The Wendy’s Company 2017 Form 10-K Summary
Business context and reporting period
The filing covers the 52-week fiscal year ended December 31, 2017, with quarterly information for the fourth quarter ended December 31, 2017. Wendy’s operates and franchises quick-service hamburger restaurants, primarily in North America, and reports one operating segment. The system included 6,634 restaurants at year-end, including 337 Company-operated and 6,297 franchised locations. Approximately 95% of the system was franchised.
Key financial metrics
| Metric | 2017 | 2016 | Change or margin |
|---|---|---|---|
| Revenue | $1,223.4 million | $1,435.4 million | Down 14.8% |
| Company-operated sales | $622.8 million | $920.8 million | Down $298.0 million |
| Franchise royalty revenue and fees | $410.5 million | $371.5 million | Up 10.5% |
| Franchise rental income | $190.1 million | $143.1 million | Up 32.8% |
| Operating profit | $214.8 million | $314.8 million | 17.6% margin vs. 21.9% |
| Net income | $194.0 million | $129.6 million | Up 49.7% |
| Diluted EPS | $0.77 | $0.49 | Up $0.28 |
| Operating cash flow | $251.6 million | $188.9 million | Up $62.7 million |
| Capital expenditures | $81.7 million | $150.0 million | Down $68.3 million |
| Long-term debt, including current portion | $2,754.4 million | $2,512.3 million | Up $242.1 million |
| Cash and cash equivalents | $171.4 million | $198.2 million | Down $26.8 million |
Restaurant margin was 17.6% in 2017 versus 19.1% in 2016. Global systemwide sales increased 3.5% on a constant-currency basis to $10.3 billion. Systemwide same-restaurant sales increased 2.1%, including 0.2% for Company-operated restaurants and 2.2% for franchised restaurants.
Fourth-quarter revenue was $309.2 million, operating profit was $66.6 million, net income was $159.3 million and diluted EPS was $0.64. Fourth-quarter net income benefited substantially from a $121.6 million income-tax benefit, including the impact of the Tax Cuts and Jobs Act.
Material changes versus the prior comparable period
- Revenue declined primarily because the system optimization initiative reduced Company-operated restaurant sales by $316.4 million as restaurants were shifted to franchisees. Franchise royalties and rental income increased as the franchised base expanded.
- Company-operated same-restaurant sales increased only 0.2%, while franchised same-restaurant sales increased 2.2%. Higher commodity costs, particularly for chicken, bacon and beef, and higher restaurant labor rates reduced restaurant margin.
- Operating profit declined by $100.0 million. Results included a $43.6 million loss from the DavCo and NPC transactions, $22.6 million of reorganization and realignment costs, and $39.1 million of net system optimization losses.
- The May 2017 general and administrative realignment plan generated $21.7 million of costs in 2017. The Company expects total plan costs of approximately $28 million to $33 million and annual G&A savings of approximately $35 million, with most savings expected by the end of 2018.
- Net income increased despite lower operating profit because of the $93.0 million income-tax benefit, including a provisional $140.4 million benefit from the Tax Cuts and Jobs Act. The effective tax rate was negative 92.1%, compared with 35.7% in 2016, making reported earnings unusually tax-driven.
- The restaurant system grew to 6,634 locations from 6,537. Wendy’s opened 174 restaurants and closed 77, while 551 North America restaurants were reimaged or newly built in the Image Activation format. Approximately 43% of the global system was on the new image at year-end.
Guidance, outlook, risks and unusual items
Management expects 2018 sales to benefit from menu improvements, product innovation, selective price increases, operational execution, new restaurant openings and Image Activation restaurants. Franchise fees are expected to decline because of fewer franchisee-to-franchisee transfers and the adoption of new revenue-recognition guidance. Higher wages and commodity costs are expected to partially offset operating improvements.
Expected 2018 cash requirements include approximately $75 million to $80 million of capital expenditures, up to approximately $81.4 million of dividends, and potential share repurchases under the remaining 2017 authorization and the new $175 million authorization approved in February 2018. The Company stated that available cash and operating cash flow should meet operating requirements for the next 12 months based on current operations.
On January 17, 2018, the Company refinanced $925.0 million of securitized debt with new fixed-rate notes bearing rates of 3.573% and 3.884%, and established a $150.0 million revolving facility with no borrowings outstanding at closing. The refinancing is expected to produce an approximately $11.5 million loss on early extinguishment of debt in the first quarter of 2018.
- Debt is secured by substantially all assets of designated securitization entities and is subject to financial covenants, reserve requirements and rapid-amortization events. The Company reported compliance with covenants at December 31, 2017.
- Key operating risks include intense restaurant competition, discounting, commodity and labor inflation, food safety events, adverse consumer trends, franchisee financial difficulties, execution of Image Activation, supply-chain disruptions, weather and regulatory changes.
- The Company continues to face litigation and investigations related to 2015-2016 malware incidents affecting certain franchise-owned restaurants. The filing states that potential aggregate losses cannot be estimated, although management believes existing accruals and insurance are adequate and the matters are not expected to be material.
- Lease guarantees and contingent obligations totaled approximately $93.3 million, including $59.9 million of lease guarantees, $0.3 million of franchisee loan recourse and $32.6 million of letters of credit.
- Future minimum obligations included $1.6 billion of operating lease payments, $996.3 million of capital lease payments and $2.8 billion of long-term debt obligations, before considering related sublease receipts and subsequent refinancing.
- Adoption of new revenue-recognition guidance in 2018 was expected to defer approximately $86 million of franchise revenue and consolidate national advertising funds, increasing reported revenue and expenses by approximately $324 million and $327 million, respectively, for 2017 on a pro forma basis.
Most important facts for investors to verify
- Whether franchisee sales growth and royalty revenue can offset the continuing decline in Company-operated sales.
- The recurring earnings impact excluding the $140.4 million Tax Act benefit and other system optimization and restructuring items.
- Progress toward the projected $35 million of annual G&A savings and the remaining restructuring costs through 2019.
- Restaurant margin trends amid beef, chicken, bacon, wage and other cost inflation.
- Franchisee liquidity, compliance with securitized-financing covenants and the ability to refinance or repay anticipated debt maturities.
- Participation in and sales performance of Image Activation restaurants, including the effect of royalty and advertising incentives.
- The ultimate cost and resolution of cybersecurity-related litigation and claims.
- The effect of the 2018 revenue-recognition and advertising-fund changes on reported revenue, expenses, cash flow and comparability.