Wingstop Inc. — Q2 2017 Form 10-Q
Business context and reporting period. The filing covers the 13 and 26 weeks ended July 1, 2017, compared with periods ended June 25, 2016. Wingstop operates a predominantly franchised restaurant system: 1,035 franchised locations and 21 company-operated locations across 42 states and seven countries at quarter-end. The fiscal year ends on the last Saturday of the calendar year.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $24.7m | $22.7m | $51.2m | $44.8m |
| Operating income | $8.7m | $7.2m | $17.7m | $14.9m |
| Net income | $5.3m | $4.1m | $11.8m | $8.4m |
| Diluted EPS | $0.18 | $0.14 | $0.40 | $0.29 |
| Adjusted EBITDA | $9.8m | $8.3m | $19.8m | $17.2m |
Q2 revenue increased 8.6%; operating income rose 20.8% and net income rose 29.1%. First-half revenue increased 14.4%; operating income rose 19.0% and net income rose 40.9%. Approximate operating margin was 35.5% in Q2 versus 31.9% a year earlier; first-half margin was 34.6% versus 33.2%. First-half net margin was approximately 23.0% versus 18.7%.
Revenue and restaurant trends. Q2 royalty revenue and franchise fees grew 10.6% to $15.8m, driven mainly by restaurant growth and 2.0% domestic system-wide same-store sales growth. Company restaurant sales rose 5.1% to $8.8m, while company same-store sales grew 0.8%. For the first half, system-wide same-store sales growth was 0.5%, but company-operated same-store sales declined 2.1%; management attributed the company-store decline in part to cannibalization from nearby openings. Domestic restaurant AUV was $1.095m, down from $1.123m. System-wide sales were $268.5m in Q2 and $528.4m in the first half.
Costs and margins. Company restaurant cost of sales increased to 77.6% of company restaurant sales in Q2 from 73.5%; first-half cost of sales was 77.4% versus 72.1%. Management cited a 10.9% increase in bone-in wing commodity rates and higher wage and staffing costs. Franchise segment profit increased 23.2% in Q2 and 23.4% in the first half; company segment profit declined 15.1% and 27.5%, respectively.
Cash flow and liquidity. First-half operating cash flow was $10.7m, versus $10.0m; capital expenditures were $1.3m, versus $1.0m. Cash after capital expenditures was approximately $9.4m. Financing used $8.7m, including $9.8m of debt repayments; cash increased $0.7m to $4.4m. At July 1, current assets were $14.2m and current liabilities $15.9m.
Debt and capital. The credit facility had $141.5m outstanding: $66.5m term debt and $75.0m revolver borrowings, at a reported 3.55% interest rate. The revolving facility permits up to $110m of borrowings, subject to its terms. The facility is secured by substantially all company assets; Wingstop reported compliance with covenants. Scheduled principal payments total $141.5m, with $130.1m due in fiscal 2021. Stockholders’ deficit was $61.2m. Management stated that available liquidity sources should be sufficient for operations and its growth strategy.
Material changes and notable items
- Franchised restaurants increased to 1,035 from 894 a year earlier; total system restaurants increased to 1,056 from 914.
- First-half franchise revenue included a one-time vendor-agreement payment based on prior-year system volumes, primarily intended to support national advertising. The company also made $3.8m of discretionary advertising fund contributions in the first half, compared with $1.1m a year earlier.
- First-half effective tax rate fell to 21.8% from 37.4%, including $2.4m of tax benefits from excess share-based compensation tax benefits under a newly adopted accounting standard. These benefits boosted reported earnings and are not necessarily recurring.
- Interest expense rose 84.9% in Q2 and 77.5% in the first half, primarily reflecting higher debt and the rate following the 2016 refinancing.
- After quarter-end, the company acquired two franchised restaurants for approximately $3.9m, funded with operating cash and revolver proceeds. It also declared a $0.07-per-share quarterly dividend, totaling approximately $2.0m.
Outlook, risks and contingencies
The filing provides no specific revenue, earnings, unit-opening or same-store-sales guidance. Management expressed confidence that liquidity would support operations and growth, but cautioned that forward-looking expectations are subject to risks. Key exposures include volatile chicken-wing costs, labor and wage inflation, interest-rate changes on variable-rate debt, same-store sales and new-store cannibalization, franchisee execution, food safety, competition, and compliance with debt covenants. A 10% increase in bone-in wing costs would have added approximately $0.4m to first-half cost of sales; a one-percentage-point interest-rate change would affect annual interest expense by approximately $1.4m. Ordinary-course legal claims are generally insured; management did not expect them to have a material adverse effect.
Wingstop expected to become a large accelerated filer and cease qualifying as an emerging growth company at fiscal year-end 2017, bringing additional reporting and internal-control requirements and costs. The company expects to adopt the new revenue-recognition standard in fiscal 2018; it anticipates changed timing for certain franchise and renewal fees but had not yet selected a transition method or completed its impact assessment. Lease accounting changes were also under evaluation.
Important facts for investors to verify
- Whether system-wide and company-operated same-store sales trends improve, and whether new openings continue to affect nearby stores.
- Whether elevated wing commodity and labor costs persist and how they affect company-store profitability.
- How recurring franchise economics compare with reported growth that included a one-time vendor payment and tax benefits.
- Debt-service capacity, variable-rate exposure, covenant headroom, and the effect of the post-quarter restaurant acquisition and dividend on liquidity.
- The eventual effects of revenue-recognition adoption and the added public-company control and reporting requirements.