UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A
Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
(Amendment No. )
Filed by the Registrant x Filed by a Party other than the Registrant ¨
Check the appropriate box:
¨ | Preliminary Proxy Statement |
¨ | Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2)) |
x | Definitive Proxy Statement |
¨ | Definitive Additional Materials |
¨ | Soliciting Material Pursuant to §240.14a-12 |
Wendys International, Inc.
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
x | No fee required. |
¨ | Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. |
(1) | Title of each class of securities to which transaction applies: |
(2) | Aggregate number of securities to which transaction applies: |
(3) | Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): |
(4) | Proposed maximum aggregate value of transaction: |
(5) | Total fee paid: |
¨ | Fee paid previously with preliminary materials. |
¨ | Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. |
(1) | Amount Previously Paid: |
(2) | Form, Schedule or Registration Statement No.: |
(3) | Filing Party: |
(4) | Date Filed: |
Notice of 2005 Annual Meeting of Shareholders,
Proxy Statement, Financial Statements and Other Information
WENDYS INTERNATIONAL, INC.
P.O. Box 256
Dublin, Ohio 43017-0256
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
To the Shareholders of Wendys International, Inc.:
Notice is hereby given that the Annual Meeting of Shareholders of Wendys International, Inc. (the Company) will be held at the AMC Theatres, 6700 Village Parkway, Dublin, Ohio 43017, on Thursday, April 28, 2005, at 8:00 a.m., local time, for the following purposes, all of which are more completely set forth in the accompanying Proxy Statement:
1. | To elect four Directors, each for a term of three years. |
2. | To ratify the selection of PricewaterhouseCoopers LLP as the independent registered public accounting firm of the Company for the current year. |
3. | To consider two Shareholder Proposals, if presented at the Annual Meeting, as described on pages 20 to 24 of the Proxy Statement. |
4. | To transact such other business as may properly come before the meeting. |
Only shareholders of record at the close of business on March 7, 2005 are entitled to notice of and to vote at the Annual Meeting of Shareholders.
YOUR VOTE IS IMPORTANT
Again this year we are offering registered shareholders the opportunity to vote their shares electronically through the internet or by telephone. Please see the Proxy Statement and the enclosed Proxy for details about electronic voting. You are urged to date, sign and promptly return the enclosed Proxy, or to vote electronically through the internet or by telephone, so that your shares may be voted in accordance with your wishes and so that the presence of a quorum may be assured. Voting promptly, regardless of the number of shares you hold, will aid the Company in reducing the expense of additional Proxy solicitation. Voting your shares by the enclosed Proxy, or electronically through the internet or by telephone, does not affect your right to vote in person in the event you attend the meeting.
You are invited to attend the meeting, and we request that you indicate your plans in this respect in the space provided on the enclosed Proxy or as prompted if you vote electronically through the internet or by telephone. For shareholders of record, an admission ticket (which is attached to the enclosed Proxy) and government-issued picture identification will be required to enter the meeting. Shareholders owning common shares through a broker, bank or other record holder must bring evidence of ownership as of March 7, 2005, such as an account statement, proxy issued by the record holder or other acceptable document in addition to a government-issued picture identification. An individual arriving at the meeting site without an admission ticket, account statement, proxy issued by the record holder or other acceptable document and a government-issued picture identification will not be admitted unless the Company can otherwise verify ownership as of the record date. Seating at the meeting is limited and admission is on a first-come, first-served basis. Cameras, cell phones, recording equipment and other electronic devices will not be permitted at the meeting. Additional details about admission to the meeting are stated on the back cover of the Proxy Statement.
/s/ Leon M. McCorkle, Jr.
LEON M. McCORKLE, JR.
Secretary
Dublin, Ohio
March 28, 2005
WENDYS INTERNATIONAL, INC.
P.O. Box 256
Dublin, Ohio 43017-0256
(614) 764-3100
The enclosed Proxy, for use at the Annual Meeting of Shareholders to be held on Thursday, April 28, 2005, and any adjournments thereof, is being solicited on behalf of the Board of Directors of the Company. A shareholder may also choose to vote electronically by accessing the internet site or by using the toll-free telephone number stated on the form of Proxy. Without affecting any vote previously taken, the Proxy may be revoked by the shareholder by giving notice of revocation to the Company in writing, by accessing the internet site, by using the toll-free telephone number stated on the form of Proxy, or in open meeting. A shareholder may also change his or her vote by executing and returning to the Company a later-dated Proxy, by a later-dated electronic vote through the internet site, by using the toll-free telephone number stated on the form of Proxy, or by voting at the open meeting. All properly executed Proxies received by the Board of Directors, and properly authenticated electronic votes recorded through the internet or by telephone, will be voted as directed by the shareholder. All properly executed Proxies received by the Board of Directors which do not specify how shares should be voted will be voted FOR the election as Directors of the nominees listed below under ELECTION OF DIRECTORS, FOR the ratification of the selection of PricewaterhouseCoopers LLP as the independent registered public accounting firm of the Company for the current year, and AGAINST the Shareholder Proposals, if presented at the Annual Meeting, as described on pages 20 to 24 of this Proxy Statement.
Solicitation of Proxies may be made by mail, personal interview and telephone by Officers, Directors and regular employees of the Company, and by employees of the Companys transfer agent, American Stock Transfer and Trust Company. In addition, the Company has retained, at an estimated cost of $10,000 plus reasonable expenses, Georgeson Shareholder Communications, Inc., a firm specializing in proxy solicitations. All costs related to the solicitation of Proxies on behalf of the Board of Directors will be borne by the Company, except as noted below. The Company will reimburse its transfer agent, banks, brokers, and other custodians, nominees and fiduciaries for their reasonable costs in sending proxy materials to shareholders.
The internet and telephone procedures for voting and for revoking or changing a vote are designed to authenticate shareholders identities, to allow shareholders to give their voting instructions and to confirm that shareholders instructions have been properly recorded. Shareholders that vote through the internet should understand that there may be costs associated with electronic access, such as usage charges from internet access providers and telephone companies, that will be borne by the shareholder.
This Proxy Statement, including the Notice of Meeting, was first mailed to shareholders on March 31, 2005.
VOTING SECURITIES AND PRINCIPAL HOLDERS THEREOF
Voting Rights
The total number of outstanding shares entitled to vote at the meeting is 113,296,001, and only shareholders of record at the close of business on March 7, 2005, are entitled to notice of and to vote at the meeting or any adjournments thereof. Each shareholder is entitled to one vote for each share held and has cumulative voting rights in the election of Directors. A shareholder wishing to exercise cumulative voting must notify the President, a Vice President or the Secretary of the Company in writing not less than 48 hours before the meeting. If cumulative voting is requested and if an announcement of such request is made upon the convening of the meeting by the Chairman or Secretary or by or on behalf of the shareholder requesting cumulative voting, each shareholder will have a number of votes equal to the number of Directors to be elected multiplied by the number of shares owned by such shareholder and will be entitled to distribute votes among the nominees as the shareholder sees fit. If cumulative voting is requested, as described above, the enclosed Proxy, and votes recorded through the internet or by telephone, would grant discretionary authority to the Proxies named therein to cumulate votes and to distribute the votes among the candidates.
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Security Ownership of Certain Beneficial Owners
The following table sets forth information (based upon filings with the Securities and Exchange Commission) with respect to the persons known to the Company to own beneficially more than 5% of the outstanding common shares of the Company as of March 7, 2005:
(1) Title of Class |
(2) Name and address of beneficial owner |
(3) Amount and nature of beneficial ownership |
(4) Percent of class |
|||||
Common shares |
FMR Corp. 82 Devonshire Street Boston, Massachusetts 02109 |
8,601,466 | (a)(b) | 7.6 | % | |||
Common shares |
Barrow, Hanley, Mewhinney & Strauss, Inc. One McKinney Plaza 3232 McKinney Avenue 15th Floor Dallas, Texas 75204-2429 |
8,058,991 | (a) | 7.1 | % |
(a) | As of December 31, 2004. |
(b) | Fidelity Management and Research Company (Fidelity), a wholly-owned subsidiary of FMR Corp., is the beneficial owner of 6,923,580 common shares as the result of acting as investment advisor to various investment companies (the Fidelity Funds) registered under Section 8 of the Investment Company Act of 1940. Edward C. Johnson 3d (Chairman of FMR Corp.), FMR Corp., through its control of Fidelity, and the Fidelity Funds each have sole power to dispose of the 6,923,580 common shares. Neither FMR Corp. nor Edward C. Johnson 3d has the sole power to vote or direct the voting of the common shares owned directly by the Fidelity Funds. The sole power to vote or direct the voting of the common shares owned directly by the Fidelity Funds resides with the Board of Trustees of such funds. |
Fidelity Management Trust Company, a wholly-owned subsidiary of FMR Corp., is the beneficial owner of 1,516,205 common shares as the result of its serving as investment manager of institutional accounts. Edward C. Johnson 3d and FMR Corp., through its control of Fidelity Management Trust Company, each has sole dispositive power over the 1,516,205 common shares owned by the institutional accounts and sole power to vote or direct the voting over such common shares.
Strategic Advisors, Inc., a wholly-owned subsidiary of FMR Corp., provides investment advisory services to individuals. As such, FMR Corp.s beneficial ownership includes 1,721 common shares beneficially owned through Strategic Advisors, Inc.
Members of the Edward C. Johnson 3d family are the predominant owners of Class B shares of the common stock of FMR Corp., representing approximately 49% of the voting power of FMR Corp. Mr. Johnson 3d owns 12.0% and Abigail P. Johnson owns 24.5% of the aggregate outstanding voting stock of FMR Corp. Mr. Johnson 3d is Chairman of FMR Corp. and Abigail P. Johnson is a director of FMR Corp. The Johnson family group and all other Class B shareholders have entered into a shareholders voting agreement under which all Class B shares will be voted in accordance with the majority vote of Class B shares. Accordingly, through their ownership of voting common stock and the execution of the shareholders voting agreement, members of the Johnson family may be deemed, under the Investment Company Act of 1940, to form a controlling group with respect to FMR Corp.
Fidelity International Limited (FIL), and various foreign-based subsidiaries provide investment advisory and management services to a number of non-U.S. investment companies and certain institutional investors. FIL is the beneficial owner of 159,960 common shares and has the sole power to vote and to dispose of such common shares.
A partnership controlled by Edward C. Johnson 3d and members of his family own shares of FIL voting stock with the right to cast approximately 39.89% of the total votes which may be cast by all
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holders of FIL stock. Mr. Johnson 3d is Chairman of FMR Corp. and FIL. FMR Corp. and FIL are of the view that they are not acting as a group for purposes of Section 13(d) of the Securities Exchange Act of 1934 and that they are not otherwise required to attribute to each other beneficial ownership of securities owned by the other corporation. However, the shares beneficially owned by FIL are included in the amount listed in the table above.
Security Ownership of Management
The following table sets forth, as of March 7, 2005, information with respect to the Companys common shares owned beneficially by each Director, by each nominee for election as a Director of the Company, by the Executive Officers named in the Summary Compensation Table set forth on page 11 of this Proxy Statement and by all Directors and Executive Officers as a group:
(1) Title of Class |
(2) Name of beneficial owner |
(3) Amount and nature of beneficial |
(4) Percent of class |
||||
(All of these are |
John T. Schuessler | 597,259 | .5 | % | |||
common shares.) |
Kerrii B. Anderson | 212,743 | .2 | % | |||
Paul D. House | 314,123 | .3 | % | ||||
Ann B. Crane | 3,889 | | |||||
Janet Hill | 21,764 | | |||||
Thomas F. Keller | 22,575 | | |||||
William E. Kirwan | 5,905 | | |||||
David P. Lauer | 149,343 | .1 | % | ||||
J. Randolph Lewis | 2,600 | | |||||
James F. Millar | 6,389 | | |||||
James V. Pickett | 89,511 | .1 | % | ||||
John R. Thompson | 5,000 | | |||||
Donald F. Calhoon | 112,392 | .1 | % | ||||
George Condos | 84,060 | .1 | % | ||||
Kathie T. Chesnut | 106,306 | .1 | % | ||||
Thomas J. Mueller | 262,600 | .2 | % | ||||
All Directors and Executive Officers as a group (19 persons) | 2,239,987 | 1.9 | % |
(a) | The amounts reflected in this table include common shares in which there is shared voting and investment power. |
(b) | Includes options exercisable within 60 days following March 7, 2005 and restricted shares. |
In addition to the amounts shown above, as of March 7, 2005, Dr. Kirwan and all Directors and Executive Officers as a group held 774 and 1,639, respectively, phantom shares under the Companys Deferred Compensation Plan. Under that Plan, phantom shares are payable in common shares of the Company not earlier than six months after termination as a Director or employment with the Company (as applicable). Phantom shares do not have voting rights.
The information with respect to beneficial ownership is based upon information furnished by each Director, nominee or Executive Officer, or information contained in filings made with the Securities and Exchange Commission.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Companys Directors and Executive Officers to file reports of ownership and changes of ownership with the Securities and Exchange Commission and the New York Stock Exchange. The Company assists its Directors and Executive Officers in completing and filing those reports. The Company believes that all filing requirements applicable to its Directors and Executive Officers were complied with during the last completed fiscal year.
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The Board of Directors has designated the following nominees for election as Directors of the Company with their terms to expire in 2008:
Name |
Age |
Directors and Their Principal Occupations / Business Experience |
Director Since | |||
John T. Schuessler
|
54 | Chairman of the Board, Chief Executive Officer and President. Mr. Schuessler joined the Company in 1976 and has been promoted several times. He was Executive Vice President, U.S. Operations from February 20, 1995 until February 19, 1997, when he became President and Chief Operating Officer, U.S. Operations. He became Chief Executive Officer and President on March 16, 2000. He assumed his current position on May 1, 2001. | 2000 | |||
Kerrii B. Anderson
|
47 | Executive Vice President and Chief Financial Officer. Mrs. Anderson joined the Company on September 1, 2000. Prior to joining the Company, Mrs. Anderson had held the titles of Senior Vice President and Chief Financial Officer of M/I Schottenstein Homes, Inc. since 1987. She was also Secretary of M/I Schottenstein Homes, Inc. from 1987 to 1994 and Assistant Secretary from 1994 until she joined the Company. (1) | 2000 | |||
William E. Kirwan
|
66 | Chancellor, University System of Maryland, Adelphi, Maryland. Dr. Kirwan assumed this position effective August 1, 2002. He had previously served as President of The Ohio State University for four years and as President of the University of Maryland for nine years. | 2001 | |||
Ann B. Crane
|
48 | President and Chief Executive Officer, Crane Group, Columbus, Ohio. Ms. Crane has been President of Crane Group since 1996 and assumed the position of Chief Executive Officer in January, 2003. Crane Group is a diversified company comprised of several manufacturing businesses primarily serving the home building and commercial markets, real estate investments and equities. | 2003 |
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The following Directors will continue to serve after the 2005 Annual Meeting:
Terms Expiring in 2006
Name |
Age |
Directors and Their Principal Occupations / Business Experience |
Director Since | |||
James V. Pickett
|
63 | Chairman, The Pickett Realty Advisors Inc., Dublin, Ohio. Mr. Pickett has served as President and Chief Executive Officer of various companies generally known as The Pickett Companies since 1969. The Pickett Companies are involved in real estate development, ownership and management. Mr. Pickett was the Vice Chairman of Banc One Capital Corporation from February 1, 1993 to August 4, 1999. He was also a Principal of Stonehenge Financial Holdings, Inc., an investment management firm, from August 6, 1999 to July 31, 2004. | 1982 | |||
Thomas F. Keller
|
73 | R.J. Reynolds Professor Emeritus of Business Administration and Dean Emeritus, Fuqua School of Business, Duke University, Durham, North Carolina. Dr. Keller was the R.J. Reynolds Professor of Business Administration at the Fuqua School of Business at Duke University until he retired on September 1, 2004. He was Dean of the Fuqua School of Business until he retired from that position on May 31, 1996. He was also Dean of the Fuqua School of Business Europe from July 1, 1999 to June 30, 2001. (1) | 1991 | |||
David P. Lauer
|
62 | Retired President and Chief Operating Officer, Bank One, Columbus, NA, Columbus, Ohio. Mr. Lauer was Office Managing Partner of the Columbus office of Deloitte & Touche LLP from January, 1989 until he retired in June, 1997. He was also a member of the board of directors of Deloitte & Touche LLP from 1988 to 1995. He was appointed to his former position with Bank One, Columbus, NA in June, 1997. Mr. Lauer retired from that position in January, 2001. He has been a Certified Public Accountant since 1968. (1) | 2000 | |||
James F. Millar
|
57 | Retired Executive Director Strategic Initiatives, Cardinal Health, Inc., Dublin, Ohio. Mr. Millar was President and Chief Operating Officer Pharmaceutical Distribution and Medical Products of Cardinal Health, Inc. from 1987 until February, 2004, at which time he was named Executive Director Strategic Initiatives. He retired from Cardinal Health effective March 5, 2005. Cardinal Health, Inc. provides products and services to healthcare providers and manufacturers. | 2001 |
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Terms Expiring in 2007
Name |
Age |
Directors and Their Principal Occupations / Business Experience |
Director Since | |||
Janet Hill
|
57 | Vice President, Alexander & Associates, Inc., Washington, D.C. Mrs. Hill provides corporate planning, advice and analysis to directors, executives and managers in the areas of human resource planning, corporate responsibility, corporate communications and government consultation. Alexander & Associates, Inc. is a corporate consulting firm. (1) | 1994 | |||
Paul D. House
|
61 | President and Chief Operating Officer, The TDL Group Corp., Oakville, Ontario, Canada. Mr. House has been the Chief Operating Officer of The TDL Group Corp. since January, 1992. He assumed his current position on December 29, 1995. The TDL Group Corp. franchises and operates Tim Hortons restaurants. | 1998 | |||
John R. Thompson
|
53 | Senior Vice President and General Manager, BestBuy.com, a subsidiary of Best Buy Co., Inc. Mr. Thompson joined Best Buy in April, 2001 as Senior Vice President of Supply Chain and Business Systems. He was Chief Information Officer and Senior Vice President for Customer Service, Information Systems, Distribution, Logistics and e-Business at Liz Claiborne, Inc. from February, 1995 to March, 2001. Mr. Thompson was Chief Information Officer and Executive Vice President at Goodys Family Clothing, Inc. from February, 1993 to February, 1995. Best Buy is a retailer of consumer electronics, home-office equipment, entertainment software and major appliances. | 2004 | |||
J. Randolph Lewis
|
55 | Senior Vice President, Distribution and Logistics, Walgreen Co. Mr. Lewis joined Walgreen Co. in March, 1992 as Vice President, Logistics and Planning. He was promoted to his current position in March, 1996. Prior to joining Walgreen Co. he was a partner in the consulting division of Ernst & Young. Walgreen Co. is the nations largest drugstore chain. | 2004 |
(1) | Mrs. Anderson serves as a director of Lancaster Colony Corporation; Dr. Keller serves as a director of DIMON International and Biogen Idec Inc.; Mr. Lauer serves as a director of AirNet Systems, Inc., Diamond Hill Investment Group, Huntington Bancshares Incorporated and R.G. Barry Corporation; and Mrs. Hill serves as a director of Dean Foods Company and Nextel Communications, Inc. |
Unless otherwise directed, the persons named in the Proxy will vote the Proxies FOR the election of Mr. Schuessler, Mrs. Anderson, Dr. Kirwan and Ms. Crane, as Directors of the Company, each to serve for a term of three years and until his or her successor is elected and qualified, or until his or her earlier death,
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resignation or removal. While it is contemplated that all nominees will stand for election, in the event any person nominated fails to stand for election, the Proxies will be voted for such other person or persons as may be designated by the Directors. Management has no reason to believe that any of the above-mentioned persons will not stand for election or serve as a Director.
Under Ohio law and the Companys Regulations, the nominees receiving the greatest number of votes will be elected as Directors. Shares as to which the authority to vote is withheld and broker non-votes are not counted toward the election of Directors or toward the election of the individual nominees specified on the Proxy.
OTHER DIRECTOR INFORMATION, COMMITTEES OF DIRECTORS AND CORPORATE GOVERNANCE INFORMATION
The Board of Directors originally adopted Principles of Governance and Governance Guidelines in February, 2001. The Board last amended its Governance Guidelines in October, 2004. The Governance Guidelines address Board structure, membership (including nominee qualifications), performance, operations and management oversight. Pursuant to the Principles of Governance and Governance Guidelines, the Board of Directors meets quarterly in executive session (without management present). The chair of the Nominating and Corporate Governance Committee serves as lead Director and in that capacity presides at executive sessions of the independent Directors (except where the principal matters to be considered are within the scope of authority of one of the other chairs).
The Governance Guidelines provide that the Boards goal is that a substantial majority of the Directors should be independent Directors. A Director will be designated as independent if he or she (i) has no material relationship with the Company or its subsidiaries; (ii) satisfies the other criteria specified by New York Stock Exchange listing standards; (iii) has no business conflict with the Company or its subsidiaries; and (iv) otherwise meets applicable independence criteria specified by law, regulation, exchange requirement or the Board of Directors. The Board of Directors has affirmatively determined that the following Directors are independent under that definition:
Ann B. Crane |
J. Randolph Lewis | |
Janet Hill |
James F. Millar | |
Thomas F. Keller |
James V. Pickett | |
William E. Kirwan |
John R. Thompson | |
David P. Lauer |
The Governance Guidelines further provide that the Directors are invited and expected to attend the Annual Meeting of Shareholders. A total of 11 Directors attended the Annual Meeting of Shareholders in 2004.
The Corporate Governance section of the Companys corporate and investor website (www.wendys-invest.com) contains the Principles of Governance and Governance Guidelines. The Companys corporate and investor website also contains a description of its strategic plan, including the elements of the plan and the role of the Directors in the development, formulation and oversight for future performance and refinement of the plan.
A total of 10 meetings of the Board of Directors of the Company were held during 2004. No Director attended less than 75% of the aggregate of (i) the total number of meetings of the Board of Directors, and (ii) the total number of meetings held by all committees of the Board of Directors on which that Director served during the period each served as a Director.
Directors who are not employees of the Company or its subsidiaries are paid $7,500 quarterly, plus $1,500 for each Board meeting and $1,250 for each qualified committee meeting attended, including telephonic meetings, for all services, plus expenses. If more than one qualified meeting is held on the same day, a separate fee is paid for each meeting attended. Meetings of the Audit, Compensation and the Nominating and Corporate Governance Committees are qualified meetings, as are meetings of any special committees established from time to time. In addition, the Chair of the Audit Committee is paid a retainer of $2,500 quarterly, the Chairs of the Compensation and Nominating and Corporate Governance Committees are paid a retainer of $1,875 quarterly and the lead Director is paid a retainer of $1,875 quarterly. Directors who are not employees of the Company are also reimbursed for expenses related to attendance at director education seminars attended pursuant to the Boards director education program.
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Directors who are not employees of the Company or its subsidiaries also receive an annual award of 2,040 restricted shares under the 2003 Stock Incentive Plan. Restricted shares will be awarded on the date on which the regularly scheduled Board meeting is held during the Companys second fiscal quarter. 25% of the shares awarded each year will vest on each of the first four anniversaries of the award date for those shares.
The Company has adopted a code of ethics that applies to all of its officers and employees, including its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. This code of ethics, designated as the Standards of Business Practices by the Company, can be found on the Companys corporate and investor website at www.wendys-invest.com. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding any amendment to, or waiver from, any applicable provision (related to elements listed under Item 406(b) of Regulation S-K) of the Standards of Business Practices that applies to the Companys principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions by posting such information on the Companys corporate and investor website.
In accordance with New York Stock Exchange requirements, the Board of Directors has a Nominating and Corporate Governance Committee, a Compensation Committee and an Audit Committee, all of which have written charters and are comprised solely of independent Directors as discussed above. The Principles of Governance, Governance Guidelines, the Standards of Business Practices, a Code of Business Conduct (applicable to directors) and written charters for the Nominating and Corporate Governance, Compensation and Audit Committees are available on the Companys investor website at www.wendys-invest.com and a copy of the foregoing will be made available (without charge) to any shareholder upon request.
Nominating and Corporate Governance Committee
Each member of the Nominating and Corporate Governance Committee is independent as discussed above. In January, 2004 the Committee recommended, and the Board of Directors approved, a Nominating and Corporate Governance Committee Charter, which can be found on the Companys corporate and investor website.
The members of the Nominating and Corporate Governance Committee are Messrs. Pickett (Chair), Kirwan, Lauer and Millar. The Committee met four times during 2004. Its functions include assisting the Board in determining the desired qualifications of Directors, identifying potential individuals meeting those qualification criteria, proposing to the Board a slate of nominees for election by the shareholders and reviewing candidates nominated by shareholders. In addition, the Committee also reviews the Principles of Governance and Governance Guidelines, makes recommendations to the Board with respect to other corporate governance principles applicable to the Company, oversees the annual evaluation of the Board and management, and reviews Board and management succession plans.
The Nominating and Corporate Governance Committee meets regularly to discuss, among other things, identification and evaluation of potential candidates for nomination as a Director. Potential candidates are identified with the assistance of a paid outside search firm and evaluated according to the qualification criteria as set forth in the Boards Governance Guidelines:
· | High personal and professional ethics, integrity, practical wisdom and mature judgment; |
· | Board training and experience in business, government, education or technology; |
· | Expertise that is useful to the Company and complementary to the background and experience of other Board members; |
· | Willingness to devote the required amount of time to carrying out the duties and responsibilities of Board membership; |
· | Commitment to serve on the Board over a period of several years to develop knowledge about the Company and its operations; |
· | Willingness to represent the best interests of all shareholders and objectively appraise managements performance; and |
· | Board diversity, and other relevant factors as the Board may determine. |
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The Nominating and Corporate Governance Committee will consider nominees recommended by shareholders for the 2006 Annual Meeting of Shareholders, provided that the names of such nominees are submitted in writing, not later than December 1, 2005, to James V. Pickett, P.O. Box 256, Dublin, Ohio 43017-0256. Each such submission must include a statement of the qualifications of the nominee, a consent signed by the nominee evidencing a willingness to serve as a Director, if elected, and a commitment by the nominee to meet personally with the Nominating and Corporate Governance Committee members.
Other than the submission requirements set forth above, there are no differences in the manner in which the Nominating and Corporate Governance Committee evaluates a nominee for Director recommended by a shareholder.
Compensation Committee
Each member of the Compensation Committee is independent as discussed above. In February, 2004 the Committee recommended, and the Board of Directors approved, a revised Compensation Committee Charter, which can be found on the Corporate Governance section of the Companys corporate and investor website.
The members of the Compensation Committee are Messrs. Millar (Chair), Kirwan and Lewis, and Mses. Crane and Hill. The Compensation Committee met nine times during 2004. The Compensation Committees functions include examining the levels and methods of compensation employed by the Company with respect to the Chief Executive Officer and non-CEO officers, reviewing and approving the compensation package of the Chief Executive Officer, making recommendations to the Board with respect to non-CEO officer compensation, making recommendations to the Board with respect to incentive compensation plans and equity-based plans, making administrative and compensation decisions under equity compensation plans approved by the Board, and adopting and administering one or more cash bonus plans, subject to shareholder approval, which will qualify compensation paid thereunder as performance-based compensation within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code), and implementing and administering such plans.
Audit Committee
Each member of the Audit Committee is independent as discussed above. In January, 2004 the Committee recommended, and the Board of Directors approved, a revised Audit Committee Charter, which can be found on the Corporate Governance section of the Companys corporate and investor website.
The members of the Audit Committee are Messrs. Keller (Chair), Lauer, Pickett and Thompson. The Committee met 12 times during 2004. Its functions include providing assistance to the Board of Directors in fulfilling its oversight responsibility relating to the Companys financial statements and the financial reporting process, compliance with legal and regulatory requirements, the qualifications and independence of the Companys independent registered public accounting firm, the Companys system of internal controls, the internal audit function, the Companys code of ethical conduct, retaining and, if appropriate, terminating the independent registered public accounting firm, and approving audit and non-audit services to be performed by the independent registered public accounting firm.
The Board of Directors has determined that each of Thomas F. Keller, David P. Lauer and James V. Pickett is an audit committee financial expert as such term is defined by the Securities and Exchange Commission under Item 401(h) of Regulation S-K. The Board of Directors has affirmatively determined that each member of the Audit Committee is independent in accordance with the listing standards of the New York Stock Exchange.
Mr. Lauer currently serves on the audit committees of more than three public companies. The Board of Directors has determined that such service does not impair Mr. Lauers ability to effectively serve on the Companys Audit Committee.
The Audit Committee has adopted a policy under which audit and non-audit services to be rendered by the Companys independent registered public accounting firm are pre-approved. The Committees Pre-Approval Policy can be found on the Companys corporate and investor website. No services were
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provided by the independent registered public accounting firm in 2004 that were approved by the Committee under Securities and Exchange Commission Regulation S-X Section 2-01(c)(7)(i)(C) (which addresses certain services considered de minimus approved by the Committee after such services have been performed).
Audit and Other Service Fees
The following table sets forth the aggregate fees for professional services rendered by PricewaterhouseCoopers LLP for each of the last two fiscal years of the Company.
2004 |
2003 | |||||
Audit fees (1) |
$ | 3,083,900 | $ | 1,036,650 | ||
Audit-related fees (2) |
$ | 178,100 | $ | 301,700 | ||
Tax fees (3) |
$ | 118,300 | $ | 413,400 | ||
All other fees (4) |
$ | 0 | $ | 0 | ||
Total |
$ | 3,380,300 | $ | 1,751,750 |
(1) | Includes services rendered for the audit of the Companys annual financial statements, review of financial statements included in the Companys quarterly reports on Form 10-Q, services related to the audit of internal control over financial reporting (which totaled $1,926,500 in 2004) and other audit services normally provided by PricewaterhouseCoopers LLP in connection with statutory and regulatory filings or engagements. |
(2) | Includes assurance and related services reasonably related to the performance of the audit or review of the Companys financial statements not reported as audit fees. Audit-related fees for both years primarily include accounting research, benefit plan audits and services provided to advertising funds. |
(3) | Includes services rendered for tax compliance, tax advice and tax planning. Tax fees for both years primarily include services related to the organization of the Companys subsidiaries, other tax and tax planning advice and services rendered in connection with federal and international tax audits. |
(4) | No products or services were provided to the Company other than those reported as audit, audit-related or tax fees. |
In performing its responsibilities, the Audit Committee, in addition to other activities, (i) reviewed and discussed the Companys audited financial statements with management; (ii) discussed with PricewaterhouseCoopers LLP the matters required to be discussed by Statement on Auditing Standards 61 (Communication with Audit Committees), as modified or supplemented, and the Public Company Accounting Oversight Boards Auditing Standard No. 2 (An Audit of Internal Control Over Financial Reporting performed in conjunction with an Audit of Financial Statements); and (iii) received the letter from PricewaterhouseCoopers LLP required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), as modified or supplemented, and discussed with PricewaterhouseCoopers LLP the firms independence. Based on these reviews, discussions and activities, the Committee recommended to the Board of Directors that the audited financial statements be included in the Companys Annual Report on Form 10-K for fiscal 2004 for filing with the Securities and Exchange Commission.
The Audit Committee considered whether the provision of non-audit services by PricewaterhouseCoopers LLP was compatible with maintaining such firms independence.
Respectfully submitted,
Audit Committee
Thomas F. Keller, Chair
David P. Lauer
James V. Pickett
John R. Thompson
10
The following table summarizes compensation awarded or paid to, or earned by, each of the named Executive Officers during each of the Companys last three fiscal years.
Name and |
Year |
Annual Compensation |
Long Term Compensation |
All Other Compensation ($) (2) | ||||||||||||
Salary ($)(1) |
Bonus ($) |
Other Annual Compensation ($) |
Restricted Stock Awards ($) |
Securities Underlying Options (#) |
||||||||||||
John T. Schuessler, | 2004 | 1,047,750 | 0 | 86,276 | (3) | 5,722,609 | (4) | 518,009 | ||||||||
Chairman of the Board, | 2003 | 934,192 | 1,606,500 | 60,329 | (3) | 318,000 | 461,465 | |||||||||
Chief Executive Officer and President |
2002 | 863,693 | 1,931,250 | 78,683 | (3) | 330,000 | 347,955 | |||||||||
Kerrii B. Anderson, | 2004 | 439,519 | 0 | (5 | ) | 682,935 | (6) | 111,098 | ||||||||
Executive Vice | 2003 | 388,765 | 803,250 | 72,000 | 95,038 | |||||||||||
President and Chief Financial Officer | 2002 | 359,885 | 965,625 | 88,000 | 62,253 | |||||||||||
Donald F. Calhoon, | 2004 | 392,531 | 283,360 | (5 | ) | 370,027 | (6) | 158,715 | ||||||||
Executive Vice | 2003 | 350,435 | 397,785 | 39,000 | 141,309 | |||||||||||
President | 2002 | 321,923 | 523,275 | 49,500 | 61,292 | |||||||||||
George Condos, | 2004 | 366,500 | 283,360 | (5 | ) | 370,027 | (6) | 157,675 | ||||||||
Executive Vice | 2003 | 342,215 | 397,785 | 39,000 | 143,010 | |||||||||||
President | 2002 | 326,500 | 523,275 | 49,500 | 78,857 | |||||||||||
Kathie T. Chesnut, | 2004 | 355,385 | 283,360 | (5 | ) | 370,027 | (6) | 82,148 | ||||||||
Executive Vice | 2003 | 326,827 | 397,785 | 39,000 | 92,192 | |||||||||||
President | 2002 | 201,346 | 249,610 | 49,500 | 84,251 | |||||||||||
Thomas J. Mueller, | 2004 | 402,546 | 202,240 | (5 | ) | 682,935 | (6) | 122,585 | ||||||||
President and Chief | 2003 | 364,989 | 553,440 | 72,000 | 108,234 | |||||||||||
Operating Officer North America | 2002 | 339,154 | 728,035 | 88,000 | 121,358 |
(1) | Fiscal year 2004 includes 53 weeks. Fiscal years 2003 and 2002 include 52 weeks. |
(2) | The amounts shown in this column for each named Executive Officer consist of (i) executive health insurance premiums paid by the Company for coverage for the named Executive Officers of $3,173 per person for each year; and (ii) contributions or other allocations to the Companys Profit Sharing and Savings Plan, and the amount allocated to the account of each of the named Executive Officers under the Companys Supplemental Executive Retirement Plan (SERP), as follows: |
Profit Sharing and Savings Plan |
SERP Allocations | |||||||||||||||||
Name |
2004 |
2003 |
2002 |
2004 |
2003 |
2002 | ||||||||||||
Mr. Schuessler |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 497,386 | $ | 446,225 | $ | 336,782 | ||||||
Mrs. Anderson |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 91,957 | $ | 81,199 | $ | 51,080 | ||||||
Mr. Calhoon |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 138,874 | $ | 126,796 | $ | 50,119 | ||||||
Mr. Condos |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 137,394 | $ | 128,074 | $ | 67,684 | ||||||
Mrs. Chesnut |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 62,307 | $ | 77,679 | $ | 73,078 | ||||||
Mr. Mueller |
$ | 8,200 | $ | 8,000 | $ | 8,000 | $ | 102,839 | $ | 93,813 | $ | 110,185 |
The amounts shown in this column for 2004 also include premiums paid by the Company for each of the named Executive Officers under a supplemental long-term disability insurance program implemented in 2003 as follows: John T. Schuessler, $4,250; Kerrii B. Anderson, $2,768; Donald F. Calhoon, $3,468; George Condos, $3,908; Kathie T. Chesnut, $3,468; and Thomas J. Mueller, |
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$3,373; and a one time cash payment of $5,000 to each named Executive Officer in lieu of further participation in the Companys executive health care reimbursement program (which was terminated as of December 31, 2004). |
(3) | Other annual compensation for Mr. Schuessler in 2004, 2003 and 2002 consists of personal use of Company aircraft in the amount of $72,715, $47,681 and $67,123, respectively, personal use of a Company car in the amount of $12,914, $12,648 and $11,560, respectively, and $647 in 2004 for non-cash gifts which is taxable income to Mr. Schuessler under the American Jobs Creation Act of 2004. |
(4) | Amount shown was determined by multiplying 66,250 performance shares and 72,875 restricted stock units awarded to Mr. Schuessler in 2004 by the closing price of the Companys common shares on the dates of the awards, March 19, 2004 ($40.85) and April 22, 2004 ($41.39), respectively. The March 19 performance share award was made subject to approval of the Companys 2003 Stock Incentive Plan at the 2004 Annual Meeting of Shareholders. The performance shares will be settled in restricted shares on the date of the regularly scheduled meeting of the Board of Directors held in the second fiscal quarter of 2005. The number of restricted shares issued will be 59,625 and was determined based on the Companys earnings per share in 2004 and the Companys three-year average total shareholder return through fiscal 2004 relative to the Standard & Poors 500 Index. Once the restricted shares are issued, the restrictions with respect to 25% of such shares will lapse on April 26, 2006. Restrictions will lapse on an additional 25% of such restricted shares on each successive April 26 and such restricted shares will have the other terms with respect to dividend reinvestment, termination of employment and acceleration of restriction lapse as described below in footnote 6. If Mr. Schuesslers employment is terminated for any reason prior to the regularly scheduled meeting of the Board of Directors held in the second quarter of 2005, all performance shares will be forfeited (and he would not be entitled to settlement in restricted shares). The value of the performance shares as of the last trading day of fiscal 2004 (based on the closing price of the Companys common shares, $39.26) was $2,600,975. |
The restricted stock units can be settled only in common shares of the Company and include dividend equivalent rights. 25% of the restricted stock units awarded to Mr. Schuessler will vest on April 22, 2005. An additional 25% will vest on each successive April 22. The vesting dates would be accelerated if the Company is involved in certain change-in-control transactions as specified in the Companys 2003 Stock Incentive Plan. If Mr. Schuesslers employment is terminated for any reason other than death, disability or retirement, any remaining restricted stock units will be forfeited as of the date of such termination. If his employment is terminated by reason of his death, disability or retirement, all remaining restricted stock units will vest as of the date of such termination. Dividends on restricted stock units, payable only as additional common shares, are paid on all restricted stock units outstanding as of the dividend payment date. The additional shares issued under the terms of the dividend equivalent rights will vest at the same time as the underlying shares. Notwithstanding the vesting of restricted stock units, Mr. Schuessler will only be entitled to receive common shares on the first date that such shares may be issued without resulting in the disallowance of a deduction by the Company under Section 162(m) of the Code. The value of the restricted stock units (including dividends on the restricted stock units) as of the last trading day of fiscal 2004 (based on the closing price of the Companys common shares, $39.26) was $2,890,596. |
(5) | The aggregate amount of perquisites and other benefits received by Mses. Anderson and Chesnut and Messrs. Calhoon, Condos and Mueller did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus of such individuals in 2004, 2003 or 2002. |
(6) | Amount shown was determined by multiplying the following amounts of restricted stock awarded to the named Executive Officers in 2004 by the closing price of the Companys common shares on the date of the award, April 22, 2004 ($41.39): Mrs. Anderson, 16,500; Mr. Calhoon, 8,940; Mr. Condos, 8,940; Mrs. Chesnut, 8,940; and Mr. Mueller, 16,500. Restrictions with respect to 25% of the number of restricted shares awarded will lapse on April 22, 2005. Restrictions will lapse on an additional 25% of such restricted shares on each successive April 22. The dates that restrictions lapse would be accelerated if the Company is involved in certain change-in-control transactions as specified in the Companys 2003 Stock Incentive Plan. If the Executive Officers employment is terminated for any |
12
reason other than death, disability or retirement, any remaining restricted shares will be forfeited as of the date of such termination. If the Executive Officers employment is terminated by reason of his or her death, disability or retirement, the restrictions will lapse as to all remaining restricted shares as of the date of such termination. Dividends on restricted shares, payable only as additional restricted shares, are paid on all restricted shares outstanding as of the dividend payment date. The restrictions on additional shares issued under the dividend reinvestment provision lapse at the same time as the underlying shares. |
The number and value of restricted shares held by each of the named Executive Officers as of the last trading day of fiscal 2004 (based on the closing price of the Companys common shares, $39.26) was as follows: |
Name |
Number of Restricted Shares |
Value | |||
Mrs. Anderson |
16,670 | $ | 654,464 | ||
Mr. Calhoon |
9,032 | $ | 354,596 | ||
Mr. Condos |
9,032 | $ | 354,596 | ||
Mrs. Chesnut |
9,032 | $ | 354,596 | ||
Mr. Mueller |
16,670 | $ | 654,464 |
The Company had awarded stock options to the named Executive Officers prior to 2004. The following table sets forth information regarding the exercise of stock options made during the last fiscal year by each of the named Executive Officers.
IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Name |
Shares acquired on |
Value realized ($) |
Number of securities underlying at fiscal year-end (#) |
Value of unexercised in-the-money options at fiscal year-end ($) (1) (2) | ||||||||
Exercisable |
Unexercisable |
Exercisable |
Unexercisable | |||||||||
John T. Schuessler |
280,693 | 3,922,474 | 360,141 | 457,046 | 3,022,145 | 3,588,466 | ||||||
Kerrii B. Anderson |
15,009 | 252,301 | 133,770 | 113,094 | 1,281,745 | 858,937 | ||||||
Donald F. Calhoon |
| | 68,884 | 64,016 | 610,569 | 489,574 | ||||||
George Condos |
130,818 | 1,701,462 | 45,219 | 64,241 | 381,469 | 492,391 | ||||||
Kathie T. Chesnut |
| | 65,751 | 64,096 | 556,306 | 490,576 | ||||||
Thomas J. Mueller |
| | 196,462 | 113,556 | 2,415,857 | 864,721 |
(1) | All values as shown are pretax. |
(2) | Based on the fiscal year-end closing price of $39.26 per share. |
The Company has three retirement plans which apply to Executive Officers in addition to other Officers and/or employees. The amounts of contributions or other allocations under the Profit Sharing and Savings Plan and the SERP for each of the named Executive Officers are set forth in footnote 2 to the Summary Compensation Table (see page 11). The third retirement plan is the Companys Pension Plan. Under the Pension Plan as in effect since January 1, 2001, each participant is credited with a basic benefit determined by years of service. The Company contribution is 1.5% of current compensation for participants with less than five years of service, 2.0% of current compensation for participants with at least five but less than 10 years of service, and 2.5% of current compensation for participants with 10 or more years of service. Notwithstanding the contribution rates set forth above, the maximum annual compensation amount for which contributions can be made to the Pension Plan under the Internal Revenue Code is currently $205,000. All accounts are credited with interest at an annual rate equal to the greater of 5% or the average of the 1 year Constant Maturity Treasury Rates for each of the 12-months ending with the month of November, plus 1%. The estimated annual benefits payable upon retirement at normal retirement age under the Pension Plan for each of the named Executive Officers are as follows: John T. Schuessler, $76,157; Kerrii B. Anderson, $24,787; Donald F. Calhoon, $69,372; George Condos, $90,343; Kathie T. Chesnut, $45,047; and Thomas J. Mueller, $19,783. The estimated annual retirement benefits assume a 7.5% interest factor and retirement at age 65.
13
REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
The Companys executive compensation policy has been pay for performance since well before the current popularity of that concept. In an effort to provide shareholders with a better understanding of the Companys executive compensation practices, this Report provides information beyond the information required by the proxy rules of the Securities and Exchange Commission.
Compensation Philosophy
The Companys executive compensation program is based on two objectives:
Providing market-competitive compensation opportunities, and
Creating a strong link among the interests of the shareholders, the Companys financial performance, and the total compensation of the Companys Executive Officers.
There are three components to the Companys executive compensation program: annual cash compensation, longer-term incentive compensation and benefits. The annual cash compensation program is comprised of base salary and annual incentive compensation. Base salary and annual incentive compensation opportunities are set by periodic comparison to external rates of pay for comparable positions within the food-service industry. The companies used for this comparison for 2004 were comprised of the participants in the National Chain Restaurant Compensation Association annual survey and the same companies which comprise the Peer Group Index shown on the graph on page 17. The companies which comprise the Peer Group Index have revenues of at least $1 billion and reflect the Companys scope of operations and the competitive market in the restaurant industry for senior executive talent.
Base salary ranges are targeted at the 50th percentile of competitive data. Individual variability is based on performance and experience. Adjustments are normally considered annually, based upon general movement in external salary levels, individual performance and potential, and/or changes in the positions duties and responsibilities.
Under the Senior Executive Annual Performance Plan (the Senior Executive Plan) (which Messrs. Schuessler and Mueller, and Mrs. Anderson, participated in during fiscal 2004) and the Executive Annual Performance Plan (the Executive Plan) (which other Executive Officers participated in), participants received annual incentive awards which were based on the extent to which the Company met or exceeded specified earnings per share, return on assets, and, for certain participants, Wendys North America or International Division income goals for the year. The Committee established specific performance objectives for 2004 under both plans, and the eligible participants and individual award opportunities for those participants under the Senior Executive Plan. In accordance with the terms of the Executive Plan, Mr. Schuessler determined the participants, the individual award opportunities for those participants, and the allocation of performance objectives between overall corporate results and business unit results in consultation with the Committee under the Executive Plan. Annual incentive opportunities under both plans were targeted at the 75th percentile of competitive practice. The performance objectives and individual award opportunities were designed to create financial incentives that were closely tied to Company performance.
Total cash compensation that could be earned was highly dependent on Company performance, rather than adjustments to base salary, since individual award opportunities were targeted independently from adjustments to base salary. Increases in base salary had no impact on individual award opportunities under the bonus plans. Total annual cash compensation may well be below the 50th percentile of competitive practice when target performance is not achieved. When targets are significantly exceeded, total annual cash compensation may equal or exceed the 75th percentile.
In the fourth quarter of 2004 the Company concluded that a goodwill impairment was required under generally accepted accounting principles related to its Baja Fresh Mexican Grill brand, which was acquired by the Company in 2002. The Company also announced that Baja Fresh would close a total of 15
14
underperforming restaurants in the fourth quarter and that it would impair asset values of restaurants in three markets. The aggregate effect of the goodwill impairment, restaurant closings and market impairments was to reduce the Companys reported earnings per share and return on assets for 2004 below the threshold performance objectives established by the Committee under the Senior Executive Plan. As a result, Mr. Schuessler and Mrs. Anderson received no bonus for 2004, and Mr. Mueller received only that portion of his award opportunity that reflected the extent to which the Wendys North America income goal was exceeded for the year. The performance objectives under the Executive Plan for other Executive Officers excluded the effect of the charges, as well as the effect of a correction in the Companys accounting for leases and leasehold improvements, and the awards paid to those participants were substantially lower than they would have been if the Company had attained its earnings per share and return on assets goals for the year.
Beginning in 2004, the longer-term incentive compensation program applicable to Executive Officers consists of restricted stock granted under the Companys 2003 Stock Incentive Plan, which was approved by shareholders in 2004. Prior to 2004 the longer-term incentive program consisted of stock options. Under the new program one restricted share was awarded for every four stock options that would have been granted previously to participants. Award opportunities under the restricted stock program for 2004 were set by comparison to equity awards made to comparable positions at companies with revenues of at least $1 billion within the food-service industry and other industrial companies with revenues between $1 billion and $3 billion, and were set at approximately the 60th percentile. Prior to 2003 award opportunities had been targeted at the 75th percentile. The companies used for the food-service industry comparison were the same companies which comprise the Peer Group Index shown on the graph on page 17. Award opportunities under the restricted stock program are based primarily on a fixed number of restricted shares for each eligible employee grade. The fixed number of restricted shares awarded is adjusted periodically by comparison to comparable positions within the food-service industry and to other industrial companies with revenues between $1 billion and $3 billion. In addition, the number of restricted shares awarded was adjusted in 2004 to reflect earnings per share growth and the Companys three-year average total shareholder return relative to the Standard & Poors 500 Index. This adjustment serves to more closely align equity compensation opportunities to Company performance.
The value of restricted stock awarded under this program increases as the market price of the Companys common shares increases. This program accomplishes the objective of linking each Executive Officers opportunity for financial gain to increases in shareholder wealth, as reflected by the market price of the Companys common shares.
The benefits program is comprised of retirement income and group insurance plans. The objective of the program is to provide Executive Officers with reasonable and competitive levels of protection against the four contingencies (retirement, death, disability and ill health) which will interrupt the Executive Officers employment and/or income received as an active employee. The retirement program consists of two tax-qualified plans that cover all full-time management and administrative employees, and a supplemental retirement plan which covers the Executive Officers and other Officers of the Company. The group insurance program consists of life, disability and health insurance benefit plans that cover all full-time management and administrative employees and the supplemental long-term disability plan, which covers Executive Officers and other Officers. Executive Officers and other Officers also participated in an executive health care reimbursement plan during 2004. That plan was terminated on December 31, 2004.
Section 162(m) of the Internal Revenue Code of 1986, as amended, generally limits the ability of a publicly-held corporation, such as the Company, to claim a deduction on its federal income tax return for compensation in excess of $1 million paid for a given fiscal year to the chief executive officer (or person acting in that capacity) at the close of the corporations fiscal year and the four most highly compensated officers of the corporation, other than the chief executive officer, at the end of the corporations fiscal year, unless the requirements specified in applicable Internal Revenue Service regulations are met. The $1 million compensation deduction limitation does not apply to performance-based compensation. The Company believes that compensation paid under the Senior Executive Plan, its stock option plans and the performance shares awarded to Mr. Schuessler under the 2003 Stock Incentive Plan qualifies as performance-based compensation for purposes of Section 162(m).
15
Compensation for Chief Executive Officer
Mr. Schuessler was named Chief Executive Officer and President of the Company on March 16, 2000. He had previously served as President and Chief Operating Officer, U.S. Operations of the Company. Mr. Schuessler was named Chairman of the Board, Chief Executive Officer and President on May 1, 2001.
Mr. Schuesslers base salary for 2004 was targeted at the 50th percentile of competitive data, taking into consideration the Companys overall compensation philosophy, Mr. Schuesslers performance since being named Chief Executive Officer and President, and the Companys performance under his leadership.
An annual cash incentive award was payable under the Senior Executive Plan to Mr. Schuessler only if the Company achieved or exceeded specified earnings per share and return on assets goals. The amount of the award increased if the Company exceeded the specified goals. Conversely, no award was payable if the Company did not achieve the specified goals. As noted previously in this Report, the Company did not achieve the specified earnings per share and return on assets goals for 2004 due to goodwill, market impairment and restaurant closings charges at Baja Fresh Mexican Grill announced in the fourth quarter. As a result, Mr. Schuessler received no bonus for 2004.
Long-term incentives in the form of performance shares and restricted stock units were granted to Mr. Schuessler in 2004. The principal terms of these awards are described in footnote 4 to the Summary Compensation Table (see page 12). Performance shares and restricted stock units serve to directly align Mr. Schuesslers interests with the interests of other shareholders, since the value of these awards increases as the market price of the Companys common shares increases.
The Committee considered the number of unexercised options already held by Mr. Schuessler, competitive practices and the Companys earnings per share growth and three-year average total shareholder return relative to the Standard & Poors 500 Index in determining the number of performance shares and restricted stock units to grant in 2004. The number of performance shares and restricted stock units granted in 2004 to Mr. Schuessler was designed to approximate the 60th percentile of competitive practice for comparable positions within the food-service industry and at other industrial companies with revenues between $1 billion and $3 billion, consistent with the policy previously described, adjusted for the Companys earnings per share growth and three-year average total shareholder return relative to the Standard & Poors 500 Index.
The Committee believes that Mr. Schuessler was reasonably compensated for the job he has done as the Chairman of the Board, Chief Executive Officer and President. His opportunities to increase his future compensation depend on the Companys future performance and the competitive pay practices of comparable positions within the food-service industry. The compensation programs applicable to Mr. Schuessler have accomplished the objective of linking shareholder and financial performance to Mr. Schuesslers total compensation.
Respectfully submitted,
Compensation Committee
James F. Millar, Chair
Ann B. Crane
Janet Hill
William E. Kirwan
J. Randolph Lewis
16
COMPARISON OF FIVE-YEAR TOTAL RETURN FOR WENDYS INTERNATIONAL, INC., THE PEER GROUP INDEX AND THE S&P 500 INDEX
The following graph compares the yearly percentage change in the Companys cumulative total shareholder return (as measured by dividing (i) the sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the Companys share price at the end and the beginning of the measurement period; by (ii) the share price at the beginning of the measurement period) against the cumulative total return of the S&P 500 Stock Index and a peer group of other companies with restaurant operations (excluding the Company) (the Peer Group Index). The companies which comprise the Peer Group Index have revenues of at least $1 billion and reflect the Companys scope of operations and the competitive market in the restaurant industry for senior executive talent.
COMPARISON OF FIVE-YEAR TOTAL RETURN(1)
FOR WENDYS INTERNATIONAL, INC.,
THE PEER GROUP INDEX AND THE S&P 500 INDEX(2)
1999 | 2000 | 2001 | 2002 | 2003 | 2004 | |||||||
WEN |
$100.00 | 128.09 | 143.66 | 134.26 | 196.20 | 198.90 | ||||||
PEER GROUP INDEX |
$100.00 | 96.64 | 89.22 | 69.27 | 100.47 | 142.01 | ||||||
S&P 500 INDEX |
$100.00 | 89.86 | 78.14 | 59.88 | 75.68 | 82.49 |
(1) | Assumes $100 invested on December 31, 1999, in Wendys International, Inc. common shares, the Peer Group Index and the S&P 500 Index. Total return assumes dividend reinvestment. |
(2) | The Peer Group Index has been computed by the Company, and is comprised of the following 10 companies: Brinker International, Inc.; CBRL Group, Inc.; CKE Restaurants, Inc.; Darden Restaurants, Inc.; Dennys Corporation (f/k/a Advantica Restaurant Group, Inc.); Jack in the Box Inc.; McDonalds Corporation; Outback Steakhouse, Inc.; Starbucks Corporation; and YUM! Brands, Inc. This Index has been weighted by market capitalization of each component company. |
17
The Company has entered into employment agreements (Key Executive Agreements) with each of the Executive Officers named in the Summary Compensation Table (see page 11) as well as certain other Executive Officers. The Key Executive Agreements are intended to assure the Company that it will have the continued dedication, undivided loyalty, and objective advice and counsel from these key executives in the event of a proposed transaction, or the threat of a transaction, which could result in a change in control of the Company.
The Key Executive Agreements provide that in the event of a change in control (as defined therein), the key executives will be employed by the Company in their present positions for a period of approximately five years, or until the executive dies, is terminated for cause by the Company or terminates employment himself or herself without good reason (as such terms are defined therein), whichever occurs first (the Employment Term).
In the event of a change in control, the key executives will be entitled to continue to receive during their Employment Term the annual salary, bonus and other benefits made available to them by the Company immediately prior to the change in control. The Board of Directors will review annually the performance of each key executive during such Employment Term to determine whether or not such salary and bonus should be increased.
A key executives employment may be terminated under the Key Executive Agreement for cause by the Company as defined therein. If a key executive is terminated for cause by the Company, the Company has no further obligation to pay any compensation or to provide benefits to the key executive.
A key executive may terminate his or her employment under the Key Executive Agreement after a change in control for good reason if the Company (i) changes the key executives status, title, position or responsibilities in a way that does not represent a promotion, (ii) either reduces the key executives base salary or provides an annual salary increase less than the increase in a defined consumer price index, (iii) requires the key executive to relocate beyond a 30 mile radius from the executives business office location immediately prior to the change in control, (iv) takes action which results in a material reduction in compensation and benefits otherwise payable to the key executive, (v) materially breaches the Key Executive Agreement, or (vi) fails to notify the key executive that a successor to the Company has agreed to assume and perform under the Key Executive Agreement. If a key executives employment is terminated by the Company without cause prior to a change in control, but the executive reasonably demonstrates that the termination of employment (i) was at the request of a third party who had indicated an intention or taken steps reasonably calculated to effect a change in control, or (ii) otherwise occurred in connection with, or in anticipation of, a change in control which had been threatened or proposed, then such termination will be deemed to have occurred after a change in control for the purposes of the Key Executive Agreement, provided that a change in control shall actually have occurred.
If the employment of a key executive is terminated under a Key Executive Agreement by the executive for good reason or by the Company other than for cause, the Company will be obligated to make a lump-sum payment to the key executive of three times the sum of the executives then-current salary plus average annual bonuses over the prior three years. If the key executive had not previously received bonus payments for three full plan years under the annual bonus plans and was an eligible participant under such plans at the time his employment was terminated, he or she will be deemed to have received a bonus in prior years equal to the bonus paid to such key executives predecessor in the same position. If there was not a predecessor in the same position, the key executive will be deemed to have received a bonus in prior years equal to the average of the bonuses paid to participants in positions comparable to the executives then-current position. The lump-sum payment will not be subject to offset. If the employment of the key executive is terminated under a Key Executive Agreement by the executive for good reason or by the Company other than for cause, the key executive will also be entitled to (i) continuation of group insurance benefits for three years, subject to offset for any benefits from subsequent employment, if any, (ii) purchase his or her Company automobile at the then-current book value, and (iii) a lump-sum payment equal to the present value of accrued retirement benefits after adding three additional years of benefit accrual, reduced by any vested benefits. In addition, any stock options or stock appreciation rights granted under plans of
18
the Company will become immediately vested and exercisable, and any restrictions on any stock awarded to the key executive by the Company shall lapse.
If any payments or other benefits payable to an executive under a Key Executive Agreement or otherwise is subject to the excise tax under Code Section 4999 or any similar tax, the Company is obligated under the Key Executive Agreement to pay to the executive an additional amount which, after deduction of any income, withholding and excise tax thereon, equals the excise tax.
The Company has established a benefits protection trust to provide for the payment of benefits to the key executives and to provide for the payment of reasonable legal fees or expenses incurred in good faith by the key executives in enforcing their rights under the Key Executive Agreements or any other benefit plans in which they participate.
The Company also has a severance policy that is applicable to Officers generally, including Executive Officers. Under that policy an Officer whose employment is terminated by the Company except for cause is generally entitled to continue to receive two weeks of salary continuation, and continued participation in the Companys other benefit plans, for each year of service, with a minimum of 26 weeks. An Officer can elect to receive the total remaining amount payable in a lump sum at any time during the severance period, in which case participation in the other benefit plans ceases.
CERTAIN TRANSACTIONS INVOLVING MANAGEMENT OR 5% SHAREHOLDERS
A trust for the benefit of Paul D. House is the sole shareholder of a corporation which purchased a shopping center property in Tottenham, Ontario, Canada from an unrelated third party in 1998. As part of the shopping center purchase transaction, the corporation now leases a Tim Hortons restaurant to a subsidiary of the Company. The remaining term of the lease is 9 years. The amount of rent paid to the corporation in 2004 was the Canadian dollar equivalent of $42,287 (the exchange rate used for all Canadian dollar equivalents in this section is 1.30064942 Canadian dollars per U.S. dollar). In the opinion of the Company, the terms of this lease are no less favorable than the Company and its subsidiaries could have obtained from an unrelated third party.
RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Companys Audit Committee has selected PricewaterhouseCoopers LLP as the independent registered public accounting firm of the Company for the current fiscal year. Management expects that representatives of PricewaterhouseCoopers LLP will be present at the Annual Meeting with the opportunity to make a statement if they desire to do so and will be available to respond to appropriate questions.
The affirmative vote of the holders of a majority of the common shares represented at the meeting in person or by proxy is necessary to ratify the selection of the Companys independent registered public accounting firm for the current year. Under applicable law, listing requirements and the Companys Regulations, abstentions and broker non-votes are counted as present; the effect of an abstention or a broker non-vote is the same as a no vote. THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR RATIFICATION OF THE SELECTION OF PRICEWATERHOUSECOOPERS LLP AS THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM OF THE COMPANY FOR THE CURRENT YEAR. Unless otherwise indicated, the persons named in the Proxy will vote all Proxies in favor of ratification. If the selection of PricewaterhouseCoopers LLP is not ratified, the Audit Committee will reconsider the selection of the Companys independent registered public accounting firm.
Even if the selection of PricewaterhouseCoopers LLP is ratified by shareholders, the Audit Committee in its discretion could decide to terminate the engagement of PricewaterhouseCoopers LLP and to engage another firm if the Committee determines such action to be necessary or desirable.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth, as of the end of the Companys last fiscal year, (a) the number of securities that could be issued upon exercise of outstanding options under the Companys equity compensation plans,
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(b) the weighted-average exercise price of outstanding options under such plans, and (c) the number of securities remaining available for future issuance under such plans, excluding securities that could be issued upon exercise of outstanding options.
EQUITY COMPENSATION PLAN INFORMATION | ||||||
Plan Category | Number of securities to be issued upon exercise of outstanding and rights (a) |
Weighted-average exercise price of outstanding options, warrants and rights (b) |
Number of securities for future issuance under equity compensation plans (excluding securities | |||
Equity compensation plans approved by security holders |
9,770,684 | 30.1173 | 2,358,942 | |||
Equity compensation plans not approved by security holders |
2,785,469 | 27.9871 | 574,832 | |||
Total |
12,556,153 | 29.6447 | 2,933,774 |
On August 2, 1990, the Board of Directors adopted the WeShare Stock Option Plan (the WeShare Plan), a non-qualified stock option plan that provided for grants of options equal to 10% of each eligible employees earnings, with a minimum of 20 options to be granted to each eligible employee annually. Beginning in 2002, options equal to 8-12% of each eligible employees earnings could be granted annually under the WeShare Plan. The percentage of each eligible employees earnings is determined by the Companys annual performance as measured by earnings per share growth and the Companys three-year average total shareholder return relative to the Standard & Poors 500 Index. Most employees of the Company and its subsidiaries who are full-time employees on the grant date and on December 31 of the year preceding the grant date are eligible employees. An aggregate of 9.2 million common shares of the Company have been reserved pursuant to the WeShare Plan (including shares already issued pursuant to option exercises).
Options granted under the WeShare Plan have a term of 10 years from the grant date and become exercisable in installments of 25% on each of the first four anniversaries of the grant date. These exercise dates may be accelerated if the Company is involved in certain merger, consolidation, reclassification or exchange of securities transactions as specified in the WeShare Plan. If an employees employment is terminated for any reason other than death, disability, termination without cause in connection with the disposition of one or more restaurants or retirement, the options will be canceled as of the date of such termination. If the employees employment is terminated by reason of his or her death, disability or termination without cause in connection with the disposition of one or more restaurants (disposition termination), the options will become immediately exercisable and may be exercised at any time during the 12-month period after his or her death, disposition termination or date of becoming disabled, subject to the stated term of the options. If the employees employment is terminated by reason of his or her retirement, the options may be exercised during the 48-month period after the retirement date, subject to the stated term of the options. The Company had granted options under the WeShare Plan annually to several thousand employees. However, the Company no longer makes grants of options under the WeShare Plan. The WeShare Plan has not been submitted to the shareholders of the Company for approval as permitted under current New York Stock Exchange listing requirements.
Set forth below are two shareholder proposals received by the Company for the Annual Meeting of Shareholders. As required by rules of the Securities and Exchange Commission, the text of the shareholder proposals and supporting statements appear as submitted to the Company by the shareholders. The Board of Directors and the Company accept no responsibility for the proposals and supporting statements. The Board of Directors has recommended a vote against each of these proposals for the broader policy reasons set forth following each proposal.
SHAREHOLDER PROPOSAL NO. 1
The Sinsinawa Dominicans, 7200 West Division Street, River Forest, Illinois 60305, owner of 32 common shares of the Company, and the Adrian Dominican Sisters, 1257 East Siena Heights Drive, Adrian,
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Michigan 49221-1793, owner of 100 common shares of the Company, have notified the Company that they intend to propose the following resolution at the Annual Meeting of Shareholders:
Report on Impacts of Genetically Engineered Products
2004-05
RESOLVED: Shareholders request that an independent committee of the Board review Company policies and procedures for monitoring genetically engineered (GE) products and report (at reasonable cost and omitting proprietary information) to shareholders within six months of the annual meeting on the results of the review, including:
(i) | the scope of Company products that are genetically engineered; |
(ii) | the environmental impacts of continued use of GE products sold or manufactured by the company; |
(iii) | contingency plans for removing GE seed and other GE products from the ecosystem should circumstances so require; |
(iv) | evidence of independent long-term safety testing demonstrating that GE crops, organisms, or products thereof are actually safe for humans, animals, and the environment. |
Supporting Statement
Indicators that genetically engineered organisms MAY be harmful to humans, animals, or the environment include:
· | The report Safety of Genetically Engineered Foods: Approaches to Assessing Unintended Health Effects (National Academy of Sciences [NAS] 7/2004) states: . . . there remain sizable gaps in our ability to identify compositional changes that result from genetic modification of organisms intended for food; to determine the biological relevance of such changes to human health; to devise appropriate scientific methods to predict and assess unintended adverse effects on human health. (p. 15) |
· | The study Gone to Seed, (Union of Concerned Scientists, 3/2004), found that genetically engineered DNA is contaminating U.S. traditional seeds (corn, soybean, canola), and that if left unchecked could disrupt agricultural trade, unfairly burden the organic foods industry, and allow hazardous materials into the food supply. |
The FDA does not require producers of GE food products to seek prior FDA approval of finished GE food products; producers of GE-products are merely encouraged to have voluntary safety consultations with the FDA. The testing protocol on foods derived from biotechnology adopted in 2003 by the Joint UN FAO/WHO Codex Alimentarius Commission is not required by the FDA to assess GE foods on the U.S. market.
No post-marketing surveillance is in effect to verify pre-market screening for unanticipated adverse health consequences from the consumption of GE food. (NAS 7/2004).
European Union rules require traceability of food and feed ingredients to their source materials, and labeling of food containing more than 0.9% GE ingredients.
Insurers in Germany, the UK and elsewhere are refusing liability coverage for genetically engineered crops, an example of heightened concern about the long-term safety of GE crops.
Weed resistance to the herbicide used widely by farmers who plant genetically engineered herbicide resistant crops, is increasing. (Agriculture Research Service 8/24/04).
In December 2002, StarLink corn, not approved for human consumption, was detected in a U.S. corn shipment to Japan. StarLink first contaminated U.S. corn supplies in September 2000, triggering a recall of 300 products.
An August-September 2004 survey of 1,194 grain elevators across the United States conducted by the American Corn Growers Foundation Farmer Choice-Customer First program found that nearly one-quarter (23.7%) reported that they require segregation of biotech corn from conventional corn varieties.
We believe such a report will disclose information material to the companys future.
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Managements Response
The Board of Directors recommends a vote AGAINST this Shareholder Proposal.
The Company is committed to food safety as its highest priority and understands and supports its customers interest in food safety matters. Menu offerings include a wide variety of products that are derived from products or ingredients produced by the agricultural industry. The Company firmly believes that all of the food products served in its restaurants, including those that may contain genetically engineered ingredients, are safe. Furthermore, the Company relies on the United States Food & Drug Administration, the Environmental Protection Agency and the Biotechnology Regulatory Services of the U.S. Department of Agriculture, who are charged with protecting the health and safety of the public and the environment, to properly evaluate and make judgments about environmental and health risks regarding crops derived through biotechnology. The Company believes that these regulatory authorities have not found any meaningful safety, health or environmental risks posed by genetically engineered food products grown in the U.S. The Company, nonetheless, has monitored and intends to continue to actively monitor developments in agricultural biotechnology. In addition, the Company has supported, and intends to continue its support of, initiatives issued by the regulatory authorities to ensure that food served at the Companys restaurants is safe for consumers.
The Company is aware of the concerns of some who oppose the use of biotechnology-derived crops in agriculture, as well as the strong contrary views of those who believe that use of such crops will benefit humanity and the environment by increasing the worlds food supply and decreasing the use of pesticides. The Company does not believe that preparation of the report requested by the proponents of this proposal would add new information to the ongoing dialogue on this issue. The Company believes the subject is more appropriately addressed under regulatory authority and leadership on an industry-wide basis, including food producers, processors, distributors and sellers (not just restaurants), and in light of scientific findings and the conclusions of regulatory authorities. It would be an imprudent expenditure of the Companys limited resources to require its management to devote time, attention and funds to research the complex issues involved and compile the report requested by the proposal.
The Company understands that the use of genetic engineering with respect to certain staple foods, such as corn and soybeans, is widespread in the United States. Even when these foods are produced in an unmodified form, under current practices they are combined with other biotechnology-derived foods during storage, distribution and processing. It would be difficult and costly, if not impossible in the absence of federal laws and regulations, for the Company to require its vendors to identify the scope of the Companys products that are derived from biotechnology-derived ingredients and identify sources of alternative food ingredients that are not biotechnology-derived.
The Company will continue to develop and revise plans as required to address business and safety issues as they arise. These issues are critical to the Companys business. However, the publication of the Companys business plans would serve only to compromise its efforts and businesses. The proposed report would require the Company (i) to make public confidential and proprietary business information regarding its products and business plans; and (ii) to make highly speculative scientific and environmental judgments about issues which the Company is not in a position to evaluate independently. Such a report would not advance consumer safety, but it would jeopardize the business interests of the Company and its shareholders as a result of the publication of confidential business plans and proprietary information.
The Company opposes this proposal on the basis that it would require significant cost and business risks without the prospect of advancing food safety. The Company emphasizes that it is committed to the use of only those products and ingredients that meet its high quality and safety standards and will continue to support the efforts of regulatory authorities to take whatever steps are necessary to assure that any new food technology is safe for consumers and the environment. The Companys shareholders and consumers can count on its compliance with all such regulations. Particularly in light of the scientific and regulatory attention being given to the use of genetically engineered ingredients, the Company believes that preparation and publication of the report requested in this proposal would not constitute an effective use of the Companys assets. The Company believes that shareholders will be better served if regulatory
22
authorities continue to monitor farmers and scientists to determine the safety of biotechnology-derived food ingredients for both human consumption and the environment while the Company keeps its focus on offering a variety of menu items that comply with applicable food safety regulations.
Accordingly, the Board of Directors recommends that shareholders vote AGAINST this Shareholder Proposal.
Vote Required
The affirmative vote of a majority of the common shares that are voted on this Shareholder Proposal is necessary to adopt this Shareholder Proposal. Abstentions and broker non-votes will not be counted in determining the number of common shares necessary for approval. Unless otherwise indicated, the persons named in the Proxy will vote all Proxies against the preceding Shareholder Proposal.
SHAREHOLDER PROPOSAL NO. 2
The People for the Ethical Treatment of Animals, 501 Front Street, Norfolk, Virginia 23510, owner of 120 common shares of the Company, have notified the Company that it intends to propose the following resolution at the Annual Meeting of Shareholders:
Shareholders Resolution
This resolution is submitted by People for the Ethical Treatment of Animals (PETA), which owns 120 shares of Wendys stock.
In its online Animal Welfare Program Fact Sheet, our company states, [W]e believe it is our obligation to ensure that each of our suppliers exceeds government regulations by meeting Wendys more exacting standards pertaining to the humane treatment of animals.1 However, the facilities that supply our restaurants with animal products are still home to abuses that most decent people would deem unacceptable. Our company has taken some laudable first steps to address these issues, but there is much work to be done.
One area in which much improvement is needed is that of chicken slaughter. Currently, chickens raised for Wendys are hung upside-down by their often-injured legs in painful metal shackles and run through an electrified stun bath that often gives them painful shocks without rendering them insensible to pain. Many are still fully conscious when their throats are slit or when they are dunked into tanks of scalding-hot water for feather removal. Clearly, there are major animal welfare concerns with this outdated process.
Other companies are starting to explore a new slaughter technology known as controlled-atmosphere killing (CAK), which eliminates mostif not allof these concerns. When using CAK, chickens are placed into a controlled environment where the oxygen they are breathing is slowly replaced with an inert gas, such as argon or nitrogen, putting the birds to sleep quickly and painlessly. CAK is a USDA-approved method of slaughtering chickens and has been described by animal welfare experts as the most stress-free, humane method of killing poultry ever developed. The technology also has positive worker and food safety implications, and it has been shown that the resulting savings would recoup the initial investment in a year and a half or less.
Wendys Animal Welfare Program Fact Sheet also states, To remain an industry leader in the area of animal welfare, we actively work with our suppliers to research, evaluate and implement advances in the science of animal handling and care.2 CAK is perhaps the single most important scientific advance in the field of chicken slaughter, and our company acknowledges its responsibility to fully explore advances that can improve animal welfare.
1 | http://www.wendys.com/w-6-3-1.shtml |
2 | http://www.wendys.com/w-6-3-1.shtml |
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RESOLVED:
Shareholders request that the board of directors issue a report to shareholders by October 2005, prepared at reasonable cost and omitting proprietary information, on the feasibility of Wendys requiring its chicken suppliers to phase in controlled-atmosphere killing within a reasonable timeframe, with a focus on the animal welfare and economic benefits that this technology could eventually bring to all our companys slaughter facilities.
Managements Response
The Board of Directors recommends a vote AGAINST this Shareholder Proposal.
As noted by the proponent in its proposal, the Company actively works with its suppliers to research, evaluate and implement advances in the science of animal handling and care. The Company has a long-standing policy with respect to the humane treatment of animals and of working with its suppliers to ensure humane animal handling and care. Wendys animal welfare program fact sheet is available on its website under corporate initiatives at www.wendys.com. The Company is continually working with its suppliers to ensure that the newest slaughter procedures are thoroughly tested and scientifically evaluated and, if satisfactory to the Company and its suppliers, implemented by its suppliers. Certain of the Companys suppliers have already evaluated, and continue to evaluate, controlled atmosphere stunning. These evaluations considered a number of factors, including: animal welfare; scientific research and studies; production methods used commercially both in the U.S. and internationally; food safety and product quality; the safety of humans involved in the slaughter process; technical difficulties in operating equipment and procedures; environmental factors and expected costs. The Companys suppliers currently believe that the research is incomplete and inconclusive as to whether controlled atmosphere stunning is a better and more humane method of stunning than conventional stunning methods.
Moreover, the Companys suppliers believe that further research should be conducted to evaluate controlled atmosphere stunning and its effects on food safety and product quality issues. The Companys first priority has always been the safety and quality of its products. The Company is also committed to the humane treatment of animals. The Company does not own, raise, transport or process livestock. However, it contracts with suppliers who perform these functions and the Company believes it has the obligation to ensure that each of its suppliers exceeds government regulations by meeting the Companys more exacting standards pertaining to the humane treatment of animals. The Company believes that handling animals in a humane manner, and preventing neglect or abuse, is the right thing to do.
The Companys commitment, leadership and results with respect to animal welfare matters are well established, and recognized, within the industry. The Company works hard to be a good corporate citizen and is a strong advocate of good animal handling practices. Its policies are designed to help to achieve humane treatment of animals. It has been, and will continue to be, committed to upholding and abiding by its established policies and principles. In addition, the Company continually monitors its suppliers for compliance with the policies it establishes. As noted above, the Company and its suppliers have already reviewed and continue to evaluate controlled atmosphere stunning as a new slaughtering technique; however, based on the testing results and scientific data currently available, the Company and its suppliers consider it premature to implement the technique at this time. The Company believes that the proposed animal welfare report is unnecessary and would not result in any additional benefit to shareholders. The proposed report would be costly and time-intensive, and is duplicative of many existing policies, initiatives and efforts.
Accordingly, the Board of Directors recommends that the shareholders vote AGAINST this Shareholder Proposal.
Vote Required
The affirmative vote of a majority of the common shares that are voted on this Shareholder Proposal is necessary to adopt this Shareholder Proposal. Abstentions and broker non-votes will not be counted in determining the number of common shares necessary for approval. Unless otherwise indicated, the persons named in the Proxy will vote all Proxies against the preceding Shareholder Proposal.
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Shareholder Proposals Pursuant to Rule 14a-8
In order to be considered for inclusion in the Proxy Statement distributed to shareholders prior to the Annual Meeting of Shareholders in 2006, a shareholder proposal pursuant to Securities and Exchange Commission Rule 14a-8 must be received by the Company no later than December 1, 2005. Written requests for inclusion should be addressed to: Corporate Secretary, P. O. Box 256, Dublin, Ohio 43017-0256. It is suggested that you mail your proposal by certified mail, return receipt requested.
Shareholder Proposals other than Pursuant to Rule 14a-8
With respect to any shareholder proposal not submitted pursuant to Securities and Exchange Commission Rule 14a-8 in connection with the Annual Meeting of Shareholders in 2006, the proxy for such meeting will confer discretionary authority to vote on such proposal unless (i) the Company is notified of such proposal not later than February 14, 2006, and (ii) the proponent complies with the other requirements set forth in Securities and Exchange Commission Rule 14a-4.
Shareholder Communications to the Board of Directors
Shareholders may communicate with the Board of Directors or one or more Directors by sending a writing addressed to the Board or to any one or more Directors in care of Corporate Secretary, P. O. Box 237, Dublin, Ohio 43017-0237, in an envelope clearly marked shareholder communication. The Corporate Secretarys office will forward such correspondence unopened to either Mr. Pickett or Mr. Lauer, or to another independent Director as the Board of Directors may specify from time to time, unless the envelope specifies that it should be delivered to another Director.
Householding of Annual Meeting Materials
The Securities and Exchange Commission has adopted rules that permit companies and intermediaries such as brokers to satisfy delivery requirements for proxy statements with respect to two or more shareholders sharing the same address by delivering a single proxy statement addressed to those shareholders. This process, which is commonly referred to as householding, potentially provides extra convenience for shareholders and cost savings for companies. The Company and some brokers household proxy materials, delivering a single proxy statement to multiple shareholders sharing an address unless contrary instructions have been received from the affected shareholders. Once you have received notice from your broker or us that they or we will be householding materials to your address, householding will continue until you are notified otherwise or until you revoke your consent. If, at any time, you no longer wish to participate in householding and would prefer to receive a separate proxy statement, or if you are receiving multiple copies of the proxy statement and wish to receive only one, please notify your broker if your shares are held in a brokerage account or us if you hold registered shares. You can notify us by sending a written request addressed to Investor Relations Department, P.O. Box 256, 4288 West Dublin-Granville Road, Dublin, Ohio 43017-0256, by calling Investor Relations at 614-764-3138 or by sending an e-mail to Investor Relations at investor_relations@wendys.com.
General Information
A COPY OF FORM 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION WILL BE SENT TO ANY SHAREHOLDER WITHOUT CHARGE UPON WRITTEN REQUEST ADDRESSED TO INVESTOR RELATIONS DEPARTMENT, P. O. BOX 256, 4288 WEST DUBLIN-GRANVILLE ROAD, DUBLIN, OHIO 43017-0256.
Management knows of no other business which may be properly brought before the Annual Meeting of Shareholders. However, if any other matters shall properly come before such meeting, it is the intention of the persons named in the enclosed Proxy to vote such Proxy in accordance with their best judgment on such matters.
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IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. THEREFORE, WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING IN PERSON, YOU ARE URGED TO FILL IN, SIGN AND RETURN THE PROXY IN THE ENCLOSED STAMPED, SELF-ADDRESSED ENVELOPE, OR TO VOTE ELECTRONICALLY AS DESCRIBED ON PAGE 1 OF THIS PROXY STATEMENT.
By order of the Board of Directors.
/s/ Leon M. McCorkle, Jr.
LEON M. McCORKLE, JR.
Secretary
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2004 Financial Statements and Other Information
AA-1 | ||
AA-24 | ||
AA-24 | ||
AA-27 | ||
AA-28 | ||
AA-29 | ||
AA-30 | ||
AA-31 | ||
AA-32 | ||
AA-51 | ||
AA-52 | ||
AA-52 | ||
AA-53 |
Wendys International, Inc. and Subsidiaries
Managements Discussion and Analysis
Executive Overview
The core Wendys and Tim Hortons (Hortons) brands for Wendys International, Inc. and subsidiaries (the Company) delivered record annual revenues and earnings before interest and taxes in 2004, despite facing a challenging competitive environment. The years results, however, were significantly impacted by a $190.0 million pretax ($186.6 million after tax) goodwill impairment charge for Baja Fresh and restaurant closure and impairment charges of $21.7 million pretax ($13.8 million after tax) related to underperforming Baja Fresh restaurants. As a result, the Companys net income declined from $236.0 million in 2003 to $52.0 million in 2004 and fully diluted earnings per share (EPS) declined from $2.05 in 2003 to $0.45 in 2004. The 2004 EPS impact of the Baja Fresh goodwill impairment charge was $1.61 and the Baja Fresh store closure and impairment charges were $0.12. For the last three years, the Companys reported EPS was $0.45 in 2004, $2.05 in 2003 and $1.89 in 2002. The 2004 sales and income improvements in the Companys two core brands over 2003 were led by increases in average same-store sales, strengthening of the Canadian dollar and continued growth in the number of restaurants operated by the Company and franchisees. Partially offsetting the overall improvements in the core brands were higher food costs due to rising commodity prices, especially beef.
One of the key indicators in the restaurant industry that management monitors to assess the health of the Company is average same-store sales. This metric provides information on total retail sales at restaurants operating during the relevant period and provides a useful comparison between periods, in addition to the opening of new stores. Average same-store sales changes, including company operated and franchised restaurants, for 2004 are shown in the table below on a comparable 52-week basis. Franchisee operations are not included in the Companys financial statements; however, franchisee sales result in royalties and some rental income which are included in franchise revenues. Wendys U.S. company-operated same-store sales increased 2.9% for the year, the 17th consecutive annual increase; however, sales slowed during the second half. Hortons Canadian same-store sales increased 7.4% in local currency, the 13th consecutive annual increase, with steady increases throughout the year. The declining average same-store sales for Baja Fresh both in 2004 and 2003 (see below) was a significant consideration in the determination that the recorded value of Baja Fresh goodwill was impaired and in managements decision to close or impair the assets of a number of underperforming Baja Fresh restaurants in 2004.
2004 Average Same-Store Sales Increase /(Decrease) | ||||||||||
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Year | ||||||
Wendys U.S. Company |
9.1 % | 5.9 % | 2.0 % | (4.3)% | 2.9 % | |||||
Wendys U.S. Franchise |
7.6 % | 3.7 % | 0.9 % | (4.0)% | 1.8 % | |||||
Hortons - Canada(1) |
6.6 % | 7.8 % | 8.4 % | 6.6 % | 7.4 % | |||||
Hortons - U.S.(1) |
10.3 % | 10.2 % | 9.8 % | 9.1 % | 9.8 % | |||||
Baja Fresh U.S.(1) | (4.9)% | (6.2)% | (7.5)% | (6.1)% | (6.3)% |
(1) | Amounts include both company operated and franchise restaurants. |
For comparative purposes, average same-store sales changes, including company operated and franchised restaurants, for 2003 are shown in the table below. The Wendys U.S. average same-store sales declines in the first half of 2003 had a significant impact on the Companys first half overall results as many restaurant costs are fixed or semi-fixed and the Wendys U.S. operations represent a significant portion of the Companys results.
2003 Average Same-Store Sales Increase / (Decrease) | ||||||||||
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Year | ||||||
Wendys U.S. Company |
(3.1)% | (2.3)% | 0.5 % | 8.6 % | 0.9 % | |||||
Wendys U.S. Franchise |
(1.7)% | (2.0)% | 0.9 % | 7.6 % | 1.1 % | |||||
Hortons - Canada(1) |
3.9 % | 4.0 % | 5.5 % | 5.7 % | 4.8 % | |||||
Hortons - U.S.(1) |
0.4 % | 3.3 % | 6.8 % | 7.2 % | 4.5 % | |||||
Baja Fresh U.S.(1) (2) | (1.8)% | (6.8)% | (4.1)% | (5.3)% | (4.6)% |
(1) | Amounts include both company operated and franchise restaurants. |
(2) | The Company acquired Baja Fresh on June 19, 2002. First and second quarters for 2003 represent a comparison to periods prior to this acquisition date. |
AA-1
Other financial and operating highlights include:
| Consolidated revenues, which do not include sales in franchise restaurants, increased 15.5% to an annual record $3.6 billion in 2004. The components of and changes in consolidated revenues are shown in the tables on page AA-4. |
| Systemwide sales, which include sales at both company operated and franchise restaurants, increased 12.4% in 2004 and 10.9% in 2003. |
| The Company continued its growth, opening 552 new restaurants in 2004 (127 company operated and 425 franchised), including 287 Wendys, 224 Hortons, 40 Baja Fresh and one Cafe Express. New restaurant openings continued to be concentrated in the Wendys North America and Hortons Canada markets. |
| Positively impacting the Companys 2004 results were stronger Canadian dollar exchange rates throughout 2004 and the resulting favorable impact when translating the Canadian results for the Hortons and Wendys Canadian operations. The stronger Canadian dollar positively impacted the Companys EPS by approximately $0.11 in 2004 compared to 2003 and $0.14 in 2003 compared to 2002. |
| Positively impacting 2004 results was one additional operating week (the 53rd week) in the Companys 2004 fiscal year. The additional week occurs periodically because the Companys fiscal year ends on the Sunday nearest to December 31. |
| Baja Fresh results were disappointing. In addition to closing underperforming restaurants, the Company made significant management changes at Baja Fresh to position the brand for future growth. |
| In late 2004 and early 2005, a number of companies in the restaurant and retail industries announced corrections to their accounting for leases. In the fourth quarter of 2004, the Company corrected its accounting for leases to conform the lease term used to amortize improvements on leased properties with the term used to recognize rent for operating leases on a straight-line basis, including during rent holiday periods while constructing leasehold improvements. In the case of property that is leased or sub-leased by the Company to franchisees, the adjustment also includes recording of straight-line rent revenue. The lease adjustments reduced income for the year by $9.1 million pretax ($5.8 million after-tax) or $.05 per share (see Note 1 to the Consolidated Financial Statements). These adjustments are non-cash and do not affect the timing or amount of lease payments. |
| In 2004 the Company repurchased 3.6 million common shares for $138.1 million. In 2003 the Company repurchased 2.1 million common shares for $57.0 million. Since 1998, the Company has repurchased a total of 40.4 million shares for $1.0 billion. |
| The Company took steps to implement its integrated Financial Strategy, including doubling dividends paid, share repurchases, beginning to transition to a new equity-based compensation program for its employees that features restricted stock rather than stock options, new stock ownership guidelines for Company officers and a long-term goal for annual EPS growth. Information on these components of the integrated Financial Strategy is included in the Liquidity and Capital Resources and Managements Outlook sections of this report. |
See also Managements Outlook section of this report for a discussion on the Companys strategic initiatives and future expectations.
Operating Income
Total operating income (equal to income, before income taxes and interestsee chart on page AA-3) for the Company declined in 2004 primarily due to the $190.0 million Baja Fresh goodwill impairment charge and Baja Fresh restaurant closure and impairment charges of $21.7 million. Segment operating income (operating income attributable to the Companys reportable segments which excludes the Baja goodwill impairment chargesee chart on page AA-3) increased 3.8% in 2004 and 10.0% in 2003. The improvements primarily relate to Wendys and Hortons increases in average same-store sales, a stronger Canadian dollar and development of new restaurants. Overall, the Companys total segment operating income from its reportable segments as a percent of total revenues was 13.2%, 14.7% and 15.4% in 2004, 2003 and 2002, respectively.
In 2004, total segment operating income increased $17.6 million primarily driven by Hortons, which increased operating income 21.1% (9.5% excluding currency translation). Hortons increased Canadian average same-store sales 7.4%, continued to develop new restaurants and benefited from a stronger Canadian dollar. Wendys increased operating income 3.1%, reflecting systemwide average same-store sales increases of 2.1% for U.S. restaurants and food cost pressure, particularly higher beef prices. Wendys average same-store sales increases were not sufficient to leverage higher restaurant and food costs
AA-2
and, as a result, Wendys operating income as a percent of sales declined from 12.1% in 2003 to 11.2% in 2004. The 2004 operating loss of $38.3 million attributable to the Developing Brands includes $21.7 million in Baja Fresh restaurant closure and impairment charges. Higher 2004 corporate costs include accruals for certain legal proceedings, expensing of restricted stock grants made for the first time in 2004 and higher costs incurred to implement the internal control requirements of the Sarbanes-Oxley Act of 2002.
In 2003, total operating income increased $37.1 million primarily driven by Hortons, which increased operating income 29.3% (15.6% excluding currency translation). Hortons Canadian average same-store sales increased 4.8%, continued to develop new restaurants and benefited from a stronger Canadian dollar. Wendys operating income increased 0.6%, reflecting systemwide average same-store sales increases of 1.1% for domestic restaurants and cost pressure from beef prices. The Wendys average same-store sales increases were not sufficient to leverage restaurant costs which tend to be fixed or semi-fixed. Although total operating income increased, as a percent of total revenues, operating income was 13.3% in 2003 versus 14.0% in 2002.
OPERATING INCOME (In thousands) |
2004 Compared to
2003 | |||||||||||||||||
% of | % of | 2004 Change | ||||||||||||||||
2004 | Revenues | 2003 | Revenues | Dollars | Percentage | |||||||||||||
Wendys |
$ | 272,362 | 11.2 % | $ | 264,050 | 12.1 % | $ | 8,312 | 3.1 % | |||||||||
Hortons |
247,485 | 24.9 % | 204,431 | 25.3 % | 43,054 | 21.1 % | ||||||||||||
Developing Brands* |
(38,347 | ) | (18.6)% | (4,554 | ) | n/m | (33,793 | ) | n/m | |||||||||
Segment Operating Income |
481,500 | 13.2 % | 463,927 | 14.7 % | 17,573 | 3.8 % | ||||||||||||
Baja Fresh Goodwill Impairment |
(190,000 | ) | 0 | (190,000 | ) | n/m | ||||||||||||
Corporate ** |
(64,896 | ) | (45,485 | ) | (19,411 | ) | (42.7)% | |||||||||||
Total Operating Income | $ | 226,604 | 6.2 % | $ | 418,442 | 13.3 % | $ | (191,838 | ) | (45.8)% | ||||||||
2003
Compared to 2002 | ||||||||||||||||||
% of | % of | 2003 Change | ||||||||||||||||
2003 | Revenues | 2002 | Revenues | Dollars | Percentage | |||||||||||||
Wendys |
$ | 264,050 | 12.1 % | $ | 262,541 | 13.1 % | $ | 1,509 | 0.6 % | |||||||||
Hortons |
204,431 | 25.3 % | 158,129 | 24.3 % | 46,302 | 29.3 % | ||||||||||||
Developing Brands * |
(4,554 | ) | n/m | 1,143 | n/m | (5,697 | ) | n/m | ||||||||||
463,927 | 14.7 % | 421,813 | 15.4 % | 42,114 | 10.0 % | |||||||||||||
Corporate ** |
(45,485 | ) | (40,445 | ) | (5,040 | ) | (12.5)% | |||||||||||
Total Operating Income | $ | 418,442 | 13.3 % | $ | 381,368 | 14.0 % | $ | 37,074 | 9.7 % |
* | Developing Brands includes Baja Fresh and Cafe Express. Baja Fresh was acquired by the Company on June 19, 2002. Information prior to that date is not included. Included in Developing Brands operating income in 2003 and 2002 are losses of $2.0 million and $1.2 million, respectively, related to the Companys equity investment in Cafe Express. The Company had previously included these results accounted for using the equity method in corporate charges. |
** | Corporate charges include certain overhead costs which are not allocated to individual business units. |
n/m | The comparison is not meaningful. |
AA-3
RESULTS OF OPERATIONS
Below is a summary of comparative results for the Companys reportable segments and a more detailed discussion of results from 2002 through 2004.
REVENUES (In thousands) |
2004 Compared to
2003 |
||||||||||||||||||
% of | % of | 2004 Change |
|||||||||||||||||
2004 | Total | 2003 | Total | Dollars | Percentage | ||||||||||||||
Retail sales |
|||||||||||||||||||
Wendys |
$ | 2,124,973 | 72.4 | % | $ | 1,899,299 | 75.0 | % | $ | 225,674 | 11.9 | % | |||||||
Hortons |
613,050 | 20.9 | % | 492,563 | 19.4 | % | 120,487 | 24.5 | % | ||||||||||
Developing Brands* |
197,876 | 6.7 | % | 142,273 | 5.6 | % | 55,603 | 39.1 | % | ||||||||||
$ | 2,935,899 | 100.0 | % | $ | 2,534,135 | 100.0 | % | $ | 401,764 | 15.9 | % | ||||||||
Franchise revenues |
|||||||||||||||||||
Wendys |
$ | 308,128 | 44.0 | % | $ | 291,510 | 47.4 | % | $ | 16,618 | 5.7 | % | |||||||
Hortons |
382,588 | 54.7 | % | 314,081 | 51.1 | % | 68,507 | 21.8 | % | ||||||||||
Developing Brands* |
8,823 | 1.3 | % | 9,186 | 1.5 | % | (363 | ) | (4.0 | )% | |||||||||
$ | 699,539 | 100.0 | % | $ | 614,777 | 100.0 | % | $ | 84,762 | 13.8 | % | ||||||||
Total revenues |
|||||||||||||||||||
Wendys |
$ | 2,433,101 | 66.9 | % | $ | 2,190,809 | 69.6 | % | $ | 242,292 | 11.1 | % | |||||||
Hortons |
995,638 | 27.4 | % | 806,644 | 25.6 | % | 188,994 | 23.4 | % | ||||||||||
Developing Brands* |
206,699 | 5.7 | % | 151,459 | 4.8 | % | 55,240 | 36.5 | % | ||||||||||
$ | 3,635,438 | 100.0 | % | $ | 3,148,912 | 100.0 | % | $ | 486,526 | 15.5 | % | ||||||||
2003
Compared to 2002 |
|||||||||||||||||||
% of | % of | 2003 Change |
|||||||||||||||||
2003 | Total | 2002 | Total | Dollars | Percentage | ||||||||||||||
Retail sales |
|||||||||||||||||||
Wendys |
$ | 1,899,299 | 75.0 | % | $ | 1,731,341 | 79.2 | % | $ | 167,958 | 9.7 | % | |||||||
Hortons |
492,563 | 19.4 | % | 391,779 | 17.9 | % | 100,784 | 25.7 | % | ||||||||||
Developing Brands* |
142,273 | 5.6 | % | 64,318 | 2.9 | % | 77,955 | n/m | |||||||||||
$ | 2,534,135 | 100.0 | % | $ | 2,187,438 | 100.0 | % | $ | 346,697 | 15.8 | % | ||||||||
Franchise revenues |
|||||||||||||||||||
Wendys |
$ | 291,510 | 47.4 | % | $ | 279,100 | 51.4 | % | $ | 12,410 | 4.4 | % | |||||||
Hortons |
314,081 | 51.1 | % | 259,280 | 47.8 | % | 54,801 | 21.1 | % | ||||||||||
Developing Brands* |
9,186 | 1.5 | % | 4,443 | 0.8 | % | 4,743 | n/m | |||||||||||
$ | 614,777 | 100.0 | % | $ | 542,823 | 100.0 | % | $ | 71,954 | 13.3 | % | ||||||||
Total revenues |
|||||||||||||||||||
Wendys |
$ | 2,190,809 | 69.6 | % | $ | 2,010,441 | 73.6 | % | $ | 180,368 | 9.0 | % | |||||||
Hortons |
806,644 | 25.6 | % | 651,059 | 23.9 | % | 155,585 | 23.9 | % | ||||||||||
Developing Brands* |
151,459 | 4.8 | % | 68,761 | 2.5 | % | 82,698 | n/m | |||||||||||
$ | 3,148,912 | 100.0 | % | $ | 2,730,261 | 100.0 | % | $ | 418,651 | 15.3 | % |
* | Developing Brands includes Baja Fresh and Cafe Express. Amounts for 2003 and 2002 do not include Cafe Express, which was accounted for using the equity method in 2003. Baja Fresh was acquired by the Company on June 19, 2002. Information prior to that date is not included. |
n/m | The comparison is not meaningful. |
AA-4
WENDYS
Retail Sales
Total Wendys retail sales include sales from company operated Wendys restaurants in the U.S. (domestic), Canada, two restaurants located outside of North America and sales of sandwich buns from Wendys bun baking facilities to Wendys franchisees. Franchise sales are not included in reported retail sales. Of the total Wendys retail sales shown in the above tables, domestic Wendys retail sales were $1.9 billion, $1.7 billion and $1.6 billion in 2004, 2003 and 2002 respectively. This represents an increase of 11.4% in 2004 and 8.6% in 2003. Domestic retail sales increases were due to a combination of increases in average same-store sales, an increase in the number of restaurants and 2004 being a 53-week year compared with 2003 and 2002 being 52-week years.
The following table summarizes the changes in average same-store sales, average number of transactions, average check, selling prices and total restaurants open for domestic company operated Wendys restaurants for the last three years on a comparable 52-week basis:
2004 | 2003 | 2002 | ||||
Average same-store sales increase |
2.9% | 0.9% | 4.7% | |||
Increase in average number of transactions |
0.3% | 0.4% | 2.5% | |||
Increase in average check |
2.6% | 0.4% | 2.2% | |||
Increase in selling prices |
0.8% | 0.5% | 0.8% | |||
Year-end company operated restaurants open |
1,328 | 1,312 | 1,183 |
The following chart reflects average unit volumes per domestic Wendys restaurant for the last three years. Total domestic Wendys average unit volumes increased 1.9% and 1.1% in 2004 and 2003, respectively. Franchise sales are not included in retail sales recorded on the Companys financial statements. The 2004 amounts have been adjusted to a comparable 52-week basis.
Average Unit Volumes | 2004 | 2003 | 2002 | ||||||
Company |
$ | 1,416,000 | $ | 1,389,000 | $ | 1,387,000 | |||
Franchise |
$ | 1,291,000 | $ | 1,268,000 | $ | 1,251,000 | |||
Total domestic | $ | 1,319,000 | $ | 1,294,000 | $ | 1,280,000 |
Of Wendys total retail sales, Canadian Wendys retail sales were $184.2 million, $156.1 million and $121.8 million in 2004, 2003 and 2002, respectively. Canadian Wendys retail sales increased $28.1 million, or 18.0% in 2004 and $34.3 million, or 28.1%, in 2003. Approximately $13 million, or 46%, of the increase in 2004 and approximately $17 million, or 49%, of the increase in 2003 was due to the strengthening of the Canadian dollar. Canadian Wendys average same-store sales for company operated restaurants, in local currency, increased 3.1% in 2004 following a 4.2% increase in 2003. Also, the total number of Canadian company operated Wendys restaurants continued to grow. As of the end of each year, Canadian company operated restaurants totaled 154, 148 and 133 for 2004, 2003 and 2002, respectively.
Franchise Revenues
Total Wendys franchise revenues primarily consist of royalty income from franchisees, rental income from properties leased to franchisees and franchise fees. Franchise fees cover charges for various costs and expenses related to establishing a franchisees business. Of the total reported Wendys franchise revenues, domestic Wendys represented approximately 91% in 2004 and 92% in both 2003 and 2002, and Canadian Wendys represented 6%, 5% and 3% in 2004, 2003 and 2002, respectively. Total Wendys franchise restaurants open at year-end were 5,184, 5,016 and 4,933 for 2004, 2003 and 2002, respectively.
The increases in Wendys franchise revenues in 2004 and 2003 are primarily due to higher royalties. Royalties increased $16.0 million, or 6.6%, to $257.0 million in 2004, and $9.9 million, or 4.3%, to $241.0 million in 2003. The increases were primarily the result of more domestic Wendys franchise restaurants open in 2004 compared to 2003, more domestic Wendys franchise restaurants open in 2003 compared to 2002, and average same-store sales increases at domestic franchise restaurants of 1.8% and 1.1% in 2004 and 2003, respectively.
Canadian Wendys royalties also increased primarily due to a stronger Canadian dollar in both 2004 and 2003. Average same-store sales realized by Canadian franchisees increased, in local currency, 3.0% and 2.9% in 2004 and 2003, respectively. At year-end, total Canadian franchise Wendys restaurants open were 230, 219 and 221 for 2004, 2003 and 2002, respectively.
Rental income from restaurants leased by the Company to franchisees of $42.7 million in 2004 increased $0.9 million compared to $41.8 million in 2003 primarily due to the 53rd week in 2004 and an increase in percentage rents (charged as a percentage of sales), partially offset by a decline in the number of restaurants leased to franchisees.
AA-5
Total restaurants leased to franchisees were 434, 483 and 502 at year-end 2004, 2003 and 2002, respectively. Franchise fees were $4.3 million in 2004, $4.6 million in 2003 and $4.7 million in 2002.
HORTONS
Most of Hortons operations are in Canada. The strengthening of the Canadian dollar in 2004 and 2003 increased amounts reported in U.S. dollars from Hortons on average by approximately 8% in 2004 and 11% in 2003.
Retail Sales
Hortons retail sales primarily include sales of dry goods and supplies from Hortons Canadian distribution warehouses to franchisees as well as sales from company operated Hortons restaurants. Of the total 2,721 Hortons restaurants open at the end of 2004, only 98 were company operated. Beginning in 2004, Hortons retail sales also include the impact of consolidating approximately 80 Hortons franchisees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46R. Although the impact of FIN 46R resulted in the increase or elimination of certain amounts on the Companys financial statements, there was no net operating income impact. Retail sales in 2004 include a 53rd week compared to 52 weeks in 2003 and 2002.
In reviewing the comparative revenue summaries in the table on page AA-4, the strengthening of the Canadian dollar accounted for approximately $38 million of the Hortons $120.5 million retail sales increase in 2004 and approximately $51 million of the Hortons $100.8 million retail sales increase in 2003. The consolidation of approximately 80 franchisees in accordance with FIN 46R also increased Hortons retail sales $46.3 million in 2004.
The remaining increase in retail sales reflected Canadian distribution warehouse sales, which increased $29.1 million, or 6.5%, in 2004 from $451.5 million and increased $60.2 million, or 17.6%, in 2003. These increases reflected higher numbers of Hortons Canadian franchised restaurants serviced and positive average same-store sales growth, in local currency, of 7.4% in 2004 and 4.8% in 2003.
Retail sales from U.S. company operated units increased $8.9 million, or 49.1%, in 2004 due to acquiring 42 restaurants formerly operating under the Bess Easton name. Retail sales decreased $12.1 million, or 24.8%, in 2003 reflecting the Companys franchising of company operated units in the U.S.
Franchise Revenues
Included in Hortons franchise revenues are royalty income from franchisees, rental income from properties leased to franchisees and franchise fees. Franchise fees cover charges for various costs and expenses related to establishing a franchisees business, and include initial equipment packages for the Hortons franchises. Beginning in 2004, Hortons franchise revenues also includes the impact of consolidating approximately 80 Hortons franchisees in accordance with FIN 46R. Franchise revenue in 2004 includes a 53rd week compared to 52 weeks in 2003 and 2002.
The strengthening of the Canadian dollar accounted for approximately $26 million of the Hortons $68.5 million franchise revenue increase in 2004 and approximately $31 million of the $54.8 million franchise revenue increase in 2003. The consolidation of approximately 80 franchisees in accordance with FIN 46R means the Company no longer recognizes royalty and rental income from the franchisees and resulted in a decrease of $10.5 million in Hortons 2004 franchise revenues. The discussion in the following three paragraphs excludes the impact of the stronger Canadian dollar and FIN 46R.
Canadian rental income from restaurants leased to franchisees increased $28.9 million, or 15.7%, in 2004 compared with $21.4 million, or 14.9%, in 2003 reflecting an additional number of restaurants leased to Canadian franchisees and positive average same-store sales growth (rent is generally charged as a percent of sales). At the end of 2004, total Hortons restaurants leased to franchisees were 2,102 versus 1,977 in 2003 and 1,799 in 2002.
Hortons royalties increased $10.1 million, or 15.2%, in 2004 and $7.7 million, or 14.7%, in 2003. This primarily reflected the increase in the number of Canadian franchise restaurants open and the positive average same-store sales growth in Canada, in local currency, of 7.4% and 4.8% in 2004 and 2003, respectively. At the end of 2004, total Hortons restaurants franchised were 2,623 versus 2,470 in 2003 and 2,277 in 2002.
Total Hortons franchise fees increased $2.3 million, or 4.8%, reflecting higher fees from franchises sold in 2004. In 2003, total Hortons franchise fees decreased $2.7 million, or 5.8%, reflecting a decrease in the number of standard-size businesses sold to franchisees.
AA-6
DEVELOPING BRANDS
Developing Brands includes Baja Fresh and Cafe Express. The full results of Cafe Express operations have been included in the Companys Consolidated Financial Statements since February 2004 when a controlling interest in Cafe Express was acquired by the Company. Previously, the Company accounted for its investment in Cafe Express using the equity method. The results of Baja Freshs operations have been included in the Companys Consolidated Financial Statements since June 19, 2002, the date Baja Fresh was acquired by the Company.
Retail Sales
Developing Brands retail sales include sales from company operated Baja Fresh and Cafe Express restaurants. The increase in retail sales in 2004 is due to the consolidation of Cafe Express beginning in the first quarter of 2004 and an increase in the number of Baja Fresh company operated restaurants. The increase in 2003 retail sales over 2002 is substantially due to the timing of the Companys acquisition of Baja Fresh in mid-2002. The 2004 and 2003 increases were partially offset by decreases in Baja Fresh average same-store sales of 7.3% and 3.3%, respectively, for company operated units. At year-end 2004 and 2003, total Baja Fresh company operated restaurants open were 144 and 132, respectively, and at year-end 2004 there were 19 Cafe Express stores.
Franchise Revenues
Baja Fresh comprises all of the Developing Brands franchise revenues as Cafe Express does not have franchised restaurants. Baja Fresh franchise revenues consist of royalty income from franchisees and franchise fees. The decrease in Baja Fresh franchise revenues in 2004 is due to lower franchise fees due to a decrease in the number of franchises sold to franchisees. The increase in Baja Fresh 2003 franchise revenues over 2002 is substantially due to the timing of the Companys acquisition in mid-2002. Additionally, 2003 franchise revenues increased due to an increase in the number of Baja Fresh franchise restaurants, partially offset by a 2003 average same-store sales decrease in franchise operated units of 5.9%. At year-end 2004 and 2003, total Baja Fresh franchise restaurants open were 151.
AA-7
COST OF SALES, COMPANY RESTAURANT OPERATING COSTS AND OPERATING COSTS
The following table is a comparative summary of cost of sales, company restaurant operating costs and operating costs from 2002 through 2004, followed by a discussion of those results.
(In thousands) |
2004 Compared to
2003 |
||||||||||||||||||
% of | % of | 2004 Change |
|||||||||||||||||
2004 | Total | 2003 | Total | Dollars | Percentage | ||||||||||||||
Cost of sales |
|||||||||||||||||||
Wendys |
$ | 1,320,118 | 68.7 | % | $ | 1,156,141 | 70.7 | % | $ | 163,977 | 14.2 | % | |||||||
Hortons |
473,408 | 24.7 | % | 387,731 | 23.7 | % | 85,677 | 22.1 | % | ||||||||||
Developing Brands* |
126,776 | 6.6 | % | 90,690 | 5.6 | % | 36,086 | 39.8 | % | ||||||||||
$ | 1,920,302 | 100.0 | % | $ | 1,634,562 | 100.0 | % | $ | 285,740 | 17.5 | % | ||||||||
Company restaurant operating costs |
|||||||||||||||||||
Wendys |
$ | 556,615 | 85.7 | % | $ | 479,156 | 89.7 | % | $ | 77,459 | 16.2 | % | |||||||
Hortons |
25,889 | 4.0 | % | 11,974 | 2.2 | % | 13,915 | 116.2 | % | ||||||||||
Developing Brands* |
66,777 | 10.3 | % | 42,953 | 8.1 | % | 23,824 | 55.5 | % | ||||||||||
$ | 649,281 | 100.0 | % | $ | 534,083 | 100.0 | % | $ | 115,198 | 21.6 | % | ||||||||
Operating costs |
|||||||||||||||||||
Wendys |
$ | 21,060 | 12.5 | % | $ | 18,245 | 13.5 | % | $ | 2,815 | 15.4 | % | |||||||
Hortons |
147,432 | 87.5 | % | 117,087 | 86.5 | % | 30,345 | 25.9 | % | ||||||||||
Developing Brands* |
0 | 0.0 | % | 0 | 0.0 | % | 0 | 0.0 | % | ||||||||||
$ | 168,492 | 100.0 | % | $ | 135,332 | 100.0 | % | $ | 33,160 | 24.5 | % | ||||||||
2003 Compared to 2002 |
|||||||||||||||||||
% of | % of | 2003 Change |
|||||||||||||||||
2003 | Total | 2002 | Total | Dollars | Percentage | ||||||||||||||
Cost of sales |
|||||||||||||||||||
Wendys |
$ | 1,156,141 | 70.7 | % | $ | 1,036,331 | 74.9 | % | $ | 119,810 | 11.6 | % | |||||||
Hortons |
387,731 | 23.7 | % | 305,323 | 22.1 | % | 82,408 | 27.0 | % | ||||||||||
Developing Brands* |
90,690 | 5.6 | % | 42,011 | 3.0 | % | 48,679 | n/m | |||||||||||
$ | 1,634,562 | 100.0 | % | $ | 1,383,665 | 100.0 | % | $ | 250,897 | 18.1 | % | ||||||||
Company restaurant operating costs |
|||||||||||||||||||
Wendys |
$ | 479,156 | 89.7 | % | $ | 428,067 | 93.2 | % | $ | 51,089 | 11.9 | % | |||||||
Hortons |
11,974 | 2.2 | % | 15,359 | 3.4 | % | (3,385 | ) | (22.0 | )% | |||||||||
Developing Brands* |
42,953 | 8.1 | % | 15,715 | 3.4 | % | 27,238 | n/m | |||||||||||
$ | 534,083 | 100.0 | % | $ | 459,141 | 100.0 | % | $ | 74,942 | 16.3 | % | ||||||||
Operating costs |
|||||||||||||||||||
Wendys |
$ | 18,245 | 13.5 | % | $ | 17,477 | 14.7 | % | $ | 768 | 4.4 | % | |||||||
Hortons |
117,087 | 86.5 | % | 101,166 | 85.3 | % | 15,921 | 15.7 | % | ||||||||||
Developing Brands* |
0 | 0.0 | % | 0 | 0.0 | % | 0 | 0.0 | % | ||||||||||
$ | 135,332 | 100.0 | % | $ | 118,643 | 100.0 | % | $ | 16,689 | 14.1 | % |
* | Developing Brands includes Baja Fresh and Cafe Express. Amounts for 2003 and 2002 do not include Cafe Express, which was accounted for using the equity method in 2003 and 2002. Baja Fresh was acquired by the Company on June 19, 2002. |
n/m | The comparison is not meaningful. |
AA-8
WENDYS
Cost of Sales
Wendys total cost of sales includes food, paper and labor costs for company operated restaurants and the cost of goods sold to franchisees from Wendys bun baking facilities. Domestic Wendys company operated restaurant cost of sales comprise approximately 88% of Wendys total cost of sales and accounted for most of the cost of sales increases between years. Of the Wendys total cost of sales increases between years, domestic Wendys company restaurant cost of sales increased $138.8 million, or 13.6%, in 2004 and increased $95.4 million, or 10.3%, in 2003. These increases were driven primarily by growth in the number of domestic Wendys company operated restaurants open and increases in average same-store sales as well as an extra week of operations in 2004.
Domestic Wendys company restaurant cost of sales also increased to 61.8% of domestic Wendys company restaurant retail sales in 2004, compared to 60.5% in 2003 and 59.6% in 2002. Most of the increases between years as a percent of sales were due to higher food costs. Domestic food costs, as a percent of domestic retail sales, were 31.2% in 2004, 29.8% in 2003 and 29.0% in 2002. Food costs in 2004, as a percent of retail sales, reflected an increase in beef costs of approximately 15% and increases in tomato prices and other commodity prices, partially offset by a selling price increase of 0.8%. Food costs in 2003, as a percent of retail sales, reflected an increase in beef costs of 7% and increases in other commodity costs, partially offset by a selling price increase of 0.5%.
Domestic Wendys labor costs were 27.1% of domestic Wendys company restaurant retail sales in 2004, compared with 27.2% in 2003 and 27.0% in 2002. Average wage rates increased 0.1% in 2004 and 1.2% in 2003. The Company continues to control labor costs by adherence to its labor guidelines and store-level productivity programs.
Canadian Wendys company restaurant cost of sales increased $20.9 million, or 20.8%, to $121.5 million in 2004 and $22.7 million, or 29.2%, to $100.6 million in 2003. The strengthening of the Canadian dollar accounted for approximately $9 million, or 41%, of the Wendys Canada increase in 2004 and approximately $11 million, or 47%, of the increase in 2003. The remaining Wendys Canada increases between years are due primarily to an increase in the number of Canadian company operated restaurants. Canadian Wendys cost of sales increased to 66.0% of Canadian Wendys retail sales in 2004 from 64.5% in 2003 and 63.9% in 2002, primarily reflecting increased beef costs in 2004 and 2003.
Company Restaurant Operating Costs
Wendys total company restaurant operating costs include costs necessary to manage and operate restaurants, except cost of sales and depreciation. Domestic Wendys company restaurant operating costs comprise over 90% of Wendys total company restaurant operating costs and increased $68.7 million, or 15.7%, to $507.2 million in 2004 and $42.8 million, or 10.8%, to $438.5 million in 2003. The increase between years is primarily due to growth in the number of stores. Domestic Wendys company restaurant operating costs, as a percent of domestic Wendys company restaurant retail sales, were 27.0% in 2004, 25.9% in 2003 and 25.4% in 2002. The higher percentages in 2004 and 2003 primarily reflect average same-store sales increases that were not sufficient to leverage operating costs. The increase in 2004 also includes the impact of the lease correction (discussed earlier) recorded in the fourth quarter as well as an extra week of operations in 2004.
Canadian Wendys company restaurant operating costs increased $7.9 million, or 20.3%, to $46.6 million in 2004 and $8.3 million, or 27.2%, to $38.7 million in 2003. The strengthening of the Canadian dollar accounted for approximately $3 million of the 2004 increase and approximately $4 million of the 2003 increase. The increases in 2004 and 2003 also include an increase in the number of Canadian Wendys company operated restaurants and for 2004, the lease correction recorded in the fourth quarter and an extra week of operations in 2004.
Operating Costs
Wendys total operating costs include rent expense and other costs related to properties subleased to franchisees and costs related to operating and maintaining Wendys bun-baking facilities. The increases between years primarily relate to cost of properties subleased to franchisees. These costs totaled $16.6 million in 2004, $15.1 million in 2003 and $14.6 million in 2002.
HORTONS
Cost of Sales
Hortons total cost of sales includes food, paper and labor costs for company operated restaurants, and the cost of goods sold to franchisees from Hortons distribution warehouses. The Hortons distribution warehouses distribute primarily dry goods such as coffee, sugar and
AA-9
restaurant supplies to Hortons franchisees. Beginning in 2004, Hortons cost of sales also includes the impact of consolidating approximately 80 Hortons franchisees in accordance with FIN 46R. Although the impact of FIN 46R resulted in the increase or elimination of certain amounts on the Companys financial statements, there was no net operating income impact.
The Hortons Canadian warehouse cost of sales increased 16.3% to $418.9 million in 2004 and 32.7% to $360.3 million in 2003, reflecting additional sales to franchisees due to the increased number of restaurants serviced and higher average sales per restaurant, as well as a stronger Canadian dollar and an additional week of operations in 2004. Warehouse cost of sales, as a percent of warehouse sales, was 82.1% in 2004, 79.8% in 2003 and 79.1% in 2002, reflecting a changing mix of products sold.
Cost of sales for company operated units amounted to $54.5 million, $27.4 million and $33.6 million in 2004, 2003 and 2002, respectively. The differences between years primarily reflect the consolidation of approximately 80 franchisees in accordance with FIN 46R and changes in the number of company operated units in the U.S. At year-end 2004, there were 67 company operated Hortons restaurants in the U.S. versus 25 at year-end 2003 and 40 at year-end 2002.
Company Restaurant Operating Costs
Hortons company restaurant operating costs include costs necessary to manage and operate Canadian and U.S. restaurants, except cost of sales and depreciation. Beginning in 2004, Hortons company restaurant operating costs also include the impact of consolidating approximately 80 Hortons franchisees in accordance with FIN 46R.
The $13.9 million, or 116.2%, company restaurant operating costs increase in 2004 primarily relates to consolidating the approximate 80 Hortons franchisees for the first time in 2004. The 2004 increase also includes additional costs related to managing and operating 42 restaurants acquired in May 2004. The 42 restaurants formerly operated under the Bess Eaton name and are located throughout Rhode Island, Connecticut and Massachusetts. The $3.4 million, or 22.0%, decrease in 2003 company restaurant operating costs compared to 2002 primarily reflected the decrease in the number of company operated units in the U.S.
Operating Costs
Hortons operating costs include rent expense related to properties subleased to franchisees under operating leases and cost of equipment sold to Hortons franchisees as part of the initiation of the franchise business. Training and other costs necessary to ensure a successful Hortons franchise opening and costs to operate and maintain the distribution warehouses and coffee roaster facility are also included in operating costs.
Hortons total operating costs increased $30.3 million in 2004 and $15.9 million in 2003. The strengthening of the Canadian dollar accounted for approximately $10 million, or 32%, of the increase in 2004. The remaining increase in 2004 primarily reflected Hortons rent expense, which increased $11.3 million in 2004, excluding the translation impact, due to the growth in the number of properties being leased and then subleased to Canadian franchisees, as well as higher percentage rent resulting from increases in sales, an extra week of operations and the lease correction recorded in the fourth quarter. The strengthening of the Canadian dollar accounted for approximately $11 million, or 71%, of the increase in Hortons total operating costs in 2003. The remaining increase in 2003 primarily reflected Hortons rent expense which increased $4.7 million in 2003, excluding the translation impact, due to the growth in the number of properties being leased and then subleased to Canadian franchisees, as well as higher percentage rent resulting from increases in sales. There were 1,549 total restaurants leased by Hortons and then subleased to franchisees at year-end 2004 versus 1,466 in 2003 and 1,342 in 2002.
DEVELOPING BRANDS
Cost of Sales and Company Restaurant Operating Costs
The increases in Developing Brands cost of sales and company restaurant operating costs over 2003 were primarily due to fully consolidating Cafe Express beginning in February 2004, when a controlling interest was acquired, and an increase in the number of Baja Fresh company operated restaurants. The increases in reported Developing Brands 2003 cost of sales and company restaurant operating costs over 2002 were substantially due the timing of the Companys acquisition of Baja Fresh in mid-2002.
CONSOLIDATED
General and Administrative Expenses
As a percent of revenues, general and administrative expenses decreased to 7.8% in 2004, down from 8.3% in 2003 and 8.8% in 2002. The percentage decrease in 2004 and 2003 reflects that revenues grew at a higher rate than
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general and administrative costs. Included in 2004 and 2003 general and administrative expenses is an approximate $4 million and $6 million increase due to a stronger Canadian dollar, respectively. General and administrative expenses in 2004 included an additional $3.8 million for restricted stock granted and expensed for the first time by the Company in 2004 and $4.5 million in higher external professional fees to implement the internal control requirements of the Sarbanes-Oxley Act of 2002, partially offset by reduced performance-based bonuses. Also impacting the comparability between years is the approximate half year impact of Baja Fresh (acquired in June 2002) versus a full year of Baja Fresh general and administrative expenses in 2003 and additional general and administrative expenses due to the consolidation of Cafe Express beginning in February 2004.
Goodwill Impairment
In conjunction with the Companys policy to review goodwill for impairment in the fourth quarter of each year, the Company recorded an impairment charge of $190.0 million pretax related to Baja Fresh. The amount of the impairment charge was based on an estimate of the fair value of Baja Fresh primarily using a combination of historical performance and comparative market data. The declining average same-store sales for Baja Fresh in both 2004 and 2003 were a significant consideration in managements conclusion that the recorded value of Baja Fresh goodwill was impaired.
For further discussion of the Companys goodwill impairment approach, see The Application of Critical Accounting Policies section of Managements Discussion and Analysis.
Depreciation of Property and Equipment
Consolidated depreciation of property and equipment increased 9.1% in 2004 and 17.5% in 2003. The increase in 2004 primarily reflects additional restaurant development and a stronger Canadian dollar, partially offset by a reduction in depreciation expense related to the lease correction recorded in the fourth quarter. The increase in 2003 primarily reflected additional restaurant development.
Other Expense
Other expense, net of other income, includes amounts that are not directly derived from the Companys primary businesses. This includes income from equity investments in joint ventures and other minority investments, expenses related to store closures, other asset write-offs and reserves for international and legal issues.
Other expense, net of other income, was $18.6 million, $1.9 million and $6.9 million in 2004, 2003 and 2002, respectively. The increase in 2004 primarily reflects Baja Fresh 2004 restaurant closure and impairment charges of $21.7 million, including fixed asset impairment charges of $12.2 million related to certain markets, higher legal reserves and less favorable currency adjustments, partially offset by income from Hortons joint venture with IAWS Group/Cuisine de France. Other expense in 2003 included income from the joint venture with IAWS Group/Cuisine de France turning profitable and favorable currency adjustments, partially offset by provisions for store closures and other asset write-offs and the absence of income from Hortons cup manufacturing business, which was sold in 2002.
Interest Expense
Interest expense was $47.0 million in 2004, $45.8 million in 2003 and $41.5 million in 2002. The increase in 2003 primarily reflects the $225 million of 6.20% Senior Notes issued by the Company in the second quarter of 2002. This was partially offset by 2002 interest expense recognized prior to the conversion into common shares of $200 million in term convertible securities in the second quarter of 2002.
Interest Income
Interest income was $4.4 million in 2004, $4.9 million in 2003 and $6.0 million in 2002. Interest income has declined in each of the last three years, primarily reflecting lower available interest income rates. The decrease in interest income also reflects franchisees repayment of franchise notes receivable.
Income Taxes
The effective income tax rate for 2004 was 71.7% compared to 37.5% for 2003 and 36.75% for 2002. The 2004 high effective rate results because the Companys tax basis in Baja Fresh is primarily in the stock of Baja Fresh and not the assets and liabilities of Baja Fresh. As a result, the Company recorded only $3.4 million of tax benefit for the $190.0 million Baja Fresh goodwill impairment charge. Excluding the impact of the goodwill charge, the effective income tax rate for 2004 was 36.2%. The higher 2003 effective tax rate was primarily due to increasing current and deferred state tax liabilities as a result of income tax increases enacted by various states in response to declining state revenues.
Comprehensive Income
Comprehensive income was higher than net income by $55.9 million and $107.0 million in 2004 and 2003,
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respectively, and lower than net income by $12.1 million in 2002. The increases in comprehensive income over net income in 2004 and 2003 include $56.0 million and $93.8 million, respectively, in income related to favorable translation adjustments on the Canadian dollar and $0.1 million and $15.2 million, respectively, in income related to a minimum pension liability adjustment on the Companys pension plans (see Note 11 of the Companys Consolidated Financial Statements). In 2002 comprehensive income includes $4.0 million in income related to favorable translation adjustments on the Canadian dollar and $16.2 million in expense related to a minimum pension liability adjustment on the Companys pension plans.
FINANCIAL POSITION
Overview
The Company generates considerable cash flow each year from net income excluding depreciation and amortization. The main recurring requirement for cash is capital expenditures. In the last three years the Company has generated cash from operating activities well in excess of capital expenditure spending. Acquisition and investment activity can be an important expenditure, and the Company may borrow money to fund major purchases, such as Baja Fresh in 2002. Share repurchases are part of the ongoing financial strategy utilized by the Company, and normally these repurchases come from cash on hand and the cash provided by option exercises. Longer term, both the cash provided from option exercises and the cash used for share repurchases should decrease as the Company implements its new equity compensation program featuring restricted stock. The Company will increase its dividend payment rate by 12.5% in 2005 after increasing the rate by 100% in 2004. The Company currently has a $500 million shelf registration and $200 million line of credit which are unused.
The Company maintains a strong balance sheet and has taken steps to increase its financial flexibility in order to meet the Companys strategic objectives. Standard & Poors and Moodys rate the Companys senior unsecured debt BBB+ and Baa1, respectively. The long-term debt-to-total equity ratio declined to 35% at year-end 2004 from 39% at year-end 2003, primarily reflecting the impact of the 6.35% Notes due December 15, 2005, which are now classified as a current liability.
Total assets increased $64.6 million in 2004 to $3.2 billion. Net property and equipment increased $195.5 million, primarily reflecting an increase in the number of Wendys and Hortons restaurants. A total of $138.1 million of cash was used to repurchase 3.6 million common shares in 2004, including 1.4 million shares repurchased in an accelerated share buyback transaction for $52.6 million in the fourth quarter. Return on average assets was 1.7% in 2004 and 8.4% in 2003. The decrease reflects the impact of the $190.0 million pretax ($186.6 million after tax) Baja Fresh goodwill impairment charge recorded in the fourth quarter. Excluding the impact of the 2004 Baja Fresh goodwill impairment charge, the 2004 return on average assets was 7.6%. Return on average assets is computed as net income divided by average assets over the previous five quarters, excluding advertising fund restricted assets. Advertising fund restricted assets are separately presented on the Companys balance sheets and the Company is restricted from utilizing these assets for its own purposes. See also Note 12 of the Companys Consolidated Financial Statements, Advertising Costs, for further information.
Total shareholders equity decreased $42.9 million in 2004 primarily due to the Companys repurchase of common shares, partially offset by 2004 earnings, option exercises and currency translation adjustments. Return on average equity, defined as net income divided by average equity over the previous five quarters, was 2.9% in 2004 and 14.9% in 2003. Excluding the impact of the 2004 Baja Fresh goodwill impairment charge, the 2004 return on average equity was 13.1%. The Company believes that providing financial results excluding the non-cash charge for the reduction in the goodwill of Baja Fresh provides investors with a meaningful perspective of the current underlying operating performance of the Company.
Comparative Cash Flows
Cash provided from operating activities was $502.4 million in 2004 compared to $430.2 million in 2003 and $443.9 million in 2002. Each year, operating cash flows has benefited from higher net income, excluding non-cash amounts such as depreciation expense, amortization expense and impairment charges, than the prior year. Cash flows in 2004 also benefited from an increase in accounts payable and accrued expenses primarily due to the timing of payments and increases in certain accruals such as legal reserves. In 2003 these improvements were offset by approximately $51 million in higher tax payments compared to 2002. Also, reported cash increased in 2004 and 2003 because the Companys Canadian dollars held by Canadian operations are translated into a higher U.S. dollar value due to the stronger Canadian dollar.
Net cash used in investing activities totaled $322.5 million in 2004 compared to $438.6 million in 2003 and $603.5 million in 2002. Capital expenditures are the largest
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ongoing component of the Companys investing activities and include expenditures for new restaurants, improvements to existing restaurants and other capital needs. A summary of capital expenditures for the last three years follows.
Capital Expenditures (In millions) |
2004 | 2003 | 2002 | ||||||
New restaurants |
$ | 184 | $ | 224 | $ | 173 | |||
Restaurant improvements |
83 | 86 | 111 | ||||||
Other capital needs |
74 | 32 | 47 | ||||||
Total capital expenditures |
$ | 341 | $ | 342 | $ | 331 |
Other significant items impacting the comparability of investing cash flows between years include the acquisition of Baja Fresh in 2002 using $287.4 million in cash, increased acquisitions of franchisee restaurants in 2003, $23.0 million in short-term financial investment outflows in 2003 compared to 2004 cash inflows of $24.7 million from the maturity of financial investments, Hortons 2004 acquisition of 42 restaurants formerly operating under the Bess Eaton name, higher proceeds in 2004 from the sale of restaurants to franchisees and the variability in the amount invested in a joint venture between Hortons and IAWS Group/Cuisine de France.
The higher acquisitions of franchisee restaurants in 2003 totaling $97.6 million, compared to $16.5 million in 2004 and $2.3 million in 2002, is due to the acquisition of 68 Wendys restaurants in Florida. Subsequent proceeds from the refranchising of 35 of the 68 Florida restaurants totaled $35.8 million in 2004.
In 2002 the Company invested $9.0 million for a 45% minority interest in Cafe Express, a fast-casual concept, and $12 million for a 25% (fully diluted) minority interest in Pasta Pomodoro, also a fast-casual concept. In 2004 the Company invested an additional $5.0 million in Cafe Express, bringing its total equity interest to 70%, and an additional $4.0 million in Pasta Pomodoro, bringing its equity interest to approximately 29% (fully diluted). These investments are consistent with the Companys strategy to invest in opportunities that have the potential to add to the Companys long-term earnings growth. The Company also invested $6.2 million and $21.6 million in 2003 and 2002, respectively, in the joint venture with IAWS Group/Cuisine de France, which was formed in 2001 to build a par-baked goods manufacturing facility in Canada.
Financing activities used cash of $183.7 million and $3.6 million in 2004 and 2003, respectively, and provided cash of $220.0 million in 2002. The primary differences impacting the comparability of financing activities between years are proceeds from debt issuances, proceeds from employee stock options exercised and the amount of common shares repurchased. In 2002 the Company received $223.0 million net proceeds from the issuance of 6.20% Senior Notes which were used for the acquisition of Baja Fresh. At year-end 2003, $40.0 million of commercial paper was outstanding, which was used for the acquisition of 68 Wendys restaurants in Florida from a franchisee. The Company repaid the $40.0 million in the first half of 2004. In 2004 the Company issued, and subsequently repaid in the first quarter of 2005, $25.0 million of commercial paper related to its fourth quarter 2004 accelerated share repurchase transaction.
The timing of employees stock option exercises is usually driven by the market price for the Companys common shares. The Company generally attempts to offset dilution as a result of employees exercising stock options by repurchase of its common shares, including utilizing the cash provided from option exercises. Dividends paid in 2004 increased $27.4 million due to a 100% increase in the dividend rate.
Liquidity and Capital Resources
Cash flow from operations, cash and investments on hand, possible asset sales, and cash available through existing revolving credit agreements and through the possible issuance of securities should provide for the Companys projected short-term and long-term cash requirements, including cash for capital expenditures, potential share repurchases, dividends, repayment of debt (including the repayment of the 6.35% Notes due December 15, 2005), future acquisitions of restaurants from franchisees or other corporate purposes.
In the past three years, cash provided by operating activities, borrowings and other sources was used to fund continued growth in restaurants, other capital expenditures, dividend payments, repurchases of shares of common stock, and, primarily in 2002, acquisitions and investments.
The Company expects 2005 capital expenditures to be in the range of $335 million to $380 million for new restaurant development, remodeling, maintenance and technology initiatives. Capital spending in 2005 is expected to be higher than the last several years due primarily to a new distribution and warehousing facility to be completed in 2006 to better serve Hortons Canada distribution needs. The expected investment in the new facility is in excess of $70 million in Canadian dollars, of which approximately 25% was spent in 2004, and it is currently estimated that approximately 55% will be spent in 2005 and 20% in 2006. The increase in 2005 capital expenditures also reflects the installation of double-sided grills in all Wendys North
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America restaurants. In 2005, the Company plans to open new company operated and franchised restaurants which, in the aggregate, would total between 510 and 560. The number of anticipated 2005 restaurant openings is somewhat lower than the last several years reflecting the effort to roll-out the double-sided grills throughout Wendys. Development is expected to be concentrated in the Wendys North America and Hortons Canada markets.
As in prior years, the Company may also invest in new business opportunities and expand its IAWS Group/Cuisine de France joint venture. In February 2004, the Company invested an additional $5 million to acquire a controlling 70% share of Cafe Express, up from the previous 45% minority interest position. In October 2004 the Company invested an additional $4 million in Pasta Pomodoro, bringing its investment to approximately 29% on a fully diluted basis. The Company will evaluate other opportunities as they arise.
The Company has used cash to repurchase common shares totaling $138.1 million, $57.0 million and $49.4 million in 2004, 2003 and 2002, respectively. As of the end of 2004, approximately $227 million remained under the repurchase authorization as approved by the Companys Board of Directors, which includes an additional $200 million authorized in the first quarter of 2004. Generally, the Companys objective in its share repurchase program is to offset the dilution impact of the Companys equity compensation program. Since 1998 and through the end of 2004, the Company has repurchased 40.4 million common and other shares exchangeable into common shares for approximately $1 billion.
In February 2004, the Company announced a new equity-based compensation program for directors and employees featuring restricted stock shares and restricted stock units rather than stock options which had previously been used exclusively. This new program will permit up to 3.6 million common shares to be issued. The year 2004 was a transition year with restricted shares and restricted stock units awarded along with a reduced number of stock options. The Company does not expect to award stock options in 2005 or future years. The new program is expected to reduce overhang (all approved but unexercised options and shares divided by shares outstanding plus all approved but unexercised options and shares) and reduce the long-term effect of the equity compensation program on the Companys EPS.
The expected reductions in the Companys overhang and effect on EPS are based on a number of assumptions, including the number of stock option exercises, share repurchases, increases in employee salaries, net additions in the number of employees, the Company achieving specified annual earnings per share goals and the Companys total shareholder return relative to the Standard & Poors 500 Index. Other types of incentives could also be awarded under the new program, although the Company presently does not have plans to do so. The new equity-based compensation program was approved at the 2004 Annual Meeting of Shareholders held April 22, 2004.
In February 2005, the Company announced that based on its strong cash position and strategic direction the Board of Directors had approved a 12.5% increase in the common stock dividend rate. The announced increase is in addition to the 100% increase in the rate of common stock dividends paid in 2004 over 2003. The Companys target for its dividend payout ratio remains at 18% to 22% of earnings, with a dividend yield of 1.1% to 1.2%. As a result, dividend payments in 2005 are expected to increase to approximately $62 million from approximately $55 million in 2004.
In the first quarter of 2003, the Company took two steps to increase its financial flexibility to respond to potential opportunities and longer-term cash requirements. These included filing a shelf registration statement on Form S-3 with the Securities and Exchange Commission to issue up to $500 million of securities and entering into a new $200 million revolving credit facility. The $200 million revolving credit facility replaced the six revolving credit facilities totaling $200 million that were previously in place. The new revolving credit facility contains various covenants which, among other things, require the maintenance of certain ratios, including indebtedness to total capitalization and a fixed charge coverage ratio, and limits on the amount of assets that can be sold and liens that can be placed on the Companys assets. The Companys Senior Notes and debentures also have limits on liens that can be placed on the Companys assets and limits on sale leaseback transactions. As of January 2, 2005, the Company was in compliance with its covenants under the revolving credit facility and the limits of its Senior Notes and debentures. As of January 2, 2005, no amounts under the credit facility were outstanding and all of the $500 million of securities available under the above-mentioned Form S-3 filing remained unused.
The Company also has a commercial paper program, under which approximately $25 million was outstanding at January 2, 2005 and $40 million was outstanding at December 28, 2003. The amount of commercial paper outstanding at January 2, 2005 and December 28, 2003 was
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repaid in the first quarter of 2005 and the first half of 2004, respectively. The availability of the Companys unused revolving credit facility supports the Companys commercial paper and lowers the Companys borrowing costs by improving the credit rating of the Companys commercial paper.
Standard & Poors and Moodys rate the Companys senior unsecured debt BBB+ and Baa1, respectively. The Company is committed to a strong capital structure and financial profile, and intends to maintain an investment grade rating. If additional funds are needed for mergers, acquisitions or other strategic investments, the Company believes it could borrow additional cash and still maintain its investment grade rating. In the event the Companys rating declines, the Company may incur an increase in borrowing costs. If the decline in the rating is significant, it is possible that the Company would not be able to borrow on acceptable terms. Factors that could be significant to the determination of the Companys credit ratings include sales and cost trends, the Companys cash position, cash flow, capital expenditures and stability of earnings.
The Companys 6.35% Notes in the principal amount of $100 million mature and are payable in December 2005. Beyond 2005, the Company does not have significant term-debt maturities until 2011. The Company believes it will be able to pay or refinance its debt obligations as they become due based on its strong financial condition and sources of cash described above. The Companys significant contractual obligations and commitments as of January 2, 2005 are shown in the following table. Purchase obligations primarily include commitments for advertising expenditures and purchases for certain food-related ingredients.
Payments Due by Period | |||||||||||||||
Contractual Obligations(1) (In thousands) |
Less Than 1 Year |
1-3 Years | 3-5 Years | After 5 Years |
Total | ||||||||||
Long-term debt, including interest and current maturities: |
|||||||||||||||
Wendys |
$ | 164,789 | $ | 69,145 | $ | 66,984 | $ | 720,512 | $ | 1,021,430 | |||||
Hortons |
143 | 387 | 602 | 14,055 | 15,187 | ||||||||||
Developing Brands |
68 | 114 | 0 | 0 | 182 | ||||||||||
Total |
$ | 165,000 | $ | 69,646 | $ | 67,586 | $ | 734,567 | $ | 1,036,799 | |||||
Capital leases: |
|||||||||||||||
Wendys |
$ | 2,235 | $ | 3,359 | $ | 2,910 | $ | 17,284 | $ | 25,788 | |||||
Hortons |
7,584 | 14,053 | 10,630 | 41,527 | 73,794 | ||||||||||
Total |
$ | 9,819 | $ | 17,412 | $ | 13,540 | $ | 58,811 | $ | 99,582 | |||||
Operating leases: |
|||||||||||||||
Wendys |
$ | 60,065 | $ | 103,431 | $ | 90,560 | $ | 702,083 | $ | 956,139 | |||||
Hortons |
43,471 | 78,320 | 71,283 | 267,723 | 460,797 | ||||||||||
Developing Brands |
18,818 | 36,690 | 35,651 | 57,162 | 148,321 | ||||||||||
Total |
$ | 122,354 | $ | 218,441 | $ | 197,494 | $ | 1,026,968 | $ | 1,565,257 | |||||
Purchase obligations: |
|||||||||||||||
Wendys |
$ | 172,187 | $ | 364 | $ | 0 | $ | 0 | $ | 172,551 | |||||
Hortons |
125,735 | 6,223 | 324 | 167 | 132,449 | ||||||||||
Developing Brands |
34,432 | 18,067 | 0 | 0 | 52,499 | ||||||||||
Corporate |
7,686 | 2,643 | 0 | 0 | 10,329 | ||||||||||
Total |
$ | 340,040 | $ | 27,297 | $ | 324 | $ | 167 | $ | 367,828 | |||||
Total Contractual Obligations |
$ | 637,213 | $ | 332,796 | $ | 278,944 | $ | 1,820,513 | $ | 3,069,466 |
(1) | As of January 2, 2005, the Companys pension plans were funded such that pension assets are greater than the projected benefit obligation. The Company made contributions totaling approximately $9 million into its pension plans in 2004. Estimates of reasonably likely future pension contributions are heavily dependent on expectations about future events outside of the pension plans, such as future pension asset performance, future interest rates, future tax law changes and future changes in regulatory funding requirements. The Company estimates contributions to its pension plans in 2005 will not exceed $9 million, however no such contributions would be required. It is possible future legislative changes could require significant future contributions. Certain executive employees are also eligible to participate in the Companys supplemental executive retirement plan. Under this plan, each participating employees account reflects amounts credited by the Company based on the employees earnings plus or minus investment gains and losses of specified investments in which amounts credited by the Company are deemed to be invested. The supplemental executive retirement plan is not funded, but account balances are payable to participating employees when they retire or otherwise are no longer employed by the Company. Estimates of reasonably likely future payments by the Company under the supplemental executive retirement plan are heavily dependent on future events outside of this plan, such as the timing of participating employees leaving the Company, the performance of the investments and the time period over which employees elect to receive distributions from the supplemental executive retirement plan. Due to the significant uncertainties regarding future pension fund contributions and payments under the Companys supplemental executive retirement plan, no pension fund contributions or supplemental executive retirement plan payments are included in the table. |
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Other Commercial Commitments (In thousands) |
As of January 2, 2005 | ||
Franchisee lease and loan guarantees: |
|||
Wendys |
$ | 165,455 | |
Hortons |
1,218 | ||
Developing Brands |
4,939 | ||
Total |
$ | 171,612 | |
Contingent rent on leases: |
|||
Wendys |
$ | 24,575 | |
Letters of credit: |
|||
Wendys |
$ | 5,954 | |
Hortons |
4,134 | ||
Total |
$ | 10,088 | |
Total Other Commercial Commitments |
$ | 206,275 |
The Company has guaranteed certain leases and debt payments of franchise owners amounting to $171.6 million. In the event of default by a franchise owner, the Company generally retains the right to acquire possession of the related restaurants. The Company is also contingently liable for certain leases of non-franchisees amounting to an additional $24.6 million. These leases have been assigned to unrelated third parties, which have agreed to indemnify the Company against future liabilities arising under the leases. The Company is also the guarantor on $10.1 million in letters of credit with various parties; however, management does not expect any material loss to result from these instruments because it does not believe performance will be required. Effective January 1, 2003, the Company adopted FIN 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. In accordance with FIN 45 and based on available information, the Company has accrued for certain guarantees and indemnities as of January 2, 2005 and December 28, 2003, in amounts which, in total, are not material.
At January 2, 2005 and December 28, 2003, the Companys reserves established for doubtful royalty receivables were $3.2 million and $2.5 million, respectively. Reserves related to possible losses on notes receivable, real estate, guarantees, claims and contingencies involving franchisees totaled $10.5 million at January 2, 2005 and $9.4 million at December 28, 2003. These reserves are included in accounts receivable, notes receivable and other accrued expenses.
In prior years, the Company had generated a significant amount of interest income on invested cash balances; however, given the current interest rate environment, management expects interest income rates to remain relatively low in the near future. In addition, $13.2 million and $9.4 million of franchise notes receivable were paid off in 2004 and 2003, respectively. As a result, management expects relatively low interest income to continue in 2005.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements as of January 2, 2005 and December 28, 2003 as that term is described by the Securities and Exchange Commission.
Market Risk
Inflation
Financial statements determined on a historical cost basis may not accurately reflect all the effects of changing prices on an enterprise. Several factors tend to reduce the impact of inflation for the Company. Inventories approximate current market prices, there is some ability to adjust prices and liabilities are repaid with dollars of reduced purchasing power.
Foreign Exchange Risk
The Companys exposure to foreign exchange risk is primarily related to fluctuations in the Canadian dollar relative to the U.S. dollar. The impact of foreign exchange rates on the Companys income statement is predominately related to Canadian Hortons and Wendys operations, since exposure outside of North America is limited to royalties paid by franchisees. The exposure to Canadian dollar exchange rates on the Companys 2004 cash flows primarily includes imports paid for by Canadian operations in U.S. dollars and payments from the Companys Canadian operations to the Companys U.S. operations. In aggregate, cash flows between the Canadian and U.S. dollar currencies were in excess of $100 million in 2004 and 2003.
The Company seeks to manage its cash flows and balance sheet exposure to changes in the value of foreign currencies. The Company may use derivative products to reduce the risk of a significant negative impact on its U.S. dollar cash flows or income. The Company does not hedge foreign currency exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates on net income and cash flows. The Company has a policy forbidding trading or speculating in foreign currency and does not hedge foreign currency translation or foreign currency net assets and liabilities.
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Forward currency contracts to sell Canadian dollars and buy $38.8 million and $77.3 million U.S. dollars were outstanding as of January 2, 2005 and December 28, 2003, respectively, to hedge inter-company payments and purchases from third parties. The contracts outstanding at January 2, 2005 and December 28, 2003 mature at various dates through June 2005 and January 2005, respectively, and are considered to be highly effective cash flow hedges according to criteria specified in Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities.
In accordance with SFAS No. 133, the Company defers unrealized gains and losses arising from these contracts until the impact of the related transactions occur. The fair value unrealized losses on the contracts as of January 2, 2005 and December 28, 2003 of $5.0 million and $4.2 million, respectively, will offset the impact of the underlying transactions. Fair values are determined from quoted market prices. Changes in the fair value of the cash flow hedges due to changes in U.S. and Canadian dollar exchange rates are offset by the underlying transaction with little or no impact to the Companys net income.
At the current level of annual operating income generated from Canada, if the Canadian currency rate changes U.S. $0.05, or 4% compared to the average 2004 exchange rate, for an entire year, the annual impact on the Companys diluted EPS would be $0.05 per share. At current royalty levels outside of North America, if all foreign currencies moved 10% during each royalty collection period in the same direction, at the same time, the annual impact on the Companys diluted EPS would be approximately one-half cent per share. The Company does not hedge its exposure to currency fluctuations related to royalty collections outside North America because it does not believe the risk is significant.
Interest Rate Risk
The Companys debt is primarily denominated in U.S. dollars, at fixed interest rates. The Company is exposed to interest rate risk impacting its net borrowing costs. The Company seeks to manage its exposure to interest rate risk and to lower its net borrowing costs by managing the mix of fixed and floating rate instruments based on capital markets and business conditions.
To manage interest rate risk, the Company entered into an interest rate swap in 2003, effectively converting some of its fixed interest rate debt to variable interest rates. By entering into the interest rate swap, the Company agreed, at specified intervals, to receive interest at a fixed rate of 6.35% and pay interest based on the floating LIBOR-BBA interest rate, both of which are computed based on the agreed-upon notional principle amount of $100.0 million. The Company does not enter into speculative swaps or other financial contracts.
The interest rate swap outstanding at January 2, 2005 and December 28, 2003 was for the notional amount of $100.0 million, matures in December 2005 and meets specific conditions of SFAS No. 133 to be considered a highly effective fair value hedge of a portion of the Companys long-term debt. Accordingly, gains and losses arising from the swap are completely offset against gains or losses of the underlying debt obligation.
The fair value loss on the interest rate swap was $0.9 million and $0.5 million as of January 2, 2005 and December 28, 2003, respectively, based on quoted market prices. An average 1.0% increase or decrease in the LIBOR-BBA rate over a year would increase or decrease, respectively, the Companys interest expense before income taxes by $1.0 million.
Commodity Risk
The Company purchases certain products in the normal course of business, which are affected by commodity prices. Therefore, the Company is exposed to some price volatility related to weather and various other market conditions outside the Companys control. However, the Company employs various purchasing and pricing contract techniques in an effort to minimize volatility. Generally these techniques include setting fixed prices with suppliers generally for one year, setting in advance the price for products to be delivered in the future (sometimes referred to as buying forward), and unit pricing based on an average of commodity prices over a period of time. The Company does not generally make use of financial instruments to hedge commodity prices, partly because of the contract pricing utilized. While price volatility can occur, which would impact profit margins, there are generally alternative suppliers available and, if the pricing problem is prolonged, the Company has some ability to increase selling prices to offset a rise in commodity price increases.
In instances such as reported cases of mad cow disease, it is possible the Company may be exposed to risks other than price risk. The reported cases of mad cow disease in
AA-17
North America in 2004 and 2003, however, did not significantly impact the Companys sales or earnings. There can be no assurance, however, that a future case of mad cow disease or another food-borne illness would not have a significant impact on the Companys sales and earnings.
Concentration of Credit Risk
The Company has cash balances in various domestic bank accounts above the Federal Deposit Insurance Corporation (FDIC) guarantee limits. The Company subscribes to a bank rating system, and only utilizes high-grade banks for accounts that might exceed these limits. At year-end 2004, the amount in domestic bank accounts above FDIC limits was approximately $32 million. The Company also has cash in various Canadian bank accounts above amounts guaranteed by the Canadian Deposit Insurance Corporation of Canada (CDIC). At year-end 2004, the amount in Canadian banks above CDIC limits was approximately $98 million dollars equivalent. The Company utilizes only high-grade banks in Canada for accounts that might exceed CDIC limits.
MANAGEMENTS OUTLOOK
The Company continues to employ its strategic initiatives. These initiatives include leveraging the Companys core assets, growing average same-store sales, improving store-level productivity to enhance margins, improving underperforming operations, developing profitable new restaurants and implementing new technology initiatives. Management intends to allocate resources to improve long-term return on assets and invested capital, and monitor its progress by tracking various metrics, including return on average assets, return on average equity and return on invested capital, as well as comparing to historical performance, the Companys peers and other leading companies.
The Company also continues to execute its integrated Financial Strategy announced in 2004 that includes a focus on a dividend policy, continued share repurchases, a new equity-based compensation program for employees and directors, stock ownership guidelines for Company officers and a long-term goal for annual EPS growth.
The Company obtained shareholder approval at its 2004 Annual Meeting of Shareholders for a revised equity-based compensation program (Omnibus Plan) which has the objectives of remaining competitive in attracting and retaining employees, lowering stock option overhang and minimizing EPS dilution from stock option grants over the next several years. The Omnibus Plan allows for the transition from stock options to a combination of restricted stock and restricted stock units. The Company also developed a new cash bonus/profit-sharing program that generally applies to non-executive employees. In an effort to further align employee and shareholder goals, the Company also established stock ownership guidelines which include requiring officers to hold Company stock and in-the-money stock options equal to their annual base salary, and the named executive officers, as established in the proxy statement, to hold Company stock and in-the-money stock options equal to three times their annual base salary.
In February 2005, the Company reiterated its long-term annual EPS growth goal of 11% to 13%. Consistent with this goal, the Companys anticipated diluted EPS is in the range of $2.17 to $2.23 for the full year 2005. The Company will adopt SFAS No. 123R in the first quarter of 2005 and will retroactively apply SFAS No. 123R, which will impact 2004 EPS to reflect the expensing of stock options as if it had occurred at the beginning of the year. To enhance total return to shareholders, the Company also increased the dividend 100% in 2004 and announced an additional 12.5% increase for 2005.
The Company intends to remain focused on established long-term operational strategies of exceeding customer expectations, fostering a performance-driven culture, delivering a balanced message of brand equity plus value in marketing, growing a healthy restaurant system and partnering finance with operations. The Company believes its success depends on providing everyday value, quality and variety, not price discounting. As a result, the Company provides a variety of menu choices and will continue to evaluate and introduce new products to meet the trends and desires of its customers. Management believes in reinvesting in its restaurants to maintain a fresh image, providing convenience for its customers and increasing the overall efficiency of restaurant operations. The goal of these strategies is to increase average sales over time, primarily through greater customer traffic in the restaurants. The Company intends to effectively manage corporate and field-level costs to control overall general and administrative expense growth.
New restaurant development will continue to be very important to the Company. Wendys, Hortons and Baja Fresh restaurant concepts are all under penetrated in key
AA-18
markets. The Company intends to grow aggressively, but responsibly, focusing on the markets with the best potential for sales and return on investment. A total of 552 new restaurants were opened in 2004. Current plans call for 510 to 560 new company and franchise restaurants to open in 2005. Over the next several years, the Company anticipates opening a substantial number of new Wendys, Hortons and Baja Fresh restaurants. The primary focus will be on core operations of Wendys in North America and Hortons in Canada, with the majority of units being standard sites.
The Company is optimistic about the development of Hortons in the U.S. The Companys strategy for Hortons U.S. is to enhance brand awareness, increase average same-store sales, build customer loyalty and attract additional franchisees.
In 2005, the Company plans to develop approximately 50 new Hortons franchise units in the U.S. Management believes that Hortons U.S. has the potential to become a long-term growth opportunity for the Company through further development in existing markets, entering into new markets, acquisitions and entering into area development agreements with franchisees. However, there is no assurance that the anticipated growth will occur.
Another element of the Companys strategic plan is the evaluation of potential mergers, acquisitions, joint venture investments, alliances, vertical integration opportunities and divestitures that could add to the Companys long-term earnings growth. As part of this initiative, in 2001, the Company formed a joint venture between Hortons and IAWS Group/Cuisine de France to build a par-baked goods manufacturing facility in Canada.
In 2002, the Company purchased 100% of the common stock of Baja Fresh (see Note 8 to the Consolidated Financial Statements). Baja Fresh is in the Mexican segment of fast-casual restaurants and currently represents about 5% of the Companys revenues. However, Baja Fresh was not profitable in 2003 and 2004 due to average sales declines and cost increases. The Company took decisive action in 2004 to position Baja Fresh for improved performance. In addition to closing and impairing a number of underperforming restaurants, the Company made significant management changes at Baja Fresh. The Companys strategy for Baja Fresh will focus on strengthening the management team, improving unit-level economics, evolving the concept and positioning it for future growth. The Company believes that the concept has the potential to contribute to earnings long-term; however, as with all developing companies, there are challenges to gaining customer acceptance and the industry is extremely competitive. In 2004 the Company recorded a $190 million goodwill impairment related to Baja Fresh (see Note 2 to the Consolidated Financial Statements).
In 2002, the Company made several investments including a 45% minority ownership investment of $9.0 million in Cafe Express and a 25% minority ownership (fully diluted) investment of $12 million in Pasta Pomodoro (see Note 8 of the Companys Consolidated Financial Statements for more information on these investments). In February 2004, the Company invested an additional $5.0 million to increase its ownership in Cafe Express to a 70% majority interest and in the fourth quarter of 2004, invested an additional $4.0 million in Pasta Pomodoro bringing its investment to an approximate 29% minority interest (fully diluted). Both Cafe Express and Pasta Pomodoro are fast-casual restaurant concepts. Also, the Company is making an investment in a new warehousing and distribution facility to be completed in 2006 to better serve Hortons Canada distribution needs.
The Company also continues to focus on improving its global brand image and supporting its franchisees business plans and growth objectives. The International Wendys division produced a profit for the fourth consecutive year. However, in the last three years, the International division has reduced the number of restaurants operated. Most of Wendys development outside North America is with franchisees that can be affected by adverse economic and political conditions. Economic and competitive pressures remain very challenging in Latin America and certain other markets outside of North America.
Revenue Recognition
Wendys and Baja Fresh have a significant number of company operated restaurants, while Hortons is predominately franchised. Revenue at company operated restaurants is recognized as customers pay for products at the time of sale. Hortons operates warehouses in Canada to distribute coffee and other dry goods to an extensive franchise system. Revenues from these sales are recorded when the product is delivered to the franchisee.
Franchise revenues consist of royalties, rents and various franchise fees. Royalties and rent revenues are recognized in the month earned at estimated realizable amounts. Franchise fee revenues are recognized when the related services have been performed and when the related franchise store is opened.
AA-19
The Application of Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that can have a material impact on the results of operations of the Company. The earnings reporting process is covered by the Companys system of internal controls, and generally does not require significant management estimates and judgments. However, estimates and judgments are inherent in the calculations of royalty and other franchise-related revenue collections, legal obligations, pension and other postretirement benefits, income taxes, insurance liabilities, various other commitments and contingencies, valuations used when assessing potential impairment of goodwill, other intangibles and other long lived assets and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions.
The Company collects royalties, and in some cases rent, from franchisees and Hortons collects distribution revenues from Canadian franchisees. The Company provides for estimated losses for revenues that are not likely to be collected. Although the Company generally enjoys a good relationship with franchisees, and collection rates are currently very high, if average sales or the financial health of franchisees were to deteriorate, the Company might have to increase reserves against collection of franchise revenues.
The Company is self-insured for most domestic workers compensation, health care claims, general liability and automotive liability losses. The Company records its insurance liabilities based on historical and industry trends, which are continually monitored, and accruals are adjusted when warranted by changing circumstances. Outside actuaries are used to assist in estimating casualty insurance obligations. Since there are many estimates and assumptions involved in recording insurance liabilities, differences between actual future events and prior estimates and assumptions could result in adjustments to these liabilities. Workers compensation insurance can particularly involve significant time before the ultimate resolution of claims. Wendys had accrued $42.6 million and $37.6 million at year-end 2004 and 2003, respectively, for domestic workers compensation liabilities, domestic general liability, domestic automotive liability and other property liabilities. In Canada, workers compensation benefits are part of a government-sponsored plan and although the Company and its employees make contributions to that plan, management is not involved in determining these amounts.
Pension and other retirement benefits, including all relevant assumptions required by generally accepted accounting principles, are evaluated each year with the oversight of the Companys retirement committee. Due to the technical nature of retirement accounting, outside actuaries are used to provide assistance in calculating the estimated future obligations. Market interest rates are reviewed to establish pension plan discount rates and expected returns on plan assets are based on the mix of investments and expected market returns. Since there are many estimates and assumptions involved in retirement benefits, differences between actual future events and prior estimates and assumptions could result in adjustments to pension expenses and obligations. If the Company were to change its discount rate by 0.25%, this would change annual pension costs by $0.2 million. If the Company were to change its long-term return on assets rate by 0.25%, this would change annual pension costs by $0.2 million.
In the normal course of business, the Company must make continuing estimates of potential future legal obligations and liabilities, which requires the use of managements judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required.
The Company records income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. When considered necessary, the Company records a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. Management must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to determine the proper valuation allowance. When the Company determines that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are
AA-20
involved in determining the proper valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance. The Company uses an estimate of its annual effective tax rate at each interim period based on the facts and circumstances available at that time while the actual effective tax rate is calculated at year-end.
Depreciation and amortization are recognized using the straight-line method in amounts adequate to amortize costs over the following estimated useful lives: buildings, up to 40 years; restaurant equipment, up to 15 years; other equipment, up to 10 years; and leasehold improvements and property under capital leases, the lesser of the useful life of the asset or the lease term, as that term is defined in SFAS No. 13, Accounting for Leases, as amended. The Company estimates useful lives on buildings and equipment based on historical data and industry trends. The Company capitalizes certain internally developed software costs which are amortized over a period of up to 10 years. The Company monitors its capitalization and amortization policies to ensure they remain appropriate. Intangibles separate from goodwill are amortized on a straight-line basis over periods of up to 30 years. Lives may be related to legal or contractual lives, or must be estimated by management based on specific circumstances.
Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates that an impairment may exist. The Company tests for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing. If an impairment is indicated, the fair value of the fixed assets is estimated using the discounted cash flows of the operating market. The interest rate used in preparing discounted cash flows is managements estimate of the weighted average cost of capital.
The Company tests goodwill for impairment annually (or in interim periods if events or changes in circumstances indicate that its carrying amount may not be recoverable) by comparing the fair value of each reporting unit, as measured by discounted cash flows and market multiples based on earnings, to the carrying value, to determine if there is an indication that a potential impairment may exist. One of the most significant assumptions is the projection of future sales. The Company reviews its assumptions each time goodwill is tested for impairment and makes appropriate adjustments, if any, based on facts and circumstances available at that time. In the fourth quarter of 2004, the Company tested goodwill for impairment and recorded an impairment charge of $190.0 million related to Baja Fresh, which is included in the Developing Brands segment. The Company, with the assistance of an independent third-party, determined the amount of the charge, which was primarily based on comparative market data. The Company tested for goodwill impairment as of year-end 2003, and no impairment was indicated.
AA-21
WENDYS INTERNATIONAL, INC. AND SUBSIDIARIES
SYSTEMWIDE RESTAURANTS
As of January 2, 2005 |
As of September 26, 2004 |
Increase/ (Decrease) From Prior Quarter |
As of December 28, 2003 |
Increase/ (Decrease) From Prior Year |
||||||||
Wendys |
||||||||||||
U.S. |
||||||||||||
Company |
1,328 | 1,302 | 26 | 1,312 | 16 | |||||||
Franchise |
4,607 | 4,552 | 55 | 4,449 | 158 | |||||||
5,935 | 5,854 | 81 | 5,761 | 174 | ||||||||
Canada |
||||||||||||
Company |
154 | 150 | 4 | 148 | 6 | |||||||
Franchise |
230 | 223 | 7 | 219 | 11 | |||||||
384 | 373 | 11 | 367 | 17 | ||||||||
Other International |
||||||||||||
Company |
5 | 5 | 0 | 5 | 0 | |||||||
Franchise |
347 | 340 | 7 | 348 | (1 | ) | ||||||
352 | 345 | 7 | 353 | (1 | ) | |||||||
Total Wendys |
||||||||||||
Company |
1,487 | 1,457 | 30 | 1,465 | 22 | |||||||
Franchise |
5,184 | 5,115 | 69 | 5,016 | 168 | |||||||
6,671 | 6,572 | 99 | 6,481 | 190 | ||||||||
Hortons |
||||||||||||
U.S. |
||||||||||||
Company |
67 | 66 | 1 | 25 | 42 | |||||||
Franchise |
184 | 167 | 17 | 159 | 25 | |||||||
251 | 233 | 18 | 184 | 67 | ||||||||
Canada |
||||||||||||
Company |
31 | 28 | 3 | 32 | (1 | ) | ||||||
Franchise |
2,439 | 2,371 | 68 | 2,311 | 128 | |||||||
2,470 | 2,399 | 71 | 2,343 | 127 | ||||||||
Total Hortons |
||||||||||||
Company |
98 | 94 | 4 | 57 | 41 | |||||||
Franchise |
2,623 | 2,538 | 85 | 2,470 | 153 | |||||||
2,721 | 2,632 | 89 | 2,527 | 194 | ||||||||
Baja Fresh |
||||||||||||
Company |
144 | 148 | (4 | ) | 132 | 12 | ||||||
Franchise |
151 | 157 | (6 | ) | 151 | 0 | ||||||
Total Baja Fresh | 295 | 305 | (10 | ) | 283 | 12 | ||||||
Cafe Express |
||||||||||||
Company |
19 | 18 | 1 | 18 | 1 | |||||||
Total Cafe Express | 19 | 18 | 1 | 18 | 1 | |||||||
Total System |
||||||||||||
Company |
1,748 | 1,717 | 31 | 1,672 | 76 | |||||||
Franchise |
7,958 | 7,810 | 148 | 7,637 | 321 | |||||||
9,706 | 9,527 | 179 | 9,309 | 397 |
AA-22
Recently Issued Accounting Standards
In October 2004, the Emerging Issues Task Force (EITF) of the FASB ratified the consensuses reached on Issue No. 04-01, Accounting for Preexisting Relationships between the Parties to a Business Combination. The EITF requires that all preexisting relationships between two parties that have consummated a business combination should be evaluated to determine if settlement of a preexisting contract has occurred requiring accounting separate from the business combination. The Issue also requires that the acquisition of a right to use recognized or unrecognized intangible assets be included as part of the business combination and recognized as an intangible asset separate from goodwill. A settlement gain or loss is also required to be recognized in conjunction with the effective settlement of a lawsuit or executory contract in a business combination. The consensuses reached are effective for business combinations consummated and goodwill impairment tests performed in reporting periods beginning after October 13, 2004. The Company will adopt Issue No. 04-01 in the first quarter of 2005. The Company is currently evaluating the impact of adoption, but does not expect it to have a significant impact on the Companys financial statements.
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award using an option-pricing model. The cost of the awards, including the related tax effects, will be recognized over the vesting period of the award. This statement eliminates the alternative to use the intrinsic value method for valuing stock based compensation, which typically resulted in recognition of no compensation cost. This statement is effective for interim or annual periods beginning after June 15, 2005, with early adoption encouraged. The Company will adopt SFAS No. 123R in the first quarter of 2005 using the modified retrospective application whereby the Company will retroactively apply SFAS No. 123R, which will impact all prior periods presented to give effect to the fair-value-based method of accounting for stock options on a basis consistent with the pro forma disclosures provided in Note 1 to the Consolidated Financial Statements. The net income impact, however, may be different than that disclosed in Note 1 to the Consolidated Financial Statements because SFAS No. 123R specifies different income tax treatments than SFAS No. 123. The presentation of cash flows will also be affected due to a change in treatment for tax benefits realized. The Company is currently in the process of evaluating the tax implications.
Safe Harbor Statement
Certain information contained in the Financial Statements and Other Information section of the Proxy Statement, particularly information regarding future economic performance and finances, plans and objectives of management, is forward looking. In some cases, information regarding certain important factors that could cause actual results to differ materially from any such forward-looking statement appears together with such statement. In addition, the following factors, in addition to other possible factors not listed, could affect the Companys actual results and cause such results to differ materially from those expressed in forward-looking statements. These factors include: competition within the quick-service restaurant industry, which remains extremely intense, both domestically and internationally, with many competitors pursuing heavy price discounting; changes in economic conditions; changes in consumer perceptions of food safety; harsh weather, particularly in the first and fourth quarters; changes in consumer tastes; labor and benefit costs; legal claims; risk inherent to international development (including currency fluctuations); the continued ability of the Company and its franchisees to obtain suitable locations and financing for new restaurant development; governmental initiatives such as minimum wage rates, taxes and possible franchise legislation; changes in applicable accounting rules; the ability of the Company to successfully complete transactions designed to improve its return on investment; or other factors set forth in Exhibit 99 to the Companys most recent Form 10-K filed with the Securities and Exchange Commission and in the Financial Statements and Other Information section of the Proxy Statement for the 2005 Annual Meeting of Shareholders.
AA-23
Managements Statement of Responsibility for Financial Statements and Report on Internal Control Over Financial Reporting
Financial Statements
Management is responsible for preparation of the consolidated financial statements and other related financial information included in the Financial Statements and Other Information furnished with the Companys Proxy Statement for the 2005 Annual Meeting of Shareholders. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, incorporating managements reasonable estimates and judgments, where applicable.
Managements Report on Internal Control Over Financial Reporting
This report is provided by management pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and the SEC rules promulgated thereunder. Management is responsible for establishing and maintaining adequate internal control over financial reporting and for assessing the effectiveness of internal control over financial reporting.
The Companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use, or disposition of the Companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the Companys internal control over financial reporting as of January 2, 2005, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has excluded certain franchised Hortons restaurants from its assessment of internal control over financial reporting as of January 2, 2005 because the Company does not have the ability to dictate or modify the controls of these entities and does not have the ability, in practice, to assess those controls. These restaurants, each of which was in existence prior to December 15, 2003, are consolidated in the Companys financial statements pursuant to FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 and had total assets and total revenues less than 1%, respectively, of the consolidated financial statement amounts as of January 2, 2005 and for the year then ended. The consolidation of these entities had no net income impact on the consolidated financial statements for the year ended January 2, 2005. Based on the assessment of the Companys internal control over financial reporting, management has concluded that, as of January 2, 2005, the Companys internal control over financial reporting was effective. Managements conclusion regarding the effectiveness of the Companys internal control over financial reporting as of January 2, 2005 does not extend to the franchised Hortons restaurants referred to above.
The Companys independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited managements assessment of the effectiveness of the Companys internal control over financial reporting as of January 2, 2005, as stated in their report which follows.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Wendys International, Inc.:
We have completed an integrated audit of Wendys International, Inc.s January 2, 2005 consolidated financial statements and of its internal control over financial reporting as of January 2, 2005 and audits of its December 28, 2003 and December 29, 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
AA-24
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders equity, comprehensive income and cash flows present fairly, in all material respects, the financial position of Wendys International, Inc. and its subsidiaries at January 2, 2005 and December 28, 2003, and the results of their operations and their cash flows for each of the years ended January 2, 2005, December 28, 2003, and December 29, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of January 2, 2005 based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 2, 2005, based on criteria established in Internal Control Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
AA-25
As discussed in Managements Report on Internal Control Over Financial Reporting, management has excluded certain franchised Hortons restaurants from its assessment of internal control over financial reporting as of January 2, 2005 because the Company does not have the ability to dictate or modify the controls of these entities and does not have the ability, in practice, to assess those controls. We have also excluded these franchised Hortons restaurants from our audit of internal control over financial reporting. These restaurants, each of which was in existance prior to December 15, 2003, are consolidated in the Companys financial statements pursuant to FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 and had total assets and total revenues less than 1%, respectively, of the consolidated financial statement amounts as of January 2, 2005 and for the year then ended. The consolidation of these entities had no net income impact on the consolidated financial statements for the year ended January 2, 2005.
/s/ PricewaterhouseCoopers LLP
Columbus, Ohio
March 31, 2005
AA-26
Wendys International, Inc. and Subsidiaries
Consolidated Statements of Income
Years ended January 2, 2005, December 28, 2003 and December 29, 2002 | ||||||||||||
(In thousands, except per share data) | 2004 | 2003 | 2002 | |||||||||
Revenues |
||||||||||||
Retail sales |
$ | 2,935,899 | $ | 2,534,135 | $ | 2,187,438 | ||||||
Franchise revenues |
699,539 | 614,777 | 542,823 | |||||||||
Total revenues |
3,635,438 | 3,148,912 | 2,730,261 | |||||||||
Costs and expenses |
||||||||||||
Cost of sales |
1,920,302 | 1,634,562 | 1,383,665 | |||||||||
Company restaurant operating costs |
649,281 | 534,083 | 459,141 | |||||||||
Operating costs |
168,492 | 135,332 | 118,643 | |||||||||
Depreciation of property and equipment |
178,394 | 163,481 | 139,101 | |||||||||
General and administrative expenses |
283,721 | 261,070 | 241,438 | |||||||||
Goodwill impairment |
190,000 | 0 | 0 | |||||||||
Other expense, net |
18,644 | 1,942 | 6,905 | |||||||||
Total costs and expenses |
3,408,834 | 2,730,470 | 2,348,893 | |||||||||
Operating income |
226,604 | 418,442 | 381,368 | |||||||||
Interest expense |
(46,950 | ) | (45,773 | ) | (41,454 | ) | ||||||
Interest income |
4,409 | 4,929 | 5,985 | |||||||||
Income before income taxes |
184,063 | 377,598 | 345,899 | |||||||||
Income taxes |
132,028 | 141,599 | 127,118 | |||||||||
Net income |
$52,035 | $235,999 | $218,781 | |||||||||
Basic earnings per common share |
$0.46 | $2.07 | $1.96 | |||||||||
Diluted earnings per common share |
$0.45 | $2.05 | $1.89 | |||||||||
Dividends per common share |
$0.48 | $0.24 | $0.24 | |||||||||
Basic shares |
113,832 | 113,866 | 111,900 | |||||||||
Diluted shares |
115,685 | 115,021 | 116,558 | |||||||||
See accompanying Notes to the Consolidated Financial Statements.
AA-27
Wendys International, Inc. and Subsidiaries
January 2, 2005 and December 28, 2003 | ||||||||
(Dollars in thousands) | 2004 | 2003 | ||||||
Assets |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 176,749 | $ | 171,206 | ||||
Accounts receivable, net |
127,158 | 109,880 | ||||||
Notes receivable, net |
11,626 | 14,125 | ||||||
Deferred income taxes |
27,280 | 19,776 | ||||||
Inventories and other |
56,010 | 54,353 | ||||||
Short-term investments |
0 | 24,648 | ||||||
Advertising fund restricted assets |
60,021 | 68,677 | ||||||
Total current assets |
458,844 | 462,665 | ||||||
Property and equipment, net |
2,349,820 | 2,154,307 | ||||||
Notes receivable, net |
12,652 | 18,122 | ||||||
Goodwill |
166,998 | 320,959 | ||||||
Deferred income taxes |
6,772 | 822 | ||||||
Intangible assets, net |
41,787 | 44,547 | ||||||
Other assets |
160,671 | 131,540 | ||||||
Total assets |
$ | 3,197,544 | $ | 3,132,962 | ||||
Liabilities and Shareholders Equity |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 197,247 | $ | 159,957 | ||||
Accrued expenses |
||||||||
Salaries and wages |
46,971 | 49,785 | ||||||
Taxes |
108,025 | 81,921 | ||||||
Insurance |
53,160 | 46,677 | ||||||
Other |
92,838 | 70,565 | ||||||
Advertising fund restricted liabilities |
60,021 | 68,677 | ||||||
Current portion of long-term obligations |
130,125 | 50,891 | ||||||
Total current liabilities |
688,387 | 528,473 | ||||||
Long-term obligations |
||||||||
Term debt |
538,055 | 622,596 | ||||||
Capital leases |
55,552 | 70,036 | ||||||
Total long-term obligations |
593,607 | 692,632 | ||||||
Deferred income taxes |
109,674 | 101,874 | ||||||
Other long-term liabilities |
90,187 | 51,377 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity |
||||||||
Preferred stock, Authorized: 250,000 shares |
||||||||
Common stock, $.10 stated value per share, Authorized: 200,000,000 shares, Issued: 118,090,000 and 116,760,000 shares, respectively |
11,809 | 11,676 | ||||||
Capital in excess of stated value |
111,286 | 54,310 | ||||||
Retained earnings |
1,700,813 | 1,703,488 | ||||||
Accumulated other comprehensive income (expense): |
||||||||
Cumulative translation adjustments and other |
102,950 | 47,142 | ||||||
Pension liability |
(913 | ) | (1,018 | ) | ||||
1,925,945 | 1,815,598 | |||||||
Treasury stock, at cost: 5,681,000 and 2,063,000 shares, respectively |
(195,124 | ) | (56,992 | ) | ||||
Unearned compensation restricted stock |
(15,132 | ) | 0 | |||||
Total shareholders equity |
1,715,689 | 1,758,606 | ||||||
Total liabilities and shareholders equity |
$ | 3,197,544 | $ | 3,132,962 | ||||
See accompanying Notes to the Consolidated Financial Statements.
AA-28
Wendys International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended January 2, 2005, December 28, 2003 and December 29, 2002 | ||||||||||||
(In thousands) | 2004 | 2003 | 2002 | |||||||||
Cash flows from operating activities |
||||||||||||
Net income |
$ | 52,035 | $ | 235,999 | $ | 218,781 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities |
||||||||||||
Depreciation and amortization |
182,175 | 167,844 | 142,773 | |||||||||
Goodwill impairment |
190,000 | 0 | 0 | |||||||||
Deferred income taxes |
(9,668 | ) | 34,811 | 17,941 | ||||||||
Loss from property dispositions, net |
12,170 | 3,422 | 2,623 | |||||||||
Net reserves for receivables and other contingencies |
6,036 | 1,108 | (109 | ) | ||||||||
Changes in operating assets and liabilities, net of effects of acquisitions and dispositions of restaurants |
||||||||||||
Accounts and notes receivable |
(12,187 | ) | (23,946 | ) | (5,061 | ) | ||||||
Inventories and other |
7,205 | (12,748 | ) | (4,594 | ) | |||||||
Accounts payable and accrued expenses |
77,097 | 26,635 | 74,461 | |||||||||
Increase in other assets |
(6,156 | ) | (19,821 | ) | (18,971 | ) | ||||||
Other, net |
3,645 | 16,907 | 16,020 | |||||||||
Net cash provided by operating activities |
502,352 | 430,211 | 443,864 | |||||||||
Cash flows from investing activities |
||||||||||||
Proceeds from property dispositions |
57,404 | 27,126 | 25,122 | |||||||||
Capital expenditures |
(341,052 | ) | (341,911 | ) | (330,811 | ) | ||||||
Acquisition of franchises |
(16,489 | ) | (97,553 | ) | (2,316 | ) | ||||||
Acquisition of Baja Fresh (see Note 8) |
0 | 0 | (287,405 | ) | ||||||||
Acquisition of Bess Eaton (see Note 8) |
(44,285 | ) | 0 | 0 | ||||||||
Proceeds from sale of Conference Cup |
0 | 0 | 19,959 | |||||||||
Principal payments on notes receivable |
13,247 | 9,444 | 19,751 | |||||||||
Investments in joint ventures and other investments |
(13,434 | ) | (7,620 | ) | (43,126 | ) | ||||||
Short-term investments |
24,655 | (23,043 | ) | 0 | ||||||||
Other investing activities |
(2,532 | ) | (4,996 | ) | (4,630 | ) | ||||||
Net cash used in investing activities |
(322,486 | ) | (438,553 | ) | (603,456 | ) | ||||||
Cash flows from financing activities |
||||||||||||
Proceeds from issuance of debt, net of issuance costs |
39,512 | 39,985 | 223,037 | |||||||||
Proceeds from employee stock options exercised |
31,436 | 46,720 | 77,737 | |||||||||
Repurchase of common stock |
(138,132 | ) | (56,992 | ) | (49,401 | ) | ||||||
Principal payments on long-term obligations |
(61,761 | ) | (5,966 | ) | (4,274 | ) | ||||||
Dividends paid on common and exchangeable shares |
(54,708 | ) | (27,322 | ) | (27,076 | ) | ||||||
Net cash provided by (used in) financing activities |
(183,653 | ) | (3,575 | ) | 220,023 | |||||||
Effect of exchange rate changes on cash |
9,330 | 11,179 | 392 | |||||||||
Increase (decrease) in cash and cash equivalents |
5,543 | (738 | ) | 60,823 | ||||||||
Cash and cash equivalents at beginning of period |
171,206 | 171,944 | 111,121 | |||||||||
Cash and cash equivalents at end of period |
$ | 176,749 | $ | 171,206 | $ | 171,944 | ||||||
Supplemental disclosures of cash flow information: |
||||||||||||
Interest paid |
$ | 47,073 | $ | 46,429 | $ | 41,456 | ||||||
Income taxes paid |
119,351 | 120,027 | 69,392 | |||||||||
Non-cash investing and financing activities: |
||||||||||||
Capital lease obligations incurred |
$ | 4,415 | $ | 15,630 | $ | 8,311 | ||||||
$2.50 Term Convertible Securities, Series A, converted and redeemed |
0 | 0 | 200,000 | |||||||||
See accompanying Notes to the Consolidated Financial Statements.
AA-29
Wendys International, Inc. and Subsidiaries
Consolidated Statements of Income Shareholders Equity
Years ended January 2, 2005, December 28, 2003 and December 29, 2002 | ||||||||||||
(In thousands) | 2004 | 2003 | 2002 | |||||||||
Common stock at stated value |
||||||||||||
Balance at beginning of period |
$ | 11,676 | $ | 10,895 | $ | 13,271 | ||||||
Exercise of options |
133 | 207 | 355 | |||||||||
Conversion of exchangeable shares |
0 | 574 | 0 | |||||||||
Retirement of treasury stock |
0 | 0 | (3,488 | ) | ||||||||
Conversion of $2.50 Term Convertible Securities, Series A |
0 | 0 | 757 | |||||||||
Balance at end of period |
11,809 | 11,676 | 10,895 | |||||||||
Capital in excess of stated value |
||||||||||||
Balance at beginning of period |
54,310 | 0 | 467,687 | |||||||||
Exercise of options, including tax benefits |
37,651 | 53,624 | 92,625 | |||||||||
Restricted stock awards and other equity-based compensation |
19,325 | 686 | 0 | |||||||||
Retirement of treasury stock |
0 | 0 | (755,240 | ) | ||||||||
Conversion of $2.50 Term Convertible Securities, Series A |
0 | 0 | 194,928 | |||||||||
Balance at end of period |
111,286 | 54,310 | 0 | |||||||||
Retained earnings |
||||||||||||
Balance at beginning of period |
1,703,488 | 1,498,607 | 1,377,840 | |||||||||
Net income |
52,035 | 235,999 | 218,781 | |||||||||
Dividends |
(54,710 | ) | (27,322 | ) | (27,076 | ) | ||||||
Conversion of exchangeable shares |
0 | (3,796 | ) | 0 | ||||||||
Retirement of treasury stock |
0 | 0 | (70,938 | ) | ||||||||
Balance at end of period |
1,700,813 | 1,703,488 | 1,498,607 | |||||||||
Accumulated other comprehensive income (expense) |
102,037 | 46,124 | (60,897 | ) | ||||||||
Treasury stock, at cost |
||||||||||||
Balance at beginning of period |
(56,992 | ) | 0 | (780,265 | ) | |||||||
Purchase of common stock |
(138,132 | ) | (56,992 | ) | (49,401 | ) | ||||||
Retirement of treasury stock |
0 | 0 | 829,666 | |||||||||
Balance at end of period |
(195,124 | ) | (56,992 | ) | 0 | |||||||
Unearned compensation restricted stock |
(15,132 | ) | 0 | 0 | ||||||||
Shareholders equity |
$ | 1,715,689 | $ | 1,758,606 | $ | 1,448,605 | ||||||
Common shares |
||||||||||||
Balance issued at beginning of period |
116,760 | 108,951 | 132,711 | |||||||||
Exercise of options |
1,330 | 2,069 | 3,553 | |||||||||
Conversion of exchangeable shares |
0 | 5,740 | 0 | |||||||||
Retirement of treasury stock |
0 | 0 | (34,880 | ) | ||||||||
Conversion of $2.50 Term Convertible Securities, Series A |
0 | 0 | 7,567 | |||||||||
Balance issued at end of period |
118,090 | 116,760 | 108,951 | |||||||||
Treasury shares |
||||||||||||
Balance at beginning of period |
(2,063 | ) | 0 | (33,277 | ) | |||||||
Purchase of common stock |
(3,618 | ) | (2,063 | ) | (1,603 | ) | ||||||
Retirement of treasury stock |
0 | 0 | 34,880 | |||||||||
Balance at end of period |
(5,681 | ) | (2,063 | ) | 0 | |||||||
Common shares issued and outstanding |
112,409 | 114,697 | 108,951 | |||||||||
Common shares issuable upon conversion of exchangeable shares |
||||||||||||
Balance at beginning of period |
0 | 5,741 | 5,741 | |||||||||
Purchase and conversion of exchangeable shares |
0 | (5,741 | ) | 0 | ||||||||
Balance at end of period |
0 | 0 | 5,741 | |||||||||
Common shares issued and outstanding, including exchangeable shares |
112,409 | 114,697 | 114,692 | |||||||||
See accompanying Notes to the Consolidated Financial Statements.
AA-30
Wendys International, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Years ended January 2, 2005, December 28, 2003 and December 29, 2002 | ||||||||||
(In thousands) | 2004 | 2003 | 2002 | |||||||
Net income |
$ | 52,035 | $ | 235,999 | $ | 218,781 | ||||
Other comprehensive income (expense) |
||||||||||
Translation adjustments and other |
55,808 | 91,856 | 4,040 | |||||||
Pension liability (net of a tax benefit of $65 and $8,987 and tax expense of $9,617 for the years ended January 2, 2005, December 28, 2003 and December 29,2002, respectively) |
105 | 15,165 | (16,183 | ) | ||||||
Total other comprehensive income (expense) |
55,913 | 107,021 | (12,143 | ) | ||||||
Comprehensive income |
$ | 107,948 | $ | 343,020 | $ | 206,638 | ||||
See accompanying Notes to the Consolidated Financial Statements.
AA-31
Wendys International, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business
The Companys principal business is the operation, development and franchising of quick-service and fast-casual restaurants serving high-quality food. At year-end 2004, the Company and its franchise owners operated 6,671 restaurants under the name Wendys in 50 states and in 19 other countries and territories, 295 restaurants under the name Baja Fresh in 26 states and 19 restaurants under the name Cafe Express in Texas. Additionally, the Company and its franchise owners operated 2,470 restaurants in Canada and 251 units in the United States under the name Tim Hortons (Hortons). As of January 2, 2005, total systemwide restaurants included 1,748 company operated restaurants and 7,958 franchise restaurants.
Fiscal year
The Companys fiscal year ends on the Sunday nearest to December 31. The 2004 fiscal year consisted of 53 weeks and the 2003 and 2002 fiscal years consisted of 52 weeks.
Basis of presentation
The Consolidated Financial Statements include the results and balances of the Company, its wholly-owned subsidiaries and certain franchisees consolidated according to Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46R. All significant intercompany accounts and transactions have been eliminated in consolidation (see also Note 12 to the Consolidated Financial Statements for consolidation of the Companys advertising funds).
Investments in unconsolidated affiliates over which the Company exercises significant influence but is not the primary beneficiary and does not have control are accounted for using the equity method. The Companys share of the net income or loss of these unconsolidated affiliates is included in other expense, net.
Certain reclassifications of deferred taxes have been made for the prior year to conform with the 2004 presentation. These reclassifications did not have any impact on net income.
Cash and cash equivalents
The Company considers short-term investments with original maturities of three months or less as cash equivalents.
Accounting estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates. These affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates and judgments are inherent in the calculations of royalty and other franchise-related revenue collections, legal obligations, pension and other postretirement benefits, income taxes, insurance liabilities, various other commitments and contingencies, valuations used when assessing potential impairment of goodwill and other intangibles and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions.
In the normal course of business, the Company must make continuing estimates of potential future legal obligations and liabilities, which requires the use of managements judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required.
Inventories
Inventories, amounting to $37.8 million and $33.1 million at January 2, 2005 and December 28, 2003, respectively, are stated at the lower of cost (first-in, first-out) or market, and consist primarily of restaurant food items, new equipment and parts, and paper supplies.
Property and equipment
Depreciation and amortization are recognized using the straight-line method in amounts adequate to amortize costs over the following estimated useful lives: buildings, up to 40 years; restaurant equipment, up to 15 years; other equipment, up to 10 years; leasehold improvements and property under capital leases, the lesser of the useful life of the asset or the lease term as that term is defined in Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases, as amended. Interest and other costs associated with the construction of new restaurants are capitalized. Major improvements are
AA-32
capitalized, while maintenance and repairs are expensed when incurred. Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates an impairment may exist. The Company tests for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing (see also Note 9 to the Consolidated Financial Statements). Gains and losses on the disposition of fixed assets are classified in other expense, net.
Property and equipment, at cost, at each year-end consisted of the following:
(In thousands) | 2004 | 2003 | ||||||
Land |
$ | 500,136 | $ | 459,189 | ||||
Buildings |
1,012,265 | 885,989 | ||||||
Leasehold improvements |
769,248 | 691,654 | ||||||
Restaurant equipment |
643,908 | 597,425 | ||||||
Capital leases |
92,209 | 95,195 | ||||||
Other |
242,067 | 210,499 | ||||||
Construction in progress |
102,325 | 87,788 | ||||||
3,362,158 | 3,027,739 | |||||||
Accumulated depreciation and amortization |
(1,012,338 | ) | (873,432 | ) | ||||
$ | 2,349,820 | $ | 2,154,307 | |||||
The Company capitalizes certain internally developed software costs which are amortized over a period of up to ten years. At January 2, 2005 and December 28, 2003, capitalized software development costs, net of accumulated amortization, amounted to $46.0 million and $46.9 million, respectively, which amounts are included in Other above.
Leases
Like other companies in the restaurant and retail industries, in the fourth quarter of 2004 the Company reviewed its accounting practices with respect to leasing transactions. Following this review, the Company has corrected its prior lease accounting practices. The cumulative adjustment necessary as a result of the change in lease accounting practices totaled $9.1 million pretax ($5.8 million after tax). The cumulative adjustment was recorded in the 2004 Consolidated Financial Statements in the fourth quarter. The result of the correction is primarily to conform the lease term used to amortize leasehold improvements on leased property with the term used to recognize straight-line rent, including during rent holiday periods while constructing leasehold improvements. In the case of property that is leased or sub-leased by the Company to franchisees, the adjustment also includes recording of straight-line rent revenue.
When determining the lease term for purposes of recording depreciation and rent or for evaluating whether a lease is capital or operating, the Company includes option periods for which failure to renew the lease imposes an economic penalty on the Company of such an amount that a renewal appears, at the inception of the lease, to be reasonably assured. For example, such an economic penalty would exist if the Company were to choose not to exercise an option on leased land upon which the Company had constructed a restaurant and, as a result, the Company would lose the ability to use the restaurant.
For operating leases, minimum lease payments, including minimum scheduled rent increases, are recognized as rent expense on a straight line basis over the lease term as that term is defined in SFAS No. 13, as amended, including any option periods considered in the lease term and any periods during which the Company has use of the property but is not charged rent by a landlord (rent holiday). Contingent rentals are generally based on either a percentage of restaurant sales or as a percentage of restaurant sales in excess of stipulated amounts, and thus are not included in minimum lease payments but are included in rent expense when incurred. Rent is capitalized during the construction of a restaurant. Leasehold improvement incentives paid to the Company by a landlord are recorded as a liability and amortized as a reduction of rent expense over the lease term. No individual lease is material to the Company.
Goodwill and other intangibles
Goodwill is the excess of the cost of an acquired entity over the fair value of acquired net assets. For purposes of testing goodwill for impairment, the Company has determined that its reporting units are Wendys U.S., Wendys Canada, Hortons Canada, Hortons U.S., Baja Fresh and Cafe Express. Each constitutes a business and has discrete financial information available which is regularly reviewed by management. The Company tests goodwill for impairment at least annually by comparing the fair value of each reporting unit, using discounted cash flows or market multiples based on earnings, to the carrying value to determine if there is an indication that a potential impairment may exist (see also Note 2 to the Consolidated Financial Statements).
AA-33
Intangibles separate from goodwill are amortized on a straight-line method over periods of up to 30 years. Lives are generally related to legal or contractual lives, but in some cases must be estimated by management based on specific circumstances. The Company tests intangible assets for impairment whenever events or circumstances indicate that an impairment may exist.
Notes receivable
Notes receivable arise primarily from the sale of certain real estate and equipment to franchisees as well as agreements by the Company, under certain circumstances, to a structured repayment plan for past due franchisee obligations. The need for a reserve for uncollectible amounts is reviewed on a specific franchisee basis using information available to the Company, including past due balances and the financial strength of the franchisee. Uncollectible amounts for both principal and interest are provided for as those amounts are identified. The carrying amount of notes receivable approximates fair value.
Revenue recognition
Wendys and Baja Fresh have a significant number of company operated restaurants, while Hortons is predominately franchised. Revenue at company operated restaurants is recognized as customers pay for products at the time of sale. Hortons operates warehouses in Canada to distribute coffee and other dry goods to an extensive franchise system. Revenues from these sales are recorded when the product is delivered to the franchisee. Franchise revenues consist of royalties, rents and various franchise fees. Royalties are collected by Wendys, Hortons and Baja Fresh, and normally all revenue is collected within a month after a period ends. The timing of revenue recognition for both retail sales and franchise revenues does not involve significant contingencies and judgments other than providing adequate reserves against collections of franchise-related revenues. Also, see discussion of Franchise operations below for further information regarding franchise revenues.
Franchise operations
The Company grants franchises to independent operators who in turn pay a technical assistance fee and franchise fees which may include equipment, royalties, and in some cases, rents for each restaurant opened. A technical assistance fee is recorded as income when each restaurant commences operations. Royalties, based upon a percent of monthly sales, are recognized as income on the accrual basis. The Company has established reserves related to the collection of franchise royalties and other franchise-related receivables and commitments (see Note 10 to the Consolidated Financial Statements).
Franchise owners receive assistance in such areas as real estate site selection, construction consulting, purchasing and marketing from company personnel who also furnish these services to company operated restaurants. These franchise expenses are included in general and administrative expenses. Gains and losses on the sale of properties previously leased to franchisees are included in franchise revenues.
Variable interest entities
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