The Wendy’s Company 2015 Q2 Form 10-Q Summary
Business context and reporting period
The Wendy’s Company operates and franchises quick-service restaurants primarily in North America, its single reportable segment. The filing covers the three and six months ended June 28, 2015, compared with June 29, 2014. Each period contains 13 weeks or 26 weeks. Fiscal 2015 will contain 53 weeks, with a 14-week fourth quarter.
At June 28, 2015, the system comprised 6,477 restaurants, including 860 company-owned and 5,617 franchised restaurants. The company completed the sale of all company-owned Canadian restaurants during the quarter.
Financial performance and key metrics
| Metric | Q2 2015 | Q2 2014 | Change |
|---|---|---|---|
| Revenue | $489.5 million | $506.1 million | Down $16.6 million |
| Operating profit | $64.3 million | $61.2 million | Up $3.1 million |
| Operating margin | 13.1% | 12.1% | Up approximately 100 bps |
| Income from continuing operations | $24.8 million | $27.3 million | Down $2.5 million |
| Net income | $40.2 million | $29.0 million | Up $11.2 million |
| Diluted EPS | $0.11 | $0.08 | Up $0.03 |
| Same-restaurant sales, systemwide | 2.1% | 3.0% | Down 0.9 percentage points |
| Company-owned restaurant margin | 18.2% | 17.8% | Up 40 bps |
| Metric | Six months 2015 | Six months 2014 | Change |
|---|---|---|---|
| Revenue | $941.3 million | $1,014.5 million | Down $73.2 million |
| Operating profit | $102.2 million | $148.4 million | Down $46.2 million |
| Operating margin | 10.9% | 14.6% | Down approximately 370 bps |
| Income from continuing operations | $43.0 million | $72.3 million | Down $29.3 million |
| Net income | $67.7 million | $75.3 million | Down $7.6 million |
| Diluted EPS | $0.18 | $0.20 | Down $0.02 |
| Same-restaurant sales, systemwide | 2.6% | 1.8% | Up 0.8 percentage points |
| Company-owned restaurant margin | 16.5% | 15.4% | Up 110 bps |
Q2 sales declined primarily because restaurant dispositions reduced company-owned restaurant sales by approximately $37.2 million; the quarter also included a $3.5 million unfavorable foreign-exchange impact from Canada. Franchise revenue increased $6.1 million, driven mainly by higher rental income and franchise fees. Six-month sales were reduced by approximately $109.6 million from restaurant dispositions and $7.4 million from Canadian currency movements.
Cost of sales declined to 81.8% of sales in Q2 from 82.2% and to 83.5% from 84.6% for the six-month period. General and administrative expense decreased $5.6 million in Q2 and $15.5 million year to date, reflecting lower compensation and share-based compensation, realignment savings, and increased capitalization of internal labor.
Cash flow, balance sheet, debt and liquidity
- Cash provided by operating activities was $53.1 million for the first six months, down from $81.0 million in the prior-year period.
- Capital expenditures were $130.5 million, primarily related to the Image Activation program, compared with $114.5 million in the prior-year period.
- Net cash used in investing activities was $15.3 million, including $78.4 million of proceeds from the Bakery sale.
- Net cash provided by financing activities was $896.2 million, reflecting $2.275 billion of new debt, $1.302 billion of debt repayments, $63.2 million of share repurchases and $40.2 million of dividends.
- Cash and cash equivalents were $1.198 billion at June 28, 2015, compared with $267.1 million at December 28, 2014. Restricted cash of $27.2 million was held primarily for interest and other financing-related reserves.
- Total debt was approximately $2.397 billion before current maturities, including $2.275 billion of Series 2015-1 senior secured notes and $78.5 million of capital lease obligations.
- The June 1 securitized financing replaced the Term A and Term B loans. Fixed-rate notes carry stated rates of 3.371%, 4.080% and 4.497%; the revolving Class A-1 facility permits borrowings of up to $150 million. Letters of credit outstanding under the facility totaled $22 million.
- The company expects approximately $667 million of interest payments on long-term debt outstanding at June 28, 2015, excluding capital leases.
Material changes versus the prior comparable period
- Revenue declined because of the continuing shift from company-owned restaurants to franchised restaurants, although franchise revenue grew.
- Q2 operating profit improved despite lower revenue, but six-month operating profit fell substantially because the prior-year period included $74.4 million of system optimization gains versus $14.9 million in 2015.
- Impairment charges increased to $10.0 million in Q2 and $12.0 million year to date, principally from properties being leased or subleased to franchisees and weaker performance at certain company-owned restaurants.
- Interest expense increased $4.1 million in Q2 and $3.9 million year to date following the higher debt levels and rates associated with the securitized financing.
- The company recorded a $7.3 million loss on early extinguishment of debt, primarily from writing off deferred financing costs and terminating interest-rate swaps.
- The Bakery was sold on May 31, 2015 for $78.5 million of cash. The company recorded a $27.3 million pretax gain and $15.1 million after-tax gain in discontinued operations.
- The company adopted new debt-issuance-cost presentation guidance retrospectively, reclassifying $8.2 million from other assets to long-term debt without affecting earnings or cash flow.
Guidance, outlook, commentary and risks
- Management expects approximately $114.5 million of capital expenditures during the remainder of 2015, or approximately $245 million for the full year.
- Management expects additional G&A realignment costs of approximately $4.5 million during the remainder of 2015.
- Additional system optimization costs of approximately $11 million are expected during the remainder of 2015 and 2016, primarily accelerated amortization and professional fees.
- The company expects interest expense to increase more significantly in 2015 because of the securitized financing facility.
- Management states that operating cash flow and available cash are expected to provide sufficient liquidity for operating requirements over the next 12 months, based on current operating levels.
- The company plans to reduce company-owned restaurants to approximately 5% of the system by mid-2016 and expects to sell approximately 540 additional restaurants to franchisees.
- Major risks include competition and pricing pressure, commodity and labor inflation, consumer demand, food safety, franchisee financial condition, execution of restaurant remodeling and dispositions, legal and regulatory matters, cybersecurity, and compliance with the securitized financing covenants.
- The securitized financing contains collateral, covenant, rapid-amortization and event-of-default provisions. A rapid-amortization event could reduce or eliminate funds available to the company.
- Legal and environmental matters had accrued liabilities of $2.7 million. The company could not estimate an aggregate possible loss range but did not believe the matters would materially affect consolidated results based on available information and insurance coverage.
Important facts for investors to verify
- Whether the planned restaurant dispositions and reduction to approximately 5% company ownership improve franchise revenue and cash generation without creating additional impairment or lease liabilities.
- The effect of the new securitized debt structure on recurring interest expense, required reserves, debt-service coverage and refinancing needs at the anticipated repayment dates.
- Whether same-restaurant sales trends can recover from the Q2 slowdown while commodity, labor and competitive pressures remain elevated.
- The sustainability of reported earnings after excluding the $15.1 million after-tax Bakery disposal gain and other system optimization gains.
- The cash impact of the $850 million share repurchase program completed after quarter-end and the remaining $1.4 billion repurchase authorization.
- Progress toward the stated 2015 capital spending, G&A savings and system optimization objectives, including the expected additional charges.
- Potential exposure from franchisee loan and lease guarantees, legal matters, contractual purchasing commitments and securitization-related restrictions.