Wendy's Co (WEN) 2007 Q2 法說會逐字稿

Good afternoon, I will be your conference operator today.

As this time, I would like to welcome everyone to the Wendy's International second quarter results earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS) Thank you.

Mr.

Barker, you may begin your conference.

Thanks.

Good afternoon, everybody, the purpose of the call today and the Webcast is to talk you through our second quarter results and to provide an update on some of the key initiatives we have underway.

We did announce our earnings before the market opened today and you can find all the materials, news release and the financial statements on our Website.

The agenda for today's call will begin with remarks from Wendy's CEO and President, Kerrii Anderson; as well as Jay Fitzsimmons, our CFO.

He will discuss the financials for the quarter and then we will take your questions.

Also on the conference call today are Chief Marketing Officer, Ian Rowden; Chief Operations Officer, Dave Near, and other members of the management team, who are here to help answer questions later.

Looking ahead, please note that we do plan to release our third quarter sales.

The date for that is October 4.

And our current plan for third quarter earnings is on October 25.

And if there's any update to that I'll have that on the Website as appropriate.

Our other dates for any disclosure are on that Website, which is www.wendys-invest.com.

Now, I'd like to refer you for just a moment to the Safe Harbor statement that is attached to this morning's news release.

Certain information that we may discuss regarding future performance such as financial goals, plans and development, is forward-looking.

Various factors could affect the Company's results and cause those results to differ materially from those expressed in our forward-looking statements.

Some of those factors are set forth in the Safe Harbor statement that is attached to the earnings release.

Some of the comment today will reference non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization, or EBITDA.

And you can find reconciliations to those non-GAAP terms to the most directly comparable GAAP financial measure, either in the earnings release or on our Website.

Now I'd like to turn it over to Kerrii.

Thanks, John, and good afternoon.

The financial results that we released early today, I believe, are a clear indication that we continue to make progress in our turnaround of Wendy's.

We said back in October of '06 when we first introduced our strategic plan to our investors and our shareholders, that our overall goals were two areas, revitalize the brand and improve our financial performance.

And the great news is we are making progress on both fronts, which is good for our customers, good for our shareholders and our franchisees and our employees.

During the quarter, we continued to execute our strategic plan and re-engage with our companies.

Our brand proposition is improving with innovative products, a new advertising campaign, and better store operations.

And we are determined to fully revitalize our great brands.

Now, let me update you on our progress in several key areas.

Operations are absolutely our highest priority.

And when you talk about operations, you always talk about quality, service and cleanliness as a focus.

We continue to expand our QSC, our quality, service and cleanliness inspections to fully measure our restaurant operations performance across the entire system and to level set our expectations and achieve our objectives.

We are conducting unannounced operational audits in every restaurant in our system.

Over the past several months, the scores have continued to improve from our initial inspections that occurred last fall.

We believe that these scores are leading indicators to improved operational performance.

And that we are heading in the right direction, which is all about taking care of our customer.

From a service excellence perspective, Dave and his team are in the early stages of developing the next evolution of the initiative to improve Wendy's in every aspect of operations.

You may remember, some of you, that service excellence was our innovation in the mid-90's that enabled our Company to distinguish our operations as best in the industry and to dominate speed of service in QSR.

We won the fastest QSR drive-thru for more than six consecutive years but slipped in the past two years to the number two position.

And it is our goal to regain operational excellence not only at the drive-thru but in our dining rooms, as well.

Which will translate into more transactions at the peak hours.

From a store label perspective, we successfully reached our goal of 3.3 managers in every Company store, down from 3.6 a year ago.

In addition, effective this month, we are also reducing crew labor by about 30 hours per week, right in line with the guidance that we provided in February, which was given by Dave Near and should have a positive impact on store profitability during the third and fourth quarters.

One important note about the reduction of hours, is that these hours are not impacting the customer.

It's areas of prep and really preparation from a store perspective and opening.

With all of this change, our store managers are just doing a great job.

They remain focused on superior operations in customer service, while improving store profitability.

This was one of our imperatives in our strategic plan, and we are on track.

From a marketing and R&D perspective, we are building momentum, and we are engaging with consumers, with products and a much more powerful message.

In the second quarter, we rolled out several new menu offerings including the steakhouse double-melt cheeseburgers in April, Frosty floats, and a $0.99 buffalo crispy chicken sandwich in May, $1.99 triple stack cheeseburger in June.

In May we also introduced our new coffee, Wendy's custom bean, which is a proprietary blend of Folger's gourmet selections and we continue to expand breakfast.

And by the end of August we anticipate being in 650 restaurants nationwide with breakfast.

In July we began promoting the Baconator, and it's being advertised nationally right now.

It's a hot and juicy hamburger featuring 1/2 pound of fresh, never-frozen beef, six strips of hickory smoked bacon, American cheese, ketchup, and mayonnaise.

And if you're thinking hot and juicy, so are our customers.

It's aimed at the core QSR demographic young male customer and it meets their needs and the demand for a large, premium hamburger that's unique to Wendy's.

During the first quarter -- during this quarter, the second quarter, we also launched our new That's Right advertising campaign, which highlights Wendy's fresh, never frozen beef, and made-to-order hamburgers.

So far we are encouraged by the positive consumer reaction to the advertising and our red wig icon.

After only six weeks, national consumer research shows that more than 1/2 of respondents can play back "I deserve a hot, juicy hamburger" line from our advertising campaign, and immediately associate the red wig with Wendy's.

This is a key reason for our core hamburger business is growing, and we are excited about expanding the campaign on many fronts.

TV and radio advertising and in addition we've also had Internet impressions on our Website, YouTube, and special Websites.

There have been more than 800,000 views on YouTube of our video, and it is the sixth most viewed video on that site.

We also have other public events in which the gentleman in the red wig is showing up.

From a development standpoint, we are focused on store remodels.

We recently just completed six new, different exterior remodels in Ohio.

And we will be analyzing the impact of this on consumer impressions, our transactions and our overall business results.

Each of these remodels costs less than $100,000 as we continue to focus on driving the greatest impact of getting a return on our invested capital and that of our franchisees.

From a financial results perspective, we reported improved EBITDA income and EPS results.

And we've now produced 13 consecutive months of positive same-store sales.

We are encouraged with the positive same-store sales but we know we need to improve.

Our mid--term goal is to produce same-store sales more in the 3% to 4% range, and we acknowledge that near-term costs to comps are much tougher in both the third and fourth quarters.

Most importantly, our U.S.

Company operated restaurant EBITDA margins improved 100 basis points.

This is very encouraging as we focus on producing more profit at the store level for all of our Company and franchise restaurants.

I would probably be remiss, coming from a financial background, if I didn't give my perspective on the financial results from a numbers perspective.

When you take out the unusual items of this quarter and you take out the unusual items of last year's second quarter, I think the important point is that operating income grew almost 25% when you compare it to last year.

And Jay's going to give you a little more color and detail on that as he discusses the second quarter financial results in detail in just a few minutes.

But it was a very good quarter overall.

As we look ahead, we are focused on improving sales through better operations and marketing, to exceed our second quarter same-store sales performance in the back half of the year.

Rising commodity prices, driven by the demand for ethanol, will result in higher food costs for the balance of the year.

We talked about this when we addressed our earnings outlook in June.

This situation is not unique to Wendy's, several other restaurant companies have mentioned commodity cost pressures.

We are concerned about the forecast for inflation increases and its potential effect on consumer spending.

However, we are working on many initiatives to offset rising costs as we focus on improving margins at every Wendy's restaurant in the system.

We are confident about our initiatives to drive sales, reduce store-level management labor, and improve service will result in profit growth in the second half.

In closing, I will tell you that I'm very optimistic about the remainder of 2007.

We have good momentum in our business and a solid, strategic plan that we will continue to evolve to drive sales and profits.

This team is focused on executing the strategies, protecting and creating values for our great brand, not speculation.

So with that, I'll turn it over to Jay.

Thanks, Kerrii.

The last time we did this call, I had been here all of three days.

Now I've been here three months, so I guess that makes me a relative expert this quarter.

Seriously, from a financial perspective I would summarize the quarter as follows.

It was a quarter with solid financial performance in a difficult and competitive environment.

Income from continuing operations was up almost 215% and EBITDA was up 90% over the second quarter of the prior year.

It was a quarter with continued positive same-store sales growth.

As Kerrii said, 13 consecutive months of same-store sales growth.

It was a quarter with further improvements in Company restaurant EBITDA margins, with an increase in U.S.

operations of 100 basis points, and in consolidated Company stores of 60 basis point over the similar period in the prior year.

We are encouraged by the results but we recognize that further improvement opportunities in sales and operating margins exist.

As Kerrii alluded to, we have plans in place to generate even better results in future periods.

Now, let's look at some of the line items in the P&L.

Cost of sales.

Cost of sales declined from 62% in 2006 to 60.4% in 2007.

The 160 basis point improvement is due to menu management, including higher menu prices, tiered to the market-based pricing strategy we previously discussed; and an improved mix of products sold, including higher sales of Frosties and premium products.

Commodity costs will likely increase above first half levels, driven by higher grain, beef, dairy and potato costs.

We expect beef costs will be up between 5% and 10% in the back half of the year.

Now to offset these costs, we continue to focus on product optimization, labor initiatives, selective menu price increases and aggressive food cost management.

Company operating costs, as a percent of sales, increased from 26.5% in 2006 to 27.3% in 2007.

This year-over-year increase is due primarily to higher insurance charges, and 30 basis points due to the impact related to the accounting charge from the change in accounting for the Company's Canadian real estate joint venture with Tim Horton's.

We went from full consolidation to the equity method of accounting.

As a result of this change, the 2007 Company restaurant operating cost line includes rent pay to the JV that previously was eliminated in consolidation.

This increased expense on this line.

Without this accounting change, total Company restaurant margins would have been 12.1% versus the reported 11.8%.

Now, moving on to the operating cost line.

The $9.5 million decline is primarily due $10 million in incremental advertising spent incurred in the second quarter of 2006.

For G&A, the 20 basis point improvement, as a percent of revenue, primarily reflects the impact of the 2006 cost savings initiatives related to the next chapter restructuring and lower bonus accruals.

Now, this number was offset by higher noncash stock compensation and higher consulting fees and professional services expenses and additional breakfast advertising expense during the quarter.

A new line on your P&L is restructuring and special committee-related charges.

This includes $10.6 million of net expense and is due primarily to $5.5 million in pension settlement charges.

You will recall that this $5.5 million represents a portion of the $60 million in pension settlement charges that we previously disclosed to you.

It also includes $4.7 million in expenses related to the Board's special committee.

Last year's number, 2006, includes $29 million in expenses relating to the next chapter restructuring cost.

This included voluntary early retirement costs, severance expenses and consulting fees.

We do expect to incur additional expenses in future periods in this category.

It will come from the Board's special committee, from additional pension settlement costs, and if you remember we said $60 million given the $5 million, that would be up to $55 million, and possible restructuring charges.

On the other income and expense line, the $8 million of net income reflects $4.5 million in insurance reimbursements for the Hurricane Katrina claims and $2.6 million of income from the 50/50 joint venture with Tim Horton's that we've previously talked about.

Now remember, this is partially offset by the higher rent income expense in the Company operating cost.

And this compares last year to $0.7 million of expense in the second quarter of 2006.

Interest expense was $2.1 million higher in 2007, as a result of the sale of a portion of a royalty stream accounting for 40% or 14 months that we entered into in the fourth quarter of 2006.

We reported this as debt.

In 2006, the Company received $94 million in return for the future royalties.

In 2007 the repayment this royalty-related debt is being accounted for as a loan, comprising both repayment of debt and the recording of interest expense.

As a result, interest expense is up in 2007.

For interest income, the $8.4 million decrease in the second quarter of 2007 and interest income reflects lower cash balances, which resulted from the modified Dutch auction tender offer and the accelerated share repurchase completed in the fourth quarter of 2006 and the first quarter of 2007 respectively.

Taxes.

The Company's effective tax rate was 38.2% in the second quarter of 2007.

We expect the rate to average 38% for the year but it will fluctuate around that number from period to period.

Moving to shares outstanding.

Shares outstanding were lower this quarter due to the previously discussed share repurchases of 22.4 million shares in the Dutch auction tender offer of the four quarter of 2006, and 9 million shares in the accelerated share repurchase in the first quarter of 2007.

This resulted in a lower share count of 88.3 million in the second quarter of 2007, which compared to 117.8 million average shares in the second quarter of 2006.

Now, we did have some unusual items in both this year and last year's second quarter.

Let me detail those for you.

We had additional advertising contribution of $10 million in the second quarter of 2006, and that was recorded in operating costs.

We had restructuring costs of $29 million, and this is recorded in restructuring and special committee related charges in the second quarter of 2006.

This year we had pension settlement costs of $5.5 million in the second quarter of 2007 recorded in restructuring and special committee-related charges.

This year we also had special committee expense of $4.7 million.

And we recorded that in restructuring and special committee-related charges.

We also had the reclassification of the Tim Horton's joint venture we previously talked about to an equity investment.

That resulted in $2.2 million in lower operating income and $2.7 million increase in other income.

And finally, we had insurance reimbursements from Hurricane Katrina of $4.5 million, which was reported in other income in the second quarter of 2007.

Now if you adjust for all those items, operating income would have been $64 million in the second quarter of 2007, compared to $51.6 million in the second quarter of 2006, which represents 24%.

Kerrii, I'm the Chief Financial Officer, you said almost 25%, it's closer to 24%.

I'm rounding up.

She turned into an optimist when she left the CFO's position.

So let's talk about our revised outlook.

In June, we announced our revised outlook for 2007 for EBITDA and diluted EPS from continuing operations due primarily to lower than planned same-store sales and higher than expected commodity costs.

Today, based on our trends and the current cost outlook, we are reaffirming our guidance range for EBITDA of $295 million to $315 million.

This is a 33% to 42% increase over 2006 adjusted EBITDA from continuing operations of $221 million.

Our guidance for EPS is $1.09 to $1.23 per share.

Now remember, that the outlook excludes expenses related to the Board's special committee, $4.7 million was recorded in the current quarter, pension settlement cost could approach up to $60 million in total, of which $5.5 million were recorded in the second quarter, and any potential restructuring charges.

Excluding pension settlement charges, expenses related to the Board's special committee and restructuring charges, second quarter adjusted EBITDA would have been $95.3 million.

Now as a reminder, we've suspended our previous earnings guidance for 2008 and 2009 due to the strategic review process, which is now underway.

Let me turn it back to John.

Thanks, Jay.

A couple notes before we open up the phone lines for questions.

First, the Board approved our 118th consecutive quarterly dividend.

That will be paid on August 20 to shareholders of record as of August 6.

The quarterly payment will be $0.125 per share and this is our second dividend payment since the Board voted in February to increase our annual dividend rate by 47%, $0.34 per share to $0.50 per share on an annual basis.

One more note.

We do not intend to provide updates regarding the special committee's action.

But we will report specific developments as circumstances warrant and the special committee provide those to us.

Our last statement on actions related to the special committee was in the press release that we issued on June 18.

The committee does not have a specific timeframe for its review, and on this call, we do not intend to discuss this matter further.

We do, however, invite your questions regarding our second quarter results, our 2007 outlook for the rest of year in terms of operations and marketing, and other news for Wendy's.

Operator, we'd like you now to queue up our listeners for questions.

Thank you, sir.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Jennifer Preller with Barclays.

Yes, this is actually Tom O'Neil.

I was hoping that -- I know you mentioned you weren't going to comment on the strategic review.

But I just had a fixed income question related to your bond indenture.

If you decided to securitize your franchise fees as part of any transaction that you might do, would you have to take out your bonds?

Would that be -- would there be a violation in the indenture?

As part of the -- .

Jonathan, by the way.

I'm sorry.

Jonathan Catherwood, Treasurer.

As part of the review, the securitization will be done in the special committee and they haven't come to any conclusions yet.

Certainly, all of the indentures in our -- that are in public have been taken into fully account and we intend to comply with them fully.

That's as much as I can tell you because we haven't -- the special committee hasn't decided exactly what wants to do.

But it's done in context of our current bond indenture.

Okay.

And then just one other follow-up.

You're certainly -- you must be aware of the much higher funding rates in the high yield markets.

It's about 200 to 300 basis points of widening that we've had on the average high yield credit.

Does this affect the Company's thinking on the amount of leverage that it might want to have as a result of your strategic review?

This is Jay Fitzsimmons.

In my opinion, what you have here is a slightly positive development because the bonds that we would be talking about relative to the securitization would be rated AAA.

So, we don't believe that what you're seeing in the noninvestment-grade market will have a significant impact upon the process that the special committee is going through.

Okay.

Thank you very much.

Thanks, Tom.

Your next question comes from the line of Joe Buckley with Bear Stearns.

Thank you.

I've just had a couple of questions.

Can you talk about the pricing that you've taken in Company stores, what percent you've raised prices?

And Kerrii, I know when you gave the sales update for the June quarter, you indicated that you thought that pricing was having some negative impacts on sales.

So maybe if you would talk a little about that?

And while on pricing, just if you think you need to take more pricing given the commodity situation and labor situation?

Yes.

For competitive reasons, Joe, and I know this is not the answer you want to hear, we have chosen not to disclose the amount of actual price we are taking.

Although, I have been very clear about the fact that it is a very important component of our strategy this year.

From a pricing perspective, I think we do believe that the increase in price always has an impact on your customer.

While we still have value and feel strongly about that, certainly we have looked at the gap in which exists between us and our competition on products that are similar or products on which we are actually premium.

And it just was a tremendous gap for us to be able to provide some opportunities.

That said, with respect to what we've taken so far, Dave, you and Ian have both looked at the pricing structure and I think we believe there's still opportunity.

So, I don't know if you want to add comments here.

Yes.

This is Ian.

I would say there are still some pockets, if you call it that, of products where we -- where Dave and I both still see a gap that we can close.

We want to be very judicious in how we think about that on the back of, as Kerrii said, the price increase.

Joe, the other thing, and I know you're aware of it, but several restaurant companies have talked about increases.

I know Starbucks, for example, gave a pretty precise number the other day in terms of increases that they're planning to take.

And so we're starting to see some things like that within the industry, and I know McDonald's has talked about it.

I think it's just the reality with the commodity increases.

If you're catching up to competitors, why do you think that customers balked at the prices?

Well, Joe, we've talked about this before.

One of the other aspects that Kerrii talked about is the revitalizing of our brand.

And from a historical perspective, in terms of recent performance in the marketplace, the brand has been relatively inelastic.

And we have to deal with that.

And that's what we are dealing with.

And part of the challenge in marketing is to be able to -- for us to articulate for what we think our competitive advantages really are.

And that's why the focus is on fresh food, never frozen, made to order, fresh cut lettuce, fresh cut tomatoes, great operations.

The points of difference that really -- I don't know if you've got something that would be helpful to add there, Dave.

But to the extent someone has been coming to Wendy's and we have changed price, they see it.

And it can affect consumer behavior.

Yes.

This is Dave.

I think any time you raise prices, even given the fact that we're in catchup mode with a lot of our competitors right now, you still go through a period where it could potentially affect some transactions as you raise price.

So even though we are trying to catch up to our competition, there's still that risk of losing some transactions along the way.

Okay.

And then one last question and I'll turn it over to someone else.

With the special committee, the $4.7 million, two questions; What are they spending that kind of money on when there's been no no decision it seems?

And I think you indicated, Jay, that that spending might continue.

You didn't indicate a level but I think you did indicate there will be more expenses related to the special committee.

Yes.

It good that the analysts are no longer related to the pranksters that are out there.

But obviously the advisory fees that we're paying we are taking into account as we go along.

And whether or not there's a sale, there will be advisory fees.

There's legal fees and other fees.

Those fees are not controlled by the management of the Company.

They're controlled by the special committee.

Yes.

Now that much I understand.

But -- and will it continue at that level do you think?

Or do you have any idea?

I think it will continue at least at that level as long as the process goes forward.

At any point in time the process stops, obviously, the spigot will slow down.

Okay, thanks.

Your next question comes from the line of John Glass with CIBC.

Thanks.

I wanted to see if I could get at that pricing question maybe a little differently.

If you don't want to talk about the absolute magnitude, how much do you think your increased prices has hurt your traffic?

In other words, if you raise prices by 1%, do you lose 0.5% of traffic?

What's the relationship do you think?

John, this is Dave.

I think it's very difficult to quantify.

We don't have an exact number for you, but so -- but without a doubt when you raise prices, you do run the risk of transaction loss.

And I think we're seeing a little bit of that.

Again, I think it's the right thing for us to do in terms of looking to be competitive with our competitors from a pricing perspective.

So I can't give you a number exactly.

You don't think it's anything in the way you're doing the pricing, on that market based approach versus an all-out approach deal, do you?

We don't.

Okay.

And then on the breakfast rollout, the 650 units you're going to have done by August, are those all Company units, first of all?

And secondly, can you talk a little about the impact it's having on your business either percentage of sales run rate or the impact it's having on comps, something to gauge the success of it?

John from a -- the 650 stores, it is a mix of Company and franchise stores.

And from a from a same-store sales perspective, I don't think that we've broken out that number.

Yes.

There's very little impact on same store sales, some but little.

On the Company, it is certainly more Company stores than franchise stores.

And I don't know if, Ian, if you have a percentage?

I don't have a percentage in front of me.

But predominantly, it's Company stores at this stage as we create the base for the franchisee community to get engaged.

And really that's generally been our -- we try to take a leadership role.

We believe we've identified the four or five characteristics that make what is a great opportunity for a breakfast store.

And we're using that criteria to determine which of the Company stores we'll move forward with.

So it could be in as many of 1/3 of the Company stores by August then if it's, say, 400 stores or Company stores?

That's fair to say.

Okay.

And you're not willing at this point to talk about what the percentage of mixed breakfast is coming out at?

Not yet.

Really for 160 stores, which is what's been in test during this quarter, it's really pretty small.

Got you.

So the incremental, whatever, 300 or 400 are all coming in the next six weeks?

Right.

John, just to tag on that, we are pleased with how breakfast is going to date.

I think with the launches we've had over the past 30 to 60 days, I think we feel good about how we've launched breakfast in the additional stores.

And as we roll out these new breakfast stores, we're rolling them out with the complete package.

And what I mean by that is, a menu board that's representative of the outside, to really be able to display and show the product.

Along with a new coffee program, which is Wendy's custom bean.

As well as a full array of a menu of, we call, first generation today.

The first step of a great breakfast menu.

Thank you.

your next question comes from the line of Andrew Barish with Bank of America Securities.

Hi.

Can you give us an update or maybe kind of let us know how far along or how close you are to kind of thinking about refranchising again as the margins have moved a little bit higher?

Obviously, there's some challenges in the second half but is that more of an '08 issue or sort of on hold given the strategic alternative process?

Andy, this is Dave.

We -- first of all, for this year we talked about refranchising 50 to 60 stores, and we're on track to accomplish that and hit that number.

For guidance into '08, I think we'll probably get into fourth quarter before we decide exactly how many stores we'll look to refranchise in '08.

But yes, so, I think in fourth quarter we'll have an update for you there.

We did 21, Andy, in the second quarter.

Okay.

And any financial gain or loss in the numbers?

Very little.

Very little.

Okay.

In fact, Andy, if you -- in the franchise line itself, it would have been a negative compared to the gains that we had booked last year during this period.

Okay.

Thank you.

Thanks, Andy.

Your next question comes from the line of Rachael Rothman with Merrill Lynch.

Hi, guys.

On the 2007 guidance, can you give us some sense for kind of how your targeted margins related to the reduced EBITDA guidance?

And then could you comment a little bit on the franchisee incentive for the remodels and whether or not you're still anticipating the $12 million expense there?

Rachael , this is Dave.

On the remodels, we have spent, I believe, $4.4 million year to date on the [temps] for the remodels.

And I think that we see that kind of continuing at the clip that it's been on for this year.

So it continues to go well, I don't think that we expect to spend as much as we did at the beginning of the year but I would see it kind of continuing at the clip that it's

And I would say, certainly, you have to be candid.

The uncertainty that exists with the process that's in place at the moment certainly has put a damper.

I don't think it's an intention that franchisees don't want to re-invest but they want more certainty about what the future is before they do so.

So I think that's probably slowed the impact at the moment.

Rachael , this is Jay.

Relative to what's included in the guidance, we won't get to the 450 we're making progress toward the 450, but we're comfortable that the assumption that we've built into the revised guidance that we gave you in June are achievable, given what we've seen in food cost at this point

Can you just tell us roughly how that breaks down between restaurant margin, G&A reduction, same store sales growth?

How your different major categories broke out to come to the revised EBITDA guidance?

We're not going to get into all the individual pieces.

But what we did was assume that the sales growth going forward would be approximately the same sales growth that you saw in the second quarter.

So we're not looking for improvements in momentum on the sales side.

We have factored in what we think are even higher costs in the second half of the year than we have in the first half of the year.

And I think we'd say that what we gave you as guidance is based on the current circumstances.

I think what Kerrii would say is we would like to do better than that and we'll try to find ways to overcome some of the obstacles that we're facing.

Okay.

And then just more of a housekeeping or quantitative question.

Can you help us reconcile a little bit between what you guys disclosed as your restaurant-level margin and then the restaurant-level margins that we would calculate as presented on the income statement?

They all seem to be off slightly.

Yes, Rachael , if you would take sales as reported and track cost of sales and operating costs of sales as a percent, and Company restaurant operating costs as a percent, you're going to get very close to that number that we disclosed publicly as the overall margin.

As you know and we also have some sales of our Bakery Buns, franchisees in those numbers, as well as sales of kids meals toys.

But you should get close by looking at the face of

Okay, thank you.

Your next question comes from the line of John Ivankoe with JPMorgan.

Thanks.

I would like to ask a question similar to another couple of questions that have been asked.

Again, it's the impact of pricing as it relates to customer traffic.

I think a lot of us are struggling because a number of companies such as, John Barker mentioned, McDonald's are taking something like 3 points of pricing, and on that basis, they're obviously running positive traffic in the U.S.

So what I'd like to know is other than pricing what is it that the competition is doing better than you now?

And what is going to change near term to allow you to at least begin to perform in line with your peers if not better than your peers, other than just the price impact?

Hi, John.

John, this is Ian.

A couple of thoughts and Dave and Kerrii can weigh in here.

I said earlier, that our brand has been less elastic based on its historical performance.

And that's true.

And so the impact of price increases for us is probably a little more extreme in that regard.

The other thing that our competitors are doing and I wouldn't say doing better than us, but they're doing that we're not doing, is they're in a day-part segment that is fueling their growth in breakfast, which is why we have the initiative to get into breakfast.

And as Kerrii said, our expansion is on track.

But we said all along we're going to make this expansion at a rate and with a process that the system can digest and that we can continue to be profitable on the way through.

And that's something we're very focused on in the environment that we're in.

The other thing that we recognize that our competitors are doing that we're making ground up on, is from a beverage point of view and from a dessert point of view.

And so, our focus on Frosties and expanding our beverage portfolio is important to us.

And we are also exploring snack day-part activities, which we've traditionally not developed menu items for, and we're focused on that, as well.

And that's in addition to our ongoing focus to reinvigorate our core brand and our core business.

And so, we've got this balance going on at the moment that Dave and I and Kerrii are focused on as we blend in a price increase, we manage what that does to transactions, and we expand our business at the right rate.

Could you remind me what Late Night is as a percentage of sales, how that has been trending?

And whether, again, like some of your competition, whether there's any room to actually expand Late Night in terms of number of hours you're open?

John, I think we're at about 10% of our sales with the late night business.

And I think that we do have opportunity to look at expanding in certain areas.

The late night business, extending hours.

So that's actually an analysis that we're going through currently.

And the only thing I'd add to Ian's points, and you asked on what the competition is doing differently, on of the things I think they -- some of our competitors have done a decent job over the past couple of years with, is their value proposition.

Which again is very important to us, as well.

And we continue to explore ways where we can make sure that our value proposition resonates as well as we'd like it to and that as it needs to.

And I might just add on the late night comment that to Dave's point, not only can we perhaps extend our hours a little more, but we also I think can do a better job marketing it.

And that's an effort that we have underway today.

If you remember, a couple of years ago, we had late night tags on our commercials and we had late night stickers our windows.

And if you drive by, as of a month ago, you wouldn't see those things.

We are back focused on making sure that everybody understands that we are open late night.

And we're also tagging some of our commercials with that.

Yes.

And that we have products that, to Dave's, point extend our value proposition into day part hat we kind of led the way on and our competitors have converged on.

So that's important to us.

Okay, great.

Thanks.

I might just add one other thing.

And this is Dave's focus, as laser focused as he can be.

That's just improving operations.

We have to acknowledge that the competition has improved their facilities.

They have improved their operations and metrics from a few years ago.

And it is just really important that we are in our restaurant, talking to our customers, serving them hot foods, with a smile and a thank you.

And you know that's something we -- with these QSC inspections I think we have really been focused on stepping up the operational perspective.

Absolutely.

Your next question comes from the line of Glen Petraglia with Citigroup.

It's Petraglia, thanks.

In terms of transaction count, just building on that, in the release, it says that the core hamburger business is growing.

And maybe you can help us think about where is your -- if your hamburger business is growing, where is your business ultimately struggling?

And then Ian, regarding the advertising, could you potentially share with us any feedback in terms of consumer purchase intent after seeing the advertising?

Yes, Glen, let me make a couple of comments about just the performance of our core hamburger business.

A key to our strategy, as you know, is just to restate our position from a freshness point of view and from a point of differentiation based on fresh never frozen and made to order.

And these are important language points to us.

So, as we've introduced in recent weeks the new advertising campaign and a product that sits squarely in the middle of the message, point being the Baconator, we're seeing our core hamburger business expand.

There's no question about that.

And we've said that in statements we've made.

From a consumer point of view, I will tell you we're seeing recall levels in the first six weeks of our advertising that match levels that have been achieved in much longer periods of time with previous campaigns.

Kerrii mentioned the sort of percentage of population who are recalling not only the line but the language that we're using.

And from the copy testing we've done on the advertising, we've seeing people play back very directly to us at a rate, which is much greater than the norm, both the message that's being conveyed and how important it is.

And that's fueling purchase intent.

So the things that you would want an advertising campaign to do quickly, this campaign is doing.

So, we're really pleased with that.

Now, the caveat there is this is just the start.

And we've got lots of dimensions with which we will take this idea in the coming months.

Glen, there is Dave.

And just to tag onto Ian's comments.

And one of the things that did -- one of the products that performed very well for us last year was Frescata, when we launched Frescata at the end of first quarter, beginning of second quarter.

And that has proven to be a very good product for us.

But we also see its life cycle probably coming to an end at some point here in the future.

And we have some plans to evolve that product into something else because we have very good feedback and purchase intent on the bread carrier Frescata.

So we've got says we're looking at to evolve that product into something else.

Okay.

And then Dave -- go ahead.

I was just going to say, the final piece on the advertising is this red wig iconography is something that's becoming very powerful for us very quickly.

But that's just exciting for us.

Dave, while I have you, in terms of the exterior remodel tests that you've done perhaps give us some color in terms of what's changed and how long it takes in order to get a real read on how well that -- those remodels will perform?

Glen, we've just finished the remodels.

They were primarily focused on what we call our image stores, which are the -- our older stores from 1969 to about 1990.

And we've just finished six different versions of the exterior remodel there.

It's much too early for us to get a read as to what it looks like from a sales growth perspective doing those remodels.

But we will -- we're certainly evaluating those as the weeks roll on here.

They look great.

We've had great feedback from the customer since they've been done.

Great feedback from our management and crew.

And so we're really excited about it.

And we're also excited that we brought them in at a cost that we think is palatable for our system, as well.

Historically, would it take a month or are we talking six months before you know whether they're having an impact?

It would probably take anywhere from 30 to 45 days to do a complete exterior remodel.

Okay.

Thanks.

Your next question comes from the line of Roger [Saks] with Socit Gnrale

Thank you.

Can you tell me, the quarterly same sales number, was anything else in your view besides the increase in price that was a major impact to the figure?

You mean on why it wasn't higher, Roger?

Exactly.

I think we referred to the competitive landscape number one.

And then the pricing.

So if you were to categorize it -- was it 90% due to price increases and 10% due to competitive initiatives, 50/50?

Is there a way to categorize that?

We couldn't break it out for you like that.

One thing I can tell you that Jay referred to is if you look back at the same period last year and the activity that we were undertaking, there was incremental advertising expenditure that we've called out, there was introduction of Frescata, the introduction of a crispy chicken sandwich that revitalized our value segment, as well as a vanilla Frosty.

So, it was a period of time for us that was a very strong period.

And environmentally, that plays to the performance.

Okay.

So let me put this a different way.

If you did not have the price increase, where do you think your same-store sales would have been?

We can't tell you.

Can't tell me.

Okay.

And the second part to that.

With the new ad campaign and such and it seems to be hitting the right metrics according to what we've just heard.

Why do you still believe that the performance, the same store sales are going to be similar to the second quarter?

Wouldn't that suggest if things seem to be working right, the hamburger business doing well, you're going to put the tag back so that late nights, with the remodels going on, everything seems to be progressing nicely.

Wouldn't one expect that your same-store sales should do better than what we saw in the second quarter?

Roger, I think it's a fair question.

I think we do have to acknowledge that if you go back and all these facts and information is available, last year we did in April 0.2, in -0.5, in June, 2.5 same-store sales.

Sure.

So we're now going up against July, August and September at 3.6, 4.7, and 4.3 and we have [4.1/]

Sure.

So I think just acknowledging in this industry although we have seen our competitors with some of the initiatives they have out there be able to do it, it isn't -- it is generally very challenging to be able to topple over threes and fours against -- fours against threes and fours.

So it's just -- I think we are conservative.

I think we have to be that way, given where we are in our position today.

And I think it's more of that.

We have -- to your point, do we not have confidence in the future?

No, we have great confidence in the initiatives we have.

We also acknowledge the commodity pressures that are out there.

Sure.

And let me just -- when we had the meeting back in February, and you gave a guidance and such.

And maybe I'm quoting it wrong but I seem to remember a lot of talk of 2% to 3% or 3% to 4% comp store sales.

And I assume that all the price increases and the all strategies where pretty much in place back then.

So, I'm just a little confused as to why everything just changed?

Well, I think for one thing since February the consumers' landscape has changed.

The price of gas is -- I'm not sure -- when I stood on the stage in February, I knew that gas was going to be over $3 a gallon.

Sure.

So I do think that there are some other factors that are -- and commodities, I'm not sure we thought what was happening from an ethanol perspective would have the impact on commodities then.

So think we're just trying to take into consideration all the factors that we're aware of today that are different.

Well, the impact on commodities, that impacts your costs.

And how does that impact the consumer directly, coming into your restaurant?

Yes.

Well, it affects consumer availability of spending.

They go to the grocery store and the gasoline stations.

Right.

So, that would impact the whole industry, as well.

And other companies results seem to be a little bit better on the same-store sales.

I don't know about that.

If you look at a cross section of same-store sales, of you take look at Yum brands and some of the casual diners that have announced, I think in general, we've seen a downturn with a few exceptions.

Okay.

Fair enough.

Thank you.

Yes, thanks, Roger.

Your next question comes from the line of Scott Frost with HSBC.

Yes.

I was going to follow up on the question that I think Tom O'Neil asked earlier, talking about higher rates on below investment grade debt.

You had said that this was sort of a positive development because one of the things you were considering were AAA securitization of franchise fees, etc., etc.

Does that imply that a leveraged buyout or levered transaction or anything involving sort of a raising debt and capital markets is kind of off the table?

Or am I reading too much into that?

You're reading too much into it, Scott.

The -- it can be used either by a buyer or it could be used by a private Company.

Okay.

So we can't rule that out then, right?

No.

You can not rule that out.

Okay.

Thanks, Scott.

Your next question comes from the line of Steven Kron with Goldman Sachs.

Thanks.

Good afternoon, guys.

A couple of questions.

First, can you talk about -- getting back to kind of the same-store sales for a second, and talk about the menu mix taking maybe price out of the equation a bit, what are you seeing from the types of product consumers are buying, whether it be premium or something a little bit more value?

You noticing any change there and is that contributing to some of the year-over-year pressure in comp?

Steven, I don't think so.

I don't think that is contributing to it.

In terms of -- we did mention the hamburger business seems to be very strong right now.

Baconator is doing very well.

We've been very successful with our Frosty lines in terms of the Frosty float promotion that we just went through.

That's doing very well.

Vanilla Frosty continues to do well.

So we're starting to see, I think, some good traction from a product mix perspective, which is one of the reasons that I think you're seeing our margins continue to improve.

Okay.

And then a follow-up on breakfast.

I know in certain markets where you've been testing I think about a month ago, you tried to get a bit more aggressive with a more offensive or guerrilla-type tactics in certain markets.

Can you maybe talk a little more about the traction that you've seen from some of those more assertive initiatives?

Yes.

I can answer that for you.

And first of all, you're right.

The marketing program we've put in place is very much a community marketing place program, which was designed out of the learning of the sort of usage patterns of consumers for breakfast.

Part of that includes the rolling out, as Kerrii said, of new menu boards.

The introduction of our new coffee based on the agreement we have with Procter.

The final menu that we have in place, which we call generation one menu now, which is being rolled out through all the restaurants.

And a swag of local marketing activities that ranges from some couponing and some discount offers.

So we're seeing traction with it.

We're seeing, I will tell you, repeat purchase intent growing.

And we're seeing traffic shifts from existing competitors in those markets on an ongoing basis to our business.

So we feel good about the start we're making, and there's a lot more that we will do as part of that process.

Okay.

And might also add, Steven, that as we roll these stores out, every store has a local store marketing plan.

It does.

Which we begin to work on a couple of months before the store actually puts markets in.

And that's just a real key to success, we believe.

Okay.

Then then lastly, Ian looking year over year, clearly last year you had the $10 million incremental advertising expense in the quarter.

How should we be thinking about the competing force of trying to realign and get the messaging out?

And I know that $10 million last year was kind of a one-time in nature thing.

But it seems to have dropped back to historical levels here.

Are you spending enough on advertising you know to get that brand message out, or does there need to be a little bit more of a push given kind of what we're seeing from a sales perspective at this point?

Actually, I will tell you, first of all the $10 million in this particular quarter last year that we had, the total that we invested was more than that.

It was $25 million.

But to answer your real question, which is; Are we spending enough money?

We believe we are.

From a share of voice point of view.

From a level of penetration of the advertising.

And from a media mix point of view, we believe that from both a reach and a frequency point of view, we're very strong.

And we don't consider weight of advertising an issue.

I will say to you and we've said this publicly, what we're getting from our current advertising is much stronger impact based on the message and the way it's being portrayed.

And that's helping us.

And we believe we're going to see that continue.

Okay.

Thanks a lot.

Your next question comes from the line of David Palmer with UBS.

Thank you.

I'm going to try to rephrase this because everyone's been beating up on your sales trends but that really is the elephant in the room.

It's that everyone can see your one and two-year sales trends and it doesn't appear to be signaling any turn in any convincing manner.

It sounds like you have more confidence than what the Street has.

You have the breakfast initiatives, have re-imaging, you're trying to broaden your appeal with adults, and it seems like you're in early days there.

Could you perhaps give us some more of what you might be seeing that might be giving you confidence that we can't see here really talking about not just one quarter but long-term sustainable growth?

I think, David, from one perspective we admit the fact we're conservative.

We want to be somewhat conservative.

We're going through a year of transition.

The price we're taking, we know, while it might have an impact short term on transactions, it is absolutely the right long-term approach for this brand and for the profitable of our restaurants.

That said, we have a lot of - we've had a number of new products we introduced last year.

We're introducing a few less this year.

Last year we were doing a number of items.

The consumer is a little different.

I think we're just trying to be cautious as we talk about the current guidance.

But I think the Wendy's brand is an extremely powerful brand.

I think we're better connecting with our customers than we ever have from a marketing perspective.

And we are focused on delivering the operational experience more than we ever have been in the last several years.

So I -- while we're working on all those things, let's not ignore that there's a lot of distractions out there.

And while we are focused on re-imaging, just like you said, until we get through this process, I think it's hard for you to expect a lot of franchisees to make the changes and reinvestment.

That said, the Company is moving forward with the things that we're doing.

So we're we're just cautious.

So perhaps maybe you feel like this is kind of a build-the-foundation-type year where you might not really see necessarily any one or two year sales accelerations?

David, this is Dave.

I think we are continuing to build the foundation.

And I think the other big piece is, and Ian's talked about it a lot, we really are trying to target a demographic that we typically haven't targeted as hard in the past.

And I think when you do that it takes time to build that piece.

And I think that we're confident that what we're doing is the right thing but again, I don't think happens overnight all the time.

But I think hat's another reason that when you look at it, you have to have patience in terms of allowing that to build the right way.

David, the other thing is, seriously, if you look at the outlier in this industry right now it's McDonald's in terms of sustainable same-store sales.

And it's in the fifth year since they started a turnaround with a foundation like what we're talking about.

And they really are the outlier.

Look at some of the weakness in the industry here recently, whether it's some of the casual dining with Paneras and Yum.

McDonald's took awhile to get that turned around.

And our brand is not on -- totally dissimilar to that, right now in this year.

Okay.

The only response is that to the outside, some of these initiatives for you aren't new such as Late Night.

You haven't -- you're not yet participating in breakfast.

Those -- but to some degree you look like the odd man out within the hamburger fast food segment.

Obviously, those other two are having a pretty good run here for even a couple years in the case of BK.

Yes, for very relatively low AUV's.

And a focus on breakfast with BK.

And closing some of their worst stores.

Well, thanks very much.

Your next question comes from the line of Jeffrey Bernstein with Lehman Brothers.

Great.

Thank you.

At this point, a few follow-ups.

Just first, kind of that pricing and traffic paradigm.

Just wondering if you've had the strategy in any markets for an extended period of time where perhaps you have seen evidence of traffic bouncing back?

If you have any examples of that, that would give comfort that the pricing will ultimately lead -- we'll ultimately see traffic return.

I would say the way we've taken pricing in the last couple of months, it's too early for us to be able to definitively put numbers around that.

The expectation with all the other things that we are doing is that we will absorb a lot of this but we took a lot more price than we have historically done.

And we have to acknowledge that and we have to make sure that we manage that through the system.

I tell you, though, it's hard, Jeff, for all of you to understand, but our long-term strategy is to turnaround brand the right way.

And we know we have a gap in pricing and we are working to fix that.

The short-term impact on that, we are definitely feeling.

We're not going to break it out, definitely, in detail for you.

But we believe this is the right long-term decision to help us improve the profit gap, which all of are you aware of and have talked to us about for the last two years.

But there's no market at this point where it's had it enough where you at least see a start of a return to traffic to give comfort on that?

Well, sometimes you have to go out to profit at the expense of near-term issues like the traffic.

Right.

Okay.

And then just on breakfast, wondering maybe directionally if you could talk about how it's tracked in terms of following the launch?

I know it's a habitual day part.

I'm just trying to get some color around recent commentary you've made noting that it seems like only 30% of stores have cleared the, I think, it was the 3,000 per-week hurdle.

I'm just wondering, obviously, as you push it out further whether you're getting more comfort that more and more stores are reaching the level you want or whether perhaps you're resetting that hurdle a little bit?

Well, Jeff again, we're just -- we -- after the four test markets that we had that we started last year, we have just rolled additional stores the past two months.

So again, we -- it's a little too early to give you all the details there in terms of what's happening.

I can tell you that since the initial launch of those stores that we're seeing nice progress from the launch to week to week, as things progress.

And we feel very, very good and encouraged by that trend certainly.

So you know we're taking a very disciplined approach to this.

I think we're doing it the right way, as Kerrii mentioned.

We, in the Company stores, are leading by example here and making sure that we pave the path the right way and continuing to enhance breakfast as it continues.

Is there a certain break-even dollar amount on breakfast, below that 3,000 that you guys have targeted, this is the level we need to achieve in order to push breakfast further?

Jeff, at this point I don't know that we're comfortable giving that break-even number.

We're continuing to monitor it and as our products evolve that number will shift back and forth a little bit.

Jeff, yes, there is a number that's below that -- the number that we quoted is where we get a decent return on it.

So clearly, at lower levels we're break even.

Okay.

And then just one -- go ahead.

Sorry.

I was just saying, sorry, Jeff, that that varies sometimes depending on rent and number of other factors.

Yes.

Just lastly for Jay.

I know you started by saying that you've now been here for 93 days .

Just wondering, with those three months under your belt, in terms of opportunities to create additional value, perhaps parallels to Wal-Mart or changes to implement, kind of your

Well, I came here because it was an iconic brand and I thought there was a lot of leverage.

I will tell you, I've been very excited by the things that are happening.

I think we're doing the right things.

We're not showing the progress but we feel confident that these are the kind of things that are going to get us back to where Wendy's should.

The one thing I did know from my experience at Wal-Mart is how much the impact of higher gasoline prices had on sales.

And we did all the correlations for the analysts in retail relative to gasoline prices.

And $3 was both an economic and an emotional point for a consumer.

And so, I think we had a lot of optimism coming into the year, but we faced two situations that we hadn't counted on.

And that was the commodity increases, which I think are historic in nature because of the reasons that they occurred.

They're not the typical cyclical increases, combined with the higher gasoline prices.

And if a typical consumer is spending $7 to $10 a week more filling their tank, that's $7 or $10 that they could have spent at Wendy's.

So, I think we're making progress.

It's not showing up as quickly as we would like but I don't see anything that we're currently doing that we would change.

Great.

Thank you.

Operator, I understand we have one more question in queue?

Yes, sir, your final question is a follow-up from Joe Buckley from Bear Stearns.

One more question on the breakfast initiatives.

Have you determined what percent of your restaurants it makes sense -- how prevalent do you think it will be if you were to roll it out as completely as you thought appropriate?

Joe, we have -- there are in every system some locations where the day part just won't work.

We don't see our system being greatly different to that of our competitors.

But we acknowledge that we're going to have to do store by store, dma-by-dma and understand the characteristics.

And that's the platform that Dave and Kerrii have talked about that we're working on.

And then one last, kind of simple one.

Just on commodities, how far are you locked in?

And I'm assuming beef you still have the quarterly pricing contract.

But on chicken, how far are you locked in?

And what commodity should we be aware of that you're not locked in case we see continued volatility?

Joe, we're going to have Tad Wampfler, our SVP of Supply Chain, answer that.

Tad?

Joe, without seeing exactly when or where our locks come off and stuff, we're obviously protected on a lot of our items with our contracts.

But clearly longer term, we're all seeing beef prices in the market today that are low.

But I think longer term we're all concerned about beef going up.

They're just not holding back a lot of heifers for the future development of calves.

So, we're all concerned about that.

On the poultry side of things, you've got some good and bad news.

You've got the grain prices, the feed prices that are working against you.

But you've got -- the poultry companies are increasing their placement.

So that's our good news.

So, that one we kind of see balancing out.

I think the biggest concern in the market now probably is on the dairy side.

And we see that clearly with the pizza companies taking a hit now.

And we've got barrel cheese out there at 71% higher than last year and class two milk at 150% higher than last year.

So those are products that obviously impact cheese and Frosties and things like that for us.

So whenever those contracts roll off, you appreciate that we'll get the best available pricing but they're likely to be higher than some of the numbers we're at right now.

Okay, thank you.

Thanks, everybody, for dialing in.

If you have any follow-up questions, please dial my department and we'll get back to you.

Thanks a lot.

This concludes today's Wendy's International second quarter results conference call.

You may now disconnect.