The Wendy’s Company: Q2 2017 Form 10-Q Summary
Business context and reporting period
The filing covers the 13-week second quarter and 26-week year-to-date period ended July 2, 2017, compared with periods ended July 3, 2016. Wendy’s operated or franchised 6,564 restaurants, including 331 company-operated and 6,233 franchised locations. North America represented virtually all operations and was the company’s single reportable segment.
Financial performance and key metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $320.3 million | $382.7 million | $606.2 million | $761.5 million |
| Operating profit | $25.8 million | $65.6 million | $86.5 million | $129.5 million |
| Net income | $(1.8) million | $26.5 million | $20.5 million | $51.8 million |
| Diluted EPS | $(0.01) | $0.10 | $0.08 | $0.19 |
| Operating margin | 8.0% | 17.2% | 14.3% | 17.0% |
| Restaurant margin | 19.6% | 21.9% | 18.2% | 19.5% |
- Revenue declined primarily because restaurant dispositions reduced company-operated sales by $106.9 million in Q2 and $221.8 million year to date. Franchise royalty revenue and fees increased $23.5 million in Q2 and $29.4 million year to date, while franchise rental income increased $12.4 million and $24.8 million, respectively.
- Systemwide sales increased 4.6% in Q2 and 3.9% for the first six months on a constant-currency basis. Global systemwide sales were $2.64 billion in Q2 and $5.09 billion year to date.
- Global systemwide same-restaurant sales increased 3.2% in Q2 and 2.5% year to date. Company-operated same-restaurant sales increased 1.7% and 1.3%, while franchised same-restaurant sales increased 3.3% and 2.6%.
- Restaurant margin declined because labor rates and commodity costs, particularly chicken costs, increased. Q2 cost of sales rose to 80.4% of company-operated sales from 78.1%.
- Cash provided by operating activities was $120.6 million, compared with $105.8 million in the prior-year period. Capital expenditures were $32.1 million, and cash used in investing activities was $21.5 million.
- Cash and cash equivalents were $204.5 million at July 2, 2017, compared with $198.2 million at January 1, 2017. Net cash used in financing activities was $95.9 million, including $50.5 million of share repurchases and $34.4 million of dividends.
- Current and long-term debt totaled approximately $2.73 billion, excluding other lease-related obligations. Capital lease obligations included in debt were approximately $435.5 million on a present-value basis.
Material changes versus the prior comparable period
- The company’s franchising strategy materially changed the revenue mix: company-operated sales fell, while royalties and rental income increased. The company had completed its planned reduction of company-operated restaurants to approximately 5% of the system by January 1, 2017.
- The DavCo and NPC transactions produced a $43.1 million Q2 loss. Wendy’s acquired 140 restaurants from DavCo for $86.8 million and immediately sold them to NPC for $70.7 million, while retaining certain leases for subleasing.
- System optimization losses shifted from a $1.9 million gain in Q2 2016 to a $41.0 million loss in Q2 2017; the six-month comparison shifted from a $10.4 million gain to a $39.6 million loss.
- Reorganization and realignment costs increased to $17.7 million in Q2 from $2.5 million and to $17.9 million year to date from $5.7 million, primarily because of the May 2017 G&A reduction plan.
- The May 2017 plan is expected to generate approximately $35 million of total G&A savings, with about three-quarters expected by the end of 2018. Expected total costs are $28 million to $33 million, including $23 million to $27 million of cash expenditures, extending into 2019.
- Share repurchases were $52.4 million for the first six months, compared with $109.2 million in the prior-year period. The company had $97.6 million remaining under its $150 million authorization at July 2, 2017.
Outlook, risks, contingencies and unusual items
- Management expected approximately $85 million of total 2017 cash capital expenditures, including $52.9 million for the remainder of the year, and up to approximately $34.1 million of remaining 2017 dividend payments.
- Management stated that available cash and operating cash flows were expected to provide sufficient liquidity for operating requirements over the next 12 months.
- NPC agreed to remodel 90 acquired restaurants by the end of 2021 and build 15 new Wendy’s restaurants by the end of 2022.
- Legal matters include putative consumer and financial-institution class actions and shareholder derivative complaints related to the 2015–2016 payment-card cybersecurity incidents. Accrued legal and environmental matters totaled $2.5 million; the company could not estimate the aggregate possible loss range but did not expect a material effect based on available information and insurance coverage.
- Lease guarantees totaled $58.8 million and outstanding letters of credit totaled $37.5 million, of which $5.7 million was cash collateralized.
- The company identified significant future operating lease payments of $1.59 billion that were not on the balance sheet at the reporting date. Adoption of the new lease standard in fiscal 2019 is expected to materially affect the balance sheet and disclosures.
- Revenue-recognition guidance effective in fiscal 2018 is expected to materially affect the timing of initial franchise-fee recognition and the presentation of national advertising funds.
- Key operating risks include competition, food and labor inflation, franchisee financial health, execution of Image Activation and restaurant development, cybersecurity, legal proceedings, interest rates, debt-service requirements and the timing of restaurant dispositions.
Important facts for investors to verify
- Assess comparable earnings excluding the $43.1 million DavCo/NPC loss and $17.2 million of May-plan charges, while considering that these items affect reported results and cash requirements differently.
- Verify whether franchise royalty growth and rental income offset the long-term revenue and margin effects of reducing company-operated restaurants.
- Monitor restaurant labor and commodity-cost trends, particularly chicken costs, and their effect on restaurant margin.
- Review debt maturities, securitized financing covenants, capital lease obligations and the company’s ability to fund dividends, capital expenditures and share repurchases.
- Track execution of the May 2017 G&A plan, including actual savings, remaining charges and cash expenditures through 2019.
- Evaluate the potential balance-sheet impact of the forthcoming lease and revenue-recognition standards.
- Follow developments in the payment-card litigation and any additional cybersecurity-related costs or claims.