Wendy’s Company 2016 Q3 Form 10-Q Summary
Business context and reporting period
The Wendy’s Company operates and franchises quick-service restaurants, primarily in North America, with one reportable segment. The filing covers the 13-week third quarter and 39 weeks ended October 2, 2016, compared with periods ended September 27, 2015. The system included 6,503 restaurants, consisting of 427 company-owned and 6,076 franchised locations.
The company continued its system optimization strategy of selling company-owned restaurants to franchisees. Wendy’s expects to reduce company-owned ownership to approximately 5% of the system by the end of 2016.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenues | $364.0 million | $464.6 million | $1,125.5 million | $1,405.9 million |
| Sales | $228.6 million | $359.0 million | $747.2 million | $1,101.6 million |
| Franchise revenues | $135.4 million | $105.6 million | $378.3 million | $304.3 million |
| Operating profit | $106.1 million | $55.9 million | $235.6 million | $158.2 million |
| Income from continuing operations | $48.9 million | $8.3 million | $100.7 million | $51.3 million |
| Net income | $48.9 million | $7.6 million | $100.7 million | $75.3 million |
| Diluted EPS | $0.18 | $0.03 | $0.37 | $0.22 |
| Operating margin | 29.1% | 12.0% | 20.9% | 11.3% |
| Restaurant margin | 18.4% | 18.8% | 19.2% | 17.2% |
Revenue declined primarily because restaurant dispositions reduced company-owned restaurant sales by $139.5 million in Q3 and $397.5 million for the first nine months. Franchise revenues increased as restaurants were transferred to franchisees and as royalty, rental and franchise fee revenue grew.
North America systemwide same-restaurant sales increased 1.4% in Q3 and 1.8% for the first nine months under the company’s new reporting method. Franchise same-restaurant sales increased 1.2% in Q3 and 1.6% for the first nine months.
For the first nine months, operating cash flow was $130.8 million, compared with $118.6 million in the prior-year period. Capital expenditures were $108.7 million, compared with $188.2 million. Investing activities provided $62.5 million, primarily because of restaurant disposition proceeds. Financing activities used $215.7 million, including $161.2 million for share repurchases and $47.8 million for dividends.
At October 2, 2016, cash and cash equivalents were $308.8 million, restricted cash was $40.8 million, current liabilities were $265.0 million and total debt was approximately $2.516 billion, including $23.8 million of current maturities and $2.492 billion of long-term debt.
Material changes versus the prior comparable period
- Operating profit increased $50.2 million in Q3 and $77.4 million for the first nine months, despite lower revenue.
- System optimization gains increased to $37.8 million in Q3 and $48.1 million for the first nine months, compared with a nominal loss in Q3 2015 and $14.8 million of gains for the first nine months of 2015.
- Wendy’s sold 156 restaurants in Q3 and 211 during the first nine months, compared with 9 and 109, respectively, in the prior-year periods.
- Franchise revenues increased $29.8 million in Q3 and $74.0 million for the first nine months, led by higher rental income, royalty revenue and franchise fees.
- Restaurant margin declined in Q3 to 18.4% from 18.8%, primarily because of product mix, medical insurance costs and higher labor rates, partly offset by lower beef costs. For the first nine months, margin improved to 19.2% from 17.2%.
- Interest expense increased $0.8 million in Q3 and $27.6 million for the first nine months, primarily because the 2015 securitized financing facility carries higher debt balances and fixed interest rates than the prior credit agreement.
- Prior-year results included $24.0 million of after-tax discontinued-operation income from the sale of the Bakery; there was no comparable amount in 2016.
- Share repurchases were $162.3 million during the first nine months of 2016, versus $1.078 billion in the prior-year period. Approximately $215.9 million remained available under the repurchase authorization at quarter-end.
Guidance, outlook, commentary, risks and unusual items
Management expects approximately $36.3 million of capital expenditures during the remainder of 2016, implying approximately $145.0 million for the full year. It also expected up to approximately $15.9 million of fourth-quarter dividends and potential stock repurchases, including $22.7 million repurchased after quarter-end through November 3, 2016. Management stated that operating cash flow and available cash should provide sufficient liquidity for operating requirements for the next 12 months.
Additional 2016 costs were expected to include approximately $3.7 million for the system optimization initiative and approximately $0.4 million for the G&A realignment program. The company planned to sell 98 additional restaurants classified as held for sale at October 2, 2016; subsequent to quarter-end, assets associated with 52 restaurants were sold for approximately $36.6 million, subject to customary adjustments.
The company reported a cybersecurity incident involving malware at certain franchisee point-of-sale systems. Payment card information may have been targeted. Wendy’s stated that there was no indication company-owned restaurants were affected, but related legal proceedings, investigations, reputational effects and costs could materially affect results.
Other significant risks include competition and pricing pressure, food and labor cost inflation, franchisee financial condition, restaurant development and reimaging execution, commodity volatility, cybersecurity, litigation, impairment charges, and the ability to service and comply with covenants under the securitized financing facility. The company had $32.9 million of lease guarantees, $34.0 million of outstanding letters of credit and $1.5 million of accrued legal and environmental matters at quarter-end.
The company expects the new lease accounting standard, effective beginning in fiscal 2019, to materially affect its balance sheet because of its significant operating and capital lease arrangements. The filing does not provide a specific full-year earnings or revenue guidance figure.
Most important facts for investors to verify
- Whether restaurant disposition gains are recurring and how the transition to a predominantly franchised model affects sustainable revenue, margins and cash flow.
- The remaining timing, proceeds and accounting impact of the 98 restaurants held for sale and the broader system optimization program.
- Debt service requirements, covenants and liquidity under the approximately $2.5 billion securitized financing facility.
- The ultimate costs, insurance recovery and legal exposure from the franchisee cybersecurity incident.
- Whether same-restaurant sales growth can offset commodity, labor, medical insurance and competitive pressures.
- The effect of continued share repurchases and dividends on leverage, liquidity and per-share results.
- The impact of upcoming lease, revenue recognition and share-based compensation accounting standards.