Wendy’s Company 2017 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
The Wendy’s Company operates and franchises quick-service restaurants primarily in North America and reports as one operating segment. The first quarter ended April 2, 2017 and comprised 13 weeks, compared with the 13-week period ended April 3, 2016. The system included 6,551 restaurants, including 331 company-operated and 6,220 franchised locations.
The company completed its planned reduction of company-operated restaurants to approximately 5% of the system as of January 1, 2017. Its strategy emphasizes franchising, Image Activation remodels, new restaurant development, same-restaurant sales growth, technology, and financial management.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $285.8 million | $378.8 million | $(93.0) million |
| Operating profit | $60.7 million | $63.8 million | $(3.1) million |
| Operating margin | 21.2% | 16.9% | Improved |
| Net income | $22.3 million | $25.4 million | $(3.1) million |
| Diluted EPS | $0.09 | $0.09 | Flat |
| Restaurant margin | 16.7% | 17.2% | Down 0.5 percentage points |
| Net cash from operating activities | $38.7 million | $50.8 million | $(12.1) million |
| Capital expenditures | $14.8 million | $38.9 million | $(24.0) million |
Revenue consisted of $148.2 million of company-operated restaurant sales, $94.7 million of franchise royalty revenue and fees, and $42.9 million of franchise rental income. Global systemwide sales increased 3.0% on a constant-currency basis to $2.45 billion. Total systemwide same-restaurant sales increased 1.8%, compared with 3.4% in the prior-year quarter.
Cash and cash equivalents were $193.2 million at April 2, 2017, compared with $198.2 million at January 1, 2017. Total debt, including the current portion, was approximately $2.55 billion, compared with $2.51 billion at year-end. The company had $49.3 million of restricted cash and $38.0 million of outstanding letters of credit, of which $6.2 million was cash collateralized.
Financing activities used $38.0 million, including $17.3 million of dividends and $16.0 million of share repurchases. The quarterly dividend was $0.07 per share. Stockholders’ equity was $524.8 million at quarter-end.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because the sale of company-operated restaurants reduced company-operated sales by $114.9 million. This was partly offset by higher royalty revenue and rental income following franchising activity.
- Franchise royalty revenue and fees increased $5.8 million, and franchise rental income increased $12.3 million.
- Restaurant margin declined to 16.7% from 17.2%, primarily because of higher restaurant labor rates, partly offset by lower beef commodity costs and sales growth at Image Activation restaurants.
- General and administrative expense decreased $12.3 million, mainly due to lower professional services, employee compensation, incentive compensation, share-based compensation, and legal reserves. The prior-year period included cybersecurity-related legal and other costs.
- System optimization gains declined to $1.4 million from $8.4 million because the prior-year period included the sale of 55 company-operated restaurants; no company-operated restaurants were sold in the current quarter.
- Impairment charges decreased to $0.5 million from $7.1 million, while reorganization and realignment costs decreased to $0.2 million from $3.3 million.
- Net income decreased despite higher operating margin because revenue declined, interest expense increased by $0.9 million, and the prior-year period benefited from larger unusual operating gains. Diluted EPS remained $0.09 because the weighted-average diluted share count declined to 254.2 million from 274.8 million.
- Operating cash flow decreased $12.1 million, while investing cash use increased to $6.4 million. Financing cash use declined by $31.6 million, principally because share repurchases were lower than in 2016.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected approximately $85.0 million of total 2017 cash capital expenditures, including approximately $70.2 million for the remainder of the year.
- The company expected regular 2017 dividends to require approximately $51.5 million, assuming a $0.07 quarterly dividend continued.
- A $150.0 million share repurchase authorization was approved through March 4, 2018. The company repurchased $17.8 million during the quarter and an additional $11.2 million through May 4, 2017.
- Management expects to reduce general and administrative expense to approximately 1.5% of global systemwide sales by 2020, with approximately $35.0 million of savings. Related costs are expected to total $28.0 million to $33.0 million, including $23.0 million to $27.0 million of cash expenditures, beginning in the second quarter of 2017 and continuing through 2019.
- The company expects approximately $1.3 million of additional 2017 reorganization costs related to an in-process system optimization transaction.
- Management stated that available cash and operating cash flow should provide sufficient liquidity for operating requirements over the next 12 months, but noted risks related to debt service, securitized financing covenants, interest rates, commodity costs, labor costs, competition, franchisee performance, weather, restaurant development, and consumer demand.
- Outstanding lease guarantees totaled $59.6 million, with obligations extending through 2056. Legal and environmental accruals totaled $1.4 million.
- Wendy’s continued to face putative consumer and financial-institution class actions and shareholder derivative litigation related to the 2016 payment-card cybersecurity incidents. The filing states that the potential range of loss could not be estimated and that the company did not expect the matters to materially affect its financial position or results based on available information, defenses, accruals, and insurance.
- Future minimum operating-lease payments totaled $1.42 billion. The company expected adoption of the new lease accounting standard in the first quarter of 2019 to have a material balance-sheet and disclosure impact.
- Management identified food safety, cybersecurity, legal and regulatory developments, franchisee financial condition, wage and benefit costs, commodity prices, and the execution and cost of the G&A reduction plan as significant risks.
Important Facts for Investors to Verify
- Whether the continued shift from company-operated to franchised restaurants improves recurring royalty and rental economics enough to offset lower reported sales and restaurant margin.
- Progress toward the 1.5% G&A-to-systemwide-sales target and whether the projected $28.0 million to $33.0 million implementation costs remain accurate.
- Debt service capacity, securitized financing covenants, capital lease obligations, and the effect of future lease-accounting adoption.
- Actual same-restaurant sales, franchisee development, Image Activation remodel activity, and systemwide sales growth relative to management’s long-term objectives.
- The pace and value of share repurchases and dividends relative to operating cash flow and leverage.
- Developments in the payment-card cybersecurity litigation and any resulting settlements, legal costs, or reputational effects.
- Exposure to labor inflation, beef and other commodity costs, competitive pricing, consumer spending, and adverse weather.