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EX-24 - POWERS OF ATTORNEY - Tim Hortons Inc.dex24.htm
EX-21 - SUBSIDIARIES OF THE REGISTRANT - Tim Hortons Inc.dex21.htm
EX-23 - CONSENT OF PRICEWATERHOUSECOOPERS LLP - Tim Hortons Inc.dex23.htm
EX-10.(Y) - ACKNOWLEDGMENT , DATED AS OF OCTOBER 29, 2010 - Tim Hortons Inc.dex10y.htm
EX-31.(A) - SECTION 302 CEO CERTIFICATION - Tim Hortons Inc.dex31a.htm
EX-32.(B) - SECTION 906 CFO CERTIFICATION - Tim Hortons Inc.dex32b.htm
EX-31.(B) - SECTION 302 CFO CERTIFICATION - Tim Hortons Inc.dex31b.htm
EX-32.(A) - SECTION 906 CEO CERTIFICATION - Tim Hortons Inc.dex32a.htm
EX-10.(L) - AMENDED AND RESTATED PERSONAL SUPPLEMENTAL EXECUTIVE RETIREMENT SAVINGS PLAN - Tim Hortons Inc.dex10l.htm
EX-99 - SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT 1995 - Tim Hortons Inc.dex99.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

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

For the Fiscal Year Ended January 2, 2011

 

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

For the transition period from            to            

Commission File Number: 001-32843

TIM HORTONS INC.

(Exact name of Registrant as specified in its charter)

 

Canada   98-0641955

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

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

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

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

 

Title of each class

 

Name of each exchange on which registered

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

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

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

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

Large accelerated filer  x    Accelerated filer  ¨
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
   Smaller reporting company  ¨

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

The aggregate market value of the common shares held by non-affiliates of the Registrant computed by reference to the price at which such shares were last sold, as of July 4, 2010, was Cdn.$5,923,576,430 (US$5,558,138,401).

Number of common shares outstanding as of February 22, 2011: 167,532,579

DOCUMENTS INCORPORATED BY REFERENCE:

Exhibit index on pages 183-186.

 

 

 


Table of Contents

EXPLANATORY NOTE

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

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


Table of Contents

TIM HORTONS INC.

2010 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 

          Page  
     PART I       

Item 1.

   Business      4   

Item 1A.

   Risk Factors      23   

Item 1B.

   Unresolved Staff Comments      37   

Item 2.

   Properties      37   

Item 3.

   Legal Proceedings      40   

Item 4.

   (Removed and Reserved)      41   
   PART II   

Item 5.

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

Item 6.

   Selected Financial Data      47   

Item 7.

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

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      105   

Item 8.

   Financial Statements and Supplementary Data      106   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      174   

Item 9A.

   Controls and Procedures      174   

Item 9B.

   Other Information      174   
   PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance      176   

Item 11.

   Executive Compensation      179   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      179   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      179   

Item 14.

   Principal Accounting Fees and Services      180   
   PART IV   

Item 15.

   Exhibits and Financial Statement Schedules      181   

SIGNATURES

     182   

 

 

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

 

(US$)

   At End of
Fiscal Year
     Year
Average
     High      Low  

December 31, 2006

     0.8582         0.8849         0.9100         0.8528   

December 30, 2007

     1.0221         0.9419         1.0908         0.8437   

December 28, 2008

     0.8192         0.9399         1.0291         0.7710   

January 3, 2010

     0.9559         0.8834         0.9719         0.7695   

January 2, 2011

     0.9991         0.9663         1.0040         0.9280   

On February 22, 2011, the noon buying rate in New York City for cable transfers in foreign currencies as certified for customers purposes by the Federal Reserve Bank of New York was US$0.9827 for Cdn.$1.00.

 

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PART I

 

 

Item 1. Business

 

 

The Company

We are the fourth largest publicly-traded quick service restaurant chain in North America based on market capitalization and the largest in Canada. We appeal to a broad range of consumer tastes, with a menu that includes premium coffee, flavoured cappuccinos, specialty teas, home-style soups, fresh sandwiches, wraps, hot breakfast sandwiches and fresh baked goods, including our trademark donuts.

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

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

Our primary business model is to identify and franchise restaurant locations. As of January 2, 2011, 99.5% of our systemwide restaurants were franchised or run by independent operators. We also own and operate a small number of corporate-run locations. Our business model also includes vertically-integrated businesses, including warehouse and distribution operations that supply goods to a substantial majority of our Canadian restaurants. In the United States, we supply similar products to our restaurants through third-party distributors. We currently operate four distribution centres that supply paper and dry goods to Canadian restaurants, and one facility that also provides frozen and some refrigerated products, as well as paper and dry goods to most of our Ontario locations. We are currently constructing a replacement distribution centre for our Kingston facility, expected to be operational in 2011, that will increase the distribution of frozen and refrigerated products to our Ontario restaurants and begin to provide this service to certain of our restaurants in Quebec. Our operations also include coffee roasting plants in Rochester, New York and Hamilton, Ontario, and a fondant and fills manufacturing facility in Oakville, Ontario. In 2010, we sold our 50% joint venture interest in Maidstone Bakeries, which provides certain bread, pastries, donuts and Timbits™ to our system restaurants. Pursuant to our supply agreement with Maidstone Bakeries, our obligations to purchase supply of donuts and Timbits extend until early 2016, and we have supply rights until late 2017, at our option, allowing us sufficient flexibility to secure alternative means of supply, if necessary.

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

 

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All dollar amounts referenced in this Form 10-K are in Canadian dollars, unless otherwise expressly stated.

 

 

Business Overview and 2011 Objectives

We seek to grow our business by executing strategic and operational plans and initiatives designed to help us achieve both annual and longer-term goals that create shareholder value. We have a unique, layered business model that adds to the scale and success of our system.

Unique business model

Key aspects of our business include:

 

   

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

 

   

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

 

   

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

 

   

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

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

Increasing same-store sales is an important measure of success in the restaurant sector. We view same-store sales growth as vital to the ongoing health of our franchise system and the Company. Our strategies to increase same-store sales include:

 

   

continuing to create menu and product innovation to expand our market share across various dayparts and product categories, responding to customer needs and trends;

 

   

we continue to place particular focus on morning and afternoon/evening snacking dayparts, as well as extending lunch opportunities in the Canadian segment;

 

   

in the U.S., we plan to test and roll-out menu items that help differentiate our cafe and bake shop brand identity;

 

   

we plan to grow our market share in both hot and cold beverage categories; and

 

   

leveraging our marketing strengths and advantages. In Canada, we will leverage our scale as one of the country’s largest advertisers to reinforce our attractive price to value position and to reinforce our brand equity, and continue to focus on our hospitality initiatives. In the United States, we plan to significantly increase our marketing and advertising spending in all markets, and in particular in our core, more developed growth markets, to increase awareness of our brand. In addition, we will continue to seek other marketing means, such as community involvement, sponsorships, and other forms of communication, to supplement traditional advertising to reinforce our brand position with customers and to broaden our brand awareness as a cafe and bake shop destination.

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

Restaurant development in new and existing markets has historically contributed significantly to the Company’s growth. In 2011, our specific development plans include:

 

   

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

 

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

 

   

evaluating flexible new restaurant designs tailored to urban and rural markets;

 

   

based on results from our initial pilot new restaurant format for standard restaurants, broaden the pilot in Canada to include varying regions and adaptations from test results;

 

   

working to accelerate the time it takes to create critical mass for convenience and advertising scale in our most developed U.S. markets;

 

   

prioritizing and accelerating our U.S. restaurant development capital in our core growth markets which are most developed, while continuing to develop, to a lesser extent, in other emerging markets for longer-term growth;

 

   

applying successful elements of our new concept restaurants, including exterior and interior design treatments, menu items, equipment and fixtures, in new restaurants in the U.S., and seeking opportunities to introduce these elements in renovations; and

 

   

complementing our standard restaurant development activity in both Canada and the U.S. with non-standard formats and location.

Growing differently in ways we have not grown before

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

 

   

extending our competitive advantage for service excellence in Canada through a hospitality strategy;

 

   

expanding the Cold Stone Creamery© co-branding concept in Canada, where we have exclusive development rights, and to a lesser extent in the U.S., where we already have a significant co-branded presence;

 

   

testing new restaurant formats in Canada, as mentioned above;

 

   

pursuing, as part of a broader international restaurant development strategy, development of approximately five restaurants in 2011 in Gulf Cooperation Council markets through master licensee, The Apparel Group FZCO (“Apparel Group”), based in Dubai;

 

   

opportunistically pursuing strategic alliances and partnerships to take our brand to markets where we have not yet established a presence, to complement our existing presence, or to increase average unit volumes in existing locations. This may include co-branding or other initiatives; and

 

   

opening up to 75 co-branded Cold Stone Creamery locations in North America in 2011, with a primary focus on Canada.

Leveraging our core business strengths and franchise system

As one of the most franchised systems in the restaurant industry, we focus extensively on our relationships with our restaurant owners and the success of our system. We also seek to leverage our strengths and capabilities to grow our business in ways that benefit us and our system. In 2011, our focus includes:

 

   

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

 

   

pursuing additional vertical integration and supply chain opportunities to create value for our restaurant owners and shareholders, including completion of our new replacement distribution centre in Kingston, Ontario; and

 

   

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

 

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The Company’s 2011 operational objectives (See Accompanying Notes Below)

In support of the initiatives outlined above for 2011, we have established the following objectives:

 

   

we are targeting same-store sales growth of 3% to 5% in both Canada and the U.S.; and

 

   

we expect to open a total of 230 to 270 restaurant locations. Of these openings, we are planning to open 160 to 180 restaurants in Canada. In the U.S., we plan to open 70 to 90 locations, which will be split approximately equally between standard and non-standard full serve locations.

2011 Financial Outlook (See Accompanying Notes Below)

Based on our strategic and operational plans, we have established the following 2011 financial targets:

 

   

Earnings per share (EPS) of $2.30 to $2.40;

 

   

U.S. segment operating income of US$13 million to US$16 million;

 

   

Effective tax rate of approximately 30%; and

 

   

Capital expenditures of $180 million to $200 million.

Long-Term Aspirations (See Accompanying Notes Below)

 

   

EPS: long-term aspirational EPS compounded annual growth from 2011 through to the end of 2013 is expected to be between 12% to 15% (excluding the 2010 impact of the disposition of our 50% joint venture interest in Maidstone Bakeries and the U.S. asset impairment and related closure costs);

 

   

New restaurant development from 2010 to the end of 2013:

 

   

Canada: approximately 600;

 

   

U.S.: approximately 300;

 

   

Total North America: approximately 900; and

 

   

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

 

 

Notes :

The operational objectives, financial outlook, and aspirational goals (collectively, “targets”) established for 2011 and longer-term are based on the accounting, tax, and other legislative rules in place at the time the targets were issued and on the continuation of share repurchase programs relatively consistent with historical levels. The impact of future changes in accounting; tax and/or other legislative rules that may or may not become effective in fiscal 2010, 2011 and/or future years, changes to our share repurchase activities; and other matters not contemplated at the time the targets were established that could affect our business (such as, for example, the impact of disposition of our 50% joint venture interest in Maidstone Bakeries and other significant matters), were not included in the determination of these targets. In addition, the targets are forward-looking and are based on our expectations and outlook on, and shall be effective only as of, the date the targets were originally issued. Except as required by applicable securities laws, we do not intend to update these targets. You should refer to the Company’s public filings for any reported updates. These targets and our performance generally are subject to various risks and uncertainties and are based on certain underlying assumptions, set forth in Item 1A. Risk Factors of this Annual Report on Form 10-K (the “Annual Report”), which may impact future performance and our achievement of these targets.

 

 

 

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Operations

Our primary business model is to identify potential restaurant locations, develop suitable sites, and make these new restaurants available to approved restaurant owners. As of January 2, 2011, restaurant owners, including operators, operated 99.5% of our systemwide restaurants. We directly own and operate (without restaurant owners) only a small number of company restaurants in Canada and the U.S. We also have warehouse and distribution operations that supply paper and dry goods to a substantial majority of our Canadian restaurants, and supply frozen baked goods and some refrigerated products to most of our Ontario restaurants. In the U.S., we supply similar products to system restaurants through third-party distributors. Our operations also include coffee roasting plants in Rochester, New York, and Hamilton, Ontario, and a fondant and fills manufacturing facility in Oakville, Ontario. Until we sold our 50% interest in the Maidstone Bakeries joint venture to our former partner on October 29, 2010, our operations also included a bakery joint venture. See “Manufacturing” below. These vertically integrated manufacturing and distribution capabilities provide important benefits to our restaurant owners and systemwide restaurants, while allowing us to: improve product quality and consistency; protect proprietary interests; facilitate the expansion of our product offerings; control availability and timely delivery of products; provide economies of scale and labour efficiencies; and generate additional sources of income for the Company.

Our business model results in several distinct sources of revenues and corresponding income, consisting of distribution sales, franchise rent and royalties revenues, equity income (which is included in operating income), manufacturing income, and, to a much lesser extent, sales from Company-operated restaurants. Franchise royalties are typically collected weekly based on a percentage of gross sales. Rental income results from our controlling interest (i.e., lease or ownership) in the real estate for approximately 79% of franchised restaurants, generating base rent and, for most sites, percentage rent, which results in higher rental income as same-store sales increase. Historically, as we have opened new restaurants and made them available to restaurant owners, our operating income base has expanded. In addition, our product distribution and warehouse operations have generated consistent positive operating income.

Our segments for financial reporting purposes are Canada and the U.S. Financial information about these segments is set forth in Items 6 and 7 of this Form 10-K. We recently announced that we have entered into a master license agreement with Apparel Group to develop up to 120 multi-format restaurants in markets in the Gulf Cooperation Council. We will manage this expansion corporately and, accordingly, operating income from our international operations, which currently are insignificant, will continue to be included in Corporate charges in our segmented operating results. In addition, reference should be made to the Consolidated Financial Statements and Supplementary Data in Item 8 of this Annual Report for further information regarding revenues, segment operating profit and loss, total assets attributable to our segments, and for financial information attributable to certain geographic areas.

Restaurant formats. Tim Hortons restaurants operate in a variety of formats. From start to finish, the development process for each individual standard restaurant location, typically averaging 1,400 to 3,090 square feet, usually takes between 12 to 18 months. Development of non-standard sites and self-serve kiosks typically requires much less time. See Item 2. Properties of this Annual Report for additional information regarding our restaurants.

Our non-standard development growth includes small, full-service restaurants and/or self-serve kiosks in offices, hospitals, colleges, airports, grocery stores, gas and convenience locations and drive-thru-only units on smaller pieces of property. In 2010, we piloted a new restaurant format in Canada, and based on our early test results, we intend to broaden the pilot to include varying formats, regions and adaptations. Our self-serve kiosks typically have single-serve hot and cold beverage offerings and a limited selection of donuts, muffins, Danishes, and other pastries, although the product offering varies with the size of the kiosk and is generally more limited in the U.S. The primary format for our self-serve kiosks is the self-pour brewed coffee model. In Canada, these kiosks are located mainly in Esso® convenience locations, as a result of our relationship with Imperial Oil*. In the U.S., the majority of kiosks are located in Tops Friendly Markets®. Our financial arrangements for self-serve

 

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locations vary and may not be consistent with arrangements for other non-standard restaurants. In addition, self-serve kiosks typically generate much smaller average unit sales compared to non-standard, full-serve restaurants that have staff, larger locations, and more expansive beverage and food product offerings. Average unit volumes at self-serve kiosks are highly variable, depending upon the location, size of the site, product offerings, and hours of operation. In the U.S., self-serve kiosks only contribute nominal amounts to our distribution sales, royalty revenues and consolidated operating income at this time. Self-serve kiosks, however, complement our core growth strategy by increasing customer convenience and frequency of visits, and allowing for additional market penetration of our brand, including in areas where we may not be as well known or where an alternative model for unit growth and development is appropriate. Additionally, in Canada, we have used self-serve kiosks in locations where existing full-service locations are at capacity.

The development of co-branded locations is also increasing in our system. Based on positive results and customer response to the introduction of co-branded Cold Stone Creamery® locations opened in Canada during 2009, we entered into an agreement with Kahala Franchise Corp., the franchisor of the Cold Stone Creamery brand, for exclusive development rights in Canada, in order to provide us flexibility for future expansion. During 2010, we opened 78 co-branded restaurants in Canada and our co-branding initiative with Cold Stone Creamery in Canada contributed slightly to same-store sales growth in spite of relatively few locations relative to the entire system.

In the U.S., we opened 24 Cold Stone Creamery co-branded restaurants in 2010 and closed 13 locations as part of the New England restaurant closures, and our co-branding relationship had a slightly positive impact on same-store sales. Although the pace of our co-branding activity in the U.S. decreased during 2010, we also complemented our core standard restaurant development activity in the U.S. with non-traditional formats and locations, as described above, and we began testing a new concept restaurant in certain U.S. markets to differentiate our brand and customer menu offerings as a cafe and bake shop destination. We had four new concept restaurants open in 2010. Successful elements of our new concept restaurants, including exterior and interior design treatments, menu items, equipment and fixtures, will be incorporated in new restaurants in the U.S., and we will further consider these new applications in connection with the ongoing renovation program.

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

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

In Canada, we believe we have opportunity for future development for up to at least 4,000 locations. In 2011, we plan to slightly accelerate development in Canada. Our Canadian development is primarily focused in continuing to build our core growth markets of Quebec, western Canada, Ontario and major urban locations. As part of our broader development strategy, we are also targeting new areas, including urban and rural communities, and locations as part of our broader development strategy, through utilizing new, flexible restaurant formats and designs. For example, in 2010, we opened three self-serve kiosks in Nunavut.

As of January 2, 2011, the number of Tim Hortons restaurants across Canada, both standard and non-standard locations, which for this purpose includes self-serve kiosks, totaled 3,148. Standard restaurants constitute approximately 72% of this total. Also as of January 2, 2011, our restaurant owners operated substantially all of our Canadian restaurants. In the U.S., as of January 2, 2011, we have a regional presence with 602 restaurants in 9 states, concentrated in the Northeast in New York and Maine, and in the Midwest in

 

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Michigan and Ohio. We own, rather than lease, the land underlying a higher percentage of our standard system restaurants in the U.S. than in Canada. As of January 2, 2011, restaurant owners, including operators (See “Franchise and Other Arrangements—Other Arrangements” below for a description of “operators”), operated substantially all of the restaurants in the U.S. See Item 2. Properties of this Annual Report for a description of the number and type of restaurants by province/territory in Canada and by state in the U.S. owned or operated by our restaurant owners and owned by the Company.

During 2010, we continued to develop our growing regional presence in certain markets in the Midwest and certain markets in the Northeastern U.S., focusing primarily on our existing major regional markets such as New York, Ohio and Michigan. We continued adjusting certain elements of in our standard restaurant development, including right-sizing our restaurants, which we believe will better meet the needs of our customers while also creating efficiencies for our restaurant owners and us.

During the third quarter of 2010, an impairment review was initiated for markets in the New England region, the performance of which continued to fall below our expectations. These markets included: Portland, Maine; Providence, Rhode Island; and Hartford, Connecticut. Upon completion of such review, it was determined that the future expected cash flows of these markets were insufficient to recover the carrying value of the long-lived assets in these markets. As a result, we recorded a non-cash asset impairment charge of $20.9 million in our U.S. operating segment in the third quarter of 2010. Additionally, during the fourth quarter of 2010, we closed 34 restaurants and 18 self-serve kiosks in the Hartford and Providence markets and two restaurants in the Portland market. The closure of these restaurants resulted in closure costs of $7.4 million, net of a reversal of $2.5 million in asset impairment charges reflecting changes in estimates from the third quarter of 2010, which will primarily be in cash when ultimately settled. Combined, the asset impairment and related closure costs totaled $28.3 million. These markets represent a relatively small portion of our overall system in the U.S., but historically had a disproportionately negative impact on earnings, average unit volumes and same-store sales growth in the U.S. segment. We believe that these closures will allow us to focus on and reinvest our savings realized from the closed restaurants into core growth markets in the U.S. Northeast and Midwest by increasing our advertising and marketing scale. We expect this decision to contribute directly to operating income improvement in the U.S. segment in 2011.

In 2011, our development strategy will focus on working to establish a greater density of restaurants in our most developed U.S. markets to accelerate the time it takes to create critical mass for convenience and advertising scale in those markets, while continuing to develop other emerging markets for long-term growth. We will also continue to test a new concept restaurant in certain U.S. markets, adopting elements of those concepts to significantly differentiate our brand and customer offerings as a café and bake shop destination. It is also our plan to support our key markets through additional marketing and advertising investments in our growth and core markets to build increased awareness and to support the development focus in these targeted markets.

As a result of a broader international restaurant development strategy, we have entered into a master license agreement with a licensee for the development of Tim Hortons restaurants in the Gulf Cooperation Council pursuant to which approximately five restaurants will be developed in 2011 and up to an aggregate of 120 multi-format restaurants may be developed over a five-year period pursuant to the agreement. See “Franchise and Other Arrangements—Master License Agreements” and “International Operations” below.

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

 

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our restaurants the ability to manage a variety of the day-to-day operations and management functions. The Company has also allocated $30 million in connection with the sale of its 50% joint venture interest in Maidstone Bakeries with the intent of supporting our key relationship with restaurant owners to help to partially mitigate anticipated rising operating costs.

Restaurant owner financing. Despite the challenging economic climate and credit conditions, our restaurant owners continue to have access to lending programs with third-party lenders, although processing may take longer and costs may be higher, consistent with prevailing market conditions. Currently, a significant portion of our notes are past-due under our franchise incentive program. In many cases, we have also chosen to hold the note for longer periods of time than we have historically done to ensure the restaurant has achieved certain profitability targets. In the event a restaurant owner cannot repay the note, we may take back ownership of the restaurant and equipment, which effectively collateralizes the note and, therefore, minimizes our risk. Initially, we are also entering into operator agreements more frequently in the U.S. than full franchise agreements, and once the restaurant is established and reaches certain profitability measures, we may convert it to a full franchise agreement. See “Franchise and Other Arrangements” below for additional information regarding the franchise incentive program.

Distribution. The Company is a distributor to Tim Hortons restaurants. We have five distribution centres located in Langley, British Columbia; Calgary, Alberta; Kingston, Ontario; Guelph, Ontario; and Debert, Nova Scotia. The Guelph facility is unique in our distribution system in that it distributes frozen and refrigerated products in addition to dry goods and shelf-stable products, known as one-stop delivery. The Guelph facility serves approximately 85% of our Ontario restaurants, which represents approximately 44% of restaurants in Canada. We are in the process of constructing a replacement distribution centre in Kingston, Ontario which also will have capability and capacity for frozen and refrigerated products in addition to dry goods to our restaurant owners. Total planned capital expenditures on this facility are currently estimated to be approximately $45.0 million, with approximately $10.3 million incurred in 2010. The facility is expected to be fully operational during the second half of 2011 and serve more than 650 restaurants in eastern Ontario, and Quebec, responding to continued projected growth in that market. As with other vertical integration initiatives, we expect this new facility will deliver important system benefits, including improved efficiency and cost-effective service for our restaurant owners, as well as providing a reasonable return for the Company. Under the franchise arrangements with our Canadian restaurant owners, each restaurant owner is required to purchase substantially all products, such as coffee, sugar, and restaurant supplies, from us. Canadian and U.S. restaurant owners are also required to purchase par-baked Maidstone Bakeries products from either us or an outside distributor, depending upon the restaurant location. We own or lease a significant number of trucks and trailers that deliver to most of our Canadian restaurants on a regular basis. We use third-party distributors to deliver all products to the U.S. restaurants and to deliver to certain limited geographic areas of Canada.

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

We also offer home-brew coffee through various lines of distribution in Canada and the U.S., including certain grocery stores. In late 2008 through 2009, we expanded our distribution in the grocery channel in Canada. Home-brew coffee, other hot beverages and various accessories are also offered and distributed through TimShopTM. See “E-commerce Platform” below.

Menu items and new product innovation. Each Tim Hortons restaurant offers a relatively standard menu that spans a broad range of categories designed to appeal to customers throughout the day. While the largest portion of systemwide sales is generated in the morning, we generate sales throughout the day with no two-hour period

 

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accounting for more than 20% of our average daily sales. A substantial majority of Tim Hortons restaurants are open 24 hours. Our average cheque size in both Canada and the U.S. is in the range of approximately $2.75 to $3.50 (includes both standard and non-standard locations).

The Tim Hortons menu consists of products such as our premium blend coffee, flavoured hot and iced cappuccinos, specialty and steeped teas, cold beverages, flavour shots in hot and cold beverages, home-style soups, chili, freshly prepared sandwiches, wraps, yogurt and berries, oatmeal and freshly baked goods, including donuts, Timbits, bagels, muffins, cookies, croissants, Danishes, pastries and more. We also offer a variety of breakfast sandwiches in both Canada and the U.S., including the sausage/bacon and egg on a biscuit, bagel or an English muffin, as well as a variety of breakfast wraps. New product offerings have historically contributed significantly to same-store sales growth. In 2010, we continued to reinforce our commitment to providing customers with value by focusing advertising and promotions on product-specific items and combos. In addition to food items, Tim Hortons restaurants sell a variety of promotional products on a seasonal basis and also sell home coffee brewers, home-brew coffee, boxed teas, and other products throughout the year. We will also tailor our menu offerings to meet the needs of our international customers in connection with our recently announced international expansion into the Gulf Cooperation Council market.

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

Manufacturing. We have two wholly owned coffee roasting facilities. Our Maidstone Coffee facility, located in Rochester, New York and, therefore, part of our U.S. segment for financial reporting purposes, roasts coffee for approximately 44% of our total coffee requirements. We acquired this plant in 2001 as part of our U.S. expansion efforts. In 2009, we constructed a new coffee roasting facility in Hamilton, Ontario. Together, our coffee roasting plants will have the capacity to produce at least 75% of our total coffee requirements. We blend our coffee prior to providing it to our third-party roasters as we believe this practice protects the proprietary nature of our coffee. We also own a fondant and fills manufacturing facility that was acquired in 2003 and produces fondants, fills, and ready-to-use glaze, which is used in connection with a number of the products produced in the Always Fresh baking system.

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

 

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In April 2010, we received notice from Aryzta invoking the buy/sell provisions of the Maidstone Bakeries joint venture. Pursuant to such buy/sell provisions, Aryzta gave us notice offering to purchase all but not less than all of our interest in Maidstone Bakeries for an aggregate purchase price of $475 million or to sell to us all but not less than all of Aryzta’s interest for an aggregate purchase price of $475 million. We accepted Aryzta’s offer to purchase our interest in Maidstone Bakeries in August, 2010. The all-cash transaction closed on October 29, 2010 for gross proceeds of $475 million. See “Source and Availability of Raw Materials” below and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Executive Overview.”

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

As of January 2, 2011, there were 102 combination restaurants in the TIMWEN Partnership, all of which were in Canada, and 98 of which were franchised. We also have a small number of combination restaurants that are not held by the TIMWEN Partnership. At January 2, 2011, there were 21 such restaurants in Canada, all of which were franchised, and 30 combination restaurants in the U.S., 29 of which were franchised. For the U.S. combination restaurants, we generally own or lease the land, and typically own the building and lease or sublease, as applicable, a portion of the location to the Tim Hortons restaurant owner (for the Tim Hortons restaurant) and to Wendy’s (for the Wendy’s restaurant). We do not intend to actively open combination restaurants with Wendy’s in future years, nor has there been significant development of these restaurants in recent years.

Credit, Debit and Cash Card Arrangements. In 2004, electronic payment systems for credit cards were implemented in the U.S. restaurants. We introduced electronic payment systems in Canada to allow for payment by credit card in 2007. In late 2010, electronic payment systems for debit cards were available at most of our restaurants in Canada. By the end of December 2010, electronic payment capabilities (including our Tim Card®, see below) were in place at approximately 2,840 locations in Canada and 450 locations in the U.S. We also have a Tim Card quick-pay cash card program. The Tim Card is a reloadable cash card that can be used by customers for purchases at system restaurants. Customers can reload the Tim Card online at www.timhortons.com. Our electronic payment systems provide customers with more payment options. As of January 2, 2011, “Restricted cash and cash equivalents” and “Restricted investments,” which represent outstanding customer deposits on our Tim Card, totaled $105.1 million ($80.8 million as of January 3, 2010).

E-commerce Platform. TimShop, an e-commerce platform, serves Canadian and U.S. residents. Canadian customers may order a range of items online such as gift baskets, coffee brewers, travel mugs, and our full canned beverage line-up of coffee, teas, cappuccinos and hot chocolate, at shop.timhortons.com. Beginning in December 2010, U.S. customers may also order products online, including ground coffee, hot chocolate, cappuccinos, boxed tea, various travel mugs and insulated coffee carriers, at shopus.timhortons.com.

 

 

Source and Availability of Raw Materials

Our food products are sourced from a combination of third-party suppliers and our own manufacturing facilities. We and our restaurant owners have not experienced any material shortages of food, equipment, fixtures, or other products that are necessary to restaurant operations. We currently do not anticipate any

 

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shortages of products. Alternative suppliers are available for most of our products, although we currently source some of our beverage and food offerings from a single supplier. As described below, in the event of an interruption in supply from any of these sources, our restaurants could experience shortages of certain products. While customers might purchase other products when a desired menu item is unavailable, this might not entirely offset the loss of revenue from the unavailable products.

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

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

Under certain circumstances as a result of our exit from the joint venture, we may be required to purchase products currently sourced from Maidstone Bakeries at a higher cost, build our own facility to manufacture these products, or find alternative products and/or production methods, any of which would cause us to incur significant start-up and other costs. Also, if Maidstone Bakeries’ operations were negatively impacted by an unexpected event, our restaurants could experience shortages of donuts, Timbits, European pastries, and other bread products sourced from Maidstone Bakeries. We expect that any such shortage for most products would be for a limited period of time, until such products could be sourced from alternate suppliers, except for certain par-baked donuts and Timbits, for which we have not identified alternate suppliers. Any product shortages, however, even of a limited duration, could negatively affect our sales as well as injure our relationships with restaurant owners and our customers’ perception of Tim Hortons and our brand.

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

World markets for some of the commodities that we use in our business (such as coffee, wheat, edible oils and sugar) have experienced high volatility, including a number of commodities which experienced elevated spot market prices relative to historic prices. We currently have purchase contracts in place covering key commodities such as coffee, wheat, sugar, and cooking oils that generally extend to the fourth quarter of 2011, albeit at prices generally higher than those secured for 2010. The current strength of the Canadian dollar may help to mitigate

 

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some, but not all, of these price increases as certain of these commodities are sourced in U.S. dollars. Also, we may be subject to higher commodity prices depending upon prevailing market conditions at the time we make purchases beyond our current commitments.

Our business will continue to be subject to changes related to the underlying costs of key commodities. These cost changes can impact revenues, costs and margins, and can create volatility quarter-over-quarter and year-over-year. Increases and decreases in commodity costs are largely passed through to restaurant owners, resulting in higher or lower revenues and higher or lower costs of sales from our business. These changes may impact margins as many of these products are typically priced based on a fixed-dollar mark-up. Although we have implemented purchasing practices that mitigate our exposure to volatility to a certain degree, as mentioned above, if costs increased to a greater degree for 2011 purchases, we and our restaurant owners have some ability to increase product pricing to offset a rise in commodity prices, but these price increases could negatively affect sales.

In addition, we purchase certain products, such as coffee, in U.S. dollars. As the Canadian dollar strengthens against the U.S. dollar, these products become less expensive for us and, therefore, our Canadian restaurant owners. For our U.S. restaurant owners, as the U.S. dollar weakens against the Canadian dollar, certain other products become more expensive for them. As a result, although world commodity prices have increased, in a rising Canadian dollar environment, the positive impact of foreign exchange has partially offset the overall effect to us and our Canadian restaurant owners of such price increases. See Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Foreign Exchange Risk and Commodity Risk.

 

 

Franchise and Other Arrangements

Restaurant owners. Our objective is to have restaurant owners own substantially all Tim Hortons restaurants and to maintain a small number of Company-operated restaurants for restaurant owner training. As of January 2, 2011, restaurant owners owned or operated 99.5% of our Canadian restaurants and 99.3% of our U.S. restaurants.

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

Generally, we retain the right to reacquire a restaurant owner’s interest in a restaurant. To keep system restaurants up-to-date, both aesthetically and operationally, our license agreements require a full-scale renovation of each system restaurant by the restaurant owner, including our non-standard restaurants, approximately every ten years. We typically contribute up to 50% of the funding required for certain front-of-store construction costs incurred in connection with renovations on property that we own or lease.

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

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

 

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Other Arrangements. For most restaurant owners new to the system, we will enter into arrangements, typically called operator agreements, in which the operator acquires the right to operate a Tim Hortons restaurant, but we continue to be the owner of the equipment, signage and trade fixtures. These are not typical franchise relationships. Such arrangements usually require the operator to pay approximately 20% of the restaurant’s weekly gross sales, as described in the operator agreement, to the Company. Additionally, the operator will be responsible for paying all trade debts, wages and salary expenses, maintenance and repair costs, taxes, and any other expenses incurred in connection with the operation of the restaurant. These operators also make the required contributions to our advertising funds, described below. In any such arrangement, the Company and the operator each have the option of terminating the agreement upon 30 days notice. Although we do not consider our operators as typical restaurant owners, for purposes of this Form 10-K, references to restaurant owners include these operators, and references to license agreements include these operator agreements, unless otherwise indicated. Under Financial Accounting Standards Board Accounting Standards Codification™ 810 – Consolidation (formerly FASB Interpretation 46R – Consolidation of Variable Interest Entities – an Interpretation of ARB 51 (revised December 2003)), we are required to consolidate the financial results of certain of these operators. Additional detail regarding these arrangements for operators that are consolidated, as well as additional detail regarding the consolidation, is set forth in Notes 1 and 20 to the Consolidated Financial Statements.

We have developed a franchise incentive program for U.S. restaurant owners that provides financing for both the initial franchise fee and the purchase of certain restaurant equipment, furniture, trade fixtures, and interior signs. Payment for the purchase of those assets is deferred for a period of 104 weeks from the date of opening, and the restaurant owner has the option to pay the initial franchise fee, including interest thereon, over this period as well. Payment for the equipment package is due and owing at the end of 104 weeks. The only benefit received under the franchise incentive program is deferred payment for 104 weeks for the franchise fee, which is otherwise paid weekly, and the equipment, which is to be paid at the end of the term. Currently, the royalty rate and rent rate under this program are consistent with the standard rates referred to above for U.S. restaurants, although some restaurant owners are still on the prior program, under which the royalty and rental rates were reduced. In addition, at the conclusion of the franchise incentive program, if our restaurant owners are unable to secure financing for the equipment package, we may extend the necessary financing to these restaurant owners. See Notes 1 and 6 to the Consolidated Financial Statements for additional details regarding the franchise incentive program and related notes receivable.

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

Master License Agreements. In the fourth quarter of 2009, we entered into two separate master licensing arrangements with Kahala Franchise Corp., the franchisor of the Cold Stone Creamery brand. The nature and purpose of the arrangements are to expand the parties’ co-branding initiatives. We have exclusive development rights in Canada, and certain rights to use licenses within the U.S., in both cases to operate ice cream and frozen confections retail outlets. In 2011, we entered into a master license agreement with Apparel Group to develop Tim Hortons restaurants in the Gulf Cooperation Council States of United Arab Emirates, Qatar, Bahrain, Kuwait and Oman. See “Trademarks and Service Marks” and “International Operations” below.

 

 

 

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Advertising and Promotions

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

National Marketing Program. Restaurant owners fund substantially all of our national marketing programs by making contributions to our Canadian or U.S. advertising funds, which were established to collect and administer contributions for advertising efforts. In fiscal 2010, restaurant owners and Company-operated restaurants in Canada contributed approximately $179 million (approximately 3.5% of their sales) to the Canadian advertising fund. Although the franchise or license agreement requires contributions of up to 4.0% of sales, we have voluntarily reduced the current contribution to 3.5%, but retained the right to increase the contribution at any time. Restaurant owners and Company-operated restaurants in the U.S. contribute 4.0% of their sales to the U.S. advertising fund. We have made, and from time to time may make at our discretion, additional investments in advertising for specific programs in the U.S. to support the growth of our brand in our developing markets. We have national advisory boards of elected restaurant owners. The mandate for these boards includes responsibility for matters related to the Canadian and U.S. advertising funds, respectively, including promotions, operations, and research and development.

In 2011, one key component of our strategies to increase same-store sales includes leveraging our marketing strengths and advantages. In Canada, we will leverage our scale as one of the country’s largest advertisers to reinforce our attractive price to value position and to reinforce our brand equity, and continue to focus on our hospitality initiatives. In the United States, we plan to significantly increase our marketing and advertising spending in all markets over historical contribution levels and, in particular, in our core, more developed growth markets, to increase awareness of our brand. In addition, we will seek other marketing means, such as community involvement, sponsorships, and other forms of communication, to supplement traditional advertising to reinforce our brand position with customers and to broaden our brand awareness as a cafe and bake shop destination.

Regional Marketing Programs. Part of the national marketing program contribution is allocated to regional marketing groups (approximately 323 in Canada and 33 in the U.S.). The regional marketing groups sponsor and support locally targeted marketing programs. We also support these regional marketing groups with market strategy and regional plans and programs.

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

See Note 20 to the Consolidated Financial Statements for further information regarding our advertising funds.

 

 

Competition

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

 

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

In Canada, we have the leading market position in this segment, based on systemwide sales and number of restaurants, with a strong presence in every province. According to industry market studies, based on transactions, our system restaurants represented 41% of the Canadian quick service restaurant sector for the 12 months ended August 2010 and 78% of the brewed coffee sector of the Canadian quick service restaurant sector for the same period, in each case based on number of customers served. We believe our presence in key markets and our ability to leverage our scale in advertising support our drive to maintain and extend our market leadership position in Canada over 2011.

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

Competition in both Canada and the U.S. continues to intensify as new players enter the coffee market, and quick service restaurants have increasingly focused efforts on specialty coffee and other coffee-based beverages and baked goods. Also, our competitors in the coffee and baked goods sector are continuing to expand their food offerings, particularly during breakfast, which is a key daypart for us. Commencing in 2009, a number of our competitors also commenced and/or intensified discounting (heightened by the continuing economic challenges in North America) and “combo” or value-pricing practices, as well as free product promotions. This cross-over of brands and menu offerings, and general increased competition on price and other factors, continued through 2010. In 2010, we continued to offer targeted value-priced food and beverage programs, in addition to the launch of new products at a variety of everyday value price points, with the intent to strengthen and build on our price/value position and to enhance this message with our consumers in a tangible way. In the U.S., we also introduced the use of coupons as a vehicle to attract new customers and introduce them to our brand and new product offerings. While we do not intend to stray from our core everyday positioning of quality food at reasonable prices, we are working with our restaurant owners to communicate and interact with customers in a manner that responds to their current situation and the economic environment. We believe that continued business refinements will help, over time, position our U.S. business to defend aggressive competitive discounting activity, while also creating sales momentum.

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

 

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greater levels of relief to U.S. restaurant owners as a result. Such decisions are based on a long-term view of strengthening and expanding our business in the U.S. See “Operations—Restaurant Development” above.

 

 

Trademarks and Service Marks

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

 

   

Tim Hortons signature;

 

   

Tim Hortons and Always Fresh Oval Background Design;

 

   

Roll Up The Rim To Win;

 

   

Timbits; and

 

   

Tim Card.

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

In 2009, we entered into a master license agreement with Kahala Franchise Corp. giving us the exclusive right to use the Cold Stone Creamery® trademarks in Canada together with the right to sub-franchise said marks on an exclusive basis. In 2009, we also entered into a master license agreement with Kahala Franchise Corp. giving us the right to use the Cold Stone Creamery trademarks in the United States, together with the right to sublicense said marks.

In 2011, the Company entered into a master license agreement with Apparel Group based in Dubai, giving Apparel Group the right to use the Tim Hortons trade marks in Oman, Bahrain, Qatar, Kuwait and United Arab Emirates.

 

 

Sustainability and Responsibility

Sustainability and responsibility at Tim Hortons focuses on initiatives and programs framed around three pillars—Individuals, Communities, and the Planet. We have developed a number of overarching sustainability and responsibility commitments and goals and have reported our performance against these goals in our first sustainability and responsibility report issued in our 2009 annual report. Our report was also developed using the process outlined by the Global Reporting Initiative’s (“GRI”) G3 Guidelines. We intend to publish an annual sustainability and responsibility report in accordance with the GRI Sustainability reporting framework.

Governance and Accountability for Sustainability and Responsibility. Our sustainability and responsibility policy includes a structure and supporting processes for effective sustainability and responsibility governance and accountability. The Tim Hortons Board of Directors governs sustainability and responsibility. The Nominating and Corporate Governance Committee of the Board manages this accountability on behalf of the Board. Oversight activities include review of: policy development; sustainability and responsibility strategies, and supporting implementation and resource plans, including mitigation of risks; and organizational sustainability and responsibility commitments, goals and external reporting. Management accountability for sustainability and responsibility resides with the Tim Hortons Executive Team.

 

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Management of Sustainability Risks and Opportunities. The assessment and management of sustainability related risks and opportunities are embedded as part of our governance framework, and our sustainability and responsibility strategy and its supporting implementation plan. Key aspects of our approach include: the assessment of sustainability and responsibility impacts of major business decisions; the integration of sustainability and responsibility into the Company’s Enterprise Risk Management process and internal performance scorecards; monitoring our relations with our stakeholders, including our sustainability and responsibility Advisory Council of external experts; the assessment of sustainability and responsibility trends; and, consideration of public policy, consumer, corporate, general public trends, issues, and developments that may impact the Company.

 

 

Environmental Matters

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

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

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

Variations in weather, due to climate change, have the potential to impact growing conditions in regions where we source our agricultural commodities, including coffee. On a year-to-year basis, agricultural production can be negatively affected by variations in weather and resulting physical impacts to the environment. The overall supply and demand of agricultural commodities and the price we pay for these commodities on the world market can therefore be impacted. With respect to potential climate-change legislation, the Canadian government has indicated that it will follow the U.S. with respect to implementing any climate-change related regulations. Proposed cap and trade systems and/or new carbon taxation may present risks or opportunities that will likely be unique to every business sector. We are unable to predict the effect on our operations of possible future environmental legislation or regulation in these areas.

Stewardship fee programs require all industry stewards with branded packaging, such as Tim Hortons, to contribute to a fund that subsidizes a portion of the costs of municipal recycling programs. Volumes of designated packaging are enumerated by the industry steward and fees are paid regardless of whether the designated materials are managed in municipal recycling programs. Stewardship programs for packaging currently exist in Ontario, Quebec and Manitoba. The Canadian Council of Ministers of the Environment’s (“CCME”) Canada-Wide Action Plan for Extended Producer Responsibility (“EPR”) has recommended that all Canadian jurisdictions (with the exception of the Territories) develop and implement EPR legislation for packaging (and other designated materials) by 2015. Some provinces (i.e. British Columbia) have begun this process. A change in EPR programs involves a shift towards paying 100% of the fees associated with managing

 

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packaging waste in municipal systems. As the CCME recommendations are only guidelines, there is no certainty regarding future increases in stewardship fees. In 2010, our stewardship fees in the aggregate were not financially material.

 

 

Acquisitions and Dispositions

We have from time-to-time acquired the interests of, and sold Tim Hortons restaurants to, restaurant owners, and we expect to continue to do so from time-to-time in the future, where prudent. We generally retain a right of first refusal in connection with any proposed sale of a restaurant owner’s interest. The Company is in the process of exploring options in connection with the disposition and sale of Company-owned properties as a result of the restaurant closures in the Southern New England area. In October 2010, we sold our 50% joint venture interest in Maidstone Bakeries to our former partner. See “Operations—Manufacturing” above. We intend to evaluate other potential mergers, acquisitions, joint ventures, investments, strategic initiatives, alliances, vertical integration opportunities and divestitures when opportunities arise or our business warrants evaluation of such strategies. See “Business Overview and 2011 Objectives” above and Item 1A. Risk Factors.

 

 

International Operations

Following a comprehensive assessment and due diligence process, we entered into a master license agreement with Apparel Group based in Dubai in February 2011 providing for the development of up to 120 multi-format restaurants over a five-year period in markets in the Gulf Cooperation Council (“GCC”) of United Arab Emirates, Qatar, Bahrain, Kuwait and Oman. Based on the level of success in our initial market entry into the GCC region, our international growth strategy is currently designed to evaluate potential additional regional market entries. In 2011, Apparel Group is committed to developing and operating approximately five restaurants. The master license agreement with Apparel Group is primarily a royalty-based model and also includes an upfront license fee, and our supply chain costs will be covered. The Apparel Group is responsible for capital spending and real estate development to open restaurants, along with operations. As a result, this arrangement minimizes our capital requirements, while still allowing us to pursue identified international growth opportunities. It is our intention to invest an amount between $2 million to $4 million in 2011, net of royalties, license fees and other costs, to support Apparel Group’s investments to launch the business in our GCC market entry.

We have self-serve kiosks in the Republic of Ireland through offerings at gas and other convenience locations, primarily under the Tim Hortons brand but also under another brand owned by Tim Hortons. These kiosks offer our premium coffee, tea, specialty hot beverages and a selection of donuts and muffins. As of January 2, 2011, there were a total of 194 units in the Republic of Ireland, 191 of which were self-serve and three of which were full-serve, licensed as Tim Hortons locations. We also have self-serve kiosks at gas and other convenience locations in the United Kingdom, where we had 81 units as of January 2, 2011. In addition, we have begun to experiment with larger footprints and drive-thrus at certain of these sites. As of January 2, 2011, we have continued our temporary location in Kandahar, Afghanistan, which is a full-serve location. These arrangements are not expected to contribute significantly to financial results in 2011.

See Item 2. Properties of this Annual Report for a listing of our international locations by country. We include the self-serve kiosks and full-serve restaurants as licensed locations under “International Operations,” as described under Item 2 but not in our U.S. or Canadian restaurant counts.

Our financial and other business arrangements for international locations (and for international development in general) are likely to differ from our traditional development models. We believe these international activities (and others we may test or undertake in the future), provide us with opportunities to evaluate a variety of new strategies for the development of our brand, which, if successful, may be adapted to existing markets as well as other new markets.

 

 

 

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Seasonality

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

 

 

Employees

Our principal office locations are in Oakville, Ontario (Canada) and Dublin, Ohio (U.S.). We have ten other regional offices, including our five distribution centres. Our manufacturing facilities are located in Rochester, New York, Hamilton, Ontario and Oakville, Ontario. Our other regional offices (other than our distribution and manufacturing facilities) are located in Lachine, Quebec; Brighton, Michigan; and Williamsville, New York. As at January 2, 2011, we had approximately 1,863 employees in our principal offices, regional offices, distribution centres, and manufacturing facilities. We also have three employees that work on international activities in the Republic of Ireland and the U.K.

As at January 2, 2011, the Company operated directly (without restaurant owners) 16 restaurants in Canada and four restaurants in the U.S. The total number of full-time employees working in these corporate restaurants at January 2, 2011 was approximately 220, with another approximately 239 employees working part-time, bringing the total number of our restaurant employees to approximately 459. None of our employees is covered by a collective bargaining agreement. At franchised locations, employees are hired and managed by the restaurant owners and not the Company.

We believe in creating and fostering a positive employee-relations environment. We do this through active training and development, employee communication, a competitive total reward philosophy, a promotion-from-within philosophy, and other initiatives and programs focused on employee engagement. Our corporate values evidence our commitment to our strong “people” focus and the other critical elements of our culture.

 

 

Government Regulations and Affairs

The successful development and operation of restaurants depend to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use (including the placement of drive-thrus), environmental (including litter and drive-thru emissions), traffic and transportation, land transfer tax, and other regulations. Restaurant operations, including our restaurants and our manufacturing and distribution facilities, are also subject to licensing and regulation by state, provincial, and local departments relating to the environment, health, food preparation, sanitation and safety standards and, for our distribution business, traffic and transportation regulations; federal, provincial, and state labour laws (including applicable minimum wage requirements, overtime, working and safety conditions and citizenship requirements); federal, provincial, and state laws prohibiting discrimination; federal, provincial, state and local tax laws and regulations; and, other laws regulating the design and operation of facilities, such as the Americans with Disabilities Act of 1990 and similar Canadian provincial legislation that can have a significant impact on our restaurant owners and our performance. See also “Environmental Matters” above regarding environmental regulations affecting the Company.

A number of states in the U.S., and the provinces of Ontario, Alberta, Prince Edward Island, and New Brunswick, have enacted or are in the final stages of enacting legislation that affects companies involved in

 

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franchising. The Province of Manitoba is also considering such legislation. Franchising activity in the U.S. is also regulated by the U.S. Federal Trade Commission. Much of the legislation and rules adopted have been aimed at requiring detailed disclosure to a prospective restaurant owner, duties of good faith as between the franchisor and the restaurant owner, and/or periodic registration by the franchisor with applicable regulatory agencies. Additionally, some U.S. states have enacted legislation that governs the termination or non-renewal of a franchise agreement and other aspects of the franchise relationship. The Province of Manitoba and certain U.S. states, as well as the U.S. Congress, have also considered or are considering legislation of this nature. We have complied with regulatory requirements of this type in all applicable jurisdictions. We cannot predict the effect on our operations, particularly on our relationship with restaurant owners, of the future enactment of additional legislation or modifications of existing legislation.

Governments and consumer advocacy groups are encouraging alternative food processing methods that will result in significant reductions in trans fatty acids (“TFA”). During 2006, significant progress was made to reduce trans fat in most of our products to at or below acceptable levels in Canada and the U.S. As required by Canadian and U.S. legislation, we comply with nutritional labeling for foods, including those that contain TFA. Certain local governmental authorities, such as New York City, have banned TFA. We continue to research approaches to allow us to keep our products at acceptable levels of TFA while still maintaining the taste and quality that consumers desire.

The Canadian government continues to work with members of the quick service restaurants sector to reduce sodium intake. The Sodium Working Group, which consists of members from the manufacturing, health advocacy group, health professional organizations, and food service groups, agreed on a three pronged approach that includes: voluntary reduction of sodium levels in processed goods sold in food service establishments; education and awareness of consumers; and, research. As such, we have voluntarily posted the sodium content of our products in our on-line and printed nutrition guides for a number of years as part of our commitment to providing our guests with up to date nutritional information. We are currently working with suppliers to reduce the amount of sodium in our products and reducing sodium content by approximately 19% across our soup offering. Our main objective is to continue to provide our guests with the same great tasting, quality products without sacrificing flavour and freshness.

Legislation has been enacted in the U.S. requiring restaurants to post calorie count information on menu boards. We will monitor and comply with all regulations enacted by the U.S. Food and Drug Administration in connection with such calorie count posting requirements. Certain provinces within Canada are also considering similar laws to post calorie count information on menu boards.

 

 

Availability of Information

We currently qualify as a foreign private issuer in the U.S. for purposes of the Exchange Act. Although as a foreign private issuer we are no longer required to do so, we currently continue to file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K with the Securities and Exchange Commission (“SEC”) instead of filing the reporting forms available to foreign private issuers. We make available, through our internet website for investors (www.timhortons-invest.com), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the SEC and with Canadian securities regulators. The foregoing reference to our website address does not constitute incorporation by reference of the information contained on the website, and such information should not be considered part of this document.

 

 

 

Item 1A. Risk Factors

Certain information contained in this Annual Report on Form 10-K (the “Report”), including information regarding future financial performance and plans, expectations, and objectives of management, constitute

 

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

Many of the factors that could determine our future performance are beyond our ability to control or predict. Investors should carefully consider our risk factors and the other information set forth in this Report and are further cautioned not to place undue reliance on the forward-looking statements contained in this Report, which speak only as of the date of this Report. The events and uncertainties outlined in the risk factors, as well as other events and uncertainties not set forth below, could cause our actual results to differ materially from the expectation(s) included in the forward-looking statement, and if significant, could materially affect the Company’s business, sales revenue, stock price, financial condition, and/or future results, including, but not limited to, causing the Company to (i) close restaurants, (ii) fail to realize our same-store sales, which are critical to achieving our operating income and other financial targets, (iii) fail to meet the expectations of our securities analysts or investors, or otherwise fail to perform as expected, (iv) have insufficient cash to engage in or fund expansion activities, dividends, or share repurchase programs, or (v) increase costs, corporately or at restaurant level, which may result in increased restaurant-level pricing, which, in turn, may result in decreased customer demand for our products resulting in lower sales, revenue, and earnings. We assume no obligation to update or alter any forward-looking statements after they are made, whether as a result of new information, future events, or otherwise, except as required by applicable law.

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

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

Our growth strategy to a large extent depends on our ability to increase the number of Tim Hortons restaurants through internal growth and potentially through strategic initiatives (such as acquisitions, joint ventures, and alternative business models, such as self-serve kiosks and co-branding) and increased emphasis (especially outside Canada) on non-standard restaurant development and other initiatives. However, we may not be able to achieve our growth objectives, new restaurants may not be profitable, and strategic initiatives may not be successful and may expose us to various risks.

 

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

We may also enter markets where our brand is not well known and where we have little or no operating experience, although we will do this to a lesser extent in 2011. New markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets; as a result, new restaurants in those markets may be less successful than restaurants in existing markets. When we enter new regions and markets, we will need to build brand awareness in those markets through advertising and promotional activity, and those activities may not promote our brand as effectively as intended, if at all. For example, our advertising expenditures in the U.S., particularly with respect to television advertising, do not yield the desired leverage across all marketing areas because our regional markets do not overlap to a significant degree, and we have not achieved significant market penetration in all regions.

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

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

The success of any restaurant depends in substantial part on its location. There can be no assurance that current locations will continue to be attractive as demographic patterns change. Neighbourhood or economic conditions where restaurants are located could decline in the future, thus resulting in potentially reduced sales in those locations. If we cannot obtain desirable locations for our restaurants at reasonable prices, our ability to execute our growth strategy will be adversely affected.

We also intend to continue to evaluate potential mergers, acquisitions, joint venture investments, alliances, vertical integration opportunities and divestitures, which are subject to many of the same risks that also affect new restaurant development. In addition, these transactions involve various other financial and tax, managerial

 

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and operational risks, including accurately assessing the value, future growth potential, strengths, weaknesses, contingent and other liabilities and potential profitability of acquisition candidates; the potential loss of key personnel of an acquired business; the Company’s ability to achieve projected economic and operating synergies; difficulties successfully integrating, operating, maintaining and managing newly acquired operations or employees; difficulties maintaining uniform standards, controls, procedures and policies; the possibility the Company could incur impairment charges if an acquired business performs below expectations; unanticipated changes in business and economic conditions affecting acquired business; ramp-up costs, whether anticipated or not; the potential for the unauthorized use of the Company’s trademarks and brand name by third parties; the possibility of a breach of contract or spoliation of the business relationship with a third party; the potential negative effects such transactions may have on the Company’s relationship with restaurant owners and existing business relationships with suppliers; the potential exposure to restaurant owners and others arising from the Company’s reliance on and dissemination of information provided by third parties; and diversion of management’s and restaurant owners’ attention from the demands of the existing business. In addition, there can be no assurance that the Company will be able to complete the desirable transactions, for reasons including restrictive covenants in debt instruments or other agreements with third parties, or a failure to secure financing if there was a tight credit market.

Strategic alliances have been and will continue to be an integral part of our strategic plan to “grow in ways we have not grown before.” There can be no assurance that: significant value will be recognized through such strategic alliances; we will be able to maintain our existing strategic alliances; or, we will be able to enter into new strategic relationships in the future. While we believe we could ultimately take action to terminate any alliances that prove to be unsuccessful, we may not be able to identify problems and take action quickly enough and, as a result, our brand image and reputation may suffer, or we may suffer increased liabilities, costs and other financial burdens. Entry into and the subsequent unwinding of strategic alliances may expose us to additional risks which may adversely affect our brand and business and decrease our revenue and growth prospects.

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

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

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

 

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beyond our control. Consumer demand for our products and our brand value could diminish significantly if any such incidents or other matters erode consumer confidence in us or our products, which would likely result in lower sales and, ultimately, lower earnings and profits.

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

Our financial performance is highly dependent on our Canadian operating segment, which accounted for approximately 83.4% of our consolidated revenues, and all our profit, in 2010. Any substantial or sustained decline in our Canadian business would materially and adversely affect our financial performance.

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

The quick service restaurant segment of the food service industry is intensely competitive. Tim Hortons restaurants compete with international, regional, and local organizations primarily through the quality, variety, and value perception of food products offered. Other key competitive factors include: the number and location of restaurants; quality and speed of service; attractiveness of facilities; effectiveness and magnitude of advertising, marketing, promotional, and operational programs; price; changing demographic patterns and trends; changing consumer preferences and spending patterns, including weaker consumer spending in difficult economic times, or a desire for a more diversified menu; changing health or dietary preferences; and, perceptions and new product development. Our major competitors continue to engage in discounting, free sampling and other promotional activities. In addition, some of our competitors, particularly in the U.S., have substantially greater financial and other resources than we do, including larger marketing budgets and greater leverage from marketing spend, which may provide them with a competitive advantage. Also, Tim Hortons restaurants compete within the food service industry and the quick service restaurant segment not only for customers but also for management and hourly employees, suitable real estate sites, and qualified restaurant owners. If we are unable to maintain our competitive position, we could experience lower demand for products, downward pressure on prices, reduced margins, an inability to take advantage of new business opportunities, the loss of market share, and the inability to attract qualified restaurant owners.

Increases in the cost of commodities could have an adverse impact on our business and financial results.

We are exposed to price volatility in connection with certain key commodities that we purchase in the ordinary course of business such as coffee, wheat, edible oil and sugar, which can impact revenues, costs and margins. Although we monitor our exposure to commodity prices and our forward hedging program (of varied duration, depending upon the type of underlying commodity) partially mitigates the negative impact of any costs increases, price volatility for commodities we purchase has increased due to conditions beyond our control, including recent economic conditions, currency fluctuations, availability of supply, weather conditions and consumer demand. Increases and decreases in commodity costs are largely passed through to restaurant owners, and we and our restaurant owners have some ability to increase product pricing to offset a rise in commodity prices, subject to restaurant owner and customer acceptance, respectively. Notwithstanding the foregoing, we may not be able to, or we may choose not to, as we did in 2009 with respect to certain products, pass along all price increases to our restaurant owners. As a result, commodity cost increases could have a more significant effect on our business and results of operations than if we had passed along all increases to our restaurant owners. Price fluctuations may also impact margins as many of these commodities are typically priced based on a fixed-dollar mark-up. A number of commodities have recently experienced elevated spot market prices relative to historic prices. Although we have secured commitments for most of our key commodities through year-end 2011

 

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in anticipation of continued high prices in 2011, these are at higher prices than our previous commitments. In addition, if further escalation in prices continues, we may be forced to purchase commodities at higher prices at the end of the respective terms of our current commitments. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Commodity Risk.

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

Incidents or reports, whether true or not, of food-borne illness (such as e-coli, listeria, bovine spongiform encephalopathy, hepatitis A or salmonella); injuries caused by or claims of food tampering, employee hygiene and cleanliness failures or impropriety at Tim Hortons or other quick service restaurants unrelated to Tim Hortons; and, the health aspects of consuming our products, could result in negative publicity, damage our brand value, and potentially lead to product liability or other claims. Any decrease in customer traffic or temporary closure of any of our restaurants as a result of such incidents or negative publicity may have a material adverse effect on our business and results of operations.

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

Our distribution operations and supply chain may be impacted by various factors, some of which are beyond our control, that could injure our brand and negatively affect our results of operations and our ability to generate expected earnings and/or increase costs, including:

 

   

transportation and/or shipping costs, including but not limited to energy and fuel costs (and/or fuel shortages) for our fleet of trucks and trailers or increased costs from third-party transportation companies that make deliveries to system restaurants from our five distribution centres;

 

   

inclement weather, which could affect the cost and timely delivery of products and supplies to us and to our restaurant owners;

 

   

increased food and other supply costs;

 

   

the risks of having a single source of supply for certain of our food products, including certain par-baked goods, iced cappuccinos, and other popular food products;

 

   

shortages or interruptions in the availability or supply of perishable food products and/or their ingredients, which could affect the availability, quality, and cost of such food products and ingredients, as well as other factors that could affect the quality of products we supply;

 

   

potential negative impacts on our relationship with our restaurant owners associated with the increase of required purchases or prices of products purchased from our distribution business; and

 

   

political, physical, environmental, labour, or technological disruptions in our own or our suppliers’ manufacturing and/or warehouse plants, facilities, or equipment.

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

In the U.S., because we do not provide distribution services to our U.S. restaurant owners, our U.S. restaurant owners may not receive the same level of service and reliability as we are able to provide through our distribution business for our Canadian restaurant owners.

 

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

A substantial portion of our earnings come from royalties and other amounts paid by restaurant owners, who operated 99.5% of the Tim Hortons restaurants as of January 2, 2011. Our restaurant owners are independent contractors and, as a result, the quality of their operations may be diminished by factors beyond our control. Some restaurant owners may not successfully operate restaurants in a manner consistent with our standards and requirements and may not train qualified managers and other restaurant personnel. Any operational shortcoming of a franchise restaurant is likely to be attributed by consumers to our entire system, thus damaging our brand reputation and potentially affecting revenues and profitability. Our principal competitors that have a significantly higher percentage of company-operated restaurants than we do may have greater control over their respective restaurant systems and have greater flexibility to implement operational initiatives and business strategies. Our success will also continue to depend on our ability to attract and retain qualified restaurant owners.

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

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

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

From time to time, we are subject to claims incidental to our business, such as illness or injury relating to food quality or food handling. In addition, class action lawsuits have been filed in the past, and may continue to be filed, against quick service restaurants alleging, among other things, that quick service restaurants have failed to disclose the health risks associated with their products or that certain food products contribute to obesity. These types of claims could harm our brand reputation, making it more difficult to attract and retain qualified restaurant owners and grow the business. We may also be subject to claims from employees, customers, and others relating to health and safety risks and conditions of our restaurants associated with design, construction, site location and development, indoor or airborne contaminants and/or certain equipment utilized in operations. In addition, from time to time, we face claims from: our employees relating to employment or labour matters, including potentially class action suits, regarding wages, discrimination, unfair or unequal treatment, harassment, wrongful termination, or overtime compensation; our restaurant owners and/or operators regarding their profitability (which is a present claim against us), wrongful termination of their franchise or operating (license) agreement, as the case may be, or other restaurant owner relationship matters; taxation authorities regarding certain tax disputes; or, other stakeholders or business partners. We are also exposed to a wide variety of falsified claims due to our size and brand recognition. All of these types of matters have the potential to unduly distract

 

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management attention and increase costs, including costs associated with defending such claims. Any negative publicity resulting from these claims may adversely affect our reputation. Our current exposure with respect to legal matters pending against us could change if determinations by judges and other finders of fact are not in accordance with management’s evaluation of the claims. Should management’s evaluation prove incorrect, our exposure could exceed expectations and have a material adverse effect on our financial condition and results of operations. If successful, any such claims could adversely affect our business, financial condition, and financial results. With respect to restaurant owner litigation, see Item 3. Legal Proceedings of this Annual Report.

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

We and our restaurant owners are subject to various international, federal, state, provincial and local laws, treaties and regulations affecting our and their businesses. These laws and regulations include those regarding or relating to: zoning, land use (including the development and/or operation of drive-thru windows), and traffic; health, food, sanitation and safety; privacy; immigration and labour laws, including significant increases in minimum wage requirements that were implemented in certain provinces in Canada in 2010 and others that are planned for certain other provinces in 2011, that will substantially increase our and our restaurant owners’ labour costs in those provinces; laws preventing discrimination and harassment in the workplace and providing certain civil rights to individuals with disabilities, laws affecting the design of facilities (such as the Americans with Disabilities Act of 1990 and similar Canadian legislation); tax laws affecting our restaurant owners’ business; environmental matters; product safety; nutritional disclosure and regulations regarding the nutritional content, including menu labeling; advertising and marketing; record keeping and document retention procedures; and new and/or additional franchise legislation. We are also subject to applicable accounting and reporting requirements and regulations, including those imposed by Canadian and U.S. securities regulatory authorities, the NYSE and the TSX. The complexity of the regulatory environment in which we operate and the related cost of compliance are both increasing due to additional legal and regulatory requirements.

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

 

   

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

 

   

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

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

As “sustainability” issues become more prevalent and accepted, there may be increased governmental, shareholder, and other stakeholder awareness and sentiment for more regulation as well as voluntarily adopted programs relating to reduction and mitigation of environmental impacts. There is a possibility that, when and if enacted, the final form of such legislation or any voluntary actions taken by us in this regard would impose

 

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stricter requirements or alternative modes of conducting business, which could lead to the need for significant capital expenditures in order to meet those requirements and/or higher ongoing compliance and operating costs. Our participation in or implementation of, or our decision not to participate in or implement, certain types of programs also may have an adverse impact on our brand due to potentially negative publicity or negative perception of stakeholders regarding our business practices and lack of willingness to demonstrate environmental leadership. Such injury to our brand and reputation may, in turn, also reduce revenues and profits. See also our disclosure under “Sustainability and Responsibility” in Item 1 of this Report regarding our planned activities with respect to sustainability and corporate responsibility initiatives.

We are reviewing a comprehensive U.S. health care reform law regarding government-mandated health benefits that was enacted in 2010 as well as the new U.S. food safety modernization law that was enacted in January 2011. We cannot currently determine with certainty the financial and operational impact that the new laws will have on us, our restaurant owners and/or our third-party suppliers and distributors.

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

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

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

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

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

 

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Based on the provisions of the Income Tax Act (Canada), the U.S. Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder at the time of completing certain of our public or internal company corporate reorganizations (the “Reorganizations”), we anticipated that the Reorganizations would not result in any ongoing material Canadian and/or U.S. federal income tax liabilities to us. However, there can be no assurance that Canada Revenue Agency (the “CRA”) and/or the U.S. Internal Revenue Service (the “IRS”) will agree with our interpretation of the tax aspects of the Reorganizations or any related matters associated therewith. The CRA or the IRS may disagree with our view and take the position that material Canadian or U.S. federal income tax liabilities, interest and penalties, respectively, are payable as a result of the Reorganizations. If we are unsuccessful in disputing the CRA’s or the IRS’ assertions, we may not be in a position to take advantage of the effective tax rates and the level of benefits that we anticipated to achieve as a result of the Reorganizations and the implications could be materially adverse to us. Even if we are successful in maintaining our positions, we may incur significant expense in contesting positions asserted or claims made by tax authorities. Similarly, other costs or difficulties related to the Reorganizations and related transactions, which could be greater than expected, could also affect our projected results, future operations, and financial condition.

We are party to a tax sharing agreement with Wendy’s, which sets forth the principles and responsibilities of Wendy’s and the Company regarding the allocation of taxes, audits and other tax matters relating to periods when we were part of the same U.S. federal consolidated or state and local combined tax filing group. Either we or Wendy’s may be required to reimburse the other party for the use of tax attributes while we filed U.S. consolidated or state and local combined returns, as a result of audits or similar proceedings giving rise to “adjustments” to previously filed returns, in accordance with the terms of the agreement. As several years remain open to review and adjustment by taxation authorities, payments may be made by one party to the other for the use of the other party’s tax attributes.

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

We have entered into a master license agreement with a licensee for the development of Tim Hortons restaurants in the Gulf Cooperation Council. The licensee is committed to open and operate approximately five restaurant locations in 2011. The implementation of our international strategic plan may require considerable or dedicated management time as well as start-up expenses for market development before any significant revenues and earnings are generated. Expansion into new international markets carries risks similar to those risks described above relative to expansion into new markets in the U.S.; however, some or all of these factors, including food safety, brand protection and intellectual property protection, may be more pronounced in markets outside Canada and the U.S. due to cultural, political, legal, economic, regulatory and other conditions and differences. As such, our international business operations will be subject to additional legal, accounting, tax and regulatory risks associated with doing business internationally, including: tariffs, quotas, other trade protection measures; import or export regulations and licensing requirements; foreign exchange controls; restrictions on our ability to own or operate or repatriate profits from our subsidiaries, make investments or acquire new businesses in foreign jurisdictions; difficulties in enforcement of contractual obligations governed by non-Canadian or U.S. law due to differing interpretation of rights and obligations in connection with international franchise or licensing agreements and collection of royalties from international restaurant owners; compliance with multiple and potentially conflicting laws; new and potentially untested laws and judicial systems; and reduced or diminished protection of intellectual property. For example, we currently plan to export our proprietary products to our restaurant owners in our new international markets. Numerous government regulations apply to both the export of food products from Canada and the U.S. as well as the import of food products into other countries. If one or more of the ingredients in our products are banned, alternative ingredients would need to be identified and sourced. Although we intend to be proactive in addressing any product ingredient issues, such requirements may delay our ability to open restaurants in other countries in accordance with our planned or desired schedule.

 

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Any operational shortcoming of a licensee is likely to be attributed by consumers to our entire system, thus damaging our brand reputation and potentially affecting revenues and profitability. Additionally, we may also have difficulty finding suppliers and distributors to provide us with adequate and stable supplies of ingredients meeting our standards in a cost-effective manner. Although we believe we have developed the support structure required for international growth, there can be no assurance that our international operations will achieve or maintain profitability or meet planned growth rates. There can be no assurance that appropriate restaurant owners and/or other licensees will be available in our new international markets. We currently expect that our international restaurant owners may be responsible for the development of a larger number of restaurants than typical for our Canadian or U.S. restaurant owners. As a result, our international operations may be more closely tied to the success of a smaller number of our restaurant owners than typical for our Canadian and U.S. operations.

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

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

Catastrophic events may disrupt our business.

Unforeseen events, including war, terrorism and other international, regional or local instability or conflicts (including labour issues), embargos, public health issues (including tainted food, food-borne illnesses, food tampering, or water supply or widespread/pandemic illness such as the avian or H1N1 flu), and natural disasters such as earthquakes, hurricanes, or other adverse weather and climate conditions, whether occurring in Canada, the U.S. or abroad, could disrupt our operations; disrupt the operations of our restaurant owners, suppliers, or customers; or, result in political or economic instability. These events could reduce traffic in our restaurants and demand for our products; make it difficult or impossible to adequately staff our restaurants, receive products from suppliers, deliver products to our restaurant owners on a timely basis, or perform functions at the corporate level; and, otherwise impede our ability to continue our business operations in a continuous manner consistent with the level and extent of our business activities prior to the occurrence of the unexpected event or events.

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

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

 

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In connection with our integrated financial system and our electronic payment solutions, we rely extensively on third-party vendors to retain data, process transactions, and provide certain services. While we make every reasonable effort to ensure that these vendors have appropriate processes and controls in place to make certain that there is continuity of services and protection of data, we have no direct control over the same; consequently, the possibility of failure in such third-party vendors’ systems and processes exists. In such an event, we could experience business interruptions or privacy and/or security breaches surrounding our data. For additional information regarding risks surrounding privacy and/or security breaches, refer to our risk factor “Privacy protection is increasingly demanding, and the introduction of electronic payment exposes us to increased risk of privacy and/or security breaches as well as other risks.”

We continue to enhance our integrated enterprise resource planning system. The introduction of new modules for inventory replenishment, sustainability, and business reporting and analysis will be implemented over the next two years. These systems will integrate and exchange data with the financial modules already in place. There may be risks associated with adjusting to and supporting the new modules which may impact our relations with our restaurant owners, vendors and suppliers and the conduct of our business generally.

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

Our Canadian restaurants are vulnerable to increases in the value of the U.S. dollar, as certain commodities, such as coffee, are priced in U.S. dollars in international markets. We typically do not enter into purchase agreements for coffee or other commodities in excess of one year; however, we do engage in purchasing activity that mitigates, to a certain degree, our exposure to fluctuations in commodity costs, and we do hedge certain exposures to foreign exchange risk.

Conversely, our U.S. restaurants are impacted when the value of the U.S. dollar falls relative to the Canadian dollar. Although we have been shifting sourcing for U.S. restaurants for some of our products and supplies to the U.S., our U.S. restaurants are required to purchase many goods from Canadian suppliers through our third-party distributors. The costs of these goods in U.S. dollars rise when the Canadian dollar increases in value relative to the U.S. dollar. Increases in these costs would affect the profitability of our U.S. restaurants and potentially make it harder for us to expand in the U.S. In addition, relief and support costs for U.S. restaurant owners would likely increase, adversely affecting our earnings.

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

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

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

 

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Privacy protection is increasingly demanding, and the introduction of electronic payment exposes us to increased risk of privacy and/or security breaches as well as other risks.

The protection of customer, employee, vendor, restaurant owner and other business data is critical to us. Federal, state, provincial and international laws and regulations govern the collection, retention, sharing and security of data that we receive from and about our employees, customers, vendors, suppliers and restaurant owners. The regulatory environment surrounding information security and privacy has been increasingly demanding in recent years, and may see the imposition of new and additional requirements. Compliance with these requirements may result in cost increases due to necessary systems changes and the development of new processes to meet these requirements by us and our restaurant owners. In addition, customers and restaurant owners have a high expectation that we will adequately protect their personal information. If we or our service provider fail to comply with these laws and regulations or experience a significant breach of customer, employee, vendor, restaurant owner or other company data, our reputation could be damaged and result in an increase in service charges, suspension of service, lost sales, fines, or lawsuits.

With our use of credit payment systems, our reloadable cash card, and use of debit card systems across Canada, we are more susceptible to a risk, particularly with respect to an external security breach of customer information that we or third parties under arrangements with us control (including those with whom we have strategic alliances). We could become subject to various claims, including those arising out of thefts and fraudulent transactions in the event of a security breach, theft, leakage, accidental release or other illegal activity with respect to employee; customer; vendor; restaurant owner; third-party, including those with whom we have strategic alliances; or, other company data. This may also result in the suspension of electronic payment processing services. This could harm our reputation as well as divert management attention and expose us to potentially unreserved claims and litigation. Any loss in connection with these types of claims could be substantial. In addition, if our electronic payment systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. In addition, we are reliant on these systems, not only to protect the security of the information stored, but also to appropriately track and record data. Any failures or inadequacies in these systems could expose us to significant unreserved losses, which could result in an earnings and stock price decline. Our brand reputation would likely be damaged as well.

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

The success of our business depends on our continued ability to use our existing trademarks, service marks, and other components of our brand in order to increase brand awareness and further develop branded products in the U.S. and Canadian markets, as well as in international markets in which we may wish to expand. We may not be able to adequately protect our trademarks, and use of these trademarks may result in liability for trademark infringement, trademark dilution, or unfair competition. In addition, in certain jurisdictions outside of the U.S. and Canada, there are substantial uncertainties regarding the interpretation and application of laws and regulations relating to, and the enforceability of, intellectual property and related contract rights. Our business could be adversely affected if we are unable to adequately monitor the use of our intellectual property or enforce our intellectual property and related contract rights in courts in international jurisdictions.

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

As of January 2, 2011, we owned or leased the land or building for approximately 79% of our 3,750 system restaurants. Accordingly, we are subject to all of the risks associated with owning and leasing real estate. In particular, the value of our assets could decrease, and/or our costs could increase, because of changes in the investment climate for real estate, demographic trends, demand for restaurant sites and other retail properties, and exposure to or liability associated with environmental contamination and reclamation, as further discussed above.

 

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

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

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

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

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

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

 

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

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

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

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

 

 

 

Item 1B. Unresolved Staff Comments

None.

 

 

 

Item 2. Properties

We have construction and site management personnel who oversee the construction of our restaurants by outside contractors. The restaurants are built to our specifications as to exterior style and interior decor. Tim Hortons restaurants operate in a variety of formats. A standard Tim Hortons restaurant is a free-standing building typically ranging in size from 1,400 to 3,090 square feet, with a dining room and drive-thru window. Each of these restaurants typically includes a kitchen capable of supplying fresh baked goods throughout the day. We also have non-standard restaurants designed to fit anywhere, consisting of small full-service restaurants and/or self-serve kiosks in offices, hospitals, colleges, airports, grocery stores, gas and convenience locations and drive-thru-only units on smaller pieces of property. These units typically average between 150 to 1,000 square feet. Some of the drive-thru-only units, kiosks, and carts also have bakery production facilities on site.

 

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

As of January 2, 2011, the number of Tim Hortons restaurants, both standard and non-standard locations across Canada and the U.S., totaled 3,750, with standard restaurants comprising 71.6% of the total. For purposes of the foregoing, we have included self-serve kiosks as “non-standard locations.” At January 2, 2011, all but 20 of the Tim Hortons restaurants were franchise-operated. Of the 3,730 franchised restaurants, 751 were sites owned by the Company and leased to restaurant owners, 2,176 were leased by us, and in turn, subleased to restaurant owners, with the remainder either owned or leased directly by the restaurant owner. Our land or land and building leases are generally for terms of 10 to 20 years, and often have one or more five-year renewal options. In certain lease agreements, we have the option to purchase or right of first refusal to purchase the real estate. Certain leases require the payment of additional rent equal to a percentage (ranging from 0.75% to 13%) of annual sales in excess of specified amounts.

The following tables illustrate Tim Hortons system restaurant locations by type, and whether they are operated by the Company or our restaurant owners, as of January 2, 2011.

Company and Franchised Locations

 

Canadian Locations by Province/Territory

   Standard      Non-Standard      Self-Serve
Kiosks
        
     Company      Franchise      Company      Franchise      Franchise      Total  

Alberta

     1         202         1         68         19         291   

British Columbia

             195                 56         27         278   

Manitoba

             55                 24         1         80   

New Brunswick

             102                 14                 116   

Newfoundland

             45                 9         1         55   

Nova Scotia

     1         134                 30         3         168   

Northwest Territories

             1                                 1   

Nunavut

                                     3         3   

Ontario

     6         1,133         3         446         46         1,634   

Prince Edward Island

             12                 7                 19   

Quebec

     3         349         1         86         6         445   

Saskatchewan

             38                 12         6         56   

Yukon

             2                                 2   
                                                     

Canada

     11         2,268         5         752         112         3,148   
                                                     

 

% of restaurants that are standard—Canada   72.4%
% of restaurants that are standard—Systemwide   71.6%

 

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United States Locations by State

   Standard      Non-Standard      Self-Serve
Kiosks
        
     Company      Franchise      Company      Franchise      Franchise      Total  

Indiana

             1                                 1   

Kentucky

             2                 1                 3   

Maine

     3         25                 1                 29   

Michigan

             132                 5         1         138   

New York

             122         1         59         106         288   

Ohio

             104                 6         4         114   

Pennsylvania

             9                 1         12         22   

Virginia

             1                                 1   

West Virginia

             6                                 6   
                                                     

United States

     3         402         1         73         123         602   
                                                     

 

% of restaurants that are standard—U.S.   67.3%
% of restaurants that are standard—Systemwide   71.6%

 

International Locations by Country

   Non-Standard Arrangements         
     Self-Serve
Kiosks
     Full-Service
Locations
     Total  

Republic of Ireland(1)

     191         3         194   

United Kingdom (1)

     81                 81   

Kandahar, Afghanistan(2)

             1         1   
                          

Total

     272         4         276   
                          

 

(1)

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

(2)

Temporary restaurant operated by the Canadian Armed Forces.

 

 

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

 

Location

   Type      Owned/Leased    Approximate Square
Footage
 

Rochester, New York (Maidstone coffee roasting facility)

   Manufacturing      Leased      38,000   

Oakville, Ontario (fondant and fills facility)

   Manufacturing      Owned      36,650   

Hamilton, Ontario (Canadian coffee roasting facility)

   Manufacturing      Owned      76,000   

Guelph, Ontario

   Distribution/Office      Owned      155,750   

Calgary, Alberta

   Distribution/Office      Owned      35,500   

Debert, Nova Scotia

   Distribution/Office      Owned      28,000   

Langley, British Columbia

   Distribution/Office      Owned      27,500   

Kingston, Ontario

   Distribution/Office      Owned      42,750   

Kingston, Ontario*

   Distribution/Office      Owned      135,080   

Oakville, Ontario

   Warehouse      Owned      37,000   

Oakville, Ontario

   Office      Owned      153,060   

Dublin, Ohio

   Office      Leased      17,200   

Lachine, Quebec

   Office      Owned      5,000   

Lachine, Quebec

   Office      Leased      8,000   

West Greenwich, Rhode Island

   Office      Owned      < 2,500   

Williamsville, New York

   Office      Leased      < 2,500   

Brighton, Michigan

   Office      Leased      < 2,500   

 

* This facility is currently under construction and expected to open in the latter half of 2011, at which time it is currently expected that the existing Kingston distribution centre/office will be closed and the land and building sold.

 

 

 

Item 3. Legal Proceedings

On June 12, 2008, a claim was filed against the Company and certain of its affiliates in the Ontario Superior Court of Justice (the “Court”) by two of its restaurant owners, Fairview Donut Inc. and Brule Foods Ltd., alleging, generally, that the Company’s Always Fresh baking system and expansion of lunch offerings have led to lower restaurant owner profitability. The claim, which seeks class certification on behalf of Canadian restaurant owners, asserts damages of approximately $1.95 billion. Those damages are claimed based on breach of contract, breach of the duty of good faith and fair dealing, negligent misrepresentation, unjust enrichment and price maintenance. The plaintiffs filed a motion for certification of the putative class in May of 2009 and the Company filed its responding materials as well as a motion for summary judgment in November of 2009. The two motions are now scheduled to be heard together in August 2011. The Company continues to believe the claim is without merit and will not be successful, and the Company intends to oppose the certification motion and defend the claim vigorously. However, there can be no assurance that the outcome of the claim will be favourable to the Company or that it will not have a material adverse impact on the Company’s financial position or liquidity in the event that the ultimate determinations by the Court and/or appellate court are not in accordance with the Company’s evaluation of this claim.

 

 

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

 

 

 

Item 4. (Removed and Reserved)

 

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PART II

 

 

 

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

The Company’s common shares are traded on the Toronto Stock Exchange (“TSX”) and New York Stock Exchange (“NYSE”) (trading symbol: THI). The following tables set forth the High, Low and Close prices of the Company’s common shares on NYSE and TSX commencing with the first quarter 2009, as well as the dividends declared per share for such period.

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

 

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

2009 Fiscal Year

       High              Low              Close              High              Low              Close      

First Quarter (Ended March 29)

   $ 35.23       $ 28.01       $ 31.73       $ 29.15       $ 22.20       $ 25.70   

Second Quarter (Ended June 28)

   $ 33.36       $ 28.00       $ 28.66       $ 27.44       $ 23.84       $ 24.84   

Third Quarter (Ended September 27)

   $ 33.00       $ 28.28       $ 30.60       $ 30.18       $ 24.27       $ 27.99   

Fourth Quarter (Ended January 3, 2010)

   $ 32.30       $ 29.59       $ 32.13       $ 30.75       $ 27.55       $ 30.51   
     Toronto Stock Exchange (Cdn.$)      New York Stock Exchange (US$)  

2010 Fiscal Year

   High      Low      Close      High      Low      Close  

First Quarter (Ended April 4)

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

Second Quarter (Ended July 4)

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

Third Quarter (Ended October 3)

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

Fourth Quarter (Ended January 2, 2011)

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

 

(1)

Source: Thomson Reuters

As of February 22, 2011, there were 167,532,579 common shares outstanding, of which 278,082 are owned by The TDL RSU Plan Trust.

Dividends Declared Per Common Share (Cdn.$)

 

2009 Fiscal Year

      

First Quarter (Declared February 2009)

   $ 0.10   

Second Quarter (Declared May 2009)

   $ 0.10   

Third Quarter (Declared August 2009)

   $ 0.10   

Fourth Quarter (Declared October 2009)

   $ 0.10   

2010 Fiscal Year

      

First Quarter (Declared February 2010)

   $ 0.13   

Second Quarter (Declared May 2010)

   $ 0.13   

Third Quarter (Declared August 2010)

   $ 0.13   

Fourth Quarter (Declared November 2010)

   $ 0.13   

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

 

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receiving U.S. dollars are exposed to foreign exchange risk from the date the dividend is declared until the date CDS or we, as applicable, convert the dividend payment to U.S. dollars.

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

In 2010, our Board of Directors approved an increase in the quarterly dividend from $0.10 to $0.13 per common share and our dividend payout range from 20% to 25% to 30% to 35% of prior year, normalized annual net income attributable to Tim Hortons Inc., which is net income attributable to Tim Hortons Inc. adjusted for certain discrete items, such as gains on divestitures, tax impacts and asset impairments that affect our annual net income attributable to Tim Hortons Inc. In February 2011, our Board of Directors approved a 31% increase in the quarterly dividend from $0.13 per common share to $0.17 per common share for the first quarter of 2011. Notwithstanding our long-term targeted dividend payout range and the recent increase in our dividend, the declaration and payment of all future dividends remains subject to the discretion of our Board of Directors and the Company’s continued financial performance, debt covenant compliance, and other factors when considering dividend declarations.

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

 

 

Shareholders

As of January 2, 2011, we had approximately 43,076 shareholders of record (as registered shareholders), as determined by the Company based on information supplied by Computershare Investor Services Inc. We also have approximately 135,828 beneficial holders, based on information provided by Broadridge Financial Solutions.

See Note 17 of the Consolidated Financial Statements for information on related shareholder matters.

 

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Securities Authorized for Issuance Under Equity Compensation Plans

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

 

EQUITY COMPENSATION PLAN INFORMATION

 

Plan Category

   Number of securities
to be issued upon
exercise of  outstanding
options, warrants

and rights(1)
(a)
     Weighted-
average
exercise price of
outstanding
options, warrants
and rights

(b)(2)
     Number of securities
remaining available
for future issuance  under
equity compensation
plans (excluding securities
reflected in column (a))
(c)
 

Equity compensation plans approved by security holders

     1,379,181       $ 31.87         844,735   

Equity compensation plans not approved by security holders

     N/A         N/A         N/A   
                          

Total

     1,379,181       $ 31.87         844,735   
                          

 

(1)

The Company’s 2006 Stock Incentive Plan provides that an aggregate of 2.9 million common shares may be awarded as restricted stock, stock units, stock options, stock appreciation rights (“SARs”), performance shares, performance units, dividend equivalent rights, and/or share awards. Included in the 1,379,181 total number of securities in column (a) above are approximately 293,175 restricted stock units (“RSUs,” including RSUs issued as a result of performance-based restricted stock units or “P+RSUs”), subject to vesting requirements, and dividend equivalent rights associated with the RSUs and 1,086,006 stock options and related SARs. Of the 1,086,006 options/SARs outstanding at January 2, 2011, only 263,498 were exercisable as of that date due to vesting requirements.

(2)

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

 

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Performance Graph

The following graph compares the yearly percentage change in the Company’s cumulative total shareholder return on the TSX and NYSE as measured by (i) the change in the Company’s share price from March 23, 2006 (the date we became a public company) to December 31, 2010, and (ii) the reinvestment of dividends at the closing price on the dividend payment date, against the cumulative total return of the S&P/TSX Composite Index, S&P/TSX Consumer Discretionary Index, and S&P 500. The information provided under the heading “Performance Graph” shall not be considered “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference in any filing under the Securities Act or the Exchange Act.

LOGO

 

     23-Mar-06      29-Dec-06      28-Dec-07      26-Dec-08      31-Dec-09      31-Dec-10  

S&P/TSX Composite Index (Cdn$)(2)

   $ 100.0       $ 109.6       $ 120.3       $ 74.4       $ 108.9       $ 128.1   

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

   $ 100.0       $ 108.3       $ 112.7       $ 67.0       $ 84.0       $ 105.4   

S&P 500 (U.S.$)

   $ 100.0       $ 109.0       $ 111.1       $ 63.9       $ 97.6       $ 118.9   

Tim Hortons Inc. (TSX)

   $ 100.0       $ 125.3       $ 138.6       $ 125.8       $ 123.4       $ 160.2   

Tim Hortons Inc. (NYSE)

   $ 100.0       $ 125.6       $ 164.5       $ 121.8       $ 136.7       $ 187.3   

 

(1)

The majority of the Company’s operations, income, revenues, expenses, and cash flows are in Canadian dollars, and the Company is primarily managed in Canadian dollars. This drives our Canadian-dollar earnings per share that may be translated to U.S. dollars by analysts and others. Fluctuations in the foreign exchange rates between the U.S. and Canadian dollar can affect the Company’s share price. See “Risk Factors” in Part 1A. Over the course of 2007, the Canadian dollar appreciated approximately 19% relative to the U.S. dollar, which was the primary cause of the larger appreciation in the U.S. dollar share price relative to the Canadian dollar share price over 2007. However, in 2008, the Canadian dollar depreciated

 

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approximately 20% relative to the U.S. dollar and caused the opposite effect, resulting in a decline in the U.S. dollar share price as a result of the currency fluctuation that is not directly attributable to changes in the Company’s underlying business or financial condition aside from the impact of foreign exchange. Over the course of 2009, the Canadian dollar appreciated approximately 13% relative to the U.S. dollar which was the primary cause of the larger appreciation in the U.S. dollar share price relative to the decrease in the Canadian dollar share price over 2009. In 2010, the Canadian dollar continued to strengthen relative to the U.S. dollar, as it appreciated approximately 4.5%. This was the primary cause of the larger appreciation in the U.S. dollar share price relative to the increase in the Canadian dollar share price over 2010.

(2)

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

Sales and Repurchases of Equity Securities

The following table presents the Company’s repurchases of its common shares for each of the three periods included in the fourth quarter ended January 2, 2011:

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

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

Purchased Under
the Plans
or Programs (Cdn.)(3)(4)
 

Period #10 (October 4, 2010—November 7, 2010)

    380,649      $ 37.85        380,649      $ 86,235,597   

Period #11 (November 8, 2010— December 5, 2010)

    1,395,311 (5)    $ 40.59        1,385,856      $ 230,000,459   

Period #12 (December 6, 2010— January 2, 2011)

    871,469      $ 41.20        871,469      $ 194,107,436   
                               

Total

    2,647,429      $ 40.39        2,637,974      $ 194,107,436   
                               

 

(1)

Based on settlement date.

(2)

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

(3)

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

(4)

On March 1, 2010, the Company announced that it had obtained regulatory approval from the TSX under TSX normal course issuer bid rules to commence a 2010 share repurchase program (“2010 program”) for up to $200 million in common shares, not to exceed the regulatory maximum of 8,817,291 common shares, equivalent to 5% of the outstanding common shares as of February 19, 2010. On November 10, 2010, the Company announced that it had obtained regulatory approval from the TSX to amend the 2010 program, to increase the maximum number of shares that may be purchased effective November 16, 2010, to a total of $400 million (from the $200 million original amount approved), subject to the limitation that the Company could not repurchase more than the regulatory maximum of 17,531,446 of its common shares (representing 10% of the Company’s “public float” as of February 19, 2010, as defined under TSX rules). Under the amended program, as of January 2, 2011, the Company had spent $205.9 million. Purchases of common shares have been made through a combination of automatic trading plan purchases, and at management’s discretion in compliance with regulatory requirements, given prevailing market, cost, and other considerations. Repurchases have been made by the Company on the TSX and NYSE. Shares repurchased pursuant to the 2010 program have been cancelled. The 2010 program commenced March 3, 2010 and will end on March 2, 2011. The first purchases were made under the 2010 program on March 9, 2010.

(5)

In November 2010, the Company purchased 9,455 common shares in the open market to settle restricted stock unit awards of certain of the Company’s employees who did not have shares delivered to them for settlement from The TDL RSU Plan Trust.

 

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Item 6. Selected Financial Data

The following table presents our selected historical consolidated financial and other data and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Effective January 4, 2010, we adopted a new accounting standard relating to variable interest entities and retroactively applied this standard to comparative periods presented in our selected historical consolidated financial data, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements. See Note 20 to the Consolidated Financial Statements for additional information regarding the impact of the adoption of this accounting standard. Our historical consolidated financial information may not be indicative of our future performance and, because we were a subsidiary of Wendy’s until September 2006, does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, standalone entity during fiscal year 2006.

 

    Fiscal Years(1)(2)  
    2010     2009     2008     2007     2006  
   

(in thousands, except share and per share data,

number of restaurants, and otherwise where noted)

 

Consolidated Statements of Operations Data

         

Revenues

         

Sales

  $ 1,755,244      $ 1,704,065      $ 1,541,882      $ 1,404,986      $ 1,249,076   

Franchise revenues:

         

Rents and royalties(3)

    687,039        644,755        593,483        546,925        499,324   

Franchise fees

    94,212        90,033        93,808        93,835        83,769   
                                       
    781,251        734,788        687,291        640,760        583,093   
                                       

Total revenues

    2,536,495        2,438,853        2,229,173        2,045,746        1,832,169   
                                       

Asset impairment and related closure costs

    28,298               21,266                 

Other costs and expenses

    1,997,034        1,913,251        1,729,460        1,586,010        1,417,648   
                                       

Total costs and expenses

    2,025,332        1,913,251        1,750,726        1,586,010        1,417,648   
                                       

Gain on sale of interest in Maidstone Bakeries(4)

    (361,075                            
                                       

Operating income

    872,238        525,602        478,447        459,736        414,521   

Interest expense, net

    24,180        19,184        19,632        14,923        16,918   
                                       

Income before income taxes

    848,058        506,418        458,815        444,813        397,603   

Income taxes

    200,940        186,606        150,309        147,226        112,365   
                                       

Net income

  $ 647,118      $ 319,812      $ 308,506      $ 297,587      $ 285,238   

Net income attributable to noncontrolling interests

  $ 23,159      $ 23,445      $ 23,828      $ 28,036      $ 25,642   
                                       

Net income attributable to Tim Hortons Inc.

  $ 623,959      $ 296,367      $ 284,678      $ 269,551      $ 259,596   
                                       

Fully diluted earnings per common share

  $ 3.58      $ 1.64      $ 1.55      $ 1.43      $ 1.40   

Weighted average number of common shares outstanding – diluted (thousands)

    174,215        180,609        183,492        188,759        185,401   

Dividends per common share (post initial public offering)

  $ 0.52      $ 0.40      $ 0.36      $ 0.28      $ 0.14   

 

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    Fiscal Years(1)(2)  
    2010     2009     2008     2007     2006  
   

(in thousands, except share and per share data,

number of restaurants, and otherwise where noted)

 

Consolidated Balance Sheets Data

         

Cash and cash equivalents

  $ 574,354      $ 121,653      $ 124,717      $ 186,982      $ 226,912   

Restricted cash and cash equivalents and Restricted investments

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

Total assets

  $ 2,481,516      $ 2,094,291      $ 2,097,694      $ 1,902,200      $ 1,852,652   

Long-term debt(5)

  $ 437,348      $ 411,694      $ 405,500      $ 401,166      $ 399,389   

Total liabilities(5)

  $ 1,039,074      $ 838,605      $ 865,891      $ 806,764      $ 742,146   

Total equity(6)

  $ 1,442,442      $ 1,255,686      $ 1,231,803      $ 1,095,436      $ 1,110,506   

Other Financial Data

         
EBITDA attributable to Tim Hortons Inc.(7)   $ 956,532      $ 599,939      $ 541,168      $ 516,597      $ 460,923   

Capital expenditures

  $ 132,912      $ 160,458      $ 184,538      $ 195,094      $ 184,606   

Operating margin(8) (%)

    34.4     21.6     21.5     22.5     22.6

EBITDA margin attributable to Tim Hortons Inc.(7) (%)

    37.7     24.6     24.3     25.3     25.2

Other Operating Data

         

Total systemwide sales growth(10)(11)

    6.2     7.9     8.3     10.2     12.8

Systemwide restaurant unit growth(10)

    4.8     4.1     6.7     5.7     5.6

Canada average same-store sales growth(10)

    4.9     2.9     4.4     6.1     7.7

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

    3.9     3.2     0.8     4.1     8.9

Total system restaurants franchised (%)

    99.5     99.5     99.0     97.8     96.9

Restaurants open at end of year – Canada

         

Standard

    2,279        2,193        2,116        2,055        1,983   

Non-standard

    757        724        702        664        622   

Self-serve kiosk

    112        98        99        104        106   

Restaurants open at end of year – U.S.

         

Standard

    405        422        398        361        318   

Non-standard

    74        54        34        22        18   

Self-serve kiosk

    123        87        88        15          
                                       

Total

    3,750        3,578        3,437        3,221        3,047   
                                       

Average sales per standard restaurant:(9)(10)

         

Canada (in thousands of Canadian dollars)

  $ 2,070      $ 2,025      $ 1,955      $ 1,888      $ 1,793   

U.S. (in thousands of U.S. dollars)

  $ 978      $ 957      $ 930      $ 956      $ 944   

U.S. (in thousands of Canadian dollars)

  $ 1,012      $ 1,097      $ 977      $ 1,023      $ 1,070   

Average sales per non-standard restaurant:(10)

         

Canada (in thousands of Canadian dollars)

  $ 830      $ 794      $ 751      $ 707      $ 662   

U.S. (in thousands of U.S. dollars)

  $ 459      $ 426      $ 457      $ 397      $ 326   

U.S. (in thousands of Canadian dollars)

  $ 475      $ 488      $ 481      $ 425      $ 370   

 

(1)

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

(2)

Our selected historical consolidated financial data has been derived from our audited historical Consolidated Balance Sheets at January 2, 2011 and January 3, 2010, and the results of operations and cash flows for each of the years ended January 2, 2011, January 3, 2010 and December 28, 2008, and the unaudited financial statements from December 30, 2007 and December 31, 2006.

(3)

Rents and royalties revenues consist of (a) royalties, which typically range from 3.0% to 4.5% of gross franchise restaurant sales and (b) rents, which consist of base rent and percentage rent in Canada and percentage rent only in the U.S. Rents typically range from 8.5% to 10.0% of gross franchise restaurant sales. Franchise restaurant sales are reported to us by our franchisees. Franchise restaurant sales are not included in our Consolidated Financial Statements, other than approximately 250 to 275 restaurants whose

 

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results of operations are consolidated with ours, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Definitions—Sales.” However, franchise restaurant sales result in royalties and rental income, which are included in our franchise revenues, as well as distribution income. The reported franchise restaurant sales for the last five years were:

 

     Fiscal Years(1)(2)  
     2010      2009      2008      2007      2006  

Franchised restaurant sales:

              

Canada (in thousands of Canadian dollars)

   $ 5,181,831       $ 4,880,934       $ 4,546,027       $ 4,197,478       $ 3,821,857   

U.S. (in thousands of U.S. dollars)

   $ 439,227       $ 409,882       $ 345,429       $ 301,255       $ 246,343   

 

(4)

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

(5)

Long-term debt includes long-term debt and capital leases.

(6)

In March 2006, we completed an initial public offering (“IPO”), selling 17.25% of our common stock for total proceeds, net of issuance costs, of $841.9 million. Prior to our IPO, we were a wholly owned subsidiary of Wendy’s International, Inc. On September 29, 2006, Wendy’s distributed its remaining interest of 82.75% of our outstanding common stock to its stockholders through a special, pro rata dividend distribution. On September 28, 2009, we reorganized as a Canadian public company; however, the reorganization did not change the total equity of the Company.

(7)

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

 

   

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

 

   

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

 

   

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

 

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

 

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

 

     Fiscal Years(1)(2)  
     2010      2009      2008      2007      2006  
     (in thousands)  

Net income

   $ 647,118       $ 319,812       $ 308,506       $ 297,587       $ 285,238   

Interest expense, net

     24,180         19,184         19,632         14,923         16,918   

Income tax expense

     200,940         186,606         150,309         147,226         112,365   
                                            

Operating income

     872,238         525,602         478,447         459,736         414,521   

Depreciation and amortization

     118,385         113,475         103,793         93,041         80,977   
                                            

EBITDA*

     990,623         639,077         582,240         552,777         495,498   

EBITDA attributable to noncontrolling interests

     34,091         39,138         41,072         36,180         34,575   
                                            

EBITDA attributable to Tim Hortons Inc.

     956,532         599,939       $ 541,168       $ 516,597       $ 460,923   
                                            

 

  * EBITDA includes and has not been adjusted for the asset impairment and related closure costs of $28.3 million, $21.3 million in fiscal 2010 and 2008, respectively. It has also not been adjusted for the gain on sale from our interest in Maidstone Bakeries of $361.1 million, partially offset by the $30 million allocated to our restaurant owners, for a total net pre-tax gain of $331.1 million.
(8)

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

(9)

Our standard restaurant typically measures between 1,400 to 3,090 square feet, with a dining room, a counter for placing orders and drive-thru service. Standard restaurants comprised 71.6% of our system as of January 3, 2011. We also have “combination restaurants” that offer Tim Hortons and Wendy’s products at one location. Our combination restaurants typically have a common area dining room and separate counters and, typically, separate franchisees operate the two different concepts. In fiscal 2010, we had approximately 123 combination restaurants in Canada and 30 in the U.S.

(10)

Includes both franchised and Company-operated restaurants. Franchise restaurant sales are not included in our Consolidated Financial Statements, other than approximately 250 to 275 restaurants whose results of operations are required to be consolidated with ours. However, franchise restaurant sales result in royalties and rental income, which are included in our revenues as well as distribution revenues. U.S. average sales per standard and non-standard restaurant are disclosed in both Canadian and U.S. dollars, the reporting and functional currency, respectively, of our U.S. operations. The U.S. average sales per standard and non-standard restaurant were converted into Canadian dollars for each year using the average foreign exchange rate in the applicable year. The U.S. average sales per standard and non-standard restaurant, when converted into Canadian dollars, includes the effects of exchange rate fluctuations, which decreases comparability between the years. We believe the presentation of the U.S. dollar average sales per standard and non-standard restaurant is useful to investors to show the local currency amounts for restaurants in the U.S. and provides transparency on the underlying business performance without the impact of foreign exchange. The average unit volumes for non-standard restaurants excludes volumes from self-serve kiosks. Self-serve kiosks differ in size and product offering and, as a result, contribute significantly less than standard and non-standard restaurants to both systemwide sales as well as our revenues and operating income, particularly in the U.S. Self-serve kiosks are, however, important as they drive convenience and brand-penetration, especially in the U.S. where our brand is less developed.

(11)

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

 

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

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the 2010 Consolidated Financial Statements and accompanying Notes included elsewhere in our Annual Report on Form 10-K for the year ended January 2, 2011 (“Annual Report”). All amounts are expressed in Canadian dollars unless otherwise noted. The following discussion includes forward-looking statements that are not historical facts but reflect our current expectation regarding future results. Actual results may differ materially from the results discussed in the forward-looking statements because of a number of risks and uncertainties, including the matters discussed below. Please refer to “Risk Factors” included elsewhere in our Annual Report for a further description of risks and uncertainties affecting our business and financial results. Historical trends should not be taken as indicative of future operations and financial results.

Our financial results are driven largely by changes in systemwide sales, which include restaurant-level sales at both franchise and Company-operated restaurants. As of January 2, 2011, 3,730 or 99.5% of our restaurants were franchised, representing 99.5% in Canada and 99.3% in the United States. The amount of systemwide sales affects our franchisee royalties and rental income, as well as our distribution income. Changes in systemwide sales are driven by changes in same-store sales and changes in the number of restaurants and are ultimately driven by consumer demand. Average same-store sales growth, one of the key metrics we use to assess our performance, provides information on growth in total systemwide sales at all restaurants, which have been operating for thirteen or more months, and provides a useful comparison between periods. We believe systemwide sales and average same-store sales growth provide meaningful information to investors concerning the size of our system, the overall health and financial performance of the system, and the strength of our brand and franchisee base, which ultimately impacts our consolidated and segmented financial performance. Franchise restaurant sales generally are not included in our Consolidated Financial Statements (except for certain non-owned restaurants consolidated in accordance with applicable accounting rules; however, franchise restaurant sales result in royalties and rental income, which are included in our franchise revenues, and also generate distribution income. We adopted this standard effective January 4, 2010 and retrospectively applied the standard to all fiscal years presented herein.

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

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

Executive Overview

We primarily franchise Tim Hortons restaurants in Canada and the U.S. As the franchisor, we collect royalty income from franchised restaurant sales. Our business model also includes controlling the real estate for the majority of our franchised restaurants. As of January 2, 2011, we leased or owned the real estate for approximately 79% of our system restaurants, which generates a recurring stream of rental income. Real estate that is not controlled by us is generally for non-standard restaurants, including, for example, kiosks in offices, hospitals, colleges, and airports, as well as self-serve kiosks located in gas and convenience locations and grocery stores. We distribute coffee and other beverages, non-perishable food, supplies, packaging and equipment to system restaurants in Canada through our five distribution centres, and, in some cases, through third-party

 

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distributors. We supply frozen and some refrigerated products as well as paper and dry goods from our Guelph facility to approximately 85% of our Ontario restaurants. We are currently constructing a replacement distribution centre in Kingston, Ontario which is expected to serve more than 650 restaurants in eastern Ontario and Quebec with dry goods, frozen and refrigerated products. We anticipate the facility to be fully operational in the second half of 2011. In the U.S., we supply similar products to system restaurants through third-party distributors. In addition to our Canadian and U.S. franchising business, we have 275 licensed locations in the Republic of Ireland and the United Kingdom, which are mainly self-serve kiosks operating primarily under the name “Tim Hortons.” In keeping with our vertical integration initiatives, we also operate two coffee roasting facilities located in Hamilton, Ontario and Rochester, New York and a fondant and fills manufacturing facility in Oakville, Ontario.

2010 Performance against Targets

The following table sets forth our 2010 actual performance as compared to our 2010 financial targets, as well as management’s views on our 2010 performance relative to such targets:

 

Measure

  

Target

  

Actual

  

Commentary

Average Same-store Sales Growth

        

• Canada

• U.S.

  

3% - 5%

2% - 4%

  

4.9%

3.9%

   Average same-store sales growth was driven by menu innovation, promotional programs, and operational strategies, such as our hospitality program, and pricing. In addition, the core markets in our U.S. business had strong same-store sales growth in the latter half of 2010. Cold Stone Creamery continues to be a contributor to same-store sales growth, but to a lesser extent than in 2009.

Adjusted Operating Income Growth

(on a 52- week basis)

   8% - 10%    11.4%    See Selected Operating and Financial Highlights below for a breakdown of year-over-year operating income adjustments, which we believe provide a more meaningful comparison to our 2010 target as these items were not contemplated at the time the target was set. Strong same-store sales growth in both Canada and U.S. was one of the primary drivers of our higher operational performance, primarily in our rent and royalties and our distribution operations, and contributed to the Company exceeding its key growth targets for 2010.

Effective Tax Rate

   Approximately 32%    23.7%    Our original target did not include the lower effective tax rate that resulted from the sale of our interest in Maidstone Bakeries, which positively impacted our effective tax rate by approximately 8%. Partially offsetting the decrease in our effective tax rate was the negative impact of approximately 1% resulting from the asset impairment and related restaurant closure costs in the New England region.

 

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Measure

  

Target

  

Actual

  

Commentary

Restaurant Development

• Canada

 

 

• U.S.

  

 

130 – 150

restaurants

 

40 – 60

restaurants

  

 

149 restaurants

 

96 restaurants

   Canada and U.S. new restaurant development, including self-serve kiosk locations, was within the targeted range. Included in our 2010 new restaurant development were 20 and 52 new self-serve kiosks in Canada and U.S., respectively. Also included were 27 new Cold Stone Creamery co-branded restaurants (12 in Canada, 15 in U.S.). In addition, we converted 66 and 9 existing Tim Hortons locations in Canada and the U.S., respectively, to include Cold Stone Creamery.

Capital Expenditures

   $180 - $200 million    $132.9 million    Capital expenditures were lower than the targeted range primarily due to changes in restaurant development formats and higher amount of capital leases versus purchases within our 2010 restaurant development. We entered into $29.2 million of capital lease obligations in 2010.
Earnings per share (fully diluted)    $1.95 - $2.05    $3.58 per share    The factors noted above that impacted our 2010 operating income also impacted our diluted earnings per share (“EPS”) target, including the unanticipated gain on sale of our interest in Maidstone Bakeries, partially offset by our $30.0 million allocation to restaurant owners, which, net of tax, impacted EPS growth by approximately $1.70 per share. As planned, EPS growth also benefited from 3.5% fewer shares outstanding in 2010 versus 2009 due to our share repurchase programs. Partially offsetting these increases were asset impairment and related closure costs recognized in the latter half of the year, and other net costs which reduced EPS growth by approximately $0.16 per share.

The gain on the sale of our interest in Maidstone Bakeries, our $30 million allocation to restaurant owners, which was recorded as a reduction of Sales on the Consolidated Statement of Operations, as well as the asset impairment charge and costs associated with the decision to close restaurants in the New England region, were not contemplated as part of Management’s 2010 guidance for operating income growth, effective tax rate, or EPS, as noted above and within Selected Operating and Financial Highlights.

The macro-economic climate in North America improved throughout 2010 as compared to 2009, which was characterized by persistently high unemployment levels and other pressures in the U.S. and in certain Canadian regions that have a larger manufacturing base, including Ontario. The improvement in economic conditions translated into increased systemwide sales for our business in fiscal 2010. While we are not immune from recessionary and inflationary impacts, historically, we have proven to be fairly resilient in Canada during challenging economic times, and we continue to be well-positioned, due in part, to our quality product offerings at reasonable prices.

 

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We opened a total of 245 restaurants (which included 72 self-serve kiosks) in fiscal 2010 compared to 176 restaurants (which included 3 self-serve kiosks) in fiscal 2009. Our restaurant development program is typically highest in the fourth quarter each year. We execute our development activities prudently and only with what we believe to be the right opportunities. In 2010, we continued with the shift we began in 2008, focusing our restaurant development towards smaller restaurants, with a higher mix of non-standard units in Canadian growth markets and core growth markets in the U.S., which are most developed, as well as strategic alliances and co-branding opportunities. We are also targeting urban and rural communities in Canada as part of our broader development strategy, including evaluating new flexible restaurant designs tailored to urban and rural markets.

Two major events that impacted our fiscal 2010 financial results were the sale of our interest in Maidstone Bakeries and our decision to close 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets, as well as two restaurants in our Portland market.

In April 2010, we received notice from IAWS Group Ltd., a subsidiary of Aryzta AG, our 50-50 partner under the Maidstone Bakeries joint venture (“Maidstone Bakeries”), invoking the buy/sell provisions of the joint-venture agreement. We decided to sell our 50% interest in Maidstone Bakeries for gross cash proceeds of $475 million. Due to Aryzta’s ability to potentially leverage available surplus capacity for other channels and the international nature of their tax structure, this facility represented greater economic value to Aryzta than to Tim Hortons. The all-cash transaction closed on October 29, 2010. Our supply obligations for products extend for donuts and TimbitsTM until early 2016, and we have supply rights until late 2017, at our option, allowing us sufficient flexibility to secure alternative means of supply, if necessary. The results of Maidstone Bakeries were consolidated in our financial results in accordance with applicable accounting rules until October 29, 2010, at which point we were no longer required to consolidate their results. Due to the continuing business relationship that exists, Maidstone Bakeries did not qualify to be presented as discontinued operations. In fiscal 2010, Maidstone Bakeries contributed approximately $24 million to our adjusted operating income attributable to Tim Hortons Inc., $21 million to our net income attributable to Tim Hortons Inc., and $0.12 per share attributable to Tim Hortons Inc., representing our 50% share of earnings for the ten month period prior to the sale (fiscal 2009: Maidstone Bakeries contributed approximately $26 million, $22 million and $0.12 per share to our adjusted operating income, net income, and diluted earnings per share attributable to Tim Hortons Inc., respectively). See “Selected Operating and Financial Highlights” for a GAAP reconciliation of adjusted operating income attributable to Tim Hortons Inc. to operating income. We have recorded a pre-tax gain on sale of Maidstone Bakeries in the fourth quarter of 2010 of $402 million, less approximately $41 million which, for accounting purposes, has been deferred and will be amortized over the remaining term of the supply agreement.

During the third quarter of 2010, an impairment review was initiated on our Portland, Providence and Hartford markets in the New England region based on their same-store sales growth and financial performance, which were continuing to fall below our expectations. Upon completion of this review, we determined that the future expected cash flows of these markets were insufficient to recover the carrying value of the long-lived assets in these markets. Commensurate with this review, we decided to close 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets in the fourth quarter of 2010 and two restaurants in our Portland market. The Providence and Hartford markets are among the most densely penetrated market areas in U.S. by quick service restaurants, and we were not successful in expanding our customer base to the levels required for future profitability. As a result, total asset impairment and related closure costs of $28.3 million were recorded in our U.S. operating segment in the latter half of 2010. These markets represent a relatively small portion of our overall system in the U.S., but historically had a disproportionately negative impact on earnings, average unit volumes and same-store sales growth in the U.S. segment. Average unit volumes for standard restaurants in the Providence and Hartford markets were approximately half of our other core markets in the U.S. These restaurant closures will allow us to focus on and reinvest a portion of our savings from these closed restaurants into our core growth markets in the Northeast and Midwest U.S. by increasing our advertising and marketing scale where the brand continues to demonstrate strengthening average unit volumes, cash flows and brand progression. We expect this decision to contribute directly to operating income improvement in our U.S. segment in 2011.

Operating income increased $346.6 million, or 66.0%, in fiscal 2010 compared to fiscal 2009, primarily as a result of the gain on sale of our interest in Maidstone Bakeries of $361.1 million, partially offset by our $30.0

 

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million allocation to restaurant owners. The large gain was also offset, in part, by asset impairment and related closures costs of $28.3 million. Exclusive of these factors, other significant contributors to operating income growth were higher revenues driven by continued same-store sales growth in both Canada and the U.S. and an increase in the number of systemwide restaurants, resulting in higher royalty, rental and distribution income. Fiscal 2010 had 52 weeks as compared to our fiscal 2009 year which had a 53rd week of operations. This 53rd week impacted 2010 operating income growth by approximately 1.5%. Partially offsetting these operating gains were higher general and administrative expenses and lower franchise fee income and, in 2009 we had a $2.4 million gain from a land sale which did not recur in 2010.

Net income attributable to Tim Hortons Inc. increased $327.6 million, or 110.5%, compared to fiscal 2009. The increase in net income was primarily a result of the higher operating income, offset to a much lesser extent by higher net interest expense and higher income tax expense due to the sale of Maidstone Bakeries, albeit at a lower effective tax rate in 2010. The higher net interest expense was primarily driven by higher interest rates on long-term debt, the early settlement of our interest rate swaps associated with the prepayment of our term debt that would otherwise have expired in February 2011, and the write-off of deferred financing costs associated with the portion of the term debt that was prepaid. These impacts were partially offset by approximately $20.0 million of tax-related expenses incurred in 2009 in connection with our Canadian public company reorganization, which did not recur in 2010 and contributed to the overall growth rate, as well as interest income earned on higher cash balances on hand during the fourth quarter of 2010 mainly due to the proceeds from the sale of our interest in Maidstone Bakeries.

Fully diluted EPS increased to $3.58 in fiscal 2010 compared to $1.64 in fiscal 2009. In addition to the operating income gains and significant items noted above, the lower basic and diluted weighted average number of shares outstanding in fiscal 2010, as a result of our share repurchase program, was another driver of higher EPS in 2010.

We generate substantial cash flows from operations and have historically self-funded our growth requirements from internally-generated cash flows. We, therefore, decided to distribute approximately $400 million of the approximately $430 million in after-tax proceeds from the sale of Maidstone Bakeries through the repurchase of common shares. It is our intention, subject to regulatory approval and in parallel with our annual capital allocation process, to distribute the remaining net cash proceeds from the sale of Maidstone Bakeries of up to approximately $245 million through an additional normal course issuer bid. We expect the net proceeds to be distributed in their entirety through share repurchases by the end of the third quarter of 2011, although we may terminate the program at any time, subject to compliance with regulatory requirements. In addition, we have also allocated $30 million related to the Maidstone Bakeries sale to support our key relationship with restaurant owners with the intent of helping to partially mitigate anticipated rising operating costs.

 

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2011 Performance Targets

The following table sets forth our 2011 performance targets, as well as management’s views on achieving such objectives (see accompanying notes below):

 

Measure

  

Target

  

Commentary

Same-store Sales Growth

• Canada

• U.S.

  

 

3% – 5%

3% – 5%

  

 

Same–store sales growth to be driven by daypart, marketing and menu opportunities, as well as our continued focus on our hospitality initiatives. We plan to create menu and product innovation to expand our market share across various dayparts and product categories, responding to customer needs and trends. We plan to place particular focus on morning and afternoon/evening snacking dayparts, as well as extending lunch opportunities in the Canadian segment. In the U.S., we plan to test and roll-out menu items that help differentiate our cafe and bake shop brand identity. We also plan on leveraging our marketing strengths and advantages in Canada, and significantly increase our marketing and advertising spend in U.S. markets compared to historical contribution levels, and in particular in our core, more developed markets. Our full-year targets incorporate the impact of adverse weather conditions in several of our major Canadian and U.S. markets, as well as minimal residual pricing in most Canadian markets.

Earnings per share (fully diluted)    $2.30 - $2.40   

We are targeting EPS growth, on a fully diluted basis, for 2011 to be within our long-range aspirational target of 12%-15% (excluding the 2010 impact of the disposition of our 50% joint-venture interest in Maidstone Bakeries and the U.S. asset impairment and related closure costs).

 

Our EPS target includes U.S. segment operating income of US$13 million to US$16 million.

Effective Tax Rate

   Approximately 30%    We expect to continue to realize benefits associated from the public company reorganization completed in 2009.

Restaurant Development

• Canada

 

• U.S.

  

 

160 – 180

restaurants

 

70 – 90

restaurants

  

 

Our specific plans include continued active development of both standard and non-standard restaurants in Canadian growth markets; working to accelerate the time it takes to create critical mass for convenience and advertising scale in our most developed U.S. markets; and complementing our standard restaurant development activity in both Canada and the U.S. with non-standard formats and locations.

Capital Expenditures

   $180 million to $200 million    Includes increased new restaurant development in Canada compared to historical levels, the commencement of increased development in U.S. core markets, and the completion of our replacement distribution facility in Kingston, Ontario.

Notes:

The operational objectives, financial outlook, and aspirational goals (collectively, “targets”) established for 2011 and longer-term are based on the accounting, tax, and other legislative rules in place at the time the targets were issued and on the continuation of share repurchase programs relatively consistent with historical levels. The

 

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impact of future changes in accounting, tax and/or other legislative rules that may or may not become effective in fiscal 2010, 2011 and/or future years, changes to our share repurchase activities, and other matters not contemplated at the time the targets were established that could affect our business (such as, for example, the impact of disposition of our 50% joint venture interest in Maidstone Bakeries and other significant matters), were not included in the determination of these targets. In addition, the targets are forward-looking and are based on our expectations and outlook on, and shall be effective only as of, the date the targets were originally issued. Except as required by applicable securities laws, we do not intend to update these targets. You should refer to the Company’s public filings for any reported updates. These targets and our performance generally are subject to various risks and uncertainties and are based on certain underlying assumptions, set forth in Item 1A. Risk Factors of this Annual Report, which may impact future performance and our achievement of these targets. For 2011, our targets are based on expectations of a gradual, continued economic recovery in both Canada and the U.S.

Additional information on our 2011 Financial Outlook is included under Item 1. Business in this Annual Report.

We recently announced that we have entered into a Master License Agreement (“MLA”), based primarily on a royalty model, with The Apparel Group FZCO (the “Apparel Group”) based in Dubai to develop up to 120 multi-format restaurants over five years, including approximately five in 2011. The MLA includes markets in the Gulf Cooperation Council (“GCC”) markets of United Arab Emirates, Qatar, Bahrain, Kuwait and Oman. The business structure for the MLA also includes an upfront license fee and a small percentage of sales to cover procurement and product supply services to the GCC. We believe there is opportunity over the long-term to explore international opportunities and seed the Tim Hortons brand in various markets outside of North America.

Selected Operating and Financial Highlights

 

     Fiscal Years  
     2010     2009     2008  

Systemwide sales growth(1) (2)

     6.2     7.9     8.3

Average same-store sales growth

      

Canada

     4.9     2.9     4.4

U.S.

     3.9     3.2     0.8

Systemwide restaurants

     3,750        3,578        3,437   

Revenues (in millions)(1)

   $ 2,536.5      $ 2,438.9      $ 2,229.2   

Operating income (in millions)(1)

   $ 872.2      $ 525.6      $ 478.4   

Adjusted operating income attributable to THI (in millions)(3)

     541.6        486.4        N/A   

Net income attributable to THI (in millions)(1)

   $ 624.0      $ 296.4      $ 284.7   

Basic and diluted earnings per share(1)

   $ 3.58      $ 1.64      $ 1.55   

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

     174.2        180.6        183.5   

 

N/A – Not applicable

(1)

Fiscal years include 52 weeks, except for fiscal 2009, which consisted of 53 weeks. Systemwide sales growth for 2010 and 2009 measured on a year-over-year 52-week basis was 7.9% and 6.1%, respectively.

 

(2)

Total systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. U.S. dollar sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes sales from our Republic of Ireland and United Kingdom licensed locations. Systemwide sales growth in Canadian dollars, which includes the effects of foreign currency translation, was 5.3% and 8.6% for fiscal 2010 and fiscal 2009, respectively.

 

(3)

Adjusted operating income attributable to Tim Hortons Inc. and operating income attributable to Tim Hortons Inc. are non-GAAP measures (see table below). Operating income attributable to Tim Hortons Inc. excludes operating income attributable to noncontrolling interests. Prior to the adoption of a new accounting

 

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standard at the beginning of the first quarter of 2010, operating income was, for the most part, unaffected by noncontrolling interests, which is not the case post-adoption. This new accounting standard requires the consolidation of variable interest entities of which we are considered to be the primary beneficiary, including Maidstone Bakeries up to the date of sale on October 29, 2010, as well as, on average, approximately 250 to 275 non-owned restaurants from fiscal 2008 to 2010. Previously, we did not consolidate Maidstone Bakeries and we consolidated approximately 120 non-owned restaurants, on average, in accordance with the prior accounting standard. Management believes that operating income attributable to Tim Hortons Inc. provides important information for comparison purposes to prior periods and for purposes of evaluating the Company’s operating income performance without the effects of the new accounting standard.

Adjusted operating income attributable to Tim Hortons Inc. excludes operating income attributable to noncontrolling interests, as described above, the gain on sale of our interest in Maidstone Bakeries, the $30.0 million allocation to restaurant owners and other Maidstone Bakeries related operating income adjustments, and excludes asset impairment and related closure cost charges. The closure of these New England restaurants impacted three U.S. operating markets, which represents approximately 2% of our overall systemwide restaurants. In addition, we have adjusted operating income for 2009 for the 53rd week of operations and for 2 months of Maidstone Bakeries’ operating income so that year-over-year results are on a comparable basis. We have excluded these items as we consider them to have a disproportionate impact on the overall performance of our consolidated business. They also distort the comparison of financial results year-over-year and therefore, the assessment of ongoing operational performance.

The presentation of these non-GAAP measures is made with operating income, the most directly comparable U.S. GAAP measure. We present information excluding amounts related to the impacts described above, and set forth on the table below, as it is more reflective of the way we manage and measure our performance internally. Therefore, these measures provide a more consistent view of management’s perspectives on underlying performance than the closest equivalent U.S. GAAP measure.

 

                 Change
from prior
year
 
     Fiscal Year     2010 vs.
2009
 
     2010     2009     %  
     (In millions)        

Operating income

   $ 872.2      $ 525.6        66.0

Less: Operating income attributable to noncontrolling interests

     (26.5     (27.8     n/m   
                        

Operating income attributable to Tim Hortons Inc.

   $ 845.7      $ 497.8        69.9

Add: Asset impairment and related closure costs

     28.3               n/m   

Add: Restaurant owner allocation

     30.0               n/m   

Less: Gain on sale of our interest in Maidstone Bakeries

     (361.1            n/m   

Less: Amortization of Maidstone Bakeries supply agreement

     (1.3            n/m   

Less: Maidstone Bakeries 2-month operating income adjustment (November/December)

            (4.8     n/m   

Less: 53rd week operating impact

            (6.7     n/m   
                        

Adjusted operating income attributable to Tim Hortons Inc.

   $ 541.6      $ 486.4        11.4
                        

All numbers rounded

n/m – not meaningful

Systemwide Sales Growth

Systemwide sales growth was 6.2%, as a result of continued same-store sales growth in Canada and the U.S and new restaurant expansion in fiscal 2010 and 2009.

 

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Our financial results are driven largely by changes in systemwide sales, which include restaurant-level sales at both franchised and Company-operated restaurants, although approximately 99.5% of our system is franchised. Franchise restaurant sales are reported to us by our franchisees. Franchise restaurant sales are not included in our Consolidated Financial Statements, other than approximately 275 non-owned restaurants, on average whose results of operations are consolidated with ours pursuant to variable interest entity accounting rules. The amount of systemwide sales impacts our royalties and rental income, as well as our distribution income. Changes in systemwide sales are driven by changes in average same-store sales and changes in the number of restaurants (i.e., historically the addition of new restaurants) and are ultimately driven by consumer demand. Systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. U.S. dollar sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes sales from our Republic of Ireland and United Kingdom licensed locations as these locations operate on a significantly different business model compared to our North American operations.

Average Same-Store Sales Growth

Average same-store sales, one of the key metrics we use to assess our performance, provides information on total retail sales at restaurants operating systemwide that have been operating for thirteen or more months (i.e., includes both franchised and Company-operated restaurants), and provides a useful comparison between periods. Our average same-store sales growth is generally attributable to several key factors, including new product introductions, improvements in restaurant speed of service and other operational efficiencies, hospitality initiatives, more frequent customer visits, expansion into broader menu offerings, promotional activities, and pricing. Restaurant-level price increases are primarily used to offset higher restaurant-level costs on key items such as coffee, wheat, cooking oils and other commodities, labour, supplies, utilities and business expenses. Our primary commodity, coffee, has seen high double-digit percentage increases in the past year, and while increases in our coffee supply costs have not been up as high as the overall markets, they are up significantly year-over-year, and there has been no relief in green coffee pricing in the first part of 2011. Costs of producing baked goods have also been under pressure. The most important input costs in our baked goods commodities basket, wheat and cooking oils, have also seen significant year-over-year increases. We secured pricing on our 2011 sugar supply last year at much lower prices, however, which will help offset some of the pressure on baked goods ingredient costs. As a result of these rising prices, we expect that certain regions and markets in Canada will need to increase prices to consumers in 2011 to help offset some of these significant cost pressures, as we did in February 2011 on certain products in our U.S. market. Across the U.S., prices on certain products, including coffee, increased approximately 3%. In 2010, the U.S. increased prices to consumers in May. The majority of the Canadian regions have minimum residual pricing remaining in the system in 2011, prior to any new increases. There can be no assurance that these price increases will result in an equivalent level of sales growth, which depends upon customers maintaining the frequency of their visits even with the new pricing.

In fiscal 2010, Canadian average same-store sales increased 4.9% over fiscal 2009, which was our 19th consecutive annual increase in Canada. In the U.S., average same-store sales (measured in U.S. currency) increased 3.9% in fiscal 2010 over fiscal 2009, which represented our 20th consecutive annual increase.

Product innovation is one of our focused strategies to drive same-store sales growth, including innovation at breakfast as well as other dayparts. Marketing and promotional activities which were designed to drive same-store sales growth contributed to our 2010 same-store sales results in both Canada and the U.S. In fiscal 2010, we had an active menu and product-focused promotional program designed to reinforce value to our customers. In addition, we rolled out our Canadian hospitality program and continued our Cold Stone Creamery co-branding initiative, with same-store sales benefiting from both of these initiatives. Our product offerings, promotional activity, and operational efficiencies led to transaction growth in 2010. Price increases in the front half of the year in Canada and in the latter half of the year in the U.S. also helped contribute to a higher average cheque.

 

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The following tables set forth average same-store sales growth by quarter for fiscal 2010, 2009, and 2008 and by year for the ten-year period from 2001 to 2010. Our historical average same-store sales trends are not necessarily indicative of future results.

 

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

Canada

          

2010

     5.2     6.4     4.3     3.9     4.9

2009

     3.4     1.7     3.1     3.4     2.9

2008

     3.5     5.7     3.8     4.4     4.4

U.S.

          

2010

     3.0     3.1     3.3     6.3     3.9

2009

     3.2     3.3     4.3     2.1     3.2

2008

     1.0     3.1     (0.6 )%      (0.1 )%      0.8

 

     Canada     U.S.  

2010

     4.9     3.9

2009 *

     2.9     3.2

2008

     4.4     0.8

2007

     6.1     4.1

2006

     7.7     8.9

2005

     5.5     7.0

2004 *

     7.8     9.8

2003

     5.3     4.5

2002

     7.9     9.9

2001

     8.5     7.7

10-year average

     6.1     6.0

 

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

New Restaurant Development

Opening restaurants in new and existing markets in Canada and the U.S. has been a significant contributor to our growth. Below is a summary of restaurant openings and closures for our 2010, 2009, and 2008 fiscal years:

 

    Fiscal Year 2010                 Fiscal Year 2009                 Fiscal Year 2008  
    Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total                 Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total                       Full-serve
Standard and
Non-standard
    Self-serve
Kiosks
    Total  

Canada

                           

Restaurants opened

    129        20        149            128        3        131              130               130   

Restaurants closed

    (16            (16         (29     (4     (33           (31     (5     (36
                                                                                       

Net change

    113        20        133            99        (1     98              99        (5     94   
                                                                                       

U.S.

                           

Restaurants opened

    44        52        96            45               45              63        73        136   

Restaurants closed

    (39     (18     (57         (1     (1     (2           (14            (14
                                                                                       

Net change

    5        34        39            44        (1     43              49        73        122   
                                                                                       

Total Company

                           

Restaurants opened

    173        72        245            173        3        176              193        73        266   

Restaurants closed

    (55     (18     (73         (30     (5     (35           (45     (5     (50
                                                                                       

Net change

    118        54        172            143        (2     141              148        68        216   
                                                                                       

 

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From the beginning of 2008 to the end of fiscal 2010, we opened 529 system restaurants including both franchised and Company-operated restaurants, net of restaurant closures. Typically, 20 to 40 system restaurants are closed annually, the majority of which are in Canada. Restaurant closures generally result from an opportunity to acquire a better location, which will permit us to upgrade size and layout or add a drive-thru. Restaurant closures made in the normal course typically occur at the end of a lease term or the end of the useful life of the principal asset. We have also closed, and may continue to close, restaurants for which the restaurant location has performed below our expectations for an extended period of time, and/or we believe that sales from the restaurant can be absorbed by surrounding restaurants. In fiscal 2010, we closed a total of 73 system restaurants, including the closure of 36 standard and 18 self-serve kiosks in our New England region. In 2009, we closed a total of 35 restaurants, the substantial majority being in Canada. In 2008, we closed a total of 50 restaurants, which included the closure of 10 restaurants in the fourth quarter of 2008 in New England (one additional restaurant was closed by February 1, 2009, for a total of 11 closures in southern New England). New England closures were outside of the normal course of operations, arising from strategic profitability reviews of our U.S. operations. These closures, therefore, triggered impairment reviews, ultimately resulting in impairment charges and related closure costs in fiscal 2010 and 2008.

Included in our fiscal 2010 U.S. restaurant openings were 52 self-serve kiosks (nil in 2009 and 73 in 2008) primarily located within Tops Friendly Market stores as part of our continued strategic alliance. Self-serve kiosk locations have significantly different economics than our standard and non-standard restaurants, including substantially less capital investment, as well as significantly lower sales and, therefore, lower associated royalties and distribution income; however, such kiosks serve to increase our brand awareness and create another outlet to drive convenience, which is important in our developing markets.

One of our strategic planning initiatives is to grow differently in ways we have not grown before. Initiatives in support of this strategy include the expansion of our Cold Stone Creamery co-branding concept. In 2009, we began to co-brand certain U.S. restaurants with Cold Stone Creamery and, in the second half of 2009; we expanded this initiative to Canada. In the fourth quarter of 2009, we entered into two separate licensing arrangements with Kahala Franchise Corp., the franchisor of the Cold Stone Creamery brand. The nature and purpose of the arrangements were to expand the parties’ co-branding initiatives. We have exclusive development rights in Canada, and certain rights to use licenses within the U.S., in both cases to operate ice cream and frozen confections retail outlets. As of January 2, 2011, we had 170 co-branded locations, including 79 co-branded locations in the U.S. (73 in Tim Hortons restaurants and 6 in Cold Stone Creamery locations) and 91 co-branded locations in Tim Hortons restaurants in Canada. In addition, we have a few Cold Stone Creamery locations that are operating on a limited term agreement, and we are testing some take-home-only formats inside our restaurants.

In addition to the Cold Stone Creamery co-branding initiative, we began testing new concept restaurants in certain U.S. markets to differentiate our customer offering as a cafe and bake shop destination. At the end of fiscal 2010, we had four new concept restaurants opened in the U.S. These restaurants will be utilized to test various new products, equipment and restaurant design features in support of our U.S. strategic plan. During 2011, we plan to incorporate various restaurant design features, product offerings, and/or equipment from these new concept restaurants into our new restaurant development and renovation programs.

The following table shows our restaurant count as of the end of fiscal 2010, 2009 and 2008 and provides a breakdown of our Company-operated and franchised restaurants. At January 2, 2011, 3,730 system restaurants across Canada and the U.S., or 99.5%, were franchised (representing 99.5% in Canada and 99.3% in the U.S.).

 

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Systemwide Restaurant Count

 

     Fiscal Year  
     2010     2009     2008  

Canada

      

Company-operated

     16        13        15   

Franchised – standard and non-standard

     3,020        2,904        2,803   

Franchised – self-serve kiosks

     112        98        99   
                        

Total

     3,148        3,015        2,917   
                        

% Franchised

     99.5     99.6     99.5

U.S.

      

Company-operated

     4        5        19   

Franchised – standard and non-standard

     475        471        413   

Franchised – self-serve kiosks

     123        87        88   
                        

Total

     602        563        520   
                        

% Franchised

     99.3     99.1     96.3

Total system

      

Company-operated

     20        18        34   

Franchised – standard and non-standard

     3,495        3,375        3,216   

Franchised – self-serve kiosks

     235        185        187   
                        

Total

     3,750        3,578        3,437   
                        

% Franchised

     99.5     99.5     99.0

In fiscal 2008 and 2009, we converted most of our U.S. Company-operated restaurants to operator agreements. The effect of these conversions to date has been slightly accretive to operating income. We believe that, in the long-term, this franchising strategy generally provides better overall profitability to the business. Initially, after conversion, we generally provided additional relief to the operator, and we have been required to consolidate some of these restaurants in accordance with variable interest entity accounting rules for consolidations, which changed effective for our first quarter of 2010. We consolidated approximately 120 non-owned restaurants, on average, under the previous accounting standard and, with the adoption of the new variable interest entities accounting standard, we are now consolidating, on average, approximately 275 non-owned restaurants in fiscal 2010. We adopted this standard with retroactive application to prior periods for comparability.

Segment Operating Income (Loss)

Systemwide sales and average same-store sales growth is affected by the business and economic environments in Canada and the U.S. We manage and review financial results from Canadian and U.S. operations separately. We, therefore, have determined the reportable segments for our business to be the geographic locations of Canada and the U.S. Each segment includes all manufacturing and distribution operations that are located in their respective geographic locations. We continue to manage the development of our international operations in the Republic of Ireland and the United Kingdom, which consist primarily of branded, licensed self-serve kiosk locations, corporately. Our reportable segments exclude the effects of the variable interests accounting standard, reflective of the way the business is managed.

 

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

 

     Fiscal 2010 Compared to Fiscal 2009  
     2010     % of
Revenues
    2009     % of
Revenues
    Change  
             Dollars     Percentage  
     (In thousands, except where noted)  

Operating Income (Loss)

            

Canada (1) (2)

   $ 904,768        35.7   $ 538,292        22.1   $ 366,476        68.1

U.S. (3)

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

Reportable segment operating income

     886,405        34.9     543,132        22.3     343,273        63.2

Variable interest entities

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

Corporate charges(4)

     (40,701     (1.6 )%      (45,292     (1.9 )%      4,591        (10.1 )% 
                                                

Consolidated operating income

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

 

     Fiscal 2009 Compared to Fiscal 2008  
     2009     % of
Revenues
    2008     % of
Revenues
    Change  
             Dollars     Percentage  
     (In thousands, except where noted)  

Operating Income (Loss)

            

Canada (1)

   $ 538,292        22.1   $ 512,255        23.0   $ 26,037        5.1

U.S. (3)

     4,840        0.2     (26,488     (1.2 )%      31,328        n/m   
                                                

Reportable segment operating income

     543,132        22.3     485,767        21.8     57,365        11.8

Variable interest entities

     27,762        1.1     29,631        1.3     (1,869     (0.6 )% 

Corporate charges(4)

     (45,292     (1.9 )%      (36,951     (1.6 )%      (8,341     22.6
                                                

Consolidated operating income

   $ 525,602        21.6   $ 478,447        21.5   $ 47,155        9.9
                                                

 

(1)

While the adoption of amended accounting rules for variable interest entities resulted in the consolidation of Maidstone Bakeries, the Company’s chief decision maker viewed and evaluated the performance of the Canadian segment with Maidstone Bakeries accounted for on an equity accounting basis, which reflects 50% of its operating income (consistent with views and evaluations prior to the adoption of the accounting standard). As a result, the net revenues and the remaining 50% of operating income of Maidstone Bakeries up to October 29, 2010, the date of disposition, were included in the Variable interest entities line item, along with revenues and operating income from our non-owned consolidated restaurants.

(2)

Fiscal 2010 includes a $361.1 million gain recognized from the sale for our 50% interest in Maidstone Bakeries, less $30.0 million allocated to restaurant owners and $1.3 million income relating to the amortization of a deferred gain in connection with our continuing supply agreement with Maidstone Bakeries.

(3)

The U.S. operating income (loss) includes $28.3 million (2010) and $21.3 million (2008) of asset impairment and related closure costs in connection with the closure of 36 restaurants and 18 self-serve kiosks primarily in the New England region in 2010 (11 restaurants in 2008).

(4)

Corporate charges include certain overhead costs that are not allocated to individual business segments, the impact of certain foreign currency exchange gains and losses, and the operating income from international operations (discussed above), which continue to be managed corporately.

n/m – The comparison is not meaningful.

Fiscal 2010 compared to Fiscal 2009

Reportable segment operating income increased $343.3 million, or 63.2%, in fiscal 2010 to $886.4 million compared to $543.1 million in fiscal 2009, and, as a percentage of total revenues, was 34.9% and 22.3%, respectively. Our Canadian segment includes a $361.1 million gain on the sale of our interest in Maidstone Bakeries, less $30.0 million allocated to our restaurant owners and $1.3 million of income relating to the

 

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amortization of our deferred gain in connection with our continuing supply agreement with Maidstone Bakeries. Also included in our 2010 segment operating income are asset impairment and related closure costs of $28.3 million related to our New England region that was recorded in our U.S. segment. Excluding the gain on sale and related impacts, allocation to restaurant owners and asset impairment and related closure costs, segment operating income would have increased $40.5 million, or 7.5%. Fiscal 2010 has 52 weeks of operations whereas fiscal 2009 includes a 53rd week of operations. The 53rd week increased 2009 segment revenues and reportable segment operating income growth rates by approximately 1.8% and 1.5%, respectively.

Canada

Exclusive of the gain on the sale of our interest in Maidstone Bakeries and the $30.0 million restaurant owner allocation, described above, our Canadian segment operating income increased $35.4 million, or 6.6%, from $538.3 million in fiscal 2009 to $573.7 million in fiscal 2010, primarily due to systemwide sales increases and increased contribution from our distribution business. Canadian same-store sales growth was 4.9% in fiscal 2010, which includes some pricing benefits. In fiscal 2010, we opened 149 restaurants in Canada and closed 16, compared to opening 131 restaurants and closing 33 in fiscal 2009. Transaction growth continued to add to same-store sales growth, benefiting from our ongoing menu initiatives, promotions, and operational initiatives such as our hospitality program. We also co-branded 78 locations in 2010 with Cold Stone Creamery, which contributed slightly to the segment’s same-store sales growth and contributed positively to our Canadian franchise fee income. In 2011, we will continue our focus on driving same-store sales, through menu and product innovation to expand our market share across various dayparts and product categories, with a particular focus on morning and afternoon/evening snacking dayparts, as well as lunch. We also plan on leveraging our marketing strengths and advantages and will continue to promote improvement in restaurant service levels through our hospitality program (see Item 1. Business—Business Overview and 2011 Objectives). There is minimal residual pricing remaining in the system in 2011, prior to any new increases.

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

U.S.

In 2010, our U.S. segment had an operating loss of $18.4 million, compared to operating income of $4.8 million in 2009. The operating loss is entirely due to the asset impairment and closure costs recorded in the back half of 2010 relating to our underperforming restaurants in the New England region (described below). Excluding the asset impairment and related closure costs, we would have more than doubled our operating income from fiscal 2009 in our U.S. segment to $9.9 million in fiscal 2010. This is a considerable improvement over the prior year, due, in large part, to same-store sales growth of 3.9% amid a continued challenging macro-economic climate in many of our core markets in the U.S. The closure of the underperforming restaurants also contributed to the improvement in the U.S. segment operating income as they resulted in higher rents and royalties (due to lower relief). We plan on reinvesting a portion of our savings from these closed restaurants into our core U.S. growth markets in Northeast and Midwest U.S. in 2011 to increase our advertising and marketing scale and increase awareness of our brand. In addition, as a result of rising commodity costs, including coffee, the U.S. increased prices to consumers in February 2011 by approximately 3%. The U.S. had previously increased pricing in May 2010.

 

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During the third quarter of 2010, an impairment review was initiated related to our Portland, Providence and Hartford markets in the New England region based on their same-store sales growth and financial performance, which were continuing to underperform against expectations. Upon completion of this review, we determined that the future expected cash flows of these markets were insufficient to recover the carrying value of the long-lived assets in these markets. Commensurate with this review, we decided to close 34 restaurants and 18 self-serve kiosks in our Hartford and Providence markets and two restaurants in our Portland market. The Providence and Hartford markets are among the most densely penetrated market areas in U.S. by quick service restaurants, and we were not successful in expanding our customer base to the levels required for future profitability. As a result, total asset impairment and related closure costs of $28.3 million were recorded in our U.S. operating segment in the latter half of 2010, comprised of $18.4 million in an asset impairment charge and $9.9 million in restaurant closure costs representing primarily lease commitment obligations. We intend to settle the majority of these obligations, to the extent possible in 2011, with the obligation being paid out in cash, as required. These markets represent a relatively small portion of our overall system in the U.S., but have had a disproportionately negative impact on earnings, average unit volumes, and same-store sales growth in the U.S. segment. Average unit volumes for standard restaurants in the Providence and Hartford markets were approximately half of other core markets in the U.S.

While we expect the decision to close the underperforming restaurants will contribute directly to earnings improvement, primarily through reduced depreciation and lower franchise relief provided to support these underperforming restaurants, in the U.S. segment throughout 2011, we will be redeploying a portion of these savings into advertising programs in our other core markets (as described above), which we expect will help drive sales improvements. Our U.S. segment operating income may continue to show volatility, quarter-to-quarter and year-to-year, as we expand our new unit growth. When we enter new markets, average unit sales volumes for our franchisees may be lower than sales levels in our more established markets. In addition, based on past experience, as we add new restaurants in developing markets, average unit sales growth for existing restaurants may be affected for a period of time until awareness of the brand improves and the market adjusts to the added convenience that new locations provide. In certain situations, we provide relief of rents and royalties, and in some cases, relief for other operating costs, for a period of time to support these franchisees. Such relief offsets our rent and royalty revenues. In developing markets, when we transition a restaurant from a Company-operated restaurant to either a full franchised restaurant or a restaurant governed by an operator agreement, we also generally provide relief to the franchisee for an initial period.

We are typically able to identify franchisees for new restaurants, but in certain developing markets, it may be more challenging; however, it has not historically been a major impediment to our growth. Despite the current economic climate and credit conditions, our franchisees continue to have access to lending programs with third-party lenders, although processing may take longer and costs may be higher, consistent with prevailing market conditions. We continue to experience a higher number of past-due notes under our franchise incentive program with approximately 70% of the notes past due as of January 2, 2011. In many cases, we have also chosen to hold the note for longer periods of time than we have historically done to ensure the restaurant has achieved certain profitability targets. In the event a franchisee cannot repay the note, we will take back ownership of the restaurant and equipment, which effectively collateralizes the note and, therefore, minimizes our risk. In addition, we are also entering into operator agreements more frequently than full franchise agreements when opening new restaurants, and once the restaurant is established and reaches certain profitability measures, we may sell the restaurant to the operator under a full franchise agreement.

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

 

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message with our consumers in a tangible way. In the U.S., we also introduced the use of coupons as a vehicle to attract new customers and introduce them to our brand and new product offerings. While we do not intend to stray from our core everyday positioning of quality food at reasonable prices, we are working with our franchisees to communicate and interact with customers in a manner that responds to their current situation and the economic environment. We believe that continued business refinements will help, over time, position our U.S. business to defend aggressive competitive discounting activity, while also creating sales momentum.

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

In 2011, we plan to further prioritize U.S. restaurant development capital spending among our core growth markets which are most developed. Our strategy is designed to increase our density in these core markets, and to accelerate the process to reach critical mass for both customer convenience and advertising scale. While targeting a considerable increase in U.S. segment operating income contribution in 2011, we are also investing corporately in expanded brand development and marketing activities across our markets and, in particular, in these core growth markets during the upcoming year. We also plan to test and roll-out menu items that help differentiate our brand and offerings as a cafe and bake shop destination.

Variable interest entities

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

Corporate charges

Corporate charges include certain overhead costs that are not allocated to individual business units and the impact of certain foreign currency exchange gains and losses. Corporate charges were $40.7 million in fiscal 2010 and $45.3 million in fiscal 2009. The $4.6 million decrease primarily reflects the professional advisory and shareholder costs associated with our public company reorganization in 2009 that did not recur in 2010, which amounted to $7.3 million. Partially offsetting these lower costs were higher salary and benefit costs and higher professional fees related to other corporate initiatives including developing our international strategy.

The Company, through a wholly-owned Irish subsidiary, has self-serve kiosks and on a limited basis, some full-serve kiosks in certain licensed locations within convenience stores in the Republic of Ireland and the United Kingdom. The self-serve kiosks feature our premium coffee, tea, specialty hot beverages and a selection of donuts and muffins. As of January 2, 2011, there were 275 licensed locations in the Republic of Ireland and in the United Kingdom (2009 – 291). These kiosks are operated by independent licensed retailers. At present, the distribution of coffee and donuts through licensed locations with respect to these self-serve kiosks is not a material contributor to our operating income, and therefore, is netted in corporate charges. These arrangements have resulted in incremental distribution sales and royalties. Our financial arrangements for these self-serve

 

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kiosks are different than our traditional franchise models, and we may not, therefore, collect similar data or include these locations in certain of our metrics, including systemwide and same-store sales growth.

We recently announced that we have entered into a Master License Agreement with Apparel Group to develop up to 120 multi-format restaurants in markets in the GCC. Our top priority continues to be growing our Canadian and U.S. businesses. We will manage this expansion corporately. Operating income from our international operations, which currently are insignificant, will continue to be included in Corporate charges in our segmented operating results. In 2011, we expect to invest $2 million to $4 million, net of royalties, license fees and other costs, to support Apparel Group’s investments to launch the business in our GCC market entry.

Fiscal 2009 compared to Fiscal 2008

Segment operating income increased $57.3 million, or 11.8%, in fiscal 2009 to $543.1 million compared to $485.8 million in fiscal 2008, and, as a percentage of total revenues, was 22.3% and 21.8%, respectively. Included in our 2008 segment operating income were asset impairment and related closure cost charges of $21.3 million that were recorded in our U.S. segment. Excluding the asset impairment and related closure costs, segment operating income would have increased $36.1 million, or 7.1%. Fiscal 2009 includes a 53rd week of operations whereas fiscal 2008 only had 52 weeks of operations. The 53rd week increased segment revenues and reportable segment operating income growth rates by approximately 1.8% and 1.5%, respectively.

Canada

Our Canadian segment operating income increased $26.0 million, or 5.1%, from $512.3 million in fiscal 2008 to $538.3 million in fiscal 2009, primarily due to systemwide sales increases and increased contribution from our distribution business. Canadian same-store sales growth was 2.9% in fiscal 2009, including some pricing contributions. In fiscal 2009, we opened 131 restaurants in Canada and closed 33, compared to opening 130 restaurants and closing 36 in fiscal 2008.

Canadian systemwide sales growth drove higher rents and royalties income, as well as higher income from our distribution business. The distribution business also benefited from incremental income related to new products in our supply chain. Distribution is a critical element of our business model as it allows us to control costs to our franchisees and service our restaurants efficiently and effectively while contributing to our profitability. During 2009, we supported our franchisees through the difficult economic conditions by not passing through certain cost increases to franchisees incurred in our distribution business. Partially offsetting this growth in segment operating income were lower franchise fee income; higher general and administrative expenses, due largely to additional headcount required to support the growth of our business.

U.S.

In fiscal 2009, our U.S. segment had operating income of $4.8 million, compared to an operating loss of $26.5 million in fiscal 2008, which exceeded our 2009 break-even operating income target. The significant improvement in our U.S. segment operating loss was, in part, due to the $21.3 million asset impairment and related closure costs recorded during the fourth quarter of 2008 (see below). Excluding the asset impairment and related closure costs, our 2008 operating loss in the U.S. segment would have been $5.2 million. Therefore, the 2009 results compared to 2008, excluding the impairment and related closure cost impacts, reflect a $10.0 million improvement from 2008. The closure of the underperforming Company-operated restaurants, and the related asset impairment charge contributed to the improvement in the U.S. segment operating income as they resulted in lower Company-operated restaurant losses and lower depreciation and rent expense, benefiting operating income by $4.6 million. In addition, lower general and administrative expense and contributions from vertical integration also positively impacted operating income. The U.S. operating segment income improvement also resulted from higher systemwide sales, which benefited distribution and rents and royalties income. Our 2009 co-branding initiative with Cold Stone Creamery contributed a significant portion of our sales growth, leading to rents and royalties revenues and, in some cases, lower relief provided to franchisees. Our core brand

 

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same-store sales continued to be positive, excluding the impacts of co-branding. Partially offsetting these improvements were additional relief provided to certain franchisees, particularly as we transitioned more Company-operated restaurants to franchisees or operator agreements, and lower franchise fee income.

In 2009, we explored other complementary strategic development opportunities to grow the business, including our co-branding initiative, our expansion into New York City utilizing unique restaurant formats, and the opening of restaurants on two U.S. military bases. We saw the benefits of these initiatives in our U.S. systemwide sales results in 2009. These initiatives complement our core strategy of selectively developing full-serve, standalone Tim Hortons locations in our core markets.

We also adapted our marketing and promotional activities to the challenging economic environment and related circumstances. In 2009, we continued to see a large amount of competitive discounting and, as a result, we targeted “combo” food programs at a variety of value price points, with the intent to strengthen and build on our price/value position and enhance this message with U.S. consumers. We introduced the use of coupons as a vehicle to attract new customers and introduce them to our brand and new product offerings.

During fiscal 2009, we opened 45 new restaurants, and closed two restaurants in the U.S., as compared to opening 136 new restaurants, including 73 self-serve kiosks, and closing 14 restaurants, in fiscal 2008. The 2008 self-serve openings included 71 that were part of a strategic alliance with Tops Friendly Markets and are located in Tops stores in western and central New York, and northern Pennsylvania.

We typically expect price increases in one or more regions during the course of the year, but there can be no assurance that price increases will result in an equivalent level of sales growth, which depends upon customer response to the new pricing, and levels of discretionary spending, and our promotional activities. In 2009, we did not implement any price increases given the challenging U.S. economic environment.

Additionally, in 2009, we completed our initiative to transition most of our company-operated restaurants to franchise or operator agreements. This shift was part of our longer-term strategy of having a primarily franchised-system model, similar to our Canadian operations. At the end of 2009, approximately 99.1% of our U.S. restaurants were franchised, compared to 96.3% at the end of 2008. Our historical experience indicates that franchised restaurants are more successful for the franchisee, and therefore us, over the long term. While transitioning company restaurants to franchise or operator agreements usually results in an initial increase in franchisee relief, particularly in our newer markets, and may increase the number of restaurants that we are required to consolidate in accordance with applicable accounting rules, this increase in relief is typically less than the operating loss we would otherwise incur from operating the restaurants corporately. As a result, for 2009, there was a net slightly positive benefit to our U.S. segment as a result of the completion of this initiative.

Variable interest entities

Our variable interest entities’ income before income tax pertains to our previously-held 50% ownership in Maidstone Bakeries and certain non-owned restaurants that we consolidate in accordance with applicable accounting rules. Our variable interest entities’ income before income tax was $27.8 million in fiscal 2009 and $29.6 million in fiscal 2008. Included in this income was $26.2 million and $28.0 earned by Maidstone Bakeries with the difference representing income earned on an average of 250 to 275 non-owned consolidated restaurants from fiscal 2008 to fiscal 2009, respectively. During 2009, we had a gradual shift towards a greater proportion of U.S. non-owned consolidated restaurants as a result of the progression of U.S. restaurants to an owner/operator model, versus Company-operated restaurants.

Corporate charges

Corporate charges include certain overhead costs that are not allocated to individual business units and the impact of certain foreign currency exchange gains and losses. Corporate charges were $45.3 million in fiscal

 

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2009 and $37.0 million in fiscal 2008. The $8.3 million increase primarily reflects the professional advisory and shareholder costs associated with our public company reorganization in 2009, which amounted to $7.3 million. Included in 2008 corporate charges was a management restructuring charge, net of savings, of $2.5 million.

The Company, through a wholly-owned Irish subsidiary, has self-serve kiosks and on a limited basis, some full-serve kiosks in certain licensed locations within convenience stores in the Republic of Ireland and the United Kingdom. The self-serve kiosks feature our premium coffee, tea, specialty hot beverages and a selection of donuts and muffins. As of January 3, 2010, there were 291 licensed locations in the Republic of Ireland and in the United Kingdom (2008 – 293).

Results of Operations

Fiscal 2010 Compared to Fiscal 2009

Below is a summary of comparative results of operations and a more detailed discussion of results for fiscal 2010 and 2009. Financial definitions can be found immediately following “Liquidity and Capital Resources.”

 

     Fiscal 2010 Compared to Fiscal 2009     Change from Prior
Year
 
     2010     % of
Revenues
    2009     % of
Revenues
    $     %  
     (in thousands, except where noted)  

Revenues

            

Sales

   $ 1,755,244        69.2   $ 1,704,065        69.9   $ 51,179        3.0

Franchise revenues:

            

Rents and royalties(1)

     687,039        27.1     644,755        26.4     42,284        6.6

Franchise fees

     94,212        3.7     90,033        3.7     4,179        4.6
                                                
     781,251        30.8     734,788        30.1     46,463        6.3
                                                

Total revenues

     2,536,495        100.0     2,438,853        100.0     97,642        4.0
                                                

Costs and expenses

            

Cost of sales

     1,527,405        60.2     1,464,844        60.1     62,561        4.3

Operating expenses

     246,335        9.7     236,784        9.7     9,551        4.0

Franchise fee costs

     91,743        3.6     86,903        3.6     4,840        5.6

General and administrative expenses

     147,300        5.8     141,739        5.8     5,561        3.9

Equity (income)

     (14,649     (0.6 )%      (13,700     (0.6 )%      (949     6.9

Asset impairment and related closure costs

     28,298        1.1            0.0     28,298        n/m   

Other (income), net

     (1,100     0.0     (3,319     (0.1 )%      2,219        (66.9 )% 
                                                

Total costs and expenses, net

     2,025,332        79.8     1,913,251        78.4     112,081        5.9
                                                

Gain on sale of interest in Maidstone Bakeries

     361,075        (14.2 )%             0.0     (361,075     n/m   
                                                

Operating income

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

Interest (expense)

     (26,642     (1.1 )%      (21,134     (0.9 )%      (5,508     26.1

Interest income

     2,462        0.1     1,950        0.1     512        26.3
                                                

Income before income taxes

     848,058        33.4     506,418        20.8     341,640        67.5

Income taxes

     200,940        7.9     186,606        7.7     14,334        7.7
                                                

Net income

     647,118        25.5     319,812        13.1     327,306        102.3

Net income attributable to noncontrolling interests

     23,159        0.9     23,445        1.0     (286     (1.2 )% 
                                                

Net income attributable to Tim Hortons Inc.

   $ 623,959        24.6   $ 296,367        12.2   $ 327,592        110.5
                                                

 

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n/m – The comparison is not meaningful.
(1)

Rents and royalties revenues consist of (i) royalties, which typically range from 3.0% to 4.5% of gross franchise restaurant sales and (ii) rents, which consist of base and percentage rent in Canada and percentage rent only in the U.S., and typically range from 8.5% to 10.0% of gross franchise restaurant sales. Franchise restaurant sales are reported to us by our franchisees. Franchise restaurant sales are not included in our Consolidated Financial Statements, other than approximately 275 non-owned restaurants, on average whose results of operations are consolidated with ours pursuant to applicable accounting rules. Franchise restaurant sales do, however, result in royalties and rental income, which are included in our franchise revenues, as well as distribution income. The reported franchise restaurant sales (including those consolidated pursuant to applicable accounting rules) were:

 

     Fiscal Years  
     2010      2009  

Franchised restaurant sales:

     

Canada (in thousands of Canadian dollars)

   $ 5,181,831       $ 4,880,934   

U.S. (in thousands of U.S. dollars)

   $ 439,227       $ 409,882   

Revenues

Sales

Our sales include distribution sales, sales from Company-operated restaurants, and sales from variable interest entities that are required to be consolidated pursuant to applicable accounting rules.

Sales for fiscal 2010 increased $51.2 million, or 3.0%, over fiscal 2009, to $1,755.2 million. The increase in sales was primarily driven from our distribution business; however, partially offsetting the increase were lower sales from variable interest entities consolidated in accordance with applicable accounting rules and Company-operated restaurants. Also negatively impacting year-over-year sales growth is the $30.0 million commitment made to restaurant owners which has been recorded as a reduction of sales. Fiscal 2009 also had the benefit of an additional week of sales from the inclusion of a 53rd week of operations, which impacted sales growth in 2010 by approximately 1.7%.

Distribution sales. Distribution sales increased $138.4 million, or 10.7%, from $1,295.7 million to $1,434.1 million. New products managed through our supply chain, continued systemwide sales growth, product mix and higher commodity prices contributed to distribution sales growth. New products managed through the supply chain, including some products from Maidstone Bakeries, represented approximately $120.7 million in incremental sales (and incremental corresponding costs—see below). Systemwide sales growth, which reflects higher same-store sales and sales from a higher number of restaurants, represented approximately $48.8 million of total distribution sales growth. Product mix and pricing related primarily to higher prices for coffee and other commodities due to higher underlying costs also contributed to the sales increase. Distribution sales growth was negatively impacted by the $30.0 million commitment to restaurant owners made in relation to the sale of Maidstone Bakeries in the fourth quarter of 2010. Distribution sales growth was also negatively impacted by approximately 1.9% due to the inclusion of a 53rd week of operations in fiscal 2009, as well as fluctuations in foreign exchange rates.

Distribution sales represented approximately 56.5% of our total revenues in fiscal 2010 compared to 53.1% of our revenues in fiscal 2009. Our revenue mix has shifted towards a higher proportion of distribution sales, due primarily to new products being managed through the supply chain, partially offset by lower sales from our variable interest entities. Sales as a percentage of total revenues were relatively consistent year-over-year at 69.2% in fiscal 2010 as compared to 69.9% in fiscal 2009.

 

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Our distribution revenues are subject to changes related to the underlying costs of key commodities, such as coffee, sugar, etc. Underlying product costs can also be impacted by currency changes. Increases and decreases in product costs may be passed through to franchisees, resulting in higher or lower sales and higher or lower costs of sales from our distribution business. In 2009, we did not pass on all cost increases to our franchisees due to the weaker economic climate. Recently, the restaurant industry has experienced sharp increases across-the-board in the commodities basket. Our primary commodity, coffee, has seen significant increases in the past year. Other key commodities have also seen increases. As a result of these increasing commodity costs, and with our goal to provide the restaurant owner with consistent, predictable pricing over longer periods of time and to secure a stable supply chain, we have extended our forward purchasing beyond our historical pattern of six months, and we now have coverage for our key commodities for the remainder of 2011. Commodity cost increases will be passed on to our restaurant owners in 2011. These commodity cost changes may also impact margins as many of our products are typically priced based on a fixed-dollar mark-up and this can, therefore, create volatility year-over-year.

Company-operated restaurants sales. Company-operated restaurants sales decreased from $24.2 million in fiscal 2009 to $22.2 million in fiscal 2010. We operated on average 20 restaurants in 2010 compared to 26 Company-operated restaurants in 2009, resulting in lower sales. We ended 2010 with 16 Company-operated restaurants in Canada, and four in the U.S., representing in total approximately 0.5% of total systemwide restaurants. On occasion, we may open Company-operated restaurants when we enter new markets in the U.S., and we may also repurchase restaurants from existing franchisees, operate them corporately for a short period of time, and then refranchise these restaurants. As such, Company-operated revenue is impacted by the timing of these events throughout the year and also the type of restaurant (standard or non-standard) that we own.

Variable interest entities’ sales. Variable interest entities’ sales include sales from the consolidation of our previously-held interest in Maidstone Bakeries and from the consolidation of certain non-owned restaurants in accordance with applicable accounting rules. Variable interest entities’ sales were $299.0 million and $384.2 million in fiscal 2010 and 2009, respectively. The decline is mainly due a more significant proportion of output from Maidstone Bakeries being managed and billed through our supply chain. In addition, the sale and de-consolidation of Maidstone Bakeries in October 2010 resulting in only 10 months of sales in fiscal 2010 as compared to fiscal 2009, which had a full year of operations. The majority of non-owned restaurants that are consolidated operate either solely under an operator agreement or are franchised locations participating in our U.S. franchise incentive program. On average, we consolidated approximately 275 non-owned restaurants during fiscal 2010 and 2009. While the overall number of non-owned consolidated restaurants has remained consistent, a greater proportion of U.S. non-owned restaurants are being consolidated as a result of the progression of U.S. restaurants to the owner/operator model from Company-operated restaurants (noted previously). These U.S. locations have historically had lower sales and income than Canadian non-owned restaurants that were previously consolidated. Also contributing to the year-over-year sales decline is the impact of approximately 1.3% from the inclusion of a 53rd week of operations in fiscal 2009.

Foreign exchange. Sales from our U.S. segment are denominated in U.S. dollars and translated into Canadian dollars for reporting of our consolidated results. The strengthening of the Canadian dollar relative to the U.S. dollar decreased the value of reported sales by approximately 1.2% in fiscal 2010 compared to the value that would have been reported had there been no exchange rate movement during fiscal 2010.

Franchise Revenues

Rents and Royalties. Revenues from rents and royalties were $687.0 million in fiscal 2010, an increase of $42.3 million, or 6.6%, over fiscal 2009, ahead of fiscal 2010 systemwide sales growth of 5.3%, unadjusted for currency. Systemwide sales growth was driven by higher same-store sales and sales from new restaurants opened during the year, both of which result in higher royalty and rental revenues because both are typically based, in whole or part, on a percentage of restaurant sales.

 

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Rents and royalty growth was driven by overall systemwide sales growth and lower relief, partially offset by unfavourable foreign exchange. Both Canada and the U.S. (excluding the effect of foreign exchange translation) contributed to our growth in rents and royalties revenues largely in proportion to their overall share of systemwide sales. Continued same-store sales growth provided $19.6 million to our rents and royalties growth, while the addition of 174 new full-serve restaurants in the system (and 2009 restaurants which have not yet been open for more than 12 months) year-over-year contributed approximately $22.7 million. Relief, which was primarily all within our U.S. operations, was lower in fiscal 2010 on a year-to-date basis as compared to fiscal 2009, partially due to foreign exchange and lower relief provided, due mainly from one less week of operations in 2010 and, to a lesser extent, from the closure of restaurants in the New England region. We believe this trend of less relief will continue in 2011 as we focus on our core growth markets in the Northeast and Midwest U.S. and have the benefit of a full year of closures in New England. As previously mentioned, we will be redeploying a portion of savings from New England closure into advertising spend in our other core markets (as described above), which we expect will help drive sales improvements.

Rents and royalties growth was negatively impacted by approximately 1.8% due to an additional week of sales from the inclusion of a 53rd week in fiscal 2009 which we did not benefit from in fiscal 2010.

Franchise Fees. Franchise fees include the sales revenue from initial equipment packages, as well as fees to cover costs and expenses related to establishing a franchisee’s business. In the U.S., we have a franchise incentive pro