Business Context and Reporting Period
The Wendy’s Company filed an unaudited Form 10-Q for the 13 weeks ended March 31, 2019, compared with the 13 weeks ended April 1, 2018. Wendy’s operates and franchises quick-service restaurants, primarily in North America, and reports one operating segment. The system included 6,710 restaurants at quarter-end, including 358 company-operated and 6,352 franchised restaurants.
Financial Performance and Position
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $408.6 million | $380.6 million | +$28.0 million |
| Operating profit | $66.3 million | $55.3 million | +$11.0 million |
| Income before taxes | $39.9 million | $14.4 million | +$25.5 million |
| Net income | $31.9 million | $20.2 million | +$11.7 million |
| Diluted earnings per share | $0.14 | $0.08 | +$0.06 |
| Cash flow from operations | $62.0 million | $68.7 million | -$6.7 million |
- Revenue increased 7.4%, led by higher company-operated sales, franchise royalty revenue and fees, and franchise rental income. Advertising funds revenue increased to $80.5 million, with an equal amount recorded as advertising funds expense.
- Operating margin was approximately 16.2%, compared with 14.5% in the prior-year quarter. Net margin was approximately 7.8%, compared with 5.3%.
- Restaurant margin increased to $25.1 million, or 15.0% of company-operated sales, from $21.5 million, or 13.9%. Lower food and paper costs and occupancy, advertising and other operating costs as a percentage of sales offset higher labor rates.
- North America systemwide same-restaurant sales increased 1.3%; company-operated same-restaurant sales increased 2.1% and franchised same-restaurant sales increased 1.3%.
- Global systemwide sales increased to $2.591 billion from $2.532 billion, or 3.3% on a constant-currency basis.
- Cash, cash equivalents and restricted cash totaled $472.0 million at March 31, 2019, including $414.2 million of cash and cash equivalents. Total assets were $5.186 billion and stockholders’ equity was $640.7 million.
- Long-term debt was $2.302 billion, excluding current maturities. Finance lease liabilities totaled $468.0 million, and newly recognized operating lease liabilities totaled $1.001 billion.
- Capital expenditures were $11.2 million, acquisitions totaled $5.1 million, dividends paid were $23.1 million, and share repurchases totaled $30.9 million in cash flow terms.
Material Changes Versus the Prior Comparable Period
- Net income benefited from the absence of the $11.5 million loss on early extinguishment of debt recorded in Q1 2018, as well as higher operating profit and other income. This benefit was partly offset by an $8.0 million tax provision versus a $5.8 million tax benefit in the prior year.
- The effective tax rate was 20.0%, compared with negative 40.5% in Q1 2018. The prior-year rate reflected discrete benefits related to share-based compensation and the Tax Cuts and Jobs Act.
- General and administrative expense declined to $49.3 million from $50.4 million, primarily due to lower employee compensation under the G&A realignment plan.
- Franchise rental income and franchise rental expense increased by $8.3 million and $9.1 million, respectively, primarily because of the gross presentation of certain executory-cost reimbursements under the new lease accounting standard.
- The company adopted the new lease standard in Q1 2019. Operating lease assets of $919.3 million and operating lease liabilities of $1.001 billion were recognized at March 31, 2019. Prior-period results were not restated.
- Operating cash flow declined 9.7%, primarily due to the timing of royalty receivable collections and national advertising fund payments. Financing cash outflows increased to $62.6 million from $25.7 million, principally because Q1 2018 included significant net debt proceeds from refinancing.
- The company acquired five restaurants from franchisees for $5.1 million and ended the quarter with five more company-operated restaurants than at December 30, 2018.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expects 2019 capital expenditures of approximately $75 million to $80 million, including $64 million to $69 million for the remainder of the year.
- Management expects available cash and operating cash flow to provide sufficient liquidity for operating requirements over the next 12 months.
- The company expects up to approximately $69.2 million of additional 2019 cash dividends, assuming quarterly dividends remain at $0.10 per share. A $225 million share repurchase authorization remained, with $217.1 million available at March 31, 2019; an additional $5.7 million was repurchased through May 1, 2019.
- The G&A realignment plan had incurred approximately $31.2 million through quarter-end, with approximately $3.5 million of additional costs expected. Leadership changes announced in May 2019 are expected to add approximately $2.5 million, bringing estimated total costs to $34.5 million to $37.5 million.
- Management is evaluating its management and operating structure and expects a change to the existing operating segment structure by the end of 2019.
- Key risks include competition and pricing pressure, consumer preferences, food safety, labor and commodity inflation, franchisee financial condition, restaurant development and reimaging execution, technology and cybersecurity, debt covenant and refinancing risk, legal proceedings, and leadership changes.
- Wendy’s guaranteed certain leases and other obligations totaling $69.8 million at March 31, 2019, with leases extending through 2056. Outstanding letters of credit totaled $27.1 million.
- The company states that it has adequate accruals for legal and environmental matters but cannot estimate the aggregate possible loss; future developments could materially affect a reporting period.
- Recorded unusual items included $1.5 million of long-lived asset impairment charges, $0.8 million of reorganization and realignment costs, and $4.0 million of other operating income, including gains on sales-type leases.
Most Important Facts to Verify
- Whether same-restaurant sales and systemwide sales trends support continued royalty and franchise growth, particularly given the decline in systemwide same-restaurant sales growth from 1.6% to 1.3%.
- The effect of lease accounting adoption on revenue, rental expense, operating assets, liabilities, leverage and comparability with prior periods.
- Debt service capacity, securitized financing covenants, and the relationship between $2.3 billion of debt and $62.0 million of quarterly operating cash flow.
- Whether planned capital spending, dividends and share repurchases can be funded while maintaining adequate liquidity.
- The actual timing and cost of the G&A realignment and leadership restructuring programs.
- Commodity, labor and competitive pricing pressures, including whether strategic price increases can offset cost inflation without reducing customer counts.
- Potential exposure from lease guarantees, letters of credit, litigation and the disclosed Financial Institutions case settlement risk.