Wendy's (WEN) is trading modestly higher (+3%) today after reporting Q2 earnings this morning. The burger chain is in the midst of a multi-year transformation. We thought this would be a good opportunity to provide an update on how it's going.
One of the major undertakings by Wendy's is to contemporize the brand and dramatically improve the customer experience. In what it calls its Image Activation (remodeling and new restaurant design) program, its restaurants are being remodeled to feature bold, sleek, "ultra-modern" designs. Design features include lounge seating with fireplaces, flat-screen TVs, Wi-Fi and digital menuboards. The reimages completed so far have generated a range of strong sales increases.
By the end of 2020, WEN expects that 70% of its worldwide locations will have been remodeled. That number was at 32% at the end of 2016 and the goal is to reach 42% by the end of 2017. The company re-imaged 521 North America restaurants and built 99 new North America restaurants and 50 new International restaurants in 2016. Overall, WEN has 6,500 global locations. Franchisees continue to see the benefits of Image Activation (remodeling) and are re-imaging restaurants faster than WEN had anticipated. Another big part of its strategy is to move away from a company-owned model to more of a franchise/franchisee model. This shift is nearing completion.
Another strategy has been to improve the menu. The chain wants to put a greater emphasis on fresh ingredients and fresh preparation. Wendy's has also improved its advertising campaign. Also, its 4 for $4 offering, which launched in 2016, has been a big hit with consumers and has been a good traffic generator.
Quickly turning to the Q2 results, non-GAAP EPS rose 50% YoY to $0.15 from $0.10 in the prior year period, this was better than market expectations. Revenue fell 16.3% year/year to $320.3 mln, which was a good bit better than expected. In terms of operating metrics, North America system same-restaurant sales increased +3.2%. Adjusted EBITDA margin improved to 36.2%, compared to 26.8% in 2Q16. The 940 basis-point improvement reflects the positive impact of the company's system optimization initiative.
Do not be too concerned about that revenue decline. Recall that WEN is moving from an ownership model to a franchise model, which means less revenue but higher margins in the long term. The 16.3% revenue decrease resulted primarily from the ownership of 251 fewer company-operated restaurants at the end of Q2, this was partly offset by higher franchise royalty revenue and fees and franchise rental income. Company-operated restaurant margin was 19.6% in Q2, a 230 basis-point decrease YoY, primarily the result of increased labor rates and higher commodity costs.
In sum, Wendy's continues to make steady progress with its transformation. If you have been to a renovated Wendy's recently, you'll see they have done a nice job in terms of modernizing their restaurants. Also, moving to more of a franchise model makes sense as it lowers WEN's cap-ex spending and should boost margins. Investors seem pleased with WEN's Q2 results.