Wendy's Co (WEN) 2016 Q3 法說會逐字稿

Audio in progress.

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 Gunter 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 of the Safe Harbor statement that appears at the end of our earnings release.

This disclosure reminds investors that certain information we may discuss 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 will now turn the call over to our President and Chief Executive Officer Todd Penegor.

Thank you, Peter, and good morning, everyone.

We are pleased to report solid third-quarter results, which reflect the benefit of our brand transformation efforts and a strengthened economic model.

Starting with the top line, North America system same-restaurant sales increased 1.4% or 4.5% on a two-year basis.

This is our 15th consecutive quarter of positive same-restaurant sales, which demonstrates the long-term strength and relevance of our brand.

Adjusted EBITDA margin improved in the third quarter by 600 basis points to 27.5%.

This significant improvement continues to demonstrate the higher quality of earnings that we are generating as the result of our system optimization initiative.

Royalties and rental income are contributing a higher amount of our earnings along with ongoing focus on G&A expense.

Image activation, which includes restaurant reimaging and new restaurant development, has been a cornerstone of our brand transformation and is a key driver of our growth strategy going forward.

Franchisees continue to see the benefits of image activation and are accelerating their pace of reimaging.

We now expect to image activate approximately 600 restaurants in 2016, which is a significant step up from our original expectations of 540.

In light of our third-quarter results, we are increasing our 2016 guidance for both adjusted earnings per share and adjusted EBITDA.

Lastly, as part of our previously announced share repurchase authorization, we intend to enter into an accelerated share repurchase transaction for $150 million in the near future.

We also announced that our Board of Directors has authorized an 8% increase in our quarterly dividend rate.

We continue to deliver on our commitment to return significant amounts of capital to our shareholders and remain focused on returning excess cash to shareholders going forward.

On our second-quarter conference call, we stressed the importance of a balanced marketing approach, particularly in today's environment.

After a slightly LTO-heavy promotional calendar in Q2, we shifted our messaging in Q3 to emphasize our core and price value offerings.

By highlighting core menu items, offerings that are only available in Wendy's restaurants every day, we can promote brand equities that differentiate us from the competition.

Quality, freshness, and sandwiches made-to-order are some of the qualities that have been instilled in our restaurants since 1969 and are as important as ever to consumers today.

On the price value front, our 4-for-4 offering, which launched a little over a year ago, has been a hit with consumers and we remain focused on continuing to find ways to provide value across our entire menu.

Our promotional calendar in the third quarter came together nicely and was successful in refocusing attention on core and price value.

And our results benefited greatly.

The summer berry chicken salad was our first national message in Q3.

This salad LTO highlighted our focus on freshness by serving fresh strawberries and blackberries on a bed of hand-cut lettuce with feta cheese, apple chips, and grilled chicken, a great combination of sweet and savory.

Next up was the Baconator, a deliciously different menu item that features fresh, never frozen North American beef and six strips of Applewood smoked bacon, cooked in our restaurants each day.

By also offering Baconator fries at an attractive price point of $1.99, we were able to provide compelling value to consumers while also highlighting our brand equities through a core offering.

Following the Baconator promotion was $0.50 Frosty, which drove strong customer counts in a very profitable way.

What better way to fight the dog days of summer with an amazing deal on an iconic product that you can only get at Wendy's.

Rounding out the Q3 calendar was our redesigned grilled chicken sandwich, which features a fantastic new multigrain bun and fresh grilled cooking procedures that results in a more tender and juicy filet.

We leveraged a $5 price point for a small combo that gave our customers great value on an upgraded core menu item.

The balanced approach in the third-quarter promotional calendar drove a solid increase in both our one- and two-year same-restaurant sales in North America.

Our same-restaurant sales outperformed the QSR sandwich category for seven consecutive weeks to end the third quarter, according to the NPD Group's Sales Track Weekly.

Included in this segment are 16 of the top QSR sandwich and hamburger chains in the US.

Our outperformance versus our peers started with the introduction of the $0.50 Frosty promotion and continued with the launch of our upgraded grilled chicken sandwich.

Both promotions brought profitable customer counts into our restaurants and helped us gain QSR burger category traffic share in the third quarter according to the NPD Group.

These solid third-quarter results were achieved in spite of tougher 2015 compares and without relief from the challenging industry conditions.

It is imperative that we continue to find ways to meet the consumers' economic model.

Our brand position of delivering new QSR quality at traditional QSR prices has allowed us to drive profitable customer counts, even in a difficult environment, which becomes evident when you take a deeper look at our Q3 results.

Our third-quarter same-restaurant sales for the North America system were driven by strong customer count growth and a slight increase in average check.

The benefits from our brand initiatives, image activation, and our system's continued progress on disciplined pricing has contributed to us bringing in more customers to our restaurants.

Conversely, the QSR hamburgers category's growth was driven by an increase in average eater check, which was largely offset by a substantial decrease in customer counts.

We believe the healthy and sustainable way to grow is to remain committed to driving profitable customer counts.

We are focused on bringing in more customers more often to our restaurants.

This is more important than ever, as the gap between food-at-home and food-away-from-home prices in the restaurant industry continues to widen.

The focus on our core brand equities and a balanced marketing strategy across core, price value, and LTOs has resulted in year-over-year improvements in key brand health metrics.

Our food quality and messaging continues to resonate with consumers, as evidenced by a 16% increase in our key quality metric, high-quality food.

Wendy's is consistently ranked the highest among traditional QSR hamburger competitors for food quality and we remain committed to widening this gap even further.

Our efforts, upgrading our hamburger line, and grilled chicken offering are delighting customers.

Our focus on price value is connecting with consumers, as reflected by a 7% increase in our key value metric: worth what you pay.

The year-over-year improvements we have seen in our brand health metrics are encouraging and we will continue to strive to provide consumers an even better total experience in our restaurants.

Everything at Wendy's centers around delivering on our brand promise of delighting every customer period.

In order to achieve this, we have to be focused on our food, providing great value, delivering exceptional service, and elevating our restaurants.

Fresh, honest ingredients, craveable taste made right.

That is how we create food our customers love.

Competitive prices, Wendy's quality, and a great experience are going to make our customers feel Wendy's is worth what they pay.

Service is a key pillar for us.

Service that is friendly, accurate, and fast creates an experience that brings our customers back.

Last, but not least, our restaurants have to be clean and well maintained, up-to-date, convenient, upbeat, and comfortable.

In the eyes of our customers, a place they just love to go.

We can create joy and opportunity through our food, family, and community when we are excelling in these key focus areas.

And now here's GP to take you through our third-quarter financial highlights.

Thanks, Todd.

North America system same-restaurant sales increased 1.4%, 4.5% on a two-year basis.

Higher sales at reimaged restaurants contributed approximately 80 basis points to our North America system same-restaurant sales results in quarter three.

North America Company restaurant margin came in at 18.4% in quarter three, a slight decrease compared to the third quarter of 2015.

General administrative expense was $58.9 million in quarter three compared to $63.7 million in 2015.

This 7.5% year-over-year decrease was mainly due to savings from systems optimization and lower share-based compensation and incentive compensation, which were partially offset by an increase in professional and legal fees associated with the unusual payment card activity.

Adjusted EBITDA was $100.2 million in the third quarter of 2016, a slight increase compared to the third quarter of last year.

Our strong adjusted EBITDA performance as well as the 600-basis-point improvement in adjusted EBITDA margins exemplifies our higher quality of earnings resulting from our system optimization initiative.

Adjusted earnings per share was $0.11 in the third quarter of 2016 compared to $0.09 in this third quarter of 2015.

Now we will take a deeper look at our adjusted EBITDA performance.

During the third quarter, adjusted EBITDA was essentially flat year over year, but we are proud of the fact that we successfully replaced the EBITDA that was lost from owning 433 fewer Company restaurants with royalties, franchise fees, and net rental income, which increased by $24 million compared to quarter three of 2015.

Switching now to our $0.02 improvement in adjusted earnings per share, in the third quarter, we saw $0.01 of accretion from our ongoing share repurchase program.

During the quarter, we repurchased 5.3 million shares for $53.1 million, and we have reduced our shares outstanding by over 10% since the end of the third quarter of 2015.

This marks the first quarter that share repurchase activity net of interest expense has been accretive to EPS, as we are now lapping over the higher debt levels resulting from our 2015 whole business securitization.

Depreciation declined year over year primarily due to the sale of Company-operated restaurants, which resulted in another $0.01 of EPS improvement.

Now I would like to provide an update on where we stand with our capital return plans.

Year to date, we have repurchased about 18 million shares for around $185 million.

As noted in our release, today we announced our intent to repurchase $150 million of our stock in an accelerated share repurchase transaction in the near future.

After the completion of the anticipated transaction, we will have utilized substantially all of our $1.4 billion share repurchase authorization that was approved by our Board of Directors last June.

We also announced that our Board has authorized an 8% increase in our quarterly dividend rate, from $0.06 per share to $0.065 effective with our December dividend.

This marks the fifth consecutive year that we have raised our dividend, and during that time, our dividend has grown by 225%.

We plan to provide additional details on our future capital allocation strategy when we provide updated guidance early next year.

Now let's take a look at our full-year 2016 outlook.

We are increasing our guidance for adjusted earnings per share to $0.40 to $0.41, up from our prior guidance of $0.39 to $0.40.

We also expect adjusted EBITDA to come in at the high end of our previously issued range of flat to up 1% compared to 2015.

With a little over seven weeks to go for the year, we are tightening our same-restaurant sales guidance to approximately 1.5% growth for the North America system.

This updated guidance implies slightly positive same-restaurant sales in the fourth quarter as we lap over the launch of 4-for-4 in October of last year.

We have also updated our guidance for cash flows from operations to $180 million to $200 million.

Capital expenditures are now expected to be approximately $145 million, and we now expect free cash flow to come in at approximately $35 million to $55 million.

We continue to expect commodity deflation of 5% to 6%, Company-operated restaurant margin of approximately 19%, general and administrative expense of approximately $245 million to $250 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 some of our key growth initiatives.

Thanks, GP.

We are in the final stages of the third phase of system optimization.

As of today, we have completed about 85% of the 2016 transactions.

The remaining markets we expect to sell have been awarded to their respective buyers and we remain on track to close all remaining deals by year-end.

During 2016, we expect to sell a total of approximately 315 restaurants on top of the 227 restaurants that were sold in the second half of 2015, which will leave the Company with ownership of approximately 5%.

We continue to expect total pre-tax proceeds for system optimization three 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 strategies.

During the third quarter, 18 restaurants were transferred through buy-and-flip transactions, which brings our year-to-date total to 144.

We continue to expect about 200 restaurants to be transferred through buy-and-flips in 2016.

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 to image activation, we now expect the North America system to image activate approximately 600 restaurants, which includes about 100 newbuilds.

As I mentioned earlier, this is a significant increase from our prior expectation of 540 reimaged and new restaurants.

About 28% of the Wendy's system is now image activated and we expect that number will exceed 30% by the end of this year.

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.

We now expect to achieve total net new development in 2016 of 15 to 20 restaurants for the North America system, which is higher than our original plans of 5 to 10.

This would be our first year of positive net new restaurant openings since 2010, a great momentum builder for our future development goals.

And finally, we are on track with our 2020 goals.

For the North America system, we continue to target average unit sales volumes of $2 million, restaurant margins of 20%, a sales-to-investment ratio of at least 1.3 times for new restaurants, restaurant development growth of 1,000 new restaurants and approximately 500 net, and image activating at least 60% of our restaurants.

We also remain committed to our 2020 Company goal of delivering adjusted EBITDA margin of 38% to 40%, and we plan to provide additional details on our roadmap to deliver this margin expansion early next year when we provide updated guidance.

Now here's Peter.

Thanks, Todd.

Please note we will be returning scheduled calls with 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 soon as we can.

Before we open the line for questions, I would like to review some upcoming events on our investor relations calendar.

On Tuesday, November 15, GP and I will be in New York for the Morgan Stanley consumer and retail conference.

A few weeks later, on Friday, December 9, we will be in New York for our one-day road show hosted by Bernstein.

If you're interested in meeting with us at these events, please contact the respective sell side analyst or equity sales contact at the host firm.

And finally, on Thursday, February 16, we plan to host our 2017 investor today here in Dublin, where we will issue our preliminary 2016 earnings release and updated outlook.

Please hold the date and we will give you more detail soon.

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

(Operator Instructions) John Glass, Morgan Stanley.

First, can you just maybe bridge the change in your free cash flow guidance and your cash from operation guidance versus what you reported?

You raised your EBITDA guidance at the high end in earnings and you've lowered -- yet, you lowered cash from operations by $5 million to $20 million.

I understand higher interest is a piece of that, but what are the other components of the cash from operations change?

Good morning, John.

This is Gunther.

Thanks for the question.

You are right: we changed cash flow guidance a little bit.

Basically what happened is we lowered cash from operations to the slightly lower end of the range.

Capital came in slightly higher as a result of it.

We kind of slightly lowered the guidance for this year.

I do want to point out that the cash flow guidance for 2017 and 2018 remains unchanged, as we have previously communicated.

And why did the CapEx come in at the high end?

Is this a timing issue?

Were remodels more expensive than you thought?

What are the dynamics driving the higher CapEx?

I think the majority is timing issue.

And again, what -- we have this complicated situation that we are trying to sell off our markets.

We obviously have a much more stable picture going forward in 2017 and 2018.

And we have a fair amount of confidence that we're going to stay within the capital guidance we have previously issued, which is in the $80 million to $90 million range.

Okay.

And then just finally, you commented on the capital allocation announcement that's coming up next year.

Is this about leverage targets or what are you thinking about?

I thought you laid these out a year ago.

So I think your question was in terms of allocation guidance.

So what we have is -- we stay committed that we are returning all excess cash to our investors.

So you continue to -- can expect that we are -- continue going to do dividends and continue going to the share repurchases.

As you know, the share repurchase authorization has expired or will expire at the end of the year.

And we are going through an internal process with our Board of Directors at the moment how we might allocate those excess funds out to our investor community.

Thanks very much.

Will Slabaugh, Stephens Inc.

Want to ask you on menu innovation, which you went through a little bit as far as how it worked out for 3Q.

And also I know the 4-for-4s worked well alongside with that and that continues to mix well.

Can you talk about where there might be additional opportunities to bring new product news?

I know you're lapping up against some pretty tough comparisons going forward.

So not focusing too much on the short term, but just wanted to get a sense of where your head was in terms of where the opportunities could be on the menu for more innovation and then driving more traffic?

Hi, Will, good morning.

And this is Todd.

I think it is a balance.

As you guys know, there's a lot of things that we continue to test out in the marketplace to bring news to the brand.

But what we are really focused on is telling our unique brand story.

And if you look at where our calendar has gone into the early fourth quarter, we brought news against our 4-for-4 promotion.

We brought the Swiss JBC into play to make sure that we can keep the 4-for-4 fresh and ownable.

We brought back something that is truly differentiated in the category from a burger QSR perspective -- the taco salad LTO, which -- not just in LTO.

It's going to be permanent on our calendar long term.

And then really coming back to some of our equity messaging that's out there right now and really talking about fresh beef.

And the messaging, frozen is for later and fresh is for now, is something that is truly differentiated in our space.

And we think we can continue to have a nice balance between focus on the core and telling our brand story, bringing a bit of news into play, as we've always has with some impactful LTOs.

But also making sure that we continue to bring value.

That could be 4-for-4; that could be the total experience in the restaurant.

And you saw that work with things like the $0.50 Frosty when we were able to put that out there to really drive some profitable customer count growth.

Got it, thank you.

If I could follow up really quickly on the raised guidance, to get down to the high end of the EPS range, given the strength you saw in 3Q, I have to assume some pretty material deleveraging at the restaurant level for 4Q, which looks like it may even include some cost of sales rising sequentially as well.

So any thoughts on where the deleveraging might show up in 4Q more materially as you lap over that tough comparison?

I think, Will, I will turn it over to GP in a moment on deleveraging.

We don't really have deleveraging built-in tremendously.

I think as you get into our fourth quarter, our tough comp is really driven by two things.

Remember, we still got a 53rd week that we have to lap.

And we said that was about $7 million of EBITDA in the past, so that's one of the headwinds.

And last year, you may recall with a lot of the system optimization activity, we had a lot of TAS that came through in the quarter.

So that is more the function of the EBITDA growth year on year.

We don't see -- and I'm looking over to GP to me a little more color on any material deleveraging, as we're still confident in that 19% full-year restaurant operating margin.

That's exactly right, Todd.

We had -- year to date, we have a restaurant margin of 19.2%.

We are guiding to 19%, so you can expect that the fourth quarter is going to be slightly below the 19% mark.

And it's really in line with the guidance we gave at the second quarter.

So really no surprise for us on our restaurant margin construct.

Understood, thank you.

Michael Gallo, CL King.

One question and one follow-up.

Todd, obviously nice to see the acceleration in image activation.

I was wondering how much of that is a function of just as you start to get these transactions done versus franchisees just getting increasingly confident that they are doing the returns and the sales list that they would like.

Then I have a follow-up.

Yes, Mike, it's less of a function of the transactions that are happening.

It's nice that we get commitments for reimaging and commitments to newbuilds with the system optimization initiatives and the buy-and-flips that we are doing.

But it's really continued momentum as we continue to work the economic model on reimaging and really try to work to find the sweet spot on the investment and the return.

It's driven a lot of confidence in our franchise community that they feel good that that investment will drive a return.

And all the work that we've done along the way to really optimize the investment as well as continue to expand our margins has been helpful.

And what we're seeing is a nice positive trend in the health of our franchise community with positive cash flow, which helps to continue to reinvest in the business to stimulate growth for the future.

So we feel good about that momentum that we are seeing.

Okay, great.

And then a follow-up for GP.

GP, how much -- what was the cost for the unusual credit card payment activity in the third quarter and what is the year to date?

And should we assume that this is pretty much done on a go-forward basis?

Good morning, Mike.

So what we have is on a year-to-date basis, our costs have been in the $4 million to $5 million range.

Remember in the first quarter, we highlighted about $2 million, and in the third quarter, it's a little bit more than $2 million.

It's basically in the Q explained there.

Are we done?

No, we are not done, obviously.

We still have two pending lawsuits that we need to work through, so expect there there's going to be a little bit more cost to come.

And we have taken care of that cost estimate in our outlook for the year.

Okay, thank you.

Jeff Farmer, Wells Fargo.

Franchise rental income has been the largest revenue growth contributor for the Company it looks like over the last several quarters.

So can you help us just better project future rental income by providing some detail on I think it's the number of restaurants that you own and then rent to franchisees.

And then the number of restaurants that you rent and then sublease to franchisees.

Any detail there would help us think about this moving forward.

Yes.

So we keep working through the rental income stream and we keep actually revising the projections upwards, absolutely right.

What we have at the moment -- we have about 667 properties that we own.

And as we said in 2015, we had monetized about 50% of it.

As we are fast forwarding where we have 5% of all restaurants being Company restaurants, you are going to expect that about 45% of them are going to be on a land and building that we own.

So as a result, 45% of about 320 restaurants, you can basically estimate that we have about monetized 78% of all our land and building.

You can also expect that since we are now finished really with system optimization by the end of the year that we have reached our peak real rental income kind of from 2017 onwards.

Slightly increased, yes, a little bit, but only because of the kind of industry-standard rent escalators and the likes.

But the brunt of the income is now generated come the end of the year.

I hope that answers your question.

Yes, thank you.

Sara Senatore, Bernstein.

Two questions, if I may.

One is on commodity costs.

In particular, I think they didn't -- your outlook didn't change for this year.

I know we don't have too much left of the year to go.

But I was wondering if you could share your thoughts on that.

Does that suggest things are stabilizing?

Because it had looked to us like the futures markets were suggesting we still might have another couple of quarters before that happens.

And I guess I ask in the context of the food-away versus food-at-home gap and if you think that that might improve where industry trends go.

Because I noticed that you -- I think you took the comp guidance out of your longer-term guidance, kept the AUVs, but the comp guidance seems to have gone away.

So I was just wondering if you could tie those together, kind of the commodity outlook in the context of food at home and food away from home.

And then I will have a second question, please.

Good morning, Sara.

This is GP.

Yes, on the commodity side, you are right: we maintained the outlook of 5% to 6% deflation.

If you are a betting man, we'll probably come in higher on more than the midpoint.

Are we confident on the commodities going forward?

I would say grain supplies great, herds are stocked well, so we actually expect that commodities are going to stay our friend for next year.

But we're going to update more specific guidance on the investor day as we lay out all the expectations we have for 2017.

On your subsequent question in terms of food away from home and at-home inflation/deflation, I think Todd wants to add a couple of points.

Yes, no.

As the years progressed, we have continued to see that to widen.

But as you get into next year and commodities kind of flatten out, I think you'll see that gap slightly start come back together, which would be a healthy thing for the industry over time.

Be just a function of lapping what happened this year.

And to your question on same-restaurant sales guidance, we have been sticking to our long-term guidance of approximately 3% for the system, and that holds.

Okay, that's great.

And just -- sorry, one question on the margin side.

I know you said you will give more details on the margin -- the longer-term margin targets.

But I noticed that this quarter, you are pretty close to your franchise mix target of 95%.

But your EBITDA margin is somewhere around 1,000 to 1,300 basis points below the longer-term.

Is there anyway just you can give some sort of broad guardrails about where that margin expansion might come from?

Hi Sara.

Great question.

I assume you are referring to the 38% to 40% EBITDA margin target for 2020?

I am.

Okay, that's what I thought.

So what's going to happen is we continue to expect that our restaurant margin is going to expand.

We continue to expect that we are going to develop our restaurants both in North America and in international that is going to create scale for us.

And we continue to expect that obviously G&A is going to come down.

As you know, we have a midpoint of the guidance range for this year is $248 million.

We had previously said that that needs to come down to $230 million.

So you can at least expect that to happen.

And the combination of all those, so growth plus moderate margin expansion in our restaurant business plus continued prudent approach in G&A, is going to drive our margins into that range.

I think the other piece is you got to start to factor in the net new restaurant development, both from what we're seeing here with the momentum in North America as well as our longer-term plans in net development across international.

We will provide more insight on our international plans in our analyst day in February.

Thank you.

Matt McGinley, Evercore ISI.

My question is on the cash balances.

It was obviously, very high at quarter end and that's probably why you announced the intention to do an ASR, but it is steady-state.

When you're done with the refranchising and you are, theoretically, this much more asset-light business, how much cash do you think you need to maintain on your balance sheet just to run Wendy's as a business?

Good morning, Matt.

Great question.

So we think we need about $150 million.

We are setting aside about $100 million for international and about $50 million to run the North American operation.

Okay.

And on the restaurant labor and occupancy cost, it looks like it had gone from a benefit to a headwind -- a little bit of a headwind in the third quarter relative to the prior quarters.

Is that a function of you are just not getting as much benefits or something has changed with the labor rates or your ability to get efficiency?

Or is that just related to mix as you continue to sell off these stores?

Great question, Matt.

Overall, we are actually proud in terms of how we progressed with margin.

If you think about it, restaurant margin overall year to date is 19.2%, so we expanded margin by 200 basis points.

So that plan works.

What has changed versus the second quarter, I would say, we implemented minimum wage in the Chicago area in the third quarter.

That put a little bit of pressure onto the labor rates, which we couldn't quite overcome in the quarter.

Don't forget, we remain totally committed that we're going to continue to invest in mobile ordering, mobile kiosks, back-of-the-house automation to make sure that that headwind that is coming towards us on labor rate is a real drag on our earnings.

And as Todd always says, we are driving very hard traffic, because the way our restaurant structure is, the more traffic you run through, the more leverage you get.

All right.

Okay, thank you very much.

Chris O'Cull, KeyBanc.

GP, what working capital needs will continue in 2017 that maybe could depress CFO?

For example, deferred tax liabilities has been a fairly significant use of cash this year.

Are things like that -- should that continue in 2017?

Yes, we keep looking obviously at the components of the free cash flow.

The biggest improvement for us is clearly getting down to a capital number which we are confident about.

Secondly, you're absolutely right.

We have in the base a fairly complicated situation with deferred taxes and the like.

So we think that's going to ease on a going-forward basis.

And absolutely, we're going to watch our core working capital a little bit.

Because as you get more franchised, your receivables are going to go up over time, and your payables are going down.

So it's kind of a headwind for your core working capital performance, and we're trying to get on top of that.

Okay.

Thank you; that's helpful.

And then can you update us on what the gross rental expense is estimated to be after you complete the system optimization program?

The number is about $80 million.

And you're asking --

Expense.

You asked for expense, right.

So what we always said is net rental income is about $170 million, expense is $80 million, so the net income is $90 million.

Okay.

Is the $80 million of rental expense -- does that include any existing leases or rent expense that the Company's going to have?

Or is that just the incremental -- I'm trying to get to what the gross rental expense for the Company will be going forward so we can kind of understand the lease adjusted leverage.

That is the total number.

Okay.

Great, that's helpful.

Thank you.

David Palmer, RBC Capital Markets.

A quick one on image activation.

How is the average investment and lift these days?

My suspicion is that many of the franchisees are choosing that lower spend option.

You may have even commented on this.

And the lift may also be more moderate than it had been in the past.

And I have a follow-up.

Yes, David.

With the momentum that we have and the choices that we have out there, you are seeing more of the lower investment reimages take place in the marketplace.

But with the evolution of the design, they are still really impactful, and we're seeing some really nice lifts in the mid-single-digit range for the lower cost investment option.

And for the higher investment option, the more of the standard build, we're still seeing the high-single, low-double-digit lifts on that.

Scrape and rebuilds are still north of 20%.

So we're still seeing a nice combination.

And what we've really been doing is working with the franchise community on the joint capital planning and really looking at what does it take to compete in that particular trade area to really optimize their investment and their return.

But what we are really feeling good about is when you go out into any of our new reimaged restaurants, whether it is the lower cost option or all the way up to a scrape and rebuild, it feels like a new Wendy's, a much more modern and contemporary.

And it's driving excitement into the restaurants and clearly driving the franchise community to invest behind it with the acceleration on the reimaging.

Thanks.

And just to follow up on value and marketing, you seem to be having way more success than your competition with premium items and marketing like taco salads, Baconator.

But I can't decide how dependent you are on value.

You had the 4-for-4.

The $0.50 Frosty seemed to have been a big hit.

Those seem to be important to driving traffic.

So it doesn't seem like you are exactly free from needing to rehit value.

When you are off air from a value perspective, are you holding up on traffic?

And what do you think your value strategy will be going forward?

David, no, it's a balance.

And I think when we have the momentum really on, we have a balanced message around either the core or an LTO as well as an underlying message on value.

And if you look at the progression that happened through the third quarter with things like $0.50 Frosty, things like the work that we did on renovating our grilled chicken sandwich to make it more juicy and tender at a price point to actually drive trial and then bring the repeat back over time, those are healthy options to continue to drive predictable, sustainable growth for the long run.

And you see that balance continue into the fourth quarter.

And we got a big comp that we up against in the fourth quarter.

But we feel like we have the tools in the toolbox to lap that, as is evidenced by our guidance.

The quarter started out a little slow with the headwinds from Hurricane Matthew, but has really continued to progress with that nice balance around what we have on the taco salad, which I said is unique to the category.

What we're seeing on our fresh beef messaging right now and frozen is for later.

And the continued news that we have to keep the 4-for-4 fresh and ownable with the Swiss JBC being added to the lineup.

So it is that balance that really plays well.

But all underneath the overarching ladder of quality is our recipe within the Wendy's brand.

Thank you.

Matthew DiFrisco, Guggenheim Securities.

My question is with respect to the 500 net number being added over 2020.

I wonder -- a lot has changed in the global world and domestic world as well since you set out that target.

Labor obviously has become a greater headwind than maybe you initially had thought.

Interest rates obviously looking like they're going to rise.

I wonder how has that 500 net -- the composite of that changed, if at all.

Can you describe that as far as the balance between domestic and international as well as how that might progress over the next five years.

Should we be thinking it's very back-end weighted because of -- I guess the pace you're coming from now, 15 to 20 net development this year.

And then all of a sudden, you're going to have it looks like a pace of almost over 100 per year net over the remaining couple of years.

So first off, Matt, remember that 1,000 gross and 500 net is a North American number.

So that is the focus across North America.

We haven't put out a net development goal yet for international.

We will talk about that more in February in the analyst day.

And remember, through the whole system optimization process, we did get a lot of commitments around newbuilds.

So between system optimization one, two, and three, all the buy-and-flip activity that's been out there, we've got about 325 commitments for newbuilds over the next five years.

From that activity, Company has always said that we will do our fair share.

So about 50 newbuilds from 2015 to 2020.

And we continue to expect to see a lot of buy-and-flip activity into the foreseeable future.

And we said about 200 every year, which can generate even more commitments around new development.

And that's just with the restaurants that have been impacted as part of that system optimization initiative.

We have got a lot of work that's going on in joint capital planning that continues to get folks excited about driving growth.

We've got the markets identified where we think we can grow.

We got margin expansion, which is healthy.

We are seeing strong free cash flow from our franchise operators, giving them the courage to reinvest back into their restaurants.

And we continue to provide different designs.

The smart design that we now have a restaurant opened in Canada and a few in the US.

Not for every trade area, but gives us a whole other opportunity to have a restaurant that is a little lower investment cost, still has all the wow of a reimaged Wendy's, but can actually fit into different trade areas that we might not have been able to access in the past.

So it's that composite of all of that activity that gives us the great confidence that we can continue to grow net new restaurants across North America really under the guise of the quality message that we have in Wendy's.

When you think about fresh customization, we think it's a point of difference that's continuing to attract more customers more often.

I guess is there something that you would cite as the third rail that might derail that or change that view of 500?

Obviously, wage pressure is mounting and interest rates are going up.

What would make those -- make your franchise community maybe try and defer some of those commitments a little bit longer term?

We feel confident that we can continue the momentum.

The biggest offset to wage inflation is bringing in more customer counts and driving leverage in the restaurants.

And we believe we've got the programs at the high low, telling our unique brand story to continue all of that momentum.

We have built a stronger franchise system over the last several years, so they are more healthy than ever.

And really committed to really aligning behind the brand initiatives and the spirit of being a vibrant and growing system.

So we feel good on all those fronts.

We will have to do a lot of work to help the system to manage some of these headwinds around labor inflation.

And the work that we're doing around kiosks, the work that we're doing around mobile order, those not only help drive productivity within the restaurants, but they actually provide an even better customer experience in those restaurants, too, as that customer comes more in control of the whole service experience.

We think those things are all healthy for the long-term growth.

Great, thank you.

Jeffrey Bernstein, Barclays.

Two questions as well.

One, Todd, just as you look at the broader quick-service category, you gave some good color in your prepared remarks that it seems like your comp has been driven by traffic.

And yet, your peers all of a sudden are seeing more significant average check increase, but traffic down significantly.

And I think you made reference to the last seven weeks of the quarter, where you were beating the industry pretty consistently.

So I'm just wondering if you can provide any high-level color on what you are seeing across the industry from the competitive environment standpoint, promotional activity.

Maybe whether there's been directional change from the competitive landscape just over the past quarter or so.

And then I have a follow-up.

No real directional change.

It is still intensely competitive out there, which we would expect it to always be.

The consumer economic model continues to be under pressure.

They are seeing increases in rents, healthcare costs, student loans.

The gap between food at home and food away from home had continued to widen, but that's going to continue to happen through any cycle in the restaurant business.

And what we need to do is break through the clutter and make sure that you have a strong brand.

A brand that is relevant for the long term.

And coming back to the earlier comments, that's where I think when we really play our game the best and we are focused on being the best Wendy's that we can be, we have this balance of this high-low message and really coming back to our core attributes as a brand.

Quality, freshness, customization, and really providing that new QSR experience at traditional QSR prices that really allows us to stand out from our competitive set.

Got it.

And then just as you look to 2017, I can understand that -- I guess we should expect 2017 guidance within the 4Q results at the invested day.

But I'm just wondering, in terms of the key features, you have provided some guidance in the past specific to 2017.

So I'm just wondering is it still reasonable to believe that the 3% comp would hold in 2017?

That would seem to be a nice acceleration from what has been a strong 1.5% this year.

And whether it's still reasonable to assume that flattish EBITDA and high-teens EPS that he was talking about before?

Or might there be meaningful change to any of those guardrails as we think about 2017 versus what you've provided already.

Yes, as we said in the past, I don't want to make news on this call.

But when we think about the guidance that we have previously provided, we still feel quite good about that guidance and that we can continue to deliver on those expectations.

And if you look at our track record over the last four years, we have absolutely been doing what we said we would do.

So we do believe that we are creating some confidence that when we set out goals, we will find ways to deliver on those expectations.

But a lot more to come, to your point, when we get to analyst day in February.

Got it.

Thank you for the color.

John Ivankoe, JPMorgan.

G&A is very, very topical for a lot of companies for a lot of different reasons now.

GP, I heard you I guess basically confirm your previous guidance on 2017 and 2018 in terms of G&A being around $230 million.

I guess just in terms of taking the most modern thinking that's available, how should we think about G&A?

Should we think about it on a systemwide sales basis?

Should we think about it on a store basis.

And as productivity is such an important thing for companies today, do you think that number has an opportunity to come down?

Good morning, John.

You're right.

As Todd, I don't want to make news and provide new G&A guidance for 2017 and 2018.

So you can expect that we at least are going to get to the $230 million number that we have.

The other thing I want to point out is we need to strike the right balance for our G&A.

And I keep saying this.

We need to provide the right service to our franchisees to make sure they are actually really motivated to be part of the system so they keep investing in it.

And that will be a goal continue to do.

We are going to thread the needle to make sure we are getting this balance quite right.

In terms of benchmarks that I see, I think all benchmarks have its merit.

Just be careful as you compare, you're really in most cases compare apples with oranges.

Because different companies have different franchise levels and different companies are disclosing their P&L slightly differently.

So the biggest difference is we don't have a franchise expense line, couple of other competitors do, and that creates obviously some noise as you do your benchmarks.

Do we absolutely believe that the $248 million that we have this year is too high?

Absolutely.

Does it need to come down?

Yes.

That's excellent color.

John, remember, our G&A guidance is through 2018.

But we did provide some updated longer-range guidance through 2020 with a EBITDA margin of 38% to 40%.

So if you do the math across all the components of that, as GP said earlier, we are going to have to work hard against all of those levers to deliver on that commitment.

Thank you.

Excellent color from both of you.

Can I ask -- do you guys think about CapEx as a percentage of EBITDA over time as we think about those long-term targets?

Is that a metric that you all think about in terms of how much CapEx you want to invest against that growing EBITDA number?

John, that's a great question.

Let me think about this.

No, haven't done before.

We more think in dollar ranges and we more think about, like, what's the capital spend we have on a per-restaurant basis.

That's kind of more a guide range that we have.

Percent of sales, interesting.

Need to think about a little [bit].

Or percent of EBITDA, for example?

Yes, no.

We really look at what does it take to grow and deliver our growth targets.

And when you think about our business going forward, it is about our fair share of new restaurant development.

What we need to do to continue to reimage to get our restaurants almost all the way there, which we've made great progress against.

Investments in technology for the system and ongoing maintenance CapEx being the big buckets.

So we look more add it on what's necessary to operate and drive the business for long-term sustainable growth.

Thank you.

Joseph Buckley, Bank of America.

Thank you.

Todd, I was wondering if we can get maybe a specific breakdown of check and traffic for the quarter.

I know you said traffic was up and the check was up slightly.

And then maybe if you can compare it to the QSR sandwich category, that would be helpful.

And then I have one more.

Yes, Joe.

I won't give you the specifics since we haven't done that in the past.

But if you think about where our system growth was for the quarter at 1.4%, as we said on the call, that was almost all driven by traffic.

So just a very slight increase in average check.

That's for the system.

If you dig into the Q and you look at the specifics on the Company, the Company was growing at 2.7%.

Different mix of restaurants, but from a Company perspective, customer counts were up even more than the sales growth, with a slight degradation in average check.

So we look at that as a very healthy growth mix.

On the call, we talked a little bit about the directional trends on the NPD data that we are seeing.

I won't be able to give the specifics on that data, but you will see -- and you guys will see it through the data that you are seeing customer counts or traffic down fairly dramatic.

Really offset by average eater checks increasing.

And you just got to look at with the widening gap between food at home and food away from home, is that a healthy, sustainable way to grow for the long run?

And we've chose to play the game a little different.

I was curious.

On the image activated restaurants, over time, do you see the dine-in business picking up versus drive-through?

Is there a change in that mix over time?

No, what we've historically seen, Joe, is when you image activate a restaurant, you see the lifts across takeaway, dine in, and drive-through.

It slightly changes the mix a bit towards the dine-in as you get a nice-looking restaurant that folks want to come in and sit in for a lunch or for a dinner, but not that dramatic.

If you look about the trends over the last few years, you will see that the mix has tripped down a little bit on the amount of business that goes through the drive-through.

But at the end of the day, why we are so well positioned for the long term in the QSR space is around speed, convenience, and affordability.

And the drive-through business and the on-the-move business is a big part of that and will always continue to be a big part of that.

Okay.

And then just one more, if I can.

GP, I think you said your ongoing normalized cash need would be about $150 million.

And $100 million of that being international, which kind of surprised me.

Can you talk a little bit about that, on why the international cash levels would be so much higher than domestic?

That's a great question.

So what we have -- remember, as we sold off our Canadian restaurants, we don't own any restaurants in Canada.

We have -- we got a proceeds there back then of around CAD87 million and that cash is permanently invested in international.

And we are obviously using this cash to develop the Canadian market.

We want to get from 350 restaurants to 500 restaurants.

And it's also the way our legal structure goes, it's also cash that we can invest in the rest of international business.

So Joe, it's really cash that we can't effectively, efficiently -- tax efficiently get back to the US.

But we have a great use for that cash, as GP said, with the build-to-suit program in Canada, which is helping to stimulate growth.

That's helpful, thank you.

Jake Bartlett, SunTrust.

Thanks for taking the question.

First, I had a question -- just maybe a clarification on the unit growth targets.

You talked about 15 to 20 net in 2016.

I'm wondering first whether that includes any international stores.

I believe the Japanese franchisee is starting to convert their first kitchens.

And then maybe if you can remind us what the pace of the first kitchen conversions would be.

It looks like there's over 130 stores that could be coming into the store base here.

Is that something that's going to dramatically impact 2017?

Yes, Jake.

As we provide in our guidance, the 1,000 gross and the 500 net new restaurants, that's again all North-America-driven.

So when you think about that 15 to 20 number this year, that's North America net new openings.

So on top of that, and you'll see that up in the Q, we are seeing net new openings in international.

Year to date, we are about 5 net new openings on the international front, so 17 new restaurants against 12 closures.

Within the numbers, we will have a few of the conversions come through on first kitchen by the end of this calendar year.

You'll start to see that activity really ramp up in 2017 and 2018.

And we're still really encouraged about that partnership with our franchisee in that market and the access to some great locations in Japan.

Great.

And then I had a question on the image activation.

The impact to the same-store sales is now above where you had originally or maybe last year at your investor day, you talked about it 40 basis points to 50 basis points.

It's been 60 basis points last 2 quarters and now it's 80 basis points.

Should we expect that to continue to rise?

Maybe what's driving that?

Is that simply that you are -- the reimagings are happening quicker?

And then building on that question, it looks like there's some momentum with the reimagings among the franchisees.

Is that -- should we expect it to -- I know you are not giving guidance now, but is it reasonable to expect a material increase?

Just the fact that you are increasing the back half of the year here, should we expect pretty strong momentum into 2017 and 2018?

We continue to see a nice [IA] tailwind in our same restaurant sales.

And you're right, it has ticked up.

We talked about 40 basis points and 50 basis points in the past.

We are seeing it more around that 60 basis points, and that's what's built into our long-term guidance.

It will -- depending on the pace of activity and the mix of restaurants, it could go up or down.

But on average, it's about 60 basis points of tailwind that we would expect to continue to see.

And I think the great news is because we've got a lot of options out there and we are really partnering with our franchise community and the joint capital planning, we are really customizing what does it take to win in each individual trade area.

What investment -- what return are they looking for, and it's given them the confidence to continue to invest back into the Wendy's brand.

And it's not just about the economics of the restaurant per se, it's about the complete picture.

What is happening on the restaurant margin as that continues to grow.

What is happening at the restaurant level with cash flow.

What are we doing around telling our unique brand story to make sure that we are differentiated in the marketplace so we can bring in more customers more often.

All of those things lead to the long-term faith and confidence to reinvest back in the brand as well as the ongoing system optimization initiative.

As we continue to bring some fresh folks into the system, they are very interested in continuing to invest for the long run.

But we are also seeing a lot of our existing franchisees really excited about where we can take the brand in the long term.

Great.

And then lastly, it looks like you're going to have about two years here where you are not taking any menu price, at least at the Company side.

I assume it is fairly similar across the system.

Does that create opportunity to take some price in 2017?

Or given that commodities are expected to be friendly, would you take the same stance and maybe have three years in a row of no menu price?

Yes.

Built into our guidance, we have basically been saying not only near-term but longer-term guidance that is with minimal pricing.

And the consumer model is still under pressure and we need to take that into consideration.

We can provide choices with the high-low.

We can bring great LTOs to market to get folks to trade up and make their own choice with their pocketbooks if they want to pay a little bit more.

But we will also have some great value offerings out there consistently.

And we really think the right game is to continue to drive a little more loyalty into our brand by bringing more customers in more often.

And having that discipline on price is part of the work that we're doing with our system right now.

Great, thank you very much.

That was our final question.

We thank you for participating in the Wendy's Company third-quarter 2016 earnings results conference call.

You may now disconnect your lines and have a wonderful day.