Wendy's Co quarterly report, Q3 FY2010

Wendy’s/Arby’s Group, Inc. — Fiscal 2010 Third-Quarter Form 10-Q

Reporting period: Quarter and nine months ended October 3, 2010, compared with September 27, 2009. Each period contained 13 weeks and 39 weeks, respectively. The company operated and franchised Wendy’s and Arby’s restaurants, with 10,216 systemwide restaurants at quarter-end, including 2,537 company-owned locations.

Financial overview

Metric	Q3 2010	Q3 2009	First 9 months 2010	First 9 months 2009
Total revenues	$861.2 million	$903.2 million	$2,575.7 million	$2,679.9 million
Operating profit	$20.3 million	$56.8 million	$119.3 million	$127.3 million
Income from continuing operations	$(0.9) million	$14.3 million	$6.4 million	$18.2 million
Net income	$(0.9) million	$14.7 million	$6.4 million	$18.7 million
Basic and diluted EPS	$0.00	$0.03	$0.01	$0.04
Operating margin	2.4%	6.3%	4.6%	4.7%

Revenue declined 4.7% in the quarter and 3.9% year to date. Sales decreased 5.0% in the quarter and 4.1% year to date, while franchise revenue decreased 2.0% in both comparisons. Q3 restaurant margin declined to 12.4% from 15.0%; first-nine-month restaurant margin declined to 13.9% from 14.3%.

Wendy’s: Q3 total revenue was $600.7 million and segment operating profit was $32.9 million, versus $69.9 million in the prior-year quarter. Company-owned same-store sales declined 3.1%; systemwide same-store sales declined 1.7%.
Arby’s: Q3 total revenue was $260.5 million and segment operating loss was $7.3 million, compared with a $8.9 million loss in the prior-year quarter. Company-owned same-store sales declined 9.5%; systemwide same-store sales declined 5.9%.
Q3 cost of sales was 87.1% of sales, up from 84.9%, primarily reflecting commodity cost increases and deleveraging of fixed costs on lower sales.
Q3 impairment charges were $27.4 million, including $20.9 million for Wendy’s and $6.5 million for Arby’s. Nine-month impairment charges were $41.4 million, up from $31.1 million.

Cash flow, liquidity and debt

Cash provided by operating activities was $167.4 million for the first nine months, down from $251.3 million. The decrease primarily reflected higher interest payments, incentive compensation payments, QSCC start-up funding and income-tax payments.
Cash capital expenditures were $94.7 million, including $30.7 million for restaurant remodeling, $6.1 million for new restaurants and $8.0 million for software. Management expected approximately $50.3 million of additional capital expenditures during the remainder of 2010, or approximately $145 million for the year.
Cash and cash equivalents were $520.5 million at October 3, 2010, compared with $591.7 million at January 3, 2010. Net cash decreased $71.2 million during the first nine months.
Total debt, including the current portion, was $1.58 billion at quarter-end, compared with $1.52 billion at year-end 2009. Long-term debt, excluding the current portion, was $1.56 billion.
In May 2010, the company entered into a $650 million credit agreement consisting of a $500 million senior secured term loan and a $150 million revolving facility. The term loan had a 5.0% interest rate at quarter-end and matures in 2017; the revolving facility expires no later than 2015.
Term-loan proceeds funded repayment of approximately $253.8 million of prior debt, redemption of $200 million of Wendy’s 6.25% senior notes and related fees. The refinancing generated a $26.2 million loss on early extinguishment of debt.
The company reported compliance with the credit-agreement and Wendy’s debt covenants as of October 3, 2010. It was not compliant with certain reporting requirements under some Arby’s leases, although no lessor had declared a default and management did not expect a material adverse effect.
The company repurchased $173.5 million of common stock during the first nine months and had repurchased 52.3 million shares for an aggregate $245.5 million as of October 3, 2010, excluding commissions.

Material changes and unusual items

The company received $30.8 million from repayment of the DFR Notes and recognized $4.9 million of related investment income.
The remaining 5% convertible notes were repurchased for $2.1 million, including accrued interest.
Wendy’s impairment charges increased substantially because of underperforming restaurant locations, while Arby’s impairment charges decreased from the prior year.
General and administrative expense declined $14.6 million year to date, primarily from lower staffing, integration, incentive compensation, legal and services-agreement costs, partly offset by SSG costs, severance and higher doubtful-account provisions.
The company’s interim goodwill impairment assessment, prompted by a sustained decline in market value, concluded that reporting-unit fair values exceeded carrying values; no goodwill impairment was recorded.
A subsequent collective bargaining agreement is expected to eliminate a recorded $5.0 million bakery pension withdrawal liability in the fourth quarter of 2010 but add approximately $0.9 million of fourth-quarter expense.

Outlook, risks and contingencies

Management stated that there were no material changes to its 2010 outlook, except that restaurant margins were expected to be negatively affected by continuing commodity-cost increases. Management expected the decline in Arby’s average customer check to be partly offset by higher customer transactions in the fourth quarter and expected continued positive operating cash flow.

Approximately 500 Arby’s franchised restaurants had royalties, rent or other fees at least 60 days past due. Franchisee financial difficulties, closures and declining sales could reduce royalty revenue, increase doubtful accounts and require the company to support or reacquire restaurants.
Arby’s franchised restaurants declined by 33 during the first nine months, including 75 closures. Franchisee financial weakness also reduced advertising contributions.
Key operating risks include weak consumer demand, high unemployment, intense price competition, food and labor inflation, commodity volatility, adverse weather, food-safety events, franchisee defaults, lease obligations, legal matters and potential asset impairments.
Legal and environmental reserves totaled $4.5 million. Management did not expect pending matters to have a material adverse effect, although outcomes could not be predicted with certainty.
The company expected cash from operations and available cash to satisfy operating requirements for the next 12 months. Planned uses included dividends of approximately $8.4 million in the fourth quarter, $4.4 million of scheduled debt principal payments, $2.9 million under QSCC and SSG agreements, additional capital expenditures and potentially up to $250 million of stock repurchases.

Important facts for investors to verify

Whether Wendy’s and Arby’s same-store sales and restaurant margins recover from the negative Q3 trends.
The collectability of Arby’s franchisee receivables and the financial condition of delinquent franchisees.
Compliance with all debt covenants and unresolved reporting requirements under Arby’s leases.
The effect of commodity, labor and occupancy costs on future restaurant margins.
Future impairment charges, particularly for underperforming Wendy’s and Arby’s locations, and the sensitivity of goodwill valuations.
Whether operating cash flow remains sufficient to fund capital expenditures, dividends, debt service and authorized share repurchases.