Business Context and Reporting Period
Wendy’s/Arby’s Group, Inc. filed a combined Form 10-K with wholly owned Wendy’s/Arby’s Restaurants, LLC for the 52-week fiscal year ended January 2, 2011. The filing covers two operating segments: Wendy’s and Arby’s. The requested 2010 Q4 period corresponds to the quarter ended January 2, 2011; the filing primarily reports full-year results and provides unaudited quarterly data.
At year-end, the system included 10,225 restaurants: 6,576 Wendy’s locations and 3,649 Arby’s locations. Company-owned restaurants represented 1,394 Wendy’s locations and 1,144 Arby’s locations.
Key Financial Metrics
| Metric | FY 2010 | FY 2009 | Change |
|---|---|---|---|
| Revenue | $3,416.4 million | $3,580.8 million | Down $164.4 million |
| Sales | $3,045.3 million | $3,198.3 million | Down $153.0 million |
| Franchise revenue | $371.1 million | $382.5 million | Down $11.4 million |
| Operating profit | $132.4 million | $112.0 million | Up $20.4 million |
| Net income | $(4.3) million | $5.1 million | Declined $9.4 million |
| Net cash from operating activities | $226.3 million | $298.8 million | Down $72.5 million |
| Cash capital expenditures | $148.0 million | $101.9 million | Up $46.1 million |
| Cash and equivalents | $512.5 million | $591.7 million | Down $79.2 million |
| Total debt, including current portion | $1,572.4 million | $1,522.9 million | Up $49.5 million |
Operating margin was approximately 3.9% in 2010, compared with approximately 3.1% in 2009. The improvement in operating profit included lower general and administrative expense and lower impairment charges, partly offset by weaker restaurant sales and margins.
- Wendy’s revenue was $2,375.5 million, with segment operating profit of $204.9 million.
- Arby’s revenue was $1,041.0 million, with a segment operating loss of $50.7 million.
- Total restaurant margin declined to 13.8% from 14.6%. Wendy’s restaurant margin was 14.8%, compared with 14.9%; Arby’s declined to 11.6% from 13.9%.
- Wendy’s North America company-owned same-store sales decreased 1.7%; Arby’s decreased 7.1%.
- Fourth-quarter 2010 consolidated revenue was $840.7 million, operating profit was $13.0 million, and net loss was $10.8 million. Fourth-quarter systemwide same-store sales declined 0.6% for Wendy’s and 5.8% for Arby’s.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because 2010 had 52 weeks versus 53 weeks in 2009, combined with negative same-store sales. The additional 2009 week contributed approximately $51.2 million of company-owned restaurant sales.
- Wendy’s sales declined 2.7%, while Arby’s sales declined 9.2%. Arby’s results were pressured by lower average checks, reduced advertising, value-menu pricing, and franchisee closures.
- Arby’s franchised restaurant count declined by 44 net units in 2010. Approximately 350 Arby’s franchised restaurants had royalties, rent, or other fees at least 60 days past due.
- Long-lived asset impairment charges decreased to $69.4 million from $82.1 million, although charges remained significant: $26.3 million for Wendy’s and $43.2 million for Arby’s.
- General and administrative expense decreased $36.1 million to $416.6 million, primarily due to nonrecurring 2009 Wendy’s purchasing-cooperative charges, lower merger integration costs, reduced legal reserves, and lower incentive compensation.
- Operating cash flow declined 24% to $226.3 million, reflecting payments for incentive compensation and QSCC start-up costs, higher interest payments, and lower operating performance.
- The company entered into a new $650.0 million secured Credit Agreement in May 2010, including a $500.0 million term loan and a $150.0 million revolving facility. Proceeds were used to refinance debt and redeem Wendy’s 6.25% senior notes.
- The refinancing generated a $26.2 million loss on early extinguishment of debt. Interest expense increased to $137.2 million from $126.7 million.
- Common-stock repurchases increased to $173.5 million from $72.9 million. The board extended the repurchase authorization through January 1, 2012, with approximately $250.0 million authorized at year-end.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management expected 2011 sales to remain affected by weak industry trends, unemployment, economic uncertainty, and price competition. Wendy’s planned to emphasize product innovation, expanded dayparts, facility modernization, new-unit development, international growth, and expansion of its breakfast initiative. Arby’s planned a new brand positioning and marketing campaign, premium products, and continued emphasis on everyday value.
Management projected approximately $184 million of 2011 cash capital expenditures, including remodeling approximately 100 Wendy’s company-owned restaurants and opening approximately 21 new company-owned Wendy’s restaurants. Scheduled debt principal repayments were expected to total approximately $18 million. Management stated that operating cash flow and available cash were expected to meet operating requirements for at least the next 12 months.
- In January 2011, the company announced that it was exploring strategic alternatives for Arby’s, including a potential sale. Arby’s was not classified as held for sale or discontinued operations at year-end. A sale could require use of proceeds to repay the term loan and could trigger the wind-up of SSG.
- Arby’s franchisee financial distress, declining royalties, past-due receivables, store closures, and advertising-fund reductions were identified as significant risks.
- Debt was substantial, with approximately $1.6 billion outstanding. The Credit Agreement is secured by substantially all non-real-estate assets of the restaurant subsidiaries and contains leverage, interest-coverage, dividend, asset-sale, and other restrictive covenants.
- The company reported compliance with the Credit Agreement and senior-note covenants. However, Arby’s remained noncompliant with certain financial-reporting requirements under leases for which waivers had not been obtained; no lessor had asserted a default.
- Guarantees and other contingencies totaled approximately $127.4 million, including $81.3 million of lease guarantees and contingent rent, $13.0 million of loan guarantees, and $33.1 million of letters of credit.
- Legal and environmental reserves totaled $3.9 million at the parent level and $3.7 million at Wendy’s/Arby’s Restaurants. The filing states that pending matters were not expected to have a material adverse effect.
- The filing included $9.7 million of provision for doubtful accounts, reflecting deterioration in franchisee financial condition.
- Wendy’s/Arby’s had $36.4 million of unrecognized tax benefits, of which approximately $25.2 million could reduce tax expense if resolved favorably.
- Management disclosed related-party advisory fees of approximately $2.5 million in 2010 and SSG expenses of approximately $5.2 million, with $2.0 million paid during 2010.
Most Important Facts for Investors to Verify
- Whether Arby’s strategic review resulted in a sale, restructuring, or additional retention, transaction, or debt-repayment costs.
- Whether Arby’s same-store sales, franchisee liquidity, past-due balances, and restaurant closures improved or continued to deteriorate.
- Actual 2011 operating cash flow relative to the planned $184 million capital-expenditure program and scheduled debt repayments.
- Compliance with Credit Agreement leverage and interest-coverage covenants, including restrictions on dividends and subsidiary cash transfers.
- Progress on Wendy’s breakfast rollout, remodeling, new-unit development, and resulting restaurant margins.
- The sustainability of the $250 million stock-repurchase authorization and quarterly dividends given the company’s net loss, leverage, and restricted subsidiary cash.
- Potential additional impairment charges, particularly for underperforming Wendy’s and Arby’s company-owned restaurants and goodwill-sensitive reporting units.
- Changes in commodity, labor, advertising, lease, insurance, and health-care costs that could pressure margins.