The Wendy’s Company — Q1 2016 Form 10-Q Summary
Business context and reporting period
The filing covers the 13 weeks ended April 3, 2016, compared with the 13 weeks ended March 29, 2015. Wendy’s operates and franchises quick-service restaurants primarily in North America and reports one operating segment. The system included 6,482 restaurants at quarter-end, including 582 company-owned and 5,900 franchised restaurants.
The company continued its system optimization strategy of selling company-owned restaurants to franchisees. The New Bakery Company, sold in May 2015, is presented as discontinued operations in the 2015 comparison.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $378.8 million | $451.8 million | $(73.0) million |
| Company restaurant sales | $259.3 million | $357.6 million | $(98.3) million |
| Franchise revenue | $119.5 million | $94.2 million | $25.3 million |
| Operating profit | $63.8 million | $37.9 million | $25.9 million |
| Operating margin | 16.9% | 8.4% | Improved |
| Income from continuing operations | $25.4 million | $18.2 million | $7.3 million |
| Net income | $25.4 million | $27.5 million | $(2.1) million |
| Diluted earnings per share | $0.09 | $0.07 | $0.02 |
| Restaurant margin | 17.2% | 14.7% | Improved |
| Cash flow from operations | $47.3 million | $21.7 million | $25.5 million |
Net income declined year over year because the 2015 period included $9.4 million of income from the discontinued Bakery operation. Net income from continuing operations increased despite higher interest expense.
Cash and cash equivalents were $312.9 million at April 3, 2016, compared with $327.2 million at January 3, 2016. Total debt was approximately $2.50 billion, consisting of $23.5 million current debt and $2.48 billion long-term debt. Total liabilities were $3.42 billion and stockholders’ equity was $733.6 million.
Cash used in investing activities was $0.2 million, reflecting $38.9 million of capital expenditures offset largely by $41.2 million of disposition proceeds. Cash used in financing activities was $66.0 million, including $47.6 million of share repurchases and $16.2 million of dividends. Net cash decreased by $14.3 million during the quarter.
Material changes versus the prior comparable period
- Revenue decreased 16.2%, primarily because restaurant sales declined by $118.4 million following company-owned restaurant dispositions. Franchise revenue increased 26.9%.
- Systemwide same-restaurant sales increased 3.6% under the new reporting methodology, or 3.3% under the prior methodology. Company-owned same-restaurant sales increased 4.8% under the new methodology, while franchised same-restaurant sales increased 3.2%.
- Restaurant margin increased to 17.2% from 14.7%, primarily due to lower commodity costs, including beef, and higher same-restaurant sales.
- Operating profit benefited from an $8.4 million system optimization gain compared with a $0.8 million loss in the prior-year quarter.
- Interest expense increased $15.4 million to $28.1 million, primarily because of the $2.275 billion securitized financing facility completed in June 2015.
- General and administrative expense increased $5.0 million, partly due to cybersecurity investigation costs and higher legal reserves.
- The company sold 55 restaurants to franchisees during the quarter versus 17 in the prior-year period and facilitated 113 franchisee-to-franchisee transfers.
- The company repurchased 4.9 million shares for $48.2 million under its repurchase authorization. Approximately $330.0 million remained available at April 3, 2016.
Guidance, outlook, commentary, risks and unusual items
Management expected to sell approximately 260 additional company-owned restaurants during the remainder of 2016, reducing company-owned ownership to approximately 5% of the system by year-end. Eighty-six restaurants were classified as held for sale at quarter-end.
The company expected approximately $5.9 million of additional system optimization costs and approximately $1.3 million of additional G&A realignment costs during the remainder of 2016. It also anticipated approximately $101.1 million of additional capital expenditures for the remainder of 2016, resulting in approximately $140.0 million of total cash capital expenditures for the year.
Management stated that operating cash flow and available cash were expected to provide sufficient liquidity for operating requirements over the next 12 months. Planned uses included capital expenditures, up to approximately $48.0 million of remaining 2016 dividends, potential share repurchases of up to approximately $330.0 million, and restaurant acquisitions and dispositions.
Unusual items included $7.1 million of impairment charges, an $8.4 million system optimization gain, $3.3 million of reorganization and realignment costs, and $1.8 million of accelerated depreciation associated with the Image Activation program. The company also recorded $2.6 million of purchases from the Bakery buyer under transitional supply arrangements.
The company disclosed a cybersecurity incident involving malware at fewer than 300 franchised North American restaurants, allegedly introduced through compromised third-party vendor credentials. Approximately 50 additional franchise restaurants were suspected of experiencing unrelated cybersecurity issues. Two putative class actions had been filed, and potential payment-card-network claims and investigation costs could adversely affect reputation, operations and financial results.
Other risks include commodity and labor cost inflation, competition, franchisee financial condition, restaurant development and remodel execution, food safety, legal proceedings, impairment charges, debt-service and covenant requirements under the securitized financing facility, and the timing and scale of share repurchases. Legal and environmental accruals totaled $4.4 million; management stated that currently known matters were not expected to materially affect consolidated results.
Important facts for investors to verify
- Reconcile reported revenue and earnings trends for the ongoing franchising model after the substantial reduction in company-owned restaurants.
- Assess debt-service capacity, interest-rate exposure and covenant compliance under the $2.275 billion securitized financing facility.
- Verify the pace, proceeds and accounting gains or losses from the remaining 2016 restaurant dispositions.
- Evaluate whether same-restaurant sales and restaurant-margin improvements are sustainable after commodity costs and product-mix effects.
- Monitor the final cybersecurity investigation, litigation, payment-card claims and any related remediation or indemnification costs.
- Compare actual capital expenditures, dividends and share repurchases with management’s stated 2016 cash requirements.
- Confirm the effect of discontinued Bakery operations when making year-over-year comparisons.