Business Context and Reporting Period
The Wendy’s Company, formerly Wendy’s/Arby’s Group, filed a combined Form 10-Q with Wendy’s Restaurants, LLC for the 13-week quarter and 26-week year-to-date periods ended July 3, 2011. The companies operated Wendy’s and Arby’s during the reported periods, but Arby’s was sold on July 4, 2011 and is presented as discontinued operations. The companies changed their names on July 5, 2011. Continuing operations primarily comprise the operation and franchising of Wendy’s restaurants and related bakery operations.
At July 3, 2011, the Wendy’s system had 6,571 restaurants, including 1,400 company-owned and 5,171 franchised locations.
Financial Highlights
| Metric | Q2 2011 | Q2 2010 | First Half 2011 | First Half 2010 |
|---|---|---|---|---|
| Revenue | $622.5 million | $607.4 million | $1,204.9 million | $1,192.1 million |
| Operating profit | $47.4 million | $58.9 million | $75.5 million | $96.6 million |
| Income from continuing operations | $11.4 million | $5.4 million | $11.1 million | $12.8 million |
| Net income | $11.3 million | $10.7 million | $9.9 million | $7.3 million |
| Net income per diluted share | $0.03 | $0.03 | $0.02 | $0.02 |
| Cash flow from operations | Not separately provided | Not separately provided | $132.6 million | $102.3 million |
Q2 operating margin declined to approximately 7.6% from 9.7%; first-half operating margin declined to approximately 6.3% from 8.1%. Wendy’s restaurant margin was 13.9% in Q2 versus 16.4% in the prior-year quarter, and 13.7% for the first half versus 15.9%.
- Q2 sales increased 2.2% and franchise revenues increased 4.3%. First-half sales increased 0.8% and franchise revenues increased 3.1%.
- North America systemwide same-store sales increased 2.3% in Q2 and 1.2% for the first half, compared with declines of 1.7% and 0.5%, respectively, in the comparable 2010 periods.
- Cost of sales increased 5.1% in Q2 and 3.4% in the first half, outpacing revenue growth, primarily because of higher commodity costs and increased advertising spending related to breakfast testing.
- Six-month cash capital expenditures were $56.0 million, including approximately $9.6 million for restaurant remodels and $6.4 million for new restaurant construction.
Balance Sheet, Debt and Liquidity
- The Wendy’s Company reported cash and cash equivalents of $492.4 million at July 3, 2011, compared with $512.5 million at January 2, 2011. Total assets were $4.75 billion.
- Long-term debt, including current maturities, was approximately $1.35 billion on a carrying-value basis. Reported debt fair value was approximately $1.45 billion.
- Wendy’s Restaurants reported $222.8 million of cash and $1.34 billion of long-term debt, including current maturities.
- The Wendy’s Company used $85.7 million in financing cash flow during the first half, including $34.8 million of debt repayments, $37.4 million of stock repurchases and $16.8 million of dividends.
- Cash and cash equivalents decreased by $13.0 million during the first half on a consolidated company basis. Management stated that operating cash flows and available cash were expected to satisfy operating requirements for the next 12 months.
- The term loan required a $24.9 million excess-cash-flow repayment during the first quarter. Management stated that proceeds from the Arby’s sale were not then expected to be required for a term-loan prepayment.
Material Changes Versus the Prior Comparable Period
- Revenue increased modestly, supported by improved same-store sales, higher average checks and currency translation, while customer transactions were flat for the first half.
- Restaurant margins contracted materially as commodity costs rose. Food and paper costs increased to 33.5% of Wendy’s sales in Q2 from 31.8%, and to 32.8% for the first half from 31.5%.
- General and administrative expense declined by $7.3 million for the first half, primarily because of lower prior-year SSG and integration costs, partly offset by higher professional fees.
- The company recorded $6.9 million of retention and other transaction-related costs in the first half, versus none in the prior-year period, and $8.3 million of long-lived asset impairment charges versus $0.5 million.
- Interest expense declined by $3.1 million for the first half. The prior-year period included a $26.2 million loss on early extinguishment of debt and $4.9 million of investment income from repayment of the DFR Notes; neither item recurred in 2011.
- Arby’s first-half revenue was $546.5 million, and its discontinued operations contributed a $1.2 million net loss after the estimated disposal loss, compared with a $5.4 million net loss in the prior-year period.
Sale of Arby’s, Outlook, Risks and Unusual Items
On July 4, 2011, Wendy’s Restaurants sold Arby’s for $130.0 million in cash, subject to customary adjustments, plus an indirect retained 18.5% interest in Arby’s with a preliminary estimated fair value of $19.0 million. The buyer assumed approximately $190.0 million of Arby’s debt. The company recorded an estimated $6.0 million pretax disposal loss, net of a $2.2 million tax benefit. The estimates remain subject to change.
- The company expected approximately $103 million of net cash proceeds from the Arby’s sale after closing costs and adjustments.
- Management expected significant commodity-cost increases to continue through the remainder of 2011, with strategic pricing intended to offset part of the pressure.
- Planned remaining-2011 uses included approximately $94 million of additional capital expenditures, approximately $27 million for breakfast equipment programs, approximately $5 million of retention and transaction costs, scheduled debt repayments of approximately $1.1 million, dividends of approximately $15.8 million and potential stock repurchases of up to approximately $127.6 million as of August 5, 2011.
- Breakfast initiatives included up to $20 million of franchisee loans and up to $7 million of leased equipment expenditures. No breakfast loans had been made as of July 3, 2011; equipment with a net book value of approximately $1.9 million had been leased.
- The company expected additional third-quarter costs, including approximately $5.1 million under the retention program, $1.8 million of sale-related bonuses, $1.1 million of accelerated equity compensation, approximately $2.4 million of relocation costs and approximately $5.8 million of deferred tax expense related to the Arby’s sale.
- Legal and environmental reserves for continuing operations were approximately $3.2 million. Management did not believe existing proceedings would materially affect consolidated results, but stated that potential loss ranges could not be estimated.
- Key risks include commodity inflation, labor and operating costs, competition and pricing pressure, consumer spending, food safety, franchisee financial condition, development and remodeling costs, weather, financing availability, regulatory changes, litigation and impairment of restaurant assets.
Important Facts for Investors to Verify
- Final purchase-price adjustments, retained-interest valuation and tax consequences of the Arby’s sale, including the anticipated third-quarter tax expense.
- Whether commodity inflation and breakfast-related advertising costs continue to reduce Wendy’s restaurant margins.
- Actual 2011 capital spending, franchisee breakfast-program funding and transaction-related cash costs compared with management’s estimates.
- Debt maturities, term-loan covenants, interest-rate swap exposure and the availability of cash for dividends and share repurchases.
- The sustainability of improved same-store sales and the effect of strategic pricing on transaction volumes and customer demand.
- Potential changes in legal, environmental, impairment and franchisee-related obligations, including guarantees and breakfast or core-menu financing programs.