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Lower profits attributed to Wendy's 'reduced gains' in sale of restaurants

The Wendy's Company reported unaudited results for Q1 ended March 29, 2015.

May 6, 2015

The Wendy's Company reported unaudited results for Q1 ended March 29, 2015, according to a company press release.

"Our first-quarter results demonstrate continued progress with Wendy's brand transformation," President and Chief Executive Officer Emil Brolick said in a statement. "We generated an increase in same-restaurant sales of 2.6 percent at Company-operated restaurants and a 160-basis-point year-over-year improvement in restaurant operating margin. Our Image Activation initiative continues to produce solid results, as reimaged restaurants made a strong contribution to Company-operated same-restaurant sales, primarily as a result of increased customer counts.

"In addition to the increase in restaurant operating margin, we achieved a significant improvement in Adjusted EBITDA margin," Brolick said. "This demonstrates the higher quality of earnings that we are generating as a result of our system optimization initiative, which includes increased royalties and rental income, along with a reduction in G&A expense.

"Our previously announced plan to reduce our ownership of Company-operated restaurants also remains on schedule," Brolick said. "Given the success of the first phase of our system optimization initiative, we have re-engaged The Cypress Group to assist with the divestiture of the 540 remaining domestic restaurants targeted for sale to franchisees.

"We also plan to divest our bakery operations, a non-core asset," Brolick said. "We believe this divestiture will provide us with greater sourcing flexibility, focus resources on our core restaurant business and eliminate future bakery capital expenditures. We expect the transaction to close in the second quarter of 2015.

"Our balance sheet recapitalization remains on schedule, and we intend to return the net proceeds from our debt refinancing to shareholders via a share repurchase program.

"Based on our operating results through early May, we are reaffirming our 2015 Adjusted EBITDA and Adjusted Earnings Per Share outlook," Brolick said. "We plan to update our outlook on June 3, to reflect the expected impact of our debt refinancing and anticipated share repurchase program, along with the planned sale of our bakery operations."

First-quarter 2015 summary:

• Same-restaurant sales increased 2.6 percent at North America Company-operated restaurants in the first quarter of 2015, while same-restaurant sales increased 3.4 percent at North America franchise-operated restaurants. Systemwide same-restaurant sales increased 3.2 percent during the first quarter of 2015. Higher sales at reimaged Image Activation restaurants contributed approximately 150 basis points to Company-operated same-restaurant sales results, primarily from increased customer counts.
• Consolidated revenues were $466.2 million in the first quarter of 2015, compared to $523.2 million in the first quarter of 2014. The 10.9 percent decrease resulted from the ownership of 240 fewer Company-operated restaurants at the end of the 2015 first quarter compared to the end of the 2013 fourth quarter, along with lower technical assistance fees attributable to a year-over-year reduction in the number of Company-operated restaurants sold. Partly offsetting this decrease were higher same-restaurant sales and increased rent and royalty revenue.
• North America Company-operated restaurant margin was 14.7 percent in the first quarter of 2015, compared to 13.1 percent in the first quarter of 2014.
• General and administrative expense was $60.3 million in the first quarter of 2015, compared to $70.4 million in the first quarter of 2014. The 14.3 percent decrease resulted primarily from cost savings related to the Company's system optimization initiative and 2014 resource realignment, along with lower equity compensation expense.
• Adjusted EBITDA was $84.0 million in the first quarter of 2015, an 11.6 percent increase compared to first-quarter 2014 Adjusted EBITDA of $75.3 million. The 2014 results exclude $12.0 million in pretax gains, primarily from the sale of restaurants previously not included in the Company's system optimization initiative. (See "Changes to presentation in statement of operations" below.)
• Adjusted EBITDA margin was 18.0 percent in the first quarter of 2015 compared to 14.4 percent in the first quarter of 2014. The 360-basis-point improvement reflects the positive impact of the first phase of the Company's system optimization initiative, including increased royalties and rental income, along with a reduction in G&A expense.
• Operating profit was $52.3 million in the first quarter of 2015, compared to $89.0 million in the first quarter of 2014. The 41.2 percent decrease resulted primarily from year-over year reductions in gains on the sale of Company-operated restaurants, partly offset by a reduction in costs related to the Company's system optimization initiative and a reduction to cost of sales of $12.5 million as a result of the reversal of a liability associated with the bakery's withdrawal from a multi-employer pension plan related to the Company's planned sale of its bakery operations. Also offsetting the decrease in operating profit was a reduction in G&A expense.
• Operating profit margin was 11.2 percent in the first quarter of 2015 compared to 17.0 percent in the first quarter of 2014. The 580 basis-point decrease resulted primarily from year-over year reductions in gains on the sale of Company-operated restaurants, partly offset by the items described above in "operating profit."
• Net income was $27.5 million in the first quarter of 2015, compared to $46.3 million in the first quarter of 2014. The 40.6 percent decrease resulted primarily from year-over year reductions in gains on the sale of Company-operated restaurants, partly offset by the items described above in "operating profit," as well as an 870-basis-point year-over-year decrease in the Company's effective tax rate.
• Adjusted Earnings Per Share were $0.06 in the first quarter of 2015, compared to $0.05 in the first quarter of 2014. The 2014 results exclude certain gains, primarily from the sale of restaurants previously not included in the Company's system optimization initiative. (See "Changes to presentation in statement of operations" below.)
• Reported diluted earnings per share were $0.07 in the first quarter of 2015, compared to $0.12 in the first quarter of 2014. The decrease resulted primarily from year-over year reductions in gains on the sale of Company-operated restaurants.

Wendy's plans to reduce its company-operated restaurant ownership to approximately 5 percent of the total system by the middle of 2016, the announcement said.

"We believe our system optimization initiative will drive future growth by providing opportunities for expanded restaurant ownership to strong operators who have demonstrated a commitment to Image Activation and opening new restaurants," Brolick said. "We believe the sale of our domestic restaurants will result in pretax cash proceeds of approximately $400 to $475 million and significantly reduce future capital expenditure requirements, as reflected in our long-term free cash flow outlook.

"Going forward, we intend to buy and sell restaurants opportunistically to act as a catalyst for growth by further strengthening our franchisee base, driving new restaurant development and accelerating Image Activation adoption," Brolick said.

Wendy's also announced plans to sell its bakery operations in Zanesville, Ohio, with the expectation the transaction will close in May 2015. The Company plans to update its outlook on June 3 to reflect the expected impact of its debt refinancing and anticipated share repurchase program, along with the planned sale of its bakery operations.

Based on its results and current trends in the year to date, the Company now expects:

• Same-restaurant sales growth of 2.5 to 3.0 percent at Company-operated restaurants.
• Company-operated restaurant margin of 16.5 to 17.0 percent, an improvement of approximately 70 to 120 basis points compared to 15.8 percent in 2014. This estimate includes the benefit of same-restaurant sales increases, partly offset by an increase in commodity costs of approximately 1.5 percent (or 40 basis points), driven primarily by higher costs for fresh beef.
• A reported tax rate of approximately 41 to 42 percent. The increase compared to the 2014 reported tax rate of 39.7 percent is primarily due to goodwill disposed of in connection with the sale of Company-operated restaurants which is non-deductible for income tax purposes.

Due to the sale of 640 Company-operated restaurants, the Company expects:

• High single-digit Adjusted Earnings Per Share growth in 2016 and 2017, followed by Adjusted Earnings Per Share growth in the mid-to-high teens in 2018.
• Flattish Adjusted EBITDA in 2016, followed by low-single digit Adjusted EBITDA growth in 2017 and high single-digit Adjusted EBITDA growth in 2018.
• Significantly lower annual capital expenditure requirements, beginning in 2016. The Company expects capital expenditures of approximately $135 to $145 million in 2016, followed by approximately $80 to $90 million in 2017 and approximately $75 million in 2018.

In addition, the Company expects Adjusted EBITDA margins as follows:

• In 2015: 20 to 22 percent
• In 2016: 28 to 30 percent
• In 2017: 32 to 34 percent
• In 2018: approximately 35 percent

The Company also expects to achieve the following system goals by the end of 2020:

• Average unit sales volumes of $2.0 million
• Restaurant margins of 20 percent
• A sales-to-investment ratio of 1.3 times for new restaurants
• Restaurant development growth of 1,000 new restaurants (excluding closures)
• The reimaging of 60 percent of Wendy's North America Systemwide restaurants