Business Context and Reporting Period
The Wendy’s Company filed a combined Form 10-K with wholly owned subsidiary Wendy’s Restaurants, LLC for the 52-week fiscal year ended January 1, 2012. The filing is an annual report, not a standalone quarterly filing; the fourth quarter ended January 1, 2012 contained 13 weeks. Following the July 4, 2011 sale of Arby’s, continuing operations are substantially the Wendy’s brand. Arby’s results are presented as discontinued operations.
At year-end, the Wendy’s system had 6,594 restaurants: 1,417 company-owned and 5,177 franchised. North America represented virtually all operating activity.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $2,431.4 million | $2,375.4 million | +2.4% |
| Operating profit | $137.1 million | $150.4 million | -8.8% |
| Operating margin | 5.6% | 6.3% | Down approximately 0.7 percentage points |
| Income from continuing operations | $17.9 million | $18.1 million | -1.1% |
| Net income | $9.9 million | $(4.3) million | Improved by $14.2 million |
| Diluted earnings per share | $0.02 | $(0.01) | Improved |
| Cash flow from operating activities | $246.7 million | $226.3 million | +$20.5 million |
| Capital expenditures | $146.8 million | $148.0 million | Slightly lower |
| Cash and cash equivalents | $475.2 million | $512.5 million | -$37.3 million |
| Total debt, including current portion | $1,357.0 million | $1,572.4 million | -$215.4 million |
Wendy’s restaurant margin declined to 14.0% from 14.8%, primarily because commodity costs increased. North America same-store sales increased 1.9% systemwide, including 2.0% for company-owned restaurants and 1.9% for franchised restaurants. Company-owned average unit volume increased to approximately $1.46 million from $1.42 million.
The company reported $2,050.1 million of Wendy’s restaurant sales, $74.3 million of bakery sales, $280.5 million of royalty income and $24.3 million of other franchise-related and other revenue. Royalties generally were 4% of franchise sales.
Material Changes Versus the Prior Comparable Period
- Revenue increased $56.0 million, driven primarily by positive same-store sales, higher average checks, increased transactions, pricing and new products. Canadian currency translation contributed $9.4 million to sales.
- Operating profit declined despite higher revenue because cost of sales increased $59.1 million and restaurant margin contracted. Food and paper costs increased 0.9 percentage points of sales, including a 1.4-point commodity-cost impact partly offset by pricing.
- General and administrative expense declined $19.1 million, reflecting lower SSG and franchise incentive costs, reimbursement of certain transition-service costs and completion of merger integration activities.
- 2011 included $45.7 million of transaction-related and other costs and $12.9 million of long-lived asset impairment charges. The transaction costs primarily related to the Arby’s sale, executive severance and relocation of the Atlanta support center to Ohio.
- Arby’s was sold for $130 million of cash, a retained 18.5% interest valued at $19 million, and assumption by the buyer of approximately $190 million of Arby’s debt. The sale generated net proceeds of $97.9 million after adjustments and costs and an $8.8 million after-tax loss from discontinued operations.
- Debt declined primarily because approximately $190 million of Arby’s debt was assumed by the buyer. The company also repaid $37.3 million of long-term debt, including a $24.9 million excess-cash-flow prepayment.
- The company repurchased 31.0 million shares for $157.0 million, excluding commissions, and paid $32.4 million of dividends. The repurchase authorization expired at fiscal year-end.
Liquidity, Debt and Cash Flow
- Operating cash flow was $246.7 million, compared with $146.8 million of cash capital expenditures. Cash used in investing activities was $58.2 million, including capital expenditures, restaurant acquisitions and franchise incentive loans, partly offset by Arby’s sale proceeds.
- Cash used in financing activities was $224.6 million, primarily reflecting share repurchases, dividends and debt repayments.
- Wendy’s Restaurants had $1,345.7 million of debt, consisting principally of $554.9 million of 10% Senior Notes due 2016, a $466.1 million Term Loan due 2017, $224.6 million of 6.20% senior notes due 2014 and $82.3 million of 7% debentures due 2025. The parent company had an additional $11.3 million aircraft term loan.
- The $500 million senior secured Term Loan had a 5.00% interest rate at year-end. The $150 million revolving facility was available subject to applicable covenants and included a $70 million letter-of-credit subfacility.
- Management stated that cash flows from Wendy’s operations and available cash were expected to meet operating requirements for the next 12 months. Under credit-agreement restrictions, $77.7 million was available for dividends directly to The Wendy’s Company at year-end.
- Total contractual obligations were $3.12 billion, including $1.88 billion of long-term debt payments, $958.7 million of operating leases, $193.6 million of purchase obligations and $89.8 million of guarantees and letters of credit.
Guidance, Outlook, Risks and Unusual Items
Management expected 2012 sales and franchise revenue to benefit from core-menu improvements, product innovation, customer-experience initiatives, brand positioning and breakfast development. The net impact of restaurant openings and closings was not expected to be significant. Commodity inflation was expected to pressure cost of sales, while depreciation and amortization was expected to increase with planned capital investment.
Management expected approximately $225 million of 2012 cash capital expenditures, including remodeling approximately 50 company-owned restaurants, opening approximately 20 company-owned restaurants, maintenance and information-technology projects. Approximately $23 million of additional 2012 transaction-related costs was expected for closing and relocating the Atlanta support center, with activities substantially complete by the third quarter.
- Key risks include intense price and promotional competition, consumer spending and traffic trends, food and commodity costs, labor costs, food safety, supply interruptions, franchisee financial condition and execution, and the success of the breakfast initiative.
- The company is highly leveraged, and debt agreements impose financial covenants and restrictions on dividends, asset sales, investments, additional debt and subsidiary distributions. Wendy’s Restaurants reported compliance with its covenants at year-end.
- Guarantee exposure included $54.8 million of lease guarantees and contingent rent, $13.7 million of franchisee loan recourse and $21.3 million of letters of credit. The company also reported approximately $2.9 million of obligations related to the Japan joint venture and anticipated potentially up to $5 million of additional guarantees in 2012.
- Wendy’s recorded $2.1 million of discontinued-operations accruals for certain tax liabilities related to periods before the Arby’s sale and stated that additional accruals could arise as tax audits are resolved.
- A disputed tax matter with Tim Hortons involved Wendy’s claim of approximately $1 million and Tim Hortons’ claims of approximately C$29 million. The filing states that the potential loss could not be estimated.
- The North America goodwill reporting unit passed its impairment test, but its estimated fair value exceeded carrying value by only approximately 10%, leaving sensitivity to adverse changes in cash-flow projections, economic conditions or competition.
Investor Verification Priorities
- Verify the quality and durability of the 1.9% systemwide same-store sales increase and whether pricing, transactions and commodity inflation support or weaken future restaurant margins.
- Reconcile reported earnings with the $45.7 million of transaction-related costs, $12.9 million of impairment charges and discontinued-operations effects.
- Assess debt maturities, interest-rate exposure, covenant headroom and the ability of Wendy’s Restaurants to upstream cash to the parent, particularly given the large 2014 and 2016 obligations.
- Track execution and returns on the planned $225 million of 2012 capital expenditures, remodeling program, new units and breakfast expansion.
- Monitor the Atlanta support-center relocation, expected $23 million of 2012 costs and potential redundant staffing or execution disruption.
- Review contingent obligations, franchisee guarantees, lease exposure, tax indemnities from the Arby’s sale and the unresolved Tim Hortons dispute.
- Confirm that future cash dividends remain permitted under subsidiary debt covenants and are supported by subsidiary cash generation.