Business Context and Reporting Period
The Wendy’s Company filed an unaudited Form 10-Q for the 13-week quarter and 26-week year-to-date period ended July 1, 2012, compared with July 3, 2011. The company operates and franchises Wendy’s restaurants, primarily in North America, which represents substantially all current operations and one reportable segment. The system had 6,547 restaurants, including 1,425 company-owned and 5,122 franchised locations.
Arby’s was sold on July 4, 2011; its prior-period results are presented as discontinued operations. Wendy’s Restaurants, LLC ceased separate SEC reporting after the company redeemed its remaining Senior Notes on July 16, 2012.
Financial Performance and Position
| Metric | Three months ended July 1, 2012 | Three months ended July 3, 2011 | Six months ended July 1, 2012 | Six months ended July 3, 2011 |
|---|---|---|---|---|
| Total revenue | $645.9 million | $622.5 million | $1,239.1 million | $1,204.9 million |
| Operating profit | $38.4 million | $47.4 million | $59.3 million | $75.5 million |
| Operating margin | 5.9% | 7.6% | 4.8% | 6.3% |
| Net income attributable to The Wendy’s Company | $(5.5) million | $11.3 million | $6.9 million | $9.9 million |
| Diluted earnings per share | $(0.01) | $0.03 | $0.02 | $0.02 |
| Cash flow from operating activities | Not separately provided | Not separately provided | $68.5 million | $132.6 million |
Second-quarter sales increased 4.0%, while franchise revenues increased 2.0%. North America systemwide same-store sales increased 3.2% under the new methodology, compared with 2.3% in the prior-year quarter. Wendy’s restaurant margin improved to 14.1% from 13.9% in the quarter, but declined to 13.0% from 13.7% for the first half because of commodity and other operating cost pressure.
- Cash and cash equivalents were $435.1 million at July 1, 2012, down from $475.2 million at January 1, 2012.
- Total debt, including current maturities, was $1.394 billion, compared with $1.357 billion at January 1, 2012.
- The company had $1.125 billion of senior secured term-loan capacity and a $200 million revolving facility; no revolver borrowings were outstanding, although $19.0 million of letters of credit had been issued.
- The term loan carried a 4.75% interest rate at July 1, 2012, was due in 2019, and required 1% annual amortization beginning in the fourth quarter.
- Cash used in investing activities was $82.1 million, including $84.1 million of capital expenditures and $21.8 million for restaurant acquisitions.
- The company paid $15.6 million of dividends during the first half, equal to $0.04 per share.
Material Changes Versus the Prior Comparable Period
- Revenue increased $23.4 million, or 3.8%, in the second quarter and $34.2 million, or 2.8%, in the first half. Growth primarily reflected strategic menu-price increases, higher average customer checks, same-store sales gains and incremental sales from restaurants opened or acquired.
- Operating profit declined $9.0 million in the quarter and $16.1 million in the first half. Cost of sales increased faster than revenue, with first-half cost of sales rising to 86.4% of revenue from 85.8%.
- The second quarter included $9.4 million of facilities relocation and transition costs, $3.3 million of restaurant impairment charges and a $25.2 million loss on early extinguishment of debt.
- First-half operating cash flow fell $64.1 million, primarily because of the $27.4 million Jurlique gain, lower accounts payable and accrued liabilities, higher transition-related payments and lower depreciation and amortization following the Arby’s divestiture.
- The company recorded a $27.4 million gain on the February 2012 sale of its Jurlique investment, partially offset by a $2.9 million loss on a related foreign-currency derivative.
- Wendy’s acquired 30 franchised restaurants in the Austin, Texas area for $19.2 million in cash and assumed $14.8 million of capitalized lease obligations. It also acquired two additional franchised restaurants during the first quarter.
- The company closed 15 underperforming company-owned restaurants during the second quarter and ended the period with 47 fewer systemwide restaurants than at the beginning of the quarter.
Outlook, Commentary, Risks and Unusual Items
- Management expected approximately $141 million of additional capital expenditures during the remainder of 2012, resulting in approximately $225 million for the full year. The company expected operating cash flow and available cash to fund operating requirements for the next 12 months.
- The Atlanta restaurant support center relocation to Ohio was expected to be substantially completed in the third quarter of 2012. Total relocation and transition costs were expected to reach approximately $36.1 million, including approximately $2.6 million expected in 2013.
- The company planned to reimage approximately 50 company-owned restaurants and open 17 new company-owned restaurants under its Image Activation program in 2012, with approximately $80 million of planned investment. Results are not guaranteed, and franchisee financing constraints could limit systemwide participation.
- After July 1, 2012, the company drew the remaining $494.3 million of net term-loan proceeds and redeemed the remaining $440.8 million principal amount of Senior Notes on July 16, 2012. Management expected a further $49.8 million debt-extinguishment loss in the third quarter.
- Commodity costs, especially beef, chicken, corn and wheat, increased during the first half and were expected to remain a risk. Management stated that price increases may not fully offset future cost inflation because of competitive pressures and timing.
- The Union Pension Fund entered critical status, requiring contribution surcharges of 5% from June 1 through December 31, 2012 and 10% beginning January 1, 2013 until a revised rehabilitation plan and contribution rate are established. Management did not expect a material effect on results.
- The company had approximately $2.4 million of reserves for legal and environmental matters. It stated that existing proceedings were not expected to materially affect consolidated financial position or results, although the aggregate possible range of loss could not be estimated.
- The company’s portion of Japan joint-venture guarantee obligations was approximately $4.2 million, with up to $3.3 million of additional guarantees potentially required in 2012.
- Management identified risks from competition, consumer spending and preferences, food safety, franchisee financial condition, commodity and labor costs, restaurant development and remodeling, interest rates, legal and regulatory matters, impairment charges and obligations related to the former Arby’s business.
Most Important Facts to Verify
- Confirm the post-quarter July 16, 2012 Senior Note redemption, resulting debt balance, refinancing terms and the anticipated $49.8 million third-quarter extinguishment loss.
- Assess whether the planned approximately $225 million of 2012 capital expenditures and Image Activation investment are supported by operating cash flow and liquidity.
- Track restaurant margin recovery against commodity inflation, labor costs, strategic pricing and customer-transaction trends.
- Evaluate the performance and financing requirements of the Image Activation program, including potential franchisee incentives, guarantees or royalty reductions.
- Monitor compliance with the new credit agreement’s interest-coverage and senior-secured-leverage covenants and its restrictions on dividends and other payments.
- Review the effect of the Atlanta support-center relocation, restaurant closures, impairment charges and pension-fund surcharges on future earnings and cash flow.