Wendy’s Company 2016 Q2 Form 10-Q Summary
Business context and reporting period
The Wendy’s Company operates and franchises Wendy’s quick-service restaurants, primarily in North America, which represents its single reportable segment. The filing covers the 13 and 26 weeks ended July 3, 2016, compared with June 28, 2015. The system included 6,490 restaurants, including 582 company-owned and 5,908 franchised locations. The company continued shifting from company-owned to franchised restaurants.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $382.7 million | $489.5 million | $761.5 million | $941.3 million |
| Operating profit | $65.6 million | $64.3 million | $129.5 million | $102.2 million |
| Income from continuing operations | $26.5 million | $24.8 million | $51.8 million | $43.0 million |
| Net income | $26.5 million | $40.2 million | $51.8 million | $67.7 million |
| Diluted EPS | $0.10 | $0.11 | $0.19 | $0.18 |
| Operating cash flow | Not separately provided | Not separately provided | $101.0 million | $53.1 million |
Q2 operating margin was approximately 17.2%, compared with 13.1% in the prior-year quarter. Six-month operating margin was approximately 17.0%, compared with 10.9%. Restaurant margin improved to 21.9% of company-owned sales in Q2 from 18.2%, and to 19.5% for the first six months from 16.5%. Lower beef and other commodity costs, same-restaurant sales growth and performance at Image Activation restaurants supported margin expansion.
Cash and cash equivalents were $266.2 million at July 3, 2016, versus $327.2 million at January 3, 2016. Restricted cash was $35.7 million. Total debt was approximately $2.51 billion, including $2.49 billion of long-term debt and $23.7 million of current maturities. The company reported total liabilities of $3.44 billion and stockholders’ equity of $693.2 million.
Six-month investing cash use was $22.2 million, including $68.5 million of capital expenditures, partly offset by $45.1 million of disposition proceeds. Financing cash use was $145.3 million, including $108.1 million of share repurchases and $32.2 million of dividends. Management expects approximately $71.5 million of additional capital expenditures during the remainder of 2016 and stated that operating cash flow and available cash should satisfy operating requirements for the next 12 months.
Material changes versus the prior comparable period
- Revenue declined 21.8% in Q2 and 19.1% for the first six months, primarily because company-owned restaurant sales decreased by $139.5 million and $257.9 million, respectively, following restaurant dispositions.
- Franchise revenue increased $19.0 million in Q2 and $44.2 million for the first six months, driven by higher royalty revenue, rental income and franchise fees from the franchising strategy.
- Systemwide same-restaurant sales increased 0.4% in Q2 and 1.9% for the first six months under the company’s revised reporting methodology, but growth was below the comparable prior-year rates of 2.4% and 2.8%.
- Operating profit increased $1.3 million in Q2 and $27.3 million for the first six months despite lower revenue, reflecting improved restaurant margins, lower depreciation, reduced reorganization costs and lower impairment charges.
- Interest expense increased $11.4 million in Q2 and $26.8 million for the first six months because of the larger, higher-rate securitized financing facility completed in June 2015.
- Net income declined because the prior-year periods included $15.4 million in Q2 and $24.7 million for the first six months from discontinued Bakery operations, including a $15.1 million after-tax disposal gain.
- The company repurchased 10.8 million shares for $109.2 million during the first six months. Approximately $269.0 million remained available under the repurchase authorization at July 3, 2016.
Guidance, outlook, commentary, risks and unusual items
- Management expected to sell 258 additional company-owned restaurants during the remainder of 2016, completing its plan to reduce company-owned ownership to approximately 5% of the system. All 258 restaurants were classified as held for sale at July 3, 2016.
- The company expected approximately $3.7 million of additional system optimization costs and approximately $1.0 million of additional G&A realignment costs during the remainder of 2016.
- Subsequent to quarter-end, the company sold assets used in 82 company-owned restaurants for approximately $66.3 million, subject to customary adjustments.
- Q2 included $5.5 million of impairment charges; six-month impairment charges were $12.6 million. The company stated that additional impairment could result from further restaurant sales, leasing or subleasing activity and operating deterioration.
- The company disclosed a cybersecurity incident involving malware at certain franchise-owned restaurants that targeted payment-card information. It reported no indication that company-operated restaurants were affected. Customer and financial-institution litigation was pending, and potential losses could not be estimated clearly.
- Legal and environmental accruals totaled $5.2 million. The company stated that current matters were not expected to have a material effect, but the aggregate possible loss range could not be estimated.
- Lease guarantees totaled $34.1 million, and outstanding letters of credit totaled $35.0 million, of which $6.2 million was cash collateralized. The company did not expect material losses from the letters of credit.
- Key ongoing risks include intense competition, commodity and labor-cost inflation, food safety, franchisee financial condition, restaurant development and remodeling execution, cybersecurity, litigation, reliance on cash flows to service securitized debt, and restrictions under the financing facility.
Important facts for investors to verify
- Verify the pace, proceeds and profitability effects of the remaining 258 restaurant dispositions and the company’s progress toward approximately 5% company-owned restaurants.
- Assess whether franchise revenue growth can offset the continuing decline in company-owned sales and whether same-restaurant sales momentum improves.
- Review debt-service requirements, covenants, refinancing exposure and liquidity under the $2.275 billion securitized financing structure.
- Monitor the financial, legal and reputational consequences of the franchisee payment-card cybersecurity incident.
- Evaluate the sustainability of margin expansion after lower commodity costs and the effect of labor, occupancy, lease and advertising costs.
- Confirm the effect of share repurchases and dividends on liquidity, leverage and per-share results.