XTSE:THI Tim Hortons Inc Quarterly Report 10-Q Filing - 7/1/2012

Effective Date 7/1/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended July 1, 2012

OR

 

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

For the transition period from             to            

Commission File Number 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)

 

(IRS Employer

Identification Number)

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

905-845-6511

(Registrant’s phone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at August 6, 2012

Common shares   154,933,251 shares

Exhibit Index on page 44.

 

 

 


Table of Contents

TIM HORTONS INC. AND SUBSIDIARIES

INDEX

 

     Pages  

PART I: Financial Information

  

Item 1. Financial Statements (Unaudited):

     3   

Condensed Consolidated Statement of Operations for the second quarters and year-to-date periods ended July 1, 2012 and July 3, 2011

     3   

Condensed Consolidated Statement of Comprehensive Income for the second quarters and year-to-date periods ended July 1, 2012 and July 3, 2011

     4   

Condensed Consolidated Balance Sheet as at July 1, 2012 and January 1, 2012

     5   

Condensed Consolidated Statement of Cash Flows for the year-to-date periods ended July  1, 2012 and July 3, 2011

     6   

Condensed Consolidated Statement of Equity for the year-to-date period ended July  1, 2012 and year ended January 1, 2012

     7   

Notes to the Condensed Consolidated Financial Statements

     8   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     21   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     39   

Item 4. Controls and Procedures

     39   

PART II: Other Information

  

Item 1. Legal Proceedings

     40   

Item 1A. Risk Factors

     40   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     42   

Item 6. Exhibits

     42   

Signature

     43   

Index to Exhibits

     44   

On August 3, 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$1.0014 for Cdn$1.00.

Availability of Information

Tim Hortons Inc., (the “Company”), a corporation incorporated under the Canada Business Corporations Act (the “CBCA”), 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 U.S. Securities and Exchange 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 (“CSA”). The reference to our website address does not constitute incorporation by reference of the information contained on the website into, and should not be considered part of, this document.

Reporting Currency

The majority of the Company’s operations, restaurants and cash flows are based in Canada, and the Company is primarily managed in Canadian dollars. As a result, the Company’s reporting currency is the Canadian dollar. All amounts are expressed in Canadian dollars unless otherwise noted.

 

2


Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TIM HORTONS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)

(in thousands of Canadian dollars, except per share data)

 

     Second quarter ended     Year-to-date period ended  
     July 1, 2012     July 3, 2011     July 1, 2012     July 3, 2011  

Revenues

        

Sales (note 13)

   $ 563,772      $ 498,058      $ 1,087,074      $ 952,535   

Franchise revenues

        

Rents and royalties

     198,973        185,389        379,159        353,219   

Franchise fees

     22,836        19,313        40,632        40,493   
  

 

 

   

 

 

   

 

 

   

 

 

 
     221,809        204,702        419,791        393,712   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     785,581        702,760        1,506,865        1,346,247   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses

        

Cost of sales (note 13)

     493,300        434,051        958,725        836,383   

Operating expenses

     73,068        65,102        139,784        127,256   

Franchise fee costs

     24,794        20,419        45,076        41,736   

General and administrative expenses

     40,395        43,969        80,522        83,965   

Equity (income)

     (3,859     (3,820     (7,105     (6,933

Other (income) expense, net

     (956     (179     (599     19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses, net

     626,742        559,542        1,216,403        1,082,426   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     158,839        143,218        290,462        263,821   

Interest (expense)

     (8,650     (7,427     (16,548     (14,803

Interest income

     723        851        1,434        2,527   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     150,912        136,642        275,348        251,545   

Income taxes (note 2)

     41,675        40,202        76,132        73,691   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     109,237        96,440        199,216        177,854   

Net income attributable to noncontrolling interests (note 12)

     1,170        891        2,370        1,626   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Tim Hortons Inc.

   $ 108,067      $ 95,549      $ 196,846      $ 176,228   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share attributable to Tim Hortons Inc. (note 3)

   $ 0.70      $ 0.58      $ 1.27      $ 1.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share attributable to Tim Hortons Inc. (note 3)

   $ 0.69      $ 0.58      $ 1.26      $ 1.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding (in thousands) — Basic (note 3)

     155,351        163,448        155,589        165,555   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding (in thousands) — Diluted (note 3)

     155,995        163,961        156,207        166,014   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends per common share

   $ 0.21      $ 0.17      $ 0.42      $ 0.34   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

3


Table of Contents

TIM HORTONS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands of Canadian dollars)

 

     Second quarter ended     Year-to-date period ended  
     July 1, 2012     July 3, 2011     July 1, 2012     July 3, 2011  

Net income

   $ 109,237      $ 96,440      $ 199,216      $ 177,854   

Other comprehensive income (loss)

        

Translation adjustments gain (loss)

     8,342        (534     506        (11,765

Unrealized gains (losses) from cash flow hedges (note 8)

        

Gain (loss) from change in fair value of derivatives

     2,114        (2,337     (1,389     (8,898

Amount of net (loss) gain reclassified to earnings during the period

     (800     2,969        (1,948     5,566   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cash flow hedges

     1,314        632        (3,337     (3,332

Tax effect on other comprehensive (loss) income

     (334     (173     951        863   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     9,322        (75     (1,880     (14,234
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     118,559        96,365        197,336        163,620   

Comprehensive income attributable to noncontrolling interests

     1,170        891        2,370        1,626   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Tim Hortons Inc.

   $ 117,389      $ 95,474      $ 194,966      $ 161,944   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

4


Table of Contents

TIM HORTONS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

     As at  
     July 1,
2012
    January 1,
2012
 

Assets

    

Current assets

    

Cash and cash equivalents

   $ 57,733      $ 126,497   

Restricted cash and cash equivalents

     87,292        130,613   

Accounts receivable, net

     200,665        173,667   

Notes receivable, net (note 4)

     7,990        10,144   

Deferred income taxes

     8,142        5,281   

Inventories and other, net (note 5)

     130,550        136,999   

Advertising fund restricted assets (note 12)

     29,325        37,765   
  

 

 

   

 

 

 

Total current assets

     521,697        620,966   

Property and equipment, net

     1,480,954        1,463,765   

Intangible assets, net

     4,060        4,544   

Notes receivable, net (note 4)

     2,162        3,157   

Deferred income taxes

     12,820        12,197   

Equity investments

     42,765        43,014   

Other assets

     70,607        56,307   
  

 

 

   

 

 

 

Total assets

   $ 2,135,065      $ 2,203,950   
  

 

 

   

 

 

 

Liabilities and equity

    

Current liabilities

    

Accounts payable (note 6)

   $ 151,919      $ 177,918   

Accrued liabilities

    

Salaries and wages

     14,599        23,531   

Taxes

     17,787        26,465   

Other (note 6)

     137,311        179,315   

Advertising fund liabilities (note 12)

     78,103        59,420   

Current portion of long-term obligations

     10,572        10,001   
  

 

 

   

 

 

 

Total current liabilities

     410,291        476,650   
  

 

 

   

 

 

 

Long-term obligations

    

Long-term debt

     354,559        352,426   

Capital leases

     97,538        94,863   

Deferred income taxes

     4,738        4,608   

Other long-term liabilities (note 6)

     120,796        120,970   
  

 

 

   

 

 

 

Total long-term obligations

     577,631        572,867   
  

 

 

   

 

 

 

Commitments and contingencies (note 9)

    

Equity

    

Equity of Tim Hortons Inc.

    

Common shares ($2.84 stated value per share), Authorized: unlimited shares. Issued: 155,188,401 and 157,814,980 shares, respectively (note 10)

     440,099        447,558   

Common shares held in Trust, at cost: 370,650 and 277,189 shares, respectively (note 12)

     (15,605     (10,136

Contributed surplus

     11,147        6,375   

Retained earnings

     839,103        836,968   

Accumulated other comprehensive loss

     (130,097     (128,217
  

 

 

   

 

 

 

Total equity of Tim Hortons Inc.

     1,144,647        1,152,548   

Noncontrolling interests (note 12)

     2,496        1,885   
  

 

 

   

 

 

 

Total equity

     1,147,143        1,154,433   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 2,135,065      $ 2,203,950   
  

 

 

   

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

5


Table of Contents

TIM HORTONS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

(in thousands of Canadian dollars)

 

     Year-to-date periods ended  
     July 1,
2012
    July 3,
2011
 

Cash flows provided from (used in) operating activities

    

Net income

   $ 199,216      $ 177,854   

Adjustments to reconcile net income to net cash provided by (used in) operating activities

    

Depreciation and amortization

     61,637        56,564   

Stock-based compensation expense (note 11)

     11,869        11,162   

Deferred income taxes

     (2,081     (2,695

Changes in operating assets and liabilities

    

Restricted cash and cash equivalents

     43,290        (5,886

Accounts receivable

     (32,425     (77,506

Inventories and other

     7,285        (37,996

Accounts payable and accrued liabilities

     (64,156     (64,038

Taxes

     (8,674     (32,902

Other, net

     390        1,711   
  

 

 

   

 

 

 

Net cash provided from operating activities

     216,351        26,268   
  

 

 

   

 

 

 

Cash flows (used in) provided from investing activities

    

Capital expenditures (including Advertising Fund—note 12)

     (97,458     (63,414

Proceeds from sale of restricted investments

     0        38,000   

Other investing activities

     (8,710     (13,467
  

 

 

   

 

 

 

Net cash (used in) investing activities

     (106,168     (38,881
  

 

 

   

 

 

 

Cash flows (used in) provided from financing activities

    

Repurchase of common shares (note 10)

     (136,509     (401,917

Dividend payments to common shareholders

     (65,661     (56,122

Other financing activities (including Advertising Fund—note 12)

     23,445        (5,951
  

 

 

   

 

 

 

Net cash (used in) financing activities

     (178,725     (463,990
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (222     (1,574
  

 

 

   

 

 

 

(Decrease) in cash and cash equivalents

     (68,764     (478,177

Cash and cash equivalents at beginning of period

     126,497        574,354   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 57,733      $ 96,177   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Interest paid

   $ 16,199      $ 14,607   

Income taxes paid

   $ 94,605      $ 120,176   

Non-cash investing and financing activities

    

Capital lease obligations incurred

   $ 13,133      $ 10,925   

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

6


Table of Contents

TIM HORTONS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(Unaudited)

 

     Year-to-date period ended
July 1, 2012
 
     Shares
(in thousands)
    Dollars
(in thousands)
 

Common shares

    

Balance at beginning of period

     157,815      $ 447,558   

Repurchase of common shares (note 10)

     (2,627     (7,459
  

 

 

   

 

 

 

Balance at end of period

     155,188      $ 440,099   
  

 

 

   

 

 

 

Common shares held in Trust

    

Balance at beginning of period

     (277   $ (10,136

Purchased during the period

     (112     (6,139

Disbursed from Trust during the period

     18        670   
  

 

 

   

 

 

 

Balance at end of period

     (371   $ (15,605
  

 

 

   

 

 

 

Contributed surplus

    

Balance at beginning of period

     $ 6,375   

Stock-based compensation

       4,771   
    

 

 

 

Balance at end of period

     $ 11,147   
    

 

 

 

Retained earnings

    

Balance at beginning of period

     $ 836,968   

Net income attributable to Tim Hortons Inc.

       196,846   

Dividends

       (65,661

Stock-based compensation

       0   

Repurchase of common shares—excess of stated value

       (129,050
    

 

 

 

Balance at end of period

     $ 839,103   
    

 

 

 

Accumulated other comprehensive loss

    

Balance at beginning of period

     $ (128,217

Other comprehensive (loss) income

       (1,880
    

 

 

 

Balance at end of period

     $ (130,097
    

 

 

 

Total equity of Tim Hortons Inc.

     $ 1,144,647   
    

 

 

 

Noncontrolling interests

    

Balance at beginning of period

     $ 1,885   

Net income attributable to noncontrolling interests

       2,370   

Distributions, net

       (1,759
    

 

 

 

Balance at end of period

     $ 2,496   
  

 

 

   

 

 

 

Total equity

     154,817      $ 1,147,143   
  

 

 

   

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of business

Tim Hortons Inc. is a corporation governed by the CBCA. References herein to “Tim Hortons,” or the “Company” refer to Tim Hortons Inc. and its subsidiaries, unless specifically noted otherwise.

The Company’s principal business is the development and franchising of quick service restaurants primarily in Canada and the U.S., that serve premium coffee, espresso-based hot and cold specialty drinks, including lattes, cappuccinos and espresso shots, baked goods, sandwiches, soups, prepared foods and other food products. In addition, the Company has vertically integrated manufacturing, warehouse and distribution operations that supply a significant portion of the system restaurants with paper, equipment and food products. The Company also controls the real estate underlying the majority of the system restaurants, which generates another source of revenue.

The following table outlines the Company’s systemwide restaurant counts and activity.

 

     Second quarter ended     Year-to-date period ended  
     July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Systemwide Restaurant Count

        

Franchised restaurants in operation—beginning of period

     4,019        3,766        3,996        3,730   

Restaurants opened

     38        34        68        76   

Restaurants closed

     (10     (5     (12     (15

Net transfers within the franchised system

     3        (6     (2     (2
  

 

 

   

 

 

   

 

 

   

 

 

 

Franchised restaurants in operation—end of period

     4,050        3,789        4,050        3,789   

Company-operated restaurants

     21        22        21        22   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total systemwide restaurants—end of period(1)

     4,071        3,811        4,071        3,811   
  

 

 

   

 

 

   

 

 

   

 

 

 

% of restaurants franchised—end of period

     99.5     99.4     99.5     99.4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes various types of standard and non-standard restaurant formats in Canada, the U.S. and if applicable, the Gulf Cooperation Council (“GCC”) with differing restaurant sizes and menu offerings as well as self-serve kiosks, which serve primarily coffee products and a limited product selection. Collectively, the Company refers to all of these restaurants and kiosks as “systemwide restaurants.”

Excluded from the above systemwide restaurant count table are 243 and 260 primarily licensed locations in the Republic of Ireland and the United Kingdom as at July 1, 2012 and July 3, 2011, respectively.

Basis of presentation and principles of consolidation

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, the accompanying Condensed Consolidated Financial Statements contain all adjustments (all of which are normal and recurring in nature) necessary to state fairly the Company’s financial position as at July 1, 2012 and January 1, 2012, and the condensed consolidated results of operations, comprehensive income and cash flows for the second quarters ended July 1, 2012 and July 3, 2011. All of these financial statements are unaudited. These Condensed Consolidated Financial Statements should be read in conjunction with the 2011 Consolidated Financial Statements which are contained in the Company’s Annual Report on Form 10-K filed with the SEC and the CSA on February 28, 2012. The January 1, 2012 Condensed Consolidated Balance Sheet was derived from the audited 2011 Consolidated Financial Statements, but does not include all of the year-end disclosures required by U.S. GAAP.

The Condensed Consolidated Financial Statements include the results and balances of Tim Hortons Inc., its wholly-owned subsidiaries and certain entities and joint ventures the Company consolidates as variable interest entities (“VIEs”) (see note 12). Intercompany accounts and transactions among consolidated entities have been eliminated upon consolidation. Investments in non-consolidated affiliates over which the Company exercises significant influence, but for which the Company is not the primary beneficiary and does not have control, are accounted for using the equity method. The Company’s share of the earnings or losses of these non-consolidated affiliates is included in equity income, which is included as part of operating income since these investments are operating ventures closely integrated in the Company’s business operations.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

Accounting changes – new accounting standards

Effective January 2, 2012, the Company adopted Accounting Standards Update (“ASU”) No. 2011-04—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements. This ASU resulted in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP. The adoption of this ASU has been reflected in the Company’s related financial disclosures (see note 7).

NOTE 2 INCOME TAXES

The effective income tax rate for the second quarter ended July 1, 2012 was 27.6%, compared to 29.4% for the second quarter ended July 3, 2011. The effective income tax rate for the year-to-date periods ended July 1, 2012 and July 3, 2011 was 27.6% and 29.3%, respectively. The effective tax rate was favourably impacted primarily by the benefit associated with Canadian statutory rate reductions.

The Canada Revenue Agency (“CRA”) continues to conduct its general examination of the Company and various subsidiaries for 2007 and subsequent taxation years. The CRA has extended its examination in respect of certain international issues related to transfer pricing for taxation years 2005 through to 2010. Submissions by the Company are anticipated to be delivered throughout the year to clarify certain assumptions that the CRA is making in its examination. The Company does not currently expect any material impact on earnings to result from the resolution of matters related to open taxation years; however, it is possible that actual settlements may differ from amounts accrued.

NOTE 3 EARNINGS PER COMMON SHARE ATTRIBUTABLE TO TIM HORTONS INC.

 

     Second quarter ended      Year-to-date period ended  
     July 1,
2012
     July 3,
2011
     July 1,
2012
     July 3,
2011
 

Net income attributable to Tim Hortons Inc.

   $ 108,067       $ 95,549       $ 196,846       $ 176,228   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding for computation of basic earnings per common share attributable to Tim Hortons Inc. (in thousands)

     155,351         163,448         155,589         165,555   

Dilutive impact of RSUs(1)

     317         264         311         254   

Dilutive impact of stock options with tandem SARs(2)

     327         249         307         205   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding for computation of diluted earnings per common share attributable to Tim Hortons Inc. (in thousands)

     155,995         163,961         156,207         166,014   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per common share attributable to Tim Hortons Inc.

   $ 0.70       $ 0.58       $ 1.27       $ 1.06   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share attributable to Tim Hortons Inc.

   $ 0.69       $ 0.58       $ 1.26       $ 1.06   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Restricted stock units (“RSUs”).

(2) 

Stock appreciation rights (“SARs”).

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 4 NOTES RECEIVABLE, NET

 

     As at  
     July 1, 2012     January 1, 2012  

Portfolio Segment

   Gross      VIEs (2)     Total     Gross      VIEs (2)     Total  

FIPs (1)

   $ 22,467       $ (16,294   $ 6,173      $ 24,756       $ (16,219   $ 8,537   

Other (3) 

     5,639         0        5,639        6,765         0        6,765   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Notes receivable

   $ 28,106       $ (16,294     11,812      $ 31,521       $ (16,219     15,302   
  

 

 

    

 

 

     

 

 

    

 

 

   

Allowance

          (1,660          (2,001
       

 

 

        

 

 

 

Notes receivable, net

          10,152             13,301   
       

 

 

        

 

 

 

Current portion, net

          (7,990          (10,144
       

 

 

        

 

 

 

Long-term portion, net, discounted

        $ 2,162           $ 3,157   
       

 

 

        

 

 

 
      As at  
     July 1, 2012     January 1, 2012  

Class and Aging

   Gross      VIEs (2)     Total     Gross      VIEs (2)     Total  

Current status (FIPs and other)

   $ 8,172       $ (2,593   $ 5,579      $ 10,471       $ (3,121   $ 7,350   

Past due status < 90 days (FIPs)

     1,237         (906     331        1,276         (686     590   

Past due status > 90 days (FIPs)

     18,697         (12,795     5,902        19,774         (12,412     7,362   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Notes receivable

   $ 28,106       $ (16,294   $ 11,812      $ 31,521       $ (16,219   $ 15,302   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) 

Franchise incentive program (“FIP”).

(2) 

Variable interest entities (“VIEs”) (see note 12).

(3)

Other notes receivable relate primarily to various equipment and other financing programs and a note issued in 2009 to a vendor to finance a property sale.

NOTE 5 INVENTORIES AND OTHER, NET

 

     As at  
     July 1, 2012     January 1, 2012  

Raw materials

   $ 44,928      $ 49,450   

Finished goods

     74,318        77,440   
  

 

 

   

 

 

 
     119,246        126,890   

Inventory obsolescence provision

     (501     (844
  

 

 

   

 

 

 

Inventories, net

     118,745        126,046   

Prepaids and other

     11,805        10,953   
  

 

 

   

 

 

 

Inventories and other, net

   $ 130,550      $ 136,999   
  

 

 

   

 

 

 

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 6 ACCOUNTS PAYABLE, ACCRUED LIABILITIES, OTHER, AND OTHER LONG–TERM LIABILITIES

Accounts payable

 

     As at  
     July 1, 2012      January 1, 2012  

Trade payables

   $ 133,112       $ 145,985   

Construction holdbacks and accruals

     18,807         31,933   
  

 

 

    

 

 

 

Accounts payable

   $ 151,919       $ 177,918   
  

 

 

    

 

 

 

Accrued liabilities, other

 

     As at  
     July 1, 2012      January 1, 2012  

Tim Card obligations to guests

   $ 91,980       $ 125,316   

Contingent rent expense accrual

     10,516         12,698   

Deferred revenue

     9,024         8,847   

Deferred supply contract liability

     7,929         8,335   

Other accrued current liabilities(1)

     17,862         24,119   
  

 

 

    

 

 

 

Accrued liabilities, other

   $ 137,311       $ 179,315   
  

 

 

    

 

 

 

 

(1) 

Includes deposits, and various equipment and other accruals.

Other long-term liabilities

 

     As at  
     July 1, 2012      January 1, 2012  

Deferred supply contract liability

   $ 19,519       $ 23,281   

Accrued rent leveling liability

     29,416         29,564   

Uncertain tax position liability

     32,448         30,531   

Stock-based compensation liabilities

     23,396         19,861   

Other accrued long-term liabilities (1)

     16,017         17,733   
  

 

 

    

 

 

 

Other long-term liabilities

   $ 120,796       $ 120,970   
  

 

 

    

 

 

 

 

(1) 

Includes deferred revenues and various other accruals.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 7 FAIR VALUES

Financial assets and liabilities measured at fair value

 

     As at  
     July 1, 2012      January 1, 2012  
     Notional
value
     Fair value
hierarchy
     Fair value
asset
(liability)
     Notional
value
     Fair value
hierarchy
     Fair value
asset
(liability)
 

Forward currency contracts

   $ 209,737         Level 2       $ 117       $ 196,412         Level 2       $ 4,759   

TRS(1)

   $ 41,403         Level 2       $ 12,698       $ 30,591         Level 2       $ 9,286   
  

 

 

       

 

 

    

 

 

       

 

 

 

Total derivatives

   $ 251,140          $ 12,815       $ 227,003          $ 14,045   
  

 

 

       

 

 

    

 

 

       

 

 

 

 

(1) 

Total Return Swaps (“TRS”).

The Company values its derivatives using valuations that are calibrated to the initial trade prices. Subsequent valuations are based on observable inputs to the valuation model. The fair value of forward currency contracts are determined using prevailing exchange rates. The fair value of each TRS is determined using the Company’s closing common share price on the last business day of the fiscal period, as quoted on the Toronto Stock Exchange (“TSX”).

Other financial assets and liabilities not measured at fair value

The following table summarizes the fair value and carrying value of other financial assets and liabilities that are not recorded at fair value on a recurring basis on the Condensed Consolidated Balance Sheet:

 

     As at  
     July 1, 2012     January 1, 2012  
     Fair value
hierarchy
     Fair value
asset
(liability)
    Carrying
value
    Fair value
hierarchy
     Fair value
asset
(liability)
    Carrying
value
 

Cash and cash equivalents(1)

     Level 1       $ 57,733      $ 57,733        Level 1       $ 126,497      $ 126,497   

Restricted cash and cash equivalents(1)

     Level 1         87,292        87,292        Level 1         130,613        130,613   

Bearer deposit notes(2)

     Level 2         41,403        41,403        Level 2         30,591        30,591   

Notes receivable, net(3)

     Level 3         10,152        10,152        Level 3         13,301        13,301   

Senior unsecured notes, series 1(4)

     Level 2         (326,052     (301,719     Level 2         (325,308     (301,893

Advertising Fund debt(5)

     Level 2         (42,500     (42,500     Level 2         (9,929     (9,929

Other debt(6)

     Level 3         (109,014     (54,818     Level 3         (102,114     (52,305

 

(1) 

The carrying values of these financial assets approximate fair values due to the short-term nature of these investments.

(2) 

The Company holds these notes as collateral to reduce the carrying costs of the TRS (see note 8). The interest rate on these notes resets every 90 days, therefore, the carrying values of these notes approximate their fair values. These notes are included in Other assets on the Condensed Consolidated Balance Sheet.

(3) 

Management estimated the fair value based on the current value of the underlying business and collateral.

(4) 

The fair value of the bond is based on publicly disclosed trades between arm’s length institutions as documented on Bloomberg LP.

(5) 

The Advertising fund debt consists of a balance on its revolving credit facility withdrawn as bankers acceptances with maturities up to 180 days. The carrying value approximates fair value due to the short term nature of these borrowings. The Advertising fund debt is included in Advertising fund liabilities on the Condensed Consolidated Balance Sheet.

(6) 

Management estimated the fair value of its Other debt, primarily consisting of contributions received related to the construction costs of certain restaurants, by discounting future cash flows using a company risk adjusted rate, over the remaining term of the debt.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 8 DERIVATIVES

 

     As at
     July 1, 2012    January 1, 2012
     Notional
value
     Fair value
asset
(liability)
    Classification on
Condensed
Consolidated
Balance Sheet
   Notional
value
     Fair value
asset
(liability)
     Classification on
Condensed
Consolidated
Balance Sheet

Derivatives designated as cash flow hedging instruments

                

Forward currency contracts(1)

   $ 184,693       $ 172      Accounts
receivable, net
   $ 175,566       $ 3,855       Accounts
receivable, net

Derivatives not designated as hedging instruments

                

TRS(2)

   $ 41,403       $ 12,698      Other assets    $ 30,591       $ 9,286       Other assets

Forward currency contracts(3)

     25,044         (55   Accounts
payable, net
     20,846         904       Accounts receivable,
net
  

 

 

    

 

 

      

 

 

    

 

 

    
   $ 251,140       $ 12,815         $ 227,003       $ 14,045      
  

 

 

    

 

 

      

 

 

    

 

 

    

 

(1) 

Maturities as at July 1, 2012 range between July 2012 and June 2013.

(2) 

Maturities as at July 1, 2012 of May 2015, May 2016, May 2017, May 2018 and May 2019.

(3) 

Maturities as at July 1, 2012 range between July 2012 and April 2013. Includes a fair value hedge and certain cash flow hedges where the underlying transactions are not expected to occur as originally forecast, and therefore ceased to qualify as highly effective cash flow hedges.

 

         Second quarter ended July 1, 2012     Second quarter ended July 3, 2011  

Derivatives designated as cash flow

hedging instruments(3)

   Classification on
Condensed
Consolidated
Statement of
Operations
  Amount of
gain (loss)
recognized
in OCI(1)
    Amount of net
(gain) loss
reclassified
to earnings
    Total effect
on  OCI(1)
    Amount of
gain (loss)
recognized
in OCI(1)
    Amount of net
(gain) loss
reclassified
to earnings
    Total effect
on  OCI(1)
 

Forward currency contracts

   Cost of sales   $ 2,114      $ (973   $ 1,141      $ (2,337   $ 2,796      $ 459   

Interest rate forwards(2)

   Interest (expense)     0        173        173        0        173        173   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

       2,114        (800     1,314        (2,337     2,969        632   

Income tax effect

   Income taxes     (545     211        (334     660        (833     (173
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net of income taxes

     $ 1,569      $ (589   $ 980      $ (1,677   $ 2,136      $ 459   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

         Year-to-date period ended July 1, 2012     Year-to-date period ended July 3, 2011  

Derivatives designated as cash flow

hedging instruments(3)

   Classification on
Condensed
Consolidated
Statement of
Operations
  Amount of
gain (loss)
recognized
in OCI(1)
    Amount of net
(gain) loss
reclassified
to earnings
    Total effect
on  OCI(1)
    Amount of
gain (loss)
recognized
in OCI(1)
    Amount of net
(gain) loss
reclassified
to earnings
    Total effect
on  OCI(1)
 

Forward currency contracts

   Cost of sales   $ (1,389   $ (2,294   $ (3,683   $ (8,898   $ 5,220      $ (3,678

Interest rate forwards(2)

   Interest (expense)     0        346        346        0        346        346   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

       (1,389     (1,948     (3,337     (8,898     5,566        (3,332

Income tax effect

   Income taxes     441        510        951        2,424        (1,561     863   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net of income taxes

     $ (948   $ (1,438   $ (2,386   $ (6,474   $ 4,005      $ (2,469
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Other comprehensive income (“OCI”).

(2)

The Company entered into and settled interest rate forwards in 2010 relating to the Company’s outstanding term debt.

(3)

Excludes amounts related to ineffectiveness, as they were not significant.

Derivatives relating to the TRS and certain foreign currency contracts not designated as hedging instruments resulted in a net gain of less than $0.1 million and $2.2 million in the second quarters ended July 1, 2012 and July 3, 2011, respectively ($2.5 million and $3.4 million for the year-to-date periods ended July 1, 2012 and July 3, 2011, respectively).

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 9 COMMITMENTS AND CONTINGENCIES

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, price maintenance and waiver of tort. 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 two motions were heard in August and October 2011. 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.

While the Court found in favour of the Company on all claims, the plaintiffs have filed a Notice of Appeal with respect to the claims for breach of contract, breach of the duty of good faith and fair dealing, price maintenance and waiver of tort. In the plaintiffs more recent court filings, they have narrowed their appeal to include only breach of contract and breach of duty of good faith and fair dealing. The Company will continue to vigorously defend against the plaintiffs’ claim. A hearing on the appeal will be held in the fourth quarter of 2012. If all potential appeals were 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, and that the plaintiffs’ claims are without merit and will not be successful. However, if the matters were determined adversely to the Company at trial, and that determination was upheld by final order after all appeals, it is possible that the claims could have a material adverse impact on the Company’s financial statements.

In addition, the Company is party to various legal actions and complaints arising in the ordinary course of business. Reserves related to the potential resolution of any outstanding legal proceedings based on the amounts that are determined by the Company to be reasonably probable and estimable are not significant and are included in Accounts payable on the Condensed Consolidated Balance Sheet. It is the opinion of the Company that the ultimate resolution of such matters will not materially affect the Company’s financial statements.

NOTE 10 COMMON SHARES

Share repurchase programs

On February 23, 2012, the Company obtained regulatory approval from the TSX to commence a new share repurchase program (“2012 Program”) for up to $200.0 million in common shares. The Company’s common shares have been or will be purchased under the 2012 Program through a combination of 10b5-1 automatic trading plan purchases, private agreements with an arm’s length third party seller, and/or purchases at management’s discretion in compliance with regulatory requirements, and given market, cost and other considerations. Repurchases have been or will be made on the TSX, the New York Stock Exchange (“NYSE”), and/or other Canadian marketplaces, including private agreements under an issuer bid exemption order issued by a securities regulatory authority in Canada. The 2012 Program commenced on March 5, 2012 and is due to terminate on March 4, 2013, or earlier if the $200.0 million or the 10% share maximum is reached. Common shares purchased pursuant to the 2012 Program will be cancelled. The 2012 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 shares or the equivalent dollar amount of shares that may be repurchased under the 2012 Program.

In the year-to-date period ended July 1, 2012, the Company purchased and cancelled approximately 2.6 million common shares under the Company’s 2012 and 2011 repurchase program for a total cost of approximately $136.5 million, of which $7.5 million reduced the stated value of common shares and the remainder was recorded as a reduction to Retained earnings on the Condensed Consolidated Statement of Equity.

In the year-to-date period ended July 3, 2011, the Company purchased and cancelled approximately 9.2 million common shares for a total cost of approximately $401.9 million under the Company’s 2010 and 2011 repurchase programs, of which $26.2 million reduced the stated value of common shares, and the remainder was recorded as a reduction to Retained earnings on the Condensed Consolidated Statement of Equity.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 11 STOCK-BASED COMPENSATION

 

     Second quarter ended      Year-to-date period ended  
     July 1, 2012      July 3, 2011      July 1, 2012      July 3, 2011  

RSUs

   $ 3,132       $ 1,733       $ 5,790       $ 3,455   

Stock options and tandem SARs

     1,305         4,092         5,050         6,400   

DSUs(1)

     251         677         1,029         1,307   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense(2)

   $ 4,688       $ 6,502       $ 11,869       $ 11,162   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Deferred share units (“DSUs”).

(2) 

Included in General and administrative expenses on the Condensed Consolidated Statement of Operations.

The Company has entered into TRS as economic hedges for a portion of its outstanding stock options with tandem SARs, and substantially all of its DSUs. The Company recognized gains relating to the TRS of $0.2 million and $2.2 million in the second quarters ended July 1, 2012 and July 3, 2011, respectively (gain of $3.4 million and $3.6 million in year-to-date 2012 and 2011, respectively). These gains are recorded as a reduction to General and administrative expenses on the Condensed Consolidated Statement of Operations.

The Company’s Human Resource and Compensation Committee (“HRCC”) approves all stock-based compensation awards. All awards granted in May 2012 were granted under the Company’s 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan was approved by shareholders at the annual and special meeting of shareholders, held on May 10, 2012. The accounting policies under the 2012 Plan are consistent with those under the Company’s 2006 Stock Incentive Plan (the “2006 Plan”).

Details of stock-based compensation grants and settlements are set forth below.

Deferred share units

Approximately 8,100 and 12,300 DSUs were granted during the year-to-date periods of 2012 and 2011, respectively, at a fair market value of $53.78 and $43.91, respectively. There were approximately 9,400 DSUs settled during the second quarter and year-to-date periods of 2012 (nil for second quarter and year-to-date periods for 2011).

Restricted stock units

Awards of 35,000 and 154,000 RSUs with dividend equivalent rights were granted in February 2012 and May 2012, respectively. The fair market value of each RSU awarded as part of these grants (the closing price of the Company’s common shares traded on the TSX on the business day preceding the grants) was $52.85 and $54.95, respectively.

Activity for RSUs granted to employees under the Company’s 2006 Plan and the 2012 Plan (collectively the “Plans”) for the periods are set forth below:

 

     Restricted Stock
Units
    Weighted Average Grant
Value per Unit
 
     (in thousands)     (in dollars)  

Balance at January 2, 2011

     293      $ 32.83   
  

 

 

   

 

 

 

Granted

     165      $ 45.76   

Dividend equivalent rights

     5        45.53   

Vested and settled

     (138     30.24   

Forfeited

     (19     36.69   
  

 

 

   

 

 

 

Balance at January 1, 2012

     306      $ 40.91   
  

 

 

   

 

 

 

Granted

     189      $ 54.60   

Dividend equivalent rights

     2        53.74   

Vested and settled

     (41     40.45   

Forfeited

     (15     43.01   
  

 

 

   

 

 

 

Balance at July 1, 2012

     441      $ 46.78   
  

 

 

   

 

 

 

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

In the second quarter ended July 1, 2012, the Company funded the TDL RSU Employee Benefit Plan Trust (the “Trust”), which, in turn, purchased approximately 112,000 common shares for $6.2 million (61,000 common shares for $2.8 million in second quarter of 2011).

RSUs that vested during the second quarter of 2012 and 2011 were settled with the participants in the following manner:

 

     Restricted Stock Unit      Restricted Stock Unit
Settlement, net of tax
 
     (gross settlement)      Units      Amount  
     (in thousands)  

2011

        

Settled with common shares from the Trust

     45         24       $ 833   

Settled by an open market purchase

     9         6         262   
  

 

 

    

 

 

    

 

 

 

Total restricted stock settlement

     54         30       $ 1,095   
  

 

 

    

 

 

    

 

 

 

2012

        

Settled with common shares from the Trust

     34         18       $ 670   

Settled by an open market purchase

     7         5         250   
  

 

 

    

 

 

    

 

 

 

Total restricted stock settlement

     41         23       $ 920   
  

 

 

    

 

 

    

 

 

 

Stock options and tandem SARs

 

     Stock Options with
SARs
    Weighted Average
Exercise Price
 
     (in thousands)     (in dollars)  

Balance at January 2, 2011

     1,086      $ 31.87   
  

 

 

   

 

 

 

Granted

     339        45.76   

Exercised

     (224     30.56   

Forfeited

     (19     35.10   
  

 

 

   

 

 

 

Balance at January 1, 2012

     1,182      $ 36.05   
  

 

 

   

 

 

 

Granted

     249        54.95   

Exercised

     (96     33.31   

Forfeited

     (30     38.16   
  

 

 

   

 

 

 

Balance at July 1, 2012

     1,305      $ 39.81   
  

 

 

   

 

 

 

A total of 96,000 vested SARs were exercised and cash-settled, net of applicable withholding taxes for $1.5 million, in the year-to-date period ended July 1, 2012 (74,000 year-to-date 2011 for $0.8 million). The associated options were cancelled.

The fair value of outstanding stock options with tandem SARs was determined at the grant date and each subsequent re-measurement date by applying the Black-Scholes-Merton option-pricing model. The following assumptions were used to calculate the fair value of outstanding stock options/SARs:

 

     As at
     July 1, 2012    January 1, 2012

Expected share price volatility

   15% – 22%    16% – 22%

Risk-free interest rate

   1.0% – 1.2%    1.0% – 1.1%

Expected life

   1.4 – 4.4 years    1.7 – 3.9 years

Expected dividend yield

   1.6%    1.4%

Closing share price(1)

   $53.67    $49.36

 

(1)

As quoted on the TSX.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 12 VARIABLE INTEREST ENTITIES

VIEs for which the Company is the primary beneficiary

Non-owned restaurants

The Company has consolidated 312 and 309 non-owned restaurants as at July 1, 2012 and January 1, 2012, respectively, or approximately 7.7% of the Company’s total systemwide restaurants during both of these periods. On average, a total of 309 and 258 non-owned restaurants were consolidated during the second quarter of 2012 and 2011, respectively (307 and 257 year-to-date 2012 and 2011, respectively).

Advertising Funds

The Tim Hortons Advertising and Promotion Fund (Canada) Inc. (“Ad Fund”) has rolled out a program to acquire and install LCD screens, media engines, drive-thru menu boards and ancillary equipment in our restaurants (“Expanded Menu Board Program”). To finance the Expanded Menu Board Program, a $95.8 million revolving credit facility was entered into in 2011. The facility is collateralized only by the Ad Fund’s assets. The Ad Fund had borrowings of $42.5 million and $9.9 million outstanding on this facility as at July 1, 2012 and January 1, 2012, respectively. Ad Fund borrowings are reflected in Advertising fund liabilities on the Condensed Consolidated Balance Sheet and Other financing activities on the Condensed Consolidated Statement of Cash Flows. These funds have been used to purchase related equipment of $35.2 million cumulatively since 2011. In year-to-date 2012, $30.8 million of capital expenditures is reflected in Capital expenditures on the Condensed Consolidated Statement of Cash Flows. The advertising levies, depreciation and interest costs associated with the Expanded Menu Board Program are presented on a gross basis on the Condensed Consolidated Statement of Operations.

Company contributions to the Canadian and U.S. advertising funds consisted of the following:

 

     Second quarter ended      Year-to-date period ended  
     July 1, 2012      July 3, 2011      July 1, 2012      July 3, 2011  

Company contributions

   $ 2,718       $ 2,463       $ 5,321       $ 4,834   

Contributions from consolidated non-owned restaurants

     3,167         2,506         6,064         4,749   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Company contributions

   $ 5,885       $ 4,969       $ 11,385       $ 9,583   
  

 

 

    

 

 

    

 

 

    

 

 

 

These advertising funds spent approximately $47.9 million and $52.0 million in the second quarters of 2012 and 2011, respectively ($121.8 million and $112.2 million year-to-date 2012 and 2011, respectively).

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

The revenues and expenses associated with the Company’s consolidated Non-owned Restaurant VIEs and advertising funds presented on a gross basis, prior to consolidation adjustments, are as follows:

 

     Second quarter ended  
     July 1, 2012      July 3, 2011  
     Restaurant
VIEs
     Advertising
fund VIEs
     Total
VIEs
     Restaurant
VIEs
     Advertising
fund VIEs
     Total
VIEs
 

Sales

   $ 85,459       $ 0       $ 85,459       $ 67,672       $ 0       $ 67,672   

Advertising levies (2)

     0         1,056         1,056         0         158         158   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     85,459         1,056         86,515         67,672         158         67,830   

Cost of sales (1)

     84,066         0         84,066         66,615         0         66,523   

Operating expenses (2)

     0         677         677         0         158         158   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating income

     1,393         379         1,772         1,057         0         1,149   

Interest expense

     0         379         379         0         0         92   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     1,393         0         1,393         1,057         0         1,057   

Income taxes

     223         0         223         166         0         166   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to noncontrolling interests

   $ 1,170       $ 0       $ 1,170       $ 891       $ 0       $ 891   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Year-to-date period ended  
     July 1, 2012      July 3, 2011  
     Restaurant
VIEs
     Advertising
fund VIEs
     Total
VIEs
     Restaurant
VIEs
     Advertising
fund VIEs
     Total
VIEs
 

Sales

   $ 163,473       $ 0       $ 163,473       $ 128,142       $ 0       $ 128,142   

Advertising levies (2)

     0         1,543         1,543         0         343         343   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     163,473         1,543         165,016         128,142         343         128,485   

Cost of sales (1)

     160,654         0         160,654         126,217         0         126,103   

Operating expenses (2)

     0         1,062         1,062         0         343         343   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating income

     2,819         481         3,300         1,925         0         2,039   

Interest expense

     0         481         481         0         0         114   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     2,819         0         2,819         1,925         0         1,925   

Income taxes

     449         0         449         299         0         299   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to noncontrolling interests

   $ 2,370       $ 0       $ 2,370       $ 1,626       $ 0       $ 1,626   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Includes rents, royalties, advertising expenses and product purchases from the Company which are eliminated upon the consolidation of these VIEs.

(2) 

Generally, the advertising levies that are not related to the Expanded Menu Board Program are netted with advertising and marketing expenses incurred by the advertising funds in operating expenses, as these contributions are designated for specific purposes. The Company acts as an agent with regard to these contributions.

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

The assets and liabilities associated with the Company’s consolidated Non-owned Restaurant VIEs and advertising funds presented on a gross basis, prior to consolidation adjustments, are as follows:

 

     As at  
     July 1, 2012      January 1, 2012  
     Restaurant
VIEs
     Advertising
fund VIEs
     Restaurant
VIEs
     Advertising
fund VIEs
 

Cash and cash equivalents

   $ 10,393       $ 0       $ 11,186       $ 0   

Advertising fund restricted assets—current

     0         29,325         0         37,765   

Other current assets(1)

     5,927         0         6,142         0   

Property and equipment, net

     20,128         47,813         19,492         20,814   

Other long-term assets

     448         2,535         312         2,850   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 36,896       $ 79,673       $ 37,132       $ 61,429   
  

 

 

    

 

 

    

 

 

    

 

 

 

Notes payable to the Company—current (1)

   $ 15,607       $ 0       $ 15,370       $ 0   

Advertising fund liabilities—current (2)

     0         78,103         0         59,420   

Other current liabilities(1)

     14,062         264         15,062         265   

Notes payable to the Company—long-term (1)

     687         0         849         0   

Advertising fund liabilities—long-term

     0         345         0         463   

Other long-term liabilities

     4,044         961         3,966         1,281   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     34,400         79,673         35,247         61,429   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity

     2,496         0         1,885         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and equity

   $ 36,896       $ 79,673       $ 37,132       $ 61,429   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Various assets and liabilities are eliminated upon the consolidation of these VIEs, the most significant of which are the FIP Notes payable to the Company, which reduces the Notes receivable, net reported on the Condensed Consolidated Balance Sheet.

(2) 

Includes $42.5 million and $9.9 million of borrowings drawn upon the revolving credit facilities as at July 1, 2012 and January 1, 2012, respectively.

The liabilities recognized as a result of consolidating these VIEs do not necessarily represent additional claims on our general assets; rather, they represent claims against the specific assets of the consolidated VIEs. Conversely, assets recognized as a result of consolidating these VIEs do not represent additional assets that could be used to satisfy claims by the Company’s creditors as they are not legally included within the Company’s general assets.

Trust

In connection with RSUs granted to Company employees, the Company established the Trust, which purchases and retains common shares of the Company to satisfy the Company’s contractual obligation to deliver shares to settle the awards for most Canadian employees. The cost of the shares held by the Trust of $15.6 million and $10.1 million as at July 1, 2012 and January 1, 2012, respectively (see note 11), are presented as a reduction in outstanding common shares on the Condensed Consolidated Balance Sheet.

VIEs for which the Company is not the primary beneficiary

These VIEs are primarily real estate ventures, the most significant being the TIMWEN Partnership. The Company does not consolidate these entities as control is considered to be shared by both Tim Hortons and the other joint owner(s).

 

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TIM HORTONS INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements (Unaudited)

(in thousands of Canadian dollars, except share and per share data)

 

NOTE 13 SEGMENT REPORTING

 

     Second quarter ended     Year-to-date period ended  
     July 1, 2012     July 3, 2011     July 1, 2012     July 3, 2011  

Revenues(1)

        

Canada

   $ 655,849      $ 598,858      $ 1,260,103      $ 1,146,231   

U.S.

     43,217        36,072        81,746        71,531   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total reportable segments

     699,066        634,930        1,341,849        1,217,762   

VIEs

     86,515        67,830        165,016        128,485   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 785,581      $ 702,760      $ 1,506,865      $ 1,346,247   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income

        

Canada

   $ 164,563      $ 156,428      $ 305,050      $ 287,957   

U.S.

     5,617        4,008        8,827        6,619   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total reportable segments

     170,180        160,436        313,877        294,576   

VIEs

     1,772        1,149        3,300        2,039   

Corporate charges(2)

     (13,113     (18,367     (26,715     (32,794
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Operating Income

     158,839        143,218        290,462        263,821   

Interest, Net

     (7,927     (6,576     (15,114     (12,276
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   $ 150,912      $ 136,642      $ 275,348      $ 251,545   
  

 

 

   

 

 

   

 

 

   

 

 

 

Capital Expenditures

        

Canada(3)

   $ 38,478      $ 24,254      $ 78,769      $ 54,375   

U.S.

     10,697        4,533        18,689        9,039   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 49,175      $ 28,787      $ 97,458      $ 63,414   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

There are no inter-segment revenues included in the table above.

(2) 

Corporate charges include certain overhead costs which are not allocated to individual business segments, the impact of certain foreign currency exchange gains and losses, and the net operating results from the Company’s GCC, Republic of Ireland and United Kingdom international operations, which continue to be managed corporately.

(3) 

The second quarter of 2012 includes $16.8 million of capital spending by the Ad Fund ($30.8 million year-to-date 2012), related to the Expanded Menu Board Program (second quarter and year-to-date 2011: nil).

Consolidated Sales and Cost of Sales consisted of the following:

 

     Second quarter ended      Year-to-date period ended  
     July 1, 2012      July 3, 2011      July 1, 2012      July 3, 2011  

Sales

           

Distribution sales

   $ 471,274       $ 422,471       $ 911,002       $ 812,304   

Company-operated restaurant sales

     7,039         7,915         12,599         12,089   

Sales from VIEs

     85,459         67,672         163,473         128,142   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Sales

   $ 563,772       $ 498,058       $ 1,087,074       $ 952,535   
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

           

Distribution cost of sales

   $ 410,624       $ 367,577       $ 801,077       $ 711,897   

Company-operated restaurant cost of sales

     7,697         7,544         13,777         12,033   

Cost of sales from VIEs

     74,979         58,930         143,871         112,453   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Cost of sales

   $ 493,300       $ 434,051       $ 958,725       $ 836,383   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 14 RECENT ACCOUNTING PRONOUNCEMENTS

In December 2011, the FASB issued ASU No. 2011-11—Disclosures about Offsetting Assets and Liabilities. The amendments in this ASU are intended to enhance disclosures by requiring improved information about financial instruments that are either: (i) offset in accordance with applicable GAAP; or (ii) subject to an enforceable master netting arrangement or similar arrangement. The amendments in this ASU are effective for fiscal years and interim periods beginning on or after January 1, 2013, and should be applied retrospectively for all comparative periods presented. The Company is currently assessing the potential impact, if any, the adoption of this ASU may have on its Condensed Consolidated Financial Statements and related disclosures.

 

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TIM HORTONS INC. AND SUBSIDIARIES

ITEM 2. 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 in our Annual Report on Form 10-K for the year ended January 1, 2012 (“Annual Report”) filed with the U.S. Securities and Exchange Commission (“SEC”) and the Canadian Securities Administrators (“CSA”) on February 28, 2012, and the Condensed Consolidated Financial Statements and accompanying Notes included in our Interim Report on Form 10-Q for the quarter ended July 1, 2012 filed with the SEC and the CSA on August 9, 2012. 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 in our Annual Report and set forth in our long-form Safe Harbor Statement referred to below under “Safe Harbor Statement,” and attached hereto, as well as risks described herein, 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. Please refer to “Systemwide Sales Growth” and “Same-Store Sales Growth” below for additional information.

We prepare our financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”).

References herein to “Tim Hortons,” the “Company,” “we,” “our,” or “us” refer to Tim Hortons Inc. and its subsidiaries, 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 July 1, 2012, we leased or owned the real estate for approximately 83% of our full-serve system restaurants in North America. 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, grocery stores and for our international locations. We distribute coffee and other beverages, non-perishable food, 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 Guelph and Kingston distribution facilities to approximately 62% of our Canadian restaurants, namely those located in Ontario and Quebec. 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.

Executive Overview

Systemwide sales grew 6.0% in the second quarter of 2012, driven by new restaurant development in both Canada and the U.S. and by continued same-store sales growth of 1.8% in Canada and 4.9% in the U.S. In the first half of 2012, systemwide sales grew by 7.6%, led by new restaurant development and same-store sales growth of 3.4% in Canada and 6.6% in the U.S. We also continued to grow total systemwide transactions in both Canada and the U.S. during the second quarter and first half of 2012.

Same-store sales growth in Canada during the second quarter of 2012 was driven by a higher average cheque due primarily to favourable product mix. Our product mix continued to benefit from our hot espresso and latte beverages, and the new hot beverage cup sizing including the 24-ounce cup, all of which were introduced in the first quarter. In addition, product mix benefited from strength in our breakfast category with the extension of our breakfast hours from 11 a.m. to noon across Canada. We believe our growth was negatively impacted in the second quarter of 2012 by the continued challenging economic climate and persistently high unemployment levels relative to pre-recessionary rates. These factors can impact consumer discretionary spending. We experienced a slight decline in same-store transactions in Canada, due in part, we believe, to these continued economic pressures, which may have impacted guest frequency.

For the first half of 2012, same-store sales growth in Canada was driven primarily by a higher average cheque, due to both favourable product mix and pricing. In addition to the factors noted above, same-store sales growth was favourably impacted by unseasonably warm weather across most of Canada in the first quarter of 2012, which resulted in the acceleration of sales in our specialty cold drinks early in the year, some of which have higher price points.

 

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In the U.S., same-store sales growth benefited from a higher average cheque which was driven by a combination of pricing and favourable product mix. Our Panini sandwiches, which we promoted, continued to prove popular with our guests during the quarter. In addition, our specialty bagels and specialty cold drink category, including our new espresso-based iced beverages, contributed favourably to our product mix. We also experienced a slight increase in same-store transactions in the U.S. during the second quarter of 2012.

For the first half of 2012, same-store sales growth in the U.S. was driven by the same factors noted above, but was also favourably impacted by unseasonably warm weather in most of our U.S. markets in the first quarter of 2012, which drove growth in our specialty cold beverages earlier in the year.

The economic environment in both Canada and the U.S. remained volatile, and continued uncertainty appears to be impacting consumer confidence and likely had a moderating effect on the rate of our same-store sales growth in the second quarter, which has carried through into July. In both Canada and the U.S., we will continue to expand our menu with new prepared food and premium drink offerings throughout 2012. We will also maintain our focus on hospitality, speed of service and convenience so that we are reliable and relevant to our guests as we continue to reinforce our quality products at a reasonable price positioning.

Operating income increased 10.9% to $158.8 million in the second quarter of 2012 compared to $143.2 million in the second quarter of 2011. This growth was driven primarily by systemwide sales growth in both Canada and the U.S., resulting in both higher rents and royalties and distribution income. In addition, lower general and administrative expenses were incurred, due primarily to a $6.3 million charge in the second quarter of 2011 related to the separation agreement with our previous CEO (“CEO Separation Agreement”), which increased operating income growth in the second quarter of 2012 by approximately 4.6%. Partially offsetting this decline in general and administrative expenses were higher salaries and benefits and higher professional fees in 2012. We also had a temporary positive impact from the timing of coffee pricing and underlying costs in our supply chain in the second quarter of 2011, which negatively impacted operating income growth on a year-over-year basis.

Year-to-date, operating income was $290.5 million in 2012 compared to $263.8 million in 2011, increasing $26.6 million or 10.1%. In addition to the factors noted above, operating income growth was partially offset by lower franchise fee income and resource investments that we made at our replacement distribution centre in Kingston, Ontario to optimize service levels to our restaurants as we transitioned the facility.

Net income attributable to Tim Hortons Inc. increased $12.5 million, or 13.1%, to $108.1 million in the second quarter of 2012, and increased $20.6 million, or 11.7%, to $196.8 million in the first half of 2012. The primary factors driving the increase in both periods was higher operating income, as noted above, and a lower effective tax rate on these earnings, partially offset by higher net interest expense.

Diluted earnings per share attributable to Tim Hortons Inc. (“EPS”) increased 18.9% to $0.69 in the second quarter of 2012, compared to $0.58 in the second quarter of 2011. In addition to higher net income attributable to Tim Hortons Inc., our EPS growth continued to benefit from the positive, cumulative impact of our share repurchase programs. On average, we had approximately 156.0 million fully diluted common shares outstanding during the second quarter of 2012, which was, on average, approximately 8.0 million, or 4.9%, fewer fully diluted common shares outstanding than in the second quarter of 2011. For the first half of 2012, EPS increased 18.7% to $1.26 compared to $1.06 in the first half of 2011. Our share repurchase program was a strong contributor to EPS growth in the year-to-date period as well. The CEO Separation Agreement in 2011 reduced EPS by approximately $0.03 per share in both the second quarter and first half of 2011.

Selected Operating and Financial Highlights

 

     Second quarter ended     Year-to-date period ended  

($ in millions, except per share data)

   July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Systemwide sales growth(1)

     6.0     7.2     7.6     6.1

Same-store sales growth

        

Canada

     1.8     3.8     3.4     2.9

U.S.

     4.9     6.6     6.6     5.7

Systemwide restaurants

     4,071        3,811        4,071        3,811   

Revenues

   $ 785.6      $ 702.8      $ 1,506.9      $ 1,346.2   

Operating income

   $ 158.8      $ 143.2      $ 290.5      $ 263.8   

Net income attributable to Tim Hortons Inc.

   $ 108.1      $ 95.5      $ 196.8      $ 176.2   

Diluted EPS

   $ 0.69      $ 0.58      $ 1.26      $ 1.06   

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

     156.0        164.0        156.2        166.0   

 

(1) 

Total systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. Systemwide sales growth in Canadian dollars, which includes the effects of foreign currency translation, was 6.4% and 6.7% for the second quarters of 2012 and 2011, respectively (7.9% and 5.6% year-to-date 2012 and 2011, respectively).

 

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We believe systemwide sales growth 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 impact our consolidated and segmented financial performance.

Systemwide Sales Growth

Systemwide sales include restaurant-level sales at both franchised and Company-operated restaurants. 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.

Our financial results are driven by changes in systemwide sales, primarily in Canada and the U.S, with approximately 99.5% of our system franchised. Franchised restaurant sales and transactional data are reported to us by our restaurant owners. Franchised restaurant sales are not included in our Condensed Consolidated Financial Statements, other than approximately 307 and 257 non-owned restaurants, on average, for the first half of 2012 and 2011, respectively, whose results of operations are consolidated with ours pursuant to variable interest entity accounting rules. The amount of systemwide sales impacts our rental and royalties revenues, as well as our distribution revenues.

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 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 other International and North American operations.

Same-Store Sales Growth

Same-store sales growth represents the average growth 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 the same level of purchases at the new pricing.

Product innovation is one of our long-standing, focused strategies to drive same-store sales growth, including innovation at breakfast, lunch and snacking dayparts. During the second quarter of 2012, we promoted our cold beverage category, with a focus on our popular Iced Capp, our new frozen lemonade (Canada) and fruit smoothies (U.S.). In addition, we also promoted our lunch category, with lasagna casserole featured in Canada and our Tuscan Chicken Panini sandwich in the U.S. The combination of unseasonably warm spring in the second quarter of 2012, and our marketing and promotional activities focused on cold beverages during this period, including an introductory price point for small frozen lemonade for $1 (Canada) and promotional price points for a freshly brewed iced tea or a small iced coffee for $0.99 (U.S.), drove sales volumes in our cold drink category.

Other recent marketing and operational initiatives

We have reached a North American-wide agreement with Kraft Foods Inc. (“Kraft”) to enter the single-serve, on-demand coffee market, leveraging Tim Hortons premium coffee and Kraft’s Tassimo® system. Under the terms of the agreement, Tim Hortons premium-blend coffee, decaffeinated coffee, and lattes, in a single-serve format, will be sold in Tim Hortons restaurants in Canada and the U.S., and online, using the Tassimo T-Disc on-demand beverage platform. Tim Hortons and Kraft are planning to launch the new Tim Hortons single-serve T-Discs in time for the 2012 holiday season.

We also continue to make excellent progress on a number of initiatives in Canada. We have installed free Wi-Fi internet access at more than 1,100 of our Canadian restaurants in order to provide our guests with the added convenience of staying connected while visiting our restaurants and expect that approximately 2,000 restaurants in Canada will have free Wi-Fi by the end of 2012. We have also installed digital menu boards to enhance the overall guest experience inside approximately 60% of our restaurants during the first half of 2012 and expect installations to be completed in the fourth quarter of 2012. We will also continue to implement our enhanced drive-thru menu boards into 2013. In addition, we have recently broadened the roll-out of a grilling platform to our Canadian restaurants in preparation for our national launch of Panini sandwiches later in the second half of 2012. We also continue to implement the first stages of drive-thru double order stations as part of our capacity-building efforts. These initiatives support of our ‘More than a Great Brand’ strategic plan, which is designed to drive growth over the life of the plan through a range of strategies and initiatives.

 

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Table of Contents

New Restaurant Development

Opening restaurants in new and existing markets in Canada and the U.S. has historically been a significant contributor to our growth. Below is a summary of restaurant openings and closures for the second quarters and year-to-date periods ended July 1, 2012 and July 3, 2011, respectively:

 

     Second quarter ended July 1, 2012     Second quarter ended July 3, 2011  
     Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total     Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total  

Canada

            

Restaurants opened

     19        —          19        23        1        24   

Restaurants closed

     (3     (5     (8     (3     (1     (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     16        (5     11        20        0        20   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S.

            

Restaurants opened

     6        9        15        8        2        10   

Restaurants closed

     (1     (1     (2     (1     —          (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     5        8        13        7        2        9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

International (GCC)

            

Restaurants opened

     5        —          5        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Company

            

Restaurants opened

     30        9        39        31        3        34   

Restaurants closed

     (4     (6     (10     (4     (1     (5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     26        3        29        27        2        29   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Year-to-date period ended July 1, 2012     Year-to-date period ended July 3, 2011  
     Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total     Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total  

Canada

            

Restaurants opened

     40        1        41        52        3        55   

Restaurants closed

     (5     (5     (10     (13     (1     (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     35        (4     31        39        2        41   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S.

            

Restaurants opened

     12        10        22        14        7        21   

Restaurants closed

     (1     (1     (2     (1     —          (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     11        9        20        13        7        20   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

International (GCC)

            

Restaurants opened

     6        —          6        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Company

            

Restaurants opened

     58        11        69        66        10        76   

Restaurants closed

     (6     (6     (12     (14     (1     (15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     52        5        57        52        9        61   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

From the end of the second quarter of 2011 to the end of the second quarter of 2012, we opened 260 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, permitting us to upgrade size and layout or add a drive-thru or when a restaurant performs below our expectations for an extended period of time. These closures typically occur at the end of a lease term or at the end of the useful life of the principal asset.

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 use self-serve kiosks in locations where existing full-serve locations are at capacity.

 

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We have a master license agreement with Apparel FZCO (“Apparel”) for the development and operation of Tim Hortons restaurants in the Gulf Cooperation Council (“GCC”). The master license agreement with Apparel is primarily a royalty-based model that also includes an up-front license fee, franchise fees with the opening of each location, and restaurant equipment and distribution sales. Apparel is responsible for the capital spending and real estate development to open restaurants, along with operations and marketing. As at July 1, 2012 we had 11 restaurants in the GCC.

In addition, we have exclusive development rights in Canada, and certain rights to use licenses within the U.S. to operate Cold Stone Creamery® ice cream and frozen confection retail outlets within Tim Hortons locations. As of July 1, 2012, we had 239 co-branded locations, including 139 co-branded locations in Tim Hortons restaurants in Canada and 100 co-branded locations in the U.S. (93 in Tim Hortons restaurants and 7 in Cold Stone Creamery locations).

The following table shows our restaurant count, by restaurant type, in Canada, the U.S., and the GCC:

Systemwide Restaurant Count

 

     As at:  
     July 1,
2012
    January 1,
2012
    July 3,
2011
 

Canada

      

Company-operated

     11        10        16   

Franchised—standard and non-standard

     3,200        3,166        3,059   

Franchised—self-serve kiosks

     115        119        114   
  

 

 

   

 

 

   

 

 

 

Total

     3,326        3,295        3,189   
  

 

 

   

 

 

   

 

 

 

% Franchised

     99.7     99.7     99.5

U.S.

      

Company-operated

     10        8        6   

Franchised—standard and non-standard

     551        542        486   

Franchised—self-serve kiosks

     173        164        130   
  

 

 

   

 

 

   

 

 

 

Total

     734        714        622   
  

 

 

   

 

 

   

 

 

 

% Franchised

     98.6     98.9     99.0

International (GCC)

      

Franchised—standard and non-standard

     11        5        —     
  

 

 

   

 

 

   

 

 

 

% Franchised

     100.0     100.0     n/a   

Total system

      

Company-operated

     21        18        22   

Franchised—standard and non-standard

     3,762        3,713        3,545   

Franchised—self-serve kiosks

     288        283        244   
  

 

 

   

 

 

   

 

 

 

Total

     4,071        4,014        3,811   
  

 

 

   

 

 

   

 

 

 

% Franchised

     99.5     99.6     99.4

Segment Operating Income

Systemwide sales and same-store sales growth are 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 its respective geographic locations. We continue to manage the development of our international operations in the Republic of Ireland and the United Kingdom, which consist primarily of 243 branded, licensed self-serve kiosk locations at the end of the second quarter of 2012 (260 at the end of the second quarter 2011), corporately. In addition, our international operations now include our expansion into the GCC and consisted of 11 restaurants at the end of the second quarter of 2012 (nil at the end of the second quarter of 2011). Our expansion into the GCC is in its early stages and is also being managed corporately. As such, results from these operations, which are not currently significant, are included in Corporate charges in our segmented operating results. Corporate charges also include overhead costs that support all business segments. Our reportable segments exclude financial results of VIEs, reflective of the way our business is managed.

 

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

 

     Second quarter ended     Change  
     July 1, 2012     % of
Revenues
    July 3, 2011     % of
Revenues
    Dollars      Percentage  
     ($ in thousands)  

Operating Income

             

Canada

   $ 164,563        20.9   $ 156,428        22.3   $ 8,135         5.2

U.S.

     5,617        0.8     4,008        0.5     1,609         40.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Reportable segment operating income

     170,180        21.7     160,436        22.8     9,744         6.1

VIEs

     1,772        0.2     1,149        0.2     623         54.2

Corporate charges

     (13,113     (1.7 )%      (18,367     (2.6 )%      5,254         (28.6 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Consolidated operating income

   $ 158,839        20.2   $ 143,218        20.4   $ 15,621         10.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

     Year-to-date period ended     Change  
     July 1, 2012     % of
Revenues
    July 3, 2011     % of
Revenues
    Dollars      Percentage  
     ($ in thousands)  

Operating Income

             

Canada

   $ 305,050        20.2   $ 287,957        21.4   $ 17,093         5.9

U.S.

     8,827        0.6     6,619        0.5     2,208         33.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Reportable segment operating income

     313,877        20.8     294,576        21.9     19,301         6.6

VIEs

     3,300        0.2     2,039        0.2     1,261         61.8

Corporate charges

     (26,715     (1.7 )%      (32,794     (2.4 )%      6,079         (18.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Consolidated operating income

   $ 290,462        19.3   $ 263,821        19.6   $ 26,641         10.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Consolidated operating income increased by $15.6 million in the second quarter of 2012 and $26.6 million in the first half of 2012. Operating income growth was driven by continued growth in our Canadian and U.S. operating segments. In addition, lower corporate charges and higher VIE operating income also contributed to our operating income growth year-over-year.

Canada

Operating income increased $8.1 million, or 5.2%, in the second quarter of 2012 to $164.6 million. Systemwide sales growth of 5.3%, driven by incremental sales from the net addition of 137 new restaurants year-over-year and same-store sales growth of 1.8%, resulted in higher rents and royalties and distribution income, was the primary growth driver. Also contributing to growth year-over-year was favourable product mix in distribution. Partially offsetting these growth factors was a temporary positive impact from the timing of coffee pricing and underlying costs in our supply chain in the second quarter of 2011, which negatively impacted operating income growth versus the prior year. In addition, general and administration expenses increased due primarily to higher salaries and benefits required to support growth of the business. Total restaurant transactions continued to grow during the second quarter and first half of 2012 as a result of the addition of new restaurants.

Same-store sales growth in the second quarter of 2012 was driven by a higher average cheque, due primarily to favourable product mix. Our product mix continued to benefit from our hot espresso and latte beverages, and new hot beverage cup sizing, including the 24-ounce cup, all of which were introduced in the first quarter. In addition, product mix in the second quarter benefited from strength in our breakfast category with the extension of our breakfast hours from 11 a.m. to noon across Canada. Higher average cheque growth more than offset the slight decline in same-store transactions during the second quarter of 2012. We opened 19 restaurants and closed 8 in the second quarter of 2012, compared to opening 24 restaurants and closing 4 in the second quarter of 2011. We will continue to focus on improving speed of service, as we build incremental capacity at existing restaurants through a number of initiatives, and on increased convenience through the net addition of new restaurants in Canada for the remainder of 2012.

For the first half of 2012, operating income was $305.1 million compared to $288.0 million in the first half of 2011, increasing $17.1 million, or 5.9%. The same factors influencing growth rates in the second quarter were prevalent in the first half, with the exception that systemwide sales growth was stronger resulting in higher growth from rents and royalties and distribution income. On a year-to-date basis, the favourable timing of benefits and other costs was also a factor. Partially offsetting these additional growth factors were lower franchise fee income related primarily to timing of restaurant openings year-over-year and higher support costs, and resource investments made in the first quarter of 2012 to optimize service levels to our restaurants as we transition our replacement distribution centre in Kingston, Ontario. Canadian systemwide sales growth was 6.9% in the first half of 2012, driven by the net addition of restaurants and same-store sales growth of 3.4%. From a development perspective, we opened 41 restaurants and closed 10 in the first half of 2012 compared to opening 55 restaurants and closing 14 in the first half of 2011.

 

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Table of Contents

U.S.

Operating income grew by $1.6 million to $5.6 million in the second quarter of 2012, from $4.0 million in the second quarter of 2011. Higher systemwide sales, which resulted in higher rents and royalties and distribution income, were the primary growth drivers in the second quarter of 2012. A $0.7 million benefit associated primarily with the reversal of previously accrued closure costs upon the conclusion of activities related to our New England markets was also included in the second quarter of 2012. In addition, we had higher franchise fee income due to a higher number of sales. Partially offsetting operating income growth in the second quarter of 2012 was higher relief relating primarily to restaurants that have been open for less than 13 months, and higher general and administrative costs due to higher salaries and benefits required to support the growth of the business.

Systemwide sales grew 12.8% in the second quarter of 2012, driven by the net addition of 69 new full-serve restaurants year-over-year and continued same-store sales growth of 4.9%. Same-store sales growth benefited from a higher average cheque, which was driven by a combination of pricing and favourable product mix. Our Panini sandwiches continued to prove popular with our guests during the quarter. In addition, our specialty bagels and specialty cold drinks category, including our new iced espresso based beverages, contributed favourably to our product mix. We also experienced a slight increase in transactions in the U.S. during the second quarter of 2012. We opened 15 restaurants and closed 2 in the U.S. in the second quarter of 2012 (including the net addition of 8 self-serve kiosks), compared to 10 openings and 1 closure (including the net addition of 2 self-serve kiosks) in the second quarter of 2011.

For the first half of 2012, operating income was $8.8 million compared to $6.6 million in the first half of 2011, increasing $2.2 million, or 33.4%. The same factors influencing growth rates in the second quarter were prevalent in the first half, with the exception that systemwide sales growth was stronger resulting in higher growth from rents and royalties and distribution income, and we had higher manufacturing income. Systemwide sales growth was 14.3% in the first half of 2012, driven by the net addition of restaurants and continued same-store sales growth of 6.6%. We opened 22 restaurants and closed 2 in the first half of 2012 (including the net addition of 9 self-serve kiosks) compared to opening 21 restaurants and closing 1 in the first half of 2011 (including the net addition of 7 self-serve kiosks).

Variable interest entities (“VIEs”)

Operating income for VIEs pertains primarily to the non-owned entities that operate restaurants where we may own the equipment in addition to controlling the real estate, and for accounting purposes, we are deemed to be the primary beneficiary (“Non-owned Restaurants”). Beginning in 2012, operating income also includes advertising levies and depreciation associated with the Tim Hortons Advertising and Promotion Fund (Canada) Inc. (“Ad Fund”) program to acquire and install LCD screens, media engines, drive-thru menu boards and ancillary equipment in our restaurants (“Expanded Menu Board Program”) as the Ad Fund retains ownership and controls this equipment. Generally, the advertising levies and advertising and marketing expenses incurred by our advertising funds that are not related to the Expanded Menu Board Program continue to be netted in operating expenses as the Company acts as an agent with regard to these contributions.

In the second quarter of 2012, the operating income for VIEs was $1.8 million, including $0.4 million associated with the Ad Fund. Comparatively, operating income was $1.1 million in the second quarter of 2011. We consolidated 309 and 258 Non-owned Restaurants, on average, in the second quarters of 2012 and 2011, respectively. In the first half of 2012, operating income was $3.3 million (including $0.5 million from the Ad Fund) compared to $2.0 million in the first half of 2011. We consolidated, on average, 307 and 257 Non-owned Restaurants in the first half of 2012 and 2011, respectively.

The increase in Non-owned Restaurants consolidated as VIEs year-over-year relates primarily to an increase in restaurant openings under operator agreements, principally in the U.S., which require minimal up-front capital from the restaurant owner. Operating income related to our VIEs depends largely on the number of Non-owned Restaurants consolidated, but also varies depending on the size, type, same-store sales growth and, ultimately, average unit volumes and financial results of the restaurants. The consolidation of VIEs also has the effect of reducing overall operating margins as a percentage of revenues, given the nature of the entities consolidated.

Corporate charges

Corporate charges were $13.1 million in the second quarter of 2012 and $26.7 million in first half of 2012. Comparatively, corporate charges were $18.4 million and $32.8 million in the second quarter and first half of 2011, respectively. The primary factor contributing to lower Corporate charges in both the second quarter and first half of 2012 was a $6.3 million charge in the second quarter of 2011 related to the CEO Separation Agreement. Partially offsetting this impact in the second quarter of 2012 were higher professional fees. In the first half of 2012 we also had higher stock-based compensation expenses, due in part to an equity grant in February 2012.

 

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Table of Contents

Results of Operations

Below is a summary of comparative results of operations and is followed by a more detailed discussion of results for the second quarter and year-to-date periods of 2012, as compared to the second quarter and year-to-date periods of 2011:

 

     Second quarter ended     Change (1)  
     July 1,
2012
    % of
Revenues
    July 3,
2011
    % of
Revenues
    Dollars     Percentage  
     ($’s in thousands)  

Revenues

            

Sales

   $ 563,772        71.8   $ 498,058        70.9   $ 65,714        13.2

Franchise revenues

            

Rents and royalties (2)

     198,973        25.3     185,389        26.4     13,584        7.3

Franchise fees

     22,836        2.9     19,313        2.7     3,523        18.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     221,809        28.2     204,702        29.1     17,107        8.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     785,581        100.0     702,760        100.0     82,821        11.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses

            

Cost of sales

     493,300        62.8     434,051        61.8     59,249        13.7

Operating expenses

     73,068        9.3     65,102        9.3     7,966        12.2

Franchise fee costs

     24,794        3.2     20,419        2.9     4,375        21.4

General and administrative expenses

     40,395        5.1     43,969        6.3     (3,574     (8.1 )% 

Equity (income)

     (3,859     (0.5 )%      (3,820     (0.5 )%      (39     1.0

Other (income), net

     (956     (0.1 )%      (179     —       (777     n/m   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses, net

     626,742        79.8     559,542        79.6     67,200        12.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     158,839        20.2     143,218        20.4     15,621        10.9

Interest (expense)

     (8,650     (1.1 )%      (7,427     (1.1 )%      (1,223     16.5

Interest income

     723        0.1     851        0.1     (128     (15.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     150,912        19.2     136,642        19.4     14,270        10.4

Income taxes

     41,675        5.3     40,202        5.7     1,473        3.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     109,237        13.9     96,440        13.7     12,797        13.3

Net income attributable to noncontrolling interests

     1,170        0.1     891        0.1     279        31.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Tim Hortons Inc.

   $ 108,067        13.8   $ 95,549        13.6   $ 12,518        13.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

n/m

Not meaningful

(1) 

The financial results of our U.S. segment are denominated in U.S. dollars and translated into Canadian dollars for consolidated reporting purposes. The change of the Canadian dollar relative to the U.S. dollar year-over-year did not have a significant impact on any component of net income in the second quarter of 2012.

(2) 

Rents and royalties revenues consist of: (i) royalties, which typically range from 3.0% to 4.5% of gross franchised restaurant sales; (ii) advertising levies of $1.1 million and $0.2 million in 2012 and 2011, respectively, associated with the Ad Fund (see note 12 to the Condensed Consolidated Financial Statements); and (iii) rents, which consist of base and percentage rent in Canada and percentage rent only in the U.S., and typically range from 8.5% to 10.0% of gross franchised restaurant sales. Franchised restaurant sales are reported to us by our restaurant owners. Franchised restaurant sales are not included in our Condensed Consolidated Financial Statements, other than approximately 309 and 258 Non-Owned Restaurants, on average, in the second quarter of 2012 and 2011, respectively, whose results of operations are consolidated with ours pursuant to applicable accounting rules. Franchised restaurant sales do, however, result in royalties and rental income, which are included in our franchise revenues, as well as distribution income. The reported franchised restaurant sales (including those consolidated pursuant to applicable accounting rules) were:

 

     Q2 2012      Q2 2011  
     (in thousands)  

Franchised restaurant sales:

     

Canada (Canadian dollars)

   $ 1,504,083       $ 1,426,466   

U.S. (U.S. dollars)

   $ 133,120       $ 118,311   

 

28


Table of Contents
     Year-to-date period ended     Change (1)  
     July 1, 2012     % of
Revenues
    July 3, 2011     % of
Revenues
    Dollars     Percentage  
     ($’s in thousands)  

Revenues

            

Sales

   $ 1,087,074        72.1   $ 952,535        70.8   $ 134,539        14.1

Franchise revenues

            

Rents and royalties (2)

     379,159        25.2     353,219        26.2     25,940        7.3

Franchise fees

     40,632        2.7     40,493        3.0     139        0.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     419,791        27.9     393,712        29.2     26,079        6.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     1,506,865        100.0     1,346,247        100.0     160,618        11.9