System Optimization Losses (Gains), Net

In July 2013, the Company announced a system optimization initiative, as part of its brand transformation, which includes a shift from Company-operated restaurants to franchised restaurants over time, through acquisitions and dispositions, as well as facilitating franchisee-to-franchisee restaurant transfers. In February 2015, the Company announced plans to reduce its ongoing Company-operated restaurant ownership to approximately 5% of the total system, which the Company completed as of January 1, 2017. Wendy’s will continue to optimize its system by facilitating franchisee-to-franchisee restaurant transfers, as well as evaluating strategic acquisitions of franchised restaurants and strategic dispositions of Company-operated restaurants to existing and new franchisees, to further strengthen the franchisee base, drive new restaurant development and accelerate Image Activation adoption.

During the six months ended July 2, 2017, the Company recorded post-closing adjustments on sales of restaurants and completed the sale of other assets, resulting in net gains totaling $3,506. In addition, the Company facilitated the transfer of 270 restaurants between franchisees during the six months ended July 2, 2017 (excluding the DavCo and NPC transactions discussed below).

DavCo and NPC Transactions

As part of our system optimization initiative, the Company acquired 140 Wendy’s restaurants on May 31, 2017 from DavCo Restaurants, LLC (“DavCo”) for total net cash consideration of $86,788, which were immediately sold to NPC International, Inc. (“NPC”), an existing franchisee of the Company, for cash proceeds of $70,688 (the “DavCo and NPC transactions”). As part of the transaction, NPC has agreed to remodel 90 acquired restaurants in the Image Activation format by the end of 2021 and build 15 new Wendy’s restaurants by the end of 2022. Prior to closing the DavCo transaction, seven DavCo restaurants were closed. The acquisition of Wendy’s restaurants from DavCo was not contingent on executing the sale agreement with NPC; as such, the Company accounted for the transactions as an acquisition and subsequent disposition of a business. The total consideration paid to DavCo was allocated to net tangible and identifiable intangible assets acquired based on their estimated fair values. As part of the transactions, the Company retained leases for purposes of subleasing such properties to NPC.

The following is a summary of the activity recorded as a result of the DavCo and NPC transactions:



	Three Months Ended
	July 2, 2017
Acquisition (a)
Total consideration paid	$	86,788
Identifiable assets and liabilities assumed:
Net assets held for sale	70,688
Capital lease assets	49,360
Deferred taxes	27,493
Capital lease obligations	(97,046		)
Net unfavorable leases (b)	(22,211		)
Other liabilities (c)	(6,999		)
Total identifiable net assets	21,285
Goodwill (d)	$	65,503

Disposition
Proceeds	$	70,688
Net assets sold	(70,688		)
Goodwill (d)	(65,503		)
Net favorable leases (e)	24,034
Other (f)	(1,680		)
Loss on DavCo and NPC transactions	$	(43,149	)

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(a)	The fair values of the identifiable intangible assets and taxes related to the acquisition are provisional amounts as of July 2, 2017, pending final valuations and purchase accounting adjustments. The Company utilized management estimates and consultation with an independent third-party valuation firm to assist in the valuation process.


(b)	Includes favorable lease assets of $1,228 and unfavorable lease liabilities of $23,439.


(c)	Includes a supplemental purchase price estimated at $6,344 to be paid to DavCo for the resolution of certain lease-related matters, which is included in “Accrued expenses and other current liabilities.”


(d)	Includes tax deductible goodwill of $21,871.


(e)	The Company recorded favorable lease assets of $30,068 and unfavorable lease liabilities of $6,034 as a result of subleasing land, buildings and leasehold improvements to NPC.


(f)	Includes cash payments for selling and other costs associated with the transaction.

Gains and losses recognized on dispositions are recorded to “System optimization losses (gains), net” in our condensed consolidated statements of operations. Costs related to our system optimization initiative were historically recorded to “Reorganization and realignment costs.” Costs incurred during 2017 in connection with the DavCo and NPC transactions continue to be recorded to “Reorganization and realignment costs.” All other costs incurred during 2017 related to facilitating franchisee-to-franchisee restaurant transfers are recorded to “Other operating expense (income), net.” See Note 4 for further information.

The following is a summary of the disposition activity recorded as a result of our system optimization initiative:



	Three Months Ended					Six Months Ended
	July 2, 2017			July 3, 2016		July 2, 2017			July 3, 2016
Number of restaurants sold to franchisees	—			—		—			55

Proceeds from sales of restaurants	$	—		$	—	$	—		$	39,615
Net assets sold (a)	—			—		—			(17,055		)
Goodwill related to sales of restaurants	—			—		—			(6,376		)
Net unfavorable leases (b)	—			—		—			(4,906		)
Other	—			—		—			(795		)
	—			—		—			10,483
Post-closing adjustments on sales of restaurants (c)	27			545		927			(1,590		)
Gain on sales of restaurants, net	27			545		927			8,893

Gain on sales of other assets, net (d)	2,072			1,379		2,579			1,457
Loss on DavCo and NPC transactions	(43,149		)	—		(43,149		)	—
System optimization (losses) gains, net	$	(41,050	)	$	1,924	$	(39,643	)	$	10,350

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(a)	Net assets sold consisted primarily of equipment.


(b)	During the six months ended July 3, 2016, the Company recorded favorable lease assets of $183 and unfavorable lease liabilities of $5,089 as a result of leasing and/or subleasing land, buildings and/or leasehold improvements to franchisees in connection with sales of restaurants.


(c)	The three and six months ended July 2, 2017 includes cash proceeds of $300 related to post-closing reconciliations with franchisees. The six months ended July 2, 2017 also includes the recognition of a deferred gain of $312 as a result of the resolution of certain contingencies related to the extension of lease terms for a Canadian restaurant.

(d)

During the three and six months ended July 2, 2017, the Company received cash proceeds of $5,342 and $6,992, respectively, primarily from the sale of surplus properties. The six months ended July 2, 2017 also includes the recognition of a deferred gain of $375 related to the sale of a share in an aircraft. During the three and six months ended July 3, 2016, the Company received cash proceeds of $3,893 and $5,463, respectively, primarily from the sale of surplus properties.

As of July 2, 2017 and January 1, 2017, the Company had assets held for sale of $3,174 and $4,800, respectively, primarily consisting of surplus properties. Assets held for sale are included in “Prepaid expenses and other current assets.”