The Wendy’s Company — 2018 Q3 Form 10-Q Summary
Business context and reporting period
The filing covers the 13-week quarter and 39-week year-to-date period ended September 30, 2018, compared with October 1, 2017. Wendy’s operates and franchises quick-service restaurants, primarily in North America, and reports one operating segment. The system included 6,669 restaurants at quarter-end: 350 company-operated and 6,319 franchised.
Fiscal 2018 results reflect adoption of new revenue-recognition guidance. National advertising funds are now fully consolidated, adding equal revenue and expense, while certain franchise fees are recognized over the contractual franchise term. Prior periods were not restated.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $400.6 million | $308.0 million | $1,192.1 million | $914.2 million |
| Operating profit | $77.3 million | $61.7 million | $204.1 million | $148.2 million |
| Net income | $391.2 million | $14.3 million | $441.3 million | $34.8 million |
| Diluted EPS | $1.60 | $0.06 | $1.79 | $0.14 |
| Operating cash flow | Not separately provided | Not separately provided | $229.7 million | $160.3 million |
| Restaurant margin | 15.7% | 15.9% | 15.8% | 16.9% |
- Q3 sales increased $6.5 million, or approximately 4%, to $165.3 million; franchise royalty revenue and fees increased $4.3 million to $103.2 million; and franchise rental income increased $0.2 million to $50.5 million.
- Reported advertising funds revenue and expense were each $81.5 million in Q3 and $245.0 million for the first nine months, with no direct operating-profit effect.
- Q3 operating margin was approximately 19.3%, versus approximately 20.0% in the prior-year quarter. The nine-month operating margin was approximately 17.1%, versus 16.2% in 2017.
- Restaurant margin declined because labor rates, insurance and certain operating costs increased faster than sales; strategic menu pricing and lower Q3 commodity costs partly offset the pressure.
- Global systemwide sales were $2.65 billion in Q3 and $7.92 billion year to date. Constant-currency systemwide sales increased 1.7% in Q3 and 2.7% year to date.
- Total systemwide same-restaurant sales were flat in Q3 and increased 1.3% year to date. Company-operated same-restaurant sales increased 1.2% in Q3 and 1.4% year to date, while franchised same-restaurant sales declined 0.1% in Q3 and increased 1.3% year to date.
Cash flow, debt and liquidity
- Cash, cash equivalents and restricted cash totaled $680.8 million at September 30, 2018, including $634.8 million of cash and cash equivalents, compared with $212.8 million at December 31, 2017.
- Year-to-date cash provided by operating activities was $229.7 million. Investing activities provided $391.4 million, primarily because of the $450.0 million sale of the Inspire Brands investment. Financing activities used $151.0 million.
- Total debt, including the current portion, was approximately $2.79 billion on the balance sheet, including $458.3 million of capital lease obligations. Management reported approximately $2.83 billion of debt excluding unamortized issuance costs and purchase-accounting adjustments.
- In January 2018, the company issued $925.0 million of Series 2018-1 senior secured notes at fixed rates of 3.573% and 3.884%, refinanced outstanding notes, and established a $150.0 million variable-funding facility. No amounts were borrowed under the revolving facility during the first nine months.
- The company was in compliance with its debt covenants at September 30, 2018. Management expected available cash and operating cash flow to meet operating requirements for the next 12 months.
- Expected remaining 2018 capital expenditures were approximately $30.0 million to $35.0 million, implying full-year capital expenditures of approximately $70.0 million to $75.0 million. The quarterly dividend was $0.085 per share.
Material changes versus the prior comparable period
- Net income increased by $376.9 million in Q3 and $406.5 million year to date, primarily due to the $450.0 million gain from selling Wendy’s 12.3% interest in Inspire Brands. The company expected approximately $95.0 million of related income-tax payments in Q4 2018.
- Operating profit increased $15.6 million in Q3 and $55.9 million year to date. The year-to-date comparison benefited from the absence of the $43.1 million loss associated with the 2017 DavCo and NPC transactions.
- General and administrative expense declined $5.2 million in Q3 and $7.0 million year to date, reflecting lower incentive compensation, staffing changes and professional fees.
- Reorganization and realignment costs fell to $0.9 million in Q3 and $6.7 million year to date, compared with $2.9 million and $20.8 million, respectively, in the prior periods.
- The company repurchased 6.9 million shares for $118.9 million during the first nine months and paid $60.8 million in dividends. A further 1.6 million shares were repurchased for $27.3 million through October 31, 2018.
- The company acquired 16 restaurants from a franchisee for $21.4 million during the first nine months and completed the sale of three company-operated restaurants.
Guidance, outlook, commentary and risks
- Management identified long-term growth opportunities in same-restaurant sales, the Image Activation remodeling program, new restaurant development, increased daypart and mobile utilization, financial management and continued system optimization.
- The G&A realignment plan is expected to produce approximately $35.0 million of total expense reductions, with roughly three-quarters expected by the end of 2018 and the remainder in 2019. Additional plan costs were estimated at approximately $4.5 million, with costs continuing into 2019.
- The company expects to continue quarterly dividends, but future declarations and amounts are not guaranteed. The August 2018 repurchase authorization was subsequently increased by $120.0 million to $220.0 million.
- Key risks include intense competition and pricing pressure, commodity and labor inflation, food safety, franchisee financial condition, restaurant development and remodeling execution, adverse economic or weather conditions, cybersecurity incidents, legal proceedings, lease obligations, debt-service and covenant requirements, and future accounting changes.
- Operating lease payments not recorded on the balance sheet totaled $1.55 billion in future minimum payments at September 30, 2018. The company expected the new lease standard effective in fiscal 2019 to materially increase reported assets and liabilities.
- Legal matters include consumer and financial-institution litigation related to the 2016 payment-card cybersecurity incident. A preliminary settlement in the consumer case was approved, while the financial-institution case remained pending; the company could not estimate the aggregate possible loss.
Most important facts for investors to verify
- Separate recurring operating performance from the $450.0 million one-time Inspire Brands gain when assessing earnings quality and valuation.
- Adjust revenue comparisons for the 2018 consolidation of advertising funds and the non-restated prior period.
- Monitor restaurant margin, labor and commodity costs, and the slowdown in Q3 same-restaurant sales.
- Review the refinancing terms, anticipated repayment dates, capital lease obligations, covenants and fixed-rate debt exposure.
- Assess cash requirements for the expected fourth-quarter tax payment, capital expenditures, dividends and share repurchases.
- Evaluate the effect of fiscal 2019 lease accounting adoption on leverage, assets, liabilities and disclosures.
- Track the cybersecurity-related litigation, lease guarantees of $51.3 million, outstanding letters of credit of $27.1 million and other legal contingencies.