Tim Hortons Inc. - FORM 10-Q - November 6, 2014

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 _________________________________________________
 FORM 10-Q
  _________________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2014
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 001-32843
 _________________________________________________
 TIM HORTONS INC.
(Exact name of Registrant as specified in its charter)
 ________________________________________________
Canada
 
98-0641955
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
 
 
874 Sinclair Road, Oakville, ON, Canada
 
L6K 2Y1
(Address of principal executive offices)
 
(Zip code)
905-845-6511
(Registrant’s phone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
________________________________________________
 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 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, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
x
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at November 3, 2014
Common shares
 
132,576,171 shares



TIM HORTONS INC. AND SUBSIDIARIES
INDEX
 
Pages
 
 
 
 
 
On November 3, 2014, the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York was US$0.8872 for Cdn$1.00.
Availability of Information
Tim Hortons Inc. (the “Company”), a corporation incorporated under the Canada Business Corporations Act (the “CBCA”), qualifies as a foreign private issuer in the U.S. for purposes of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Although, as a foreign private issuer, the Company is no longer required to do so, the Company currently continues to file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K with the U.S. Securities and Exchange Commission (“SEC”) instead of filing the reporting forms available to foreign private issuers.
We make available, through our internet website for investors (www.timhortons-invest.com), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the SEC and with the Canadian Securities Administrators (“CSA”). All references to our websites contained herein do not constitute incorporation by reference of the information contained on the websites and such information should not be considered part of this document.
Reporting Currency
The majority of the Company’s operations, restaurants and cash flows are based in Canada, and the Company is primarily managed in Canadian dollars. As a result, the Company’s reporting currency is the Canadian dollar. All amounts are expressed in Canadian dollars unless otherwise noted.

2

PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TIM HORTONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(in thousands of Canadian dollars, except share and per share data)
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Revenues
 
 
 
 
 
 
 
Sales (note 13)
$
634,786

 
$
575,780

 
$
1,789,645

 
$
1,668,229

Franchise revenues
 
 
 
 
 
 
 
Rents and royalties
230,383

 
212,114

 
654,845

 
608,857

Franchise fees
43,986

 
37,459

 
105,414

 
79,943

 
274,369

 
249,573

 
760,259

 
688,800

Total revenues
909,155

 
825,353

 
2,549,904

 
2,357,029

Costs and expenses
 
 
 
 
 
 
 
Cost of sales
545,050

 
501,856

 
1,545,765

 
1,452,302

Operating expenses
86,306

 
78,307

 
251,975

 
231,026

Franchise fee costs
43,577

 
37,865

 
106,166

 
83,743

General and administrative expenses
41,681

 
38,787

 
121,141

 
115,493

Equity (income)
(4,038
)
 
(4,075
)
 
(11,359
)
 
(11,340
)
Transaction costs (note 15)
27,289

 
—

 
27,289

 
—

Corporate reorganization expenses
—

 
953

 
—

 
11,032

Asset impairment (note 13)
—

 
2,889

 
—

 
2,889

Other expense (income), net
484

 
(57
)
 
2,467

 
(1,440
)
Total costs and expenses, net
740,349

 
656,525

 
2,043,444

 
1,883,705

Operating income
168,806

 
168,828

 
506,460

 
473,324

Interest (expense)
(18,518
)
 
(9,406
)
 
(53,842
)
 
(26,991
)
Interest income
879

 
919

 
2,994

 
2,638

Income before income taxes
151,167

 
160,341

 
455,612

 
448,971

Income taxes (note 2)
51,434

 
45,386

 
138,092

 
122,531

Net income
99,733

 
114,955

 
317,520

 
326,440

Net income attributable to noncontrolling interests (note 12)
1,602

 
1,092

 
4,730

 
2,670

Net income attributable to Tim Hortons Inc.
$
98,131

 
$
113,863

 
$
312,790

 
$
323,770

Basic earnings per common share attributable to Tim Hortons Inc. (note 3)
$
0.74

 
$
0.76

 
$
2.32

 
$
2.12

Diluted earnings per common share attributable to Tim Hortons Inc. (note 3)
$
0.74

 
$
0.75

 
$
2.31

 
$
2.12

Weighted average number of common shares outstanding (in thousands) – Basic (note 3)
132,439

 
150,342

 
134,817

 
152,379

Weighted average number of common shares outstanding (in thousands) – Diluted (note 3)
132,934

 
150,864

 
135,292

 
152,919

Dividends per common share
$
0.32

 
$
0.26

 
$
0.96

 
$
0.78

See accompanying Notes to the Condensed Consolidated Financial Statements.

3

TIM HORTONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)
(in thousands of Canadian dollars)
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Net income
$
99,733

 
$
114,955

 
$
317,520

 
$
326,440

Other comprehensive income
 
 
 
 
 
 
 
Translation adjustments gain (loss)
21,301

 
(9,133
)
 
18,471

 
14,250

Unrealized gains (losses) from cash flow hedges (note 9)
 
 
 
 
 
 
 
Gain (loss) from change in fair value of derivatives
5,356

 
(10,686
)
 
(553
)
 
(2,607
)
Amount of net loss (gain) reclassified to earnings during the period
47

 
(2,068
)
 
(3,654
)
 
(1,027
)
Tax (expense) recovery (note 9)
(1,260
)
 
1,509

 
216

 
(816
)
Other comprehensive income (loss)
25,444

 
(20,378
)
 
14,480

 
9,800

Comprehensive income
125,177

 
94,577

 
332,000

 
336,240

Comprehensive income attributable to noncontrolling interests
1,602

 
1,092

 
4,730

 
2,670

Comprehensive income attributable to Tim Hortons Inc.
$
123,575

 
$
93,485

 
$
327,270

 
$
333,570

See accompanying Notes to the Condensed Consolidated Financial Statements.

4

TIM HORTONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(in thousands of Canadian dollars, except share and per share data)
 
As at
 
September 28, 2014
 
December 29,
2013
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
109,085

 
$
50,414

Restricted cash and cash equivalents (note 6)
64,572

 
155,006

Accounts receivable, net
215,570

 
210,664

Notes receivable, net (note 4)
6,482

 
4,631

Deferred income taxes
8,448

 
10,165

Inventories and other, net (note 5)
141,133

 
104,326

Advertising fund restricted assets (note 12)
57,230

 
39,783

Total current assets
602,520

 
574,989

Property and equipment, net
1,718,192

 
1,685,043

Notes receivable, net (note 4)
572

 
4,483

Deferred income taxes
13,067

 
11,018

Equity investments
40,253

 
40,738

Other assets
129,850

 
117,552

Total assets
$
2,504,454

 
$
2,433,823

Liabilities and equity
 
 
 
Current liabilities
 
 
 
Accounts payable (note 6)
$
215,215

 
$
204,514

Tim Card obligation (note 6)
112,458

 
184,443

Accrued liabilities (note 6)
110,757

 
89,565

Advertising fund liabilities (note 12)
49,211

 
59,912

Short-term borrowings
—

 
30,000

Current portion of long-term obligations
18,243

 
17,782

Total current liabilities
505,884

 
586,216

Long-term obligations
 
 
 
Long-term debt (note 7)
1,294,880

 
843,020

Capital leases
125,468

 
121,049

Deferred income taxes
7,377

 
9,929

Other long-term liabilities
139,769

 
112,090

Total long-term obligations
1,567,494

 
1,086,088

Commitments and contingencies (note 10)


 


Equity
 
 
 
Equity of Tim Hortons Inc.
 
 
 
Common shares ($2.84 stated value per share), Authorized: unlimited shares. Issued: 132,576,171 and 141,329,010 shares, respectively
375,880

 
400,738

Common shares held in Trust, at cost: 315,932 and 293,816 shares, respectively
(14,806
)
 
(12,924
)
Contributed surplus
12,148

 
11,033

Retained earnings
154,569

 
474,409

Accumulated other comprehensive loss
(97,622
)
 
(112,102
)
Total equity of Tim Hortons Inc.
430,169

 
761,154

Noncontrolling interests (note 12)
907

 
365

Total equity
431,076

 
761,519

Total liabilities and equity
$
2,504,454

 
$
2,433,823

See accompanying Notes to the Condensed Consolidated Financial Statements.

5

TIM HORTONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(in thousands of Canadian dollars)
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
Cash flows provided from (used in) operating activities
 
 
 
Net income
$
317,520

 
$
326,440

Adjustments to reconcile net income to net cash provided from operating activities
 
 
 
Depreciation and amortization
121,163

 
110,447

Total return swaps (gain)
(26,509
)
 
(11,037
)
Stock-based compensation expense (note 11)
34,967

 
17,132

Deferred income taxes
224

 
(2,458
)
Changes in operating assets and liabilities
 
 
 
Restricted cash and cash equivalents
90,992

 
50,020

Accounts receivable
(8,506
)
 
(11,010
)
Inventories and other
(18,666
)
 
(7,913
)
Accounts payable and accrued liabilities
(35,516
)
 
(58,213
)
Taxes
4,164

 
7,183

Settlement of interest rate forwards
(4,851
)
 
—

Deposit with tax authorities
(1,721
)
 
—

Other
(25,626
)
 
17,561

Net cash provided from operating activities
447,635

 
438,152

Cash flows (used in) provided from investing activities
 
 
 
Capital expenditures
(138,950
)
 
(132,726
)
Capital expenditures – Advertising fund
(5,237
)
 
(9,554
)
Other investing activities
10,955

 
6,709

Net cash (used in) investing activities
(133,232
)
 
(135,571
)
Cash flows (used in) provided from financing activities
 
 
 
Repurchase of common shares
(527,640
)
 
(242,222
)
Dividend payments to common shareholders
(129,367
)
 
(118,579
)
Net proceeds from issuance of debt
448,299

 
—

Short-term (repayments) borrowings, net
(30,000
)
 
—

Principal payments on long-term debt obligations
(12,139
)
 
(12,901
)
Other financing activities
(6,269
)
 
(5,601
)
Net cash (used in) financing activities
(257,116
)
 
(379,303
)
Effect of exchange rate changes on cash
1,384

 
1,460

(Decrease) in cash and cash equivalents
58,671

 
(75,262
)
Cash and cash equivalents at beginning of period
50,414

 
120,139

Cash and cash equivalents at end of period
$
109,085

 
$
44,877

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Interest paid
$
37,096

 
$
23,259

Income taxes paid
$
144,297

 
$
117,418

Non-cash investing and financing activities:
 
 
 
Capital lease obligations incurred
$
23,238

 
$
25,217

See accompanying Notes to the Condensed Consolidated Financial Statements.

6

TIM HORTONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
(in thousands of Canadian dollars or thousands of common shares)
 
Common Shares
 
Common Shares Held
in the Trust
 
 
 
 
 
AOCI(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Contributed Surplus
 
Retained Earnings
 
Translation Adjustment
 
Cash Flow Hedges
 
Total Equity THI
 
NCI(2)
 
Total Equity
 
Number
 
$
 
Number
 
$
 
$
 
$
 
$
 
$
 
$
 
$
 
$
Balance as at December 30, 2012
153,405

 
$
435,033

 
(317
)
 
$
(13,356
)
 
$
10,970

 
$
893,619

 
$
(135,438
)
 
$
(3,590
)
 
$
1,187,238

 
$
2,853

 
$
1,190,091

Repurchase of common shares(3)
(12,076
)
 
(34,295
)
 
(43
)
 
(2,453
)
 
—

 
(686,243
)
 
—

 
—

 
(722,991
)
 
—

 
(722,991
)
Disbursed or sold from the Trust(4)
—

 
—

 
66

 
2,885

 
—

 
—

 
—

 
—

 
2,885

 
—

 
2,885

Stock-based compensation
—

 
—

 
—

 
—

 
63

 
(712
)
 
—

 
—

 
(649
)
 
—

 
(649
)
Other comprehensive income (loss) before reclassifications(5)
—

 
—

 
—

 
—

 
—

 
—

 
31,333

 
(2,407
)
 
28,926

 
—

 
28,926

Amounts reclassified from AOCI(5)
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,000
)
 
(2,000
)
 
—

 
(2,000
)
NCI transactions
—

 
—

 
—

 
—

 
—

 
(483
)
 
—

 
—

 
(483
)
 
483

 
—

Net income
—

 
—

 
—

 
—

 
—

 
424,369

 
—

 
—

 
424,369

 
4,280

 
428,649

Dividends and distributions, net
—

 
—

 
—

 
—

 
—

 
(156,141
)
 
—

 
—

 
(156,141
)
 
(7,251
)
 
(163,392
)
Balance as at December 29, 2013
141,329

 
$
400,738

 
(294
)
 
$
(12,924
)
 
$
11,033

 
$
474,409

 
$
(104,105
)
 
$
(7,997
)
 
$
761,154

 
$
365

 
$
761,519

Repurchase of common shares(3)(6)
(8,753
)
 
(24,858
)
 
(59
)
 
(3,549
)
 
—

 
(502,781
)
 
—

 
—

 
(531,188
)
 
—

 
(531,188
)
Disbursed or sold from the Trust(4)
—

 
—

 
37

 
1,667

 
—

 
—

 
—

 
—

 
1,667

 
—

 
1,667

Stock-based compensation
—

 
—

 
—

 
—

 
1,115

 
(214
)
 
—

 
—

 
901

 
—

 
901

Other comprehensive income (loss) before reclassifications(5)
—

 
—

 
—

 
—

 
—

 
—

 
18,471

 
(1,771
)
 
16,700

 
—

 
16,700

Amounts reclassified from AOCI(5)
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,220
)
 
(2,220
)
 
—

 
(2,220
)
NCI transactions
—

 
—

 
—

 
—

 
—

 
(268
)
 
—

 
—

 
(268
)
 
268

 
—

Net income
—

 
—

 
—

 
—

 
—

 
312,790

 
—

 
—

 
312,790

 
4,730

 
317,520

Dividends and distributions, net
—

 
—

 
—

 
—

 
—

 
(129,367
)
 
—

 
—

 
(129,367
)
 
(4,456
)
 
(133,823
)
Balance as at September 28, 2014
132,576

 
$
375,880

 
(316
)
 
$
(14,806
)
 
$
12,148

 
$
154,569

 
$
(85,634
)
 
$
(11,988
)
 
$
430,169

 
$
907

 
$
431,076

________________
(1) 
Accumulated other comprehensive income (“AOCI”).
(2) 
Noncontrolling interests (“NCI”).
(3) 
Amounts reflected in Retained earnings represent consideration in excess of the stated value.
(4) 
Amounts are net of tax.
(5) 
Amounts are net of tax (see note 9).
(6) 
The 2014 share repurchase program, as described in the Company’s Annual Report on Form 10-K for the year ended December 29, 2013 (“Annual Report”), filed with the SEC and the CSA on February 25, 2014, commenced on February 28, 2014 and was due to terminate on February 27, 2015, or earlier if the $440.0 million or 10.0% share maximum was reached, or upon the occurrence of certain other termination events. Following the announcement on August 24, 2014 that the Company was in discussions with Burger King Worldwide, Inc. regarding a potential strategic transaction, the 2014 Program was terminated.
See accompanying Notes to the Condensed Consolidated Financial Statements.

7

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 1     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, the accompanying Condensed Consolidated Financial Statements contain all adjustments (all of which are normal and recurring in nature) necessary to state fairly the Company’s financial position as at September 28, 2014, and the results of operations, comprehensive income and cash flows for the third quarters ended September 28, 2014 and September 29, 2013. These Condensed Consolidated Financial Statements should be read in conjunction with the audited 2013 Consolidated Financial Statements which are contained in our most recent Annual Report. The December 29, 2013 Condensed Consolidated Balance Sheet included herein was derived from the audited 2013 Consolidated Financial Statements, but does not include all of the year-end disclosures required by U.S. GAAP.
Stock-based compensation - performance stock units
In May 2014, the Company granted performance stock units ("PSUs") to certain of its employees. PSU payout levels will be based on two forward looking performance measures: return on assets and total shareholder return (see Note 15). PSUs are expensed on a straight-line basis over the relevant vesting period.
Proposed transaction with Burger King Worldwide, Inc.
On August 26, 2014, the Company announced that it had entered into a definitive agreement (the “Arrangement Agreement”) with Burger King Worldwide, Inc. (“Burger King”) and certain of its affiliates (see Note 15 for further information).
NOTE 2    INCOME TAXES
The effective income tax rate was 34.0% for the third quarter ended September 28, 2014 (third quarter fiscal 2013: 28.3%) and 30.3% for the year-to-date period ended September 28, 2014 (year-to-date period fiscal 2013: 27.3%). The increase in the effective tax rate for the 2014 quarter-to-date and year-to-date periods as compared to the respective 2013 periods is primarily due to Transaction-related costs (see Note 15), and to a lesser degree an increase in costs in 2014 related to the Company’s new long-term debt, for both of which a full tax benefit cannot be recognized.
NOTE 3    EARNINGS PER COMMON SHARE ATTRIBUTABLE TO TIM HORTONS INC.
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Net income attributable to Tim Hortons Inc.
$
98,131

 
$
113,863

 
$
312,790

 
$
323,770

Weighted average shares outstanding for computation of basic earnings per common share attributable to Tim Hortons Inc. (in thousands)
132,439

 
150,342

 
134,817

 
152,379

Dilutive impact of restricted stock units (“RSUs”) and PSUs (in thousands)
219

 
264

 
243

 
285

Dilutive impact of stock options with tandem stock appreciation rights (“SARs”) (in thousands)
276

 
258

 
232

 
255

Weighted average shares outstanding for computation of diluted earnings per common share attributable to Tim Hortons Inc. (in thousands)
132,934

 
150,864

 
135,292

 
152,919

Basic earnings per common share attributable to Tim Hortons Inc.
$
0.74

 
$
0.76

 
$
2.32

 
$
2.12

Diluted earnings per common share attributable to Tim Hortons Inc.
$
0.74

 
$
0.75

 
$
2.31

 
$
2.12


8

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 4    NOTES RECEIVABLE, NET
 
As at
 
September 28, 2014
 
December 29, 2013
 
Gross
 
VIEs(2)
 
Total
 
Gross
 
VIEs(2)
 
Total
Franchise Incentive Program (“FIP”) notes(1)
$
15,404

 
$
(12,392
)
 
$
3,012

 
$
16,677

 
$
(13,668
)
 
$
3,009

Other notes receivable(3)
6,173

 
(594
)
 
5,579

 
8,256

 
(649
)
 
7,607

Notes receivable
$
21,577

 
$
(12,986
)
 
8,591

 
$
24,933

 
$
(14,317
)
 
10,616

Allowance
 
 
 
 
(1,537
)
 
 
 
 
 
(1,502
)
Notes receivable, net
 
 
 
 
$
7,054

 
 
 
 
 
$
9,114

 
 
 
 
 
 
 
 
 
 
 
 
Current portion, net
 
 
 
 
$
6,482

 
 
 
 
 
$
4,631

Long-term portion, net
 
 
 
 
$
572

 
 
 
 
 
$
4,483

 
As at
 
September 28, 2014
 
December 29, 2013
Class and Aging
Gross
 
VIEs(2)
 
Total
 
Gross
 
VIEs(2)
 
Total
Current status (FIP notes and other)
$
6,974

 
$
(1,271
)
 
$
5,703

 
$
9,688

 
$
(2,081
)
 
$
7,607

Past-due status < 90 days (FIP notes)
—

 
—

 
—

 
328

 
—

 
328

Past-due status > 90 days (FIP notes)
14,603

 
(11,715
)
 
2,888

 
14,917

 
(12,236
)
 
2,681

Notes receivable
$
21,577

 
$
(12,986
)
 
$
8,591

 
$
24,933

 
$
(14,317
)
 
$
10,616

Allowance
 
 
 
 
(1,537
)
 
 
 
 
 
(1,502
)
Notes receivable, net
 
 
 
 
$
7,054

 
 
 
 
 
$
9,114

________________ 
(1) 
The Company has outstanding FIP arrangements with certain U.S. restaurant owners, which generally provided interest-free financing for the purchase of certain restaurant equipment, furniture, trade fixtures and signage.
(2) 
The notes payable to the Company by VIEs are eliminated on consolidation, which reduces the Notes receivable, net recognized on the Condensed Consolidated Balance Sheet (see note 12).
(3) 
Relates primarily to notes issued to vendors in conjunction with the financing of property sales, and on various equipment and other financing programs.
NOTE 5    INVENTORIES AND OTHER, NET
 
As at
 
September 28, 2014
 
December 29,
2013
Raw materials
$
21,784

 
$
22,789

Finished goods
91,346

 
69,348

 
113,130

 
92,137

Inventory obsolescence provision
(2,057
)
 
(1,754
)
Inventories, net
111,073

 
90,383

Prepaids and other(1)
30,060

 
13,943

Total Inventories and other, net
$
141,133

 
$
104,326

(1) Includes fair value of the Total Return Swaps of $10.6 million (December 29, 2013: nil) and bearer deposit notes of $7.6 million (December 29, 2013: nil) (see Note 9). Amounts have been reclassified from Other assets since December 29, 2013.

9

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 6
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable
 
As at
 
September 28, 2014
 
December 29,
2013
Accounts payable
$
143,383

 
$
142,131

Construction holdbacks and accruals
46,772

 
57,527

Transaction costs (note 15)
24,572

 
—

Corporate reorganization accrual
488

 
4,856

Total Accounts payable
$
215,215

 
$
204,514

Tim Card obligation

The decrease in our Tim Card obligation, and resulting decrease in Restricted cash and cash equivalents, is primarily driven by Tim Card redemptions, which can be seasonal, and to a much lesser extent, the recognition of breakage income. In addition, Restricted cash and cash equivalents decreased due to additional borrowings by the Tim Hortons Advertising and Promotion Fund (Canada) Inc. (“Ad Fund”) (see note 12).
Accrued liabilities
 
As at
 
September 28, 2014
 
December 29,
2013
Salaries and wages
$
26,312

 
$
22,553

Taxes payable
18,730

 
14,542

De-branding accruals(1)
1,376

 
9,538

Other accrued liabilities(2)
64,339

 
42,932

Total Accrued liabilities
$
110,757

 
$
89,565

 ________________
(1) 
Accruals related to Cold Stone Creamery® de-branding activity in Tim Hortons locations in Canada.
(2) 
Includes accruals for contingent rent, current portion of the Maidstone Bakeries supply contract, deferred revenues, deposits, the current portion of deferred income taxes, and various equipment and other accruals.
NOTE 7
LONG-TERM DEBT
The Company offered Senior Unsecured Notes, Series 3, due April 1, 2019 (“Series 3 Notes”) on a private placement basis in the first quarter of 2014 for total net proceeds of $449.9 million, which included a discount of $0.1 million. A portion of the proceeds from the Series 3 Notes were used to retire the balance of our 364-day $400.0 million revolving bank facility. Please refer to Note 7, Long-term debt, in the interim financial statements for the quarter ended March 30, 2014, filed on Form 10-Q with the SEC and CSA on May 7, 2014, for further information.

10

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 8    FAIR VALUES
Financial assets and liabilities measured at fair value
 
 
As at
 
September 28, 2014
 
December 29, 2013
 
Fair value
hierarchy
 
Fair value
asset (liability)(1)
 
Fair value
hierarchy
 
Fair value
asset (liability)(1)
Derivatives
 
 
 
 
 
 
 
Forward currency contracts(2)
Level 2
 
$
4,264

 
Level 2
 
$
4,181

Interest rate swap(3)
Level 2
 
(163
)
 
Level 2
 
(49
)
Interest rate forwards(4)
n/a
 
—

 
Level 2
 
285

Total return swaps (“TRS”)(5)
Level 2
 
47,902

 
Level 2
 
21,393

Total Derivatives
 
 
$
52,003

 
 
 
$
25,810

________________  
(1) 
The Company values its derivatives using valuations that are calibrated to the initial trade prices. Subsequent valuations are based on observable inputs to the valuation model.
(2) 
The fair value of forward currency contracts is determined using prevailing exchange rates.
(3) 
The fair value is estimated using discounted cash flows and market-based observable inputs, including interest rate yield curves and discount rates.
(4) 
The interest rate forwards were settled as part of the issuance of the Series 3 Notes (see note 7).
(5) 
The fair value of the TRS is determined using the Company’s common share closing price on the last business day of the fiscal period, as quoted on the Toronto Stock Exchange.
Other financial assets and liabilities not measured at fair value
As at September 28, 2014 and December 29, 2013, the carrying values of Cash and cash equivalents and Restricted cash and cash equivalents approximated their fair values due to the short-term nature of these investments. The following table summarizes the fair value and carrying value of other financial assets and liabilities that are not recognized at fair value on a recurring basis on the Condensed Consolidated Balance Sheet: 
 
As at
 
September 28, 2014
 
December 29, 2013
 
Fair value
hierarchy
 
Fair value
asset (liability)
 
Carrying
value
 
Fair value
hierarchy
 
Fair value
asset (liability)
 
Carrying
value
Bearer deposit notes(1)
Level 2
 
$
42,520

 
$
42,520

 
Level 2
 
$
41,403

 
$
41,403

Notes receivable, net(2)
Level 3
 
$
7,054

 
$
7,054

 
Level 3
 
$
9,114

 
$
9,114

Series 1 Notes(3)
Level 2
 
$
(306,768
)
 
$
(300,934
)
 
Level 2
 
$
(315,519
)
 
$
(301,196
)
Series 2 Notes(3)
Level 2
 
$
(458,325
)
 
$
(449,901
)
 
Level 2
 
$
(445,419
)
 
$
(449,892
)
Series 3 Notes(3)
Level 2
 
$
(452,435
)
 
$
(449,887
)
 
n/a
 
$
—

 
$
—

Advertising fund term debt(4)
Level 3
 
$
(26,415
)
 
$
(26,415
)
 
Level 3
 
$
(30,189
)
 
$
(30,189
)
Other debt(5)
Level 3
 
$
(141,995
)
 
$
(75,651
)
 
Level 3
 
$
(126,548
)
 
$
(69,794
)
________________
(1) 
The Company holds these notes as collateral to reduce the carrying costs of the TRS. The interest rate on these notes resets every 90 days; therefore, the fair value of these notes, using a market approach, approximates the carrying value.
(2) 
Management generally estimates the current value of notes receivable, using a cost approach, based primarily on the estimated depreciated replacement cost of the underlying equipment held as collateral.
(3) 
The fair value of the senior unsecured notes, using a market approach, is based on publicly disclosed trades between arm’s length institutions as documented on Bloomberg L.P.
(4) 
Management estimates the fair value of this variable rate debt using a market approach, based on prevailing interest rates plus an applicable margin.
(5) 
Management estimates the fair value of its Other debt, primarily consisting of contributions received related to the construction costs of certain restaurants, using an income approach, by discounting future cash flows using a Company risk-adjusted rate over the remaining term of the debt.

11

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 9    DERIVATIVES
 
As at
 
September 28, 2014
 
December 29, 2013
 
Asset
 
Liability
 
Net
asset
(liability)
 
Classification on
Condensed
Consolidated
Balance Sheet
 
Asset
 
Liability
 
Net
asset
(liability)
 
Classification on
Condensed
Consolidated
Balance Sheet
Derivatives designated as cash flow hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts(1)
$
3,480

 
$
—

 
$
3,480

 
Accounts receivable, net
 
$
4,181

 
$
—

 
$
4,181

 
Accounts receivable, net
Interest rate swap(2)
$
—

 
$
(163
)
 
$
(163
)
 
Other long-term liabilities
 
$
—

 
$
(49
)
 
$
(49
)
 
Other long-term liabilities
Interest rate forwards(3)
$
—

 
$
—

 
$
—

 
n/a
 
$
285

 
$
—

 
$
285

 
Accounts receivable, net
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TRS (current)(4)
$
10,609

 
$
—

 
$
10,609

 
Inventories and other, net
 
$
—

 
$
—

 
$
—

 
n/a
TRS (long-term)(4)
$
37,293

 
$
—

 
$
37,293

 
Other assets
 
$
21,393

 
$
—

 
$
21,393

 
Other assets
Forward currency contracts(1)
$
784

 
$
—

 
$
784

 
Accounts receivable, net
 
$
—

 
$
—

 
$
—

 
n/a
________________ 
(1) 
Notional value as at September 28, 2014 of $158.6 million (December 29, 2013: $154.0 million), with maturities ranging between October 2014 and April 2015; no associated cash collateral.
(2) 
Notional value as at September 28, 2014 of $26.3 million (December 29, 2013: $30.0 million), with maturities through fiscal 2019; no associated cash collateral.
(3) 
The interest rate forwards were settled in the first quarter of 2014 (notional amount at December 29, 2013: $90.0 million).
(4) 
The notional value and associated cash collateral, in the form of bearer deposit notes (see note 8), was $42.3 million as at September 28, 2014 (December 29, 2013: $41.4 million). The TRS have maturities annually, in May, between fiscal 2015 and fiscal 2021.

 
 
 
Third quarter ended September 28, 2014
 
Third quarter ended September 29, 2013
Derivatives designated as cash flow
hedging instruments(1)
Classification on
Condensed
Consolidated
Statement of
Operations
 
Amount of
gain (loss)
recognized
in OCI(2)
 
Amount of net
(gain) loss
reclassified
to earnings
 
Total effect
on OCI(2)
 
Amount of
gain (loss)
recognized
in OCI(2)
 
Amount of net
(gain) loss
reclassified
to earnings
 
Total effect
on OCI(2)
Forward currency contracts
Cost of sales
 
$
5,362

 
$
(659
)
 
$
4,703

 
$
(3,368
)
 
$
(2,300
)
 
$
(5,668
)
Interest rate swap(3)
Interest (expense)
 
(6
)
 
47

 
41

 
(83
)
 
59

 
(24
)
Interest rate forwards(4)
Interest (expense)
 
—

 
659

 
659

 
(7,235
)
 
173

 
(7,062
)
Total
 
 
5,356

 
47

 
5,403

 
(10,686
)
 
(2,068
)
 
(12,754
)
Income tax effect
Income taxes
 
(1,422
)
 
162

 
(1,260
)
 
915

 
594

 
1,509

Net of income taxes
 
 
$
3,934

 
$
209

 
$
4,143

 
$
(9,771
)
 
$
(1,474
)
 
$
(11,245
)


12

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

 
 
 
Year-to-date period ended September 28, 2014
 
Year-to-date period ended September 29, 2013
Derivatives designated as cash flow
hedging instruments(1)
Classification on
Condensed
Consolidated
Statement of
Operations
 
Amount of
gain (loss)
recognized
in OCI(2)
 
Amount of net
(gain) loss
reclassified
to earnings
 
Total effect
on OCI(2)
 
Amount of
gain (loss)
recognized
in OCI(2)
 
Amount of net
(gain) loss
reclassified
to earnings
 
Total effect
on OCI(2)
Forward currency contracts
Cost of sales
 
$
4,847

 
$
(5,548
)
 
$
(701
)
 
$
4,756

 
$
(1,685
)
 
$
3,071

Interest rate swap(3)
Interest (expense)
 
(264
)
 
150

 
(114
)
 
(128
)
 
139

 
11

Interest rate forwards(4)
Interest (expense)
 
(5,136
)
 
1,744

 
(3,392
)
 
(7,235
)
 
519

 
(6,716
)
Total
 
 
(553
)
 
(3,654
)
 
(4,207
)
 
(2,607
)
 
(1,027
)
 
(3,634
)
Income tax effect
Income taxes
 
(1,218
)
 
1,434

 
216

 
(1,226
)
 
410

 
(816
)
Net of income taxes
 
 
$
(1,771
)
 
$
(2,220
)
 
$
(3,991
)
 
$
(3,833
)
 
$
(617
)
 
$
(4,450
)
_______________ 
(1) 
Excludes amounts related to ineffectiveness, as they were not significant.
(2) 
Other comprehensive income (“OCI”).
(3) 
The Ad Fund entered into an amortizing interest rate swap to fix a portion of the interest expense on its term debt.
(4) 
The Company entered into and settled interest rate forwards relating to the issuance of its long-term debt.
Derivatives not designated as cash flow hedging instruments
Classification on Condensed Consolidated Statement of Operations
 
Third quarter ended
 
Year-to-date period ended
 
September 28,
2014
 
September 29,
2013
 
September 28,
2014
 
September 29,
2013
TRS
General and administrative expenses
 
$
(30,756
)
 
$
(2,802
)
 
$
(26,509
)
 
$
(11,037
)
Forward currency contracts
Cost of sales
 
(741
)
 
85

 
(574
)
 
(264
)
Forward currency contracts
Other (income) expense
 
(1,175
)
 
—

 
(535
)
 
—

Total loss (gain), net
 
 
$
(32,672
)
 
$
(2,717
)
 
$
(27,618
)
 
$
(11,301
)
NOTE 10    COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are parties to various legal actions and complaints arising in the ordinary course of business. As of the date hereof, the Company believes that the ultimate resolution of such matters will not materially affect the Company’s financial condition and earnings.
NOTE 11    STOCK-BASED COMPENSATION
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
RSUs and PSUs
$
1,551

 
$
1,510

 
$
4,207

 
$
5,090

Stock options and tandem SARs
27,490

 
2,573

 
25,626

 
9,912

Deferred share units (“DSUs”)
5,040

 
514

 
5,134

 
2,130

Total stock-based compensation expense(1)
$
34,081

 
$
4,597

 
$
34,967

 
$
17,132

TRS (gain)(2)
$
(30,756
)
 
$
(2,802
)
 
$
(26,509
)
 
$
(11,037
)
________________
(1) 
Primarily included in General and administrative expenses in the Condensed Consolidated Statement of Operations.
(2) 
The Company has entered into TRS contracts as economic hedges, covering 1,027,000 of the Company’s underlying common shares (September 29, 2013: 1,008,000), which represents a portion of its outstanding stock options with tandem SARs, and substantially all of its cash obligation related to DSUs. See note 9 for the revaluation of the TRS contracts.

13

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 12    VARIABLE INTEREST ENTITIES
VIEs for which the Company is the primary beneficiary
 
The revenues and expenses associated with the Company’s consolidated Non-owned restaurants and advertising funds presented on a gross basis, prior to consolidation adjustments, are as follows:
 
Third quarter ended
 
September 28, 2014
 
September 29, 2013
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs(2)
 
Total
VIEs
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs(2)
 
Total
VIEs
Sales
$
94,129

 
$
—

 
$
94,129

 
$
96,049

 
$
—

 
$
96,049

Advertising levies
—

 
2,979

 
2,979

 
—

 
2,865

 
2,865

Total revenues
94,129

 
2,979

 
97,108

 
96,049

 
2,865

 
98,914

Cost of sales
92,183

 
—

 
92,183

 
94,302

 
—

 
94,302

Operating expenses
—

 
2,761

 
2,761

 
—

 
2,379

 
2,379

Asset impairment(3)
—

 
—

 
—

 
441

 
—

 
441

Operating income
1,946

 
218

 
2,164

 
1,306

 
486

 
1,792

Interest expense
—

 
218

 
218

 
—

 
486

 
486

Income before taxes
1,946

 
—

 
1,946

 
1,306

 
—

 
1,306

Income taxes
344

 
—

 
344

 
214

 
—

 
214

Net income attributable to noncontrolling interests
$
1,602

 
$
—

 
$
1,602

 
$
1,092

 
$
—

 
$
1,092


 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs(2)
 
Total
VIEs
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs(2)
 
Total
VIEs
Sales
$
271,838

 
$
—

 
$
271,838

 
$
276,273

 
$
—

 
$
276,273

Advertising levies
—

 
8,877

 
8,877

 
—

 
7,965

 
7,965

Total revenues
271,838

 
8,877

 
280,715

 
276,273

 
7,965

 
284,238

Cost of sales
266,038

 
—

 
266,038

 
272,648

 
—

 
272,648

Operating expenses
—

 
8,227

 
8,227

 
—

 
6,771

 
6,771

Asset impairment(3)
—

 
—

 
—

 
441

 
—

 
441

Operating income
5,800

 
650

 
6,450

 
3,184

 
1,194

 
4,378

Interest expense
33

 
650

 
683

 
—

 
1,194

 
1,194

Income before taxes
5,767

 
—

 
5,767

 
3,184

 
—

 
3,184

Income taxes
1,037

 
—

 
1,037

 
514

 
—

 
514

Net income attributable to noncontrolling interests
$
4,730

 
$
—

 
$
4,730

 
$
2,670

 
$
—

 
$
2,670

______________
(1) 
Includes rents, royalties, advertising expenses and product purchases from the Company which are eliminated upon the consolidation of these VIEs.
(2) 
The advertising levies, depreciation, interest costs, capital expenditures and financing associated with the Ad Fund’s program to acquire and install LCD screens, media engines, drive-thru menu boards and ancillary equipment for our restaurants (the “Expanded Menu Board Program”) are presented on a gross basis. Generally, the advertising levies that are not related to the Expanded Menu Board Program are netted with advertising and marketing expenses incurred by the advertising funds in operating expenses, as these contributions are designated for specific purposes. The Company acts as an agent with regard to these contributions.
(3) 
The Company recognized an impairment charge in the third quarter of 2013 related to certain underperforming markets in the U.S.



14

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

The assets and liabilities associated with the Company’s consolidated Non-owned restaurants and advertising funds presented on a gross basis, prior to consolidation adjustments, are as follows:
 
As at
 
September 28, 2014
 
December 29, 2013
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs
 
Restaurant
VIEs(1)
 
Advertising
fund VIEs
Cash and cash equivalents
$
7,717

 
$
—

 
$
7,773

 
$
—

Advertising fund restricted assets – current
—

 
57,230

 
—

 
39,783

Other current assets
6,892

 
—

 
7,155

 
—

Property and equipment, net
15,134

 
62,877

 
20,471

 
70,485

Other long-term assets
91

 
746

 
370

 
1,271

Total assets
$
29,834

 
$
120,853

 
$
35,769

 
$
111,539

Notes payable to Tim Hortons Inc. – current(2)(3)
$
12,492

 
$
8,222

 
$
13,689

 
$
3,040

Advertising fund liabilities – current
—

 
49,211

 
—

 
59,913

Other current liabilities(4)
10,509

 
5,254

 
11,706

 
5,253

Notes payable to Tim Hortons Inc. – long-term(2)(3)
494

 
34,943

 
628

 
15,200

Long-term debt(4)
—

 
21,384

 
—

 
25,157

Other long-term liabilities
5,432

 
1,839

 
9,381

 
2,976

Total liabilities
28,927

 
120,853

 
35,404

 
111,539

Equity of VIEs
907

 
—

 
365

 
—

Total liabilities and equity
$
29,834

 
$
120,853

 
$
35,769

 
$
111,539

______________
(1) 
The Company consolidated 317 Non-owned restaurants as at September 28, 2014 (December 29, 2013: 331).
(2) 
Various assets and liabilities are eliminated upon the consolidation of the Restaurant VIEs, the most significant of which are the FIP Notes payable to the Company, which reduces the Notes receivable, net reported on the Condensed Consolidated Balance Sheet (see note 4).
(3) 
The Notes payable to the Company by the Advertising Fund VIEs, which are funded by the Restricted cash and cash equivalents related to our Tim Card program, are eliminated upon consolidation of the Ad Fund.
(4) 
Includes $26.4 million of Advertising fund VIEs debt with a Canadian financial institution relating to the Expanded Menu Board Program (December 29, 2013: $30.2 million), of which $5.0 million is recognized in Other current liabilities (December 29, 2013: $5.0 million) with the remainder recognized as Long-term debt.
The liabilities recognized as a result of consolidating these VIEs do not necessarily represent additional claims on the Company’s general assets; rather, they represent claims against the specific assets of the consolidated VIEs. Conversely, assets recognized as a result of consolidating these VIEs do not represent additional assets that could be used to satisfy claims by the Company’s creditors as they are not legally included within the Company’s general assets.
NOTE 13    SEGMENT REPORTING
The Company operates exclusively in the quick service restaurant industry. The chief decision maker views and evaluates the Company’s reportable segments as follows:
Canadian and U.S. business units.The results of each of the Canadian and U.S. business units includes substantially all restaurant-facing activities, such as: (i) rents and royalties; (ii) product sales through our supply chain, as well as an allocation of supply chain income, driven primarily by the business units’ respective systemwide sales; (iii) franchise fees; (iv) corporate restaurants; (v) equity income related to restaurant operating ventures; and (vi) business-unit-related general and administrative expenses. The business units exclude the effect of consolidating VIEs, consistent with how the chief decision maker views and evaluates the respective business unit’s results.

15

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

Corporate services. Corporate services comprises services to support the Canadian and U.S. business units, including: (i) general and administrative expenses; (ii) manufacturing income, and to a much lesser extent, manufacturing sales to third parties; and (iii) income related to our distribution services, including the timing of variances arising primarily from commodity costs and the related effect on pricing, which generally reverse within a year, associated with our supply chain management. Our supply chain management involves securing a stable source of supply, which is intended to provide our restaurant owners with consistent and predictable pricing. Many of these products are typically priced based on a fixed-dollar mark-up and can relate to a pricing period which may extend beyond a quarter. Corporate services also includes the results of our international operations, which are currently not significant.
 
Third quarter ended

Year-to-date period ended
 
September 28, 2014

September 29, 2013

September 28, 2014

September 29, 2013
Revenues(1)
 
 
 
 
 
 
 
Canada
$
747,692


$
676,006


$
2,092,476


$
1,927,361

U.S.
60,099


47,019


163,152


132,687

Corporate services
4,256


3,414


13,561


12,743

Total reportable segments
812,047


726,439


2,269,189


2,072,791

VIEs
97,108


98,914


280,715


284,238

Total
$
909,155


$
825,353


$
2,549,904


$
2,357,029

Operating Income (Loss)
 
 
 
 
 
 
 
Canada
$
196,204


$
179,597


$
538,536


$
500,178

U.S.(2)
7,436


2,717


21,047


6,214

Corporate services
(9,709
)

(14,325
)

(32,284
)

(26,414
)
Total reportable segments
193,931


167,989


527,299


479,978

VIEs(2)
2,164


1,792


6,450


4,378

Transaction costs (note 15)
(27,289
)
 
—

 
(27,289
)
 
—

Corporate reorganization expenses
—


(953
)

—


(11,032
)
Consolidated Operating Income
168,806


168,828


506,460


473,324

Interest, Net
(17,639
)

(8,487
)

(50,848
)

(24,353
)
Income before income taxes
$
151,167


$
160,341


$
455,612


$
448,971

________________ 
(1) 
There are no inter-segment revenues included in the above table.
(2) 
In fiscal 2013, the Company recognized an asset impairment charge in the U.S. related to certain non-core and non-priority markets, of which $2.5 million was recognized in the U.S. segment and $0.4 million related to consolidated VIEs.
Consolidated Sales comprise the following:
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Sales
 
 
 
 
 
 
 
Distribution sales
$
534,456

 
$
473,641

 
$
1,498,571

 
$
1,373,389

Company-operated restaurant sales
6,201

 
6,090

 
19,236

 
18,567

Sales from VIEs
94,129

 
96,049

 
271,838

 
276,273

Total Sales
$
634,786

 
$
575,780

 
$
1,789,645

 
$
1,668,229

 

16

TIM HORTONS INC. AND SUBSIDIARIES
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(in thousands of Canadian dollars)

NOTE 14    RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09 Revenue from Contracts with Customers. The amendments in this ASU are intended to provide a more robust framework for addressing revenue issues; improve comparability of revenue recognition practices across entities, industries, jurisdictions and markets; and provide more useful information to financial statement users through improved disclosure requirements. The amendments in this ASU are effective for fiscal years and interim periods beginning on or after December 15, 2016, and should be applied retrospectively using one of two acceptable application methods as noted in the ASU. The Company is currently assessing the potential impact that the adoption and transition to this ASU may have on its Consolidated Financial Statements and related disclosures.
NOTE 15    PROPOSED TRANSACTION WITH BURGER KING
On August 26, 2014, the Company announced that it had entered into the Arrangement Agreement with Burger King and certain of its affiliates. Pursuant to and subject to the terms and conditions of the Arrangement Agreement, the transaction (“Transaction”) will result in Burger King and Tim Hortons being indirect subsidiaries of a newly formed Canadian company, 9060669 Canada Inc. (“Holdings”, formerly known as 1011773 B.C. Unlimited Liability Company). The Transaction has been unanimously approved by the Board of Directors of the Company as well as the Board of Directors of Burger King.
Company shareholders will receive, for each Company common share held, at the election of such holder: (a) C$65.50 in cash and 0.8025 common shares of Holdings (the “Arrangement Mixed Consideration”); (b) C$88.50 in cash (the “Arrangement Cash Consideration”); or (c) 3.0879 common shares of Holdings (the “Arrangement Share Consideration”). Common shares of the Corporation with respect to which no election is made will receive the Arrangement Mixed Consideration. Shareholders who elect to receive the Arrangement Cash Consideration or the Arrangement Share Consideration will be subject to proration in accordance with the Arrangement Agreement so that the total amount of cash paid and the total number of common shares of Holdings issued to the Corporation’s shareholders as a whole are equal to the total amount of cash and number of common shares of Holdings that would have been paid and issued if all of the Corporation’s shareholders received the Arrangement Mixed Consideration.
For a Company shareholder electing the Arrangement Mixed Consideration, the value of the consideration received will depend on the price per share of Burger King’s common shares at the time the Transaction is completed. Based on Burger King’s unaffected closing stock price as of August 22, 2014, this represented total value per Company share of $89.39 and based on Burger King’s closing stock price as of August 25, 2014, this represented total value per Company share of $94.05.
The Transaction is subject to customary closing conditions, including, among others, approval by the Company’s shareholders, approval by the Ontario Superior Court of Justice and regulatory approvals. An interim order of the Ontario Superior Court of Justice with respect to the Transaction was issued on November 3, 2014. The approval of Tim Hortons shareholders will be sought at a special meeting of shareholders, for shareholders of record on November 3, 2014. The special meeting is scheduled to be held on December 9, 2014 at the Tim Hortons Innovation Centre, 226 Wyecroft Road in Oakville, Ontario. As 3G Capital currently owns approximately 70.0% of the shares of Burger King and has committed to vote in favour of the Transaction, no stockholder vote is required of Burger King stockholders. The closing of the Transaction is currently anticipated to occur in late 2014 or early 2015.
Upon termination of the Transaction under certain circumstances, the Company may be required to pay Burger King a termination fee of $345.0 million, or Burger King may be required to pay the Company a termination fee of $500.0 million. In addition, if the Company’s shareholders do not approve the Transaction, the Company may be required to pay Burger King a reimbursement fee of $40.0 million.
Certain of the Company’s arrangements and agreements will be impacted by the proposed Transaction, including the Senior Notes included in our Long-term debt, certain agreements with executives, and our outstanding equity awards. For a full description of the impact of the Transaction on the Company, please refer to Amendment No. 4 to the Registration Statement on Form S-4, filed with the SEC on November 3, 2014, by New Red Canada Limited Partnership (“Partnership”, formerly known as New Red Canada Partnership) and Holdings, which is available on the SEC’s EDGAR filing system. The Form S-4 as amended, was declared effective by the SEC on November 5, 2014. Final versions of all documents for use in connection with a special meeting of shareholders of the Company to seek shareholder approval of the Transaction will be filed by the Company on SEDAR and on EDGAR, including the draft management proxy circular, in accordance with applicable corporate and securities laws in Canada and the United States.
The Company has incurred Transaction-related costs of $27.3 million in the year-to-date period ended September 28, 2014, primarily comprised of professional fees to financial and legal advisors.

17

TIM HORTONS INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the fiscal 2013 Consolidated Financial Statements and accompanying Notes included in our Annual Report on Form 10-K for the year ended December 29, 2013 (“Annual Report”) filed with the U.S. Securities and Exchange Commission (“SEC”) and the Canadian Securities Administrators (“CSA”) on February 25, 2014, and the Condensed Consolidated Financial Statements and accompanying Notes included in our Interim Report on Form 10-Q for the quarter ended September 28, 2014 filed with the SEC and the CSA on November 6, 2014. All amounts are expressed in Canadian dollars unless otherwise noted. The following discussion includes forward-looking statements that are not historical facts, but reflect our current expectations regarding future results. These forward-looking statements include information regarding our future economic and sales performance, strategic plan, operating results and outlook based on current expectations, including the Transaction (as defined below), assumptions and information, including information about our restaurant development plans, same-store sales expectations, earnings performance, capitalization alternatives, targets and operational initiatives. Actual results may differ materially from the results discussed in the forward-looking statements because of a number of risks and uncertainties, including the matters discussed below. Please refer to Item 1A. “Risk Factors” in Part I of our Annual Report and set forth in our Safe Harbor Statement and attached hereto, as well as additional risks described herein under Item 1A and elsewhere, for a further description of risks and uncertainties affecting our business and financial results. Historical trends should not be taken as indicative of future operations and financial results.
Our financial results are driven largely by changes in systemwide sales, which include restaurant-level sales at Company-operated restaurants, and franchisee-owned restaurants and restaurants run by independent operators (collectively, we hereunder refer to both franchisee-owned and franchisee-operated restaurants as “franchised restaurants”). We believe systemwide sales growth and same-store sales growth provide meaningful information to investors regarding the size of our system, the overall health and financial performance of our system, and the strength of our brand and restaurant owner base, which ultimately impacts our consolidated and segmented financial performance. Please refer to “Executive Overview” and “Selected Operating and Financial Highlights” below for additional information.
We prepare our financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”). However, this Management’s Discussion and Analysis of Financial Condition and Results of Operations also contains certain non-GAAP financial measures to assist readers in understanding the Company’s performance. Non-GAAP financial measures either exclude or include amounts that are not reflected in the most directly comparable measure calculated and presented in accordance with GAAP. Where non-GAAP financial measures are used, we have provided the most directly comparable measures calculated and presented in accordance with U.S. GAAP and a reconciliation to GAAP measures.
References herein to “Tim Hortons,” the “Company,” “we,” “our,” or “us” refer to Tim Hortons Inc. and its subsidiaries, unless specifically noted otherwise.
Description of Business
The Company’s principal business is the franchising of Tim Hortons restaurants, primarily in Canada and the U.S. As the franchisor, Tim Hortons collects royalty revenue from franchised restaurant sales. Our business generates additional revenues by controlling the underlying real estate of our franchised restaurants; real estate that is not controlled by us is generally for our non-standard restaurants. We warehouse and distribute coffee and other beverages, non-perishable food, supplies, packaging and equipment to most system restaurants in Canada, and frozen, refrigerated and shelf-stable products to certain markets in Canada. Where we are not able to leverage our scale or create warehousing or transportation efficiencies, such as in the U.S. and in certain Canadian markets, we typically manage and control the supply chain, but use third-party warehousing and transportation. In addition, the Company has vertically integrated manufacturing operations which include two coffee roasting plants and a fondant and fills manufacturing facility.
Executive Overview
Both the Canadian and U.S. economies showed positive progress in the third quarter of 2014, and we achieved significant sales progression in the third quarter of 2014, as our systemwide sales grew by 7.5% on a constant currency basis, driven by same-store sales growth and new restaurant development.
In the third quarter of 2014, same-store sales growth of 3.5% in Canada and 6.8% in the U.S. was driven primarily by increases in average cheque, with the U.S. also benefiting from an increase in transactions. In the year-to-date period of 2014, same-store sales growth of 2.6% in Canada, and 4.8% in the U.S., was driven by increases in average cheque.

18

On August 26, 2014, the Company announced that it had entered into a definitive agreement (the “Arrangement Agreement”) with Burger King Worldwide, Inc. (“Burger King”) and certain of its affiliates. Pursuant to and subject to the terms and conditions of the Arrangement Agreement, the proposed transaction (“Transaction”) will result in Burger King and Tim Hortons being indirect subsidiaries of a newly formed Canadian company. As a result of the proposed Transaction, the Company has recognized transaction costs of $27.3 million in the year-to-date period ending September 28, 2014, comprised primarily of professional fees paid to financial and legal advisors. Please refer to Item 1. Financial Statements—Note 15 Proposed Transaction with Burger King for more information.
Operating income in the third quarter of 2014 was flat compared to the third quarter of 2013, while adjusted operating income (refer to non-GAAP table on page 20) increased 15.5%. Growth in adjusted operating income was primarily driven by systemwide sales growth, resulting in an increase in supply chain and rents and royalties income. Year-to-date in 2014, operating income increased 7.0%, while adjusted operating income (refer to non-GAAP table on page 20) increased 10.2%, compared to the year-to-date period of 2013. Similar to the quarter, year-to-date systemwide sales growth drove an increase in both rents and royalties and supply chain income. Partially offsetting these growth factors were increased general and administrative expenses, and the timing of expenses related to our CIBC Visa co-branded loyalty rewards credit card (the “Double DoubleTM Card”). We continue to expect the launch of our Double Double Card to be cost-neutral on operating income over fiscal 2014.
Net income attributable to Tim Hortons Inc. (“net income”) decreased 13.8% in the third quarter of 2014, which was significantly impacted by Transaction costs, for which a full tax benefit cannot be recognized, compared to the third quarter of 2013. In the year-to-date period of 2014, net income decreased 3.4%, which again was significantly impacted by Transaction costs, for which a full tax benefit cannot be recognized, compared to the year-to-date period of 2013, which was impacted by Corporate reorganization costs. Aside from the items noted, the change in both periods was due primarily to higher operating income, as discussed above, partially offset by the effect of our recapitalization, which generated higher interest expense and a higher effective tax rate.
Diluted earnings per share attributable to Tim Hortons Inc. (“EPS”) was $0.74 in the third quarter of 2014, which was negatively impacted by approximately $0.21 due to Transaction costs, compared to $0.75 in the third quarter of 2013. Adjusted EPS (refer to non-GAAP table on page 20) was $0.95, an increase of 25.2% compared to the third quarter of 2013. EPS was $2.31 in the year-to-date period of 2014, which was negatively impacted by approximately $0.21 due to Transaction costs, compared to $2.12 in the year-to-date period of 2013, which was negatively impacted by approximately $0.06 due to Corporate reorganization costs. Adjusted EPS (refer to non-GAAP table on page 20) increased 16.0% in the year-to-date period of 2014 compared to the year-to-date period of 2013. Adjusted EPS growth in both periods was driven by strong operating performance, as well as the impact of our recapitalization, the proceeds of which were primarily used for our expanded share repurchase program, which resulted in a lower number of shares outstanding.
Selected Operating and Financial Highlights
 
Third quarter ended
 
Year-to-date ended
($ in millions, except per share data)
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Systemwide sales growth(1)
7.5
%
 
5.3
%
 
6.4
%
 
4.5
%
Same-store sales growth(2)
 
 
 
 
 
 
 
Canada
3.5
%
 
1.7
%
 
2.6
%
 
0.9
%
U.S.
6.8
%
 
3.0
%
 
4.8
%
 
1.3
%
Systemwide restaurants
4,590

 
4,350

 
4,590

 
4,350

Revenues
$
909.2

 
$
825.4

 
$
2,549.9

 
$
2,357.0

Operating income
$
168.8

 
$
168.8

 
$
506.5

 
$
473.3

Adjusted operating income(3)
$
196.1

 
$
169.8

 
$
533.7

 
$
484.4

Net income attributable to Tim Hortons Inc.
$
98.1

 
$
113.9

 
$
312.8

 
$
323.8

Diluted EPS
$
0.74

 
$
0.75

 
$
2.31

 
$
2.12

Adjusted Diluted EPS(3)
$
0.95

 
$
0.76

 
$
2.52

 
$
2.17

Weighted average number of common shares outstanding – Diluted (in millions)
132.9

 
150.9

 
135.3

 
152.9

________________  
(1) 
Total systemwide sales growth is determined using a constant exchange rate to exclude the effects of foreign currency translation. Foreign currency sales are converted into Canadian dollar amounts using the average exchange rate of the base year for the period covered. Systemwide sales growth excludes

19

sales from our Republic of Ireland and United Kingdom licensed locations. Systemwide sales growth in Canadian dollars, including the effects of foreign currency translation, was 7.9% and 5.7% for the third quarters of 2014 and 2013, respectively, and 7.0% and 4.7% for the year-to-date periods of 2014 and 2013, respectively.
(2) 
Same-store sales growth represents the average growth in retail sales at restaurants (franchised and Company-operated restaurants) operating systemwide that have been open for 13 or more months.
(3) 
Adjusted operating income and adjusted diluted EPS (“adjusted EPS”) are non-GAAP measures. See below for reconciliation of adjusting items used to calculate adjusted operating income and adjusted EPS. Management uses adjusted operating income and adjusted EPS to assist in the evaluation of year-over-year performance and believes that it will be helpful to investors to better evaluate underlying operational growth rates. These non-GAAP measures are not intended to replace the presentation of our financial results in accordance with GAAP. The Company’s use of the term adjusted operating income and adjusted EPS may differ from similar measures reported by other companies. Adjusted operating income and adjusted EPS should not be considered a measure of income generated by our business. The reconciliations of operating income and diluted EPS, which are GAAP measures, to adjusted operating income and adjusted diluted EPS, which are non-GAAP measures, are set forth in the table below:
 
Third quarter ended
 
Year-to-date periods ended
 
September 28,
2014
 
September 29,
2013
 
Change
 
September 28,
2014
 
September 29,
2013
 
Change
 
 
 
$
 
%
 
 
 
$
 
%
 
($ in millions)
Operating income
$
168.8

 
$
168.8

 
$
—

 
—
 %
 
$
506.5

 
$
473.3

 
$
33.1

 
7.0
%
Add: Transaction costs
27.3

 
—

 
27.3

 
n/m

 
27.3

 
—

 
27.3

 
n/m

Add: Corporate reorganization expenses
—

 
1.0

 
(1.0
)
 
n/m

 
—

 
11.0

 
(11.0
)
 
n/m

Adjusted operating income
$
196.1

 
$
169.8

 
$
26.3

 
15.5
 %
 
$
533.7

 
$
484.4

 
$
49.4

 
10.2
%

 
Third quarter ended
 
Year-to-date periods ended
 
September 28,
2014
 
September 29,
2013
 
Change
 
September 28,
2014
 
September 29,
2013
 
Change
 
 
 
$
 
%
 
 
 
$
 
%
 
($ per share)
Diluted EPS
0.74

 
0.75

 
(0.02)

 
(2.2
)%
 
$
2.31

 
$
2.12

 
$
0.19

 
9.2
%
Add: Transaction costs
0.21

 
—

 
0.21

 
n/m

 
0.21

 
—

 
0.21

 
n/m

Add: Corporate reorganization expenses
—

 
0.01

 
(0.01
)
 
n/m

 
—

 
0.06

 
(0.06
)
 
n/m

Adjusted diluted EPS
$
0.95

 
$
0.76

 
$
0.19

 
25.2
 %
 
2.52

 
2.17

 
0.35

 
16.0
%
________________ 
All numbers rounded
n/m    Not meaningful
Temporary Foreign Worker Program
A substantial portion of our earnings come from royalties, rents, and other amounts paid by restaurant owners, who operate substantially all of our restaurants. In April 2014, the Federal Government of Canada imposed a moratorium on the food service sector’s access to the Temporary Foreign Workers Program (“TFWP”). On June 20, 2014, the Federal Government of Canada lifted the moratorium but announced reforms that are expected to have the net effect of restricting or reducing access to the TFWP in most markets where it existed previously. Access to labour through use of the TFWP, in some markets, particularly in parts of western Canada, has been an important tool to help our restaurant owners fill labour shortages where Canadian citizen and permanent resident employees are not sufficient. While the Company and our restaurant owners continue to pursue strategies to address the government’s TFWP policy changes, the reforms may result in less restaurant development and reduced hours of operation in certain markets, and increases in labour or other costs to our owners. For further information, please refer to Item 1A. Risk Factors of our Annual Report.

20

New Restaurant Development
The opening of restaurants in new and existing markets in Canada and the U.S. has been a significant contributor to our growth. Set forth in the table below is a summary of restaurant openings and closures:
 
Third quarter ended September 28, 2014
 
Third quarter ended September 29, 2013
 
Full-serve
Standard and
Non-standard
 
Self-serve
Kiosks
 
Total
 
Full-serve
Standard and
Non-standard
 
Self-serve
Kiosks
 
Total
Canada
 
 
 
 
 
 
 
 
 
 
 
Restaurants opened
30

 
11

 
41

 
30

 
4

 
34

Restaurants closed
(6
)
 
—

 
(6
)
 
(2
)
 
—

 
(2
)
Net change
24

 
11

 
35

 
28

 
4

 
32

U.S.

 

 

 

 

 

Restaurants opened
10

 
—

 
10

 
12

 
1

 
13

Restaurants closed
(7
)
 
—

 
(7
)
 
(2
)
 
(1
)
 
(3
)
Net change
3

 
—

 
3

 
10

 
—

 
10

International (GCC)

 

 

 

 

 

Restaurants opened
6

 
—

 
6

 
4

 
—

 
4

Total Company

 

 

 

 

 

Restaurants opened
46

 
11

 
57

 
46

 
5

 
51

Restaurants closed
(13
)
 
—

 
(13
)
 
(4
)
 
(1
)
 
(5
)
Net change
33

 
11

 
44

 
42

 
4

 
46



 
Year-to-date period ended September 28, 2014
 
Year-to-date period ended September 29, 2013
 
Full-serve
Standard and
Non-standard
 
Self-serve
Kiosks
 
Total
 
Full-serve
Standard and
Non-standard
 
Self-serve
Kiosks
 
Total
Canada
 
 
 
 
 
 
 
 
 
 
 
Restaurants opened
75

 
18

 
93

 
71

 
8

 
79

Restaurants closed
(16
)
 
—

 
(16
)
 
(14
)
 
(1
)
 
(15
)
Net change
59

 
18

 
77

 
57

 
7

 
64

U.S.
 
 
 
 
 
 
 
 
 
 
 
Restaurants opened
22

 
—

 
22

 
24

 
2

 
26

Restaurants closed
(12
)
 
—

 
(12
)
 
(9
)
 
(4
)
 
(13
)
Net change
10

 
—

 
10

 
15

 
(2
)
 
13

International (GCC)
 
 
 
 
 
 
 
 
 
 
 
Restaurants opened
18

 
—

 
18

 
9

 
—

 
9

Total Company
 
 
 
 
 
 
 
 
 
 
 
Restaurants opened
115

 
18

 
133

 
104

 
10

 
114

Restaurants closed
(28
)
 
—

 
(28
)
 
(23
)
 
(5
)
 
(28
)
Net change
87

 
18

 
105

 
81

 
5

 
86


21

Systemwide Restaurant Count
 
As at
 
September 28, 2014
 
December 29, 2013
 
September 29, 2013
Canada
 
 
 
 
 
Company-operated
15

 
14

 
15

Franchised – standard and non-standard
3,498

 
3,440

 
3,354

Franchised – self-serve kiosk
152

 
134

 
131

Total
3,665

 
3,588

 
3,500

% Franchised
99.6
%
 
99.6
%
 
99.6
%
U.S.
 
 

 
 
Company-operated
3

 
2

 
3

Franchised – standard and non-standard
685

 
676

 
637

Franchised – self-serve kiosks
181

 
181

 
177

Total
869

 
859

 
817

% Franchised
99.7
%
 
99.8
%
 
99.6
%
International (GCC)
 
 

 
 
Franchised – standard and non-standard
56

 
38

 
33

% Franchised
100.0
%
 
100.0
%
 
100.0
%
Total system
 
 
 
 
 
Company-operated
18

 
16

 
18

Franchised – standard and non-standard
4,239

 
4,154

 
4,024

Franchised – self-serve kiosks
333

 
315

 
308

Total
4,590

 
4,485

 
4,350

% Franchised
99.6
%
 
99.6
%
 
99.6
%
Segment Operating Income
Our segments consist of the Canadian and U.S. business units, and Corporate Services (see Item 1. Financial Statements—Note 13 Segment Reporting for further information). Set forth in the table below is the operating income (loss) of our reportable segments:
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
Change
 
September 28, 2014
 
September 29, 2013
 
Change
 
 
 
$
 
%
 
 
 
$
 
%
 
($ in millions)
Canada
$
196.2

 
$
179.6

 
$
16.6

 
9.2
%
 
$
538.5

 
$
500.2

 
$
38.4

 
7.7
%
U.S.
$
7.4

 
$
2.7

 
$
4.7

 
n/m

 
$
21.0

 
$
6.2

 
$
14.8

 
n/m

Corporate services
$
(9.7
)
 
$
(14.3
)
 
$
4.6

 
n/m

 
$
(32.3
)
 
$
(26.4
)
 
$
(5.9
)
 
n/m

________________
All numbers rounded
n/m    Not meaningful

Canada
Operating income increased 9.2% in the third quarter of 2014 compared to the third quarter of 2013. Systemwide sales growth of 6.9%, driven by same-store sales growth of 3.5% and the incremental sales from new restaurants year-over-year, resulted in higher rents and royalties income and a higher allocation of supply chain income, including favourable product margin variability. Canada also benefited from lower general and administrative expenses, as breakage income recognized related to our Tim Card obligation (refer to Results of Operations—General and administrative expenses) and lower Cold Stone Creamery promotional expenses, were partially offset by Tim Card program costs, increased salaries and benefits driven by higher performance-related accruals and fewer vacancies in the organization, as well as expenses related to our 50th anniversary

22

restaurant owner convention. We expect the expenses related to our 50th anniversary restaurant owner convention to be primarily offset by lower franchisee meeting costs in the fourth quarter of 2014.
Same-store sales growth in the third quarter of 2014 was driven by an increase in average cheque, resulting from pricing and favourable product mix, partially offset by a modest decline in same-store transactions. We continued to grow total systemwide transactions. In Canada, the gain in average cheque was driven by increased sales in both our breakfast and lunch dayparts, aided in part by the introduction of our Spicy Crispy Chicken Sandwich, as well as sales of baked goods, which benefited from sales of specialty donuts. Our Dark Roast coffee blend, which was introduced systemwide towards the end of the third quarter of 2014, also proved popular amongst our guests.
For the year-to-date period of 2014, operating income increased 7.7% compared to the year-to-date period of 2013. Operating income growth was driven primarily by systemwide sales growth of 5.8% in the year-to-date period of 2014, resulting from the net addition of new restaurants and same-store sales growth of 2.6%. Same-store sales growth in the year-to-date period of 2014 was driven by an increase in average cheque, resulting from favourable product mix and pricing, partially offset by a decline in same-store transactions. Systemwide sales growth resulted in higher rents and royalties income and a higher allocation of supply chain income. Canada also benefited from lower general and administrative expenses, due to the same factors impacting the quarter.
U.S.
Operating income was $7.4 million in the third quarter of 2014, a significant increase of $4.7 million compared to the third quarter of 2013. The third quarter of 2013 included the recognition of an asset impairment charge of $2.5 million. Systemwide sales growth of 12.8% was driven by same-store sales growth of 6.8%, and the incremental sales from the net addition of new restaurants. Systemwide sales growth led to growth in rents and royalties revenues, and same-store sales growth continued to drive a significant reduction in relief from restaurants open 13 months or more. We continued to note lower relief due to specific relief reduction measures, which began in the second half of 2013, and the closure of certain underperforming restaurants in the fourth quarter of 2013. Partially offsetting the growth in rents and royalties income were higher general and administrative expenses, due to increased salaries and benefits as a result of increased performance-related accruals, and the timing of expenses related to our 50th anniversary restaurant owner convention. Foreign currency translation increased U.S. operating income by approximately $0.2 million year-over-year.
In the third quarter of 2014, same-store sales growth was driven by gains in average cheque resulting from favourable product mix and pricing, and to a lesser extent, an increase in same-store transactions. We continued to grow total systemwide transactions. Our same-store sales growth in the third quarter of 2014 continued to benefit from increased sales in our breakfast daypart and cold beverage category, as a result of continued product innovation. Increased sales of coffee and hot beverages in the U.S., also contributed to same-store sales growth in the third quarter of 2014. Our Dark Roast coffee blend, which was introduced systemwide towards the end of the third quarter of 2014, also proved popular amongst our guests.
For the year-to-date period of 2014, operating income was $21.0 million, an increase of $14.8 million compared to the year-to-date period of 2013. The year-to-date period of 2013 included the recognition of an asset impairment charge of $2.5 million. Systemwide sales growth of 11.1% was driven by incremental sales from the net addition of new restaurants and same-store sales growth of 4.8%, due to an increase in average cheque resulting from favourable product mix and pricing, partially offset by a decrease in same-store transactions. Similar to the third quarter of 2014, systemwide sales growth led to growth in rents and royalties revenues, and same-store sales growth led to a significant reduction in relief from restaurants open 13 months or more, due in part to specific relief reduction measures and certain limited restaurant closures. Rents and royalties income also benefited slightly from favourable lease termination settlements in connection with such restaurant closures. This growth was partially offset by higher operating expenses, due to an overall increase in the number of properties owned or leased. A higher supply chain allocation, driven primarily by systemwide sales growth, also contributed to U.S. operating income growth. Foreign currency translation increased U.S. operating income by approximately $1.3 million year-over-year.
In October 2014, consistent with our strategic plan, we signed an additional area development agreement to develop approximately 10 restaurants in New Jersey over a five-year term. Since the fourth quarter of 2013, we have signed a total of seven agreements to develop approximately 145 standard and non-standard restaurants over the next 10 years in different U.S. markets.
Corporate services
Our Corporate services segment had an operating loss of $9.7 million in the third quarter of 2014, compared to an operating loss of $14.3 million in the third quarter of 2013. The improvement in our Corporate services segment was driven by our supply chain, due to the reversal of unfavourable product margins in the third quarter of 2014 recognized in the first half of 2014, compared to unfavourable product margins recognized in the third quarter of 2013. This was partially offset by increased

23

corporate costs as a result of higher salaries and benefits, primarily driven by increased performance-related accruals, and higher professional fees related to strategic initiatives in the third quarter of 2014 compared to the third quarter of 2013.
Year-to-date in 2014, our Corporate services segment had an operating loss of $32.3 million, compared to an operating loss of $26.4 million in the year-to-date period of 2013. The increase was primarily driven by increased corporate costs as a result of higher salaries and benefits, driven by both increased performance-related accruals and fewer vacancies in the organization, as well as higher professional fees related to strategic initiatives.
Results of Operations
 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
Change(1)
 
September 28, 2014
 
September 29, 2013
 
Change(1)
 
 
 
$
 
%
 
 
$
 
%
 
($ in millions)
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales
$
634.8

 
$
575.8

 
$
59.0

 
10.2
 %
 
$
1,789.6

 
$
1,668.2

 
$
121.4

 
7.3
%
Franchise revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rents and royalties(2)
230.4

 
212.1

 
18.3

 
8.6
 %
 
654.8

 
608.9

 
46.0

 
7.6
%
Franchise fees
44.0

 
37.5

 
6.5

 
17.4
 %
 
105.4

 
79.9

 
25.5

 
31.9
%
Total revenues
909.2

 
825.4

 
83.8

 
10.2
 %
 
2,549.9

 
2,357.0

 
192.9

 
8.2
%
Costs and expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
545.1

 
501.9

 
43.2

 
8.6
 %
 
1,545.8

 
1,452.3

 
93.5

 
6.4
%
Operating expenses
86.3

 
78.3

 
8.0

 
10.2
 %
 
252.0

 
231.0

 
20.9

 
9.1
%
Franchise fee costs
43.6

 
37.9

 
5.7

 
15.1
 %
 
106.2

 
83.7

 
22.4

 
26.8
%
General and administrative expenses
41.7

 
38.8

 
2.9

 
7.5
 %
 
121.1

 
115.5

 
5.6

 
4.9
%
Equity (income)
(4.0
)
 
(4.1
)
 
—

 
(0.9
)%
 
(11.4
)
 
(11.3
)
 
—

 
0.2
%
Transaction costs
27.3

 
—

 
27.3

 
n/m

 
27.3

 
—

 
27.3

 
n/m

Corporate reorganization expenses
—

 
1.0

 
(1.0
)
 
n/m

 
—

 
11.0

 
(11.0
)
 
n/m

Asset impairment
—

 
2.9

 
(2.9
)
 
n/m

 
—

 
2.9

 
(2.9
)
 
n/m

Other expense (income), net
0.5

 
(0.1
)
 
0.5

 
n/m

 
2.5

 
(1.4
)
 
3.9

 
n/m

Total costs and expenses
740.3

 
656.5

 
83.8

 
12.8
 %
 
2,043.4

 
1,883.7

 
159.7

 
8.5
%
Operating income
$
168.8

 
$
168.8

 
$
—

 
—
 %
 
$
506.5

 
$
473.3

 
$
33.1

 
7.0
%
Operating income %
18.6
%
 
20.5
%
 
 
 


 
19.9
%
 
20.1
%
 
 
 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest (expense)
(18.5
)
 
(9.4
)
 
(9.1
)
 
n/m

 
(53.8
)
 
(27.0
)
 
(26.9
)
 
n/m

Income tax rate
34.0
%
 
28.3
%
 
 
 


 
30.3
%
 
27.3
%
 
 
 


_____________
All numbers rounded
n/m    Not meaningful
(1) 
The financial results of our U.S. segment are denominated in U.S. dollars and translated into Canadian dollars for consolidated reporting purposes. While foreign currency translation, primarily related to the Canadian dollar relative to the U.S. dollar, impacted individual revenue and expense items in the third quarter of 2014 and the year-to-date period of 2014, it did not have a significant impact on operating income.
(2) 
Rents and royalties revenues includes rents and royalties derived from our franchised restaurant sales, and certain advertising levies primarily associated with the Tim Hortons Advertising and Promotion Fund (Canada) Inc.’s (“Ad Fund”) program to acquire LCD screens, media engines, drive-thru menu boards and ancillary equipment for our restaurants (“Expanded Menu Board Program”) (see Item 1. Financial Statements—Note 12 Variable Interest Entities). Franchised restaurant sales are reported to us by our restaurant owners, and are not included in our Condensed Consolidated Financial Statements, other than consolidated Non-owned restaurants. Franchised restaurant sales do, however, result in royalties and rental revenues, which are included in our franchise revenues, as well as distribution sales. The reported franchised restaurant sales (including consolidated Non-owned restaurants) were:

24

 
Third quarter ended
 
Year-to-date period ended
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
Franchised restaurant sales
(in millions)
Canada (Canadian dollars)
$
1,702.1

 
$
1,591.8


$
4,836.3

 
$
4,571.1

U.S. (U.S. dollars)
$
165.5

 
$
146.5


$
477.5

 
$
429.2

Revenues
Sales
In the third quarter and year-to-date period of 2014, the growth in sales compared to the respective 2013 periods was driven primarily by increased distribution sales, partially offset by a decrease in sales from variable interest entities (“VIEs”).
Distribution sales. Distribution sales were $534.5 million in the third quarter of 2014, compared to $473.6 million in the third quarter of 2013. The increase of $60.8 million, or 12.8%, was driven by systemwide sales growth, which contributed approximately 6.0% of the increase. Favorable product mix and, to a lesser extent, commodity-related pricing, contributed substantially all of the remaining increase. Sales of our single-serve products through to the grocery channel also contributed to the growth in distribution sales. Foreign currency translation increased distribution sales by approximately 0.3%.
For the year-to-date period of 2014, distribution sales were $1,498.6 million, an increase of $125.2 million, or 9.1%, compared to the year-to-date period of 2013. Similar to the quarter, the increase was driven primarily by systemwide sales growth, which contributed approximately 5.5% of the increase, with favourable product mix contributing substantially all of the remaining increase. Foreign currency translation increased distribution sales by approximately 0.6%.
Our distribution sales are subject to changes related to underlying costs of key commodities, such as coffee, wheat, edible oils and sugar, and other products. Changes in underlying costs are largely passed through to restaurant owners, but will typically occur after changes in spot market prices as we generally utilize fixed-price contracts as a method to provide restaurant owners with consistent, predictable pricing and to secure a stable source of supply. We generally have forward purchasing contracts in place for a six-month period of future supply for our key commodities, but have occasionally extended beyond this time frame in periods of elevated market volatility or tight supply conditions. Underlying commodity costs can also be impacted by currency changes. These cost changes can impact distribution sales, and cost of sales, and can create volatility quarter-over-quarter and year-over-year. These changes may impact margins in a quarter as many of these products are typically priced based on a fixed-dollar mark-up and can relate to a pricing period which may extend beyond a quarter.
The current market price of coffee, a key commodity for the Company, has recently experienced increases. Our purchase commitments to the end of fiscal 2014 reflect previous lower market coffee pricing, however, beginning in fiscal 2015, our purchase commitments are reflective of the elevated market price of coffee. As noted above, changes in underlying costs are largely passed through to restaurant owners, and we and our restaurant owners have some ability to increase product pricing to offset any rises in commodity prices, subject to restaurant owner and guest acceptance. Notwithstanding the foregoing, while it is not our current practice, we may choose not to pass along all price increases to our restaurant owners, which could have a more significant effect on our business and results of operations than if we pass along all, or a large portion of, increases to our restaurant owners. For a full description of the related risk factors, please refer to Item 1A. Risk Factors of our Annual Report.
Variable interest entities’ sales. VIEs’ sales were $94.1 million in the third quarter of 2014, a decrease of 2.0% compared to the third quarter of 2013. In the year-to-date period of 2014, VIEs’ sales were $271.8 million, a decrease of 1.6% compared to the year-to-date period of 2013. The decrease in both periods was driven primarily by the decrease, on average, of 27 fewer VIEs in the third quarter of 2014 and 24 fewer in the year-to-date period of 2014 compared to the respective 2013 periods. The decrease was partially offset by higher sales at consolidated restaurants, and foreign currency translation, which increased VIEs’ sales by 1.4% in the third quarter of 2014 and 2.9% in the year-to-date period of 2014.
The number of consolidated Non-owned restaurants has decreased slightly since the end of fiscal 2013. The following table outlines the number of consolidated Non-owned restaurants, on average, and at the end of each respective period:
 
Third quarter ended
 
Year-to-date period ended
 
As at
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
September 29, 2013
 
September 28, 2014
 
December 29, 2013
 
Average
 
Average
 
 

 
 
Canada
106

 
117

 
106

 
117

 
109

 
106

U.S.
212

 
228

 
220

 
233

 
208

 
225

Total
318

 
345

 
326

 
350

 
317

 
331


25


Franchise Revenues
Rents and Royalties. Revenue from rents and royalties increased 8.6% in the third quarter of 2014 compared to the third quarter of 2013, and in the year-to-date period of 2014, revenue from rents and royalties increased 7.6% compared to the year-to-date period of 2013. The increase in both periods was driven by systemwide sales growth, including a reduction in relief, primarily in the U.S., which collectively contributed approximately 8.2% in the third quarter of 2014 and 6.8% in the year-to-date period of 2014. Foreign currency translation increased rents and royalties revenues by approximately 0.2% and 0.5% in each respective period.
Franchise Fees. Franchise fees increased $6.5 million in the third quarter of 2014 compared to the third quarter of 2013, and in the year-to-date period of 2014, franchise fees increased $25.5 million compared to the year-to-date period of 2013. The increase in both periods was driven primarily by an increase in restaurant development, as well as an increase in renovations in Canada.
Total Costs and Expenses
Cost of Sales
In both the third quarter and year-to-date period of 2014, the growth in cost of sales compared to the respective 2013 periods was driven primarily by growth in distribution cost of sales, partially offset by a decrease in VIEs’ cost of sales.
Distribution cost of sales. Distribution cost of sales was $457.8 million in the third quarter of 2014, compared to $411.3 million in the third quarter of 2013. The increase of $46.5 million, or 11.3%, was primarily driven by systemwide sales growth, which contributed approximately 6.0% of the increase. The remaining increase was substantially all driven by increased cost of sales due to product mix. Foreign currency translation increased distribution cost of sales by approximately 0.3%.
In the year-to-date period of 2014, distribution cost of sales was $1,290.2 million compared to $1,185.9 million in the year-to-date period of 2013. Similar to the quarter, the increase of $104.3 million, or 8.8%, was driven primarily by systemwide sales growth, which contributed approximately 5.6% of the increase, while product mix drove substantially all of the remaining increase. Foreign currency translation increased distribution cost of sales by approximately 0.6%.
Our distribution costs are subject to changes related to the underlying costs of key commodities, such as coffee, wheat, edible oils, sugar, and other product costs (see Revenues—Sales—Distribution Sales above for further information).
Variable interest entities’ cost of sales. VIEs’ cost of sales was $80.9 million in the third quarter of 2014, a decrease of $3.5 million, or 4.1%, compared to the third quarter of 2013. The decrease was primarily due to the decrease in average number of VIEs, partially offset by higher sales at consolidated restaurants and foreign currency translation, which increased VIEs’ cost of sales by approximately 1.5%.
In the year-to-date period of 2014, VIEs’ cost of sales was $236.3 million, a decrease of $10.3 million, or 4.2%, compared to the year-to-date period of 2013, driven primarily by the decrease in the average number of VIEs, partially offset by foreign currency translation, which increased VIEs’ cost of sales by approximately 3.2%.
Operating Expenses
Total operating expenses increased $8.0 million, or 10.2% in the third quarter of 2014 compared to the third quarter of 2013. Rent expense increased by $4.2 million year-over-year, primarily due to additional properties that were leased and then subleased to restaurant owners, while property-related depreciation expense increased by $3.3 million, due to both an increase in the number of properties either owned or leased, and then subleased to restaurant owners, and renovations to existing restaurants. Foreign currency translation increased operating expenses by approximately 0.4%.
In the year-to-date period of 2014, operating expenses increased $20.9 million, or 9.1%, compared to the year-to-date period of 2013. Similar to the quarter, the increase was primarily due to increased rent expense of $10.7 million and depreciation expense of $10.3 million. Foreign currency translation increased operating expenses by approximately 0.8%.
Franchise Fee Costs
Franchise fee costs increased $5.7 million in the third quarter of 2014 compared to the third quarter of 2013, due primarily to increased restaurant development, higher costs to support restaurant development initiatives, and an increase in renovations in Canada. In the year-to-date period of 2014, franchise fee costs increased $22.4 million compared to the year-to-date period of 2013, due primarily to an increase in restaurant development and renovations in Canada.

26

General and Administrative Expenses
General and administrative expenses increased 7.5% in the third quarter of 2014 compared to the third quarter of 2013, due primarily to increased salaries and benefits as a result of increased performance-related accruals and fewer vacancies in the organization, as well as expenses related to our 50th anniversary restaurant owner convention and professional fees related to strategic initiatives unrelated to the Transaction. We expect convention costs to be primarily offset by lower franchisee meeting expenses in the fourth quarter of 2014. In the third quarter of 2014, we recognized breakage income related to our Tim Card obligation for dormant card balances determined based on long periods of inactivity, partially offset by Tim Card program costs. The recognition of breakage income, as well as lower Cold Stone Creamery promotional expenses, partially offset the increases noted above. Foreign currency translation increased general and administrative expenses by approximately 0.7%.
In the year-to-date period of 2014, general and administrative expenses increased 4.9% compared to the year-to-date period of 2013. Similar to the quarter, this was driven by increased salaries and benefits resulting primarily from fewer vacancies in the organization, increased performance-related accruals, and higher stock-based compensation expense, as well as expenses related to our 50th anniversary convention and professional fees related to strategic initiatives. Partially offsetting these factors was the recognition of Tim Card breakage income, as noted above, and lower promotional expenses, related primarily to Cold Stone Creamery in Canada. Foreign currency translation increased general and administrative expenses by approximately 1.1%.
Transaction Costs
As a result of the Transaction, the Company has recognized transaction costs of $27.3 million in the year-to-date period ending September 28, 2014 comprised primarily of financial and legal professional fees and, prior to, and on the completion of the Transaction, expects to recognize, total Transaction costs of approximately $80.0 to $90.0 million, comprised primarily of financial and legal professional fees. The proposed Transaction is expected to close in late 2014 or early 2015. Please refer to Item 1. Financial Statements—Note 15 Proposed Transaction with Burger King for more information.
Corporate Reorganization Expenses
We completed the realignment of roles and responsibilities into our corporate centre and business unit design at the end of the first quarter of 2013, and incurred additional Chief Executive Officer transition costs to the end of fiscal 2013 (please refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report for a full description).
Other Expense (Income), net
Other expense recognized in the third quarter of 2014 and in the year-to-date period of 2014 is primarily related to the launch of our Double Double Credit Card, which occurred in July 2014. We continue to expect the launch of the Double Double Credit Card to be cost-neutral over fiscal 2014. In comparison, other income recognized in the year-to-date period of 2013 was primarily due to the gain on a corporate property sale, as well as favourable foreign exchange.
Interest Expense
The increase in interest expense in both the third quarter of 2014 and year-to-date period of 2014, compared to the respective 2013 periods, was primarily due to the increase in our long-term debt (see Liquidity and Capital Resources for further information).
Income Taxes
The increase in the effective income tax rate for the 2014 quarter-to-date and year-to-date periods as compared to the respective 2013 periods is primarily due to Transaction-related costs, and to a lesser degree an increase in costs in 2014 related to our new long-term debt, for both of which a full tax benefit cannot be recognized.
A Notice of Appeal to the Tax Court of Canada was filed in July 2012 in respect of a dispute with the CRA related to the deductibility of approximately $10.0 million of interest expense for the 2002 taxation year. The court date for this matter has been adjourned from the second half of 2014 to the first half of 2015. The Company continues to believe it will ultimately prevail in sustaining the tax benefit of the interest deduction, and, accordingly, has not made a provision for this matter.
There have been no other significant developments related to the Canada Revenue Agency matters discussed in our Annual Report.

27

Liquidity and Capital Resources
The following reflects the Company’s current liquidity and capital resources, and does not reflect any considerations related to the proposed Transaction with Burger King. Please refer to Item 1. Financial Statements—Note 15 Proposed Transaction with Burger King for more information.
Overview
Our primary source of liquidity has historically been, and continues to be, cash generated from Canadian operations which has for the most part self-funded our operations, growth in new restaurants, capital expenditures, dividends, normal course share repurchases, acquisitions and investments. In fiscal 2014, our U.S. operations have, and are expected to continue to, contribute positively to our cash flow. Our $250.0 million revolving bank facility provides an additional source of liquidity (see Credit Facilities below for additional information). We believe that we will continue to generate adequate operating cash flows over the next 12 months.
In March 2014, Tim Hortons Inc. raised $450.0 million in long-term debt through the issuance of Senior Unsecured Notes, Series 3, due April 1, 2019 (“Series 3 Notes”), a portion of which was utilized to settle our $400.0 million revolving bank facility, which is now fully retired. Please refer to Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s First Quarter Report for the quarter ended March 30, 2014, filed on Form 10-Q with the SEC and CSA on May 7, 2014 for a full description.
We regularly assess capital structure, and seek to identify opportunities to generate value for shareholders. Since the third quarter of 2013, our outstanding long-term debt increased by $900.0 million, which was used for the retirement of the 2013 Revolving Bank Facility, and general corporate purposes, including share repurchases. The accretive benefits to EPS of our expanded share repurchase program more than offset the after-tax cost of our interest expense that resulted from increasing the amount of our debt to fund those repurchases.
If additional funds are needed for strategic initiatives or other corporate purposes beyond those currently available, we believe that, with the strength of our balance sheet and our strong capital structure, we could borrow additional funds. Our ability to incur additional indebtedness will also be limited by our financial and other covenants under our $250.0 million revolving bank facility (see Credit Facilities below for additional information). Our Senior Unsecured Notes, Series 1, due June 1, 2017, Senior Unsecured Notes, Series 2, due December 1, 2023, and Series 3 Notes are not subject to any financial covenants; however, certain other covenants apply. Any additional borrowings may result in an increase in our borrowing costs. If such additional borrowings are significant, our credit rating may be downgraded, and it is possible that we would not be able to borrow on terms which are favourable to us.
When evaluating our leverage position, we look at metrics that consider the impact of long-term operating and capital leases as well as other long-term debt obligations. We believe this provides a more meaningful measure of our leverage position given our significant investments in real estate. As at September 28, 2014, we had approximately $1.4 billion in long-term debt and capital leases (excluding current portion) on our balance sheet, excluding Ad Fund debt related to the Expanded Menu Board Program.
Credit Facilities
We have a $250.0 million unsecured senior revolving facility credit agreement (the “Revolving Bank Facility”), which we may use for general corporate purposes, including potential acquisitions and other business purposes. The Revolving Bank Facility includes a $25.0 million overdraft availability and a $25.0 million letter of credit facility. At September 28, 2014, we had utilized $5.9 million of the Revolving Bank Facility to support standby letters of credit. The Revolving Bank Facility requires the maintenance of two financial ratios: a consolidated maximum total debt coverage ratio, and a minimum fixed charge coverage ratio. We were in compliance with these covenants as at September 28, 2014.
Common Shares
On February 19, 2014, we obtained regulatory approval from the Toronto Stock Exchange (“TSX”) to commence a new share repurchase program (“2014 Program”), authorizing the repurchase of $440.0 million in common shares, not to exceed the regulatory maximum of 13,726,219 shares, representing 10% of our public float as defined under the TSX Company Manual. The 2014 Program commenced February 28, 2014 and was due to terminate on February 27, 2015, or earlier if the $440.0 million or 10% share maximum was reached, or upon the occurrence of certain other termination events. Following the announcement on August 24, 2014 that the Company was in discussions with Burger King regarding a potential strategic Transaction, the 2014 Program was terminated. In total, we repurchased 5.6 million common shares pursuant to the 2014 Program, which have subsequently been cancelled.

28

Our outstanding share capital is comprised solely of common shares. An unlimited number of common shares, without par value, is authorized, and as at September 28, 2014, we had 132,576,171 common shares outstanding, and outstanding stock options with tandem stock appreciation rights held by current and former officers and employees to acquire 1,604,848 of our common shares pursuant to our 2006 Stock Incentive Plan and 2012 Stock Incentive Plan, of which 706,848 were exercisable.
Comparative Cash Flows
Operating Activities. Net cash provided from operating activities in the year-to-date period of 2014 was $447.6 million compared to $438.2 million in the year-to-date period of 2013, an increase of $9.5 million in the year-to-date period of 2014 compared to the year-to-date period of 2013, primarily due to strong earnings, as there were offsetting changes within operating assets and liabilities.
Investing Activities. Net cash used in investing activities was $133.2 million in the year-to-date period of 2014 compared to $135.6 million in the year-to-date period of 2013, a decrease of $2.3 million. Decreases in capital expenditures of the Ad Fund, as the Expanded Menu Board Program nears completion, and increases in other investing activities, were partially offset by increased capital expenditures at existing restaurants, due to both an increase in the number of renovations year-over-year and timing of renovations completed in the fourth quarter of 2013, and new restaurant development. Below is a summary of our capital expenditures:
 
Year-to-date periods ended
 
September 28, 2014
 
September 29, 2013
 
(in millions)
Capital expenditures(1)
 
 
 
New restaurants
$
53.5

 
$
59.7

Existing restaurants(2)
73.1

 
59.3

Other capital expenditures(3)
12.4

 
13.8

Total capital expenditures
$
139.0

 
$
132.7

________________
All numbers rounded.
(1) 
Reflected on a cash basis, which can be impacted by the timing of payments compared to the actual date of acquisition.
(2) 
The increase in capital expenditures related to existing restaurants was primarily driven by an increase in renovations completed in the fourth quarter of 2013, but paid in the first quarter of 2014.
(3) 
Related primarily to our distribution facilities, and other corporate needs.
Capital expenditures for each of our reportable segments was as follows:
 
Year-to-date periods ended
 
September 28, 2014
 
September 29, 2013
 
(in millions)
Canada
$
111.6

 
$
90.7

U.S.
18.1

 
32.1

Corporate Services
9.4

 
10.0

Total capital expenditures
$
139.0

 
$
132.7

Financing Activities. Financing activities used cash of $257.1 million in the year-to-date period of 2014 compared to using cash of $379.3 million in the year-to-date period of 2013, a decrease of $122.2 million. Net proceeds from the issuance of our Series 3 Notes were offset by an additional $296.2 million returned to shareholders in the form of common share repurchases and dividends paid in the year-to-date period of 2014 compared to the year-to-date period of 2013.
Off-Balance Sheet Arrangements
We did not have “off-balance sheet” arrangements as at September 28, 2014 or December 29, 2013.
Contractual Obligations
In the first quarter of 2014, we issued Series 3 Notes of $450.0 million, and also entered into an agreement with one of our suppliers requiring minimum purchase obligations, within the normal course of operations, of U.S. $115.8 million over the six-year term of the agreement. Other than these developments, our contractual obligations have not changed materially since December 29, 2013.

29

Recent Accounting Pronouncements
See Item 1. Financial Statements—Note 14 Recent Accounting Pronouncements.

30

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Other than as noted above, there are no material changes to our exposure to various foreign exchange, commodity, interest rate, and inflationary risks as reported in our Annual Report.
ITEM 4.    CONTROLS AND PROCEDURES
(a)
The Company, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, performed an evaluation of the Company’s disclosure controls and procedures, as contemplated by Securities Exchange Act Rule 13a-15. Disclosure controls and procedures include those designed to ensure that information required to be disclosed is accumulated and communicated to the Company’s management as appropriate to allow timely decisions regarding disclosure. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded, as of the end of the period covered by this report, that such disclosure controls and procedures were effective.
(b)
There has been no change in our internal control over financial reporting during the last fiscal quarter which has been identified in connection with Management’s evaluation required by Rules 13a-15(d) or 15d-15(d) under the Exchange Act, as amended, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
ITEM 1.    LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to various legal actions and complaints arising in the ordinary course of business. As of the date hereof, the Company believes that the ultimate resolution of such matters will not materially affect the Company’s financial condition and earnings.
ITEM 1A.     RISK FACTORS
In addition to the other information set forth in this Form 10-Q and the risk factors below, you should carefully consider the factors discussed under the heading “Risk Factors” in our Annual Report, as well as information in our other public filings, press releases, and in our Safe Harbor statement. Any of these “risk factors” could materially affect our business, financial condition or future results. The risks described in the 2013 Form 10-K, and the additional risk factors and information provided in this Form 10-Q may not describe every risk facing our Company. For a full description of the risks relating to the Transaction, please refer to the amended registration statement on Form S-4 filed with the SEC on November 3, 2014 by Partnership and Holdings. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Risk Factors Relating to the Transaction
The Arrangement Agreement may be terminated in accordance with its terms and the Transaction may not be completed.
The Arrangement Agreement contains a number of conditions that must be fulfilled to complete the Transaction. Those conditions include, among other customary conditions, the approval of the arrangement resolution by Tim Hortons shareholders, the approval of the arrangement by the Ontario court, receipt of requisite regulatory approvals, absence of orders prohibiting consummation of the Transaction, effectiveness of the registration statement that has been filed by Holdings and Partnership to register the shares of Holdings common stock and Partnership exchangeable units that will be issued as consideration in the Transaction, approval of the Holdings common shares for listing on the NYSE and conditional approval for listing on the TSX and conditional approval of the Partnership exchangeable units for listing on the TSX. These conditions to the closing of the Transaction may not be fulfilled and, accordingly, the Transaction may not be completed. In addition, if the Transaction is not completed by March 31, 2015 (subject to extension to April 30, 2015, if the only conditions not satisfied or waived (other than those conditions that by their nature are to be satisfied at the closing, which conditions shall be capable of being satisfied) are conditions relating to regulatory approvals and the absence of any orders relating to regulatory approvals), either Tim Hortons or Burger King may choose to terminate the Arrangement Agreement. In addition, Tim Hortons or Burger King may elect to terminate the Arrangement Agreement in certain other circumstances, and the parties can mutually decide to terminate the Arrangement Agreement at any time prior to the closing, before or after the approval of Tim Hortons shareholders or Burger King’s stockholders, as applicable.

31

Failure to complete the Transaction could negatively impact our share price and our future business and financial results.
If the Transaction is not completed, the ongoing business of Tim Hortons may be adversely affected. Additionally, if the Transaction is not completed and the Arrangement Agreement is terminated, in certain circumstances, we may be required to pay to Burger King a termination fee of up to C$345 million. In addition, we may incur significant transaction expenses in connection with the Transaction regardless of whether the Transaction is completed. The foregoing risks, or other risks arising in connection with the failure of the Transaction, including the diversion of management attention from conducting the business of the Company and pursuing other opportunities during the pendency of the Transaction, may have a material adverse effect on our business, operations, financial results and share price. In addition, we could be subject to litigation related to any failure to consummate the Transaction or any related action that could be brought to enforce a party’s obligation under the Arrangement Agreement.
While the Transaction is pending, we are restricted from taking certain actions. In addition to affecting our business operations, this may also affect relationships with employees.
The Arrangement Agreement restricts us from taking specified actions until the Transaction occurs without the consent of the other party. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the Transaction. In addition, employee retention may be challenging during the pendency of the Transaction, as certain employees may experience uncertainty about their future roles.
Our business relationships, including relationships with franchisees and customer relationships, may be subject to disruption due to uncertainty associated with the Transaction.
Parties with which we currently do business or may do business in the future, including franchisees, customers and suppliers, may experience uncertainty associated with the Transaction, including with respect to current or future business relationships with us, Partnership or Holdings. As a result, our business relationships may be subject to disruptions if franchisees, customers, suppliers and others attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than Tim Hortons as a result of the Transaction. These disruptions could have a material and adverse effect on the businesses, financial condition, results of operations or prospects of Holdings and Partnership following the closing. The effect of such disruptions could be exacerbated by a delay in the consummation of the Transaction or termination of the Arrangement Agreement.
We may be named in legal proceedings in connection with the Transaction, the outcomes of which are uncertain, and which could delay or prevent the completion of the Transaction.
We and our directors may be named as defendants in shareholder class actions challenging the proposed Transaction. Among other remedies, the plaintiffs in such actions, if they do arise, may seek to enjoin the Transaction. Such legal proceedings could delay or prevent the Transaction from becoming effective within the agreed upon timeframe.
ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a)
Total Number
of Shares
Purchased(1)
 
(b)
Average Price
Paid per
Share (Cdn.)(2)
 
(c)
Total Number
of Shares
Purchased as
Part of Publicly
Announced 
Plans or
Programs
 
(d)
Maximum
Approximate
Dollar Value of
Shares that
May Yet be Purchased
Under the
2014 Program
(Cdn) (3)
Monthly Period #7 (June 30, 2014 – August 3, 2014)
308,187

 
60.95

 
308,187

 
$
120,346,565

Monthly Period #8 (August 4, 2014 – August 31, 2014)
241,700

 
65.91

 
241,700

 
—

Monthly Period #9 (September 1, 2014 – September 28, 2014)
—

 
—

 
—

 
—

Total
549,887

 
62.13

 
549,887

 
$
—

________________

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(1) 
Based on settlement date.
(2) 
Inclusive of commissions paid to the broker to repurchase the common shares.
(3) 
On February 19, 2014, we obtained regulatory approval from the Toronto Stock Exchange (“TSX”) to commence a new share repurchase program (“2014 Program”), authorizing the repurchase of $440.0 million in common shares, not to exceed the regulatory maximum of 13,726,219 shares, representing 10% of our public float as defined under the TSX Company Manual. The 2014 Program commenced February 28, 2014 and was due to terminate on February 27, 2015, or earlier if the $440.0 million or 10% share maximum was reached, or upon the occurrence of certain other termination events. Following the announcement on August 24, 2014 that the Company was in discussions with Burger King Worldwide, Inc. regarding a potential strategic transaction, the 2014 Program was terminated. Common shares purchased pursuant to the 2014 Program have been cancelled.
Dividend Restrictions with Respect to Part II, Item 2 Matters
The Company’s Revolving Bank Facility limits the payment of dividends by the Company. The Company may not make any dividend distribution unless, at the time of, and after giving effect to the aggregate dividend payment, the Company is in compliance with the financial covenants contained in the Revolving Bank Facility, and there is no default outstanding under the Revolving Bank Facility.
ITEM 3.    DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.    MINE SAFETY DISCLOSURE
None.
ITEM 5.    OTHER INFORMATION
None.
ITEM 6.    EXHIBITS
See Index to Exhibits following the signature page to this Form 10-Q, which is incorporated by reference herein.

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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.
 
 
 
 
 
TIM HORTONS INC. (Registrant)
 
 
 
Date:
November 6, 2014
 
/s/ CYNTHIA J. DEVINE
 
 
 
 
Cynthia J. Devine
 
 
 
 
Chief Financial Officer

34

TIM HORTONS INC. AND SUBSIDIARIES
INDEX TO EXHIBITS

Exhibit
 
Description
 
Where found
 
 
 
 
 
31(a)
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
 
Filed herewith.
 
 
 
31(b)
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
 
Filed herewith.
 
 
32(a)
 
Section 1350 Certification of Chief Executive Officer
 
Filed herewith.
 
 
 
32(b)
 
Section 1350 Certification of Chief Financial Officer
 
Filed herewith.
 
 
 
99
 
Safe Harbor under the Private Securities Litigation Reform Act 1995 and Canadian securities laws
 
Filed herewith.
 
 
 
101.INS
 
XBRL Instance Document.
 
Filed herewith.
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document.
 
Filed herewith.
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
Filed herewith.
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
Filed herewith.
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
 
Filed herewith.
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
 
Filed herewith.
Attached as Exhibit 101 to this report are documents formatted in XBRL (Extensible Business Reporting Language). The financial information contained in the XBRL-related documents is “unaudited” and/or “unreviewed.”

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