The Wendy’s Company 2014 Form 10-K Summary
Business context and reporting period
The filing covers the 52-week fiscal year ended December 28, 2014. Wendy’s operates and franchises quick-service hamburger restaurants, with substantially all operations in North America. The system comprised 6,515 restaurants at year-end: 957 company-owned and 5,558 franchised, including 403 international franchised locations.
The company continued shifting toward a predominantly franchised model through its system optimization initiative. During 2014, it sold 203 company-owned restaurants to franchisees, acquired 45 franchised restaurants, opened 16 company-owned and 87 franchised restaurants, and closed 32 company-owned and 113 franchised restaurants.
Financial performance and key metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Sales | $1,670.3 million | $2,165.8 million | Down $495.5 million |
| Franchise revenues | $390.8 million | $321.6 million | Up $69.2 million |
| Total revenues | $2,061.1 million | $2,487.4 million | Down $426.3 million |
| Operating profit | $251.5 million | $135.1 million | Up $116.4 million |
| Net income attributable to Wendy’s | $121.4 million | $45.5 million | Up $75.9 million |
| Diluted earnings per share | $0.32 | $0.11 | Up $0.21 |
| Cash flow from operating activities | $254.8 million | $329.8 million | Down $75.1 million |
| Cash and cash equivalents | $267.3 million | $580.2 million | Down $312.9 million |
| Long-term debt, including current portion | $1,448.1 million | $1,463.8 million | Down $15.7 million |
Operating margin was approximately 12.2%, compared with 5.4% in 2013. Net margin was approximately 5.9%, compared with 1.8%. Wendy’s restaurant margin improved to 15.8% from 15.3%, despite higher commodity costs, particularly beef.
North America same-restaurant sales increased 1.6% systemwide, including 2.3% at company-owned restaurants and 1.5% at North America franchised restaurants. North America systemwide sales were $9.1 billion, comprising $1.6 billion of company-owned sales and $7.5 billion of franchised sales.
Cash used in investing activities was $187.8 million, including $298.5 million of capital expenditures and $54.0 million for acquisitions, partially offset by $161.4 million of disposition proceeds. Cash used in financing activities was $374.6 million, driven primarily by $301.2 million of share repurchases and $75.1 million of dividends. Net cash decreased by $312.9 million during the year.
Working capital was $221.9 million at year-end, compared with $572.9 million in 2013. Total assets were $4.15 billion and stockholders’ equity was $1.72 billion.
Material changes versus the prior comparable period
- Sales declined primarily because company-owned restaurants were sold to franchisees; the company estimated that these dispositions reduced 2014 sales by approximately $499.5 million.
- Franchise revenues increased 21.5%, reflecting higher rental income, initial franchise fees, a larger franchised base, and 1.9% franchised same-restaurant sales growth.
- Operating profit more than doubled, benefiting from $69.6 million of net gains on restaurant sales and a $29.1 million net facilities action income item, compared with a $10.9 million charge in 2013.
- Interest expense decreased to $52.2 million from $69.0 million, primarily due to the 2013 redemption of the 6.20% senior notes and lower effective term-loan rates.
- Investment income declined to $1.2 million from $23.6 million because 2013 included a $21.1 million recognized dividend from Wendy’s investment in Arby’s.
- 2014 included $301.2 million of share repurchases, including a $275.0 million modified Dutch auction tender offer, compared with $69.3 million in 2013.
- Capital expenditures increased to $298.5 million from $224.2 million, principally for the Image Activation program and related investments.
- The company began reporting TimWen Canadian rental income and lease expense on a gross basis. Prior-period rental income and lease expense were each increased by $7.5 million for 2013 and $7.7 million for 2012, with no impact on operating profit or net income.
Guidance, outlook, commentary, risks and unusual items
Management expected 2015 sales to benefit from menu innovation, improved brand positioning, operational execution, and Image Activation, but anticipated that restaurant dispositions would continue to reduce reported sales. The company planned approximately 20 new Image Activation company-owned restaurants and approximately 150 restaurant reimages during 2015. Elsewhere in the filing, management referenced approximately 80 new and 450 reimaged company-owned and franchised restaurants; the filing text does not clearly reconcile these differing descriptions.
Management expected franchise revenues to benefit from additional franchisee purchases of company-owned restaurants, while higher beef and other commodity costs were expected to pressure cost of sales. Depreciation and amortization was expected to increase slightly, and interest expense was expected to rise because of anticipated higher interest rates and cash flow hedges becoming effective June 30, 2015.
The company expected approximately $270.0 million of 2015 cash capital expenditures, dividends of up to approximately $80.9 million, and potential share repurchases under the remaining authorization of up to $76.1 million before subsequent repurchases. Management stated that available cash and operating cash flow were expected to provide sufficient liquidity for operating needs over the next 12 months.
Significant unusual items included a $42.0 million net benefit from the system optimization initiative, consisting largely of $69.6 million of restaurant-sale gains offset by remeasurement, severance, professional fees, and other costs. The company recorded a $12.9 million fourth-quarter charge for its general and administrative realignment plan and expected an additional $11.5 million to $13.5 million of related costs in the first half of 2015. Approximately $1.0 million of additional system optimization costs was also expected through the second quarter of 2015.
Consolidated debt was approximately $1.4 billion, including $541.7 million of Term A Loans, $759.8 million of Term B Loans, $85.8 million of 7% debentures, and $60.8 million of capital lease obligations. Approximately $1.30 billion was variable-rate debt. The company was in compliance with its credit agreement covenants at year-end, but substantially all non-real-estate assets were pledged and subsidiary-level debt agreements restricted distributions to the parent.
Guarantees and other contingencies totaled $71.7 million, including $41.4 million of lease guarantees and contingent rent, $13.2 million of loan recourse, and $17.1 million of letters of credit. The company also provided a $6.0 million irrevocable standby letter of credit supporting franchisee Image Activation financing. Legal and environmental accruals totaled $3.3 million; management did not believe existing proceedings would have a material adverse effect, although aggregate potential losses could not be estimated.
Principal risks include intense restaurant competition and discounting, food safety and reputational events, commodity and labor cost inflation, franchisee financial weakness, execution and financing risk under Image Activation, restaurant disposition and lease obligations, interest-rate exposure, regulatory changes, litigation, environmental liabilities, cybersecurity, and potential impairment of long-lived assets, goodwill, or trademarks.
The company’s independent auditors issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Whether improved operating profit and net income are sustainable after excluding restaurant-sale gains, facilities action benefits, and other unusual items.
- The effect of continued company-owned restaurant dispositions on reported sales, restaurant margins, depreciation, royalty revenue, rental income, and cash flow.
- Progress and economics of the Image Activation program, including remodel returns, franchisee participation, royalty incentives, financing guarantees, and planned capital spending.
- Liquidity after the sharp reduction in cash, substantial capital expenditures, dividends, share repurchases, and ongoing debt service requirements.
- Exposure to variable interest rates, including the impact of $1.30 billion of variable-rate debt and hedges beginning June 30, 2015.
- Commodity cost trends, particularly beef, and the company’s ability to recover higher costs through pricing without damaging traffic.
- Franchisee financial health, lease guarantees, loan guarantees, and the company’s retained real-estate obligations.
- The final withdrawal liability relating to the Bakery’s multiemployer pension plan, which remained subject to negotiation.
- Future impairment charges and the valuation assumptions supporting $822.6 million of goodwill and $903.0 million of indefinite-lived trademarks.
- The company’s ability to maintain dividends and repurchases while complying with subsidiary debt covenants and funding operating and capital requirements.