Reorganizations would not result in any ongoing material Canadian and/or U.S. federal income tax liabilities to us. However, there can be no assurance that Canada Revenue Agency (the “CRA”) and/or the U.S. Internal Revenue Service (the “IRS”) will agree with our interpretation of the tax aspects of the Reorganizations or any related matters associated therewith. The CRA or the IRS may disagree with our view and take the position that material Canadian or U.S. federal income tax liabilities, interest and penalties, respectively, are payable as a result of the Reorganizations. If we are unsuccessful in disputing the CRA’s or the IRS’ assertions, we may not be in a position to take advantage of the effective tax rates and the level of benefits that we anticipated to achieve as a result of the Reorganizations and the implications could be materially adverse to us. Even if we are successful in maintaining our positions, we may incur significant expense in contesting positions asserted or claims made by tax authorities that could have a material impact on our financial position and results of operations. Similarly, other costs or difficulties related to the Reorganizations and related transactions, which could be greater than expected, could also affect our projected results, future operations, and financial condition. We are party to a tax sharing agreement with Wendy’s, which sets forth the principles and responsibilities of Wendy’s and the Company regarding the allocation of taxes, audits and other tax matters relating to periods when we were part of the same U.S. federal consolidated or state and local combined tax filing group. Either we or Wendy’s may be required to reimburse the other party for the use of tax attributes while we filed U.S. consolidated or state and local combined returns, as a result of audits or similar proceedings giving rise to “adjustments” to previously filed returns, in accordance with the terms of the agreement. As a couple of years remain open to review and adjustment by taxation authorities, payments may be made by one party to the other for the use of the other party’s tax attributes.

Our international operations are subject to various factors of uncertainty and there is no assurance that international operations will be profitable.

We have granted a master license for the development of Tim Hortons restaurants in the GCC. The licensee is expected to open and operate up to 120 multi-format restaurants over 5 years, which includes the 5 restaurant locations that were opened for business in 2011. Notwithstanding the foregoing, there can be no assurance that our international licensee will satisfy its development commitments to open the number of Tim Hortons restaurants stated in the master license agreement. From time to time, we may grant additional master licenses to licensees in other international markets in the future. International licensees may fail to meet their development commitments or may open restaurants more slowly than forecasted at the time such master license agreements are entered into, which would impact the level of expected financial return from such agreements.

The implementation of our international strategic plan may require considerable or dedicated management time as well as start-up expenses for market development before any significant revenues and earnings are generated. Expansion into new international markets carries risks similar to those risks described above relative to expansion into new markets in the U.S.; however, some or all of these factors, including food safety; brand protection and intellectual property protection; and difficulty in staffing, developing and managing operations and supply chain logistics, including ensuring the consistency of product quality and service; may be more pronounced in markets outside Canada and the U.S. due to cultural, political, legal, economic, regulatory and other conditions and differences. As such, our international business operations are subject to additional legal, accounting, tax and regulatory risks associated with doing business internationally, including: tariffs, quotas, other trade protection measures; import or export regulations and licensing requirements; foreign exchange controls; restrictions on our ability to own or operate or repatriate profits from our subsidiaries, make investments or acquire new businesses in foreign jurisdictions; difficulties in enforcement of contractual obligations governed by non-Canadian or non-U.S. law due to differing interpretation of rights and obligations in connection with international franchise or licensing agreements and collection of royalties from international restaurant owners; compliance with multiple and potentially conflicting laws; new and potentially untested laws and judicial systems; reduced or diminished protection of intellectual property; and anti-corruption laws.

 

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For example, we currently export our proprietary products to our licensee in the GCC. Numerous government regulations apply to both the export of food products from Canada and the U.S., as well as the import of food products into other countries. If one or more of the ingredients in our products are banned, alternative ingredients would need to be identified and sourced. Although we intend to be proactive in addressing any product ingredient issues, such requirements may delay our ability to open restaurants in other countries in accordance with our planned or desired schedule.

Any operational shortcoming of a licensee is likely to be attributed by guests to our entire system, thus damaging our brand reputation and potentially affecting revenues and profitability. Additionally, we may also have difficulty finding suppliers and distributors to provide us with adequate and stable supplies of ingredients meeting our standards in a cost-effective manner. We also may become subject to lawsuits or other legal actions resulting from the acts or omissions of a licensee and, even though we may have taken reasonable steps to protect against such liabilities, including by obtaining contractual indemnifications and insurance coverage, there is no assurance that we will not incur costs and expenses as a result of a licensee’s conduct even when we are not legally liable.

Although we believe we have developed the support structure required for international growth, there can be no assurance that our international operations will achieve or maintain profitability or meet planned growth rates. There also can be no assurance that appropriate restaurant owners and/or other licensees will be available in our new international markets. We currently expect that our international restaurant owners may be responsible for the development of a larger number of restaurants than typical for our Canadian or U.S. restaurant owners. As a result, our international operations may be more closely tied to the success of a smaller number of our restaurant owners than is typical for our Canadian and U.S. operations.

Our operating results and financial condition could be adversely impacted by the current worldwide economic conditions.

Our operating results and financial condition are sensitive to and dependent upon discretionary spending by guests, which may be affected by downward pressure in general economic conditions that could drive down demand for our products and result in fewer transactions or decrease average cheque per transaction at our restaurants. In addition, we have investments of cash in bank deposits and money market funds, which could experience sharp declines in returns or otherwise be at risk depending upon the extent of instability in the credit and investment markets. The current economic conditions may also have negative impacts on businesses in general, including our restaurant owners, suppliers and strategic partners. We cannot predict the timing or duration of the suppressed economic conditions or the timing or strength of a subsequent economic recovery, and many of the effects and consequences of these conditions are currently unknown. Any one or all of them could have an adverse effect on our business, results of operations, financial condition, liquidity and/or capital resources.

Catastrophic events may disrupt our business.

Unforeseen events, including war, armed conflict, terrorism and other international, regional or local instability or conflicts (including labour issues), embargos, trade barriers, public health issues (including tainted food, food-borne illnesses, food tampering, or water supply or widespread/pandemic illness such as the avian or H1N1 flu), and natural disasters such as flooding, earthquakes, hurricanes, or other adverse weather and climate conditions, whether occurring in Canada, the U.S. or abroad, could disrupt our operations; disrupt the operations of our restaurant owners, licensees, suppliers, or guests; or, result in civil disturbances and political or economic instability. For instance, guests might avoid public gathering places in the event of a health pandemic, and local, regional, or national governments might limit or ban public gatherings to halt or delay the spread of disease. These events could reduce traffic in our restaurants and demand for our products; make it difficult or impossible to adequately staff our restaurants, receive products from suppliers, deliver products to our restaurant owners on a timely basis, or perform functions at the corporate level; and, otherwise impede our ability to continue our business operations in a continuous manner consistent with the level and extent of our business activities prior to

 

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the occurrence of the unexpected event or events. The impact of a health pandemic, in particular, might be disproportionately greater on us than on other companies that depend less on the gathering of people for the sale of their products. Our receipt of proceeds under any insurance we maintain to protect against certain of these risks may also be delayed or the proceeds may be insufficient to offset our losses fully.

We rely extensively on systems to process transactions, summarize results and manage our business, and a disruption, a failure or a security breach of such networks, systems or technology could harm our ability to run our business.

Network and information systems and other technology systems are integral to retail operations at system restaurants, in our distribution facilities, at our manufacturing facilities, and at our office locations. We also rely heavily on computer systems in managing financial results. These systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer worms, viruses, phishing and other destructive or disruptive software, security breaches, catastrophic events and improper or personal usage by employees. Such an event could have an adverse impact on us and our guests, employees and restaurant owners, including a disruption of our business, and corporate, distribution and manufacturing operations, guest dissatisfaction, negative publicity or a loss of guests or revenues as well as non-compliance with regulations. Such an event also could result in expenditures necessary to repair or replace such networks or information systems or to protect them from similar events in the future.

In connection with our integrated financial system and our electronic payment solutions, we rely extensively on third-party suppliers to retain data, process transactions, and provide certain services. While we make every reasonable effort to confirm that these suppliers have appropriate processes and controls so that there is continuity of services and protection of data, we have no direct control over the same; consequently, the possibility of failure in such third-party suppliers’ systems and processes exists. In such an event, we could experience business interruptions or privacy and/or security breaches surrounding guest, employee, supplier, restaurant owner, licensee and other company data.

We continue to enhance our integrated enterprise resource planning system. The introduction of a new module for business reporting and analysis will be implemented over the next year. This system will integrate and exchange data with the financial systems already in place. There may be risks associated with adjusting to and supporting the new module which may impact our relations with our restaurant owners and suppliers, and the conduct of our business generally. With our use of credit payment systems, our reloadable cash card, and use of debit card systems, we are more susceptible to the risk of an external security breach of guest information that we or third parties under arrangements with us control (including those with whom we have strategic alliances). We could become subject to various claims, including those arising out of theft of data or hardware and fraudulent transactions in the event of a security breach, theft, leakage, accidental release or other illegal activity with respect to employee; guest; supplier; restaurant owner; third-party, including those with whom we have strategic alliances; or, other company data. This may also result in the suspension of electronic payment processing services and fines from credit card companies or regulatory authorities. This could harm our reputation as well as divert management attention and expose us to potentially unreserved claims and litigation. Any loss in connection with these types of claims could be substantial. In addition, if our electronic payment systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. In addition, we are reliant on these systems, not only to protect the security of the information stored, but also to appropriately track and record data.

Any failures or inadequacies of our security measures or in systems could damage our brand reputation and result in an increase in service charges, suspension of service, lost sales, fines, or lawsuits as well as expose us to significant unreserved losses, which could result in an earnings and share price decline. Although some losses may be covered by insurance, if there are significant losses that are not covered, our consolidated financial condition or results of operations may be adversely affected.

 

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Fluctuations in U.S. and Canadian dollar exchange rates can affect our results, as well as the price of common shares and certain dividends we pay.

The majority of our operations, restaurants, income, revenues, expenses and cash flows are in Canadian dollars and we report our results in Canadian dollars. When the U.S. dollar falls in value relative to the Canadian dollar, any profits reported by the Company’s U.S. business segment contribute less to (or, for losses, do not impact as significantly) our consolidated Canadian dollar earnings because of the weaker U.S. dollar. Conversely, when the U.S. dollar increases in value relative to the Canadian dollar, any profits reported by the Company’s U.S. business segment contribute more to (or, for losses, impact more significantly) our consolidated Canadian dollar earnings because of the stronger U.S. dollar.

Royalties paid to us by our international restaurant owners will be based on a conversion of local currencies to U.S. dollars using the prevailing exchange rate, and changes in the exchange rate could adversely affect our revenues. To the extent that the portion of any revenues generated from international operations increases in the future, our exposure to change in currency fluctuations will increase.

Canadian dollars drive our earnings per share; accordingly, our earnings per share may be translated into U.S. dollars by analysts and others. Given the foregoing, the value of an investment in our common shares to a U.S. shareholder will fluctuate as the U.S. dollar rises and falls against the Canadian dollar. Our decision to declare a dividend depends on results of operations reported in Canadian dollars, and we declare dividends in Canadian dollars. As a result, U.S. and other shareholders seeking U.S. dollar total returns, including increases in the share price and dividends paid, are subject to foreign exchange risk as the U.S. dollar rises and falls against the Canadian dollar. See Item 5 of this Report for additional information regarding the conversion of dividends.

We may not be able to adequately protect our intellectual property, which could decrease the value of our brand and branded products.

The success of our business depends on our continued ability to use our existing trademarks, service marks, and other components of our brand in order to increase brand awareness and further develop branded products in the U.S. and Canadian markets, as well as in international markets in which we have expanded or may wish to expand in the future. We may not be able to adequately protect our trademarks, and use of these trademarks may result in liability for trademark infringement, trademark dilution, or unfair competition. Even where we have effectively secured statutory protection for our trademarks and other intellectual property, our competitors may misappropriate our intellectual property and our employees, consultants and suppliers may breach their contractual obligations not to reveal our confidential information, including trade secrets. There can be no assurance that these protections will be adequate or that third parties will not independently develop products or concepts that are substantially similar to ours. Despite our efforts, it may be possible for third parties to reverse-engineer, otherwise obtain, copy, and use information that we regard as proprietary. Furthermore, defending or enforcing our trademark rights, branding practices and other intellectual property, and seeking an injunction and/or compensation for misappropriation of confidential information, could result in the expenditure of significant resources and divert the attention of management, which in turn may materially and adversely affect our business and operating results.

Although we monitor, and restrict restaurant owner, operator and licensees’ activities through our franchise, operator and license agreements, restaurant owners, operators and licensees may refer to our brands improperly in writings or conversation, resulting in the dilution or damage of our intellectual property and brand. Restaurant owner, operator and licensee non-compliance with the terms and conditions of our franchise, operator and license agreements may reduce the overall goodwill of our brands, whether through the failure to meet health and safety standard, or to engage in quality control or maintain product consistency, or through the participation in improper or objectionable business practices. Moreover, unauthorized third parties may use our intellectual property to trade on the goodwill of our brands, resulting in guest confusion or dilution. Any reduction of our brands’ goodwill, guest confusion, or dilution is likely to impact sales, and could materially and adversely impact our business and operating results.

 

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In addition, in certain jurisdictions outside of the U.S. and Canada, there are substantial uncertainties regarding the interpretation and application of laws and regulations relating to, and the enforceability of, intellectual property and related contract rights. Our business could be adversely affected if we are unable to adequately monitor the use of our intellectual property or enforce our intellectual property and related contract rights in courts in international jurisdictions.

Our ownership and leasing of significant amounts of real estate exposes us to possible liabilities, losses, and risks.

As of January 1, 2012, we owned or leased the land or building for approximately 83% of our full-service system restaurants. Accordingly, we are subject to all of the risks associated with owning and leasing real estate. In particular, the value of our assets could decrease, and/or our costs could increase, because of changes in the investment climate for real estate, demographic trends, demand for restaurant sites and other retail properties, and exposure to or liability associated with environmental contamination and reclamation, as further discussed above.

We lease land generally for initial terms of 10 to 20 years. Most of our leases provide for rent increases over the term of the lease and require us to pay all of the costs of insurance, taxes, maintenance, utilities, and other property-related costs. We generally cannot cancel these leases. If an existing or future restaurant is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease, including, among other things, paying the base rent, taxes, and common area expenses for the balance of the lease term. Certain leases may limit our ability to terminate our use of the underlying real estate, making it more costly to close undesirable locations. In addition, as leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close restaurants in desirable locations.

A downgrade of our credit rating could adversely affect our cost of funds, liquidity and access to capital markets.

Failure to maintain our credit rating could adversely affect our cost of funds, liquidity and access to capital markets. We received an inaugural debt rating in connection with the issuance of our senior unsecured, 7-year 4.20% notes in Canada on June 1, 2010. Although we have indicated our intent to target maintenance of an investment grade credit rating, ratings are evaluated and determined by independent third parties and may be impacted by events both outside of our control as well as significant decisions made by us, including major acquisitions or divestitures. Credit rating agencies perform independent analysis when assigning credit ratings and such analysis includes a number of criteria, including, but not limited to, various financial tests, business composition, and market and operational risks. The credit rating agencies continually review the criteria for industry sectors and various credit ratings. Accordingly, such criteria may change from time to time. A downgrade of our credit rating may limit our access to capital markets and increase our cost of borrowing under debt facilities or future note issuances. In addition, if the rating agency were to downgrade our credit rating, the instruments governing our future indebtedness could impose additional restrictions on our ability to make capital expenditures or otherwise limit our flexibility in planning for, or reacting to changes in our business and the industry in which we operate and our ability to take advantage of potential business opportunities. These modifications could also require us to meet more stringent financial ratios and tests or could require us to grant a security interest in our assets to secure the indebtedness in the future. Our ability to comply with covenants contained in the instruments governing our existing and future indebtedness may be affected by events and circumstances beyond our control. If we breach any of these covenants, one or more events of default, including defaults between multiple components of our indebtedness, could result, and the payment of principal and interest due and payable on our outstanding senior notes may become accelerated. These events of default could permit our creditors to declare all amounts owing to be immediately due and payable, and terminate any commitments to make further extensions of credit. The lack of access to cost-effective capital resources, an increase in our financing costs, or a breach of debt instrument covenants, could have an adverse effect on our business, financial condition, or future results. A downgrade in our credit rating could also affect the value and marketability of our outstanding notes.

 

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Credit ratings are not recommendations to buy, sell or hold investments in the rated entity. Ratings are subject to revision or withdrawal at any time by the ratings agencies and there can be no assurance that we will be able to maintain our credit rating even if we meet or exceed their criteria, or that other credit rating agencies will assign us similar ratings.

Failure to retain our existing senior management team or the inability to attract and retain new qualified personnel could hurt our business and inhibit our ability to operate and grow successfully.

Our success will continue to depend to a significant extent on our executive management team and the ability of other key management personnel to replace executives who retire or resign. We may not be able to retain our executive officers and key personnel or attract additional qualified management personnel to replace executives who retire or resign. Failure to retain our leadership team and attract and retain other important personnel could lead to ineffective management and operations, which would likely decrease our profitability.

Our articles, by-laws, shareholder rights plan and certain Canadian legislation contain provisions that may have the effect of delaying or preventing a change in control.

Certain provisions of our articles of incorporation and by-laws, together or separately, could discourage potential acquisition proposals, delay or prevent a change in control, and limit the price that certain investors might be willing to pay in the future for our common shares. Our articles of incorporation authorize our Board of Directors to issue an unlimited number of preferred shares, which are commonly referred to as “blank cheque” preferred shares and, therefore, our Board of Directors may designate and create the preferred shares as shares of any series and determine the respective rights and restrictions of any such series. The rights of the holders of our common shares will be subject to, and may be adversely affected by, the rights of the holders of any preferred shares that may be issued in the future. The issuance of preferred shares could delay, deter, or prevent a change in control and could adversely affect the voting power or economic value of the common shares. In addition, our by-laws contain provisions that establish certain advance notice procedures for nomination of candidates for election as directors and for shareholder proposals to be considered at shareholders’ meetings. Furthermore, under these provisions, directors may be removed by majority shareholder vote at special meetings of shareholders. For a further description of these provisions, see our articles of incorporation, by-laws, and the Canada Business Corporations Act.

Pursuant to our shareholder rights plan (the “Rights Plan”), one right to purchase a common share (a “Right”) has been issued in respect of each of the outstanding common shares and an additional Right will be issued in respect of each additional common share issued prior to the Separation Time (as defined below). The purpose of the Rights Plan is to provide holders of our common shares, and our Board of Directors, with the time necessary so that, in the event of a take-over bid (generally referred to as a “tender offer” in the U.S.) for our Company, alternatives to the bid which may be in the best interests of our Company are identified and fully explored. The Rights Plan can potentially impose a significant penalty on any person or group that acquires, or begins a tender or exchange offer that would result in such person acquiring, 20% or more of the outstanding common shares. See Exhibit 4(a) to this Report for reference to our Rights Plan, which is also described in more detail in the Notes to our Consolidated Financial Statements contained in this Report.

The Investment Canada Act requires that a “non-Canadian,” as defined therein, file an application for review with the Minister responsible for the Investment Canada Act and obtain approval of the Minister prior to acquiring control of a Canadian business, where prescribed financial thresholds are exceeded. Otherwise, there are no limitations either under the laws of Canada or in the Company’s articles on the right of a non-Canadian to hold or vote our common shares.

Any of these provisions may discourage a potential acquirer from proposing or completing a transaction that may have otherwise presented a premium to our shareholders.

 

 

 

Item 1B. Unresolved Staff Comments

None.

 

 

 

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Item 2. Properties

We have construction and site management personnel who oversee the construction of our restaurants by outside contractors. The restaurants are built to our specifications as to exterior style and interior decor. Tim Hortons restaurants operate in a variety of formats. A standard Tim Hortons restaurant is a free-standing building typically ranging in size from 1,000 to 3,080 square feet, with a dining room and drive-thru window. Each of these restaurants typically includes a kitchen capable of supplying fresh baked goods throughout the day. We also have non-standard restaurants designed to fit anywhere, consisting of small full-service restaurants and/or self-serve kiosks in offices, hospitals, colleges, airports, grocery stores, gas and convenience locations and drive-thru-only units on smaller pieces of property, including full-serve event sites located in sports arenas and stadiums that operate only during events with a limited product offering. These units typically average between 150 to 1,000 square feet. Some of the drive-thru-only units, kiosks, and carts also have bakery production facilities on site.

“Combination restaurants” that include Tim Hortons and Wendy’s restaurants in single free-standing units, typically average about 5,780 square feet. For additional information regarding combination restaurants, see “Operations—Combination restaurants, an ongoing relationship with Wendy’s” in Item 1 of this Report.

As of January 1, 2012, the number of Tim Hortons restaurants, both standard and non-standard locations across Canada, the U.S. and the GCC, totaled 4,014, with standard restaurants comprising 70% of the total. For purposes of the foregoing, we have included self-serve kiosks as “non-standard locations.” At January 1, 2012, all but 18 of the Tim Hortons restaurants were franchise-operated. Of the 3,996 franchised restaurants, 769 were sites owned by the Company and leased to restaurant owners, 2,326 were leased by us, and in turn, subleased to restaurant owners, with the remainder, including all self-serve locations, either owned or leased directly by the restaurant owner. Our land or land and building leases are generally for terms of 10 to 20 years, and often have 1 or more 5-year renewal options. In certain lease agreements, we have the option to purchase or right of first refusal to purchase the real estate. Certain leases require the payment of additional rent equal to a percentage (ranging from 0.75% to 13%) of annual sales in excess of specified base rental amounts.

The following tables illustrate Tim Hortons system restaurant locations by type, and whether they are operated by the Company or our restaurant owners, as of January 1, 2012.

Company and Franchised Locations

 

Canadian Locations by Province/Territory

   Standard      Non-Standard      Self-Serve
Kiosks
    

 

 
     Company      Franchise      Company      Franchise      Franchise      Total  

Alberta

             214         1         73         19         307   

British Columbia

             203                 58         28         289   

Manitoba

             61                 25         2         88   

New Brunswick

             101                 14                 115   

Newfoundland and Labrador

             45                 9         1         55   

Nova Scotia

     1         133                 29         4         167   

Northwest Territories

             1                                 1   

Nunavut

                                     3         3   

Ontario

     3         1,162         1         477         49         1,692   

Prince Edward Island

             12                 7                 19   

Quebec

     3         385                 95         7         490   

Saskatchewan

     1         46                 14         6         67   

Yukon

             2                                 2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Canada

     8         2,365         2         801         119         3,295   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

% of restaurants that are standard—Canada   72.0%

 

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United States Locations by State

   Standard      Non-Standard      Self-Serve
Kiosks
    

 

 
     Company      Franchise      Company      Franchise      Franchise      Total  

Indiana

             1                                 1   

Kentucky

             2                 1                 3   

Maine

     1         27                 1                 29   

Maryland

                             2                 2   

Michigan

             143                 18                 161   

New York

             132                 75         148         355   

Ohio

     6         105                 13         3         127   

Pennsylvania

             11                 4         13         28   

Virginia

             1                 1                 2   

West Virginia

     1         5                                 6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

United States

     8         427                 115         164         714   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

% of restaurants that are standard—U.S.

    60.9%   

 

Gulf Cooperation Council Locations by Country

   Standard      Non-Standard      Self-Serve
Kiosks
    

 

 
     Company      Franchise      Company      Franchise      Franchise      Total  

United Arab Emirates

             5                                 5   

 

% of restaurants that are standard—GCC   100.0%
% of restaurants that are standard—Systemwide     70.0%

 

Republic of Ireland and United Kingdom Locations

   Non-Standard Arrangements     

 

 
     Self-Serve
Kiosks
     Full-Service
Locations
     Total  

Republic of Ireland(1)

     186         3         189   

United Kingdom(1)

     72                 72   
  

 

 

    

 

 

    

 

 

 

Total

     258         3         261   
  

 

 

    

 

 

    

 

 

 

 

(1)

Represents licensed self-serve kiosks and full-serve locations primarily located in gas and convenience locations, mainly under the Tim Hortons brand, but also operating under other brands owned by Tim Hortons. See “International Operations” in Item 1 above. These locations are not included in our Canadian, U.S. or GCC restaurant counts, but are described, as set forth in the table above, separately by country.

 

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The following table sets forth the Company’s owned and leased office, warehouse, manufacturing and distribution facilities, including the approximate square footage of the facilities. None of these owned properties, or the Company’s leasehold interest in leased property, is encumbered by a mortgage.

 

Location

   Type      Owned/Leased    Approximate Square
Footage
 

Rochester, New York (U.S. coffee roasting facility)

   Manufacturing      Leased      38,000   

Oakville, Ontario (fondant and fills facility)

   Manufacturing      Owned      36,650   

Hamilton, Ontario (Canadian coffee roasting facility)

   Manufacturing      Owned      76,000   

Guelph, Ontario

   Distribution/Office      Owned      155,750   

Calgary, Alberta

   Distribution/Office      Owned      35,500   

Debert, Nova Scotia

   Distribution/Office      Owned      28,000   

Langley, British Columbia

   Distribution/Office      Owned      27,500   

Kingston, Ontario*

   Distribution/Office      Owned      42,750   

Kingston, Ontario

   Distribution/Office      Owned      135,080   

Montreal, Quebec

   Distribution/Office      Leased      30,270   

Oakville, Ontario

   Warehouse      Owned      37,000   

Oakville, Ontario

   Offices      Owned      153,060   

Dublin, Ohio

   Office      Leased      17,200   

Lachine, Quebec

   Office      Owned      5,000   

Lachine, Quebec

   Office      Leased      8,000   

Williamsville, New York

   Office      Leased      < 2,500   

Brighton, Michigan

   Office      Leased      < 2,500   

 

* This facility was closed when the replacement Kingston distribution centre/office opened and became operational in the latter half of 2011. It is currently contemplated that the land and building situated on this site will be sold.

 

 

 

Item 3. Legal Proceedings

On June 12, 2008, a claim was filed against the Company and certain of its affiliates in the Ontario Superior Court of Justice (the “Court”) by two of its franchisees, Fairview Donut Inc. and Brule Foods Ltd., alleging, generally, that the Company’s Always Fresh baking system and expansion of lunch offerings have led to lower franchisee profitability. The claim, which sought class action certification on behalf of Canadian restaurant owners, asserted damages of approximately $1.95 billion. Those damages were claimed based on breach of contract, breach of the duty of good faith and fair dealing, negligent misrepresentations, unjust enrichment and price maintenance. The plaintiffs filed a motion for certification of the putative class in May of 2009, and the Company filed its responding materials as well as a motion for summary judgment in November of 2009. The 2 motions were heard in August and October 2011. The Company is pleased that on February 24, 2012, the Court granted the Company’s motion for summary judgment and dismissed the plaintiffs’ claims in their entirety. The Court also found that certain aspects of the test for certification of the action as a class proceeding had been met, but all of the underlying claims were nonetheless dismissed as part of the aforementioned summary judgment decision. The Company’s view of this litigation from the outset was that the plaintiffs’ claims were without merit and would not be successful. The Court’s dismissal of the plaintiffs’ claims by way of summary judgment confirms the Company’s position. While the Court found in favour of the Company on all claims, if the matter is appealed and if the appeal is determined adversely to the Company, the effect would be that the matters would ultimately proceed to trial. The Company remains of the view that it would have good and tenable defences at any such trial however, if the matters were determined adversely to the Company at trial and that determination was upheld by final order after appeals, it is possible that the claims could have a material adverse impact on the Company’s financial position or liquidity.

From time to time, the Company is also a defendant in litigation arising in the normal course of business. Claims typically pertain to “slip and fall” accidents at franchised or Company-operated restaurants, employment

 

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claims and claims from guests alleging illness, injury or other food quality, health or operational concerns. Other claims and disputes have arisen in connection with supply contracts, the site development and construction of system restaurants, and distribution and warehouse facilities and/or leasing of underlying real estate, and with respect to various restaurant owner matters, including but not limited to those described in the first paragraph above. Certain of these claims are not covered by existing insurance policies; however, many are referred to and are covered by insurance, except for deductible amounts, and to-date, these claims have not had a material effect on the Company. Reserves related to the resolution of legal proceedings are included in the Company’s Consolidated Balance Sheets as a liability under “Accounts payable.” As of the date of hereof, the Company believes that the ultimate resolution of such matters will not materially affect the Company’s financial condition or earnings. Refer also to Item 1A. Risk Factors.

 

 

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

 

 

Item 5. Market for the Registrant’s Common Equity Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common shares are traded on the Toronto Stock Exchange (“TSX”) and New York Stock Exchange (“NYSE”) (trading symbol: THI). The following tables set forth the High, Low and Close prices of the Company’s common shares on the NYSE and TSX commencing with the first quarter 2010, as well as the dividends declared per share for such period.

Market Price of Common Shares on the Toronto Stock Exchange and New York Stock Exchange(1)

 

     Toronto Stock Exchange (Cdn.$)      New York Stock Exchange (US$)  

2010 Fiscal Year

       High              Low              Close              High              Low              Close      

First Quarter (Ended April 4)

   $ 34.68       $ 30.26       $ 33.39       $ 34.00       $ 28.33       $ 33.10   

Second Quarter (Ended July 4)

   $ 35.76       $ 32.30       $ 34.04       $ 35.17       $ 29.92       $ 31.94   

Third Quarter (Ended October 3)

   $ 38.82       $ 33.45       $ 37.36       $ 37.67       $ 31.68       $ 36.69   

Fourth Quarter (Ended January 2, 2011)

   $ 42.26       $ 36.98       $ 41.10       $ 41.83       $ 36.26       $ 41.23   

 

     Toronto Stock Exchange (Cdn.$)      New York Stock Exchange (US$)  

2011 Fiscal Year

       High              Low              Close              High              Low              Close      

First Quarter (Ended April 3)

   $ 46.05       $ 40.47       $ 44.08       $ 47.04       $ 40.78       $ 45.70   

Second Quarter (Ended July 3)

   $ 48.74       $ 43.00       $ 47.09       $ 51.04       $ 43.90       $ 49.62   

Third Quarter (Ended October 2)

   $ 51.23       $ 41.53       $ 48.71       $ 50.19       $ 41.74       $ 46.28   

Fourth Quarter (Ended January 1, 2012)

   $ 52.75       $ 47.66       $ 49.36       $ 52.06       $ 45.00       $ 48.42   

 

(1) 

Source: Thomson Reuters

As of February 21, 2012, there were 157,414,012 common shares outstanding, of which 277,189 were owned by The TDL RSU Plan Trust.

Dividends Declared Per Common Share (Cdn.$)

 

2010 Fiscal Year

      

First Quarter (Declared February 2010)

   $ 0.13   

Second Quarter (Declared May 2010)

   $ 0.13   

Third Quarter (Declared August 2010)

   $ 0.13   

Fourth Quarter (Declared November 2010)

   $ 0.13   

 

2011 Fiscal Year

      

First Quarter (Declared February 2011)

   $ 0.17   

Second Quarter (Declared May 2011)

   $ 0.17   

Third Quarter (Declared August 2011)

   $ 0.17   

Fourth Quarter (Declared November 2011)

   $ 0.17   

Subsequent to the public company reorganization, the Company declares and pays dividends in Canadian dollars, eliminating the foreign exchange exposure for our shareholders ultimately receiving Canadian dollars. For U.S. beneficial shareholders, however, Clearing and Depository Services Inc. (“CDS”) will convert, and for registered shareholders, we will convert, the Canadian dividend amounts into U.S. dollars based on exchange rates prevailing at the time of conversion and pay such dividends in U.S. dollars. Shareholders ultimately receiving U.S. dollars are exposed to foreign exchange risk from the date the dividend is declared until the date CDS or we, as applicable, convert the dividend payment to U.S. dollars.

 

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All dividends paid by the Company after September 28, 2009, unless otherwise indicated, are designated as eligible dividends for Canadian tax purposes in accordance with subsection 89(14) of the Income Tax Act (Canada), and any applicable corresponding provincial and territorial provisions. The Income Tax Act (Canada) requires the Company to deduct and withhold tax from all dividends remitted to non-residents. According to the Canada-U.S. Income Convention (tax treaty), the Company has deducted a withholding tax of 15% on dividends paid to residents of the U.S. after September 28, 2009, except in the case of a company that owns 10% of the voting stock. In such case, if applicable in the future, the withholding tax would be 5%.

In 2011, our Board of Directors approved an increase in the quarterly dividend from Cdn.$0.13 to Cdn.$0.17 per common share based on our dividend payout range of 30% to 35% of prior year, normalized annual net income attributable to Tim Hortons Inc., which is net income attributable to Tim Hortons Inc. adjusted for certain items, such as gains on divestitures, tax impacts and asset impairments that affect our annual net income attributable to Tim Hortons Inc. In February 2012, our Board of Directors approved a 23.5% increase in the quarterly dividend from $0.17 per common share to $0.21 per common share for the first quarter of 2012. Notwithstanding our long-term targeted dividend payout range and the recent increase in our dividend, the declaration and payment of all future dividends remain subject to the discretion of our Board of Directors and the Company’s continued financial performance, debt covenant compliance, and other factors the Board may consider relevant when making dividend determinations.

The revolving credit facility contains limitations on the payment of dividends by the Company. The Company may not make any dividend distribution unless, at the time of, and after giving effect to the aggregate dividend payment, the Company is in compliance with the financial covenants contained in the revolving credit facility and there is no default outstanding under the senior credit facilities. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Credit Facilities.

 

 

Shareholders

As of January 1, 2012, we had approximately 44,781 shareholders of record (as registered shareholders), as determined by the Company based on information supplied by our transfer agent, Computershare Trust Company of Canada. We also have approximately 76,522 beneficial holders, based on information provided by Broadridge Financial Solutions.

See Note 18 of the Consolidated Financial Statements for information on related shareholder matters.

 

 

 

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth, as of the end of the Company’s last fiscal year, (a) the number of securities that could be issued upon exercise of outstanding options and vesting of outstanding restricted stock units and restricted stock awards under the Company’s equity compensation plans, (b) the weighted average exercise price of outstanding options under such plans, and (c) the number of securities remaining available for future issuance under such plans, excluding securities that could be issued upon exercise of outstanding options.

 

EQUITY COMPENSATION PLAN INFORMATION

 

Plan Category

   Number of securities
to be issued upon
exercise of  outstanding
options, warrants
and rights(1)
(a)
     Weighted-
average
exercise price of
outstanding
options, warrants
and rights
(b)(2)
     Number of securities
remaining available
for future issuance under
equity compensation
plans (excluding securities
reflected in column (a))
(c)
 

Equity compensation plans approved by security holders

     1,487,757       $ 36.05         660,894   

Equity compensation plans not approved by security holders

     N/A         N/A         N/A   
  

 

 

    

 

 

    

 

 

 

Total

     1,487,757       $ 36.05         660,894   
  

 

 

    

 

 

    

 

 

 

 

(1) 

The Company’s 2006 Stock Incentive Plan provides that an aggregate of 2.9 million common shares may be awarded as restricted stock, stock units, stock options, stock appreciation rights (“SARs”), performance shares, performance units, dividend equivalent rights, and/or share awards. Included in the 1,487,757 total number of securities in column (a) above are approximately 305,674 restricted stock units (“RSUs,” including RSUs issued as a result of performance-based restricted stock units or “P+RSUs”), subject to vesting requirements, and dividend equivalent rights associated with the RSUs and 1,182,083 stock options and related SARs. Of the 1,182,083 options/SARs outstanding at January 1, 2012, only 408,208 were exercisable as of that date due to vesting requirements. Historically, SARs have been cash-settled and associated options cancelled and RSUs have been settled by way of an open market purchase by an agent of the Company on behalf of the eligible employee or by way of disbursement of shares from The TDL RSU Employee Benefit Plan Trust. See Note 19 to the Consolidated Financial Statements included in Item 8 of this Annual Report.

(2) 

The average exercise price in this column is based only on stock options and related SARs, as RSUs (including P+RSUs) have no exercise price required to be paid by the recipient upon vesting and settlement.

 

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Performance Graph

The following graph compares the yearly percentage change in the Company’s cumulative total shareholder return on the TSX and NYSE as measured by (i) the change in the Company’s share price from December 29, 2006 to December 30, 2011, and (ii) the reinvestment of dividends at the closing price on the dividend payment date, against the cumulative total return of the S&P/TSX Composite Index, S&P/TSX Consumer Discretionary Index, and S&P 500. The information provided under the heading “Performance Graph” shall not be considered “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference in any filing under the Securities Act or the Exchange Act.

LOGO

 

    29-Dec-06     28-Dec-07     26-Dec-08     31-Dec-09     31-Dec-10     30-Dec-11  

S&P/TSX Composite Index (Cdn.$)(2)

  $ 100.0      $ 109.7      $ 67.9      $ 99.4      $ 116.9      $ 106.7   

S&P/TSX Consumer Discretionary Index (Cdn.$)(2)

  $ 100.0      $ 104.1      $ 61.8      $ 77.5      $ 97.3      $ 82.3   

S&P 500 (U.S.$)

  $ 100.0      $ 101.9      $ 58.7      $ 89.5      $ 109.2      $ 109.0   

Tim Hortons Inc. (TSX)

  $ 100.0      $ 110.6      $ 100.4      $ 98.5      $ 127.8      $ 155.7   

Tim Hortons Inc. (NYSE)

  $ 100.0      $ 131.0      $ 97.0      $ 108.8      $ 149.2      $ 177.8   

 

(1) 

The majority of the Company’s operations, income, revenues, expenses, and cash flows are in Canadian dollars, and the Company reports financial results in Canadian dollars. As a result, our Canadian-dollar earnings per share that may be translated to U.S. dollars by investors, analysts and others. Fluctuations in the foreign exchange rates between the U.S. and Canadian dollar can affect the Company’s share price. See “Risk Factors” in Part 1A. The primary cause of the appreciation in the U.S. dollar share price relative to the Canadian share price during 2007, 2009 and 2010 is the percentage by which Canadian dollar appreciated against the U.S. dollar as noted below. Conversely, in 2008 and 2011, the Canadian dollar depreciated relative to the U.S. dollar by the percentages set forth below causing the opposite effect, resulting in a

 

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  decline in the U.S. dollar share price as a result of currency fluctuation that is not directly attributable to changes in the Company’s underlying business or financial condition aside from the impact of foreign exchange.

 

Year

   F/X Change Cdn.$ compared to US$  

2007

     +16

2008

     -23

2009

     +13

2010

     +5

2011

     -2

 

(2) 

Since September 29, 2006, the Company has been included in the S&P/TSX Composite Index and the S&P/TSX Consumer Discretionary Index.

Sales and Repurchases of Equity Securities

The following table presents the Company’s repurchases of its common shares for each of the three periods included in the fourth quarter ended January 1, 2012:

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

  (a)
Total Number
of Shares Purchased(1)
    (b)
Average Price
Paid Per Share (Cdn.)(2)
    (c)
Total Number
of Shares Purchased
as Part of Publicly
Announced Plans or
Programs
    (d)
Maximum
Approximate
Dollar Value of
Shares that May Yet be
Purchased Under
the Plans
or Programs (Cdn.)(3)(4)
 

Period #10 (October 3, 2011—November 6, 2011)

    274,415      $ 49.45        274,415      $ 64,317,454   

Period #11 (November 7, 2011— December 4, 2011)

    313,209 (5)    $ 50.85        304,200      $ 48,851,645   

Period #12 (December 5, 2011— January 1, 2012)

    263,316      $ 50.42        263,316      $ 35,577,541   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    850,940      $ 50.28        841,931      $ 35,577,541   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Based on settlement date.

(2) 

Inclusive of commissions paid to the broker to repurchase the common shares.

(3) 

Exclusive of commissions paid to the broker to repurchase the common shares.

(4) 

On February 23, 2011, the Company announced that it had obtained regulatory approval from the Toronto Stock Exchange (the “TSX”) under the TSX normal course issuer bid rules to commence a 2011 share repurchase program (“2011 program”) for up to $445 million in common shares, not to exceed the regulatory maximum of 14,881,870 common shares, representing 10% of its public float as of February 17, 2011. The 2011 program commenced March 3, 2011 and is due to terminate on March 2, 2012, or earlier if the $445 million or the 10% share maximum is reached. The first purchases were made under the 2011 program on March 3, 2011, and the aggregate dollar value of shares that we currently expect to purchase under the 2011 program is approximately $435 million. The 2011 program may be terminated by the Company at any time, subject to compliance with regulatory requirements. As such, there can be no assurance regarding the total number of common shares or the dollar value of common shares that may be repurchased under the 2011 program. The common shares purchased pursuant to the 2011 program are being cancelled.

(5) 

In November 2011, the Company purchased 9,010 common shares in the open market to settle restricted stock unit awards of certain of the Company’s employees who did not have shares delivered to them for settlement from The TDL RSU Plan Trust.

 

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Item 6. Selected Financial Data

The following table presents our selected historical consolidated financial and other data and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report. Our historical consolidated financial information may not be indicative of our future performance.

 

    Fiscal Years(1)(2)  
    2011     2010     2009     2008     2007  
   

(in thousands, except per share data,

number of restaurants, and otherwise where noted)

 

Consolidated Statements of Operations Data

         

Revenues

         

Sales

  $ 2,012,170      $ 1,755,244      $ 1,704,065      $ 1,541,882      $ 1,404,986   

Franchise revenues:

         

Rents and royalties(3)

    733,217        687,039        644,755        593,483        546,925   

Franchise fees

    107,579        94,212        90,033        93,808        93,835   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    840,796        781,251        734,788        687,291        640,760   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    2,852,966        2,536,495        2,438,853        2,229,173        2,045,746   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Asset impairment and closure costs, net(4)

    372        28,298               21,266          

Other costs and expenses

    2,283,119        1,997,034        1,913,251        1,729,460        1,586,010   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    2,283,491        2,025,332        1,913,251        1,750,726        1,586,010   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gain on sale of interest in Maidstone Bakeries(5)

           361,075                        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    569,475        872,238        525,602        478,447        459,736   

Interest expense, net

    25,873        24,180        19,184        19,632        14,923   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    543,602        848,058        506,418        458,815        444,813   

Income taxes

    157,854        200,940        186,606        150,309        147,226   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 385,748      $ 647,118      $ 319,812      $ 308,506      $ 297,587   

Net income attributable to noncontrolling interests

  $ 2,936      $ 23,159      $ 23,445      $ 23,828      $ 28,036   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Tim Hortons Inc.

  $ 382,812      $ 623,959      $ 296,367      $ 284,678      $ 269,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share attributable to Tim Hortons Inc.

  $ 2.35      $ 3.58      $ 1.64      $ 1.55      $ 1.43   

Weighted average number of common shares outstanding – diluted

    162,597        174,215        180,609        183,492        188,759   

Dividends per common share

  $ 0.68      $ 0.52      $ 0.40      $ 0.36      $ 0.28   

Consolidated Balance Sheets Data

         

Cash and cash equivalents

  $ 126,497      $ 574,354      $ 121,653      $ 124,717      $ 186,982   

Restricted cash and cash equivalents and Restricted investments

  $ 130,613      $ 105,080      $ 80,815      $ 62,329      $ 37,790   

Total assets

  $ 2,203,950      $ 2,481,516      $ 2,094,291      $ 2,097,694      $ 1,902,200   

Long-term debt(6)

  $ 457,290      $ 437,348      $ 411,694      $ 405,500      $ 401,166   

Total liabilities

  $ 1,049,517      $ 1,039,074      $ 838,605      $ 865,891      $ 806,764   

Total equity

  $ 1,154,433      $ 1,442,442      $ 1,255,686      $ 1,231,803      $ 1,095,436   

Other Financial Data

         

EBITDA attributable to Tim Hortons Inc.(7)

  $ 678,997      $ 956,532      $ 599,939      $ 541,168      $ 516,597   

Capital expenditures

  $ 181,267      $ 132,912      $ 160,458      $ 184,538      $ 195,094   

Operating margin(8) (%)

    20.0     34.4     21.6     21.5     22.5

 

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    Fiscal Years(1)(2)  
    2011     2010     2009     2008     2007  
   

(in thousands, except per share data,

number of restaurants, and otherwise where noted)

 

Other Operating Data

         

Total systemwide sales growth(9)(10)

    7.4     6.2     7.9     8.3     10.2

Systemwide restaurant unit growth(10)

    7.1     4.8     4.1     6.7     5.7

Canada average same-store sales growth(10)

    4.0     4.9     2.9     4.4     6.1

U.S. average same-store sales growth(10)

    6.3     3.9     3.2     0.8     4.1

Total system restaurants franchised (%)

    99.6     99.5     99.5     99.0     97.8

Restaurants open at end of year – Canada

         

Standard(11)

    2,373        2,279        2,193        2,116        2,055   

Non-standard(12)

    803        757        724        702        664   

Self-serve kiosk(12)

    119        112        98        99        104   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Canada

    3,295        3,148        3,015        2,917        2,823   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restaurants open at end of year – U.S.

         

Standard(11)

    435        405        422        398        361   

Non-standard(12)

    115        74        54        34        22   

Self-serve kiosk(12)

    164        123        87        88        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S.

    714        602        563        520        398   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total North America

    4,009        3,750        3,578        3,437        3,221   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average sales per standard restaurant:(10)(11)

         

Canada

  $ 2,129      $ 2,070      $ 2,025      $ 1,955      $ 1,888   

U.S. (U.S. dollars)(4)

  $ 1,069      $ 978      $ 957      $ 930      $ 956   

U.S. (Canadian dollars)(4)

  $ 1,059      $ 1,012      $ 1,097      $ 977      $ 1,023   

Average sales per non-standard restaurant:(10)(12)

         

Canada

  $ 870      $ 830      $ 794      $ 751      $ 707   

U.S. (U.S. dollars)

  $ 451      $ 459      $ 426      $ 457      $ 397   

U.S. (Canadian dollars)

  $ 447      $ 475      $ 488      $ 481      $ 425   

 

(1) 

Fiscal years include 52 weeks, except for fiscal 2009, which included 53 weeks.

(2) 

Our selected historical consolidated financial data has been derived from our audited financial statements for the years ending January 1, 2012, January 2, 2011, January 3, 2010, December 28, 2008, and December 30, 2007.

(3) 

Rents and royalties revenues consist of: (a) royalties, which typically range from 3.0% to 4.5% of gross franchised restaurant sales, and (b) rents, which consist of base rent and percentage rent in Canada and percentage rent only in the U.S. Rents typically range from 8.5% to 10.0% of gross franchised restaurant sales. Franchised restaurant sales are reported to us by our restaurant owners.

The reported franchised restaurant sales for the last 5 years were:

 

     Fiscal Years(1)(2)  
     2011      2010      2009      2008      2007  
     (in thousands)  

Franchised restaurant sales:

              

Canada (Canadian dollars)

   $ 5,564,263       $ 5,181,831       $ 4,880,934       $ 4,546,027       $ 4,197,478   

U.S. (U.S. dollars)

   $ 472,969       $ 439,227       $ 409,882       $ 345,429       $ 301,255   

 

(4) 

The Net asset impairment charge of $0.4 million in fiscal 2011 included an asset impairment charge of $1.9 million, net of a $1.5 million recovery of previously accrued closure costs.

 

    

In fiscal 2010, we impaired our Portland, Providence and Hartford markets. In addition, we closed 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets and 2 restaurants in our Portland market, in fiscal 2010. These markets represented a relatively small portion of our overall system

 

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  in the U.S., but historically had a disproportionately negative impact on average unit volumes. Average unit volumes for standard restaurants in the Providence and Hartford markets were approximately half of our other core markets in the U.S.

 

     Asset impairment and closure costs in fiscal 2008 related to our closure of 15 underperforming Company-operated restaurants in southern New England and the impairment of our Providence and Hartford markets in the U.S.
(5) 

The Company sold its 50% joint-venture interest in Maidstone Bakeries for a pre-tax gain of $361.1 million on October 29, 2010.

(6) 

Long-term debt includes long-term debt and capital leases, including their current portions.

(7) 

Net income before interest, taxes, depreciation and amortization (“EBITDA”) attributable to THI is defined as EBITDA after deducting EBITDA attributable to noncontrolling interests. EBITDA is used by management as a performance measure for benchmarking against our peers and our competitors. We believe EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to evaluate companies in our industry. EBITDA is not a recognized term under U.S. GAAP. EBITDA should not be viewed in isolation and does not purport to be an alternative to net income as an indicator of operating performance or as an alternative to cash flows from operating activities as a measure of liquidity. There are material limitations associated with making the adjustments to calculate EBITDA and using this non-GAAP financial measure as compared to the most directly comparable GAAP financial measure. For instance, EBITDA does not include:

 

   

interest expense, and because we have borrowed money to finance our operations, interest expense is a necessary element of our costs and ability to generate revenue;

 

   

depreciation and amortization expense, and because we use property and equipment, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue; and

 

   

income tax expense, and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate.

 

     Additionally, EBITDA is not intended to be a measure of free cash flow for management’s discretionary use, as it does not consider certain cash requirements such as capital expenditures, contractual commitments, interest payments, tax payments and debt service requirements. Since not all companies use identical calculations, this presentation of EBITDA may not be comparable to other similarly titled measures of other companies.

The following table is a reconciliation of EBITDA to our net income:

 

     Fiscal Years(1)(2)  
     2011      2010      2009      2008      2007  
     (in thousands)  

Net income

   $ 385,748       $ 647,118       $ 319,812       $ 308,506       $ 297,587   

Interest expense, net

     25,873         24,180         19,184         19,632         14,923   

Income tax expense

     157,854         200,940         186,606         150,309         147,226   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating income

     569,475         872,238         525,602         478,447         459,736   

Depreciation and amortization

     115,869         118,385         113,475         103,793         93,041   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA*

     685,344         990,623         639,077         582,240         552,777   

EBITDA attributable to noncontrolling interests

     6,347         34,091         39,138         41,072         36,180   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA attributable to Tim Hortons Inc.

   $ 678,997       $ 956,532       $ 599,939       $ 541,168       $ 516,597   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  * EBITDA includes and has not been adjusted for the asset impairment and closure costs, net of $0.4 million, $28.3 million, and $21.3 million in fiscal 2011, 2010 and 2008, respectively. It has also not been adjusted for the gain on sale from our interest in Maidstone Bakeries in fiscal 2010 of $361.1 million, partially offset by the $30 million allocated to our restaurant owners, for a total net pre-tax gain of $331.1 million.

 

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(8) 

Operating Margin represents operating income expressed as a percentage of Total revenues.

(9) 

Total systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. U.S. dollar sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes sales from the Republic of Ireland and the United Kingdom licensed locations.

(10) 

Includes both franchised and Company-operated restaurants. Franchised restaurant sales are not included in our Consolidated Financial Statements, other than approximately 250 to 275 restaurants whose results of operations are consolidated with ours as variable interest entities. U.S. average sales per standard and non-standard restaurant are disclosed in both Canadian and U.S. dollars, the reporting and functional currency, respectively, of our U.S. operations. The U.S. average sales per standard and non-standard restaurant were converted into Canadian dollars for each year using the average foreign exchange rate in the applicable year, which includes the effects of exchange rate fluctuations and decreases comparability between the years. We believe the presentation of the U.S. dollar average sales per standard and non-standard restaurant is useful to investors to show the local currency amounts for restaurants in the U.S. and provides transparency on the underlying business performance without the impact of foreign exchange.

(11) 

Our standard restaurant typically measures between 1,000 to 3,080 square feet, with a dining room, a counter for placing orders and drive-thru service. Standard restaurants comprised 70.0% of our North American system as of January 1, 2012.

(12) 

Our non-standard restaurants include small, full-service restaurants and/or self-serve kiosks in offices, hospitals, colleges, airports, grocery stores, gas and convenience locations and drive-thru-only units on smaller pieces of property, including full-serve event sites located in sports arenas and stadiums that operate only during these events with a limited product offering. Included in our U.S. non-standard restaurant counts as at January 1, 2012 are 22 event sites. On average, 9 of these sites were operating during fiscal 2011 and had average unit volumes of $179. These sites are important as they heighten brand awareness in our developing markets by exposing the brand to a large number of guests and encourage trial as we generally have product exclusivity at these locations. Non-standard restaurants comprised 30.0% of our North American system as of January 1, 2012.

 

     Average unit volumes for non-standard restaurants exclude volumes from self-serve kiosks. Self-serve kiosks differ in size and product offering and, as a result, have significantly different economics than our full-serve standard and non-standard restaurants, including substantially less capital investment, and also contribute significantly less to both systemwide sales as well as our revenues and operating income in each respective region. Self-serve kiosks are, however, important as we believe they drive convenience and brand penetration, especially in the U.S., where our brand is less developed.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the fiscal 2011 Consolidated Financial Statements and accompanying Notes included elsewhere in our Annual Report on Form 10-K for the year ended January 1, 2012 (“Annual Report”). All amounts are expressed in Canadian dollars unless otherwise noted. The following discussion includes forward-looking statements that are not historical facts, but reflect our current expectations regarding future results. Actual results may differ materially from the results discussed in the forward-looking statements because of a number of risks and uncertainties, including the matters discussed below. Please refer to “Risk Factors” included elsewhere in our Annual Report for a further description of risks and uncertainties affecting our business and financial results. Historical trends should not be taken as indicative of future operations and financial results.

Our financial results are driven largely by changes in systemwide sales, which include restaurant-level sales at franchisee-owned restaurants and restaurants run by independent operators (collectively, we hereunder refer to both franchisee-owned and franchisee-operated restaurants as “franchised restaurants”), and Company-operated restaurants. As at January 1, 2012, 3,996 or 99.6% of our restaurants were franchised, including 99.7% in Canada and 98.9% in the United States. The amount of systemwide sales affects our franchisee royalties and rental income, as well as our distribution income. Changes in systemwide sales are driven by changes in same-store sales and changes in the number of restaurants, and are ultimately driven by consumer demand. Same-store sales growth represents the average growth in retail sales at restaurants operating systemwide that have been open for thirteen or more months (i.e., includes both franchised and Company-operated restaurants). It is one of the key metrics we use to assess our performance and provides a useful comparison between periods. We believe systemwide sales and same-store sales growth provide meaningful information to investors regarding the size of our system, the overall health and financial performance of the system, and the strength of our brand and restaurant owner base, which ultimately impacts our consolidated and segmented financial performance. Franchised restaurant sales are not generally included in our Consolidated Financial Statements (except for certain non-owned restaurants consolidated in accordance with applicable accounting rules); however, franchised restaurant sales result in royalties and rental revenues, which are included in our franchise revenues, and also supports growth in distribution sales.

We prepare our financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”). However, this Management’s Discussion and Analysis of Financial Condition and Results of Operations also contains certain non-GAAP financial measures to assist readers in understanding the Company’s performance. Non-GAAP financial measures either exclude or include amounts that are not reflected in the most directly comparable measure calculated and presented in accordance with GAAP. Where non-GAAP financial measures are used, we have provided the most directly comparable measures calculated and presented in accordance with U.S. GAAP and a reconciliation to GAAP measures.

References herein to “Tim Hortons,” the “Company,” “we,” “our,” or “us” refer to Tim Hortons Inc., a corporation governed by the Canada Business Corporations Act and its subsidiaries for periods on or after September 28, 2009 and to Tim Hortons Inc., a Delaware corporation, and its subsidiaries (“THI USA”) for periods on or before September 27, 2009, unless specifically noted otherwise.

Description of Business

We franchise Tim Hortons restaurants primarily in Canada and the U.S. As the franchisor, we collect royalty income from franchised restaurant sales. Our business model also includes controlling the real estate for the majority of our franchised restaurants, which generates a recurring stream of rental income. As of January 1, 2012, we leased or owned the real estate for approximately 83% of our full-serve system restaurants. Real estate that is not controlled by us is generally for non-standard restaurants, including, for example, full-serve kiosks in offices, hospitals, colleges, stadiums, arenas, and airports, as well as self-serve kiosks located in gas and convenience locations, and grocery stores. We distribute coffee and other beverages, non-perishable food,

 

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supplies, packaging and equipment to system restaurants in Canada through our 5 distribution centres, and, in some cases, through third-party distributors. In addition to dry goods, we also supply frozen and some refrigerated products from our existing Guelph distribution facility, and more recently from our new Kingston replacement distribution facility, to approximately 60% of our Canadian restaurants, namely those located in Ontario and Quebec. Construction was completed on our replacement distribution centre in Kingston, Ontario in the second half of fiscal 2011. This facility is now capable of supplying frozen and some refrigerated products, in addition to the dry products that were previously distributed. We began start-up operations in late July 2011, and were servicing approximately 530 restaurants by the end of fiscal 2011. In the U.S., we supply similar products to system restaurants through third-party distributors. In keeping with our vertical integration model, we also operate 2 coffee roasting facilities located in Hamilton, Ontario, and Rochester, New York, and a fondant and fills manufacturing facility in Oakville, Ontario.

2011 Performance against Targets

The following table sets forth our fiscal 2011 actual performance as compared to our fiscal 2011 financial targets, as well as management’s comments on our performance relative to such targets:

 

Measure

  

Target

  

Actual

  

Commentary

Same-store Sales Growth

• Canada

• U.S.

  

3% - 5%

3% - 5%

  

4.0%

6.3%

  

Our same-store sales growth was driven mainly by menu innovation with quality products introduced at targeted price points which contributed to positive product mix, and combined with pricing, resulted in a higher average cheque in both Canada and the U.S. Additional advertising targeted at our core growth markets in the U.S. also contributed favourably, and we believe was a significant factor in the strong performance in our U.S. market.

 

        

Restaurant development

• Canada

 

 

• U.S.

  

 

160 – 180

Restaurants

 

70 – 90

Full-serve restaurants

  

 

175

Restaurants

 

72

Full-serve restaurants

42

Self-serve restaurants

   We ramped up our restaurant development efforts in fiscal 2011 and achieved our targets in both Canada and the U.S. with a combined total of 238 full-serve restaurant openings. Restaurant development in Canada was focused on our Western and Quebec markets, with two-thirds of standard restaurant openings and more than half of all new openings occurring in these markets. In the U.S., we continued to build scale in our core markets and continued to use self-serve restaurant openings as a capital-efficient method of increasing brand awareness and convenience within our U.S. markets.

U.S. operating income

  

US$13 million –

US$16 million

   US$15.2 million    We achieved record earnings in our U.S. segment in fiscal 2011 led primarily by the strength of same-store sales growth, as noted above. We continue to gain momentum and we are pleased with the progress in our U.S. operations.

 

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Measure

 

Target

  

Actual

  

Commentary

Effective tax rate

  Approximately 30%    29.0%    Our effective tax rate was at the low end of our target mainly because we benefited from a combination of a favourable jurisdictional shift of income and preferential tax treatment of certain income items.

Diluted earnings per share attributable to Tim Hortons Inc. (“EPS”)

  $2.30 - $2.40    $2.35    A combination of operating income growth driven primarily by continued strength in systemwide sales in both Canada and the U.S., a lower effective tax rate, and our share repurchase program contributed to our EPS performance in fiscal 2011. Actual EPS includes an approximate $0.03 per share reduction related to the CEO Separation Agreement(1). Excluding this charge, EPS would have been at the higher end of the range.

Capital Expenditures

 

$180 million –

$200 million

   $181 million    Capital spending was focused on new restaurant development and renovations. In addition, we completed the construction of our Kingston replacement distribution centre. Capital spending was at the lower end of our target due primarily to lower spending on new restaurants. We had fewer restaurant openings in locations where we had the ability to acquire the real estate and utilized a higher number of capital leases than anticipated.

 

(1) 

The separation agreement of $6.3 million with our former President and Chief Executive Officer, which included severance charges, advisory fees, and other related costs and expenses (“CEO Separation Agreement”), was not contemplated as part of Management’s fiscal 2011 guidance for EPS.

Executive Overview

We continued our strong momentum in fiscal 2011 with systemwide sales growth of 7.4% in fiscal 2011 despite economic conditions that remained challenging. While we began to see some economic stability in North America with unemployment levels and consumer confidence improving slightly, a number of global events transpired in fiscal 2011 that posed threats to the North American economic recovery. These events included supply chain disruptions in the aftermath of the Japan tsunami which impacted manufacturing-based markets; the volatility of commodity prices which had an impact on commodity-based markets; and the European sovereign debt crisis which contributed greatly to general consumer concern. We are certainly not immune to these global influences, nor North American recessionary and/or inflationary impacts, but historically, we have proven to be fairly resilient during challenging economic times, and we continue to believe we are well-positioned in both Canada and the U.S., due, in part, to our quality product offerings at reasonable prices.

Systemwide sales growth was driven primarily by strong same-store sales growth in both Canada (4.0%) and the U.S. (6.3%), with new restaurant development contributing in both markets as well. New product innovations and introductions in both Canada and the U.S. were significant factors driving same-store sales growth in fiscal 2011. A number of new product introductions contributed to a favourable product mix, and combined with pricing, resulted in a higher average cheque. Total transactions grew in both markets in fiscal 2011, which included transactions from new restaurant development in both Canada and the U.S. and continued

 

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same-store transactions growth in the U.S. Partially offsetting these growth factors was continued economic weakness and generally challenging macro operating conditions, which we believe were factors that led to a slight decline in same-store transactions in Canada.

We opened a total of 294 restaurants (which included 51 self-serve kiosks) in fiscal 2011 compared to 245 restaurants (which included 72 self-serve kiosks) in fiscal 2010, with a significant portion occurring in the fourth quarter of each year. In fiscal 2011, we ramped up our restaurant development in both Canada and the U.S. In Canada, we focused on increasing convenience in our urban markets and continued our expansion in our Quebec and Western markets, utilizing a higher proportion of standard restaurant formats over non-standard formats. In the U.S., we focused most of our development in our core markets with a combination of both standard and non-standard locations. We continue to use self-serve kiosks primarily in the U.S. as a capital efficient way of increasing market exposure of the Tim Hortons brand in new and developing markets. We execute our development activities in both Canada and the U.S. in a disciplined manner and only with what we believe to be the right opportunities. Our flexible “We Fit Anywhere” design allows us to scale the size of our restaurants to the market opportunities available.

There were 2 major events that occurred in fiscal 2010 that impact the comparability of our operating results year-over-year. The first event was the sale of our 50% joint-venture interest in Maidstone Bakeries (“Maidstone Bakeries”), which occurred in the fourth quarter of fiscal 2010, resulting in a significant gain on the sale and, subsequent to the sale, the loss of Maidstone Bakeries operating income. The second event was an asset impairment charge relating to our Portland, Hartford, and Providence markets in the New England region and subsequent closure of restaurants primarily in our Hartford and Providence markets in the U.S.

Maidstone Bakeries

We sold our 50% interest in Maidstone Bakeries for gross cash proceeds of $475 million in the fourth quarter of fiscal 2010. The sale of Maidstone Bakeries resulted in a pre-tax gain of $402.3 million, less approximately $41.2 million which, for accounting purposes, was deferred and is being amortized over the remaining term of the supply agreement, resulting in a net gain of $361.1 million recognized in fiscal 2010. Our obligation to purchase donuts and TimbitsTM from Maidstone Bakeries extends until early 2016, and we have supply rights until late 2017, at our option, allowing us sufficient flexibility to secure alternative means of supply, if necessary. In addition, we allocated $30 million from the proceeds of the Maidstone Bakeries sale to support our key relationship with our restaurant owners, which was intended to help partially mitigate rising operating costs. Collectively, the gain on sale, net of the allocation to our restaurant owners, represented approximately $295.6 million after tax or approximately $1.70 per share in fiscal 2010.

The results of Maidstone Bakeries were consolidated in our financial results as a variable interest entity (“VIE”) until October 29, 2010, at which point we were no longer required to consolidate its results. Due to the continuing business relationship that exists, Maidstone Bakeries did not qualify to be presented as discontinued operations. In fiscal 2010, Maidstone Bakeries, on a full-consolidation basis, contributed approximately $48.9 million to operating income and $42.7 million to net income, 50% of which represents our share of earnings for the ten month period prior to the sale. Partially offsetting this reduced income was the amortization of the supply agreement, which reduced cost of sales by $8.3 million in fiscal 2011 ($1.3 million in fiscal 2010).

Asset Impairment and Closure Costs

In the second half of fiscal 2010, we determined that the future expected cash flows from our Portland, Providence and Hartford markets were insufficient to recover the carrying value of the long-lived assets in these markets. In addition, we decided to close 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets and 2 restaurants in our Portland market. The Providence and Hartford markets were among the most densely penetrated market areas in the U.S. by quick service restaurants, and we were not successful in expanding our customer base to the levels required for future profitability. As a result, total asset impairment and

 

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related closure costs of $28.3 million were recorded in our U.S. operating segment in fiscal 2010. These markets represented a relatively small portion of our overall system in the U.S., but historically had a disproportionately negative impact on earnings, average unit volumes and same-store sales growth in the U.S. segment. Average unit volumes for standard restaurants in the Providence and Hartford markets were approximately half of those in our other core markets in the U.S. There was no associated tax benefit related to the impairment, so the negative impact on net income was $28.3 million, or approximately $0.16 per share in fiscal 2010.

Additionally, in fiscal 2011, we recorded an asset impairment charge of $1.9 million related to our Portland market, which reflected current real estate and equipment values, partially offset by $1.5 million of previously accrued closure costs which were reversed into Operating income upon the substantial conclusion of closure activities related to the above-noted closures, for a net impairment charge of $0.4 million.

Financial Performance

Operating income decreased $302.8 million in fiscal 2011 compared to fiscal 2010, primarily as a result of the sale of Maidstone Bakeries in fiscal 2010 that was offset, in part, by asset impairment and related closures costs, as noted above. In addition, we incurred a charge of $6.3 million in fiscal 2011 related to the CEO Separation Agreement, which included severance charges, advisory fees, and other related costs and expenses.

Excluding the three above-noted items (i.e. Maidstone Bakeries, asset impairment and closure costs, and the CEO Separation Agreement), adjusted operating income increased by $48.5 million in fiscal 2011, or 9.4% (refer to non-GAAP reconciliation table on page 59), driven primarily by strong systemwide sales growth in both Canada and the U.S., resulting in higher rents and royalties and higher distribution income through increased underlying product demand. Partially offsetting this operating growth was higher general and administrative expenses focused primarily on advertising and promotional activities in our core markets in the U.S., where we made targeted investments that were funded with a portion of the savings we realized from our restaurant closures, in Canada on our Cold Stone Creamery co-branding initiative, and on our international expansion.

Net income attributable to Tim Hortons Inc. decreased $241.1 million in fiscal 2011 compared to fiscal 2010. The decrease in net income was primarily a result of the net after-tax impact of the 2 significant events in fiscal 2010 noted above. Absent the impact of these 2 events and the CEO Separation Agreement, net income attributable to Tim Hortons Inc. would have increased by $45.4 million, or 13.6%. The primary factors driving the increase were higher adjusted operating income (refer to non-GAAP reconciliation table on page 59) noted above and a lower effective tax rate on these earnings. Our underlying effective tax rate benefited from statutory tax rate reductions in Canada, which lowered our average statutory tax rate to 28.3% in fiscal 2011 from 31.0% in fiscal 2010 (see Note 7 to the Consolidated Financial Statements).

EPS decreased 34.3% to $2.35 in fiscal 2011 compared to $3.58 in fiscal 2010. Absent the $0.03 negative impact related to the CEO Separation Agreement in fiscal 2011, the $1.70 per share net positive impact of the gain of Maidstone Bakeries in fiscal 2010, and $0.16 per share negative impact of the asset impairment and closure costs in fiscal 2011 and fiscal 2010, EPS growth year-over-year would have been 16.2%. A substantial component of our EPS growth resulted from the positive, cumulative impact of our share repurchase programs. The repurchase programs were primarily funded during fiscal 2011 with the use of substantially all of the net proceeds received from the sale of Maidstone Bakeries, which were fully distributed by September 2011. We had approximately 162.6 million average fully diluted common shares outstanding during fiscal 2011, which was 11.6 million, or 6.7%, fewer average fully diluted common shares outstanding than in fiscal 2010.

 

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2012 Performance Targets

The following table sets forth our 2012 performance targets, as well as management’s views on achieving such objectives (see accompanying notes below):

 

Measure

  

Target

  

Commentary

Same-Store Sales Growth

• Canada

 

• U.S.

  

 

3% - 5%

 

4% - 6%

  

 

We expect to build on our strong same-store sales performance from fiscal 2011 in both Canada and the U.S. by continuing to execute our strategic plan by: (i) creating menu and product innovation to respond to guest needs and trends, (ii) introducing product and category extensions as well as new product platforms such as chilled drinks and espresso-based beverages, (iii) leveraging our marketing strengths and advantages in Canada and increasing capacity at our existing Canadian restaurants through the design and implementation of a number of drive-thru initiatives, where feasible, and through continued evolution of our in-restaurant guest queuing systems, and (iv) enhancing our brand identity positioning efforts in the U.S. as a unique cafe and bake shop destination focused on freshness and value and sustaining increased marketing and advertising spending with a focus on our core growth markets to increase awareness of our brand in the U.S.

Restaurant Development

• Canada

 

• U.S.

 

• International

  

 

155 – 175

Restaurants

 

80 – 100

Restaurants

 

Approximately

15

Restaurants

  

 

We expect to open a total of 250 to 290 restaurant locations. In the U.S., we expect to complement the 80 – 100 full-serve openings in 2012 with the use of self-serve kiosk locations to enhance convenience for our guests. Internationally, we plan to expand our brand presence with our master licensee within the GCC.

Effective Tax Rate

   Approximately 28%    We expect to continue to realize the benefits of the scheduled Canadian statutory rate reductions.

EPS

   $2.65 – $2.75    We expect operating income to grow in both Canada and the U.S. in fiscal 2012 through continued same-store sales growth and coupled with new restaurants development. We expect a lower effective tax rate and continued share repurchases to drive EPS growth in fiscal 2012 to within our long-range aspirational target of 12% to 15%.

 

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Measure

  

Target

  

Commentary

Capital Expenditures

• Canada and U.S.

 

• Canadian Advertising Fund(1)

  

 

$220 million – $260 million

 

 

Up to $100 million

  

 

Our increased level of capital expenditures in 2012 compared to last year reflects enhanced design elements and continued restaurant development activity in both Canada and the U.S., and our share of investments to increase drive-thru capacity in Canada, including a number of initiatives such as selectively implementing order station relocations, double-order stations and, double-lane drive-thrus. Our increased capital expenditures also reflect investments to accelerate renovations in Canada, which will feature more contemporary design elements similar to our new restaurant development sites. In addition, our Canadian advertising fund will be investing up to $100 million to expand the use of digital menu boards in our Canadian restaurants in fiscal 2012, along with new drive-thru rotating menu boards, which we believe will benefit our guests and our restaurant system.

 

(1) 

These expenditures are expected to be funded primarily with third-party financing, secured by the Canadian advertising fund’s assets. As we consolidate our advertising funds as VIEs for accounting purposes, this transaction will be reflected in our Consolidated Financial Statements accordingly.

Strategic Plan Aspirations (2010-2013)

 

   

EPS compounded annual growth from 2011 through to the end of 2013 is expected to be between 12% to 15%;

 

   

New restaurant development from 2010 to the end of 2013:

 

   

Canada: approximately 600;

 

   

U.S.: approximately 300;

 

   

Total North America: approximately 900; and

 

   

Compounded annual growth of operating income of 8% to 10% to the end of 2013 (excluding the 2010 impact of the disposition of our 50% joint-venture interest in Maidstone Bakeries and the U.S. asset impairment and related closure costs).

Notes:

Earnings aspirations exclude items such as the 2010 impact of the disposition of our 50% joint-venture interest in Maidstone Bakeries, U.S. asset impairment and related closure costs, and CEO separation costs in 2011.

With respect to our 2012 restaurant opening target set forth above in our 2012 performance targets, we are planning to open approximately two-thirds standard format and one-third non-standard format restaurants in Canada per historical norms. In the U.S., we expect the restaurant formats to be evenly split between standard and non-standard full-serve locations. In addition, we expect to complement the U.S. locations with self-serve kiosk locations to enhance convenience for our guests. In the GCC, we expect the restaurant formats to consist of a combination of standard and non-standard restaurants.

 

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The performance targets and aspirational goals (collectively, “targets”) established for 2012 and longer-term are based on the accounting, tax, and/or other legislative and regulatory rules in place at the time the targets were issued and on the continuation of share repurchase programs relatively consistent with historical levels. The impact of future changes in accounting, tax; and/or other legislative and regulatory rules that may or may not become effective in fiscal 2012 and/or future years; changes to our share repurchase activities; and accounting, tax, audit or other matters not contemplated at the time the targets were established that could affect our business, were not included in the determination of these targets. In addition, the targets are forward-looking and are based on our expectations and outlook on, and shall be effective only as of, the date the targets were originally issued.

Except as required by applicable securities laws, we do not intend to update these targets. You should refer to the Company’s public filings for any reported updates. These targets and our performance generally are subject to various risks and uncertainties and are based on certain underlying assumptions, set forth in Item 1A. Risk Factors of this Annual Report, which may impact future performance and our achievement of these targets.

Selected Operating and Financial Highlights

 

($ in millions, except per share data)

   Fiscal Years(1)  
     2011     2010     2009  

Systemwide sales growth(2)(3)

     7.4     6.2     7.9

Same-store sales growth

      

Canada

     4.0     4.9     2.9

U.S.

     6.3     3.9     3.2

Systemwide restaurants

     4,014        3,750        3,578   

Revenues

   $ 2,853.0      $ 2,536.5      $ 2,438.9   

Operating income

   $ 569.5      $ 872.2      $ 525.6   

Adjusted operating income(4)

   $ 567.8      $ 519.3      $ 466.1   

Net income attributable to Tim Hortons Inc.

   $ 382.8      $ 624.0      $ 296.4   

Basic earnings per share attributable to Tim Hortons Inc.

   $ 2.36      $ 3.59      $ 1.64   

Diluted earnings per share attributable to Tim Hortons Inc.

   $ 2.35      $ 3.58      $ 1.64   

Weighted average number of shares of common shares outstanding – Basic
(in millions)

     162.1        174.0        180.5   

Weighted average number of shares of common shares outstanding – Diluted (in millions)

     162.6        174.2        180.6   

 

(1) 

Fiscal years include 52 weeks, except for fiscal 2009, which consisted of 53 weeks.

(2) 

Systemwide sales growth for fiscal 2010 and fiscal 2009 measured on a year-over-year 52-week basis was 7.9% and 6.1%, respectively.

(3) 

Total systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. U.S. dollar sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes sales from our Republic of Ireland and United Kingdom licensed locations. Systemwide sales growth in Canadian dollars, which includes the effects of foreign currency translation, was 7.1% and 5.3% for fiscal 2011 and fiscal 2010, respectively.

(4) 

Adjusted operating income is a non-GAAP measure. As applicable, adjusted operating income for fiscal years 2011, 2010, and 2009 deducts the gain on the sale of our interest in Maidstone Bakeries which was sold in the fourth quarter of fiscal 2010, and 100% of operating income and other Maidstone Bakeries related adjustments, and adds back the CEO Separation Agreement, the $30.0 million allocation to restaurant owners, and the net impact of the asset impairment charge and closure costs specific to our New England region in the U.S (see (a) below). In addition, we have adjusted operating income for fiscal 2009 to deduct the 53rd week of operations.

 

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Management uses adjusted operating income to assist in the evaluation of year-over-year performance, and believes that it will be helpful to investors as a measure of underlying growth rates. This non-GAAP measure is not intended to replace the presentation of our financial results in accordance with GAAP. The Company’s use of the term adjusted operating income may differ from similar measures reported by other companies. The reconciliation of operating income, a GAAP measure, to adjusted operating income, a non-GAAP measure, is set forth in the table below:

 

     Fiscal Year     Change
from prior
year
 
     2011     2010     %  
     (in millions)        

Operating income

   $ 569.5      $ 872.2        (34.7 )% 

Add: CEO Separation Agreement

     6.3               n/m   

Add: Restaurant owner allocation

            30.0        n/m   

Add: Net asset impairment and closure costs(a)

     0.4        28.3        n/m   

Less: Amortization of Maidstone Bakeries supply agreement

     (8.3     (1.3     n/m   

Less: Gain on sale of our interest in Maidstone Bakeries

            (361.1     n/m   

Less: Maidstone Bakeries operating income(b)

            (48.9     n/m   
  

 

 

   

 

 

   

 

 

 

Adjusted operating income(c)

   $ 567.8      $ 519.3        9.4
  

 

 

   

 

 

   

 

 

 

 

All numbers rounded

n/m – The comparison is not meaningful

(a) 

The Net asset impairment and closure costs charge of $0.4 million in fiscal 2011 included an asset impairment charge of $1.9 million, of which $0.9 million related to VIEs, net of a $1.5 million recovery of previously accrued closure costs. In fiscal 2010, the asset impairment and closure costs related to our Portland, Providence and Hartford markets in the New England region of our U.S. operations.

(b) 

Maidstone Bakeries operating income included income from the first 10 months of fiscal 2010 prior to the sale.

(c) 

Includes operating income for non-owned restaurants that we consolidate as VIEs of $3.5 million and $2.1 million in fiscal 2011 and fiscal 2010, respectively. Approximately 0.5% of adjusted operating income growth was related to VIEs.

 

     Fiscal Year     Change
from prior
year
 
     2010     2009     %  
     (in millions)        

Operating income

   $ 872.2      $ 525.6        66.0

Add: Asset impairment and related closure costs(a)

     28.3               n/m   

Add: Restaurant owner allocation

     30.0               n/m   

Less: Gain on sale of our interest in Maidstone Bakeries

     (361.1            n/m   

Less: Maidstone Bakeries operating income(b)

     (48.9     (52.4     n/m   

Less: Amortization of Maidstone Bakeries supply agreement

     (1.3            n/m   

Less: 53rd week operating impact

            (7.1     n/m   
  

 

 

   

 

 

   

 

 

 

Adjusted operating income(c)

   $ 519.3      $ 466.1        11.4
  

 

 

   

 

 

   

 

 

 

 

All numbers rounded

n/m – The comparison is not meaningful.

(a) 

The Asset impairment and related closure costs in fiscal 2010 related to our Portland, Providence and Hartford markets in the New England region of our U.S. operations.

 

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(b) 

Maidstone Bakeries operating income included the first 10 months of fiscal 2010 prior to the sale, whereas fiscal 2009 included a full year of operating income.

(c) 

Includes operating income for non-owned restaurants that we consolidate as VIEs of $2.1 million and $1.6 million in fiscal 2010 and fiscal 2009, respectively. Approximately 0.1% of adjusted operating income growth was related to VIEs.

Systemwide Sales Growth

Systemwide sales growth, which excludes the effects of foreign exchange, was 7.4% as a result of continued same-store sales growth in Canada and the U.S, and new restaurant expansion in fiscal 2011 and 2010.

Our financial results are driven largely by changes in systemwide sales primarily in Canada and the U.S., which include restaurant-level sales at both franchised and Company-operated restaurants, although approximately 99.6% of our system is franchised. Franchised restaurant sales are reported to us by our restaurant owners. Franchised restaurant sales are not included in our Consolidated Financial Statements, other than approximately 272 non-owned restaurants, on average, for fiscal 2011, whose results of operations are consolidated with ours as VIEs. The amount of systemwide sales impacts our royalties and rental income, as well as our distribution income. Changes in systemwide sales are driven by changes in same-store sales and changes in the number of restaurants (i.e., historically, the net addition of new restaurants) and are ultimately driven by consumer demand. Systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. Foreign currency sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes sales from our Republic of Ireland and United Kingdom licensed locations as these locations operate on a significantly different business model compared to our North American and other international operations.

Same-Store Sales Growth

Same-store sales growth represents growth, on average, in retail sales at restaurants (franchised and Company-operated restaurants) operating systemwide that have been open for thirteen or more months. It is one of the key metrics we use to assess our performance and provides a useful comparison between periods. Our same-store sales growth is generally attributable to several key factors, including new product introductions, improvements in restaurant speed of service and other operational efficiencies, hospitality initiatives, frequency of guest visits, expansion into, and enhancement of, broader menu offerings, promotional activities and pricing. Restaurant-level price increases are primarily used to offset higher restaurant-level costs on key items such as coffee and other commodities, labour, supplies, utilities and business expenses. There can be no assurance that these price increases will result in an equivalent level of sales growth, which depends upon guests maintaining the frequency of their visits and same volume of purchases at the new pricing.

In fiscal 2011, Canadian same-store sales increased 4.0% over fiscal 2010, which was our 20th consecutive annual increase in Canada. In the U.S., same-store sales (measured in U.S. dollars) increased 6.3% in fiscal 2011 over fiscal 2010, which represented our 21st consecutive annual increase.

Product innovation is one of our long-standing, focused strategies to drive same-store sales growth, including innovation at breakfast, lunch and snacking dayparts. We had strong menu development in fiscal 2011 that was designed to provide our guests with additional menu choices by providing a number of new, quality products at various price points. We introduced Specialty Bagels, and we enhanced our prepared food offering with the introduction of new breakfast sandwich variations with Ham and BELT options, our Beef Lasagna Casserole (Canada only) and the Panini sandwich launch (U.S. only). We also added 2 new drink categories to our menu, Real Fruit Smoothies and, more recently, Lattes and Espresso-based specialty drinks. Marketing and promotional activities coupled with operating efficiencies and initiatives, during fiscal 2011, also supported same-store sales growth in both Canada and the U.S.

 

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The following tables set forth same-store sales growth by quarter for the 2011, 2010, and 2009 fiscal years and by fiscal year for the 10-year period from 2002 to 2011. Our historical same-store sales trends are not necessarily indicative of future results.

 

     Historical Same-Store Sales Increase  
     1st Quarter     2nd Quarter     3rd Quarter     4th Quarter     Year  

Canada

          

2011

     2.0     3.8     4.7     5.5     4.0

2010

     5.2     6.4     4.3     3.9     4.9

2009

     3.4     1.7     3.1     3.4     2.9

U.S.

          

2011

     4.9     6.6     6.3     7.2     6.3

2010

     3.0     3.1     3.3     6.3     3.9

2009

     3.2     3.3     4.3     2.1     3.2

 

    

Canada

   

U.S.

 

2011

     4.0     6.3

2010

     4.9     3.9

2009 *

     2.9     3.2

2008

     4.4     0.8

2007

     6.1     4.1

2006

     7.7     8.9

2005

     5.5     7.0

2004 *

     7.8     9.8

2003

     5.3     4.5

2002

     7.9     9.9

10-year average

     5.7     5.8

 

* Indicates fiscal years that had 53 weeks; for calculation of same-store sales increase, the comparative base also includes 53 weeks.

 

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New Restaurant Development

Opening restaurants in new and existing markets in Canada and the U.S. has been a significant contributor to our growth. Below is a summary of restaurant openings and closures for our 2011, 2010, and 2009 fiscal years:

 

    Fiscal Year 2011              Fiscal Year 2010             Fiscal Year 2009  
    Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total              Full-serve
Standard  and
Non-standard
    Self-serve
Kiosks
    Total             Full-serve
Standard  and
Non-standard
    Self-serve
Kiosks
    Total  

Canada

                           

Restaurants opened

    166        9        175              129        20        149            128        3        131   

Restaurants closed

    (26     (2     (28           (16            (16         (29     (4     (33
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

Net change

    140        7        147              113        20        133            99        (1     98   
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

U.S.

                           

Restaurants opened

    72        42        114              44        52        96            45               45   

Restaurants closed

    (2            (2           (39     (18     (57         (1     (1     (2
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

Net change

    70        42        112              5        34        39            44        (1     43   
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

International

                           

Restaurants opened

    5               5                                                       
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

Total Company

                           

Restaurants opened

    243        51        294              173        72        245            173        3        176   

Restaurants closed

    (28     (2     (30           (55     (18     (73         (30     (5     (35
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

Net change

    215        49        264              118        54        172            143        (2     141   
 

 

 

   

 

 

   

 

 

         

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

 

From the beginning of fiscal 2009 to the end of fiscal 2011, we opened 577 system restaurants, net of restaurant closures, including both full-serve and self-serve locations. Typically, 20 to 40 system restaurants are closed annually, the majority of which have been in Canada. Restaurant closures made in the normal course of operations may result from an opportunity to acquire a more suitable location, which will permit us to upgrade size and layout or add a drive-thru and typically occur at the end of a lease term or the end of the useful life of the principal asset. We have also closed, and may continue to close, restaurants for which the restaurant location has performed below our expectations for an extended period of time, and/or we believe that sales from the restaurant can be absorbed by surrounding restaurants. In fiscal 2010, we closed 34 standard restaurants and 18 self-serve kiosks in the New England region and 2 in our Portland market, all of which arose from strategic profitability reviews of our U.S. operations.

Self-serve locations generally have significantly different economics than our full-serve restaurants, including substantially less capital investment, as well as significantly lower sales in their respective markets and, therefore, lower associated royalties and distribution income. In the U.S., self-serve locations are intended to increase our brand presence and create another outlet to drive convenience, which we believe is important in our developing markets. In Canada, we have recently used self-serve kiosks in locations where existing full-service locations are at capacity.

One of our strategic planning initiatives is to grow differently in ways we have not grown before. Initiatives in support of this strategy include the expansion of our Cold Stone Creamery® co-branding concept. In fiscal 2009, we began to co-brand certain U.S. restaurants with Cold Stone Creamery and, in the second half of fiscal 2009, we expanded this initiative into Canada. We have exclusive development rights in Canada, and certain rights to use licenses within the U.S. where a Cold Stone Creamery is located within a Tim Hortons restaurant, to operate ice cream and frozen confection retail outlets. As of January 1, 2012, we had 232 co-branded locations, including 133 co-branded locations in Tim Hortons restaurants in Canada and 99 co-branded locations in the U.S. (92 in Tim Hortons restaurants and 7 in Cold Stone Creamery locations).

 

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In addition, we opened 5 locations in the Gulf Cooperation Council (“GCC”) under our master license agreement with Apparel FZCO (“Apparel”) in the second half of fiscal 2011. The master license agreement with Apparel is primarily a royalty-based model that also includes an upfront license fee, opening fees per location, and distribution sales. Apparel is responsible for the capital spending and real estate development to open restaurants, along with operations and marketing.

Tim Hortons restaurant design generally evolves with changing business and guest needs. In fiscal 2010, we began testing an enhanced restaurant design in certain U.S. markets to further differentiate our brand as a cafe and bake shop destination. We have completed our testing of this enhanced design, and based on results, we are now applying significant elements of the enhanced design in all new restaurants in the U.S., including certain interior and exterior design treatments, menu items, equipment and fixtures. In 2012, we are also incorporating various elements from this design into our new Canadian restaurants as well as renovations.

The following table shows our restaurant count as of the end of fiscal 2011, 2010 and 2009 and provides a breakdown of our Company-operated and franchised restaurants.

Systemwide Restaurant Count

 

     Fiscal Year  
     2011     2010     2009  

Canada

      

Company-operated

     10        16        13   

Franchised – standard and non-standard

     3,166        3,020        2,904   

Franchised – self-serve kiosks

     119        112        98   
  

 

 

   

 

 

   

 

 

 

Total

     3,295        3,148        3,015   
  

 

 

   

 

 

   

 

 

 

% Franchised

     99.7     99.5     99.6

U.S.

      

Company-operated

     8        4        5   

Franchised – standard and non-standard

     542        475        471   

Franchised – self-serve kiosks

     164        123        87   
  

 

 

   

 

 

   

 

 

 

Total

     714        602        563   
  

 

 

   

 

 

   

 

 

 

% Franchised

     98.9     99.3     99.1

International (GCC)

      

Franchised – standard

     5                 
  

 

 

   

 

 

   

 

 

 

% Franchised

     100.0     n/a        n/a   

Total system

      

Company-operated

     18        20        18   

Franchised – standard and non-standard

     3,713        3,495        3,375   

Franchised – self-serve kiosks

     283        235        185   
  

 

 

   

 

 

   

 

 

 

Total

     4,014        3,750        3,578   
  

 

 

   

 

 

   

 

 

 

% Franchised

     99.6     99.5     99.5

Segment Operating Income (Loss)

Systemwide sales and same-store sales growth is affected by the business and economic environments in Canada and the U.S. We manage and review financial results from Canadian and U.S. operations separately. We, therefore, have determined the reportable segments for our business to be the geographic locations of Canada and the U.S. Each segment includes the gross operating results of all manufacturing and distribution operations that are located in their respective geographic locations. We continue to manage the development of our international

 

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operations in the Republic of Ireland and the United Kingdom, which consist primarily of branded, licensed self-serve kiosk locations, corporately. In addition, our international operations now include our expansion into the GCC, which is in its early stages and is also being managed corporately. As such, results from these operations are included in Corporate charges in our segmented operating results and, currently, are not significant. Our reportable segments generally exclude VIEs’ financial results, reflective of the way our business is managed.

The following tables contain information about the operating income (loss) of our reportable segments:

 

     Fiscal 2011 Compared to Fiscal 2010  
     2011     % of
Revenues
    2010     % of
Revenues
    Change  
             Dollars     Percentage  
     ($ in thousands)  

Operating Income (Loss)

            

Canada(1)

   $ 607,749        21.3   $ 916,877        36.1   $ (309,128     (33.7 )% 

U.S.

     15,106        0.5     (18,363     (0.7 )%      33,469        n/m   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reportable segment operating income(1)

     622,855        21.8     898,514        35.4     (275,659     (30.7 )% 

VIEs

     3,531        0.1     26,534        1.0     (23,003     n/m   

Corporate charges(1) (2)

     (56,911     (1.9 )%      (52,810     (2.1 )%      (4,101     7.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

   $ 569,475        20.0   $ 872,238        34.4   $ (302,763     (34.7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Fiscal 2010 Compared to Fiscal 2009  
     2010     % of
Revenues
    2009     % of
Revenues
    Change  
             Dollars     Percentage  
     ($ in thousands)  

Operating Income (Loss)

            

Canada(1)

   $ 916,877        36.1   $ 542,018        22.2   $ 374,859        69.2

U.S.

     (18,363     (0.7 )%      4,840        0.2     (23,203     n/m   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reportable segment operating income(1)

     898,514        35.4     546,858        22.4     351,656        64.3

VIEs

     26,534        1.0     27,762        1.1     (1,228     (4.4 )% 

Corporate charges(1) (2)

     (52,810     (2.1 )%      (49,018     (2.0 )%      (3,792     7.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

   $ 872,238        34.4   $ 525,602        21.6   $ 346,636        66.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

n/m – The comparison is not meaningful.

(1) 

Beginning in fiscal 2011, we modified certain allocation methods resulting in changes in the classification of certain costs, with the main change being corporate information technology infrastructure costs are now included in Corporate charges rather than in the Canadian operating segment. This change has been consistently applied for all comparative periods.

(2) 

Corporate charges include overhead costs that support all business segments, and the operating results associated with our international operations (discussed above), which are being managed corporately.

Fiscal 2011 compared to Fiscal 2010

A number of events occurring in both fiscal 2011 and fiscal 2010 operating income, as outlined below, significantly impact the comparability of results year-over-year. Consolidated operating income declined by $302.8 million in fiscal 2011 to $569.5 million from $872.2 million in fiscal 2010.

Our Canadian segment included the disposition of our 50% joint-venture interest in Maidstone Bakeries in October 2010, which resulted in a significant gain on the sale of $361.1 million, partially offset by a related $30 million restaurant owner allocation. In addition, prior to the sale of Maidstone Bakeries, we consolidated 100% of its results as a VIE. As such, our fiscal 2010 consolidated operating income included 100% of Maidstone

 

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Bakeries operating income prior to the sale, which was $48.9 million. For reportable segment purposes, 50% of Maidstone Bakeries operating income was included in Canada and the remaining 50% was included in VIEs, which was consistent with the underlying legal ownership of Maidstone Bakeries and ultimately, with the views of our chief decision maker. Amortization of $8.3 million and $1.3 million related to the deferred gain allocated to our continuing supply agreement with Maidstone Bakeries was included in fiscal 2011 and fiscal 2010, respectively, as a positive contribution to earnings. In total, these items represented $348.6 million of the decrease in operating income for our Canadian segment year-over-year.

Our U.S. segment included asset impairment and related closure costs of $28.3 million in fiscal 2010 related to certain markets in the New England region, as we determined that the future expected cash flows of these markets were insufficient to recover the carrying value of the long-lived assets in these markets, and we closed 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets and 2 restaurants in our Portland market. The Providence and Hartford markets were among the most densely penetrated market areas in the U.S. by quick service restaurants, and while progress was achieved, we were ultimately not successful in expanding our customer base to the levels required for future profitability within a reasonable period of time. In fiscal 2011, we recorded an asset impairment charge, net of a recovery of previously accrued closure costs, of $0.4 million. Approximately $0.9 million related to our U.S. VIEs, whereas our U.S. segment included a net recovery of $0.5 million related to the reversal of previously accrued closure costs, net of an asset impairment charge. In total, these items represented $28.9 million of the increase in operating income for our U.S. segment year-over-year.

Adjusted operating income, which excludes the 2 above-noted items and the CEO Separation Agreement (see non-GAAP reconciliation table on page 59), increased by $48.5 million in fiscal 2011, or 9.4%. The underlying growth was driven primarily by our Canadian operating segment, with strong systemwide sales resulting from same-store sales growth at existing locations and incremental systemwide sales at new restaurants, both of which drove higher rents and royalties and distribution income. Our U.S. segment’s strong systemwide sales growth resulted in significant underlying operating income growth year-over-year. Absent the CEO Separation Agreement, corporate charges were lower and, coupled with improved VIE income (excluding the asset impairment charge), also contributed favourably to our growth.

Canada

In fiscal 2011, operating income for our Canadian segment was $607.7 million compared to $916.9 million in fiscal 2010. Excluding the above-noted items totaling $348.6 million, the underlying operating income of our Canadian segment increased $39.5 million, or 7.0%, from $560.0 million in fiscal 2010 to $599.5 million in fiscal 2011, primarily due to systemwide sales growth of 7.3%, driven by same-store sales growth of 4.0% and incremental sales from the net addition of 147 new restaurants during the year. Comparatively, systemwide sales growth was 7.9% in fiscal 2010 (52 week basis), including same-store sales growth of 4.9% and incremental sales from the net addition of 133 restaurants. Total restaurant transactions in fiscal 2011 continued to grow as a result of the net addition of new restaurants.

Same-store sales growth in fiscal 2011 was driven by an increase in average cheque, which benefited from both favourable product mix and pricing. Our product mix was favourably influenced by a strong promotional calendar, including new breakfast sandwich variations with Ham and BELT options, our new Beef Lasagna Casserole, as well as the introduction of our Specialty Bagels. We also launched 2 new drink categories with our popular Real Fruit Smoothies, and more recently, our Espresso-based specialty coffee products. Partially offsetting these growth factors was continued economic weakness and generally challenging macro operating conditions, which we believe were factors that led to slightly lower same-store transactions in 2 quarters of fiscal 2011.

We opened 175 restaurants in Canada, of which 9 were self-serve kiosks, and closed 28 restaurants, of which 2 were self-serve kiosks, in fiscal 2011. Comparatively, we opened 149 restaurants (including 20 self-serve kiosks) and closed 16 restaurants in fiscal 2010. Our new restaurant development was skewed more heavily toward the fourth quarter in each year.

 

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Canadian systemwide sales growth drove higher rents and royalties income, as well as higher income from our distribution business. The distribution business also benefited from incremental income related to new products in our supply chain. Distribution is a critical element of our business model as it allows us to manage costs to our restaurant owners and service our restaurants efficiently and effectively while contributing to our profitability. Partially offsetting this growth in segment operating income were higher general and administrative expenses, due largely to additional headcount required to support the growth of our business as well as investments in our co-branding strategy. In addition, we incurred start-up and transition costs associated with the ramp up of our replacement distribution facility in Kingston, Ontario, which began in late July 2011 and is now capable of supplying refrigerated and frozen products, in addition to its previous dry products capabilities, to restaurant owners in eastern Ontario and Quebec. The Kingston facility was servicing approximately 530 restaurants by the end of fiscal 2011.

U.S.

In fiscal 2011, operating income from our U.S. segment was $15.1 million compared to an operating loss of $18.4 million. Excluding of the above-noted items totaling $28.9 million, the underlying operating income of our U.S. segment increased 46.7% to $14.6 million in fiscal 2011, from $9.9 million in fiscal 2010. We continued to make significant improvements in our U.S. segment profitability despite a persistently challenging macro-economic climate in many of our core markets in the U.S. Systemwide sales growth of 8.4% was driven by same-store sales growth of 6.3% and growth of 5.9% from the net addition of 70 full-serve restaurants to the system year-over-year, partially offset by the closure of restaurants in the New England region late in fiscal 2010.

Same-store sales growth in fiscal 2011 was driven primarily by an increase in average cheque, which benefited from pricing in the system and from a favourable product mix, and moderately higher transactions contributed to the growth as well. Our product mix was favourably influenced by a strong promotional calendar, including our new Panini Sandwiches launched late in fiscal 2011, and Specialty Bagels. In addition, we promoted our popular Real Fruit Smoothies, new Frozen Lemonade and, similar to Canada, we recently introduced our Espresso-based specialty coffee products. Moderately higher transactions during fiscal 2011 were supported by these new products and our enhanced menu, and by increased marketing and promotional efforts, which were designed to increase brand awareness, and guest traffic.

We opened 114 restaurants in the U.S., of which 72 were full-serve standard and non-standard restaurants, and closed 2 restaurants in fiscal 2011. Comparatively, we opened 96 restaurants (including 52 self-serve kiosks) and closed 57 restaurants in fiscal 2010, of which 52 were in the New England region and 2 to were in our Portland market. Similar to Canada, our new restaurant development in the U.S. was skewed more heavily toward the fourth quarter in each year. Although self-serve kiosks contribute minimally to systemwide sales and operating earnings, they are one of the ways we seed our brand and offer convenience to our guests in a capital efficient manner.

U.S. systemwide sales growth drove higher rents and royalties income, as well as higher income from our distribution business. Our distribution business also benefited from incremental income related to new products in our supply chain. The closure of certain underperforming restaurants, in fiscal 2010, contributed approximately $5.3 million to the improvement in the U.S. segment operating income due to lower relief and lower depreciation and support costs. Partially offsetting this growth was the reinvestment of approximately $4.0 million of our savings from these closed restaurants into our core U.S. growth markets in Northeast and Midwest U.S. in fiscal 2011 by increasing our advertising and marketing scale to expand awareness of our brand. We believe that this investment was one of the key drivers of our U.S. systemwide sales performance in fiscal 2011.

We are typically able to identify restaurant owners for new restaurants, but in certain developing markets, it may be more challenging; however, it has not historically been a major impediment to our growth. Despite the current economic climate and credit conditions, our restaurant owners continue to have access to lending programs with third-party lenders, although processing may take longer and costs may be higher, consistent with prevailing market conditions. We continue to experience a higher number of past-due notes under our franchise

 

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incentive program (“FIP”), with approximately 88% of the notes past due as of January 1, 2012. In many cases, we have also chosen to hold the note for a longer period of time than we have historically done to allow the restaurant more time to achieve certain profitability targets or to accommodate a restaurant owner seeking to obtain third-party financing. If a restaurant owner does not repay the note, we are able to take back ownership of the restaurant and equipment, based on the terms of the underlying franchise agreement, which collateralizes the note and, therefore, minimizes our credit risk. In fiscal 2011, we began entering into operator agreements more frequently than full franchise agreements when opening new restaurants, which are not eligible for a FIP. After these restaurant are established and reach certain profitability measures, we may sell the restaurant to the operator under a full franchise agreement with the restaurant owner’s financing provided by a third-party rather than through a FIP arrangement.

Variable interest entities

Our VIEs income before income tax pertains to the entities that, for accounting purposes, we are deemed to be the primary beneficiary. These entities included Maidstone Bakeries, until the date of the sale of our 50% joint-venture interest in October 2010, and certain non-owned restaurants. In fiscal 2011, the income attributable to VIEs was $3.5 million, compared to $26.5 million in fiscal 2010, of which Maidstone Bakeries represented $24.4 million. Operating income of $3.5 million from non-owned restaurants in fiscal 2011 was driven by Canada contributing $3.9 million and was partially offset by a loss of $0.4 million from the U.S. The U.S. loss was due to an asset impairment charge of $0.9 million related to the Portland market. In fiscal 2010, non-owned consolidated restaurants contributed $2.1 million of operating income, primarily from Canadian VIEs with $3.1 million, partially offset by a loss of $1.0 million from U.S. VIEs. The majority of the restaurants we closed in the New England region in the fourth quarter of fiscal 2010 were previously included within our U.S. non-owned consolidated restaurants. These restaurants were underperforming restaurants and thus negatively impacted the overall operating profit from VIEs within the U.S. in fiscal 2010. We consolidated 272 and 275 non-owned restaurants, on average, in fiscal 2011 and 2010, respectively. Approximately 61% of non-owned restaurants that we consolidated were U.S. non-owned consolidated restaurants (approximately 65% in fiscal 2010). These U.S. locations have historically had lower revenues and income than Canadian non-owned consolidated restaurants.

Corporate charges

Corporate charges include overhead costs that support all business segments, and the operating results associated with our international operations, which continue to be managed corporately. Corporate charges were $56.9 million in fiscal 2011 and $52.8 million in fiscal 2010. The primary factor contributing to higher Corporate charges year-over-year was the $6.3 million charge related to the CEO Separation Agreement, partially offset by lower professional fees due to spending on a number of corporate initiatives in fiscal 2010 that did not recur in fiscal 2011.

The Company has 261 branded, licensed locations in the Republic of Ireland and in the United Kingdom, which are primarily self-serve kiosks operating under the “Tim Hortons” brand (275 in fiscal 2010). These kiosks are operated by independent licensed retailers. The distribution of coffee and donuts through licensed locations with respect to these self-serve kiosks is not a material contributor to our net income and, therefore, is netted in Corporate charges.

We have a master license agreement with Apparel to develop up to 120 multi-format restaurants over a 5-year period in the GCC. Under this agreement, 5 full-serve, franchised restaurants were opened in the United Arab Emirates within the GCC during the second half of fiscal 2011. We are currently managing our international expansion corporately.

Our top priority continues to be growing our Canadian and U.S. businesses. Operating results from our Irish, United Kingdom and GCC international operations are currently not significant.

 

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Fiscal 2010 compared to Fiscal 2009

Reportable segment operating income increased $351.7 million, or 64.3%, in fiscal 2010 to $898.5 million compared to $546.9 million in fiscal 2009, and, as a percentage of total revenues, was 35.4% and 22.4%, respectively. Our Canadian segment included a $361.1 million gain on the sale of our interest in Maidstone Bakeries, less $30.0 million allocated to our restaurant owners and $1.3 million of income relating to the amortization of our deferred gain in connection with our supply agreement with Maidstone Bakeries. Also included in our fiscal 2010 segment operating income are asset impairment and related closure costs of $28.3 million related to certain markets in the New England region that was recorded in our U.S. segment. Excluding the gain on sale and related impacts, allocation to restaurant owners and asset impairment and related closure costs, reportable segment operating income would have increased $47.6 million, or 8.7%. Fiscal 2010 had 52 weeks of operations whereas fiscal 2009 included a 53rd week of operations. The 53rd week reduced fiscal 2010 segment revenues and reportable segment operating income growth rates by approximately 1.8% and 1.3%, respectively.

Canada

Exclusive of the items described above, our Canadian segment operating income increased $42.5 million, or 7.8%, from $542.0 million in fiscal 2009 to $584.5 million in fiscal 2010, primarily due to systemwide sales increases and increased contribution from our distribution business. Canadian same-store sales growth was 4.9% in fiscal 2010, which includes some pricing benefits. In fiscal 2010, we opened 149 restaurants in Canada and closed 16, compared to opening 131 restaurants and closing 33 in fiscal 2009. Transaction growth continued to add to same-store sales growth, benefiting from menu initiatives, promotions, and operational initiatives such as our hospitality program. We also co-branded 78 locations in fiscal 2010 with Cold Stone Creamery, which contributed slightly to the segment’s same-store sales growth and contributed positively to our Canadian franchise fee income. The 53rd week reduced our fiscal 2010 operating income growth rate by approximately 1.4% in Canada.

Canadian systemwide sales growth drove higher rents and royalties income, as well as higher income from our distribution business. The distribution business also benefited from incremental income related to new products in our supply chain. Also contributing to our Canadian segment operating income growth was our new coffee roasting facility in Hamilton, Ontario, which began operations in the fourth quarter of fiscal 2009. Partially offsetting this growth in segment operating income were higher general and administrative expenses, due largely to additional headcount required to support the growth of our business as well as investments in our hospitality and co-branding strategies and lower franchise fee income primarily due to a shift in mix of restaurant type openings to a greater number of non-standard restaurants with lower franchise fees. Our Canadian segment operating income included 50% of operating income from our previously-held interest in Maidstone Bakeries. Due to the sale of our 50% interest in Maidstone Bakeries on October 29, 2010, the income in fiscal 2010 only included 10 months of operations, as compared to 12 months in fiscal 2009.

U.S.

In fiscal 2010, our U.S. segment had an operating loss of $18.4 million, compared to operating income of $4.8 million in fiscal 2009. The operating loss was entirely due to the asset impairment and closure costs recorded in the second half of fiscal 2010 relating to our underperforming restaurants in the New England region (described below). Excluding the asset impairment and related closure costs, we would have more than doubled our U.S. segment operating income from fiscal 2009 to $9.9 million in fiscal 2010. This was a considerable improvement over the prior year, due, in large part, to same-store sales growth of 3.9% amid a continued challenging macro-economic climate in many of our core markets in the U.S. The closure of the underperforming restaurants also contributed to the improvement in U.S. segment operating income as it resulted in higher rents and royalties (due primarily to lower relief). The 53rd week had a minimal impact on our fiscal 2010 operating income growth rate in the U.S.

 

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During the third quarter of fiscal 2010, asset impairment and related closure cost charges of $28.3 million were recorded in our U.S. operating segment based on our decision to close 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets and 2 restaurants in our Portland market. These charges were comprised of $18.4 million as an asset impairment charge and $9.9 million in restaurant closure costs representing primarily lease commitment obligations.

We also adapted our marketing and promotional activities to the challenging economic environment and related circumstances. Commencing in fiscal 2009, a number of our competitors also commenced and/or intensified discounting (heightened by the continuing economic challenges in North America) and “combo” or value-pricing practices, as well as free product promotions. This cross-over of brands and menu offerings, and increased competition on price and other factors, continued through fiscal 2010. In fiscal 2010, we continued to offer targeted value-priced food and beverage programs, in addition to the launch of new products at a variety of everyday value price points. In the U.S., we also introduced the use of coupons as a vehicle to attract new customers and introduce them to our brand and new product offerings.

During fiscal 2010, we opened 96 new restaurants, including 52 self-serve kiosks, and closed 39 restaurants and 18 self-serve kiosks in the U.S., as compared to opening 45 new restaurants and closing 2 restaurants, in fiscal 2009. The majority of the self-serve openings in fiscal 2010 were part of an expansion of our strategic alliance with Tops Friendly Markets® and are located in Tops stores in western and central New York, and northern Pennsylvania. Although self-serve kiosks contributed minimally to sales and operating earnings, they are one of the ways we seed our brand and offer convenience to our customers.

Variable interest entities

Our VIEs’ income before income tax pertains to the entities that we are required to consolidate in accordance with applicable accounting rules. These entities include Maidstone Bakeries, until the date of sale of our 50% joint-venture ownership interest, and certain non-owned restaurants. In fiscal 2010, our VIEs’ income before income tax was $26.5 million as compared to $27.8 million in fiscal 2009, of which $24.4 million and $26.2 million related to Maidstone Bakeries, respectively. The year-over-year decrease in income from Maidstone Bakeries is due to only 10 months of income consolidated in our fiscal 2010 results prior to selling our interest on October 29, 2010. We consolidated approximately 275 restaurants on average in fiscal 2010 and 2009, with a greater proportion representing U.S. non-owned consolidated restaurants as a result of the progression of U.S. restaurants to our operator model versus Company-operated restaurants and increased participation in our FIP.

Corporate charges

Corporate charges were $52.8 million in fiscal 2010 and $49.0 million in fiscal 2009. The $3.8 million increase primarily reflects higher salary and benefit costs, of which a significant portion related to increased stock-based compensation costs, reflecting a higher common share price year-over-year. In addition, higher professional fees were incurred relating to corporate initiatives including developing our international strategy. Partially offsetting these higher costs were the professional advisory and shareholder costs associated with our public company reorganization in fiscal 2009 that did not recur in fiscal 2010, which amounted to $7.3 million.

 

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Results of Operations

Fiscal 2011 Compared to Fiscal 2010

Below is a summary of comparative results of operations and a more detailed discussion of results for fiscal 2011 and 2010. Financial definitions can be found immediately following “Liquidity and Capital Resources.”

 

     Fiscal 2011 Compared to Fiscal 2010     Change from Prior
Year
 
     2011     % of
Revenues
    2010     % of
Revenues
    $     %  
     ($ in thousands)  

Revenues

            

Sales

   $ 2,012,170        70.5   $ 1,755,244        69.2   $ 256,926        14.6

Franchise revenues:

            

Rents and royalties(1)

     733,217        25.7     687,039        27.1     46,178        6.7

Franchise fees

     107,579        3.8     94,212        3.7     13,367        14.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     840,796        29.5     781,251        30.8     59,545        7.6