Wendy's Co 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Introduction This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of The Wendy’s Company (“The Wendy’s Company” and, together with its subsidiaries, the “Company,” “we,” “us,” or “our”) should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the related notes included elsewhere within this report and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 29, 2019 (the “Form 10-K”). There have been no material changes as of June 28, 2020 to the application of our critical accounting policies as described in Item 7 of the Form 10-K. Certain statements we make under this Item 2 constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. See “Special Note Regarding Forward-Looking Statements and Projections” in “Part II. Other Information” of this report. You should consider our forward-looking statements in light of the risks discussed in “Item 1A. Risk Factors” in “Part II. Other Information” of this report and our unaudited condensed consolidated financial statements, related notes and other financial information appearing elsewhere in this report, the Form 10-K and our other filings with the Securities and Exchange Commission (the “SEC”). The Wendy’s Company is the parent company of its 100% owned subsidiary holding company, Wendy’s Restaurants, LLC (“Wendy’s Restaurants”). The principal 100% owned subsidiary of Wendy’s Restaurants is Wendy’s International, LLC and its subsidiaries (“Wendy’s”). Wendy’s is primarily engaged in the business of operating, developing and franchising a system of distinctive quick-service restaurants serving high quality food. Wendy’s opened its first restaurant in Columbus, Ohio in 1969. Today, Wendy’s is the world’s third largest quick-service restaurant company in the hamburger sandwich segment, with 6,806 restaurants in the United States (the “U.S.”) and 30 foreign countries and U.S. territories as of June 28, 2020. Each Wendy’s restaurant offers an extensive menu specializing in hamburger sandwiches and featuring filet of chicken breast sandwiches, which are prepared to order with the customer’s choice of condiments. Wendy’s menu also includes chicken nuggets, chili, french fries, baked potatoes, freshly prepared salads, soft drinks, Frosty ® desserts and kids’ meals. In addition, the restaurants sell a variety of promotional products on a limited time basis. Wendy’s also entered the breakfast daypart across the U.S. system on March 2, 2020. Wendy’s breakfast menu features a variety of breakfast sandwiches, biscuits and croissants, sides such as seasoned potatoes, oatmeal bars and seasonal fruit, and a beverage platform that includes hot coffee, cold brew iced coffee and our vanilla and chocolate Frosty-ccino iced coffee. The Company is comprised of the following segments: (1) Wendy’s U.S., (2) Wendy’s International and (3) Global Real Estate & Development. Wendy’s U.S. includes the operation and franchising of Wendy’s restaurants in the U.S. and derives its revenues from sales at Company-operated restaurants and royalties, fees and advertising fund collections from franchised restaurants. Wendy’s International includes the franchising of Wendy’s restaurants in countries and territories other than the U.S. and derives its revenues from royalties, fees and advertising fund collections from franchised restaurants. Global Real Estate & Development includes real estate activity for owned sites and sites leased from third parties, which are leased and/or subleased to franchisees, and also includes our share of the income of our TimWen real estate joint venture. In addition, Global Real Estate & Development earns fees from facilitating franchisee-to-franchisee restaurant transfers (“Franchise Flips”) and providing other development-related services to franchisees. In this Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Company reports on the segment profit for each of the three segments described above. The Company measures segment profit based on segment adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”). Segment adjusted EBITDA excludes certain unallocated general and administrative expenses and other items that vary from period to period without correlation to the Company’s core operating performance. See “Results of Operations” below and Note 19 to the Condensed Consolidated Financial Statements contained in Item 1 herein for segment financial information. The Company’s fiscal reporting periods consist of 52 or 53 weeks ending on the Sunday closest to December 31. All three- and six-month periods presented herein contain 13 weeks and 26 weeks, respectively. All references to years and quarters relate to fiscal periods rather than calendar periods. 29 Executive Overview Our Business As of June 28, 2020, the Wendy’s restaurant system was comprised of 6,806 restaurants, with 5,862 Wendy’s restaurants in operation in the U.S. Of the U.S. restaurants, 358 were operated by the Company and 5,504 were operated by a total of 239 franchisees. In addition, at June 28, 2020, there were 944 Wendy’s restaurants in operation in 30 foreign countries and U.S. territories, all of which were franchised. The revenues from our restaurant business are derived from two principal sources: (1) sales at Company-operated restaurants and (2) franchise-related revenues, including royalties, national advertising funds contributions, rents and franchise fees received from Wendy’s franchised restaurants. Company-operated restaurants comprised approximately 5% of the total Wendy’s system as of June 28, 2020. Wendy’s operating results are impacted by a number of external factors, including commodity costs, labor costs, intense price competition, unemployment and consumer spending levels, general economic and market trends and weather. The COVID-19 pandemic has had and may continue to have the effect of heightening the impact of many of these factors. See “COVID-19 Update” and “Special Note Regarding Forward-Looking Statements and Projections” below for additional information. Wendy’s long-term growth opportunities include accelerating U.S. same-restaurant sales through (1) its “One More Visit, One More Dollar” strategy, which includes continuing core menu improvement, product innovation and strategic price increases on our menu items, (2) focused execution of operational excellence, (3) continued implementation of consumer-facing digital platforms and technologies and (4) increased restaurant utilization in various dayparts, including the Company’s launch of breakfast across the U.S. system on March 2, 2020. Wendy’s also expects growth in the number of new restaurants through targeted U.S. expansion and accelerated international expansion through same-restaurant sales growth and new restaurant development. Key Business Measures We track our results of operations and manage our business using the following key business measures, which includes a non-GAAP financial measure: • Same-Restaurant Sales - We report same-restaurant sales commencing after new restaurants have been open for 15 continuous months and as soon as reimaged restaurants reopen. Restaurants temporarily closed for more than one fiscal week are excluded from same-restaurant sales. This methodology is consistent with the metric used by our management for internal reporting and analysis. The table summarizing same-restaurant sales below in “Results of Operations” provides the same-restaurant sales percent changes. • Restaurant Margin - We define restaurant margin as sales from Company-operated restaurants less cost of sales divided by sales from Company-operated restaurants. Cost of sales includes food and paper, restaurant labor and occupancy, advertising and other operating costs. Restaurant margin is influenced by factors such as price increases, the effectiveness of our advertising and marketing initiatives, featured products, product mix, fluctuations in food and labor costs, restaurant openings, remodels and closures and the level of our fixed and semi-variable costs. • Systemwide Sales - Systemwide sales is a non-GAAP financial measure, which includes sales by both Company-operated restaurants and franchised restaurants. Franchised restaurants’ sales are reported by our franchisees and represent their revenues from sales at franchised Wendy’s restaurants. The Company’s consolidated financial statements do not include sales by franchised restaurants to their customers. The Company believes systemwide sales data is useful in assessing consumer demand for the Company’s products, the overall success of the Wendy’s brand and, ultimately, the performance of the Company. The Company’s royalty revenues are computed as percentages of sales made by Wendy’s franchisees. As a result, sales by Wendy’s franchisees have a direct effect on the Company’s royalty revenues and profitability. The Company calculates same-restaurant sales and systemwide sales growth on a constant currency basis. Constant currency results exclude the impact of foreign currency translation and are derived by translating current year results at prior year average exchange rates. The Company believes excluding the impact of foreign currency translation provides better year over year comparability. 30 Same-restaurant sales and systemwide sales exclude sales from Argentina and Venezuela due to the highly inflationary economies of those countries. The Company considers economies that have had cumulative inflation in excess of 100% over a three-year period as highly inflationary. The non-GAAP financial measure discussed above does not replace the presentation of the Company’s financial results in accordance with GAAP. Because all companies do not calculate non-GAAP financial measures in the same way, this measure as used by other companies may not be consistent with the way the Company calculates such measure. COVID-19 Update On March 11, 2020, the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended containment and mitigation measures worldwide. We continue to monitor the dynamic nature of the COVID-19 pandemic on our business, results and financial condition; however, we cannot predict whether, when or the manner in which the conditions surrounding the pandemic will change and cannot currently estimate the impact on our business in the short or long-term. In response to the pandemic, in March 2020, Wendy’s updated its brand standard to include the closure of all dining rooms except where there were specific needs, or a drive-thru or pick-up window option was not available, subject to applicable federal, state and local requirements. Substantially all Wendy’s restaurants continued to offer drive-thru and delivery service to our customers. During the second quarter of 2020, the Company began to implement its restaurant and dining room reopening process through a phased approach in accordance with federal, state and local requirements, with customer and team member safety as its top priority. Dining rooms have been re-opening at each restaurant owner’s discretion, subject to applicable regulatory restrictions. As of August 2, 2020, over 70% of dining rooms were open across the Wendy’s system offering carryout and, in some cases, dine in services. The COVID-19 pandemic has resulted in the temporary closure of certain restaurants across the Wendy’s system. As of August 2, 2020, systemwide temporary restaurant closures totaled 34 and 93 in the U.S. and internationally, respectively, which represents approximately 2% of all system restaurants. The following table shows same-restaurant sales for the fiscal months of January through June 2020: January through February March April May June Same-restaurant sales: U.S. systemwide 3.7 % (7.7) % (14.0) % (1.9) % 5.1 % International 5.4 % (17.0) % (28.3) % (15.7) % (10.7) % Global systemwide 3.9 % (8.6) % (15.3) % (3.3) % 3.4 % As a result of the COVID-19 pandemic, global systemwide same-restaurant sales began to be materially adversely impacted in the fiscal month of March, with the fiscal month of April seeing the greatest impact. The decrease in same-restaurant sales was driven by a significant decline in customer count, partially offset by an increase in average check. Subsequently, global same-restaurant sales improved during the fiscal months of May and June, despite being impacted by the previously disclosed disruption in beef supply at the beginning of May (see “Beef Supply Update” below for further information). The improvement in same-restaurant sales was primarily driven by a significant increase in customer traffic compared to the lows seen in March and April. Global same-restaurant sales continued to improve during the fiscal month of July, with U.S. systemwide same-restaurant sales increasing 8.2%. The negative impact of the COVID-19 pandemic on same-restaurant sales has been partially offset by the Company’s entry into the breakfast daypart across the U.S. system on March 2, 2020. Breakfast represented approximately 8% of U.S. systemwide sales in the second quarter of 2020. Due to the current unprecedented market and economic conditions in the U.S. and internationally, the expected impact of the COVID-19 pandemic on the Company’s 2020 net income and cash flows cannot be reasonably estimated. Our net income and cash flows for the remainder of 2020 could continue to be materially affected by the pandemic. See “Item 1A. Risk 31 Factors” in “Part II. Other Information” for further information regarding the risks associated with the COVID-19 pandemic and the impact on our business, results and financial condition. Also, see “Liquidity and Capital Resources” below for certain actions taken by the Company in response to the COVID-19 pandemic. Beef Supply Update As previously disclosed, the Company experienced disruptions to its beef supply beginning in early May as beef suppliers across North America faced production challenges. As a result, some menu items were occasionally in short supply at some Wendy’s system restaurants. The Company and its supply chain partners effectively managed through this disruption by allocating beef to all Wendy’s system restaurants, with deliveries occurring two or three times a week, consistent with normal delivery schedules. The Company also shifted its marketing efforts in the short term to focus on chicken products in an effort to alleviate pressure on beef demand. Beef supply has returned to normal levels across the Wendy’s system as of June 28, 2020. Goodwill and Indefinite-Lived Intangible Assets We test goodwill for impairment annually, or more frequently if events or changes in circumstances indicate that it may be impaired. The negative impacts of the COVID-19 pandemic, including the decline in same-restaurant sales described above and the volatility in the price of our common stock, resulted in the Company testing its goodwill for impairment in March 2020. A goodwill impairment loss is recognized if the fair value of a reporting unit is less than its carrying value. The Company’s goodwill impairment test in March 2020 included three reporting units, which were comprised of its (1) U.S. Company-operated and franchise restaurants, (2) Canada franchise restaurants and (3) global real estate and development operations. Based on the results of our goodwill impairment test, we determined the fair values of our U.S. Company-operated and franchise restaurants and our Canada franchise restaurants reporting units continued to significantly exceed their carrying values. The goodwill impairment test for our global real estate and development operations also indicated the fair value of the reporting unit exceeded its carrying value; however, the fair value exceeded the carrying value of the reporting unit by only a nominal amount. Given the limited excess of the fair value over carrying value, this reporting unit is more sensitive to changes in assumptions regarding its fair value. As of the date of our analysis in the first quarter of 2020, a 50 basis point increase in the discount rate, or a moderate decline in estimated future cash flows, would result in the fair value of the reporting unit being less than its carrying value. As of June 28, 2020, the goodwill balance associated with our global real estate and development operations was $122.5 million. The Company also tested our indefinite-lived intangible assets, which represent trademarks, for impairment in March 2020. Based on the results of our impairment test, we determined the fair value of our trademarks continued to significantly exceed their carrying value. Further adverse changes as a result of the COVID-19 pandemic could further reduce the underlying cash flows used to estimate fair values and could result in a decline in fair value that could result in future impairment charges of goodwill and indefinite-lived intangible assets. Information Technology (“IT”) Realignment In December 2019, our Board of Directors approved a plan to realign and reinvest resources in the Company’s IT organization to strengthen its ability to accelerate growth. The Company is partnering with a third-party global IT consultant on this new structure to leverage their global capabilities, which the Company believes will enable a more seamless integration between its digital and corporate IT assets. The Company expects that the realignment plan will reduce certain employee compensation and other related costs that the Company intends to reinvest back into IT to drive additional capabilities and capacity across all of its technology platforms. Additionally, in June 2020, the Company made changes to its leadership structure that included the creation of a Chief Information Officer position and the elimination of the Chief Digital Experience Officer position. As a result, the Company now expects to incur total costs aggregating approximately $16.0 million to $17.0 million related to the plan. During the six months ended June 28, 2020, the Company recognized costs totaling $6.4 million, which primarily included third-party and other costs and severance and related employee costs. The Company expects to incur additional costs aggregating approximately $1.0 million, comprised primarily of recruitment and relocation costs. The Company expects to recognize the majority of the remaining costs associated with the plan during the remainder of 2020. 32 Results of Operations The tables included throughout this Results of Operations set forth in millions the Company’s condensed consolidated results of operations for the second quarter and the first six months of 2020 and 2019. Second Quarter Six Months 2020 2019 Change 2020 2019 Change Revenues: Sales $ 164.2 $ 181.1 $ (16.9) $ 331.0 $ 348.7 $ (17.7) Franchise royalty revenue and fees 103.1 109.1 (6.0) 204.9 211.1 (6.2) Franchise rental income 56.9 58.5 (1.6) 114.7 117.0 (2.3) Advertising funds revenue 78.1 86.6 (8.5) 156.7 167.1 (10.4) 402.3 435.3 (33.0) 807.3 843.9 (36.6) Costs and expenses: Cost of sales 140.6 151.1 (10.5) 290.6 293.7 (3.1) Franchise support and other costs 5.5 4.0 1.5 13.5 10.1 3.4 Franchise rental expense 31.3 28.0 3.3 60.6 60.5 0.1 Advertising funds expense 81.3 88.7 (7.4) 161.3 169.1 (7.8) General and administrative 48.6 50.8 (2.2) 100.2 100.1 0.1 Depreciation and amortization 34.7 31.5 3.2 65.8 64.7 1.1 System optimization gains, net (2.0) (0.1) (1.9) (2.3) (0.1) (2.2) Reorganization and realignment costs 2.9 3.6 (0.7) 6.8 4.4 2.4 Impairment of long-lived assets 0.1 0.2 (0.1) 4.7 1.7 3.0 Other operating income, net (1.4) (3.1) 1.7 (3.3) (7.1) 3.8 341.6 354.7 (13.1) 697.9 697.1 0.8 Operating profit 60.7 80.6 (19.9) 109.4 146.8 (37.4) Interest expense, net (29.1) (29.9) 0.8 (57.6) (59.0) 1.4 Loss on early extinguishment of debt — (7.2) 7.2 — (7.2) 7.2 Other (expense) income, net (0.2) 2.2 (2.4) 0.9 5.0 (4.1) Income before income taxes 31.4 45.7 (14.3) 52.7 85.6 (32.9) Provision for income taxes (6.5) (13.3) 6.8 (13.4) (21.3) 7.9 Net income $ 24.9 $ 32.4 $ (7.5) $ 39.3 $ 64.3 $ (25.0) 33 Second Quarter Six Months 2020 % of Total Revenues 2019 % of Total Revenues 2020 % of Total Revenues 2019 % of Total Revenues Revenues: Sales $ 164.2 40.8 % $ 181.1 41.6 % $ 331.0 41.0 % $ 348.7 41.3 % Franchise royalty revenue and fees: Royalty revenue 97.2 24.2 % 102.8 23.6 % 192.6 23.9 % 197.7 23.4 % Franchise fees 5.9 1.4 % 6.3 1.5 % 12.3 1.5 % 13.4 1.6 % Total franchise royalty revenue and fees 103.1 25.6 % 109.1 25.1 % 204.9 25.4 % 211.1 25.0 % Franchise rental income 56.9 14.2 % 58.5 13.4 % 114.7 14.2 % 117.0 13.9 % Advertising funds revenue 78.1 19.4 % 86.6 19.9 % 156.7 19.4 % 167.1 19.8 % Total revenues $ 402.3 100.0 % $ 435.3 100.0 % $ 807.3 100.0 % $ 843.9 100.0 % Second Quarter Six Months 2020 % of Sales 2019 % of Sales 2020 % of Sales 2019 % of Sales Cost of sales: Food and paper $ 49.3 30.0 % $ 57.8 31.9 % $ 101.8 30.8 % $ 110.0 31.5 % Restaurant labor 54.0 32.9 % 53.8 29.7 % 111.0 33.5 % 105.4 30.2 % Occupancy, advertising and other operating costs 37.3 22.7 % 39.5 21.9 % 77.8 23.5 % 78.3 22.5 % Total cost of sales $ 140.6 85.6 % $ 151.1 83.5 % $ 290.6 87.8 % $ 293.7 84.2 % Second Quarter Six Months 2020 % of Sales 2019 % of Sales 2020 % of Sales 2019 % of Sales Restaurant margin $ 23.6 14.4 % $ 30.0 16.5 % $ 40.4 12.2 % $ 55.0 15.8 % The tables below present certain of the Company’s key business measures, which are defined and further discussed in the “Executive Overview” section included herein. Second Quarter Six Months 2020 2019 2020 2019 Key business measures: U.S. same-restaurant sales: Company-operated restaurants (10.0) % 0.8 % (5.5) % 1.4 % Franchised restaurants (4.0) % 1.4 % (2.0) % 1.3 % Systemwide (4.4) % 1.3 % (2.3) % 1.3 % International same-restaurant sales (a) (18.4) % 3.9 % (10.1) % 3.3 % Global same-restaurant sales: Company-operated restaurants (10.0) % 0.8 % (5.5) % 1.4 % Franchised restaurants (a) (5.5) % 1.6 % (2.9) % 1.5 % Systemwide (a) (5.8) % 1.6 % (3.1) % 1.5 % ________________ 34 (a) Includes international franchised restaurants same-restaurant sales (excluding Argentina and Venezuela due to the impact of the highly inflationary economies of those countries). Second Quarter Six Months 2020 2019 2020 2019 Key business measures (continued): Systemwide sales: (a) Company-operated $ 164.2 $ 181.1 $ 331.0 $ 348.7 U.S. franchised 2,239.2 2,321.6 4,413.4 4,471.9 U.S. systemwide 2,403.4 2,502.7 4,744.4 4,820.6 International franchised (b) 220.2 301.0 492.8 574.3 Global systemwide $ 2,623.6 $ 2,803.7 $ 5,237.2 $ 5,394.9 ________________ (a) During the second quarter of 2020 and 2019, global systemwide sales decreased 6.2% and increased 3.3%, respectively, U.S. systemwide sales decreased 4.0% and increased 2.5%, respectively, and international franchised sales decreased 24.5% and increased 10.4%, respectively, on a constant currency basis. During the first six months of 2020 and 2019, global systemwide sales decreased 2.7% and increased 3.3%, respectively, U.S. systemwide sales decreased 1.6% and increased 2.5%, respectively, and international franchised sales decreased 12.4% and increased 10.3%, respectively, on a constant currency basis. (b) Excludes Argentina and Venezuela due to the impact of the highly inflationary economies of those countries. Second Quarter Company-operated U.S. Franchised International Franchised Systemwide Restaurant count: Restaurant count at March 29, 2020 358 5,503 944 6,805 Opened 2 17 3 22 Closed (a) (2) (16) (3) (21) Restaurant count at June 28, 2020 358 5,504 944 6,806 Six Months Company-operated U.S. Franchised International Franchised Systemwide Restaurant count at December 29, 2019 357 5,495 936 6,788 Opened 3 43 17 63 Closed (a) (2) (34) (9) (45) Restaurant count at June 28, 2020 358 5,504 944 6,806 ________________ (a) Excludes restaurants temporarily closed due to the impact of the COVID-19 pandemic. Sales Second Quarter Six Months 2020 2019 Change 2020 2019 Change Sales $ 164.2 $ 181.1 $ (16.9) $ 331.0 $ 348.7 $ (17.7) The decrease in sales for the second quarter and the first six months of 2020 was primarily due to a 10.0% and 5.5% decrease in Company-operated same-restaurant sales, respectively. Company-operated same-restaurant sales decreased due to a decrease in customer count as a result of the COVID-19 pandemic, partially offset by (1) higher average check and (2) the positive impact from the launch of breakfast on March 2, 2020. 35 Franchise Royalty Revenue and Fees Second Quarter Six Months 2020 2019 Change 2020 2019 Change Royalty revenue $ 97.2 $ 102.8 $ (5.6) $ 192.6 $ 197.7 $ (5.1) Franchise fees 5.9 6.3 (0.4) 12.3 13.4 (1.1) $ 103.1 $ 109.1 $ (6.0) $ 204.9 $ 211.1 $ (6.2) The decrease in franchise royalty revenue during the second quarter and the first six months of 2020 was primarily due to a 5.5% and 2.9% decrease in franchise same-restaurant sales, respectively, which reflects the impact of the COVID-19 pandemic, partially offset by the positive impact from the launch of breakfast on March 2, 2020. The decrease in franchise fees during the second quarter and the first six months of 2020 was primarily due to lower other miscellaneous franchise fees. Franchise Rental Income Second Quarter Six Months 2020 2019 Change 2020 2019 Change Franchise rental income $ 56.9 $ 58.5 $ (1.6) $ 114.7 $ 117.0 $ (2.3) The decrease in franchise rental income during the second quarter was primarily due to amending certain existing leases, partially offset by the impact of assigning certain leases to a franchisee during the second quarter of 2019. The decrease in franchise rental income during the first six months of 2020 was primarily due to amending certain existing leases and the impact of assigning certain leases to a franchisee. Advertising Funds Revenue Second Quarter Six Months 2020 2019 Change 2020 2019 Change Advertising funds revenue $ 78.1 $ 86.6 $ (8.5) $ 156.7 $ 167.1 $ (10.4) The Company maintains two national advertising funds established to collect and administer funds contributed for use in advertising and promotional programs for Company-operated and franchised restaurants in the U.S. and Canada. Franchisees make contributions to the national advertising funds based on a percentage of sales of the franchised restaurants. The decrease in advertising funds revenue during the second quarter and the first six months of 2020 was primarily due to a decrease in franchise same-restaurant sales as a result of the COVID-19 pandemic. Cost of Sales, as a Percent of Sales Second Quarter Six Months 2020 2019 Change 2020 2019 Change Food and paper 30.0 % 31.9 % (1.9) % 30.8 % 31.5 % (0.7) % Restaurant labor 32.9 % 29.7 % 3.2 % 33.5 % 30.2 % 3.3 % Occupancy, advertising and other operating costs 22.7 % 21.9 % 0.8 % 23.5 % 22.5 % 1.0 % 85.6 % 83.5 % 2.1 % 87.8 % 84.2 % 3.6 % The increase in cost of sales, as a percent of sales, during the second quarter and the first six months of 2020 was primarily due to (1) a decrease in customer count, reflecting the impact of the COVID-19 pandemic, and (2) restaurant labor rate increases, which included incremental recognition pay during April and May. These impacts were partially offset by (1) higher average check and (2) labor efficiencies and other dining room closure related efficiencies. 36 Franchise Support and Other Costs Second Quarter Six Months 2020 2019 Change 2020 2019 Change Franchise support and other costs $ 5.5 $ 4.0 $ 1.5 $ 13.5 $ 10.1 $ 3.4 The increase in franchise support and other costs during the second quarter was primarily due to higher costs incurred to provide information technology and other services to our franchisees. The increase in franchise support and other costs during the first six months of 2020 was primarily due to (1) investments to support U.S. franchisees in preparation of the launch of breakfast across the U.S. system on March 2, 2020 and (2) higher costs incurred to provide information technology and other services to our franchisees. Franchise Rental Expense Second Quarter Six Months 2020 2019 Change 2020 2019 Change Franchise rental expense $ 31.3 $ 28.0 $ 3.3 $ 60.6 $ 60.5 $ 0.1 The increase in franchise rental expense during the second quarter and the first six months of 2020 was primarily due to the impact of assigning certain leases to a franchisee in 2019. Advertising Funds Expense Second Quarter Six Months 2020 2019 Change 2020 2019 Change Advertising funds expense $ 81.3 $ 88.7 $ (7.4) $ 161.3 $ 169.1 $ (7.8) The decrease in advertising funds expense during the second quarter and the first six months of 2020 was primarily due to the same factor as described above for “Advertising Funds Revenue.” On an interim basis, advertising funds expense is recognized in proportion to advertising funds revenue. During the second quarter and the first six months of 2020, advertising funds expense exceeded advertising funds revenue by $3.2 million and $4.6 million, respectively, reflecting a portion of the expected advertising spend in excess of advertising funds revenue for 2020. The second quarter and the first six months of 2020 include $2.2 million related to the Company’s decision in June to fund incremental advertising during 2020. The excess of advertising funds expense over advertising funds revenue for 2020 is expected to be approximately $20.0 million, which includes (1) up to $15.0 million of Company funding of incremental advertising and (2) the amount by which advertising funds revenue exceeded advertising funds expense in 2019 and 2018 of approximately $5.0 million. General and Administrative Second Quarter Six Months 2020 2019 Change 2020 2019 Change Employee compensation and related benefits $ 26.9 $ 27.7 $ (0.8) $ 57.2 $ 56.2 $ 1.0 Severance expense — 0.3 (0.3) 1.2 0.4 0.8 Travel-related expenses 0.8 3.2 (2.4) 3.9 5.8 (1.9) Other, net 20.9 19.6 1.3 37.9 37.7 0.2 $ 48.6 $ 50.8 (2.2) $ 100.2 $ 100.1 0.1 The decrease in general and administrative expenses during the second quarter of 2020 was primarily due to a decrease in travel-related expenses as a result of reduced travel during the COVID-19 pandemic. The increase in general and administrative expenses during the first six months of 2020 was primarily due to increases in (1) employee compensation and related benefits and (2) severance expense. These increases were offset by a decrease in travel-related expenses as a result of reduced travel during the COVID-19 pandemic. 37 Depreciation and Amortization Second Quarter Six Months 2020 2019 Change 2020 2019 Change Restaurants $ 23.0 $ 20.0 $ 3.0 $ 42.5 $ 41.9 $ 0.6 Corporate and other 11.7 11.5 0.2 23.3 22.8 0.5 $ 34.7 $ 31.5 $ 3.2 $ 65.8 $ 64.7 $ 1.1 The increase in depreciation and amortization during the second quarter and the first six months of 2020 was primarily due to (1) changes in useful lives for certain asset categories and (2) the assignment of certain leases to a franchisee in 2019, resulting in the write-off of the related net investment in the leases. These increases were partially offset by (1) assets becoming fully depreciated and (2) a decrease in depreciation on assets classified as held for sale resulting from the expected sale of 43 restaurants in New York to franchisees in the first quarter of 2021. System Optimization Gains, Net Second Quarter Six Months 2020 2019 Change 2020 2019 Change System optimization gains, net $ (2.0) $ (0.1) $ (1.9) $ (2.3) $ (0.1) $ (2.2) System optimization gains, net for the second quarter and the first six months of 2020 were primarily comprised of gains on the sale of surplus and other properties. Reorganization and Realignment Costs Second Quarter Six Months 2020 2019 Change 2020 2019 Change IT realignment $ 2.8 $ — $ 2.8 $ 6.4 $ — $ 6.4 G&A realignment 0.1 3.5 (3.4) 0.3 4.3 (4.0) System optimization initiative — 0.1 (0.1) 0.1 0.1 — $ 2.9 $ 3.6 $ (0.7) $ 6.8 $ 4.4 $ 2.4 In December 2019, the Company’s Board of Directors approved a plan to realign and reinvest resources in its IT organization to strengthen its ability to accelerate growth. Additionally, in June 2020, the Company made changes to its leadership structure that included the creation of a Chief Information Officer position and the elimination of the Chief Digital Experience Officer position. During the second quarter and the first six months of 2020, the Company recognized costs associated with this plan totaling $2.8 million and $6.4 million, respectively, which primarily included third-party and other costs of $1.9 million and $5.1 million, respectively, and severance and related employee costs of $0.8 million and $1.0 million, respectively. In May 2017, the Company initiated a plan to further reduce its G&A expenses. In addition, in May 2019, the Company announced changes to its management and operating structure. G&A realignment costs for the second quarter and the first six months of 2020 were primarily comprised of share-based compensation. G&A realignment costs for the second quarter and the first six months 2019 were primarily comprised of severance and related employee costs and share-based compensation. The Company does not expect to incur any additional material costs under the plan. Impairment of Long-Lived Assets Second Quarter Six Months 2020 2019 Change 2020 2019 Change Impairment of long-lived assets $ 0.1 $ 0.2 $ (0.1) $ 4.7 $ 1.7 $ 3.0 The increase in impairment charges during the first six months of 2020 was primarily driven by the Company testing its Company-operated restaurant long-lived assets for recoverability as a result of the adverse impacts of the COVID-19 pandemic. As a result of this analysis, the Company recorded impairment charges due primarily to the expected deterioration in operating performance of certain Company-operated restaurants. 38 Other Operating Income, Net Second Quarter Six Months 2020 2019 Change 2020 2019 Change Equity in earnings in joint ventures, net $ (0.9) $ (3.1) $ 2.2 $ (2.4) $ (4.9) $ 2.5 Gains on sales-type leases (0.6) — (0.6) (1.2) (2.0) 0.8 Other, net 0.1 — 0.1 0.3 (0.2) 0.5 $ (1.4) $ (3.1) $ 1.7 $ (3.3) $ (7.1) $ 3.8 The change in other operating income, net during the second quarter and the first six months of 2020 was primarily due to a decrease in the equity in earnings from our TimWen joint venture. Interest Expense, Net Second Quarter Six Months 2020 2019 Change 2020 2019 Change Interest expense, net $ 29.1 $ 29.9 $ (0.8) $ 57.6 $ 59.0 $ (1.4) Interest expense, net decreased during the second quarter and the first six months of 2020 primarily due to the impact of the completion of refinancing a portion of the Company’s securitized financing facility in June 2019. Loss on Early Extinguishment of Debt Second Quarter Six Months 2020 2019 Change 2020 2019 Change Loss on early extinguishment of debt $ — $ 7.2 $ (7.2) $ — $ 7.2 $ (7.2) During the second quarter of 2019, in connection with the refinancing of a portion of the Company’s securitized financing facility, the Company incurred a loss on the early extinguishment of debt as a result of repaying its outstanding Series 2015-1 Class A-2-II Notes primarily with the proceeds from the issuance of its Series 2019-1 Class A-2 Notes. The loss on the early extinguishment of debt of $7.2 million was comprised of the write-off of certain deferred financing costs. Other (Expense) Income, Net Second Quarter Six Months 2020 2019 Change 2020 2019 Change Other (expense) income, net $ (0.2) $ 2.2 $ (2.4) $ 0.9 $ 5.0 $ (4.1) Other (expense) income, net decreased during the second quarter and the first six months of 2020 primarily due to lower interest income earned on our cash equivalents. Provision for Income Taxes Second Quarter Six Months 2020 2019 Change 2020 2019 Change Income before income taxes $ 31.4 $ 45.7 $ (14.3) $ 52.7 $ 85.6 $ (32.9) Provision for income taxes (6.5) (13.3) 6.8 (13.4) (21.3) 7.9 Effective tax rate on income 20.8 % 29.2 % (8.4) % 25.4 % 24.9 % 0.5 % Our effective tax rates for the second quarter of 2020 and 2019 were impacted by variations in income before income taxes, including uncertainty in 2020 income before income taxes arising from the COVID-19 pandemic, adjusted for recurring items such as non-deductible expenses and state income taxes, as well as non-recurring discrete items. The decrease in the effective tax rate for the second quarter of 2020 compared with the second quarter of 2019 was primarily due to (1) an increase in the benefit of share-based compensation and (2) a reduction in state income taxes, including non-recurring changes to state deferred taxes net of federal benefits. 39 Our effective tax rates for the first six months of 2020 and 2019 were impacted by variations in income before income taxes, including uncertainty in 2020 income before income taxes arising from the COVID-19 pandemic, adjusted for recurring items such as non-deductible expenses and state income taxes, as well as non-recurring discrete items. The increase in the effective tax rate for the first six months of 2020 compared with the first six months of 2019 was primarily due to an increase in tax on our foreign operations, offset by (1) an increase in the benefit of share-based compensation and (2) a reduction in state income taxes, including non-recurring changes to state deferred taxes net of federal benefits. Segment Information See Note 19 to the Condensed Consolidated Financial Statements contained in Item 1 herein for further information regarding the Company’s segments. Wendy’s U.S. Second Quarter Six Months 2020 2019 Change 2020 2019 Change Sales $ 164.2 $ 181.1 $ (16.9) $ 331.0 $ 348.7 $ (17.7) Franchise royalty revenue 88.1 91.5 (3.4) 173.0 175.8 (2.8) Franchise fees 5.4 5.2 0.2 10.6 10.7 (0.1) Advertising fund revenue 73.6 81.4 (7.8) 147.7 157.4 (9.7) Total revenues $ 331.3 $ 359.2 $ (27.9) $ 662.3 $ 692.6 $ (30.3) Segment profit $ 93.1 $ 103.0 $ (9.9) $ 175.0 $ 192.6 $ (17.6) The decrease in Wendy’s U.S. revenues during the second quarter and the first six months of 2020 was primarily due to a decrease in same-restaurant sales resulting from the impact of the COVID-19 pandemic. This decrease in same-restaurant sales was driven by a decrease in customer count, partially offset by (1) higher average check and (2) the positive impact from the launch of breakfast on March 2, 2020. The decrease in Wendy’s U.S. segment profit during the second quarter and the first six months of 2020 was primarily due to (1) lower revenues and (2) higher cost of sales, as a percent of sales, for Company-operated restaurants driven by the same factors as described above for “Cost of Sales, as a Percent of Sales.” Wendy’s International Second Quarter Six Months 2020 2019 Change 2020 2019 Change Franchise royalty revenue $ 9.1 $ 11.4 $ (2.3) $ 19.6 $ 21.8 $ (2.2) Franchise fees 0.4 0.4 — 0.9 1.5 (0.6) Advertising fund revenue 4.5 5.2 (0.7) 9.0 9.7 (0.7) Total revenues $ 14.0 $ 17.0 $ (3.0) $ 29.5 $ 33.0 $ (3.5) Segment profit $ 3.6 $ 5.5 $ (1.9) $ 8.7 $ 11.2 $ (2.5) The decrease in Wendy’s International revenues during the second quarter and the first six months of 2020 was primarily due to a decrease in same-restaurant sales resulting from the impact of the COVID-19 pandemic. The decrease in Wendy’s International segment profit during the second quarter and the first six months of 2020 was primarily due to lower revenues, partially offset by a decrease in travel-related expenses as a result of reduced travel during the COVID-19 pandemic. 40 Global Real Estate & Development Second Quarter Six Months 2020 2019 Change 2020 2019 Change Franchise fees $ 0.1 $ 0.7 $ (0.6) $ 0.8 $ 1.3 $ (0.5) Franchise rental income 56.9 58.5 (1.6) 114.7 117.0 (2.3) Total revenues $ 57.0 $ 59.2 $ (2.2) $ 115.5 $ 118.3 $ (2.8) Segment profit $ 23.7 $ 29.9 $ (6.2) $ 50.2 $ 56.9 $ (6.7) The decrease in Global Real Estate & Development revenues during the second quarter and the first six months of 2020 was primarily due to lower franchise rental income. See “Franchise Rental Income” above for further information. The decrease in Global Real Estate & Development segment profit during the second quarter and the first six months of 2020 was primarily due to (1) a decrease in net rental income, reflecting the impact of assigning certain leases to a franchisee during 2019 and (2) a decrease in the equity in earnings from the TimWen joint venture. Liquidity and Capital Resources Cash Flows Our primary sources of liquidity and capital resources are cash flows from operations and borrowings under our securitized financing facility. Principal uses of cash are operating expenses, capital expenditures, repurchases of common stock and dividends to stockholders. During the six months ended June 28, 2020, the Company made a payment of $24.7 million related to the settlement of the financial institutions class action (the “FI Case”) (see Note 23 of the Financial Statements and Supplementary Data contained in Item 8 of the Form 10-K for further information). In response to the COVID-19 pandemic, the Company has taken the following actions impacting its liquidity and capital resources during and subsequent to the six months ended June 28, 2020: • increased its cash position by draw downs of its Series 2019-1 Variable Funding Senior Secured Notes, Class A-1 (the “2019-1 Class A-1 Notes”), which was repaid subsequent to June 28, 2020, and the Company’s other lines of credit in March 2020, as discussed below in “Long-Term Debt, Including Current Portion;” • enhanced its debt capacity by issuing $100.0 million of Series 2020-1 Variable Funding Senior Secured Notes, Class A-1 (the “2020-1 Class A-1 Notes”) in June 2020, which remain undrawn as of the date of this report, as discussed below in “Long-Term Debt, Including Current Portion;” • reduced its quarterly cash dividend from $.12 per share in the first quarter of 2020 to $.05 per share in the second and third quarters of 2020, as discussed below in “Dividends;” • temporarily suspended all share repurchase activity under the February 2020 share repurchase authorization. The Company now intends to resume share repurchases in 2020, subject to market conditions and prevailing economic factors, as discussed below in “Stock Repurchases;” • evaluated its planned 2020 general and administrative expenses and capital plan and identified approximately $10.0 million and $20.0 million, respectively, for a total of $30.0 million in savings. The Company now expects to realize approximately $5.0 million of the previously identified general and administrative expense savings, primarily as a result of a higher incentive compensation accrual; • revised its planned 2020 advertising expenses in March 2020 to eliminate Company funding of incremental advertising. In June 2020, the Company reevaluated its marketing plans and now plans to fund up to $15.0 million of incremental advertising during the remainder of 2020; 41 • deferred payment of the Company’s share of Social Security payroll taxes as permitted under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which allows for the deferral of these payments through the end of 2020 and requires repayment of the deferred amounts in 2021 and 2022; • to support the franchise system, (1) extended payment terms for royalties and national advertising funds contributions by 45 days beginning in April for a three month period, (2) abated national advertising fund contributions on breakfast sales for the remainder of 2020, (3) offered to defer base rent payments on properties owned by Wendy’s and leased to franchisees by 50% beginning in May for a three month period, which will be repaid over 12 months beginning in August, and (4) extended Image Activation and new restaurant development requirements by one year; and • to support Company-operated restaurant employees, (1) implemented a new emergency paid sick leave policy with up to 14 days paid leave in the event an employee is unable to work as a result of the COVID-19 pandemic and (2) increased hourly pay by 10% for the months of April and May for hourly crew members, shift managers and assistant general managers, and protected part of the monthly bonus through May for general managers and district managers. In addition, the Company expects to benefit from the technical amendments under the CARES Act by treating qualified improvement property (“QIP”) as 15-year property and allowing such property to be eligible for the 100 percent bonus depreciation for QIP placed in service after December 31, 2017. Based on current levels of operations, the Company expects that available cash and cash flows from operations will provide sufficient liquidity to meet operating cash requirements for the next 12 months. We currently believe we have the ability to pursue additional sources of liquidity if needed or desired to fund operating cash requirements or for other purposes. However, there can be no assurance that additional liquidity will be readily available or available on terms acceptable to us. The table below summarizes our cash flows from operating, investing and financing activities for the first six months of 2020 and 2019: Six Months 2020 2019 Change Net cash provided by (used in): Operating activities $ 30.6 $ 154.1 $ (123.5) Investing activities (24.9) (29.9) 5.0 Financing activities 48.3 (130.2) 178.5 Effect of exchange rate changes on cash (3.2) 3.8 (7.0) Net increase (decrease) in cash, cash equivalents and restricted cash $ 50.8 $ (2.2) $ 53.0 Operating Activities Cash provided by operating activities consists primarily of net income, adjusted for non-cash expenses such as depreciation and amortization, deferred income tax and share-based compensation, and the net change in operating assets and liabilities. Cash provided by operating activities was $30.6 million and $154.1 million in the first six months of 2020 and 2019, respectively. The change was primarily due to (1) the extension of payment terms for royalties beginning in April 2020 for a three month period, (2) lower net income, adjusted for non-cash expenses, (3) a cash payment of $24.7 million related to the settlement of the FI Case in January 2020 and (4) an increase in payments for incentive compensation for the 2019 fiscal year paid in 2020. Investing Activities Cash used in investing activities was $24.9 million and $29.9 million in the first six months of 2020 and 2019, respectively. The change was primarily due to (1) no acquisitions of restaurants from franchisees in the first six months of 2020 compared with cash used for acquisitions of $5.1 million in the first six months of 2019 and (2) an increase in proceeds from dispositions of $3.1 million. These changes were partially offset by an increase in capital expenditures of $3.9 million. 42 Financing Activities Cash provided by (used in) financing activities was $48.3 million and $(130.2) million in the first six months of 2020 and 2019, respectively. The change was primarily due to (1) a net increase in cash provided by long-term debt activities of $168.8 million, reflecting the impact of the draw downs under the 2019-1 Class A-1 Notes and certain other lines of credit, (2) a decrease in dividends of $8.2 million and (3) a decrease in repurchases of common stock of $5.6 million. These changes were partially offset by a decrease in proceeds from stock option exercises, net of payments related to tax withholding for share-based compensation, of $4.0 million. Long-Term Debt, Including Current Portion Except as described below, there were no material changes to the terms of any debt obligations since December 29, 2019. The Company was in compliance with its debt covenants as of June 28, 2020. See Note 9 of the Financial Statements contained in Item 1 herein for further information related to our long-term debt obligations. Wendy’s Funding, LLC, a limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiary of The Wendy’s Company, is the master issuer (the “Master Issuer”) of outstanding senior secured notes under a securitized financing facility that was entered into in June 2015. Under this facility, in June 2019, the Master Issuer also issued outstanding 2019-1 Class A-1 Notes, which allow for the borrowing of up to $150.0 million from time to time on a revolving basis using various credit instruments, including a letter of credit facility. In March 2020, the Company drew down $120.0 million under the 2019-1 Class A-1 Notes. As a result, as of June 28, 2020, the Company had outstanding borrowings of $120.0 million under the 2019-1 Class A-1 Notes. Subsequent to June 28, 2020, the Company repaid the $120.0 million outstanding balance under the 2019-1 Class A-1 Notes. In June 2020, the Master Issuer also issued outstanding 2020-1 Class A-1 Notes, which allow for the borrowing of up to $100.0 million from time to time on a revolving basis using various credit instruments. The Company had no outstanding borrowings under the 2020-1 Class A-1 Notes as of June 28, 2020. A Canadian subsidiary of Wendy’s has a revolving credit facility of C$6.0 million. In March 2020, the Company drew down C$5.5 million under the revolving credit facility. As a result, as of June 28, 2020, the Company had outstanding borrowings of C$5.5 million under the revolving credit facility. Wendy’s U.S. advertising fund has a revolving line of credit of $25.0 million, which was established to support the advertising fund operations. In February 2020, the Company drew down $4.4 million under the revolving line of credit, which the Company repaid in February 2020. In March 2020, the Company drew down $25.0 million under the revolving line of credit. As a result, as of June 28, 2020, the Company had outstanding borrowings of $25.0 million under the revolving line of credit. Subsequent to June 28, 2020, the Company renewed the revolving line of credit, which is now guaranteed by Wendy’s. The increased borrowings were taken as precautionary measures to provide enhanced financial flexibility considering the uncertain market conditions arising from the COVID-19 pandemic. Dividends On March 16, 2020 and June 15, 2020, the Company paid quarterly cash dividends per share of $.12 and $.05, respectively, aggregating $38.0 million. On August 5, 2020, the Company announced a dividend of $.05 per share to be paid on September 15, 2020 to stockholders of record as of September 1, 2020. If the Company pays regular quarterly cash dividends for the remainder of 2020 at the same rate as declared in the third quarter of 2020, the Company’s total cash requirement for dividends for the remainder of 2020 will be approximately $22.4 million based on the number of shares of its common stock outstanding at July 29, 2020. The Company currently intends to continue to declare and pay quarterly cash dividends; however, there can be no assurance that any additional quarterly dividends will be declared or paid or of the amount or timing of such dividends, if any. 43 Stock Repurchases In February 2020, our Board of Directors authorized a repurchase program for up to $100.0 million of our common stock through February 28, 2021, when and if market conditions warranted and to the extent legally permissible. In July 2020, the Company’s Board of Directors approved an extension of the February 2020 authorization by one year, through February 28, 2022, when and if market and economic conditions warrant and to the extent legally permissible. During the six months ended June 28, 2020, the Company repurchased 0.8 million shares under the February 2020 repurchase authorization with an aggregate purchase price of $14.5 million, excluding commissions. As of June 28, 2020, the Company had $85.5 million of availability remaining under its February 2020 authorization. As previously announced, beginning in March 2020, the Company temporarily suspended all share repurchase activity under the February 2020 authorization in connection with the Company’s response to the COVID-19 pandemic. The Company now intends to resume share repurchases in 2020, subject to market conditions and prevailing economic factors. In February 2019, our Board of Directors authorized a repurchase program for up to $225.0 million of our common stock through March 1, 2020, when and if market conditions warranted and to the extent legally permissible. In November 2019, the Company entered into an accelerated share repurchase agreement (the “2019 ASR Agreement”) with a third-party financial institution to repurchase common stock as part of the Company’s existing share repurchase program. Under the 2019 ASR Agreement, the Company paid the financial institution an initial purchase price of $100.0 million in cash and received an initial delivery of 4.1 million shares of common stock, representing an estimated 85% of the total shares expected to be delivered under the 2019 ASR Agreement. In February 2020, the Company completed the 2019 ASR Agreement and received an additional 0.6 million shares of common stock. The total number of shares of common stock ultimately purchased by the Company under the 2019 ASR Agreement was based on the average of the daily volume-weighted average prices of the common stock during the term of the 2019 ASR Agreement, less an agreed upon discount. In total, 4.7 million shares were delivered under the 2019 ASR Agreement at an average purchase price of $21.37 per share. In addition to the shares repurchased in connection with the 2019 ASR Agreement, during the six months ended June 28, 2020, the Company repurchased 1.3 million shares with an aggregate purchase price of $28.8 million, excluding commissions, under the February 2019 authorization. After taking into consideration these repurchases, with the completion of the 2019 ASR Agreement in February 2020, the Company completed its February 2019 authorization. During the six months ended June 30, 2019, the Company repurchased 2.8 million shares with an aggregate purchase price of $49.7 million, of which $0.8 million was accrued at June 30, 2019, and excluding commissions, under the February 2019 authorization and the Company’s previous November 2018 authorization to repurchase up to $220.0 million of our common stock. General Inflation, Commodities and Changing Prices We believe that general inflation did not have a significant effect on our consolidated results of operations. We attempt to manage any inflationary costs and commodity price increases through product mix and selective menu price increases. Delays in implementing such menu price increases and competitive pressures may limit our ability to recover such cost increases in the future. Inherent volatility experienced in certain commodity markets, such as those for beef, chicken, pork, cheese and grains, could have a significant effect on our results of operations and may have an adverse effect on us in the future. The extent of any impact will depend on our ability to manage such volatility through product mix and selective menu price increases. Seasonality Wendy’s restaurant operations are moderately seasonal. Wendy’s average restaurant sales are normally higher during the summer months than during the winter months. Because our business is moderately seasonal, results for a particular quarter are not necessarily indicative of the results that may be achieved for any other quarter or for the full fiscal year. Currently, we are not able to predict the impact that the COVID-19 pandemic may have on the seasonality of our business.