Wendy's (WEN) is higher today after reporting Q1 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 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 reimaged 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 and are reimaging 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 a little over a year ago, has been a hit with consumers.
Quickly turning to the Q1 results, non-GAAP EPS decreased to $0.09 from $0.11 in the prior year period. However, that $0.09 was slightly better than market expectations. Revenue fell 24.6% year/year to $285.8 mln, which was also better than expected. The company also reaffirmed its prior FY17 non-GAAP EPS guidance to $0.45-0.47. In terms of operating metrics, North America system same-restaurant sales increased +1.6% (+5.2% on a two-year stack).
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 24.6% revenue decrease resulted primarily from the ownership of 301 fewer company-operated restaurants at the end of 1Q17 compared to the beginning of 1Q16, which resulted in fewer sales at company-operated restaurants, partly offset by higher franchise royalty revenue and fees and franchise rental income.
In fact, franchise royalty and franchise rental income increased to $137.6 mln from $119.4 mln a year ago. Moving to the franchise model results in a decrease in revenue but an increase in margins. Adjusted EBITDA margin in Q1 came in at 31.2% vs 25.9% in the prior year period.
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.