The Wendy’s Company: Fiscal 2017 Third-Quarter Form 10-Q
Business context and reporting period
The filing covers the 13-week third quarter and 39 weeks ended October 1, 2017, compared with the periods ended October 2, 2016. Wendy’s operates and franchises quick-service restaurants primarily in North America and reports one operating segment. The system included 6,586 restaurants, of which 333 were company-operated and 6,253 were franchised.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenue | $308.0 million | $364.0 million | $914.2 million | $1,125.5 million |
| Operating profit | $61.7 million | $106.1 million | $148.2 million | $235.6 million |
| Net income | $14.3 million | $48.9 million | $34.8 million | $100.7 million |
| Diluted EPS | $0.06 | $0.18 | $0.14 | $0.37 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $176.7 million | $137.3 million |
| Capital expenditures | Not provided quarterly | Not provided quarterly | $53.7 million | $108.7 million |
- Q3 operating margin was approximately 20.0%, versus 29.1% in the prior-year quarter; nine-month operating margin was approximately 16.2%, versus 20.9%.
- Q3 net margin was approximately 4.6%, versus 13.4%; nine-month net margin was approximately 3.8%, versus 8.9%.
- Restaurant margin declined to 16.7% of company-operated sales in Q3 from 18.4%, and to 17.7% for the first nine months from 19.2%.
- Cash and cash equivalents were $186.6 million at October 1, 2017, compared with $198.2 million at January 1, 2017. Restricted cash was $34.0 million.
- Total debt, including current and long-term portions, was approximately $2.73 billion, compared with $2.51 billion at January 1, 2017. Interest expense was $30.0 million in Q3 and $87.9 million for the first nine months.
- Cash used in financing activities was $156.9 million, including $90.1 million of share repurchases and $51.5 million of dividends, during the first nine months.
Material changes versus the prior comparable period
- Revenue declined $56.0 million, or approximately 15%, in Q3 and $211.3 million, or approximately 19%, for the first nine months. The primary driver was the franchising of company-operated restaurants, which reduced company-operated sales by $74.1 million in Q3 and $295.9 million year to date.
- Franchise royalty revenue and fees increased $0.9 million in Q3 and $30.2 million year to date, while franchise rental income increased $12.9 million and $37.8 million, respectively, reflecting the shift toward franchising and related property leasing.
- Global systemwide sales increased 3.4% on a constant-currency basis in Q3 and 3.7% for the first nine months. Systemwide same-restaurant sales increased 1.9% in Q3 and 2.3% year to date; company-operated same-restaurant sales declined 0.5% in Q3 but increased 0.7% year to date.
- Profitability was pressured by higher commodity costs, including beef, bacon and chicken, higher restaurant labor rates, and unusual charges. Cost of sales rose to 83.3% of company-operated sales in Q3 from 81.6%.
- System optimization losses were $39.7 million for the first nine months, compared with a $48.1 million gain in the prior-year period. The 2017 result included a $43.1 million loss from the DavCo and NPC transactions.
- The company incurred $20.8 million of reorganization and realignment costs year to date, including $19.9 million under its May 2017 general and administrative realignment plan, compared with $7.9 million in the prior-year period.
- Operating cash flow increased $39.4 million year over year, while investing cash flow changed from $62.5 million provided in 2016 to $38.1 million used in 2017, primarily because of lower restaurant disposition proceeds and the DavCo/NPC transactions.
Guidance, outlook, commentary and risks
- Management expects 2017 cash capital expenditures of approximately $80 million to $85 million, including $26 million to $31 million during the remainder of the year.
- The May 2017 G&A realignment plan is expected to generate approximately $35 million of total expense reductions, with about three-quarters expected by the end of 2018 and the remainder in 2019. Total related costs are estimated at $28 million to $33 million, with approximately $8 million to $13 million of additional costs expected after October 1, 2017, extending into 2019.
- Management expects available cash and operating cash flow to provide sufficient liquidity for operating requirements over the next 12 months, based on current operating levels.
- The company intends to continue quarterly dividends, subject to future board declarations. A $0.07-per-share dividend was declared for payment in December 2017.
- The company had $59.1 million remaining under its $150 million share-repurchase authorization at October 1, 2017 and repurchased an additional $6.6 million of shares through November 2, 2017.
- Key risks include commodity and labor inflation, intense restaurant competition, franchisee financial condition, execution of Image Activation remodels and new-unit development, interest rates and debt covenants, cybersecurity incidents, food safety, adverse weather, legal proceedings, and the effects of restaurant franchising on sales, margins, cash flow and depreciation.
- The company is defending putative class-action litigation related to the 2016 payment-card malware incident. A motion to dismiss the Torres case was filed October 27, 2017 and remained pending. The filing states that the potential aggregate loss cannot presently be estimated.
- Future accounting changes are expected to be material to presentation: revenue recognition adoption in 2018 is expected to change treatment of initial franchise fees and national advertising funds, while lease accounting adoption in 2019 is expected to add substantial operating lease assets and liabilities.
Most important facts to verify
- Whether systemwide sales and same-restaurant sales remain positive as the company-operated base remains near 5% of the system.
- Progress toward the stated G&A savings and the remaining $8 million to $13 million of realignment costs.
- Debt maturities, securitized financing covenants, interest-rate exposure and liquidity relative to ongoing dividends and repurchases.
- Execution of NPC’s commitments to remodel 90 restaurants by 2021 and build 15 new restaurants by 2022.
- The final financial impact of the DavCo/NPC transaction, including provisional purchase-accounting valuations and retained lease obligations.
- Developments in the payment-card litigation and any additional cybersecurity-related costs or claims.
- The effects of commodity and labor inflation on restaurant margin and the company’s ability to offset those costs through pricing.