Wendy's Co - FORM 10-Q - November 8, 2017

Attached files

file	filename
EX-32.1 - CEO & CFO 906 CERTIFICATIONS - Wendy's Co	twc_ex321xq3-17.htm
EX-31.2 - CFO 302 CERTIFICATION - Wendy's Co	twc_ex312xq3-17.htm
EX-31.1 - CEO 302 CERTIFICATION - Wendy's Co	twc_ex311xq3-17.htm
EX-10.1 - NONQUALIFIED STOCK OPTION AWARD AGREEMENT - Wendy's Co	twc_ex101xq3-17.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



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

For the quarterly period ended October 1, 2017



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

For the transition period from ______________ to _______________

Commission file number: 1-2207

THE WENDY’S COMPANY

(Exact name of registrants as specified in its charter)



Delaware		38-0471180
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

One Dave Thomas Blvd., Dublin, Ohio		43017
(Address of principal executive offices)		(Zip Code)

(614) 764-3100

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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 [ ]

Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [x]

There were 242,196,738 shares of The Wendy’s Company common stock outstanding as of November 2, 2017.

THE WENDY’S COMPANY AND SUBSIDIARIES

INDEX TO FORM 10-Q



	Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements	3
Unaudited Condensed Consolidated Balance Sheets as of October 1, 2017 and January 1, 2017	3
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended October 1, 2017 and October 2, 2016	4
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended October 1, 2017 and October 2, 2016	5
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended October 1, 2017 and October 2, 2016	6
Notes to Condensed Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3. Quantitative and Qualitative Disclosures about Market Risk	35
Item 4. Controls and Procedures	36

PART II: OTHER INFORMATION	37
Item 1. Legal Proceedings	39
Item 1A. Risk Factors	39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 6. Exhibits	41
Signatures	42

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands Except Per Share Amounts)



	October 1, 2017			January 1, 2017
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$	186,629		$	198,240
Restricted cash	34,042			57,612
Accounts and notes receivable, net	115,390			98,825
Inventories	2,895			2,851
Prepaid expenses and other current assets	23,762			19,244
Advertising funds restricted assets	58,163			75,760
Total current assets	420,881			452,532
Properties	1,252,246			1,192,339
Goodwill	743,508			741,410
Other intangible assets	1,332,130			1,322,531
Investments	58,171			56,981
Net investment in direct financing leases	213,649			123,604
Other assets	69,688			49,917
Total assets	$	4,090,273		$	3,939,314

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	29,359		$	24,652
Accounts payable	25,776			27,635
Accrued expenses and other current liabilities	121,124			102,034
Advertising funds restricted liabilities	58,163			75,760
Total current liabilities	234,422			230,081
Long-term debt	2,696,520			2,487,630
Deferred income taxes	419,293			446,513
Other liabilities	277,443			247,354
Total liabilities	3,627,678			3,411,578
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.10 par value; 1,500,000 shares authorized; 470,424 shares issued; 242,565 and 246,574 shares outstanding, respectively	47,042			47,042
Additional paid-in capital	2,883,504			2,878,589
Accumulated deficit	(305,703		)	(290,857		)
Common stock held in treasury, at cost; 227,859 and 223,850 shares, respectively	(2,117,232		)	(2,043,797		)
Accumulated other comprehensive loss	(45,016		)	(63,241		)
Total stockholders’ equity	462,595			527,736
Total liabilities and stockholders’ equity	$	4,090,273		$	3,939,314

See accompanying notes to condensed consolidated financial statements.

Table of Contents

THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Amounts)



	Three Months Ended						Nine Months Ended
	October 1, 2017			October 2, 2016			October 1, 2017			October 2, 2016
	(Unaudited)
Revenues:
Sales	$	158,843		$	228,644		$	467,914		$	747,211
Franchise royalty revenue and fees	98,882			98,039			306,120			275,886
Franchise rental income	50,275			37,329			140,127			102,420
	308,000			364,012			914,161			1,125,517
Costs and expenses:
Cost of sales	132,387			186,546			385,154			603,836
Franchise rental expense	24,076			17,534			64,841			49,684
General and administrative	52,960			58,938			156,690			184,708
Depreciation and amortization	31,216			29,362			91,690			92,456
System optimization losses (gains), net	106			(37,756		)	39,749			(48,106		)
Reorganization and realignment costs	2,888			2,129			20,768			7,866
Impairment of long-lived assets	1,041			361			1,804			12,991
Other operating expense (income), net	1,669			810			5,294			(13,483		)
	246,343			257,924			765,990			889,952
Operating profit	61,657			106,088			148,171			235,565
Interest expense	(29,977		)	(28,731		)	(87,887		)	(85,483		)
Other (expense) income, net	(125		)	498			3,108			1,036
Income before income taxes	31,555			77,855			63,392			151,118
Provision for income taxes	(17,298		)	(28,965		)	(28,639		)	(50,385		)
Net income	$	14,257		$	48,890		$	34,753		$	100,733

Net income per share:
Basic	$	.06		$	.19		$	.14		$	.38
Diluted	.06			.18			.14			.37

Dividends per share	$	.07		$	.06		$	.21		$	.18

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands)



	Three Months Ended					Nine Months Ended
	October 1, 2017		October 2, 2016			October 1, 2017		October 2, 2016
	(Unaudited)

Net income	$	14,257	$	48,890		$	34,753	$	100,733
Other comprehensive income (loss), net:
Foreign currency translation adjustment	8,787		(3,369		)	16,797		10,887
Change in unrecognized pension loss, net of income tax (provision) benefit of $(60) and $34 for the nine months ended October 1, 2017 and October 2, 2016, respectively	—		—			96		(56		)
Effect of cash flow hedges, net of income tax provision of $279 and $838 for both the three and nine months ended October 1, 2017 and October 2, 2016, respectively	444		444			1,332		1,332
Other comprehensive income (loss), net	9,231		(2,925		)	18,225		12,163
Comprehensive income	$	23,488	$	45,965		$	52,978	$	112,896

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)



	Nine Months Ended
	October 1, 2017			October 2, 2016
	(Unaudited)
Cash flows from operating activities:
Net income	$	34,753		$	100,733
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	91,690			94,056
Share-based compensation	16,356			14,260
Impairment of long-lived assets	1,804			12,991
Deferred income tax	945			(17,024		)
Non-cash rental income, net	(8,348		)	(5,138		)
Net receipt of deferred vendor incentives	4,547			4,110
System optimization losses (gains), net	39,749			(48,106		)
Gain on sale of investments, net	(1,807		)	—
Distributions received from TimWen joint venture	5,524			8,451
Equity in earnings in joint ventures, net	(6,113		)	(6,495		)
Accretion of long-term debt	927			914
Amortization of deferred financing costs	5,954			5,668
Reclassification of unrealized losses on cash flow hedges	2,170			2,170
Other, net	2,395			4,229
Changes in operating assets and liabilities:
Restricted cash	233			181
Accounts and notes receivable, net	(14,193		)	(29,118		)
Inventories	(44		)	126
Prepaid expenses and other current assets	(1,281		)	(3,958		)
Accounts payable	(1,557		)	(6,412		)
Accrued expenses and other current liabilities	3,039			5,677
Net cash provided by operating activities	176,743			137,315
Cash flows from investing activities:
Capital expenditures	(53,711		)	(108,744		)
Acquisitions	(86,788		)	(2,209		)
Dispositions	80,058			173,849
Proceeds from sale of investments	3,282			—
Payments for investments	(375		)	(172		)
Notes receivable, net	(4,174		)	(2,282		)
Changes in restricted cash	23,624			1,912
Other, net	—			103
Net cash (used in) provided by investing activities	(38,084		)	62,457
Cash flows from financing activities:
Repayments of long-term debt	(20,291		)	(18,678		)
Deferred financing costs	(1,069		)	(1,017		)
Repurchases of common stock	(90,065		)	(161,194		)
Dividends	(51,464		)	(47,793		)
Proceeds from stock option exercises	10,419			10,623
Payments related to tax withholding for share-based compensation	(4,484		)	(4,142		)
Net cash used in financing activities	(156,954		)	(222,201		)
Net cash used in operations before effect of exchange rate changes on cash	(18,295		)	(22,429		)
Effect of exchange rate changes on cash	6,684			3,997
Net decrease in cash and cash equivalents	(11,611		)	(18,432		)
Cash and cash equivalents at beginning of period	198,240			327,216
Cash and cash equivalents at end of period	$	186,629		$	308,784

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THE WENDY’S COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—CONTINUED

(In Thousands)



	Nine Months Ended
	October 1, 2017		October 2, 2016
	(Unaudited)
Supplemental cash flow information:
Cash paid for:
Interest	$	93,701	$	85,753
Income taxes, net of refunds	22,092		63,775

Supplemental non-cash investing and financing activities:
Capital expenditures included in accounts payable	$	9,621	$	20,108
Capitalized lease obligations	239,721		102,748

See accompanying notes to condensed consolidated financial statements.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements (the “Financial Statements”) of The Wendy’s Company (“The Wendy’s Company” and, together with its subsidiaries, the “Company,” “we,” “us” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and, therefore, do not include all information and footnotes required by GAAP for complete financial statements. In our opinion, the Financial Statements contain all adjustments of a normal recurring nature necessary to present fairly our financial position as of October 1, 2017 and the results of our operations for the three and nine months ended October 1, 2017 and October 2, 2016 and cash flows for the nine months ended October 1, 2017 and October 2, 2016. The results of operations for the three and nine months ended October 1, 2017 are not necessarily indicative of the results to be expected for the full 2017 fiscal year. These Financial Statements should be read in conjunction with the audited consolidated financial statements for The Wendy’s Company and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 1, 2017 (the “Form 10-K”).

The principal subsidiary of the Company is Wendy’s International, LLC and its subsidiaries (“Wendy’s”). The Company manages and internally reports its business geographically. The operation and franchising of Wendy’s^®restaurants in North America (defined as the United States of America (“U.S.”) and Canada) comprises virtually all of our current operations and represents a single reportable segment. The revenues and operating results of Wendy’s restaurants outside of North America are not material.

We report on a fiscal year consisting of 52 or 53 weeks ending on the Sunday closest to or on December 31. All three- and nine-month periods presented herein contain 13 weeks and 39 weeks, respectively. All references to years and quarters relate to fiscal periods rather than calendar periods.

Certain reclassifications have been made to the prior year presentation to conform to the current year presentation.

(2) System Optimization Losses (Gains), Net

In July 2013, the Company announced a system optimization initiative, as part of its brand transformation, which includes a shift from Company-operated restaurants to franchised restaurants over time, through acquisitions and dispositions, as well as facilitating franchisee-to-franchisee restaurant transfers. In February 2015, the Company announced plans to reduce its ongoing Company-operated restaurant ownership to approximately 5% of the total system, which the Company completed as of January 1, 2017. Wendy’s will continue to optimize its system by facilitating franchisee-to-franchisee restaurant transfers, as well as evaluating strategic acquisitions of franchised restaurants and strategic dispositions of Company-operated restaurants to existing and new franchisees, to further strengthen the franchisee base and drive new restaurant development and accelerate reimages in the Image Activation format.

During the nine months ended October 1, 2017, the Company recorded post-closing adjustments on sales of restaurants and completed the sale of other assets, resulting in net gains totaling $3,385. In addition, the Company facilitated the transfer of 270 restaurants between franchisees during the nine months ended October 1, 2017 (excluding the DavCo and NPC transactions discussed below).

DavCo and NPC Transactions

As part of our system optimization initiative, the Company acquired 140 Wendy’s restaurants on May 31, 2017 from DavCo Restaurants, LLC (“DavCo”) for total net cash consideration of $86,788, which were immediately sold to NPC International, Inc. (“NPC”), an existing franchisee of the Company, for cash proceeds of $70,688 (the “DavCo and NPC transactions”). As part of the transaction, NPC has agreed to remodel 90 acquired restaurants in the Image Activation format by the end of 2021 and build 15 new Wendy’s restaurants by the end of 2022. Prior to closing the DavCo transaction, seven DavCo restaurants were closed. The acquisition of Wendy’s restaurants from DavCo was not contingent on executing the sale agreement with NPC; as such, the Company accounted for the transactions as an acquisition and subsequent disposition of a business. The total consideration paid to DavCo was allocated to net tangible and identifiable intangible assets acquired based on their estimated fair values. As part of the transactions, the Company retained leases for purposes of subleasing such properties to NPC.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of the activity recorded as a result of the DavCo and NPC transactions:



	Nine Months Ended
	October 1, 2017
Acquisition (a)
Total consideration paid	$	86,788
Identifiable assets and liabilities assumed:
Net assets held for sale	70,688
Capital lease assets	49,360
Deferred taxes	27,639
Capital lease obligations	(97,046		)
Net unfavorable leases (b)	(22,330		)
Other liabilities (c)	(6,999		)
Total identifiable net assets	21,312
Goodwill (d)	$	65,476

Disposition
Proceeds	$	70,688
Net assets sold	(70,688		)
Goodwill (d)	(65,476		)
Net favorable leases (e)	24,034
Other (f)	(1,692		)
Loss on DavCo and NPC transactions	$	(43,134	)

_______________

(a)

The fair values of the identifiable intangible assets and taxes related to the acquisition are provisional amounts as of October 1, 2017, pending final valuations and purchase accounting adjustments. The Company utilized management estimates and consultation with an independent third-party valuation firm to assist in the valuation process. For the three months ended October 1, 2017, the Company recorded adjustments to the fair value of deferred taxes and net unfavorable leases, resulting in a decrease in goodwill of $27.


(b)	Includes favorable lease assets of $1,229 and unfavorable lease liabilities of $23,559.


(c)	Includes a supplemental purchase price estimated at $6,344 to be paid to DavCo for the resolution of certain lease-related matters, which is included in “Accrued expenses and other current liabilities.”


(d)	Includes tax deductible goodwill of $21,870.


(e)	The Company recorded favorable lease assets of $30,068 and unfavorable lease liabilities of $6,034 as a result of subleasing land, buildings and leasehold improvements to NPC.


(f)	Includes cash payments for selling and other costs associated with the transaction. For the three and nine months ended October 1, 2017, the Company recorded additional selling and other costs of $12.

Gains and losses recognized on dispositions are recorded to “System optimization losses (gains), net” in our condensed consolidated statements of operations. Costs related to our system optimization initiative were historically recorded to “Reorganization and realignment costs.” Costs incurred during 2017 in connection with the DavCo and NPC transactions continue to be recorded to “Reorganization and realignment costs.” All other costs incurred during 2017 related to facilitating franchisee-to-franchisee restaurant transfers are recorded to “Other operating expense (income), net.” See Note 4 for further information.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of the disposition activity recorded as a result of our system optimization initiative:



	Three Months Ended						Nine Months Ended
	October 1, 2017			October 2, 2016			October 1, 2017			October 2, 2016
Number of restaurants sold to franchisees	—			156			—			211

Proceeds from sales of restaurants	$	—		$	124,765		$	—		$	164,380
Net assets sold (a)	—			(58,227		)	—			(75,282		)
Goodwill related to sales of restaurants	—			(24,254		)	—			(30,630		)
Net unfavorable leases (b)	—			(6,225		)	—			(11,131		)
Other	—			(726		)	—			(1,521		)
	—			35,333			—			45,816
Post-closing adjustments on sales of restaurants (c)	418			(120		)	1,345			(1,710		)
Gain on sales of restaurants, net	418			35,213			1,345			44,106

(Loss) gain on sales of other assets, net (d)	(539		)	2,543			2,040			4,000
Gain (loss) on DavCo and NPC transactions	15			—			(43,134		)	—
System optimization (losses) gains, net	$	(106	)	$	37,756		$	(39,749	)	$	48,106

_______________


(a)	Net assets sold consisted primarily of equipment.


(b)	During the three and nine months ended October 2, 2016, the Company recorded favorable lease assets of $2,114 and $2,297, respectively, and unfavorable lease liabilities of $8,339 and $13,428, respectively, as a result of leasing and/or subleasing land, buildings and/or leasehold improvements to franchisees in connection with sales of restaurants.

(c)

The three and nine months ended October 1, 2017 includes cash payments, net of proceeds received, of $333 and $33, respectively, related to post-closing reconciliations with franchisees. The nine months ended October 1, 2017 also includes the recognition of a deferred gain of $312 as a result of the resolution of certain contingencies related to the extension of lease terms for a Canadian restaurant.

(d)

During the three and nine months ended October 1, 2017, the Company received cash proceeds of $2,411 and $9,403, respectively, primarily from the sale of surplus properties. The nine months ended October 1, 2017 also includes the recognition of a deferred gain of $375 related to the sale of a share in an aircraft. During the three and nine months ended October 2, 2016, the Company received cash proceeds of $4,006 and $9,469, respectively, primarily from the sale of surplus properties.

As of October 1, 2017 and January 1, 2017, the Company had assets held for sale of $2,509 and $4,800, respectively, primarily consisting of surplus properties. Assets held for sale are included in “Prepaid expenses and other current assets.”

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

(3) Acquisitions

The table below presents the allocation of the total purchase price to the fair value of assets acquired and liabilities assumed for acquisitions of franchised restaurants:



	Nine Months Ended
	October 1, 2017		October 2, 2016
Restaurants acquired from franchisees	—		2

Total consideration paid, net of cash received	$	—	$	2,209
Identifiable assets acquired and liabilities assumed:
Properties	—		2,218
Deferred taxes and other assets	—		9
Other liabilities	—		(18		)
Total identifiable net assets	—		2,209
Goodwill	$	—	$	—

On May 31, 2017, the Company also entered into the DavCo and NPC transactions. See Note 2 for further information.

(4) Reorganization and Realignment Costs

The following is a summary of the initiatives included in “Reorganization and realignment costs:”



	Three Months Ended				Nine Months Ended
	October 1, 2017		October 2, 2016		October 1, 2017		October 2, 2016
System optimization initiative	$	232	$	2,091	$	867	$	6,895
G&A realignment - November 2014 plan	—		38		—		971
G&A realignment - May 2017 plan	2,656		—		19,901		—
Reorganization and realignment costs	$	2,888	$	2,129	$	20,768	$	7,866

System Optimization Initiative

The Company has recognized costs related to its system optimization initiative, which includes a shift from Company-operated restaurants to franchised restaurants over time, through acquisitions and dispositions, as well as facilitating franchisee-to-franchisee restaurant transfers. The Company does not expect to incur additional costs during the remainder of 2017 in connection with the DavCo and NPC transactions. All other costs incurred during 2017 related to facilitating franchisee-to-franchisee restaurant transfers are recorded to “Other operating expense (income), net.”

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of the costs recorded as a result of our system optimization initiative:



	Three Months Ended				Nine Months Ended				Total Incurred Since Inception
	October 1, 2017		October 2, 2016		October 1, 2017		October 2, 2016		Total Incurred Since Inception
Severance and related employee costs	$	—	$	28	$	3	$	46	$	18,237
Professional fees	232		1,991		794		5,137		17,404
Other (a)	—		72		70		112		5,813
	232		2,091		867		5,295		41,454
Accelerated depreciation and amortization (b)	—		—		—		1,600		25,398
Share-based compensation (c)	—		—		—		—		5,013
Total system optimization initiative	$	232	$	2,091	$	867	$	6,895	$	71,865

_______________


(a)	The nine months ended October 2, 2016 includes a reversal of an accrual of $50 as a result of a change in estimate.


(b)	Primarily includes accelerated amortization of previously acquired franchise rights related to Company-operated restaurants in territories that have been sold in connection with our system optimization initiative.


(c)	Represents incremental share-based compensation resulting from the modification of stock options and performance-based awards in connection with the termination of employees under our system optimization initiative.

The tables below present a rollforward of our accrual for our system optimization initiative, which is included in “Accrued expenses and other current liabilities.”



	Balance January 1, 2017		Charges		Payments			Balance October 1, 2017
Severance and related employee costs	$	—	$	3	$	(3	)	$	—
Professional fees	101		794		(885		)	10
Other	—		70		(70		)	—
	$	101	$	867	$	(958	)	$	10



	Balance January 3, 2016		Charges		Payments			Balance October 2, 2016
Severance and related employee costs	$	77	$	46	$	(123	)	$	—
Professional fees	708		5,137		(5,740		)	105
Other	90		112		(202		)	—
	$	875	$	5,295	$	(6,065	)	$	105

General and Administrative (“G&A”) Realignment

November 2014 Plan

In November 2014, the Company initiated a plan to reduce its G&A expenses. The plan included a realignment and reinvestment of resources to focus primarily on accelerated restaurant development and consumer-facing restaurant technology to drive long-term growth. The Company achieved the majority of the expense reductions through the realignment of its U.S. field operations and savings at its Restaurant Support Center in Dublin, Ohio, which was substantially completed by the end of the second quarter of 2015. The Company recognized costs totaling $38 and $971 during the three and nine months ended October 2, 2016, respectively, and $23,960 in aggregate since inception. The Company did not incur any expenses during the three and nine months ended October 1, 2017 and does not expect to incur additional costs related to the plan.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

May 2017 Plan

In May 2017, the Company initiated a new plan to further reduce its G&A expenses. The Company expects to incur total costs aggregating approximately $28,000 to $33,000 related to the plan. The Company recognized costs totaling $2,656 and $19,901 during the three and nine months ended October 1, 2017, respectively, which primarily included severance and related employee costs and share-based compensation. The Company expects to incur additional costs aggregating approximately $8,000 to $13,000, comprised of (1) severance and related employee costs of approximately $3,000, (2) recruitment and relocation costs of approximately $4,000, (3) third-party and other costs of approximately $1,000 and (4) share-based compensation of approximately $3,000. The Company expects costs to be recognized during the remainder of 2017 and continue into 2019, with approximately two-thirds to be recognized during 2017.

The following is a summary of the activity recorded as a result of the May 2017 plan:



	Three Months Ended		Nine Months Ended
	October 1, 2017		October 1, 2017
Severance and related employee costs	$	1,210	$	14,436
Recruitment and relocation costs	145		145
Third-party and other costs	496		821
	1,851		15,402
Share-based compensation (a)	805		4,499
Total G&A realignment - May 2017 plan	$	2,656	$	19,901

_______________


(a)	Primarily represents incremental share-based compensation resulting from the modification of stock options in connection with the termination of employees under our May 2017 plan. The three and nine months ended October 1, 2017 includes incremental share-based compensation of $652 related to the modification of stock options granted during August 2017.

As of October 1, 2017, the accruals for our May 2017 plan are included in “Accrued expenses and other current liabilities” and “Other liabilities” and totaled $7,766 and $5,429, respectively. The table below presents a rollforward of our accruals for the May 2017 plan.



	Balance January 1, 2017		Charges		Payments			Balance October 1, 2017
Severance and related employee costs	$	—	$	14,436	$	(1,350	)	$	13,086
Recruitment and relocation costs	—		145		(36		)	109
Third-party and other costs	—		821		(821		)	—
	$	—	$	15,402	$	(2,207	)	$	13,195

(5) Investments

Equity Investments

Wendy’s has a 50% share in a partnership in a Canadian restaurant real estate joint venture (“TimWen”) with a subsidiary of Restaurant Brands International Inc., a quick-service restaurant company that owns the Tim Hortons^® brand. (Tim Hortons^™is a registered trademark of Tim Hortons USA Inc.) In addition, a wholly-owned subsidiary of Wendy’s has a 20% share in a joint venture for the operation of Wendy’s restaurants in Brazil (the “Brazil JV”). The Company has significant influence over these investees. Such investments are accounted for using the equity method of accounting, under which our results of operations include our share of the income (loss) of the investees in “Other operating expense (income), net.”

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

During the three months ended October 1, 2017, a wholly-owned subsidiary of Wendy’s agreed to lend the Brazil JV an aggregate amount up to, but not to exceed, $4,800, which is in addition to $8,000 previously loaned. During the three months ended October 1, 2017, $1,500 was loaned to the Brazil JV under this agreement. The loans are denominated in U.S. Dollars, which is also the functional currency of the subsidiary; therefore, there is no exposure to changes in foreign currency rates. The loans are due October 20, 2020 and bear interest at 6.5% per year.

Presented below is activity related to our investment in TimWen and the Brazil JV included in our condensed consolidated financial statements:



	Nine Months Ended
	October 1, 2017			October 2, 2016
Balance at beginning of period	$	54,545		$	55,541

Investment	375			172

Equity in earnings for the period	7,844			8,207
Amortization of purchase price adjustments (a)	(1,731		)	(1,712		)
	6,113			6,495
Distributions received (b)	(8,128		)	(8,451		)
Foreign currency translation adjustment included in “Other comprehensive income, net”	4,304			3,204
Balance at end of period	$	57,209		$	56,961

_______________


(a)	Purchase price adjustments that impacted the carrying value of the Company’s investment in TimWen are being amortized over the average original aggregate life of 21 years.


(b)	The nine months ended October 1, 2017 includes a distribution receivable from TimWen of $2,604, which is included in “Accounts and notes receivable, net.”

(6) Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques under the accounting guidance related to fair value measurements are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. These inputs are classified into the following hierarchy:


•	Level 1 Inputs - Quoted prices for identical assets or liabilities in active markets.


•	Level 2 Inputs - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.


•	Level 3 Inputs - Pricing inputs are unobservable for the assets or liabilities and include situations where there is little, if any, market activity for the assets or liabilities. The inputs into the determination of fair value require significant management judgment or estimation.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Financial Instruments

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments:



	October 1, 2017				January 1, 2017
	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Fair Value Measurements
Financial assets
Cash equivalents	$	337	$	337	$	5,335	$	5,335	Level 1
Non-current cost method investments (a)	962		325,869		2,436		326,283		Level 3

Financial liabilities
Series 2015-1 Class A-2-I Notes (b)	857,500		863,417		864,063		857,349		Level 2
Series 2015-1 Class A-2-II Notes (b)	882,000		900,169		888,750		880,005		Level 2
Series 2015-1 Class A-2-III Notes (b)	490,000		504,112		493,750		474,543		Level 2
7% debentures, due in 2025 (b)	89,204		106,000		88,277		99,750		Level 2
Guarantees of franchisee loan obligations (c)	224		224		280		280		Level 3

_______________

(a)

The fair value of our indirect investment in Arby’s Restaurant Group, Inc. (“Arby’s”) is based on applying a multiple to Arby’s adjusted earnings before income taxes, depreciation and amortization per its current unaudited financial information. The carrying value of our indirect investment in Arby’s was reduced to zero during 2013 in connection with the receipt of a dividend. The fair values of our remaining investments are not significant and are based on our review of information provided by the investment managers or investees which was based on (1) valuations performed by the investment managers or investees, (2) quoted market or broker/dealer prices for similar investments and (3) quoted market or broker/dealer prices adjusted by the investment managers for legal or contractual restrictions, risk of nonperformance or lack of marketability, depending upon the underlying investments.


(b)	The fair values were based on quoted market prices in markets that are not considered active markets.

(c)

Wendy’s has provided loan guarantees to various lenders on behalf of franchisees entering into debt arrangements for new restaurant development and equipment financing. In addition, during 2012, Wendy’s provided a guarantee to a lender for a franchisee in connection with the refinancing of the franchisee’s debt. We have accrued a liability for the fair value of these guarantees, the calculation of which was based upon a weighted average risk percentage established at inception and adjusted for a history of defaults.

The carrying amounts of cash, accounts payable and accrued expenses approximated fair value due to the short-term nature of those items. The carrying amounts of accounts and notes receivable, net (both current and non-current) approximated fair value due to the effect of the related allowance for doubtful accounts. Our cash and cash equivalents and guarantees are the only financial assets and liabilities measured and recorded at fair value on a recurring basis.

Derivative Instruments

The Company’s primary objective for entering into interest rate swap agreements was to manage its exposure to changes in interest rates, as well as to maintain an appropriate mix of fixed and variable rate debt.

Our derivative instruments for 2015 included seven forward-starting interest rate swaps designated as cash flow hedges to change the floating rate interest payments for $350,000 and $100,000 in borrowings associated with the Term A and Term B Loans, respectively, under the Company’s prior credit agreement, to fixed rate interest payments beginning June 30, 2015 and maturing on December 31, 2017. In May 2015, the Company terminated these interest rate swaps and paid $7,275, which was recorded against the derivative liability. The unrealized loss on the cash flow hedges at termination of $7,275 is being reclassified on a straight-line basis from “Accumulated other comprehensive loss” to “Interest expense” beginning June 30, 2015 (the original effective date of the interest rate swaps) through December 31, 2017 (the original maturity date of the interest rate swaps).

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Reclassifications of unrealized losses on cash flow hedges from “Accumulated other comprehensive loss” to “Interest expense” were $723 and $2,170 for both the three and nine months ended October 1, 2017 and October 2, 2016, respectively.

Non-Recurring Fair Value Measurements

Assets and liabilities remeasured to fair value on a non-recurring basis resulted in impairment that we have recorded to “Impairment of long-lived assets” in our condensed consolidated statements of operations.

Total impairment losses may reflect the impact of remeasuring long-lived assets held and used (including land, buildings, leasehold improvements and favorable lease assets) to fair value as a result of (1) the Company’s decision to lease and/or sublease the land and/or buildings to franchisees in connection with the sale or anticipated sale of restaurants and (2) declines in operating performance at Company-operated restaurants. The fair value of long-lived assets held and used presented in the tables below represents the remaining carrying value and was estimated based on either discounted cash flows of future anticipated lease and sublease income or current market values.

Total impairment losses may also include the impact of remeasuring long-lived assets held for sale, which primarily include surplus properties. The fair value of long-lived assets held for sale presented in the tables below represents the remaining carrying value and was estimated based on current market values. See Note 7 for further information on impairment of our long-lived assets.



			Fair Value Measurements
	October 1, 2017		Level 1		Level 2		Level 3
Held and used	$	915	$	—	$	—	$	915
Held for sale	1,290		—		—		1,290
Total	$	2,205	$	—	$	—	$	2,205



			Fair Value Measurements
	January 1, 2017		Level 1		Level 2		Level 3
Held and used	$	5,462	$	—	$	—	$	5,462
Held for sale	1,552		—		—		1,552
Total	$	7,014	$	—	$	—	$	7,014

Total impairment losses for the three and nine months ended October 1, 2017 included remeasuring long-lived assets held and used of $928 and $1,146, respectively, and remeasuring long-lived assets held for sale of $113 and $658, respectively. Total impairment losses for the three and nine months ended October 2, 2016 included remeasuring long-lived assets held and used of $242 and $12,768, respectively, and remeasuring long-lived assets held for sale of $119 and $223, respectively.

In addition, the Company measured assets acquired and liabilities assumed at fair value as part of the DavCo and NPC transactions during the three and nine months ended October 1, 2017. See Note 2 for further information.

(7) Impairment of Long-Lived Assets

During the three and nine months ended October 1, 2017 and October 2, 2016, the Company recorded impairment charges on long-lived assets as a result of (1) the Company’s decision to lease and/or sublease properties to franchisees in connection with the sale or anticipated sale of Company-operated restaurants, (2) closing Company-operated restaurants and classifying such surplus properties as held for sale and (3) the deterioration in operating performance of certain Company-operated restaurants and charges for capital improvements in previously impaired restaurants that did not subsequently recover. The Company may recognize additional impairment charges resulting from leasing or subleasing additional properties to franchisees in connection with sales of Company-operated restaurants to franchisees.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

The following is a summary of impairment losses recorded, which represent the excess of the carrying amount over the fair value of the affected assets and are included in “Impairment of long-lived assets.”



	Three Months Ended				Nine Months Ended
	October 1, 2017		October 2, 2016		October 1, 2017		October 2, 2016
Restaurants leased or subleased to franchisees	$	95	$	163	$	95	$	12,654
Surplus properties	113		119		658		223
Company-operated restaurants	833		79		1,051		114
	$	1,041	$	361	$	1,804	$	12,991

(8) Income Taxes

The Company’s effective tax rate for the three months ended October 1, 2017 and October 2, 2016 was 54.8% and 37.2%, respectively. The Company’s effective tax rate varies from the U.S. federal statutory rate of 35% due to the effect of (1) the system optimization initiative provision of $5,019 and $2,332 in the third quarter of 2017 and 2016, respectively, reflecting goodwill adjustments, changes to valuation allowances on state net operating loss carryforwards and state deferred taxes, (2) state income taxes net of federal benefits, including non-recurring changes to state deferred taxes, (3) the adoption of an amendment issued by the Financial Accounting Standards Board (“FASB”), which requires that excess tax benefits and tax deficiencies related to share-based payments be recognized in net income and (4) the rate differential between foreign and domestic taxes.

The Company’s effective tax rate for the nine months ended October 1, 2017 and October 2, 2016 was 45.2% and 33.3%, respectively. The Company’s effective tax rate varies from the U.S. federal statutory rate of 35% due to the effect of (1) the system optimization initiative, reflecting goodwill adjustments, changes to valuation allowances on state net operating loss carryforwards and state deferred taxes (including corrections to prior years identified and recorded in the first nine months of 2017 and 2016, which resulted in a benefit of $2,248 and $7,113, respectively), (2) the adoption of an amendment issued by the FASB, which requires that excess tax benefits and tax deficiencies related to share-based payments be recognized in net income, which resulted in a benefit of $5,205 during the nine months ended October 1, 2017, (3) state income taxes net of federal benefits, including non-recurring changes to state deferred taxes, and (4) the rate differential between foreign and domestic taxes.

During the next twelve months, we believe that it is reasonably possible the Company will reduce its unrecognized tax benefits by up to $7,030, primarily due to expected settlements with taxing authorities.

The current portion of refundable income taxes was $16,165 and $18,111 as of October 1, 2017 and January 1, 2017, respectively, and is included in “Accounts and notes receivable, net” in the condensed consolidated balance sheets. Long-term refundable income taxes are included in “Other assets” and amounted to $960 and $239 as of October 1, 2017 and January 1, 2017, respectively.

(9) Net Income Per Share

Basic net income per share was computed by dividing net income amounts by the weighted average number of common shares outstanding.

The weighted average number of shares used to calculate basic and diluted net income per share were as follows:



	Three Months Ended		Nine Months Ended
	October 1, 2017	October 2, 2016	October 1, 2017	October 2, 2016
Common stock:
Weighted average basic shares outstanding	243,354	260,976	245,073	265,702
Dilutive effect of stock options and restricted shares	8,383	3,832	8,103	4,239
Weighted average diluted shares outstanding	251,737	264,808	253,176	269,941

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Diluted net income per share for the three and nine months ended October 1, 2017 and October 2, 2016 was computed by dividing net income by the weighted average number of basic shares outstanding plus the potential common share effect of dilutive stock options and restricted shares. We excluded potential common shares of 1,617 and 618 for the three and nine months ended October 1, 2017, respectively, and 2,233 and 2,072 for the three and nine months ended October 2, 2016, respectively, from our diluted net income per share calculation as they would have had anti-dilutive effects.

(10) Stockholders’ Equity

Stockholders’ Equity

The following is a summary of the changes in stockholders’ equity:



	Nine Months Ended
	October 1, 2017			October 2, 2016
Balance at beginning of period	$	527,736		$	752,914
Comprehensive income	52,978			112,896
Cash dividends	(51,464		)	(47,793		)
Repurchases of common stock	(90,964		)	(162,492		)
Share-based compensation	16,356			14,260
Exercises of stock options	10,194			10,600
Vesting of restricted shares	(4,260		)	(3,853		)
Cumulative effect of change in accounting principle (a)	1,880			—
Tax benefit from share-based compensation	—			1,898
Other	139			145
Balance at end of period	$	462,595		$	678,575

_______________


(a)	During the nine months ended October 1, 2017, the Company recognized a tax benefit as a reduction to the Company’s deferred tax liability with an equal offsetting increase to “Accumulated deficit.” The adjustment was recognized as a result of adoption of an amendment to the accounting for employee share-based payment transactions. See Note 15 for further information.

Repurchases of Common Stock

In February 2017, our Board of Directors authorized a repurchase program for up to $150,000 of our common stock through March 4, 2018, when and if market conditions warrant and to the extent legally permissible. During the nine months ended October 1, 2017, the Company repurchased 6,131 shares with an aggregate purchase price of $90,876, of which $899 was accrued at October 1, 2017 and excluding commissions of $88. As of October 1, 2017, the Company had $59,124 of availability remaining under its February 2017 authorization. Subsequent to October 1, 2017 through November 2, 2017, the Company repurchased 428 shares with an aggregate purchase price of $6,628, excluding commissions of $6.

On June 1, 2015, our Board of Directors authorized a repurchase program for up to $1,400,000 of our common stock through January 1, 2017, when and if market conditions warranted and to the extent legally permissible. During the nine months ended October 2, 2016, the Company repurchased 16,034 shares with an aggregate purchase price of $162,252, of which $2,998 was accrued at October 2, 2016 and excluding commissions of $240.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Accumulated Other Comprehensive Loss

The following table provides a rollforward of the components of accumulated other comprehensive loss, net of tax as applicable:



	Foreign Currency Translation			Cash Flow Hedges (a)			Pension			Total
Balance at January 1, 2017	$	(60,299	)	$	(1,797	)	$	(1,145	)	$	(63,241	)
Current-period other comprehensive income	16,797			1,332			96			18,225
Balance at October 1, 2017	$	(43,502	)	$	(465	)	$	(1,049	)	$	(45,016	)

Balance at January 3, 2016	$	(66,163	)	$	(3,571	)	$	(1,089	)	$	(70,823	)
Current-period other comprehensive income (loss)	10,887			1,332			(56		)	12,163
Balance at October 2, 2016	$	(55,276	)	$	(2,239	)	$	(1,145	)	$	(58,660	)

_______________

(a)

Current-period other comprehensive income (loss) includes the reclassification of unrealized losses on cash flow hedges from “Accumulated other comprehensive loss” to our condensed consolidated statements of operations of $444 and $1,332 for both the three and nine months ended October 1, 2017 and October 2, 2016, respectively. The reclassification of unrealized losses on cash flow hedges consists of $723 and $2,170 for both the three and nine months ended October 1, 2017 and October 2, 2016, respectively, recorded to “Interest expense,” net of the related income tax benefit of $279 and $838 for both the three and nine months ended October 1, 2017 and October 2, 2016, respectively, recorded to “Provision for income taxes.” See Note 6 for further information.

(11) Leases

At October 1, 2017, Wendy’s and its franchisees operated 6,586 Wendy’s restaurants. Of the 333 Company-operated Wendy’s restaurants, Wendy’s owned the land and building for 146 restaurants, owned the building and held long-term land leases for 137 restaurants and held leases covering land and building for 50 restaurants. Wendy’s also owned 521 and leased 1,270 properties that were either leased or subleased principally to franchisees.

Rental expense for operating leases consists of the following components:



	Three Months Ended				Nine Months Ended
	October 1, 2017		October 2, 2016		October 1, 2017		October 2, 2016
Rental expense:
Minimum rentals	$	23,997	$	19,137	$	66,701	$	59,139
Contingent rentals	5,395		5,254		14,405		13,786
Total rental expense (a)	$	29,392	$	24,391	$	81,106	$	72,925

_______________


(a)	Amounts exclude sublease income of $35,022 and $92,434 recognized during the three and nine months ended October 1, 2017, respectively, and $25,127 and $68,400 recognized during the three and nine months ended October 2, 2016, respectively.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Rental income for operating leases and subleases consists of the following components:



	Three Months Ended				Nine Months Ended
	October 1, 2017		October 2, 2016		October 1, 2017		October 2, 2016
Rental income:
Minimum rentals	$	44,682	$	31,902	$	124,847	$	87,409
Contingent rentals	5,593		5,427		15,280		15,011
Total rental income	$	50,275	$	37,329	$	140,127	$	102,420

The following table illustrates the Company’s future minimum rental payments and rental receipts for non-cancelable leases and subleases, including rental receipts for direct financing leases as of October 1, 2017. Rental receipts below are presented separately for owned properties and for leased properties based on the classification of the underlying lease.



	Rental Payments					Rental Receipts
Fiscal Year	Capital Leases			Operating Leases		Capital Leases		Operating Leases		Owned Properties
2017 (a)	$	11,989		$	24,894	$	15,868	$	18,782	$	13,436
2018	43,406			93,431		60,844		75,167		53,896
2019	42,717			93,272		61,368		75,267		54,866
2020	43,660			92,434		62,469		74,983		55,489
2021	45,249			91,892		64,260		74,672		57,102
Thereafter	748,736			1,188,165		1,045,693		973,428		1,008,243
Total minimum payments	$	935,757		$	1,584,088	$	1,310,502	$	1,292,299	$	1,243,032
Less interest	(499,703		)
Present value of minimum capital lease payments (b)	$	436,054

_______________


(a)	Represents future minimum rental payments and rental receipts for non-cancelable leases and subleases for the remainder of our 2017 fiscal year.


(b)	The present value of minimum capital lease payments of $6,608 and $429,446 are included in “Current portion of long-term debt” and “Long-term debt,” respectively.

Properties owned by the Company and leased to franchisees and other third parties under operating leases include:



	October 1, 2017			January 1, 2017
Land	$	271,840		$	271,160
Buildings and improvements	312,796			312,067
Restaurant equipment	1,491			1,507
	586,127			584,734
Accumulated depreciation and amortization	(122,970		)	(110,166		)
	$	463,157		$	474,568

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Our net investment in direct financing leases is as follows:



	October 1, 2017			January 1, 2017
Future minimum rental receipts	$	630,352		$	401,452
Unearned interest income	(416,221		)	(277,747		)
Net investment in direct financing leases	214,131			123,705
Net current investment in direct financing leases (a)	(482		)	(101		)
Net non-current investment in direct financing leases (b)	$	213,649		$	123,604

_______________


(a)	Included in “Accounts and notes receivable, net.”


(b)	Included in “Net investment in direct financing leases.”

(12) Transactions with Related Parties

Except as described below, the Company did not have any significant changes in or transactions with its related parties during the current fiscal period since those reported in the Form 10-K.

TimWen Lease and Management Fee Payments

A wholly-owned subsidiary of Wendy’s leases restaurant facilities from TimWen for the operation of Wendy’s/Tim Hortons combo units in Canada. During the nine months ended October 1, 2017 and October 2, 2016, Wendy’s paid TimWen $9,362 and $8,926, respectively, under these lease agreements. In addition, TimWen paid Wendy’s a management fee under the TimWen joint venture agreement of $158 and $156 during the nine months ended October 1, 2017 and October 2, 2016, respectively, which has been included as a reduction to “General and administrative.”

(13) Guarantees and Other Commitments and Contingencies

The Company did not have any significant changes in guarantees and other commitments and contingencies during the current fiscal period since those reported in the Form 10-K. Refer to the Form 10-K for further information regarding the Company’s additional commitments and obligations.

Franchisee Image Activation Incentive Programs

In order to promote Image Activation new restaurant development, Wendy’s has an incentive program for franchisees that provides for reductions in royalty and national advertising payments for up to the first two years of operation for qualifying new restaurants opened by December 31, 2020, with the value of the incentives declining in the later years of the program. Wendy’s also has incentive programs for 2017 available to franchisees that commence Image Activation restaurant remodels by December 15, 2017. The remodel incentive programs provide for reductions in royalty payments for one year after the completion of construction.

Lease Guarantees

Wendy’s has guaranteed the performance of certain leases and other obligations, primarily from former Company-operated restaurant locations now operated by franchisees, amounting to $56,299 as of October 1, 2017. These leases extend through 2056. We have not received any notice of default related to these leases as of October 1, 2017. In the event of default by a franchise owner, Wendy’s generally retains the right to acquire possession of the related restaurant locations.

Wendy’s is contingently liable for certain other leases which have been assigned to unrelated third parties who have indemnified Wendy’s against future liabilities amounting to $637 as of October 1, 2017. These leases expire on various dates through 2021.

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THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

Letters of Credit

As of October 1, 2017, the Company had outstanding letters of credit with various parties totaling $32,575, of which $3,205 were cash collateralized. The outstanding letters of credit include amounts outstanding against the securitized financing facility. The related cash collateral is classified as “Restricted cash” in the condensed consolidated balance sheets. We do not expect any material loss to result from these letters of credit.

(14) Legal and Environmental Matters

We are involved in litigation and claims incidental to our current and prior businesses. We provide accruals for such litigation and claims when payment is probable and reasonably estimable. As of October 1, 2017, the Company had accruals for all of its legal and environmental matters aggregating $1,639. We cannot estimate the aggregate possible range of loss due to most proceedings, including those described below, being in preliminary stages, with various motions either yet to be submitted or pending, discovery yet to occur and significant factual matters unresolved. In addition, most cases seek an indeterminate amount of damages and many involve multiple parties. Predicting the outcomes of settlement discussions or judicial or arbitral decisions is thus inherently difficult. Based on currently available information, including legal defenses available to us, and given the aforementioned accruals and our insurance coverage, we do not believe that the outcome of these legal and environmental matters will have a material effect on our consolidated financial position or results of operations.

We previously described certain legal proceedings under Note 14 to our Condensed Consolidated Financial Statements in our Quarterly Report on Form 10-Q for the second quarter of 2017, as filed with the SEC on August 9, 2017. Except as set forth below, there were no material developments in those legal proceedings during the third quarter of 2017.

As previously reported, the Company has been named as a defendant in putative class action lawsuits alleging, among other things, that the Company failed to safeguard customer credit card information and failed to provide notice that credit card information had been compromised. Jonathan Torres and other consumers filed an action in the U.S. District Court for the Middle District of Florida (the “Torres case”). The operative complaint seeks to certify a nationwide class of consumers, or in the alternative, statewide classes of consumers for Florida, New York, New Jersey, Texas, and Tennessee, as well as statewide classes of consumers under those states’ consumer protection and unfair trade practices laws. On October 27, 2017, the Company moved to dismiss the operative complaint. The Company’s motion is pending before the court.

(15) New Accounting Standards

New Accounting Standards

In May 2017, the FASB issued new guidance on the scope of modification accounting for share-based payment arrangements. The new guidance will provide relief to entities that make non-substantive changes to their share-based payment arrangements. The Company does not expect the amendment, which requires prospective adoption and is effective commencing with our 2018 fiscal year, to have a material impact on our consolidated financial statements.

In March 2017, the FASB issued new guidance on the presentation of net periodic benefit costs that requires entities to disaggregate the current service cost component from the other components of net benefit cost in the income statement. The Company does not expect the amendment, which requires retrospective adoption and is effective commencing with our 2018 fiscal year, to have a material impact on our consolidated financial statements.

In February 2016, the FASB issued new guidance on leases, which outlines principles for the recognition, measurement, presentation and disclosure of leases applicable to both lessors and lessees. The new guidance requires lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by finance and operating leases with lease terms of more than 12 months. The amendment requires the recognition and measurement of leases at the beginning of the earliest period presented using a modified retrospective approach. We are currently evaluating the impact of the adoption of this guidance on our consolidated financial statements and plan to reflect adoption when effective in the first quarter of our 2019 fiscal year. As shown in Note 11, there are $1,584,088 in future minimum rental payments for operating leases that are not currently on our balance sheet; therefore, we expect this will have a material impact on our balance sheet and related disclosures.

In May 2014, the FASB issued amended guidance for revenue recognition. The new guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of the guidance is

Table of Contents

THE WENDY’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands Except Per Share Amounts)

that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Additionally, the guidance requires improved disclosure to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. The new guidance supersedes most current revenue recognition guidance, including industry-specific guidance, and is effective commencing with our 2018 fiscal year. The guidance allows for either a full retrospective or modified retrospective transition method. We currently expect to apply the modified retrospective method upon adoption. This guidance will not impact our recognition of revenue from Company-operated restaurant sales or our recognition of continuing royalty revenues from franchisees, which are based on a percentage of franchise sales. Under current guidance, we recognize initial fees from franchisees when we have performed all material obligations and services, which generally occurs when the franchised restaurant opens. Additionally, under current guidance, our advertising fund contributions from franchisees and the related advertising expenditures are reported on a net basis in our consolidated balance sheet as “Advertising funds restricted assets” and “Advertising funds restricted liabilities.” Under the new guidance, we anticipate recognizing the initial fees from franchisees over the life of the related franchise agreements and we expect to consolidate the operations and cash flow results of our national advertising funds, both of which will have a material impact on our consolidated financial statements.

New Accounting Standards Adopted

In March 2016, the FASB issued an amendment related to equity method accounting, which eliminates the requirement to retrospectively apply the equity method to an investment that subsequently qualifies for such accounting as a result of an increase in level of ownership interest or degree of influence. The Company adopted this amendment, prospectively, during the first quarter of 2017. The adoption of this guidance did not impact our consolidated financial statements.

In March 2016, the FASB issued an amendment that clarifies the steps for assessing triggering events of embedded contingent put and call options within debt instruments. The Company adopted this amendment during the first quarter of 2017. The adoption of this guidance did not impact our consolidated financial statements.

In March 2016, the FASB issued an amendment that modifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory withholding requirements, as well as statement of cash flows presentation. The transition requirement is generally modified retrospective, with the exception of recognition of excess tax benefits and tax deficiencies that requires prospective adoption. The Company adopted this amendment during the first quarter of 2017. The cash flows used in financing activities related to the excess tax benefits from share-based compensation arrangements, which amounted to $2,376 during the nine months ended October 2, 2016, was reclassified retrospectively to cash flows provided by operating activities. Additionally, during the nine months ended October 2, 2016, $4,142 was paid to taxing authorities for withheld shares on share-based compensation arrangement activities, which was reclassified retrospectively from cash flows provided by operating activities to cash flows used in financing activities. Upon adopting the amendment in the first quarter of 2017, the Company recognized $1,880 in unrecognized tax benefits for deductions in excess of cumulative compensation costs relating to the exercise of stock options and vesting of restricted stock. This tax benefit was recognized as a reduction to the Company’s deferred tax liability with an equal offsetting increase to “Accumulated deficit.” The Company will continue to estimate forfeitures each period.

In July 2015, the FASB issued an amendment that requires entities to measure inventory at the lower of cost and net realizable value, rather than the lower of cost or market, with market value represented by replacement cost, net realizable value or net realizable value less a normal profit margin. The Company adopted this amendment during the first quarter of 2017. The adoption of this guidance did not impact our consolidated financial statements.

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

Introduction

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of The Wendy’s Company (“The Wendy’s Company” and, together with its subsidiaries, the “Company,” “we,” “us,” or “our”) should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the related notes included elsewhere within this report and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended January 1, 2017 (the “Form 10-K”). There have been no material changes as of October 1, 2017 to the application of our critical accounting policies as described in Item 7 of the Form 10-K. Certain statements we make under this Item 2 constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. See “Special Note Regarding Forward-Looking Statements and Projections” in “Part II - Other Information” preceding Item 1 of Part II of this report. You should consider our forward-looking statements in light of our unaudited condensed consolidated financial statements, related notes and other financial information appearing elsewhere in this report, the Form 10-K and our other filings with the Securities and Exchange Commission (the “SEC”).

The Wendy’s Company is the parent company of its 100% owned subsidiary holding company, Wendy’s Restaurants, LLC (“Wendy’s Restaurants”). The principal 100% owned subsidiary of Wendy’s Restaurants is Wendy’s International, LLC and its subsidiaries (“Wendy’s”). Wendy’s franchises and operates Wendy’s^® quick-service restaurants throughout North America (defined as the United States of America (“U.S.”) and Canada). Wendy’s also has franchised restaurants in 29 foreign countries and U.S. territories.

Wendy’s restaurants offer an extensive menu specializing in hamburger sandwiches and featuring fillet of chicken breast sandwiches, chicken nuggets, chili, french fries, baked potatoes, freshly prepared salads, soft drinks, Frosty^® desserts and kids’ meals. In addition, the restaurants sell a variety of promotional products on a limited basis.

The Company manages and internally reports its business geographically. The operation and franchising of Wendy’s restaurants in North America comprises virtually all of our current operations and represents a single reportable segment. The revenues and operating results of Wendy’s restaurants outside of North America are not material. The results of operations discussed below may not necessarily be indicative of future results.

The Company reports on a fiscal year consisting of 52 or 53 weeks ending on the Sunday closest to or on December 31. All three- and nine-month periods presented herein contain 13 weeks and 39 weeks, respectively. All references to years and quarters relate to fiscal periods rather than calendar periods.

Executive Overview

Our Business

As of October 1, 2017, the Wendy’s restaurant system was comprised of 6,586 restaurants, of which 333 were owned and operated by the Company. All of our Company-operated restaurants are located in the U.S.

Wendy’s operating results are impacted by a number of external factors, including unemployment, general economic trends, intense price competition, commodity costs, labor costs and weather.

Wendy’s long-term growth opportunities will be driven by a combination of brand relevance and economic relevance. Key components of growth include (1) systemwide same-restaurant sales growth through continuing core menu improvement, product innovation and customer count growth, (2) investing in our Image Activation program, which includes innovative exterior and interior restaurant designs for our new and reimaged restaurants and focused execution of operational excellence, (3) growth in new restaurants, including global growth, (4) increased restaurant utilization in various dayparts and brand access utilizing mobile technology, (5) building shareholder value through financial management strategies and (6) our system optimization initiative.

Wendy’s revenues for the first nine months of 2017 include (1) $467.9 million of sales at Company-operated restaurants, (2) $306.1 million of franchise royalty revenue and fees and (3) $140.2 million of franchise rental income. Substantially all of our Wendy’s royalty agreements provide for royalties of 4.0% of franchisees’ revenues.

Key Business Measures

We track our results of operations and manage our business using the following key business measures, which include non-GAAP financial measures:

•

Same-Restaurant Sales - We report same-restaurant sales commencing after new restaurants have been open for 15 continuous months and as soon as reimaged restaurants reopen. This methodology is consistent with the metric used by our management for internal reporting and analysis. The table summarizing same-restaurant sales below in “Results of Operations” provides the same-restaurant sales percent changes. Same-restaurant sales exclude the impact of currency translation.

•

Restaurant Margin - We define restaurant margin as sales from Company-operated restaurants less cost of sales divided by sales from Company-operated restaurants. Cost of sales includes food and paper, restaurant labor and occupancy, advertising and other operating costs. Restaurant margin is influenced by factors such as restaurant openings, remodels and closures, price increases, the effectiveness of our advertising and marketing initiatives, featured products, product mix, the level of our fixed and semi-variable costs and fluctuations in food and labor costs.

•

Systemwide Sales - Systemwide sales is a non-GAAP financial measure, which includes sales by both Company-operated restaurants and franchised restaurants. Franchised restaurants’ sales are reported by our franchisees and represent their revenues from sales at franchised Wendy’s restaurants. The Company’s consolidated financial statements do not include sales by franchised restaurants to their customers. The Company believes systemwide sales data is useful in assessing consumer demand for the Company’s products, the overall success of the Wendy’s brand and, ultimately, the performance of the Company. The Company’s royalty revenues are computed as percentages of sales made by Wendy’s franchisees. As a result, sales by Wendy’s franchisees have a direct effect on the Company’s royalty revenues and therefore on the Company’s profitability.

The Company reviews same-restaurant sales and systemwide sales on a constant currency basis. Constant currency results exclude the impact of foreign currency translation and are derived by translating current year results at prior year average exchange rates. The Company believes excluding the impact of foreign currency translation provides better year over year comparability.

System Optimization Initiative

During the first nine months of 2017, the Company recorded post-closing adjustments on sales of restaurants and completed the sale of other assets, resulting in net gains totaling $3.4 million. Gains and losses recognized on dispositions are recorded to “System optimization losses (gains), net” in our condensed consolidated statements of operations. In addition, the Company facilitated the transfer of 270 restaurants between franchisees during the first nine months of 2017 (excluding the DavCo and NPC transactions discussed below).

DavCo and NPC Transactions

As part of our system optimization initiative, the Company acquired 140 Wendy’s restaurants on May 31, 2017 from DavCo Restaurants, LLC (“DavCo”) for total net cash consideration of $86.8 million, which were immediately sold to NPC International, Inc. (“NPC”), an existing franchisee of the Company, for cash proceeds of $70.7 million (the “DavCo and NPC transactions”). As part of the transaction, NPC has agreed to remodel 90 acquired restaurants in the Image Activation format by the end of 2021 and build 15 new Wendy’s restaurants by the end of 2022. Prior to closing the DavCo transaction, seven DavCo restaurants were closed. The acquisition of Wendy’s restaurants from DavCo was not contingent on executing the sale agreement with NPC; as such, the Company accounted for the transactions as an acquisition and subsequent disposition of a business. The total consideration paid to DavCo was allocated to net tangible and identifiable intangible assets acquired based on their estimated fair values. As part of the transactions, the Company retained leases for purposes of subleasing such properties to NPC. As a result of the transactions, the Company recognized a loss of $43.1 million during the first nine months of 2017.

Costs related to our system optimization initiative were historically recorded to “Reorganization and realignment costs.” Costs incurred during 2017 in connection with the DavCo and NPC transactions continue to be recorded to “Reorganization and realignment costs.” All other costs incurred during 2017 related to facilitating franchisee-to-franchisee restaurant transfers are recorded to “Other operating expense (income), net.” During the first nine months of 2017, the Company recognized reorganization and realignment costs totaling $0.9 million, which primarily included professional fees. The Company does not expect to incur additional costs during the remainder of 2017 in connection with the DavCo and NPC transactions.

General and Administrative (“G&A”) Realignment

November 2014 Plan

In November 2014, the Company initiated a plan to reduce its G&A expenses. The plan included a realignment and reinvestment of resources to focus primarily on accelerated restaurant development and consumer-facing restaurant technology to drive long-term growth. The Company achieved the majority of the expense reductions through the realignment of its U.S. field operations and savings at its Restaurant Support Center in Dublin, Ohio, which was substantially completed by the end of the second quarter of 2015. Costs related to the plan are recorded to “Reorganization and realignment costs.” The Company recognized costs totaling $1.0 million during the first nine months of 2016 and $24.0 million in aggregate since inception. The Company did not incur any expenses during the first nine months of 2017 and does not expect to incur additional costs related to the plan.

May 2017 Plan

In May 2017, the Company initiated a new plan to further reduce its G&A expenses. The Company expects that approximately three-quarters of the total G&A expense reduction of approximately $35.0 million will be realized by the end of 2018, with the remainder of the savings being realized in 2019. The Company expects to incur total costs aggregating approximately $28.0 million to $33.0 million, of which $23.0 million to $27.0 million will be cash expenditures, related to such savings. The cash expenditures are expected to continue into 2019, with approximately half of the total cash expenditures occurring in 2018. Costs related to the plan are recorded to “Reorganization and realignment costs.” The Company recognized costs totaling $19.9 million during the first nine months of 2017, which primarily included severance and related employee costs and share-based compensation. The Company expects to incur additional costs aggregating approximately $8.0 million to $13.0 million, comprised of (1) severance and related employee costs of approximately $3.0 million, (2) recruitment and relocation costs of approximately $4.0 million, (3) third-party and other costs of approximately $1.0 million and (4) share-based compensation of approximately $3.0 million. The Company expects costs to be recognized during the remainder of 2017 and continue into 2019, with approximately two-thirds to be recognized during 2017.

Related Party Transactions

TimWen Lease and Management Fee Payments

A wholly-owned subsidiary of Wendy’s leases restaurant facilities from TimWen for the operation of Wendy’s/Tim Hortons combo units in Canada. During the first nine months of 2017 and 2016, Wendy’s paid TimWen $9.4 million and $8.9 million, respectively, under these lease agreements. In addition, TimWen paid Wendy’s a management fee under the TimWen joint venture agreement of $0.2 million during both the first nine months of 2017 and 2016, which has been included as a reduction to “General and administrative.”

Cybersecurity Incident

The Company first reported unusual payment card activity affecting some franchise-owned restaurants in February 2016 and that malware had been discovered on certain systems. Subsequently, on June 9, 2016, the Company reported that an additional malware variant had been identified and disabled. On July 7, 2016, the Company, on behalf of affected franchise locations, provided information about specific restaurant locations that may have been impacted by these attacks, all of which are located in the United States, along with support for customers who may have been affected by the malware variants. See “Item 1 - Financial Statements,” Note 14 to the Condensed Consolidated Financial Statements for further information.

Results of Operations

The tables included throughout Results of Operations set forth in millions the Company’s condensed consolidated results of operations for the third quarter and the first nine months of 2017 and 2016.



	Third Quarter									Nine Months
	2017			2016			Change			2017			2016			Change
Revenues:
Sales	$	158.8		$	228.6		$	(69.8	)	$	467.9		$	747.2		$	(279.3	)
Franchise royalty revenue and fees	98.9			98.0			0.9			306.1			275.9			30.2
Franchise rental income	50.3			37.4			12.9			140.2			102.4			37.8
	308.0			364.0			(56.0		)	914.2			1,125.5			(211.3		)
Costs and expenses:
Cost of sales	132.4			186.5			(54.1		)	385.2			603.8			(218.6		)
Franchise rental expense	24.1			17.5			6.6			64.8			49.7			15.1
General and administrative	52.9			58.9			(6.0		)	156.7			184.7			(28.0		)
Depreciation and amortization	31.2			29.4			1.8			91.7			92.4			(0.7		)
System optimization losses (gains), net	0.1			(37.8		)	37.9			39.7			(48.1		)	87.8
Reorganization and realignment costs	2.9			2.1			0.8			20.8			7.9			12.9
Impairment of long-lived assets	1.0			0.4			0.6			1.8			13.0			(11.2		)
Other operating expense (income), net	1.7			0.9			0.8			5.3			(13.5		)	18.8
	246.3			257.9			(11.6		)	766.0			889.9			(123.9		)
Operating profit	61.7			106.1			(44.4		)	148.2			235.6			(87.4		)
Interest expense	(30.0		)	(28.7		)	(1.3		)	(87.9		)	(85.5		)	(2.4		)
Other (loss) income, net	(0.1		)	0.5			(0.6		)	3.1			1.0			2.1
Income before income taxes	31.6			77.9			(46.3		)	63.4			151.1			(87.7		)
Provision for income taxes	(17.3		)	(29.0		)	11.7			(28.6		)	(50.4		)	21.8
Net income	$	14.3		$	48.9		$	(34.6	)	$	34.8		$	100.7		$	(65.9	)



	Third Quarter								Nine Months
	2017		% of Total Revenues		2016		% of Total Revenues		2017		% of Total Revenues		2016		% of Total Revenues
Revenues:
Sales	$	158.8	51.6	%	$	228.6	62.8	%	$	467.9	51.2	%	$	747.2	66.4	%
Franchise royalty revenue and fees:
Royalty revenue	93.7		30.4	%	87.9		24.1	%	275.0		30.1	%	255.0		22.6	%
Franchise fees	5.2		1.7	%	10.1		2.8	%	31.1		3.4	%	20.9		1.9	%
Total franchise royalty revenue and fees	98.9		32.1	%	98.0