FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 ------------- OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- ----------------------- Commission File Number 1-8116 ------ WENDY'S INTERNATIONAL, INC. ------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) OHIO 31-0785108 -------------------------------- ---------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) P.O. Box 256, 4288 West Dublin-Granville Road, Dublin, Ohio 43017-0256 ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) (Registrant's telephone number, including area code) 614-764-3100 ---------------- 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 the number of shares outstanding in each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT AUGUST 4, 2002 ------------------------------------ ----------------------------- Common shares, $.10 stated value 115,663,000 shares Exhibit index on page 24. WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES INDEX PAGES PART I: Financial Information Item 1. Financial Statements: Consolidated Condensed Statements of Income for the quarters 3 - 4 and year-to-date periods ended June 30, 2002 and July 1, 2001 Consolidated Condensed Balance Sheets as of June 30, 2002 and December 30, 2001 5 - 6 Consolidated Condensed Statements of Cash Flows for the year-to-date periods ended June 30, 2002 and July 1, 2001 7 Notes to the Consolidated Condensed Financial Statements 8 - 13 Item 2. Management's Discussion and Analysis of 14 - 21 Financial Condition and Results of Operations PART II: Other Information Item 4. Submission of Matters to Vote of Security Holders 21 - 22 Item 6. Exhibits and Reports on Form 8-K 22 Signature 23 Index to Exhibits 24 Exhibit 99(a) 25 - 26 Exhibit 99(b) 27 Exhibit 99(c) 28 2 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share data) QUARTER ENDED QUARTER ENDED JUNE 30, 2002 JULY 1, 2001 --------- --------- REVENUES Retail sales $ 548,834 $ 491,464 Franchise revenues 135,213 118,146 --------- --------- 684,047 609,610 --------- --------- COSTS AND EXPENSES Cost of sales 342,427 311,063 Company restaurant operating costs 113,471 102,401 Operating costs 26,760 20,821 General and administrative expenses 58,832 53,329 Depreciation and amortization of property and equipment 35,177 29,372 Other income (39) (794) Interest expense 8,113 7,020 Interest income (1,445) (2,514) --------- --------- 583,296 520,698 --------- --------- INCOME BEFORE INCOME TAXES 100,751 88,912 INCOME TAXES 37,026 32,898 --------- --------- NET INCOME $ 63,725 $ 56,014 ========= ========= BASIC EARNINGS PER COMMON SHARE $ .58 $ .49 ========= ========= DILUTED EARNINGS PER COMMON SHARE $ .54 $ .47 ========= ========= DIVIDENDS PER COMMON SHARE $ .06 $ .06 ========= ========= BASIC SHARES 110,551 113,849 ========= ========= DILUTED SHARES 117,155 122,590 ========= ========= The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements. 3 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share data) YEAR-TO-DATE ENDED YEAR-TO-DATE ENDED JUNE 30, 2002 JULY 1, 2001 ----------- ----------- REVENUES Retail sales $ 1,041,921 $ 941,067 Franchise revenues 254,522 224,081 ----------- ----------- 1,296,443 1,165,148 ----------- ----------- COSTS AND EXPENSES Cost of sales 656,703 599,565 Company restaurant operating costs 220,098 200,810 Operating costs 51,916 41,850 General and administrative expenses 115,082 107,090 Depreciation and amortization of property and equipment 67,919 58,078 Other income (641) (1,325) Interest expense 18,786 14,359 Interest income (2,851) (5,617) ----------- ----------- 1,127,012 1,014,810 ----------- ----------- INCOME BEFORE INCOME TAXES 169,431 150,338 INCOME TAXES 62,266 55,625 ----------- ----------- NET INCOME $ 107,165 $ 94,713 =========== =========== BASIC EARNINGS PER COMMON SHARE $ .99 $ .83 =========== =========== DILUTED EARNINGS PER COMMON SHARE $ .93 $ .80 =========== =========== DIVIDENDS PER COMMON SHARE $ .12 $ .12 =========== =========== BASIC SHARES 108,345 114,095 =========== =========== DILUTED SHARES 116,282 122,853 =========== =========== The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements. 4 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands) JUNE 30, 2002 DECEMBER 30, 2001 ----------- ----------- (Unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 139,547 $ 111,121 Accounts receivable, net 91,579 83,603 Notes receivable, net 7,546 11,295 Deferred income taxes 9,941 15,000 Inventories and other 56,736 45,334 ----------- ----------- 305,349 266,353 ----------- ----------- PROPERTY AND EQUIPMENT 2,459,171 2,290,708 Accumulated depreciation and amortization (712,368) (650,730) ----------- ----------- 1,746,803 1,639,978 ----------- ----------- NOTES RECEIVABLE, NET 27,877 32,694 GOODWILL, NET 299,601 41,214 DEFERRED INCOME TAXES 28,021 36,175 OTHER ASSETS 77,963 59,629 ----------- ----------- $ 2,485,614 $ 2,076,043 =========== =========== The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements. 5 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands) JUNE 30, 2002 DECEMBER 30, 2001 ----------- ----------- (Unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 94,023 $ 112,245 Accrued expenses: Salaries and wages 32,275 34,014 Taxes 74,664 59,113 Insurance 44,049 40,719 Other 48,819 46,386 Current portion of long-term obligations 4,313 4,210 ----------- ----------- 298,143 296,687 ----------- ----------- LONG-TERM OBLIGATIONS Term debt 625,763 401,511 Capital leases 52,692 49,735 ----------- ----------- 678,455 451,246 ----------- ----------- DEFERRED INCOME TAXES 70,972 82,287 OTHER LONG-TERM LIABILITIES 24,521 16,044 COMMITMENTS AND CONTINGENCIES COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY WENDY'S FINANCING I, HOLDING SOLELY WENDY'S CONVERTIBLE DEBENTURES 0 200,000 SHAREHOLDERS' EQUITY Preferred stock, Authorized: 250,000 shares Common stock, $.10 stated value per share, Authorized: 200,000,000 shares, Issued and Exchangeable: 148,868,000 and 138,452,000 shares, respectively 14,313 13,271 Capital in excess of stated value 736,308 467,687 Retained earnings 1,471,789 1,377,840 Accumulated other comprehensive expense (28,622) (48,754) ----------- ----------- 2,193,788 1,810,044 Treasury stock at cost: 33,277,000 and 33,277,000 shares, respectively (780,265) (780,265) ----------- ----------- 1,413,523 1,029,779 ----------- ----------- $ 2,485,614 $ 2,076,043 =========== =========== The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements. 6 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED JUNE 30, 2002 JULY 1, 2001 --------- --------- NET CASH PROVIDED BY OPERATING $ 198,124 $ 137,382 ACTIVITIES --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from property dispositions 7,407 21,116 Capital expenditures (146,997) (133,123) Acquisition of Baja Fresh (287,542) -- Acquisition of franchises (746) -- Principal payments on notes receivable 11,039 2,531 Investments in joint venture and other (22,054) -- Other investing activities (1,266) (7,391) --------- --------- Net cash used in investing activities (440,159) (116,867) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of senior notes, net of issuance costs 224,345 -- Proceeds from employee stock options exercised 61,506 14,501 Repurchase of common stock -- (25,315) Principal payments on long-term obligations (2,174) (1,852) Dividends paid on common and exchangeable shares (13,216) (13,687) --------- --------- Net cash provided by (used in) financing activities 270,461 (26,353) --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 28,426 (5,838) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 111,121 169,718 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 139,547 $ 163,880 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 18,604 $ 14,485 Income taxes paid 37,887 41,455 Capital lease obligations incurred 3,173 3,310 NON-CASH INVESTING AND FINANCING ACTIVITIES: $2.50 Term Convertible Securities, Series A, converted and redeemed $ 200,000 -- The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements. 7 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) NOTE 1. MANAGEMENT'S STATEMENT ------------------------------- In the opinion of management, the accompanying consolidated condensed financial statements contain all adjustments (all of which are normal and recurring in nature) necessary to present fairly the condensed financial position of Wendy's International, Inc. and Subsidiaries (the Company) as of June 30, 2002 and December 30, 2001 and the condensed results of operations and comprehensive income (see Note 3) for the quarters and year-to-date periods ended June 30, 2002 and July 1, 2001 and cash flows for the year-to-date periods ended June 30, 2002 and July 1, 2001. All of these financial statements are unaudited with the exception of the December 30, 2001 balance sheet. The Notes to the audited Consolidated Financial Statements, which are contained in the Financial Statements and Other Information furnished with the Company's 2002 Proxy Statement, should be read in conjunction with these Consolidated Condensed Financial Statements. NOTE 2. NET INCOME PER SHARE ----------------------------- Basic earnings per common share are computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding. Diluted computations include assumed conversions of stock options, net of shares assumed to be repurchased from proceeds, and company-obligated mandatorily redeemable preferred securities, when dilutive, and the elimination of related expenses, net of income taxes. Options to purchase 2.7 million shares of common stock in the current quarter and year-to-date, and 3.4 million shares in the prior year quarter and year-to-date, were not included in the computation of diluted earnings per common share. These options were excluded from the calculation because the exercise price of these options was greater than the average market price of the common shares in the respective periods, and therefore, they are antidilutive. The computations of basic and diluted earnings per common share are shown below: QUARTER QUARTER YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED ENDED ENDED JUNE 30, 2002 JULY 1, 2001 JUNE 30, 2002 JULY 1, 2001 ------------- ------------ ------------- ------------ (In thousands, except per share data) Income for computation of basic earnings per common share $ 63,725 $ 56,014 $107,165 $ 94,713 Interest savings (net of income taxes) on assumed conversions -- 1,598 1,395 3,195 -------- -------- -------- -------- Income for computation of diluted earnings per common share $ 63,725 $ 57,612 $108,560 $ 97,908 ======== ======== ======== ======== Weighted average shares for computation of basic earnings per common share 110,551 113,849 108,345 114,095 Dilutive stock options 2,199 1,168 1,948 1,185 Assumed conversions 4,405 7,573 5,989 7,573 -------- -------- -------- -------- Weighted average shares for computation of diluted earnings per common share 117,155 122,590 116,282 122,853 ======== ======== ======== ======== Basic earnings per common share $ .58 $ .49 $ .99 $ .83 ======== ======== ======== ======== Diluted earnings per common share $ .54 $ .47 $ .93 $ .80 ======== ======== ======== ======== 8 NOTE 3. CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME ------------------------------------------------------------------ The components of other comprehensive income (expense) and total comprehensive income are shown below: QUARTER QUARTER YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED ENDED ENDED JUNE 30, 2002 JULY 1, 2001 JUNE 30, 2002 JULY 1, 2001 ------------- ------------ ------------- ------------ (In thousands) Net income $ 63,725 $ 56,014 $107,165 $ 94,713 Other comprehensive income (expense): Translation adjustments 21,665 15,768 20,132 (3,093) -------- -------- -------- -------- Comprehensive income $ 85,390 $ 71,782 $127,297 $ 91,620 ======== ======== ======== ======== The translation adjustments change of $5.9 million in the current quarter reflects a strengthening Canadian dollar in second quarter 2002 versus the prior year quarter. The $23.2 million translation adjustment change year-to-date reflects a strengthening of the Canadian dollar in the current year versus a weakening Canadian dollar last year. NOTE 4. SEGMENT REPORTING The Company operates exclusively in the food-service industry and has determined that its reportable segments are those that are based on the Company's methods of internal reporting and management structure. The Company's reportable segments are Wendy's and Tim Hortons. There were no material amounts of revenues or transfers between reportable segments. The table below presents information about reportable segments: WENDY'S TIM HORTONS TOTAL ------- ----------- ----- ( In thousands) QUARTER ENDED JUNE 30, 2002 Revenues $524,962 $159,085 $ 684,047 Income before income taxes 94,614 39,879 134,493 Capital expenditures 61,102 12,917 74,019 QUARTER ENDED JULY 1, 2001 Revenues $470,399 $139,211 $ 609,610 Income before income taxes 85,773 32,378 118,151 Capital expenditures 49,524 17,587 67,111 YEAR-TO-DATE ENDED JUNE 30, 2002 Revenues $994,674 $301,769 $1,296,443 Income before income taxes 167,135 71,375 238,510 Capital expenditures 114,422 32,575 146,997 YEAR-TO-DATE ENDED JULY 1, 2001 Revenues $895,348 $269,800 $1,165,148 Income before income taxes 148,293 60,718 209,011 Capital expenditures 97,586 35,537 133,123 A reconciliation of reportable segment income before income taxes to consolidated income before income taxes follows: QUARTER QUARTER YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED ENDED ENDED JUNE 30, 2002 JULY 1, 2001 JUNE 30, 2002 JULY 1, 2001 ------------- ------------ ------------- ------------ (In thousands) Income before income taxes $ 134,493 $ 118,151 $ 238,510 $ 209,011 Corporate charges (33,742) (29,239) (69,079) (58,673) --------- --------- --------- --------- Consolidated income before income taxes $ 100,751 $ 88,912 $ 169,431 $ 150,338 ========= ========= ========= ========= Corporate charges include certain overhead costs and net interest expense. 9 NOTE 5. INTANGIBLE ASSETS The Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (FAS 142) effective December 31, 2001. FAS 142 provides the accounting guidelines for goodwill and other intangibles. Under FAS 142, the amortization of goodwill and other indefinite-lived intangibles is prohibited and these assets must be tested for impairment annually (or in interim periods if events indicate possible impairment). In accordance with FAS 142, the Company reclassified approximately $2.5 million of net intangibles into goodwill and has ceased amortizing goodwill effective December 31, 2001. The Company has determined that no other intangibles have an indefinite life, and it will continue to amortize these remaining intangibles over their current lives. During the first quarter 2002, the Company assigned goodwill to reporting units and performed the first step of the transitional impairment tests for goodwill. The Company has determined its reporting units to be Domestic Wendy's, Canadian Wendy's, International Wendy's, Tim Hortons Canada and Tim Hortons U.S. The first step requires the Company to compare the fair value of each reporting unit as measured by discounted future cash flows, to the carrying value, to determine if there is an indication that a potential impairment may exist. There is no indication of impairment and, therefore no impairment write-off is required upon adoption of FAS 142. The table below presents amortized and unamortized intangible assets as of June 30, 2002 and December 30, 2001 (in thousands): JUNE 30, 2002 DECEMBER 30, 2001 ------------- ----------------- GROSS NET GROSS NET CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT ------------------------------------------ ----------------------------------------- Amortized intangible assets: Patents and trademarks $11,264 $(1,755) $ 9,509 $10,939 $(1,329) $ 9,610 Purchase options 7,500 (3,626) 3,874 7,500 (3,287) 4,213 Other 2,041 (410) 1,631 6,900 (2,552) 4,348 --------- ------- $ 15,014 $18,171 ======== ======= Unamortized intangible assets: Goodwill $299,601 $41,214 ======== ======= The $300 million in goodwill at June 30, 2002 is comprised of $43 million for Wendy's, $600,000 for Hortons and $256 million related to the Company's acquisition of Fresh Enterprises, Inc. Please refer to Note 7 for more information regarding this acquisition. Total intangibles amortization expense was $484,000 and $964,000 for the quarter and year-to-date ended June 30, 2002, respectively, and the estimated annual intangibles amortization expense for each year through 2006 is $1.9 million. 10 In accordance with FAS 142, the quarter and year-to-date ended July 1, 2001 have not been restated. The table below presents a reconciliation of net income, basic earnings per common share and diluted earnings per common share as if FAS 142 had been adopted for the quarter and year-to-date ended July 1, 2001. Basic and diluted earnings per common share for the quarter and year-to-date ended July 1, 2001 each would have been $.01 higher had FAS 142 been adopted for those periods. QUARTER QUARTER YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED ENDED ENDED JUNE 30, 2002 JULY 1, 2001 JUNE 30, 2002 JULY 1, 2001 ------------- ------------ ------------- ------------ (In thousands, except per share amounts) Net income $ 63,725 $ 56,014 $ 107,165 $ 94,713 Goodwill amortization (net of tax) -- 639 -- 1,275 ----------- ----------- ----------- ----------- Adjusted net income $ 63,725 $ 56,653 $ 107,165 $ 95,988 =========== =========== =========== =========== Basic earnings per common share $ .58 $ .49 $ .99 $ .83 Goodwill amortization (net of tax) -- .01 -- .01 ----------- ----------- ----------- ----------- Adjusted basic earnings per common share $ .58 $ .50 $ .99 $ .84 =========== =========== =========== =========== Diluted earnings per common share $ .54 $ .47 $ .93 $ .80 Goodwill amortization (net of tax) -- .01 -- .01 ----------- ----------- ----------- ----------- Adjusted diluted earnings per common share $ .54 $ .48 $ .93 $ .81 =========== =========== =========== =========== NOTE 6. RECENT ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" was issued in June 2001. This statement addresses accounting and reporting standards for legal obligations associated with the retirement of tangible long-lived assets. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of 2003. Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued in August 2001. This statement supersedes Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". This statement addresses accounting and reporting standards for the impairment or disposal of long-lived assets. This statement was adopted in the first quarter 2002 and currently does not impact the Company's financial statements. Statement of Financial Accounting Standards (FAS) No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued in April 2002. This statement rescinds FAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and an amendment of that Statement, FAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This Statement also rescinds FAS No. 44, "Accounting for Intangible Assets of Motor Carriers". This statement amends FAS No. 13, "Accounting for Leases", to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The provisions of this statement related to the rescission of FAS No. 4 will be applied in fiscal years beginning after May 15, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal year 2003. Statement of Financial Accounting Standards No. 146, "Accounting for Exit or Disposal Activities" was issued in June 2002. This statement addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with the exit and disposal activities, including restructuring activities, that are currently accounted for pursuant 11 to the guidance that the Emerging Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". This statement also addresses accounting and reporting standards for costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement or an individual deferred-compensation contract. This statement will be effective for exit or disposal activities that are initiated after December 31, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal year 2003. NOTE 7. ACQUISITIONS AND INVESTMENTS In 2001, the Company formed a joint venture between Hortons and IAWS Group/Cuisine de France to build a par-baked goods manufacturing facility in Canada. The Company has committed to invest $35.5 million in this joint venture, of which $14.1 million was paid in 2001 and $13.1 million has been paid year-to-date 2002. In first quarter 2002, the Company finalized an investment of $9 million for a 45% minority interest in Cafe Express, a fast-casual restaurant pioneer. Cafe Express currently operates 14 restaurants in Houston, Dallas and Phoenix. The Company is a guarantor on a revolving credit facility for Cafe Express up to $3 million. The Company is accounting for both of these investments using the equity method. On June 19, 2002, the Company completed its acquisition of Fresh Enterprises, Inc. ("Baja Fresh"), the owner and operator of the Baja Fresh Mexican Grill restaurant chain, pursuant to a Merger Agreement dated May 30, 2002. The results of Baja Fresh's operations have been included in the Company's consolidated financial statements since June 19, 2002. Baja Fresh owns, operates and franchises fast-casual restaurants in 16 states and the District of Columbia. At the date of acquisition, Baja Fresh consisted of 80 company restaurants and 91 franchise restaurants. This acquisition is consistent with the Company's strategy to invest in opportunities that can add to the Company's long-term earnings growth. The purchase price was $275 million, subject to purchase price adjustments, in exchange for 100% of the stock of Baja Fresh. Total cash paid by the Company in connection with the transaction in the second quarter was $288 million, and included $3.5 million in fees paid to third parties and $9.5 million to reimburse Baja Fresh for investment expenditures made in 2002. The Company used the proceeds from the issuance of $225 million in 6.2% senior notes due 2014 and cash on hand to finance the transaction. This acquisition was accounted for pursuant to Statement of Financial Accounting Standards No. 141, "Business Combinations". The Company has retained a third party valuation expert to assist in the valuation of the assets acquired. This valuation is expected to be complete by December 29, 2002, the end of the Company's fourth quarter. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, however, these fair values are subject to adjustment upon the completion of the third party valuation. As of Baja Fresh Acquisition June 19, 2002 ---------------------- ------------- (000's) Current assets $ 4,463 Property and equipment, net 35,977 Goodwill 255,896 Other assets 3,872 -------- Total assets acquired 300,208 -------- Current liabilities 6,210 Long-term debt 6,456 -------- Total liabilities assumed 12,666 -------- Net assets acquired $287,542 ======== 12 If the acquisition had been completed as of the beginning of the periods indicated below, pro forma revenues, net income and basic and diluted earnings per common share would have been as follows: QUARTER QUARTER YEAR-TO-DATE YEAR-TO-DATE ENDED ENDED ENDED ENDED JUNE 30, 2002 JULY 1, 2001 JUNE 30, 2002 JULY 1, 2001 ------------- ------------- ------------- ------------- Total revenues $ 710,964 $ 626,931 $ 1,346,117 $ 1,196,394 Net income 60,590 53,570 102,249 89,665 Net income per common share: Basic $ .55 $ .47 $ .94 $ .79 Diluted $ .52 $ .45 $ .89 $ .76 The selected unaudited pro forma information for the quarters and year-to-date periods ended June 30, 2002 and July 1, 2001 includes interest expense on the Company's $225 million of 6.2% senior notes that were issued in conjunction with the acquisition of Baja Fresh. In addition, the quarter and year-to-date periods ended July 1, 2001 exclude expenses incurred by Baja Fresh in conjunction with its previously planned public offering. The pro forma information is not necessarily indicative of the results of operations had the acquisition actually occurred at the beginning of each of these periods, nor is it necessarily indicative of future results. NOTE 8. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES During the quarter, the Company called for redemption all of its outstanding $2.50 Term Convertible Securities, Series A ("TECONS"), issued by Wendy's Financing I, a subsidiary of the Company. By the end of the quarter, 99.9% of the $200 million in TECONS had been converted. The remainder were redeemed by the Company. As a result of the conversion, the Company's common shares issued increased by 7.6 million shares. NOTE 9. SUBSEQUENT EVENT On July 3, 2002, the Company announced that its Tim Hortons subsidiary had signed a definitive agreement to sell its cup manufacturing business to Dopaco Canada, Inc. ("Dopaco"). The sale, which closed on July 16, 2002, resulted from a strategic business review by Tim Hortons' management team. The sale generated $20 million in cash and a one-time pretax gain of $3.9 million, which will be approximately $.02 per share in third quarter 2002 for the Company. The cup manufacturing business generated income of about $.01 per share for the Company in 2001. Under a supply agreement with Dopaco, Tim Hortons has agreed to purchase a minimum of 50% of its cup and lid supplies from Dopaco over the period from July 15, 2002 through July 15, 2007. Also as part of this agreement, Dopaco has agreed to pay Tim Hortons a total of $2.2 million over three years as a volume purchase incentive. 13 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company's diluted earnings per common share increased 14.9% to $.54 in the current quarter, and 16.3% to $.93 in the year-to-date period. In the quarter, consolidated revenues, which do not include sales in franchise restaurants, increased 12.2% to $684 million. Also in the quarter, systemwide sales, which includes sales of both franchise and company operated restaurants, increased 13.4% to $2.4 billion. Year-to-date, consolidated revenues increased 11.3% to $1.3 billion and systemwide sales increased 12.6% to $4.5 billion. Same-store sales increased for Wendy's and Tim Hortons restaurants, both in the U.S. and Canada during quarter and year-to-date. WENDY'S RETAIL SALES Wendy's retail sales for the second quarter 2002 increased $50.5 million, or 12.6%, to $452.1 million, and $90.5 million, or 11.8%, to $857.6 million for year-to-date 2002. Of this total, domestic Wendy's retail sales increased 12.4% to $405.8 million in the quarter, and 11.8% to $772.4 million for the year-to-date. For domestic company operated Wendy's, average restaurant sales increased 6.0% to $365,258 per restaurant in the quarter, and 5.6% to $698,278 year-to-date. Average same-store sales in Wendy's domestic company restaurants increased 6.6% in the quarter and 6.2% for the year- to-date. The average number of transactions in domestic company operated Wendy's increased 4.2% in the quarter and 3.5% year-to-date, while the average check increased 2.5% in the quarter and 2.7% year-to-date. In addition, domestic selling prices increased ..7% in the quarter and 1.0% year-to-date. In the second quarter, the average number of Wendy's company operated domestic restaurants open increased by 64 and 62, respectively, compared to the prior year quarter and year-to-date. Canadian Wendy's retail sales increased $4.5 million, or 16.0%, in the second quarter, and $6.4 million, or 12.0%, for the year-to-date. Canadian Wendy's average sales for company operated restaurants, in local currency, increased 5.8% in the second quarter and 3.6% for the year-to-date. Same-store sales increased 7.9% in the second quarter and 5.8% for the year-to-date. The average number of company stores open increased by twelve compared to the prior year. Nearly all international company operated restaurants outside of Canada were shut down with the closures in Argentina in 2000. FRANCHISE REVENUES Wendy's franchise revenues, before reserves for uncollectible amounts, increased $4.0 million, or 5.9%, to $72.8 million in the quarter and $8.8 million, or 6.9%, to $137.1 million year-to-date. Royalties increased $7.2 million, or 13.5%, to $60.5 million in the quarter and $13.2 million, or 13.1%, to $114.3 million year-to-date. Average net sales at franchise domestic restaurants increased 9.9% to $328,615 per restaurant in the quarter and 9.5% to $623,626 year-to-date. Average same-store sales at franchise domestic restaurants increased 9.5% for the quarter and 8.9% year-to-date. In the second quarter and year-to-date, the average number of Wendy's domestic franchise restaurants increased by 155 and 154, respectively, compared to the prior year quarter and year-to-date. In local currency, Canadian Wendy's same-store franchise sales increased 8.8% in the quarter and 7.4% year-to-date, while other international same-store franchise sales increased .2% for the quarter and .4% for the year-to-date period. Total Wendy's franchise restaurants open at quarter-end were 4,835 and 4,715, respectively, in 2002 and 2001. Asset gains from the sale of company operated restaurants and real estate to franchisees decreased $3.9 million in the current quarter to a total of $730,000 (pretax) and decreased $5.4 million for the year-to-date period to $1.5 million (pretax). COST OF SALES AND RESTAURANT OPERATING COSTS Wendy's cost of sales increased $27.0 million, or 11.2%, to $267.4 million in the quarter and $49.2 million, or 10.6%, to $512.5 million year-to-date. Of this total, Wendy's domestic restaurant cost of sales increased 11.1% to $239.0 million in the quarter and 10.6% to $459.4 million year-to-date. Wendy's domestic cost of sales as a percent of Wendy's domestic retail sales, decreased ..7% in the quarter and .6% year-to-date. Domestic food costs, as a percent of domestic retail sales, decreased .6% in the quarter and .5% year-to-date, reflecting a decrease in beef and chicken costs of 7.0% 14 and 4.8%, respectively, in the quarter and 6.1% and 3.7% year-to-date. In addition, there was a selling price increase of .7% for the quarter and 1.0% for the year-to-date as compared to the prior year. Domestic labor costs, as a percent of sales, decreased .3% in the quarter and .2% year-to-date, reflecting higher average sales. The average crew wage rate increased 1.8% in the quarter and 2.0% year-to-date. Wendy's company restaurant operating costs increased $11.4 million, or 11.6%, to $109.5 million in the quarter and $20.1 million, or 10.4%, to $212.1 million year-to-date. Of this total, domestic Wendy's company restaurant operating costs increased 11.6% to $101.0 million in the quarter and 10.7% to $196.0 million year-to-date. As a percent of retail sales, domestic restaurant costs decreased ..2% in the quarter and .3% year-to-date. The quarter and year-to-date reflected lower utility costs and the leverage benefit of higher average sales, partly offset by higher performance-based bonus expense. The factors discussed above resulted in Wendy's domestic company operating margin increasing .9% to 17.0% in the quarter and .9% to 15.9% for the year-to-date. As a percent of retail sales, Canadian Wendy's cost of sales decreased .8% in the quarter, reflecting higher average sales. As a percent of retail sales Canadian Wendy's cost of sales remained even for the year-to-date. Average wage rates increased 2.4% in the quarter and 2.8% for the year-to-date. Canadian Wendy's company restaurant operating costs increased $968,000 in the quarter and $1.2 million year-to-date reflecting the growth of the business. Nearly all international company operated restaurants outside of Canada were shut down with the closures in Argentina at year-end 2000. OPERATING COSTS Wendy's operating costs increased 23.3% to $4.6 million in the quarter, and 21.6% to $8.9 million for the year-to-date reflecting higher percentage rent due to higher average sales. Operating costs also increased reflecting the opening of a second bakery in the second half of 2001. TIM HORTONS RETAIL SALES Tim Hortons (Hortons) retail sales increased $6.8 million, or 7.6%, to $96.7 million in second quarter and $10.4 million, or 6.0%, to $184.3 million for the year-to-date. Of this total, Canadian warehouse sales (sales of dry goods to franchisees) increased $9.5 million, or 12.7%, to $83.9 million in the quarter and $14.9 million, or 10.4%, to $158.2 million for the year-to-date. This reflected the increase in the number of Hortons' Canadian franchised restaurants serviced and same-store sales growth in local currency of 9.5% for the quarter and 8.7% for the year-to-date. Retail sales in the U.S. were $7.6 million in the quarter and $16.0 million for the year-to-date. Both periods were down from the prior year, reflecting fewer company operated restaurants as Hortons continued the strategy of franchising company operated restaurants in the U.S. FRANCHISE REVENUES Hortons franchise revenues, before reserves for uncollectible amounts, increased $13.0 million, or 26.4%, to $62.4 million in second quarter and $21.6 million, or 22.6%, to $117.4 million for the year-to-date. Canadian royalties increased 17.6% to $12.5 million in the quarter and 14.5% to $23.4 million for the year-to-date. This reflected same-store sales increases in local currency of 9.5% for the quarter and 8.7% for the year-to-date, and 190 additional franchise stores. Canadian rental income from restaurants leased to franchisees increased 18.7% to $36.6 million in the quarter and 15.9% to $68.0 million for the year-to-date. These increases reflected the increase in the number of Canadian restaurants leased to franchisees and higher average sales (rent is generally charged as a percent of sales). Franchise fees increased $3.2 million to $8.7 million for the quarter and $5.3 million to $17.3 million for the year-to-date. COST OF SALES The Hortons' Canadian warehouse cost of sales increased $8.0 million, or 13.4%, to $67.3 million in the quarter and $11.9 million, or 10.5% to $125.6 million for the year-to-date. The increase in each period reflects additional sales to Canadian franchisees due to the increased number of restaurants serviced and higher average sales per restaurant. Warehouse cost of sales, as a percent of warehouse sales, increased to 80.2% in the second quarter 2002 from 79.7% in 2001 and remained unchanged at 79.4% for the year-to-date period. Hortons U.S. cost of sales were $4.8 million in the 15 quarter and $11.1 million year-to-date. Both periods were down from the prior year, reflecting the continuing strategy to franchise company operated restaurants. OPERATING COSTS Hortons operating costs increased $5.1 million, or 29.7%, to $22.2 million in the quarter and $8.5 million, or 24.6%, to $43.0 million for the year-to-date. Canadian Hortons rent expense increased 9.5% to $8.9 million in the quarter and 8.4% to $17.1 million for the year-to-date, reflecting the growth in the number of properties being leased and then subleased to Canadian franchisees, as well as higher percentage rent due to higher sales. Cost of equipment and other franchise costs increased $2.6 million to $6.7 million in the quarter and $4.2 million to $13.4 million for the year-to-date. Costs of operating and maintaining Canadian warehouse operations increased 29.7% to $5.5 million in the quarter and 27.4% to $10.7 million for the year-to-date. Hortons U.S. had an increase of $746,000 in operating costs for the quarter and $2.7 million for the year-to-date period, reflecting equipment costs and other costs incurred in the franchising of four restaurants in the quarter, and eleven restaurants year-to-date. The operating cost increase also reflects the costs to operate a coffee manufacturing company opened in 2002. CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES Company general and administrative expenses increased 10.3% to $58.8 million in the quarter and 7.5% to $115.1 million in the year-to-date period. As a percent of revenues, costs were .1% lower in the quarter at 8.6% versus 8.7% last year and .3% lower at 8.9% versus 9.2% for the year-to-date. The dollar increase in 2002 primarily reflects an increase in salaries and benefits, including performance-based bonus costs. DEPRECIATION AND AMORTIZATION EXPENSES Depreciation and amortization expenses for the quarter and year-to-date increased over 2001 reflecting the Company's information technology initiatives and additional restaurant development. INTEREST EXPENSE Interest expense increased $1.1 million in the quarter and $4.4 million for the year-to-date period reflecting $200 million of 6.25% senior notes issued by the Company in the fourth quarter of 2001 and $225 million of 6.20% senior notes issued by the Company in the current quarter. This was partially offset by the conversion into common shares of $200 million in term convertible securities in second quarter 2002. INTEREST INCOME Interest income decreased $1.1 million in the quarter and $2.8 million for the year-to-date period reflecting the low interest income rates available in the current interest rate environment. FOREIGN CURRENCY The primary currency exposure the Company has is to the Canadian dollar. The results of Wendy's and Tim Hortons' Canadian operations are translated into U.S. dollars. The change in the Canadian dollar this year versus last year reduced earnings per share by approximately one cent for the year-to-date 2002, related to translating Canadian operations. The impact on second quarter 2002 diluted earnings per share was less than one cent. COMPREHENSIVE INCOME Comprehensive income increased $13.6 million in the quarter and $35.7 million for the year-to-date. Comprehensive income includes net income, which increased $7.7 million in the quarter and $12.5 million year-to-date, and translation adjustments caused by changes in foreign currency. The translation adjustments changed $5.9 million in the current quarter reflecting a strengthening Canadian dollar in second quarter 2002 versus the prior year quarter. Year-to-date, translation adjustments changed $23.2 million reflecting a strengthening of the Canadian dollar in the current year versus a weakening Canadian dollar last year (see Note 3 to the consolidated condensed financial statements). FINANCIAL CONDITION The Company continues to maintain a strong balance sheet to support system growth and financial flexibility. The long-term debt-to-equity and debt-to-total capitalization ratios were 48% and 32%, respectively, at June 30, 2002, reflecting the $200 million in senior notes issued in fourth quarter 2001 and $225 million in senior notes issued in second quarter 2002. Equity also increased from the conversion of $200 million in term convertible securities in the second quarter of 16 2002. Standard & Poor's and Moody's rate the Company's senior unsecured debt BBB+ and Baa-1, respectively. Cash flow from operations was $198 million for the year-to-date, and $137 million for the prior year-to-date. Capital expenditures amounted to $147 million for 2002 compared with $133 million for 2001. The Company borrowed $225 million, and in addition, used $63 million of cash on hand to finance the purchase of 100% of the stock of Fresh Enterprises, Inc. ("Baja Fresh") in second quarter 2002. Baja Fresh owns, operates and franchises fast-casual restaurants in 16 states and the District of Columbia. Please refer to Note 7 for more information on this acquisition. The Company has not repurchased any common shares in 2002, however, the Company announced that it may repurchase up to $25 million of its common shares during the remainder of 2002. In 2001, the Company formed a joint venture between Hortons and IAWS Group/Cuisine de France to build a par-baked goods manufacturing facility in Canada. The Company has committed to invest $35.5 million in this joint venture, of which $14.1 million was paid in 2001 and $13.1 million has been paid year-to-date 2002. On February 28, 2002, the Company finalized an investment of $9 million for a 45% minority interest in Cafe Express, a fast-casual restaurant pioneer. Cafe Express currently operates 14 restaurants in Houston, Dallas and Phoenix. The Company is a guarantor on a revolving credit facility for Cafe Express up to $3 million. The Company is accounting for both of these investments using the equity method. During the quarter, the Company called for redemption all of its outstanding $2.50 Term Convertible Securities, Series A ("TECONS"), issued by Wendy's Financing I, a subsidiary of the Company. By the end of the quarter, 99.9% of the $200 million in TECONS had been converted. The remainder were redeemed by the Company. As a result of the conversion, the Company's common shares issued increased by 7.6 million shares. OUTLOOK The Company continues to employ its strategic initiatives as outlined in the Financial Statements and Other Information furnished with the Company's 2002 Proxy Statement. These initiatives include leveraging the Company's core assets, growing same-store sales, improving store-level productivity to enhance margins, improving underperforming operations, developing profitable new restaurants and implementing new technology initiatives. The Company intends to allocate resources to improve long-term return on assets and invested capital, and to remain focused on established long-term operational strategies of exceeding customer expectations, fostering a performance-driven culture, delivering a balanced message of brand equity plus value in marketing and growing a healthy restaurant system. New restaurant development continues to be very important. The Company also intends to evaluate potential mergers, acquisitions, joint venture investments, alliances, vertical integration opportunities and divestitures that could add to the Company's long-term earnings growth. The Company's long-term goal for EPS growth continues to be in the 12% to 15% range, excluding unusual items. The Company anticipates current year EPS will be in the $1.90 to $1.95 range. This revision from the previous range of $1.87 to $1.92 is due to strong business trends at Wendy's and Tim Hortons and takes into consideration the following items: - $.02 to $.04 per share dilution in the second half of 2002 from the acquisition of Baja Fresh (see Note 7). - $.02 per share gain from the sale of Tim Hortons' cup manufacturing business (see Note 9). - $.01 per share in asset gains from refranchising Wendy's company operated restaurants. The Company currently anticipates that between 515-540 new Wendy's and Hortons restaurants will be opened systemwide (both company and franchise) during 2002, subject to the continued ability of the Company and its franchisees to complete permitting and meet other conditions and to comply with other regulatory requirements for the completion of stores and to obtain financing for new restaurant development. In addition, Baja Fresh intends to grow to over 200 stores by year-end. In the second quarter, 86 new restaurants opened, versus 101 new restaurant openings in the prior year quarter. Year-to-date 2002, there have been 157 new restaurants opened, versus 193 new restaurant openings in the prior year-to-date. Cash flow from operations, cash and investments on hand, possible asset sales, and cash available through existing revolving credit agreements and through the possible issuance of securities should provide for the Company's projected short-term and long-term cash requirements, including cash for capital expenditures, future acquisitions of restaurants from franchisees or other corporate purposes. The Company is committed to a strong capital structure and financial profile, and intends to maintain an investment grade rating. If additional funds are needed for mergers, acquisitions or other strategic investments, the Company believes it could borrow additional cash and still maintain its investment grade rating. In the event the Company's rating declines, the Company may incur an increase in borrowing costs. If the decline 17 in the rating is significant, it is possible that the Company would not be able to borrow on acceptable terms. Factors that could be significant to the determination of the Company's credit ratings include sales and cost trends, margins at Wendy's U.S. company restaurants, the Company's cash position, cash flow, capital expenditures and capitalization, and stability of earnings. The Company does not have significant term debt maturities until 2005. The Company believes it will be able to pay or refinance future term debt obligations based on its strong financial condition and sources of cash described in the preceding paragraph. MARKET RISK The Company's debt is primarily denominated in U.S. dollars, at fixed interest rates, which limits interest rate risk on financial instruments. Therefore, the Company does not currently utilize any derivatives to alter interest rate risk. Currency exposure is predominately related to Canadian operations, since exposure outside North America is limited to royalties. The Company has cash flow exposure from Tim Hortons and Wendy's operations in Canada. The Canadian currency has been reasonably stable over time, however, in recent years the Canadian dollar has weakened which reduces the U.S. benefit of Canadian operations. While the Company monitors the situation, it does not currently hedge its exposure to Canadian currency fluctuations. At the current level of operating income generated from Canada, if the Canadian currency rate changes one penny in the quarter, the impact on the Company for the quarter would be less than $200,000. At current royalty levels outside of North America, if all foreign currencies moved 10% during each royalty collection period in the same direction, at the same time, the quarter impact would be approximately $250,000. Therefore, the Company does not hedge its exposure to currency fluctuations related to royalty collections outside North America, because it does not believe the risk is material. The Company purchases certain products in the normal course of business, which are affected by commodity prices. Therefore, the Company is exposed to some price volatility related to weather, and various other market conditions outside the Company's control. However, the Company does employ various purchasing and pricing contract techniques, in an effort to minimize volatility. The Company does not generally make use of financial instruments to hedge commodity prices, partly because of the contract pricing utilized. While volatility can occur, which would impact profit margins, there are generally alternative suppliers available and if the pricing problem is prolonged, the Company has some ability to increase selling prices to offset the commodity prices. THE APPLICATION OF CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that can have a material impact on the results of operations of the Company. Sales recognition at company operated restaurants is straightforward as customers pay for products at the time of sale, and inventory turns over very quickly, with key items counted daily and a complete food inventory taken weekly. Payments to vendors for products sold in the restaurants are generally settled within 14 days. The earnings reporting process is covered by the Company's system of internal controls, and generally does not require significant management estimates and judgments. However, estimates and judgments are inherent in the calculations of royalty and other franchise related revenue collections, legal obligations, pension and other post-retirement benefits, income taxes, insurance liabilities, various other commitments and contingencies and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions. This discussion of critical accounting policies is substantially the same as set forth in the Financial Statements and Other Information furnished with the Company's Proxy Statement for the 2002 Annual Meeting of Shareholders, which was incorporated by reference into the Company's most recent Form 10-K. The Company collects royalties, and in some cases rent, from franchisees and Hortons collects distribution revenues from Canadian franchisees. The Company provides for estimated losses for revenues that are not likely to be collected. Although the Company enjoys a good relationship with franchisees, and collection rates are currently very high, if average sales or the financial health of franchisees were to deteriorate, the Company might have to increase reserves against collection of franchise revenues. 18 The Company is self-insured for most workers' compensation, health care claims, general liability and automotive liability losses. The Company records its insurance liabilities based on historical and industry trends, which are continually monitored, and accruals are adjusted when warranted by changing circumstances. Outside actuaries are used to assist in estimating casualty insurance obligations. Since there are many estimates and assumptions involved in recording insurance liabilities, differences between actual future events and prior estimates and assumptions could result in adjustments to these liabilities. Pension and other retirement benefits, including all relevant assumptions required by generally accepted accounting principles, are evaluated each year with the oversight of the Company's retirement committee. Due to the technical nature of retirement accounting, outside actuaries are used to provide assistance in calculating the estimated future obligations. Since there are many estimates and assumptions involved in retirement benefits, differences between actual future events and prior estimates and assumptions could result in adjustments to pension expenses and obligations. In the normal course of business, the Company must make continuing estimates of potential future legal obligations and liabilities, which requires the use of management's judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required. The Company records income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. The Company records a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. Management must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to determine the proper valuation allowance. When the Company determines that deferred tax assets could be realized in greater or less amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are involved in determining the proper valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance. The Company uses an estimate of its annual effective tax rate at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at year-end. Depreciation and amortization are recognized using the straight-line method in amounts adequate to amortize costs over the following estimated useful lives: buildings, up to 40 years; leasehold improvements, up to 25 years; restaurant equipment, up to 15 years; other equipment, up to 10 years; and property under capital leases, the primary lease term. The Company estimates useful lives on buildings and equipment based on historical data and industry trends. Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates that an impairment may exist. The Company tests for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing. The Company capitalizes certain internally developed software costs which are amortized over a ten-year period. The Company monitors its capitalization and amortization policies to ensure they remain appropriate. The Company tests goodwill for impairment annually (or in interim periods if events or changes in circumstances indicate that its carrying amount may not be recoverable) by comparing the fair value of each reporting unit as measured by discounted cash flows, to the carrying value, to determine if there is an indication that a potential impairment may exist. In calculating the discounted cash flows, the Company used a discount rate of 6.75% and assumed a 3% increase in cash flows per year. The Company will review these assumptions each time goodwill is tested for impairment and will make the appropriate adjustments based on facts and circumstances available at that time. RECENTLY ISSUED ACCOUNTING STANDARDS The Company adopted Statement of Financial Accounting Standards (FAS) No. 142 "Goodwill and Other Intangible Assets", in first quarter 2002. In accordance with FAS 142, the Company reclassified approximately $2.5 million of net intangibles into goodwill at year-end 2001 and the Company is no longer recording amortization on goodwill effective December 31, 2001. The Company has determined that its goodwill is not impaired. Please refer to Note 5 to the Company's Consolidated Financial Statements for more detailed disclosures concerning FAS 142. 19 Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" was issued in June 2001. This statement addresses accounting and reporting standards for legal obligations associated with the retirement of tangible long-lived assets. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of 2003. Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued in August 2001. This statement supersedes Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". This statement addresses accounting and reporting standards for the impairment or disposal of long-lived assets. This statement was adopted in first quarter 2002 and currently, does not materially impact the Company's financial statements. Statement of Financial Accounting Standards (FAS) No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued in April, 2002. This statement rescinds FAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and an amendment of that Statement, FAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This Statement also rescinds FAS No. 44, "Accounting for Intangible Assets of Motor Carriers". This Statement amends FAS No. 13, "Accounting for Leases", to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The provisions of this statement related to the rescission of FAS No. 4 will be applied in fiscal years beginning after May 15, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal year 2003. Statement of Financial Accounting Standards No.146, "Accounting for Exit or Disposal Activities" was issued in June 2002. This statement addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with the exit and disposal activities, including restructuring activities, that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". This statement also addresses accounting and reporting standards for costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement or an individual deferred-compensation contract. This statement will be effective for exit or disposal activities that are initiated after December 31, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal year 2003. SAFE HARBOR STATEMENT Certain information contained in this Form 10-Q, particularly information regarding future economic performance and finances, plans and objectives of management, is forward looking. In some cases, information regarding certain important factors that could cause actual results to differ materially from any such forward-looking statement appears together with such statement. In addition, the following factors, in addition to other possible factors not listed, could affect the Company's actual results and cause such results to differ materially from those expressed in forward-looking statements. These factors include: competition within the quick-service restaurant industry, which remains extremely intense, both domestically and internationally, with many competitors pursuing heavy price discounting; changes in economic conditions; changes in consumer perceptions of food safety; harsh weather, particularly in the first and fourth quarters; changes in consumer tastes; labor and benefit costs; legal claims; risks inherent to international development (including currency fluctuations); the continued ability of the Company and its franchisees to obtain suitable locations and financing for new restaurant development; governmental initiatives such as minimum wage rates, taxes and possible franchise legislation; the ability of the Company to successfully complete transactions designed to improve its return on investment; and other factors set forth in Exhibit 99 (a) attached hereto. 20 The number of systemwide restaurants open as of June 30, 2002 and July 1, 2001 was as follows: 2002 2001 ----- ----- WENDY'S Company 1,248 1,159 Franchise 4,835 4,715 ----- ----- Total Wendy's 6,083 5,874 ===== ===== TIM HORTONS Company 77 106 Franchise 2,134 1,941 ----- ----- Total Tim Hortons 2,211 2,047 ===== ===== BAJA FRESH Company 81 52 Franchise 91 66 ----- ----- Total Baja Fresh 172 118 ===== ===== Total System 8,466 8,039 ===== ===== PART II: OTHER INFORMATION Item 4. Submission of Matters to Vote of Security Holders. (a) The Annual Meeting of the Company's shareholders was held on May 1, 2002. (b) The following table sets forth the name of each director elected at the meeting and the number of votes for or withheld from each director: DIRECTOR FOR WITHHELD -------- --- -------- Thekla R. Shackelford 86,843,585 1,219,208 John T. Schuessler 86,576,886 1,485,909 Kerrii B. Anderson 86,873,228 1,189,566 William E. Kirwan 86,823,722 1,239,072 The following directors did not stand for reelection at the meeting (the year in which each director's term expires is indicated in parenthesis): James V. Pickett (2003), Thomas F. Keller (2003), Andrew G. McCaughey (2003), David P. Lauer (2003), James F. Millar (2003), Ernest S. Hayeck (2004), Janet Hill (2004), True H. Knowles (2004) and Paul D. House (2004). 21 (c) The following table sets forth the brief description of each other matter voted on at the Annual Meeting and the number of votes cast for, against or abstaining from, as well as broker nonvotes on each matter: Broker For Against Abstain Nonvotes ---------- --------- ------- ---------- Approve an amendment to the Company's Regulations to permit the Directors to set the number of Directors, and the number of Directors in each class, within a specified range 72,900,341 2,382,348 839,397 11,940,708 Approve the Senior Executive Annual Performance Plan 79,689,114 7,523,194 850,466 None Approve an amendment to the Company's Regulations to revise the minimum numbers of Directors required on any committee of the Board of Directors from three to one 68,026,393 7,322,609 773,089 11,940,706 Item 6. Exhibits and Reports on Form 8-K (a) Index to Exhibits on Page 24. (b) The Company filed two reports on Form 8-K for the quarter ended June 30, 2002. The first report on Form 8-K was filed May 31, 2002 and announced (under item 5) the signing of a definitive agreement to acquire Fresh Enterprises, Inc. ("Baja Fresh"), the owner and operator of the Baja Fresh Mexican Grill restaurant chain. A copy of the press release issued May 31, 2002 was attached. The second report on Form 8-K was filed June 19, 2002 and announced (under item 2) the completion of the Company's acquisition of Baja Fresh on June 19, 2002 pursuant to a Merger Agreement dated May 30, 2002 (the "Agreement"). A copy of the Agreement was attached to the filing. 22 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WENDY'S INTERNATIONAL, INC. --------------------------- (Registrant) Date: 8/12/02 /s/ Kerrii B. Anderson -------- ------------------------------------ Kerrii B. Anderson Executive Vice President and Chief Financial Officer 23 WENDY'S INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO EXHIBITS Exhibit Number Description Page No. ------ ----------- -------- 99(a) Safe Harbor Under 25 - 26 the Private Securities Litigation Reform Act of 1995 99(b) Certification of 27 Chief Executive Officer 99(c) Certification of 28 Chief Financial Officer The Company and its subsidiaries are parties to instruments with respect to long-term debt for which securities authorized under each such instrument do not exceed ten percent of the total assets of the Company and its subsidiaries on a consolidated basis. Copies of these instruments will be furnished to the Commission upon request. 24