Wendy's Co (WEN) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Wendy's Company second-quarter earnings results conference call. I will now turn the conference over to Peter Koumas, Group Manager, Investor Relations. Please go ahead, sir.

Thank you, and good morning, everyone. Our conference call today will start with comments from our President and Chief Executive Officer, Todd Penegor; followed by our Chief Financial Officer, Gunther Plosch, who will review our results and outlook. Then Todd will conclude with an update on key initiatives. After that we will open up the line for questions.

Today's conference call and webcast includes a PowerPoint presentation which is available on the investors section of our website, www.aboutwendys.com. Before we begin, please take note (technical difficulty) appears at the end of our earnings release. This disclosure reminds investors that certain information we may disclose today is forward-looking. Various factors could affect our results and cause those results to differ materially from the projections set forth in our forward-looking statements.

Also, some of today's comments will reference non-GAAP financial measures, such as adjusted EBITDA, adjusted EBITDA margin, adjusted earnings per share, adjusted tax rate and free cash flow. Investors should refer to our reconciliations of non-GAAP financial measures to the most directly comparable GAAP measure.

And with that, I'll now turn the call to our President and Chief Executive Officer, Todd Penegor.

Thank you, Peter, and good morning, everyone. I will start out by sharing a few thoughts on our second-quarter performance and then speak to what we are currently seeing in the industry and how we believe the Wendy's brand is poised for success even in a challenging environment.

Starting with the top line, North American system same-restaurant sales increased 0.4% or 2.6% on a two-year basis. This is our 14th consecutive quarter of positive same-restaurant sales, which demonstrates the long-term strength and relevance of our brand. While our second-quarter sales results came in lower than we had anticipated, we have a strong and well balanced second-half marketing calendar that gives us confidence for the rest of the year.

Our North American Company-operated restaurant margin improved 370 basis points to 21.9%. Continuing to drive the restaurant-level economic model is a key priority for us, and we are pleased with our continued progress.

Adjusted EBITDA margin improved in the second quarter by 550 basis points to 26.8%. This significant improvement demonstrates the higher quality of earnings that we are generating as a result of system optimization.

Royalties and rental income are contributing a higher amount of earnings, along with our ongoing focus on G&A expense. In light of our second-quarter results and improved quality of earnings, we have increased our 2016 guidance for both adjusted EBITDA and adjusted EPS. Our updated guidance reflects our expectation for full-year same-restaurant sales growth of 1% to 2% for the North America system.

A little later on in the presentation, I will provide a more detailed update on where we stand with system optimization, but I am pleased to announce that we have awarded all markets that remain to be sold in 2016. The purchasing franchisees are strong operators and have demonstrated a commitment to growth. With our great franchise partners at our side, we believe Wendy's is well positioned for the future.

I would now like to take some time to talk about the QSR industry and what we have observed in relation to the recent slowdown. This chart shows year-over-year traffic changes in the QSR industry going back to the beginning of last year.

As you can see, traffic trends were improving throughout 2015, but in Q1 of this year the trend reversed course, and Q2 saw the downward trend continue. We believe there are multiple drivers behind the recent slowdown, but the most notable recent appears to be the continued GAAP between the cost of eating at home and the cost of dining out, which is now at its widest point since the recession.

While the recent shift in traffic trends is not favorable, we view this as a bump in the road when looking at the QSR industries long-term potential. QSR has consistently grown traffic share over the past 10 years, gaining over 4 share points in that time. This strong track record is driven by hitting on the three key components consumers look for when dining out: taste, convenience, and affordability.

Across the broader restaurant industry, QSR continues to win with consumers, and this is why we are so confident that this segment of the restaurant industry is well positioned to succeed. We truly believe that Wendy's offers a differentiated experience and is uniquely positioned to win by offering a new QSR experience at traditional QSR prices.

For Wendy's and the entire restaurant industry, it all comes back to food. We began the year with improvements to our core hamburgers and chicken sandwiches, returning to a bakery-style bun, inspired by Dave Thomas's original formulation, and serving the sandwiches in foil to give our customers hotter, juicier sandwiches.

In late June, we introduced our Summer Berry Chicken Salad, which features fresh blackberries picked at the peak of their season, something no other national QSR has been able to accomplish. This month we're highlighting our Baconator, which features fresh, never-frozen North American beef and six strips of applewood smoked bacon that is cooked in our restaurants every day.

Additionally, we just introduced our new Grilled Chicken Sandwich, which features a fantastic new multi-grain bun and new fresh-grilled cooking procedures that results in a more tender and juicy chicken fillet. We are very proud of the work that we have done thus far, and we will continue to focus on widening our quality gap against traditional QSRs.

Our core products and improvements I just talked about are critical elements of our menu, but balance is key. We've spoken before about how important a clear and compelling price/value proposition is to our customers, and we continue to see strength with our 4 for $4 offering, which was expanded in April with the addition of the Crispy Chicken BLT. Price/value has been and will continue to be a key part of our messaging going forward.

LTOs bring excitement to our brand by building on our core equities with innovative ingredients and on-trend flavors. In Q2 we brought back our Jalapeno Fresco Spicy Chicken Sandwich and Ghost Pepper Fries and followed this with the introduction of the Bacon Mozzarella Burger.

Our future success will depend on ensuring that we have the right balance of support across our core, price/value, and LTO messages. We are continually fine-tuning our promotional activity in order to drive profitable customer account growth.

To deliver on our brand promise, we are focused on improving our food, providing great value, delivering exceptional service, and elevating our restaurants. Simply put, our goal is to delight every customer, period.

Let me talk you through each of these components. On food, Quality Is Our Recipe has been ingrained in the DNA of Wendy's since day one, and our food and promotions all center around the idea that Wendy's is deliciously different. We use fresh, honest ingredients; create craveable tastes; and make it right -- freshly prepared, just how the customer wants it.

Looking across the top five hamburger chains, Wendy's is recognized by consumers as best-in-class for high-quality food, fresh food, and food that tastes better. Value applies to promotions like 4 for $4, but it also needs to transcend across the entire menu, and we know we have work to do here. From the customer's perspective, we need to be worth what you pay, with competitive prices, Wendy's quality, and a great overall experience. Our price/value messaging has been showing great progress, according to our brand health studies.

Service is also a key focus for us. Service that is friendly, accurate, and fast creates an experience that brings you back.

Last but not least, our restaurants have to be clean and well-maintained, up-to-date, convenient, and in the eyes of our customers a place they just love to go. Consumers are noticing the work we have been doing in this area as our commitment to Image Activation has driven consistent improvements in our modern and up-to-date restaurants brand health metric.

Now I'd like to hand the presentation over to GP to review our second-quarter financial highlights as well as provide an update on our full-year guidance.

Thanks, Todd. North America systems same-restaurant sales increased 0.4%, 2.6% on a two-year basis. Higher sales at reimaged restaurants contributed approximately 60 basis points to our North America system same-restaurant sales results in quarter two.

North America Company-operated restaurant margin came in at 21.9% in the second quarter compared to 18.2% last year. This 370 basis point improvement was primarily the result of lower commodity costs as well as the positive impact from Image Activation and the sale of our lower margin Canadian restaurants in the second quarter of 2015.

General and administrative expense was $61.1 million in quarter two compared to $60.8 million in 2015. Adjusted EBITDA was $102.5 million in the second quarter of 2016, a 1.7% decrease compared to the second quarter of last year. The slight year-over-year decrease reflects our ownership of 361 fewer Company-operated restaurants. Our adjusted EBITDA performance as well as the 550 basis point improvement in adjusted EBITDA margin exemplifies our higher quality of earnings resulting from our system optimization initiative.

Adjusted earnings per share was $0.10 in the second quarter compared to $0.08 in the second quarter of 2015, a 25% year-over-year increase.

Now let's walk through the key elements of our adjusted EBITDA performance in quarter two. In the second quarter, franchise revenues -- which includes royalties, net rental income, and franchise fees -- increased by $11 million compared to quarter two of 2015. On top of that, we were able to deliver $10 million of year-over-year restaurant EBITDA improvement, which includes the benefit from Image Activation. The combination of higher franchise revenues and higher restaurant EBITDA was almost enough to offset the $23 million of EBITDA lost from owning 361 fewer Company restaurants.

Let's talk through the drivers of our improvement in adjusted earnings per share. Similar to quarter one, we saw $0.03 of accretion from our ongoing share repurchase program. In the second quarter, we repurchased 5.9 million shares for $61 million and have reduced our shares outstanding by almost 30% since the end of second quarter of 2015. Depreciation declined year-over-year primarily due to the sale of Company-operated restaurants, which resulted in another $0.01 of EPS improvement.

We also had the benefit of lower tax rates due to a nonrecurring deferred tax expense that was recognized in quarter two of last year. This resulted in another $0.01 of accretion. Partially offsetting this growth was $0.03 of dilution from higher interest expense due to the whole business securitization that we completed in the second quarter of 2015. This will cease to be a headwind beginning in the third quarter, as we lap over this activity.

Now let's take a look at our full-year 2016 outlook. Even with our lowered same-restaurant sales guidance, we are increasing our 2016 guidance for both adjusted earnings per share and adjusted EBITDA. We now expect adjusted EPS of $0.39 to $0.40, which represents year-over-year growth of about 20%, and adjusted EBITDA to be flat to up 1% compared to 2015. On same-restaurant sales, we now expect 1% to 2% growth for the North American system.

For commodities, we have now updated our guidance to 5% to 6% deflation. This is mainly due to the continued favorability in beef prices. We are also updating our restaurant margin guidance to the top end of our previously stated range, to approximately 19% at North America Company-operated restaurants, driven by lower commodities and the positive impact from Image Activation.

We continue to expect general and administrative expense of approximately $245 million to $250 million. We have been able to maintain our full-year G&A guidance despite incremental headwinds caused by the unusual payment card activity and increased legal resource. We have also reaffirmed our capital expenditures guidance of approximately $135 million to $145 million, free cash flow of approximately $50 million to $75 million, and an adjusted tax rate of approximately 32% to 34%.

I will now turn the presentation back over to Todd to provide a brief update on system optimization, Image Activation, and international.

Thanks, GP. System optimization is proceeding as planned, and we remain on track to complete the third phase by the end of the year. During 2016 we expect to sell a total of approximately 315 restaurants to franchisees, leaving the Company with an ownership of approximately 5% of the system. No restaurants were sold in the second quarter, and we have already completed the sale of both the Raleigh and Miami markets in early Q3.

We expect that about 60% of the restaurants that remain to be sold in the second half will change hands in the third quarter, with the rest transitioning in the fourth quarter. We are now able to update our system optimization proceeds guidance, as we have awarded all remaining markets. We now expect total pretax proceeds of approximately $435 million and after-tax proceeds of approximately $340 million.

Going forward, as part of our ongoing system optimization strategy, we will continue to facilitate franchisee-to-franchisee restaurant transfers through our buy-and-flip strategy. During the second quarter, 13 restaurants were transferred through buy-and-flip transactions, and we continue to expect about 200 restaurants to be transferred through buy-and-flips in 2016.

There has been a slight change to the markets we will be selling during the remainder of this year. We have decided to retain part of the New York market, primarily on Long Island and Manhattan, and will instead sell the Virginia Beach market. The decision to divide up the New York market is consistent with our strategy to maintain restaurants in different parts of the country and with various demographics to reflect the diversity of our marketplace and maintain the scale necessary to be operationally efficient where geographic concentration allows. System optimization is all about building an even stronger system and serving as a catalyst for growth by putting restaurants in the hands of strong operators who are committed to driving new restaurant development and accelerating reimaging.

Turning now to Image Activation, in 2016 we continue to expect Wendy's North America system to open 110 new restaurants and reimage 430 restaurants. More than 26% of the Wendy's system is now on the new image, and we expect that that number will rise to approximately 30% by the end of this year with the strong pipeline we have in place.

The evolution of Image Activation and the improvement in our restaurant economic model is also enabling us to make progress with our new restaurant development goals. During the second quarter, the North American system opened 12 new restaurants, bringing the year-to-date total up to 37. We continue to expect to deliver the first year of net new restaurant openings since 2010.

I'd now like to spend a brief moment on international. The team is working extremely hard to execute our narrow and deep strategy in order to set this business up for long-term success. We opened our first restaurant in Sao Paulo, Brazil, on July 14, and the second restaurant opened a couple of weeks later on July 28. Very early results are encouraging, and we expect to open an additional 1 to 2 restaurants by the end of the year.

In the Middle East, we granted development rights for Saudi Arabia and expect the first restaurant will open there in the first half of next year. Our franchisee in the region also plans to open its first Wendy's restaurant in Kuwait late this year or in early 2017.

In June, our Japanese franchisee acquired the First Kitchen brand with the intent to convert all 136 locations into hybrid Wendy's/First Kitchen restaurants. The current plan is to convert between two and five restaurants by the end of 2016. We are pleased with our recent progress, and we are very confident our international business can be a driver of growth in the future.

And finally, we are on track with our 2020 North American system goals: average unit sales volumes of $2 million, restaurant margins of 20%, a sales-to-investment ratio of at least 1.3 times the new restaurants, restaurant development growth of 1,000 new North American restaurants and approximately 500 net, and the reimaging of at least 60% of our North American total system restaurants. As we work to achieve these goals, we are confident this will translate into a stronger, more efficient Wendy's Company economic model.

Adjusted EBITDA margin has been added as new 2020 goal this quarter. This metric will be a key indicator of our success going forward, and we expect to achieve adjusted EBITDA margin of 38% to 40% by 2020, which would be almost double the 21% realized during full-year 2015.

Now here's Peter.

Thanks, Todd. Please note that we'll be returning scheduled calls to the sell side for the remainder of the day, but if you need to reach us, please email me at peter.koumas@wendys.com or leave a message at 614-764-8478 and we will get back to you as soon as we can.

Before we open the phone line for questions, I'd like to review some upcoming events on our investor relations calendar. On Friday, August 26, Todd, GP, and I will be in New York for a one-day road show hosted by RBC. A few weeks later, on September 12, we'll be attending the Stifel Executive Summit New Jersey. And then we'll remain in town to attend the C.L. King conference the following day.

On September 28, Lee Burnside, our VP of Finance and Planning, and I will travel to Boston to attend the Wells Fargo Retail Restaurant and Consumer Forum. Lee and I will be joined by GP in Toronto the following day for a one-day road show hosted by Evercore. And then on Wednesday, November 9, we will release our third-quarter earnings and hold a conference call.

With that, we are now ready to take your questions.

(Operator Instructions) Karen Holthouse, Goldman Sachs.

Looking at the comp slowdown that we saw this quarter, there's -- clearly, guidance embeds a reacceleration in the back half against tougher compares. So just curious if there's anything you've seen intra-quarter over quarter to date, or anything you're willing to share with a little more specificity around the marketing or advertising plan that gives you confidence in that reacceleration? Thanks.

Thanks, Karen. You know, if you look at where our business has performed in the first half of this year, we're growing about 2%. So with the guidance that we have put out there today, that would imply that we are flat to 2% in the back half of the year. So you don't see an acceleration. You do see an acceleration to some extent relative to Q2, but when we look at the year to go, we do have the nicely balanced calendar, between a high-low messaging; what we're doing on core; what we're doing on LTO; and what we're doing on value.

And we're really focused on telling our story behind food news around the core. You know, telling our brand story around fresh, continuing to bring some news on the price/value front. And we feel like we've got solid LTOs sprinkled in throughout the year to finish strong. So when we look at the outlook, despite a category outlook that's flattish, we feel good that we can continue to drive growth in that environment.

So is the right way to think about that, then, that you're also anticipating category growth of flat for the back half, which would also sort of say category growth for the back half in line with the first half?

That would be the way to think about it, Karen. At this stage, there's a lot of uncertainty in the consumer's mind as we work through the election. You know, we continue to make sure that we've got the high-low messaging working, to make sure that with the gap widening between food at home and food away from home, that we drive reasons to bring our customers into our restaurants. And our focus is really to delight every customer, period, through our restaurants, our food; making sure we have the appropriate value; and then, ultimately, have a service experience that brings them back.

Okay, thank you.

Dennis Geiger, UBS.

So it may be too early to talk about 2017, but should we read anything into the omission of the goal of reducing G&A to approximately $230 million by 2017? I think previously you've noted continued G&A savings from the system optimization and G&A alignment initiatives into 2017. And there's been confidence in that number, so I just wanted to get a sense on what the latest thoughts there are. Thanks.

Dennis, it's still early to comment on 2017 guidance. We'll do that at an analyst day or early next year. But we did say in the release -- and there's nothing by the omission of not talking about G&A that should have you thinking about it differently, but we did talk about the long-term adjusted EBITDA margin goal of 38% to 40%, up from the 35%. And as you think about where we are post-system optimization, you know we do see much more improved quality of earnings. You know we do have confidence that this brand can continue to grow at our long-term guidance of approximately 3%.

But there's a few other things that are really giving us confidence for the long run on driving margin. We've got a nice pipeline around net new development -- not just driving growth in North America, but we feel like we're planting the seeds to drive net development growth in international. We continue to see a strong rental income stream. We've monetized the owned real estate that we have. But we're also seeing a lot of opportunities to pick up rental income streams through the buy-and-flip strategy that we are running that can drive long-term margin.

We're feeling good about where Company restaurant margins are going, even the face of labor inflation, and we continue to make progress on upfront. And we do have to take a hard look at our G&A and make sure that we've got a prudent G&A management. So those are the levers that will have to happen, to be pulled, to get us to the 2020 margin goal of 38% to 40%. And that will be a journey which includes all elements across the P&L.

Great, thanks very much.

Matthew DiFrisco, Guggenheim Securities.

I guess if you could just talk about what is perceived to be somewhat of a share fallback here for the second quarter in a row now, or -- well, it's a little bit more pronounced in this quarter than it's been in quarters past. You were pretty much in line with the category in the last quarter.

What particular to Wendy's do you feel that is somewhat that you can control that? And in the second half of the year, those share losses of those share drops that you've had in this most recent quarter won't persist. What will you be doing to improve that, considering that you had the October 4 for $4 that you have coming up against that you're going to have to lap against?

Thanks for the question, Matt. If we look at the second quarter specifically, the 4 for $4 continued to perform well for us. And it's mixing as we would have anticipated within the quarter, especially as we brought some news with the Crispy Chicken BLT to continue to keep 4 for $4 fresh and ownable.

Quite honestly, we were LTO-heavy in Q2 with the Jalapeno Fresco Chicken Sandwich, the Ghost Pepper Fries, and the Mozzarella Cheeseburgers. And these LTOs did not perform to our expectations. So we had some prior priced items at a time when the consumer was skittish. And when you think about how that calendar lined up, it didn't really hit the customer need within the quarter.

We also had a little bit of shift on timing of salads. Last year we had a big salad promotion started at the end of Q2. This year it started at the beginning of Q3. So you look at all of those as elements that actually drove a little bit of share decline within the quarter.

But as I said earlier, as you look forward, we have checked and adjusted the calendar, and we feel we have a nice balance across core LTO and value and a nice balance on high and low. And as you think about this fourth quarter, and coming up to lap the 4 for $4 promotion from last year -- remember, it didn't start till October 12, so we've got a couple of extra weeks of news with 4 for $4. We now have a Crispy Chicken BLT, which we didn't have last year as part of that offering.

And last year the whole message was on the low. This year we will make sure that we got a balanced high-low message throughout the fourth quarter, which we feel good will give us a nice opportunity to comp over that performance from last year.

Okay, thank you.

Will Slabaugh, Stephens Inc.

I had a question on the fiscal 2018 free cash flow guidance of the $200 million to $250 million. A lot of talk about that, given sort of the volatility that we've seen in same-store sales growth; but also, considering the smaller impact it's going to have on your bottom line over time, my main question is: do you believe that that $200 million to $250 million number will still be valid if you do put up 1% to 2% same-store sales growth between now and that point versus that 3% that you've talked about in the past?

Thanks for the question. This is Gunther. Yes, we believe this guidance is still valid. I think we're driving the right balance in all of our revenue and earnings stream, and we think, like I said, it's the right assumption going forward.

I think as you look at our long-term guidance, our P&L gets a lot less dependent on same-restaurant sales growth and a lot more dependent on a lot of these other elements that I hit on on what's driving us towards that 38% to 40% margin improvement. So things like rental income, things like net new development, things like getting more prudent on our G&A management. Those are all levers that we can and will pull that will help us continue to solidify the $200 million to $250 million of free cash flow into the future.

Great. Thanks for that. And then, just following up quickly on that raise, the longer-term EBITDA guidance -- are those things -- in particular you just touched on what's driving that slight improvement in EBITDA margin, or are there other things in there as well?

No, those would be the big drivers. I think as we continue to improve the economic model for restaurant-level economics and improved margins, really helps to sell the story to drive net new development. And we've got some nice net new development happening in the first half of this year. We've got a nice pipeline of new restaurant development across North America for the back half, got the building kicking in in Canada.

And we are optimistic on the growth avenues within international around new development. You know, the rental income stream, we think, continue to be one of those things that can drive growth for us over time. We are seeing a lot of buy-and-flip.

So as we have said in the past, we've got a long-tenured franchise system. Many of those folks haven't had the succession plans in place and are looking to monetize and exit the system. That gives us an opportunity to drive that stream. And we do know that we need to look at all of our expense management. You look at any of our benchmarking, we're in the middle of the pack. And we need to continue to optimize that front also.

Great, thank you.

John Glass, Morgan Stanley.

Thanks very much. Just first, on the back-half comp guidance again, and kind of your strategy to address this environment, you said you need to balance -- you want to be balanced in high-low, but you also said the LTOs this quarter maybe didn't resonate because the prices were higher. So when you think about the back half, if you continue high-low, you have to come in with lower priced LTOs? Is that the answer to balancing better to drive traffic?

Not necessarily. I don't want to tip our hand on where our calendar is going going forward. I think it will be -- continue to have a strong value message around the 4 for $4. So how do we keep that fresh and ownable? You know, are there other opportunities to drive some news on the value front to bring in profitable customer count? Those are things that we'll need to look at in the back half.

And the focus on the core and the halo around fresh that we have every single day -- you're seeing that now come back on air. We had that as the deliciously different campaign in Q1. You can see that behind the Baconator promotion that just went on air this week. And there will be some LTOs, but I think you'll see a much more balanced approach in the back half of the year.

I think what we really need to drive is: are we delighting every customer, period? And you know, the focus on making sure that we create a great total experience so that we have food I love; that the consumer feels that it's worth what they pay when they get into that restaurant; that we're creating an experience that brings them back; and we get them really saying that this is a place I love to go. We need to really focus on the core execution at the restaurant level. And that's what the team is doing with the Voice of the Customer work that we've got in place today.

Okay. And just on G&A, you mentioned that does now include some expenses related to legal and the cyber attack. So, one, can you quantify that? How big is that, do you think? And do you think you have it contained? And do you think those events have contributed at all to the sales weakness? Any evidence that it has or hasn't impacted consumer reaction to the brand?

So, John, let me address the sales piece first, and then I'll turn it over to GP to talk about what's in the guidance. So as you think about Q2, it's never helpful when your brand is in the news for things like this. And it's really difficult to discern exactly, but we are not currently attributing the Q2 softness to the credit card news. But in early July, when we announced on behalf of the affected franchisees a list of the affected restaurants, we do believe that that had some modest effect early in Q3. But that softness was not widespread, and then there were local differences seen across the Group. And it appears that that has lessened as we get further away from the announcement.

And now I'll turn it over to GP for some thoughts on the outlook on the expense side.

Yes, we feel we have actually included all of the expenses that we know about in outlook. If you think about it, we have three types of expenses. The one type is for third-party investigators, the period expense. Some of it is actually behind us in the first quarter already. We're offering to our consumers also credit card protection services, so that's an expense for us that we are incurring on a period basis. And last but not least, as you know, we have several lawsuits against us; and we're obviously spending legal expense on this, again, on a period basis.

I don't want to really comment on how much it all is. We have obviously done prudent G&A management for the second half of the year to ensure that despite those headwinds, we can actually stay within the guidance and be confident do so.

Okay, great. Thank you.

Greg Badishkanian, Citigroup.

Great, thanks. You know, beyond the price gap between food away from home and food at home, what do you think is leading to biggest driver, do you think, for the industry slowdown that we've seen in QSR?

Yes, Greg, I think that is the biggest driver far and away. When you look at the cost of eating at home versus the cost of eating in restaurants, it's about 3X delta. And when a consumer is a little uncertain around their future and really trying to figure out what this election cycle really means to them, they are not as apt to spend as freely as they might have even just a couple of quarters ago.

And it's at a time where we're still not seeing real wage growth, but we are seeing some of the costs of living move up, when you get into what does it cost to own a home and operate your life in general. And there is a little bit of tightening on the disposable income, especially on the low end.

And that's why it's so important to make sure that you really have a balanced menu, you have some compelling value offerings, but you also delight every customer through some things with great food on your core and on your premium menu. And that's why we're investing so much back into our food, to really make sure that we widen the quality gap, to make sure that folks feel good that they want to reward themselves with an experience at Wendy's.

And we've always been positioned, and I've been saying this for the last several years: we want to create a new QSR experience at traditional QSR prices. And that's why we think we are uniquely positioned to win in this environment.

Good color. Thank you very much.

Sara Senatore, Bernstein.

I hope that -- I don't know if you have already covered this, but I guess I just wanted to ask about -- you know, you mentioned food away from home versus food at home. I would think that the hamburger category would be relatively advantaged because so much of the deflation is coming in beef. So -- compared to, say, other categories in QSR. And it felt like we saw that in the first quarter, and then all of a sudden in the second quarter, that went away.

So I'm just trying to understand the segment dynamic, which is to say when I think about whether the gap for all of the fast food hamburger restaurants -- why it seemed to have narrowed so much sequentially. Is it just everybody else has also gotten more competitive on value? And shouldn't that be an advantage of yours? So that's part one.

And then just part two was just -- I think you touched on restaurant margins, but again, just with such a deflationary impulse on the commodity line, why you didn't take your restaurant margin up even more? Thanks.

Yes, so if you look at the hamburger segment, we do feel good, through the data that we see, that we continue to grow share of hamburgers. But the hamburger subsegment has been flattish. And I do think this food at home versus food away from home gap does impact it.

We have a value offering that continues to compete and draw customers into the restaurants. But when you look at what you pay, what you get on some of the core items, it's gotten a lot more cheaper, relatively speaking, to go get fresh beef at your local butcher and go home and grill it. So that does have a bit of an impact.

So we need to make sure that we do have this barbell strategy working well, and we attract folks in on the low side, but also give them a reason to come in to have our everyday core items. And that's what we've done is we've reworked our calendar for the back half and really focused a more balanced calendar around really telling our story, like we did at the beginning of the year around fresh and everything that differentiates us versus the rest of the folks in the QSR category. And I'll turn it over to GP talk a little bit about the margin guidance.

So Sara, as far as restaurant margin is concerned, we were actually good with having the guidance on the top end, so at 19%. If you step back, the first half, we got a margin of 19.5%. So our full-year guidance is actually not far away from it.

Also in our fiscal-year guidance of 1% to 2% sales growth, don't forget, we have a little bit of deceleration in the second half, as we are going to get a little bit less leverage out of our restaurant P&L. So all of those factors combined, I would say that we are feeling good about the 19% margin that I pointed out.

Thank you.

Alton Stump, Longbow Research.

A quick question -- you know, looking back at 2Q from a competitive standpoint, it seemed versus the first quarter that outside of the big three, so to speak, in the category that you had some of your second-, third-tier guys, you know, Hardee's, Carl's Jr., et cetera, that were a bit more promotional. Is that in fact true? And was that an impact, do you think, on your business in 2Q?

No, I think when you think about the promotional activity and what we've done on the value side, we feel very good about how we have performed on value in the second quarter. I think 4 for $4 continues to resonate. Crispy Chicken BLT provided some news.

There is a lot more activity going on longer than in the past, as the restaurant industry had slowed down. And we are seeing some of these other guys with aggressive deals out there. But this is where we need to make sure that we continue to differentiate. We deliver what everybody does the QSR space, and we do it quite well around taste, convenience, and affordability. Our opportunity is really to differentiate on quality and the quality of the experience that you have in the restaurant.

We don't see that having a huge impact on the business. I think it's more that our LTOs at that point in time didn't perform where we wanted them to. And you think about things like Jalapeno Fresco -- you know, we brought a lot of news last year. It was a very hot sandwich. When you think about the second year, the folks that might have tried it and not come back for a repeat last year might not have ever tried it this year. So that did impact us a little bit when you think about that promotion in particular.

That's helpful. Thanks, Todd. And then one quick follow-up, just on international growth: if I think back to prior presentations, like, you guys seem to imply that over the next five years, to your 2020 plan, that it will probably be more towards the back part of that -- that, you know, see international growth pick up. But you have signed some deals here recently. Is there any chance that we'll see it happen sooner than that, over the next year or two? Or is it still kind of more of an 2018 and beyond story?

I don't want to make any news today on the call. I think the good news is the team has become very disciplined, and they are very focused on executing against narrow and deep. And you know, per the commentary I had to set up the call, you can see that it's actually paying some benefits. We're actually seeing the core markets that we are focused on starting to get the brand established with great partners. And we do think that that will set up a nice foundation for growth.

We'll talk about where we think international business can go in more detail when we get ready to provide guidance for 2017 and beyond. And, you know, are the fruits of all this labor actually providing any upside or not? More to come on that front.

Got it. Thank you.

Jeffrey Bernstein, Barclays.

Two questions -- just one, Todd, looking longer-term, and I think you mentioned it earlier on the call, the 3% comp guidance presumably starting in 2017 but more so long term -- I was just wondering, that's been tough to achieve for a number of years. I'm just wondering why it wouldn't be more prudent to factor in these type of periodic consumer volatilities and competitive pressures, the thought process behind that. And what you're assuming for the broader QSR category in terms of growth relative to that 3%? And then I had one follow-up.

I guess on the category one, we provided our long-term guidance. We always thought the category would be flat to 1% in real terms. So when we provided the 3% guidance it was in that context.

If you look back at our past, last year we grew the system at 3.3%. This year we're at 2% in the first half, and we do think, to the comments we had on the call, that this was a temporary blip; that QSR is well positioned to continue to win and grow in the restaurant space. And we do think that our unique brand story really positions us to break out and gain share over time.

If you think about the growth algorithm into the future, you know, we've seen year to date about 60 basis points of tailwind on IA across the whole system. So that's up from what we were expecting, about 40 to 50. We see a nice pipeline of that continuing to be a tailwind into the foreseeable future. We do know that we need a nice balanced calendar on the price/value side as well as the premium side to continue to win the hearts and minds of customers.

But I do think our opportunity is to really get focus back on the basics, as I said earlier on the call, and really do the things that we need to do across our food, across getting our value proposition right. That's not just on the entry price value side; that's across our entire menu. And then make sure that we actually create an experience in that restaurant that brings folks back on a regular basis. I think you complement those three things with the work that we are doing on IA, that it puts us in a really good spot to continue to win share for the foreseeable future.

Got it. And then the follow-up was just -- seems like, needless to say, you're talking to franchisees a lot with all of the sales you are doing to them from a system perspective. I'm just wondering how those discussions go, especially when you're talking about menu pricing -- when you acknowledge the food at home versus the food away from home gap is pretty wide, so presumably you want to help narrow that. But I'm just wondering what type of suggestions you are making to them, especially when you're dealing with the significant labor inflation versus the commodity deflation, kind of how that dynamic plays out in your discussions with the franchisees? Thanks.

Yes, no, as you can imagine, Jeff, it is a continual discussion. And if you think about Q2, customer counts were up for the company, if you think about where the system -- where our customer counts were flattish. So there is that delta. If you think about the delta, we've got a bigger percentage of our restaurants IAed, but there is a delta on price.

So we're trying to educate that customer counts are the gift that can keep giving. And to really drive the leverage in the restaurants, you want to bring in more customers more often. That will drive economic model relevance; that will drive brand relevance.

So we are having ongoing discussion. We are trying to lead as a company, and we're trying to provide the facts to make sure that system understands what we need to do to be appropriately priced, so we are worth with the consumer thinks they should pay for our products. That said, labor inflation will continue to be a headwind. And we've done a nice job the first half of this year really mitigating that inflation; we need to continue to stay ahead of it.

But we need to do it in a fashion that we are actually driving a great customer experience. And we do think things like consumer-facing technology, mobile order/mobile pay, kiosks in the restaurants -- those things can create a great customer experience but then have an outcome of actually helping lessen some of the pressure on labor. And we do know that we still have a lot of back-of-the-house automation opportunities that the consumer never sees that will actually make our employees more productive and free them up to spend more time with the customer, if we can some of that automation in place, which will help us mitigate some of the pressure.

So that's the key. How do you mitigate the labor pressure, so you don't have to take pricing to widen that gap further at food at home versus food away from home.

Great, thank you.

Matt McGinley, Evercore ISI.

Follow up on that price comment that you made, and you typically talk about this in terms of price relative to value, and that you don't want to take too much price, because you want to maintain affordability. But how do you think you're taking price relative to the industry? And how do you think price discipline is amongst your systemwide base relative to what else you're seeing amongst your competition?

Good question, Matt. On our front, if you think about the Company restaurants, we haven't taken any new pricing this year -- very consistent with last year, where we haven't taken any pricing. We've got some modest pricing in some high minimum wage inflation markets, but it's minuscule when you think about it across the total Company side.

There's been a little more pricing taken in the franchise community. But if you look at the level of price that the franchise community has taken this year relative to what's happened in the QSR industry, we have taken less price than the rest. And I think that's important to set ourselves up the long run.

And when you think about the first half of the year, across the system we are growing customer counts. If you look at the rest of the industry, there's a lot more growth driven by price rather than bringing more customers in more often. So we're really trying to make sure that we are playing a long-term game to set ourselves up for success by being relevant with customers for the long run.

Got it. One on the store-level margins within the quarter. You obviously updated the guidance to show that you're going to have continued favorability from commodities, but you had pretty good leverage on the other operating expense line. Can you comment on what's driving that? And given the dispositions you have planned for the remainder of the year, does that benefit fade as you sell stores relative to the stores that you retain?

Well, thanks for the question. Yes, we were actually very pleased with our margin progress in the second quarter. As you pointed out, yes, absolutely, commodities played a big part of it.

Secondly, let's don't forget we are also lapping in the second quarter still the ownership of Canadian restaurants. Two Canadian restaurants were then sold, and it helped us, obviously, in our comparisons.

And as Todd said, right, our Company restaurants in the quarter grew 1.2%. It's basically all behind [strategic], and it created leverage on us. On top of it, we actually had good control of our controllable expenses in our restaurants. So that combined with the traffic actually helped us with margin expansion.

Okay, thank you.

Mike Gallo, CL King.

My question is just the labor line. You guys were able to leverage it 50 basis points despite a modest comp, which I thought was pretty impressive, given the wage rate increases you have in many of your markets and the lack of pricing, as you just discussed. So I was wondering if you can speak to some of the labor initiatives, and how you plan to bring labor as a percentage of sales down even without having comp leverage, given what you're seeing in some of those wage markets? Thanks.

Mike, thanks for your question. So you're right, we are very pleased with our 50 basis points improvement related to labor. We clearly saw inflation around 5%. And as you know, we are constantly working to make sure that line item stays in check. And we were again successful in the second quarter around this.

What helped us -- as we said previously, our restaurants experienced customer count growth, so that fully created leverage for us. On top of it we are seeing the results of our positive efforts around what we call the labor guide -- so how did we deploy our restaurant labor in our restaurants for various activities. And we have optimized that. The benefit of that has fallen to the bottom line.

And as you know, behind the scenes we are doing enhancements on the technology side. So all these things combined continue to help us on that line item in our P&L.

Just a follow-up on that, GP. Did you say that the customer accounts were up in Company stores in the quarter, or perhaps I missed that earlier?

That's correct, yes. So our 1.2% sales growth in our Company restaurants was mainly all traffic increase.

Thank you.

Jake Bartlett, SunTrust.

I just want to understand exactly what drove the slowdown in the second quarter? I think there's been a couple of things you mentioned, but I also just want to confirm -- did you do different marketing? I think you mentioned your deliciously different you focused on in the first quarter, but did you not focus on it in the second quarter? Was that one of the drivers to the slowdown?

Jake, I think I hit most of all the elements that really drove the category, but relative to your specific question on the calendar, if you think about the first quarter, we did have a nice high/low message, and it was really around what sets Wendy's apart with the deliciously different?

Fresh beef, and why is it fresh? Because it's sourced so close to our restaurants that it never needs to be frozen. And that clearly resonated with the consumer base. You know, we had an overhang of deliciously different into the second quarter, but we got a little more specific around advertising the product when it was Jalapeno Fresco or Bacon mozzarella. And I think we've learned from that -- that we really need to continue to tell our unique brand story.

And that's part of what we've done to check and adjust our calendar in the back half. And you actually see that starting now, as we are telling that story very consistent again around fresh and fresh beef with the Baconator campaign that just started Monday of this week.

Okay. And was there a reason why you didn't do it with the Bacon Mozzarella LTO?

No, we would have had the overhang, Jake, on Bacon Mozz, but probably not as direct around the fresh beef message and more alluded to it. If you think about what we did in Q1, and if you watch our copy that we have out there right now on Baconator, it's very direct, that -- why is fresh beef so important? Well, it's sourced so close to the restaurant, it never needs to be frozen; and quite honestly, it's better.

Got it. And then I had a question on unit growth. And if you could outline exactly, I think, what -- the commitments you have for domestic unit growth, tied to these re-franchisings you've done in this latest round of system optimization as well as the prior and as well as your flips. Maybe just kind of tie it all together, seeing how much of the 1,000 stores that you expect to open by 2020 you have committed to now?

Yes, so now that we have visibility through SO1, SO2, and SO3, Jake, we've got about 270 new restaurant commitments between those three initiatives. So 100 in SO1, which we have talked about the past; approximately 60 with SO2, which we've talked about the past; and then 110 that we've just gotten with SO3 as we get ready to complete sale of the 540 restaurants.

You also have -- and what we'd anticipate with all the buy-and-flip activity in 2016, that there could be upwards of about 75 commitments that we get when this year all ends on buy-and-flip. So that gets you to about approximately 350. And then, don't forget, the Company has committed to do 50 restaurants over this time. So we've got about 400 that we have lined up with commitments against that 1,000. And remember, we're going to have a lot more buy-and-flip going forward. So there will be a lot more opportunity to get commitments on that front.

But more importantly, we're doing joint capital planning across the entire franchise system. So we're working with them beyond just commitments to think about where can they help us grow as we have got the whole system aligned build these 1,000 new restaurants between 2015 and 2020.

Great. And then lastly, real quick, on the international side, I guess kind of the same question. What -- for instance, your Brazil JV -- have they committed to a certain number of units over a certain time period? And I guess same with the development agreements in Saudi Arabia?

There are commitments and a plan. So in Brazil we're a lot closer to it, because we're a 20% owner in the joint venture. We haven't publicly stated what the long-term development commitment is at this point. The Alghanim Group is our franchise partner in the Middle East. They do have development agreements in place. And in both markets we are tracking well against those commitments.

And with the First Kitchen Japan conversion play, there is a committed schedule around conversions moving forward. We'll provide a lot more guidance on that when we give full update on the international plot when we get ready to talk about 2017 and beyond guidance.

Great, thank you very much.

David Palmer, RBC Capital Markets.

Congrats on the re-franchising you just completed. A question on that: are you collecting rent in addition to franchise fee on those re-franchisings? And if so, what's the average percent of sales you'll be collecting?

And separately, I think you touched on the reimaging targets that are attached to these deals. Are there any other strings attached around development as well? And then I have a follow-up.

Thanks, David. So as we've gone through, we had about 665 owned real estate properties when we started all the system optimization process. And will have about half of those fully monetized here through SO1, SO2, SO3. The good news is the other half will sit underneath the restaurants that we continue to own and operate. So we'll have a strong economic model there.

We're getting rents in that 7% to 7.5% range when we have owned real estate. If we stay the prime on the lease, we need to pick up a spread. So that's part of what's driving that nice rental income stream that we said was $170 million of gross rental income, $90 million in net rental income over the next couple of years. I think that was a --?

2017.

2017 run rate moving forward. But then, as we get in the middle of all of these buy-and-flip transactions, it creates a lot of unique opportunities. We do stay as prime on the lease. We do have an appropriate spread on those deals. It varies dramatically, so it's hard to give you exact guidance, because what we want to do is make sure there's a great, strong economic model for that new franchisee when they buy that restaurant.

And as I just said, we do get, then, commitments to new unit development, in some cases accelerated reimaging commitments. So the buy-and-flip piece does drive a nice income stream into the future. TAF is upfront. Rental income stream of some sort into the future. May give us an opportunity to buy some land on occasion; we'd have to think if that was a good use of capital to create another rental income stream. But most importantly, we're getting the restaurants in the hands of great operators that then have commitments to new development and reimaging.

And separately -- thanks for that. And separately, and I'm fishing here a little bit, but are you seeing a widening range of comps around the country, as it appears that some other chains are? If you are seeing that widening gap and some, perhaps, lagging markets, is there an adjustment that can be made for those markets or regions?

Yes, we do see widening gaps across different regions. There's different economic conditions and different markets, and offerings like 4 for $4 resonate differently in different markets across the country. I think we can take all of those learnings -- and we have, and they are very focused market by market what we need to do to connect to the consumers in that individual trade area to make sure that the plans are completely checked and adjusted.

I think the real good-news thing that we have is -- you know, we had a public press release on leveraging SMG to really get some good Voice of the Customer data. And really having that information available to our operators at the restaurant level on a very timely basis really allows us to make sure that we are doing the things that matter most to that consumer, to ensure that we can delight every customer. And that could be one of the -- any of the four elements that we talked about on the wheel earlier, right?

Are we delivering the food experience that we want? Is the restaurant experience living up to what they would expect? Are we creating an experience through our people and our food that they are comfortable with? And are we appropriately set on value in that particular marketplace? So having that pulse is giving us a better opportunity to check and adjust even faster.

Great. Thank you.

Thanks, David.

John Ivankoe, JPMorgan.

Actually, a follow-up on the comments that you just made to David Palmer: what did you say about $90 million of -- was it rental income in 2017?

So we've provided this a couple of times in the past. So if you think about -- by the time we fast-forward to 2017, within our P&L you'll see $170 million of gross rental income across all elements that have generated and about $90 million of net rental income.

Okay, that's great. And you guys did around -- I think it was $17 million of net income in the second quarter. So that's a pretty big step up, that we still have to go from the second quarter of 2016, as just reported, to kind of 2017, correct?

What we have said for the second quarter -- our net effect on royalties, franchise fees, netting out rental income, rental expense in this whole lot year-over-year helped us with $11 million. So on the top line, the revenue side, so rental income was up $19 million year-over-year; but then you need to take into account in other operating expense, basically, the rental expenses -- you can net it off. The net impact is $11 million, as we have disclosed in the --.

And those are deltas or absolutes within the quarter. So you will have to annualize that on our step up towards that ultimate number.

Yes. Okay, yes, I can see that. And thank you for putting out your 10-Q the morning of the release. It's extremely helpful. So we definitely appreciate that.

And then, secondly, it's certainly interesting to see an increase in the longer-term margin in 2020, but is it too early to talk about what revenue you're applying that margin to in 2020? There is obviously your different ways to get a margin based on what kind of revenue that you have. So it's an enticing thing to see a margin, but what kind of revenue target do you have in 2020?

You know, as Todd said previously, there's a lot of levers we're going to pull to get to this margin target. We have, obviously -- as we are finishing system optimization, we are kind of refocusing ourselves in terms of what's the next big thing we're going after. And obviously EBITDA margin of 38% to 40% is one of our key Company goals going forward for 2020.

Do we have an internal revenue forecast for it? Yes, absolutely. Do we -- going to play with all of the components that Todd talked about, from rental income over SRS growth, restaurant development, international growth, and the like? Yes. Is it a little bit too early to talk for us? Yes.

Do we feel -- are we feeling confident that 38% to 40% is the right target range for us? Absolutely. And that's reason why we kind of put it out.

Okay. And then finally for me, how is the integration to the new Aloha system coming? What are you guys seeing? What are franchisees seeing? Any type of tangible benefits on the sales or the cost side to talk about at this point?

We are happy with the progress, where about 70% of our system is converted to all-Aloha. We are obviously on track to finish most of it by the end of the year, and we can't wait to have one point-of-sale system, because obviously for us as franchisor, we can give obviously much better -- get much better insights and analytics and help the whole system with findings and the likes.

It is conversational ordering, so it does help the register operator to try to create a better customer experience because of that. It makes it easier to train as we have turnover in the restaurant. And most importantly, that does become the platform, when we get all of this -- the whole system -- on a common point-of-sale at the end of this year, to really go full bore on mobile order and mobile pay.

Thank you.

Jason West, Credit Suisse.

Thanks. Couple questions. One, the EBITDA margin guidance you guys provided today -- I think that's the first time you've put that number out there, if I'm correct. Is that number consistent with all the other long-term guidance that you'd already given? Or is this setting a more aggressive bar as you move out to 2020?

Definitely first time we put this number out. You have us heard -- talked previously about an EBITDA margin of 35%-plus. We're basically fine-tuning a little bit what 35%-plus actually means. And we think 38% to 40% is the right target for us. As I said previously, it's a little bit too early for us to give kind of component-level guidance on how we get to it. So it's a little bit to a later date, when the time is right for us to do this. Think about early of next year.

Okay, got you. And then one other, on the grocery comments about the pricing differential there, you guys kind of led with that as the issue with the consumer. We've heard others talking about that. But do we have any sort of hard data that you guys are actually able to measure that, and you're seeing that from your customer survey work? Or is there any really analytical way for you guys to know if that's what's happening with the consumer? Or is this sort of more of a gut feel based on history and based on the obvious pricing differentials?

Some gut and some science along the way. So there's a lot of gut feel on what we're seeing and what we're hearing anecdotally in the restaurants. We do get a lot of customer feedback to make sure that we are appropriately priced across our whole menu.

And the great news is, as you think about what we talked about on our brand health metric, worth what you pay, we're making great progress on that front. But that's really generated on the heels of the 4 for $4. And what we need to do is make sure that the customer feels that our core and LTO items are appropriately priced for the value that we are providing. And that's not just what you put into the food, but that's what you create as a total customer experience to make sure they feel good, that it's worth what they pay.

Okay. Thanks, guys.

Nick Setyan, Wedbush Securities.

Can you guys maybe update us on how the Image Activations -- the sales lifts are going, and also maybe talk about the previous classes, if they are able to still sustain those original sales lifts that they saw?

Hi, Nick. Thanks for the question. No, we are very happy with the progress, as you know. We are now at about 26% of our system Image Activated. That compares to 24% at the end of the first quarter, so we're making steady progress.

We are actually seeing a little bit more lift than what we previously contemplated. We previously said, like, well, 5%, there and thereabouts. We are actually seeing lifts more in the 6% range, which, obviously, from return point of view for our investors -- for our franchisees is much better from a return point of view.

So Nick, so we're seeing the 5% to 6%s on the refresh option. To the lower investment option, which is about $300,000, that 5% to 6% is stronger, as GP said, than we had earlier anticipated. If we are doing a full reimage, we're still seeing those lifts of high single-digit to low double-digit. And if you look back after all of these classes on the sustainability, we do see great sustainability.

So what we've done is brought in lapsed and new customers, created a new higher AUV base. And we continue to see those restaurants then grow in line with the rest of the system. So we have won their hearts and minds, and we continue to bring them back. And we've got enough long track record now going back to 2011, so we've got a lot of data on that.

Got it. And then, Todd, you guys were pretty early in anticipating the deflation we were going to see this year for food at home, and you rolled out the 4 for $4 in Q4 of last year. I guess, what you're expectation for deflation going into 2017, you know, food at home? Do we think we've kind of stabilized there, or is there going to be more deflation?

We'll provide more guidance as a subset of our complete guidance when we set up 2017. But if you look out at the beef markets and the recent performance, all the fundamentals look good. Input costs are down and continue to look like they'll be down for a little bit of time. The herds have been building. So it does look like, especially on the beef side, that we could start to be in a little more stable environment, notwithstanding some drought or something that's unforeseen at this point in time.

Thank you.

Thank you. That does conclude today's Wendy's Company second-quarter 2016 earnings conference call. We thank you for your participation and ask that you please disconnect your lines and have a wonderful day.