We are the fourth largest publicly-traded quick service restaurant chain in North America based on market capitalization and the largest in Canada. Operating in the quick service sector of the restaurant industry, we appeal to a broad range of consumer tastes, with a menu that includes premium coffee, flavoured cappuccinos, specialty teas, home-style soups, fresh sandwiches, wraps, hot breakfast sandwiches and fresh baked goods, including our trademark donuts.
The first Tim Hortons® opened in May, 1964 by Tim Horton, a National Hockey League All-Star defenseman. In 1967, Ron Joyce, then the operator of three Tim Hortons restaurants, became partners with Tim Horton and together they opened 37 restaurants over the next seven years. After Tim Horton’s death in 1974, Mr. Joyce continued to expand the chain, becoming its sole owner in 1975. In the early 1990s, Tim Hortons and Wendy’s International, Inc., now wholly-owned by Wendy’s/Arby’s Group, Inc. (“Wendy’s”) entered into a partnership to develop real estate and combination restaurant sites containing Wendy’s® and Tim Hortons restaurants under the same roof. In 1995, Wendy’s purchased Mr. Joyce’s interest in the Tim Hortons system and incorporated the company known as Tim Hortons Inc., a Delaware corporation (“THI USA”), as a wholly-owned subsidiary. In 2006, we became a standalone public company pursuant to an initial public offering and a subsequent spin-off of our common stock to Wendy’s stockholders through a stock dividend on September 29, 2006.
At a special meeting of stockholders held on September 22, 2009, THI USA’s stockholders voted to approve the reorganization of THI USA as a Canadian public company. As a result of the reorganization, Tim Hortons Inc., a corporation incorporated under the Canada Business Corporations Act, became the publicly held parent company of the group of companies previously controlled by THI USA, and each outstanding share of THI USA’s common stock automatically converted into one common share of the Canadian public company. The issuance of common shares (and the associated share purchase rights) of the Canadian public company was registered under the Securities Act of 1933, as amended. The common shares of the Canadian public company, like the common stock of THI USA previously, are traded on both the Toronto Stock Exchange and the New York Stock Exchange under the symbol “THI.”
References to “we,” “our,” “us” or the “Company” refer to THI USA and its subsidiaries for periods on or before September 27, 2009 and to Tim Hortons Inc., a corporation governed by the Canada Business Corporations Act and its subsidiaries, for periods on or after September 28, 2009, unless specifically noted otherwise.
Business Overview and 2010 Objectives
We seek to grow our business by executing strategic and operational plans designed to help us achieve both annual and longer-term goals that create shareholder value. These plans are supported by our business model and by ongoing initiatives to build upon the success of our system.
Unique business model
Key aspects of our business include:
maintaining our highly effective franchised model (more than 99% of our restaurants are franchised);
collaborating with franchisees to grow our business and build positive relationships. Our franchisees typically operate an average of 3 to 4 restaurants and have a significant stake in the success of the restaurants they operate;
maintaining a controlling interest in the real estate in our restaurant system to ensure brand integrity and control of development;
operating with a “we fit anywhere” concept that allows us to adapt our brand presence to take advantage of non-traditional development opportunities; and
leveraging significant levels of vertical integration that exists in our system and continuing to explore additional system benefits through further vertical integration opportunities.
Increasing same-store sales through daypart, marketing and menu opportunities
Increasing same-store sales is an important measure of success in the restaurant sector. We view same-store sales growth as vital to the ongoing health of our franchise system and the Company. In 2010, we plan to increase same-store sales growth by focusing on the following activities:
leveraging our marketing strengths and advantages. In Canada, we will leverage our scale as one of the country’s largest advertisers to reinforce our attractive price to value position and to reinforce our brand equity. In the United States, as a “challenger brand,” we will seek other means, such as community involvement, sponsorships, and other forms of communication, to supplement traditional advertising to reinforce our brand position with customers and to broaden our brand awareness as a cafe and bake shop destination.
Restaurant development in new and existing markets has historically contributed significantly to the Company’s growth and, in 2010, we plan to continue this investment. Our specific development plans in 2010 include:
moderately increasing the rate of standard restaurant development in Canadian growth markets:
focusing development primarily in Quebec, western Canada, Ontario and major urban markets;
targeting smaller communities as part of our broader development strategy, primarily through standard restaurants, but we will also test a new, flexible restaurant design as well;
piloting a new restaurant format in Canada in one location designed to increase capacity and throughput;
continuing to develop our growing regional presence in the northeast and midwest U.S.:
focusing primarily on our existing major regional markets such as New York, Ohio and Michigan; and, expanding into contiguous markets with approximately 30% of development activities planned to take place between 2010 and 2013 in adjacent markets;
testing a new concept restaurant in certain U.S. markets to significantly differentiate our brand and customer offerings as a cafe and bake shop destination; and
complementing our standard restaurant development activity in both Canada and the U.S. with non-traditional formats and location.
Growing differently in ways we have not grown before
Our strategic growth plan includes initiatives that are designed to complement our core growth strategies with additional opportunities to grow our business. These initiatives include:
extending our competitive advantage for service excellence in Canada through a new hospitality strategy;
expanding the Cold Stone Creamery© co-branding concept. In March 2009, we undertook a co-branding test initiative with Kahala Corp. to co-brand Tim Hortons and Cold Stone Creamery locations in the U.S. We subsequently extended the test in Canada and acquired exclusive Cold Stone Creamery development rights in Canada;
testing a new concept restaurant in certain U.S. markets to differentiate our customer offering as a cafe and bake shop destination, as described above. Our brand and customer offering is well established in the Canadian market and in certain developed U.S. markets. In other U.S. markets, our brand is less established with customers;
testing new restaurant formats in Canada, as mentioned above;
assessing international market opportunities, risks, and potential business models to support the development of an international growth strategy; and
opportunistically pursuing strategic alliances and partnerships to take our brand to markets where we have not yet established a presence, to complement our existing presence, or to increase average unit volumes in existing locations. This may include co-branding or other initiatives.
Leveraging our core business strengths and franchise system
As one of the most franchised systems in the restaurant industry, we focus extensively on our relationships with our franchisees and the success of our system. We also seek to leverage our strengths and capabilities to grow our business in ways that benefit us and our system. Several initiatives are aimed at supporting this focus in 2010, including:
continuing to work collaboratively with our franchisees across a wide range of initiatives and business matters;
growing Canadian franchised restaurant sales to more than $5 billion(1);
pursuing additional vertical integration and supply chain opportunities to create value for our franchisees and shareholders; and
selectively assessing acquisition opportunities that leverage our core strengths and capabilities.
The Company’s 2010 operational objectives (See Accompanying Notes)
In support of the initiatives outlined above for 2010, we have established the following objectives:
we are targeting same-store sales growth of 3% to 5% in Canada and 2% to 4% in the U.S.;
we expect to open a total of 170 to 210 restaurant locations. Of these openings, we are planning to open 130 to 150 restaurants in Canada and 40 to 60 locations in the U.S. The majority of these locations will be standard restaurants. The targeted openings also include non-standard locations in both markets;
we plan to work together with our franchisees to convert up to 60 Tim Hortons locations to include Cold Stone Creamery, and we expect to convert between 15 to 20 existing restaurants in the U.S. to the
co-branded Cold Stone Creamery concept. In addition, of our total planned 40 to 60 new restaurant openings in the U.S., we expect that between 10 to 15 will be opened as co-branded Tim Hortons and Cold Stone Creamery locations;
we plan to test approximately 10 new concept restaurants in certain U.S. markets, as described above; and
we plan to pilot new Canadian development models, as described above.
2010 Financial Outlook (See Accompanying Notes)
Based on our strategic and operational plans, we have established the following 2010 financial targets:
EPS of $1.95 to $2.05;
Operating income growth of 8% to 10% (52-week basis)(2);
Tax rate of approximately 32%; and
Capital expenditures of $180 million to $200 million.
Long-Term Aspirations (See Accompanying Notes)
EPS: long-term aspirational earnings per share (EPS) compounded annual growth beyond 2010 and through 2013 is expected to be between 12% to 15%; and
New restaurant development from 2010 to 2013:
Canada: approximately 600;
U.S.: approximately 300; and
Total North America: approximately 900.
Canadian franchised restaurant sales are restaurant-level sales at franchised restaurants in Canada, which are reported to us by our franchisees. These franchised restaurant sales are not included in our Consolidated Financial Statements, except for certain non-owned restaurants whose restaurants are consolidated with ours as required under applicable accounting requirements. See Note 1 to the Consolidated Financial Statements. Franchise restaurant sales do, however, result in royalties and rental income, which we include in our franchise revenues, as well as distribution income. Franchised restaurant sales for fiscal years 2009 and 2008 for Canada and the U.S. are set forth on page 43 of this Annual Report on Form 10-K.
Operating income year-over-year growth rate for 2010 is based on 52 weeks to remove the benefit from 2009 of approximately 1.5% associated with 53 weeks of operations in 2009.
The operational objectives, financial outlook, and aspirational goals (collectively, “targets”) established for 2010 and long-term EPS growth are based on the accounting, tax, and other legislative rules in place at the time the targets were issued and on the continuation of share repurchase programs relatively consistent with historical levels. The impact of future changes in accounting, tax and/or other legislative rules that may or may not become effective in fiscal 2010 and future years, changes to our share repurchase activities, and other matters not contemplated at the time the targets were established that could affect our business, are not included in the determination of these targets. In addition, the targets are forward-looking and are based on our expectations and outlook on, and shall be effective only as of, the date the targets were originally issued. Except as required by applicable securities laws, we do not intend to update these targets. You should refer to the Company’s public filings for any reported updates. These targets and our performance generally are subject to various risks and uncertainties and are based on certain underlying assumptions, set forth in Item 1A of this Annual Report on Form 10-K, which may impact future performance and our achievement of these targets.
Our primary business model is to identify potential restaurant locations, develop suitable sites, and make these new restaurants available to approved franchisees. As of January 3, 2010, franchisees, including operators, operated 99.5% of our systemwide restaurants. We directly own and operate (without franchisees) only a small number of company restaurants in Canada and the U.S. We also have warehouse and distribution operations that supply paper and dry goods to a substantial majority of our Canadian restaurants, and supply frozen baked goods and some refrigerated products to most of our Ontario restaurants. In the U.S., we supply similar products to system restaurants through third-party distributors. Our operations also include coffee roasting plants in Rochester, New York and Hamilton, Ontario, a joint-venture bakery, and a fondant and fills manufacturing facility. These vertically integrated manufacturing and distribution capabilities provide important benefits to our franchisees and systemwide restaurants, while allowing us to: improve product quality and consistency; protect proprietary interests; facilitate the expansion of our product offerings; control availability and timely delivery of products; provide economies of scale and labour efficiencies; and, generate additional sources of income for the Company.
Our business model results in several distinct sources of revenues and corresponding income, consisting of distribution sales, franchise rent and royalties revenues, equity income (which is included in operating income), manufacturing income, and, to a lesser extent, sales from Company-operated restaurants. Franchise royalties are typically paid weekly based on a percentage of gross sales. Rental income results from our controlling interest (i.e., lease or ownership) in the real estate for approximately 80% of franchised restaurants, generating base rent and, for most sites, percentage rent, which results in higher rental income as same-store sales increase. As we open new restaurants and make them available to franchisees, our operating income base expands. In addition, our product distribution and warehouse operations have generated consistent positive operating income.
Our segments for financial reporting purposes are Canada and the U.S. Financial information about these segments is set forth in Items 6 and 7 of this Form 10-K. In addition, reference should be made to the Consolidated Financial Statements and Supplementary Data in Item 8 for further information regarding revenues, segment operating profit and loss, total assets attributable to our segments, and for financial information attributable to certain geographic areas.
Restaurant format, location, and development. Tim Hortons restaurants operate in a variety of formats, and we oversee and direct all aspects of restaurant development for system restaurants, from an initial review of a location’s demographics, site access, visibility, traffic counts, mix of residential/retail/commercial surroundings, competitive activity, and proposed rental/ownership structure, to considerations of the performance of nearby Tim Hortons locations, projections of the selected location’s ability to meet financial return targets, franchisee identification, and physical land development and restaurant construction costs. We typically retain a controlling interest in the real estate for system restaurants by either owning the land and building, leasing the land and owning the building, or leasing both the land and building. While we have a standard, and highly recognizable, standalone restaurant design, we may vary the design to fit into local architecture and municipal requirements. Ultimately, we control the design and building of our restaurants to cater to the market and the neighbourhood in which the restaurants are located. From start to finish, the development process usually takes between 12 to 18 months for each individual standard restaurant location. Development of non-traditional sites and self-serve kiosks typically requires much less time. See Item 2 of this Form 10-K for additional information regarding our restaurants.
Our non-standard development growth also includes self-serve kiosks. These kiosks typically have single-serve hot and cold beverage offerings and a limited selection of donuts, muffins, Danishes, and other pastries. We have two formats for our self-serve kiosks. In Canada, these kiosks are predominantly our self-pour brewed coffee model and are located mainly in Esso® convenience locations, as a result of our relationship with Imperial Oil®. In the U.S., our self-serve kiosks are predominantly our “bean to cup” model, which creates a freshly ground cup of coffee from “bean to cup” and is based on a model we have rolled out in the Republic of Ireland and the United Kingdom at licensed gas and convenience locations. See “International Operations,” below.
Our financial arrangements for self-serve locations vary and may not be consistent with arrangements for other non-standard restaurants. In addition, self-serve kiosks do not typically generate revenues at the same level as do other non-standard restaurants with staff, larger locations, and more expansive beverage and food product offerings. Average unit volumes at non-standard locations (not including self-serve kiosks) are highly variable, depending upon the location, size of the site, product offerings, and hours of operation, and at this time, only contribute nominal amounts to our distribution sales, royalty revenues and consolidated operating income at this time. Notwithstanding that they have lower average unit volumes than our standard and most non-standard locations, our self-serve kiosks complement our core growth strategy by increasing customer convenience and frequency of visits; and allowing for additional market penetration of our brand, including in areas where we may not be as well known; and, providing an additional model for unit growth and development.
As of January 3, 2010, the number of Tim Hortons restaurants across Canada, both standard and non-standard locations, which for this purpose includes self-serve kiosks, totaled 3,015. Standard restaurants constitute approximately 73% of this total. Also as of January 3, 2010, our franchisees operated substantially all of our Canadian restaurants. See Item 2 for a description of the number of restaurants by province/territory in Canada owned by the Company and owned or operated by our franchisees, respectively. Based on the positive results and customer response to the introduction of co-branded Cold Stone Creamery locations opened in Canada during 2009, we reached an agreement with Kahala Corp., the parent company of Cold Stone Creamery Inc., for exclusive development rights in Canada in order to provide us flexibility for future expansion.
In the U.S., we have a regional presence with 563 restaurants in 12 states, concentrated in the northeast in New York, Connecticut, Rhode Island, and Maine, and in the midwest in Michigan and Ohio. We own, rather than lease, the land underlying a higher percentage of our standard system restaurants in the U.S. than in Canada. Substantially all of our restaurants in the U.S. are operated by franchisees. As of January 3, 2010, franchisees, including operators (See “Franchise and Other Arrangements—Other Arrangements” below for a description of “operators”), operated 558, or 99.1%, of the restaurants in the U.S. See Item 2 for a description of the number of restaurants by state in the U.S. owned by the Company and owned or operated by its franchisees, respectively.
During 2009, we refined our restaurant development plan in the U.S. to selectively expand our use of full-service and non-standard units in more developed markets in order to promote greater market presence and broaden brand awareness and penetration with less capital. We targeted our larger U.S. regional markets such as New York, Ohio and Michigan for growth of standard restaurant locations, and adjusted certain factors in our standard restaurant development, including reducing the size of our restaurants, which we believe will better meet the needs of our customers while also creating efficiencies for our franchisees and us. We also explored other complementary strategic development opportunities to grow the business, including our co-branding initiative with Cold Stone Creamery, which made significant contributions to same-store sales growth in the U.S. in 2009, our expansion into New York City utilizing unique restaurant formats, and the opening of restaurants on the Fort Knox, Kentucky, and Norfolk, Virginia military bases. These initiatives complemented our core strategy of selectively developing full-serve, standalone Tim Hortons locations in our core U.S. markets.
Between December 2008 and early February 2009, we closed a total of 11 underperforming restaurants in southern New England, 10 of which were Company-operated locations. In conjunction with our decision to close certain underperforming restaurants, we undertook an asset impairment review in the affected markets. As a result of these activities, $7.6 million in restaurant closure costs and a related asset impairment charge of $13.7 million were recorded in the fourth quarter of 2008, for a total of $21.3 million. The closure of such underperforming restaurants was consistent with our objective to work to achieve break-even operating income performance in the U.S. for 2009, and, during 2009, approximately $4.6 million benefit was realized from the closures of the underperforming restaurants (and related impairment charge) due to decreases in depreciation costs and lower operating losses.