Business Context and Reporting Period
The Wendy’s Company, formerly Wendy’s/Arby’s Group, filed a combined Form 10-Q with Wendy’s Restaurants, LLC for the 13-week quarter and 39 weeks ended October 2, 2011, compared with October 3, 2010. The business now principally consists of operating and franchising Wendy’s restaurants and related bakery operations. Arby’s was sold on July 4, 2011 and is reported as discontinued operations.
At October 2, 2011, the Wendy’s system included 6,578 restaurants, comprising 1,404 company-owned and 5,174 franchised locations. The company had 389.1 million common shares outstanding as of November 3, 2011.
Financial Results and Key Metrics
| Metric | Q3 2011 | Q3 2010 | Change |
|---|---|---|---|
| Revenue | $611.4 million | $600.7 million | 1.8% |
| Operating profit | $32.4 million | $20.3 million | 59.6% |
| Income from continuing operations | $2.5 million | $(0.8) million | Improved |
| Net income (loss) | $(4.0) million | $(0.9) million | Declined |
| Basic and diluted EPS | $(0.01) | $0.00 | Declined |
| Restaurant margin | 13.7% | 13.4% | 0.3 percentage points |
| Metric | 9M 2011 | 9M 2010 | Change |
|---|---|---|---|
| Revenue | $1,816.3 million | $1,792.9 million | 1.3% |
| Operating profit | $107.8 million | $116.9 million | (7.8%) |
| Income from continuing operations | $13.6 million | $12.0 million | 13.3% |
| Net income | $5.9 million | $6.4 million | (7.8%) |
| Restaurant margin | 13.7% | 15.1% | (1.4) percentage points |
| Operating cash flow | $182.1 million | $167.5 million | 8.7% |
Q3 North America same-store sales increased 0.9% systemwide, including 1.8% at company-owned restaurants and 0.7% at franchised restaurants. For the first nine months, systemwide same-store sales increased 1.1%.
Cash and cash equivalents totaled $488.8 million at October 2, 2011, compared with $512.5 million at January 2, 2011. Total debt, including current maturities, was approximately $1.36 billion based on the financial-instrument disclosure. Long-term debt on the consolidated balance sheet was $1.35 billion, excluding current maturities.
Capital expenditures were $91.9 million during the first nine months, including $15.7 million for restaurant remodeling and $12.4 million for new restaurant construction. The company paid $24.6 million of dividends and repurchased $152.7 million of common stock during the period.
Material Changes Versus the Prior Comparable Period
- Revenue increased modestly, supported by higher customer transactions, strategic pricing, restaurant additions and favorable Canadian currency effects.
- Q3 operating profit improved despite higher commodity costs, primarily because of lower general and administrative expense and the absence of the $20.9 million Q3 2010 impairment charge.
- For the nine-month period, operating profit and restaurant margin declined because food and paper costs increased, largely due to higher commodity costs, and advertising costs increased in connection with breakfast testing.
- General and administrative expense declined by $15.3 million for the nine-month period, reflecting lower SSG-related costs, completed integration activities, reimbursement of transition-service costs and changes in franchise incentives.
- Transaction-related costs were $23.8 million in Q3 and $30.8 million for the nine months, primarily related to the Arby’s sale, executive termination and severance, employee retention, bonuses and professional fees.
- Interest expense declined by $3.8 million for the nine-month period. The prior-year period included a $26.2 million loss on early extinguishment of debt.
- Cash flow from operations increased, while total cash declined because of share repurchases, dividends, debt repayments and capital expenditures, partially offset by $103.2 million of net proceeds from the Arby’s sale.
Outlook, Commentary, Risks and Unusual Items
Management expects commodity costs to remain higher during the remainder of 2011. Strategic price increases and incremental sales from new products are expected to offset part of the pressure. Management identified long-term opportunities in customer experience, menu improvements, daypart expansion, remodeling, domestic development and international brand growth.
The company expected approximately $53 million of additional capital expenditures during the remainder of 2011, implying approximately $145 million for the full year. It also expected $6.5 million of additional Arby’s transaction closing costs, quarterly dividends of approximately $7.8 million for the fourth quarter, and potential share repurchases under the remaining authorization. Management stated that operating cash flow and available cash should provide sufficient liquidity for the next 12 months based on current operations.
Arby’s was sold for $130.0 million of cash, subject to customary adjustments, plus an 18.5% retained interest valued at $19.0 million; the buyer assumed approximately $190.0 million of Arby’s debt. The transaction generated a $5.3 million pretax disposal loss for the nine months and an $8.8 million after-tax loss from disposal. The company also recorded $2.1 million of Arby’s tax liabilities under indemnification provisions and warned that additional tax-related accruals may arise.
Other material matters include a breakfast equipment program with up to $20.0 million of franchisee loans, approximately $1.3 million funded as of quarter-end, and estimated foregone royalties of approximately $5.0 million over three years. The company had $1.7 million of legal and environmental reserves and stated that the aggregate possible loss could not be estimated, although it did not expect a material effect based on available information and insurance coverage.
Principal risks include commodity, labor and operating-cost inflation; competition and pricing pressure; economic conditions and consumer spending; food safety and changing consumer preferences; franchisee financial health and development; supply-chain disruptions; interest-rate and capital availability; legal and regulatory matters; impairment charges; and tax liabilities associated with the Arby’s sale.
Investor Verification Checklist
- Verify the continuing-business impact of the Arby’s disposal, including retained ownership, indemnification obligations, transition services and potential additional tax liabilities.
- Assess whether higher commodity costs continue to pressure restaurant margin after the Q3 improvement.
- Reconcile reported debt, required amortization, interest-rate swaps and approximately $3.33 billion of contractual obligations, including interest and leases.
- Review the sustainability of cash returns, including $152.7 million of year-to-date repurchases, quarterly dividends and remaining buyback authorization.
- Monitor the breakfast test, core-menu equipment incentives, franchisee loans and their effect on future royalties and cash requirements.
- Evaluate same-store sales trends, new-unit development, remodeling spending and the mix between company-owned and franchised restaurants.
- Review the executive transition and the $30.8 million of year-to-date transaction-related costs for any remaining charges.