Business Context and Reporting Period
The Wendy’s Company operates and franchises quick-service restaurants, primarily in North America, with one reportable segment. The unaudited Form 10-Q covers the 13-week second quarter and 26 weeks ended July 1, 2018, compared with the periods ended July 2, 2017. The system comprised 6,656 restaurants: 332 company-operated and 6,324 franchised.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Revenue | $411.0 million | $320.3 million | $791.6 million | $606.2 million |
| Operating profit | $71.5 million | $25.8 million | $126.7 million | $86.5 million |
| Net income | $29.9 million | $(1.8) million | $50.0 million | $20.5 million |
| Diluted EPS | $0.12 | $(0.01) | $0.20 | $0.08 |
| Operating margin | 17.4% | 8.0% | 16.0% | 14.3% |
| Net margin | 7.3% | (0.6)% | 6.3% | 3.4% |
| Restaurant margin | 17.4% | 18.8% | 15.8% | 17.5% |
Reported revenue includes $84.6 million in second-quarter and $163.5 million in six-month advertising funds revenue, with an equal expense, following adoption of new revenue recognition guidance. Accordingly, reported revenue growth is not directly comparable with 2017. Excluding advertising funds, 2018 revenue was reduced by franchise-fee timing effects under the new standard.
- North America systemwide same-restaurant sales increased 1.9% in the quarter and 1.8% year to date; global systemwide sales increased 3.1% and 3.2%, respectively, on a constant-currency basis.
- Company-operated restaurant sales increased 4.0% in the quarter and 3.9% year to date, primarily from same-restaurant sales growth, strategic pricing and product mix.
- Restaurant margin declined 140 basis points in the quarter and 170 basis points year to date, primarily from higher labor, commodity and insurance costs and adverse first-quarter weather.
- Cash provided by operating activities was $148.4 million, compared with $105.8 million in the prior-year period. Capital expenditures were $23.9 million, and cash used in investing activities was $22.6 million.
- Cash, cash equivalents and restricted cash totaled $238.9 million at July 1, 2018, including $194.9 million of cash and cash equivalents.
- Total debt, including the current portion, was approximately $2.8 billion, consisting principally of fixed-rate debt and $466.1 million of capital lease obligations. The Company reported compliance with its debt covenants.
- Stockholders’ equity was $430.5 million, compared with $573.2 million at December 31, 2017, primarily reflecting the cumulative effect of revenue-recognition adoption, share repurchases and dividends.
Material Changes Versus the Prior Comparable Period
- Operating profit increased $45.7 million in the quarter and $40.2 million year to date. The comparison benefited substantially from the absence of the $43.1 million loss related to the 2017 DavCo and NPC restaurant transactions.
- Reorganization and realignment costs declined to $3.1 million from $17.7 million in the quarter and to $5.7 million from $17.9 million year to date.
- Interest expense increased $1.2 million in the quarter and $2.4 million year to date, primarily because of capital lease obligations. The Company also recorded an $11.5 million loss on early extinguishment of debt in the first quarter of 2018.
- The Company refinanced $925.0 million of senior secured notes in January 2018, replacing the Series 2015-1 Class A-2-I Notes with Series 2018-1 notes bearing rates of 3.573% and 3.884% and adding a $150.0 million revolving facility. No amounts were borrowed under the revolving facility during the period.
- Cash used in financing activities was $95.3 million, including $84.3 million of share repurchases and $40.6 million of dividends. The Company had $112.5 million remaining under its February 2018 repurchase authorization at July 1, 2018.
- The Company adopted the revenue recognition standard on January 1, 2018 using the modified retrospective method. Franchise fees are generally recognized over the franchise term, and national advertising funds are now fully consolidated. The adoption reduced opening accumulated equity by $70.2 million.
Guidance, Outlook, Commentary and Risks
- Management expects available cash and operating cash flow to provide sufficient liquidity for operating requirements over the next 12 months.
- Remaining 2018 capital expenditures were estimated at $51.0 million to $56.0 million, implying full-year capital expenditures of approximately $75.0 million to $80.0 million.
- Management expects approximately three-quarters of planned annual G&A savings of approximately $35.0 million by the end of 2018, with the remainder in 2019. Total plan costs are expected to be approximately $30.0 million to $33.0 million, with additional costs of approximately $5.0 million expected after July 1, 2018.
- The Company expects to continue quarterly dividends at its then-current rate, but future dividends are not guaranteed. A $0.085-per-share dividend was declared for payment in September 2018.
- Key risks include competition and pricing pressure, food and labor inflation, franchisee financial condition, new restaurant and remodel execution, adverse weather, food safety, cybersecurity incidents, legal and environmental matters, commodity volatility, debt covenant and refinancing risks, and the effect of the new lease standard expected in fiscal 2019.
- Future minimum operating lease payments not yet recognized on the balance sheet totaled $1.545 billion at July 1, 2018. Management expects adoption of the lease standard to materially affect the balance sheet and disclosures, but not materially affect operating results or cash flows.
- The Company remains involved in litigation, including matters related to a historical cybersecurity incident, but does not believe current matters will materially affect its consolidated financial position or results of operations based on available information.
Important Facts for Investors to Verify
- Separate underlying operating growth from the reported revenue increase caused by consolidation of advertising funds.
- Assess restaurant-margin pressure from labor, commodities, insurance and weather against pricing and product-mix benefits.
- Review debt-service requirements, anticipated repayment dates, capital lease obligations and compliance with securitized financing covenants.
- Evaluate the cash requirements for capital expenditures, dividends and the remaining share-repurchase authorization.
- Monitor execution and final balance-sheet effects of the fiscal 2019 lease-accounting adoption.
- Track the remaining G&A realignment costs and whether expected savings are realized.
- Consider litigation, cybersecurity, franchisee, food-safety and commodity risks disclosed in the filing and the Form 10-K.