Wendy's Co (WEN) 2007 Q3 法說會逐字稿

Good morning.

I will be your conference Operator today.

At this time I'd like to welcome everyone to the Wendy's Analyst 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, appreciate it.

Good morning, everyone.

The purpose of our call and our webcast today is to talk about the third quarter and provide an update on some of our key business initiatives.

We did announce our third quarter numbers yesterday after the market closed.

We also had a brief news release out this morning about some of the initiatives we're undertaking from a strategic planning standpoint.

The agenda for today's call will begin with remarks from Wendy's CEO and President, Kerrii Anderson; and then after that Jay Fitzsimmons, our Chief Financial Officer; will discuss the quarter and then we'll take your questions.

Also on the call today with us are our Chief Marketing Officer Ian Rowden; our Chief Operations Officer Dave Near; and other members of our senior management team.

I'd like to refer you for a moment to the Safe Harbor statement that's attached to the news release.

Certain information that we may discuss today regarding future performance such as our financial goals, plans, 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 attached to the earnings release.

Finally, some of our comments today will reference non-GAAP financial measures such as EBITDA and you can find reconciliations in our press releases and on our website.

Now, least me turn it over to Kerrii.

Thanks, John, and good morning, everyone.

The financial results we released yesterday are a clear indication that we continue the Wendy's turnaround.

We are focused on exactly what we can control which is improvement in our core business, and improvement in our core business quite honestly is the best way that we can create value for our shareholders, our franchisees and our employees.

We continue to execute our strategic plan and we have delivered significantly improved results this quarter at both the Corporate as well as the restaurant level, despite a very tough competitive environment and commodity pressures.

For the third quarter we reported improving EBITDA, income, and EPS results, and we have now produced five consecutive quarters of positive same-store sales.

Our total adjusted EBITDA from continuing operations increased 57% to $95 million for the third quarter, and that's up from $60.3 million a year ago.

Now, this does include the expenses that are related to the Board Special Committee process which were about $13.4 million, restructuring charges for the quarter of $1.4 million and some pension settlement charges of about $1 million.

Our U.S.

Company operated restaurant EBITDA margins improved 330 basis points to 12.6% for the third quarter of '07 and that's compared to a 9.3% in the third quarter of last year, reflects positive same-store sales for the quarter including price increases, menu management, and labor efficiencies.

Our third quarter U.S.

operating margins and EBITDA margins would have improved an additional 140 basis points to 14% if it weren't for the commodity cost pressures and head winds we faced in the quarter.

These financial highlights are a clear signal that we are revitalizing Wendy's.

We are doing a better job of taking care of our customers with improved operations.

We are delivering new products such as the Baconator, the Frosty Floats and others that we have tested and our market based pricing strategy is working it's and improving our margins and our advertising is breaking through and gaining the attention of our consumers.

Overall our progress on the key elements of our business since June have been very encouraging.

Now, we expect to produce 2007 full year EBITDA and EPS near the high end of our guidance range that we gave you in June, and that really reflects our improving margins and our cost controls.

We are very confident about our business outlook for the remainder of 2007.

Now, Jay is going to discuss our third quarter financial results in greater detail in just a few minutes.

From a strategic perspective we introduced Wendy's Recipe for Success about a year ago in October of '06.

The plan focused on initiatives to grow sales and profit in every restaurant in our system and we've made significant progress in the last 12 months as a result of the initiatives implemented under this plan, and the foundation of our business is stronger today, thanks to the performance of our restaurant crews of our great operators, our franchisees and our field and corporate employees.

We have produced five consecutive quarters of positive same-store sales.

Store operations profit margins are up about 200 basis points year-to-date, and our consolidated earnings are improving.

This is significant progress.

Now, while we are encouraged about the improved results during the quarter and year-to-date, we know we must do more.

We must intensify our focus on driving growth and transactions, profitable transactions, improve our store economics, and accelerate our progress and that's exactly what we're doing in the second phase of our strategic plan which we highlighted this morning with the news release.

Our leadership team has identified 10 imperatives aimed at achieving improved results for every restaurant in our system.

These are a part of our 2008 business plans focused on doing what's right for our customers, and our key drivers are operations, marketing, facilities, and our people.

And these imperatives build on top of Wendy's Recipe for Success plan which is focused on revitalizing the brand, streamlining, and improving our operations, reclaiming our innovation leadership, strengthening our franchise committment, capturing new opportunities, and embracing a performance driven culture.

Now, seven of the strategic imperatives drive growth and the final three create efficiencies and improve our return on invested capital.

As we think about the -- just to talk about the first seven, number one, core hamburger.

We talk a lot about how important the hamburger business is to us.

That's the business we're in and we need to improve our large hamburger market share by increasing the appeal and building transactions with our consumers.

Second initiative is the value menu proposition.

We plan to introduce and update a more effective value strategy to capture growing share of that 18 ti 34 year old customer.

From a beverage perspective, we have initiatives to increase our drink incidents and our margins.

For example, we've expanded the Frosty brand very successfully over the last year.

From a late night and snacking day part, we are focused on reenergizing our late night business and capturing afternoon and evening snack opportunities, which is clearly what we see the consumers are demanding in the market.

Now from a breakfast standpoint, we have our new breakfast menu in more than 850 restaurants and at year-end it will grow to about 1000 restaurants including 351 franchise restaurants.

We are moving to the next stage of our program to offer high quality, premium breakfast customers and to optimize our restaurant.

Breakfast remains the fastest growing segment of the QSR restaurant segment and our major competitors attribute breakfast as a large component of their growth.

Now, from our perspective in addition to breakfast, what's most important is to focus on customer service and we are implementing in our Company restaurant a total customer feedback system to improve customer service both on a proactive perspective as well as a reactive perspective.

Our seventh initiative is reinvestment.

We must reinvest in our restaurants and it's critical to meeting the consumer needs, becoming more competitive and quite honestly driving long term sales improvement.

From a people quality standpoint, our initiative there is to elevate the customer experience by improving the hiring and the retention of our employees, while reducing our turnover, improving our training, and generating savings at the store level.

And from a refranchising perspective we are focused on improving the overall health of our system, by refranchising a number of stores in 2008.

Lastly, and probably most importantly, store margins.

We will leave no stone unturned to achieve our objective to continue to expand our store margins.

In summary our strategic plan has a bold vision for Wendy's, consumer focused, successful, more profitable in every restaurant and growing, and I am committed to driving Phase II of our strategic plan.

It's the right thing to do for our customers, our employees, our franchisees, and our shareholders.

Now finally, as we have our outlook for the remainder of the year we are on target to produce 2007 full year EBITDA and EPS near the high end of the guidance range I said earlier.

Provided to you in June, and we are confident that our business turnaround will continue.

We remain focused on driving growth and transactions through improving marketing and operations and we are working on a number of initiatives to offset rising costs as we continue to focus on improving our margins at every Wendy's restaurant in the system.

We are committed to fiercely protecting this great brand and improving the value of this great brand in this Company as we position it for future growth and profitability.

So with that, at this point I'd like to turn it over to Jay to review the numbers.

Jay?

Thanks, Kerrii.

I'd like to summarize the quarter as follows: We had a solid financial performance in the third quarter in a difficult and competitive environment, but I think the headlines are that if you exclude expenses related to the Board's Special Committee, restructuring, and pension settlement charges, adjusted income from continuing operations increased 55% to $38.6 million, that's up $24.9 million from a year ago.

Adjusted diluted EPS from continuing operations increased 110% to $0.44 up from $0.21 in the third quarter of 2006.

Adjusted EBITDA from continuing operations increased 57% to $95 million, up from the $60.3 million a year ago.

We take a look at U.S.

Company operated restaurant EBITDA margins as Kerrii said, they improved 330 basis points.

Total Company store EBITDA margins, and this includes our Canadian and international operations improved 270 basis points to 12.5% in the third quarter of 2007 and that compares to 9.7% one year ago.

It was our fifth consecutive quarter with positive same-store sales growth, with same-store sales of 0.2% at the Company operated restaurants and up 1.3% at franchised restaurants.

Another way of looking at this is the Company's two year sales trends and they continue to improve and have averaged up more than 4% in the past four months.

We're encouraged by the results but we recognize that further opportunities exist to grow sales and improve operating margins.

As Kerrii said, we have a strategic plan in place to generate even better results in future periods.

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

Cost of sales of $334.9 million or 60.4% in the third quarter of 2007 compared to $345.8 million or 62.1% in the third quarter of 2006.

The 170 basis point improvement as a percentage of sales is due primarily to our higher menu pricing tied to our market based pricing strategy and improved menu management.

Now, as Kerrii said without the impact of higher commodity costs, third quarter U.S.

Company operated restaurant cost of sales margins would have improved an additional 140 basis points.

Now let's look at the commodity outlook for the remainder of the year.

Beef prices in the fourth quarter will be down about 6 to 8% from the third quarter of this year, but will be up from the fourth quarter of last year.

Chicken prices have held fairly constant in the second half of this year, but we're expecting the prices of french fries to be the biggest drivers of upward pressure in the fourth quarter by going up 11 to 13% as our contracts take effect.

We continue to see upward pressure on dairy cost of about 5 to 7% for the quarter and we also expect higher grain prices to impact the quarter due to the continuing biofuel demand.

Paper costs are expected to be flat.

To offset these cost increases in the fourth quarter we continue to focus on product, optimization, labor initiatives, menu management, things such as the higher priced Baconator and the Frosty Float which has a great food cost carry, and aggressive food cost management.

Now let's talk about Company restaurant operating cost.

$148.6 million or 26.8% of sales in the third quarter of 2007.

That compares to $155.3 million or 27.9% of sales in the third quarter of 2006.

The year-over-year improvement as a percentage of sales is due primarily to lower utility, bonus, and insurance costs.

These improvements were partially offset by the change in accounting that we talked about in prior quarters with the real estate joint venture with Tim Hortons.

As a result of this change in accounting, third quarter 2007 Company restaurant operating costs included rental expense paid to the joint venture by Wendy's which in the prior year was eliminated in consolidation.

Without this change in accounting, reported third quarter 2007 Company operated restaurant EBITDA margins would have been 30 basis points higher, or 12.7.

On the operating cost lines, $6.3 million in the third quarter of 2007 compared to $8.3 million in the third quarter of 2006.

This year-over-year decrease is due primarily to a decline in franchisee rent expense again as a result of the change in accounting for Wendy's Real Estate joint venture with Tim Hortons, which is no longer consolidated.

Let's move on to G&A.

G&A in the quarter was 7.8% of revenue compared to 9.9% of revenue in the third quarter of 2006.

This 210 basis point improvement as a percent of revenue primarily reflects the impact of the cost savings initiative related to the reduction of salaries and benefits as a result of the elimination of positions in 2006 in last years Next Chapter program.

It also includes $6.4 million in lower insurance cost.

The decrease in insurance cost come from lower D&O expenses this year and favorable claim experience.

On the other income and expense line, the $2.9 million of income in the third quarter reflects $3.1 million in income from the 50/50 joint venture with Tim Hortons and insurance gains partially offset by store closure charges and other asset write-offs.

Remember the income from the joint venture with Tim Hortons is partially offset again by the higher rent expense I talked about in Company restaurant operating cost.

This compares to $1.6 million in other income in the third quarter of 2006.

Interest expense was $1.5 million higher in 2007 as a result of the sale of 40% of Wendy's U.S.

royalty stream for 14 months that we entered in the fourth quarter of 2006.

This obligation is recorded as debt on the balance sheet.

In 2006 we received $94 million in cash in return for the 2007 future royalties.

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

As a result, interest expense is up in 2007.

Interest income, the $11.7 million decrease in the third quarter 2007 interest income reflects lower cash balances as a result of the modified Dutch Auction Tender and the accelerated share repurchase completed in the fourth quart of 2006.

In the first quarter 2007 respectively.

Taxes.

The Company's effective tax rate was 34% in the third quarter of 2004 but that compares to 26.5% in the third quarter of last year.

Now, both quarters benefited from the settlement of prior year tax audits.

The normalized rate is 38% but as you know, certain discrete adjustments will cause that rate to fluctuate from quarter to quarter.

Shares outstanding were lower this quarter due to the share repurchases.

Previously discussed 22.4 million shares from the modified Dutch Auction Tender offer in the fourth quarter of 2006 and the 9 million shares from the accelerated share repurchase in the first quarter of 2007.

This resulted in a lower share count of 88.4 million average shares in the third quarter of 2007 compared to 118.3 million average shares a year ago.

Now as usual, we had some unusual items in both this and last year's third quarter.

Special committee expenses of $13.4 million in the third quarter of 2007 are recorded in the line restructuring and special committee related charges.

These costs did not occur in the third quarter of 2006.

There were restructuring charges of $2.4 million also recorded in that account, restructuring and special committee related charges in the third quarter of 2007.

This compared to $2 million in restructuring charges in the third quarter of 2006.

In the third quarter of 2007, this includes $1 million in pension settlement cost.

Now, year-to-date, this is what we've recorded.

$18.1 million in Special Committee expenses, $9.4 million in restructuring, which includes $6.4 million in pension settlement charges.

Now at the end of 2006, we indicated that total pension charges could be up to $60 million in total.

Based on the current interest rates, updated assumptions and pension charges recorded to date, we now expect remaining pension charges of up to $35 million of which about $10 million of that will represent a cash outflow.

The timing of these pension costs is dependent upon obtaining the necessary regulatory approvals to terminate the plan.

In the fourth quarter, we do expect additional expenses related to the Board's Special Committee process and possible restructuring and pension settlement charges.

Now, going back to the outlook for the full year 2007, as Kerrii mentioned, we expect to report 2007 full year EBITDA near the higher end of the outlook we provided to investors in June.

That outlook was a range of 295 million to $315 million.

We also expect to report full year EPS near the high end of the range that we provided which was 1.09 to 1.23.

Now remember, these ranges exclude expenses related to the Board's Special Committee activities, any potential restructuring, and pension settlement charges.

As a reminder we suspended our previous earnings guidance for 2008 and 2009 due to the Special Committee strategic review process now under way.

Finally, as you know, we cannot comment on the Special Committee's strategic review process.

It's a complicated process, I know you'd like to hear more but the Board's Special Committee is following a very disciplined approach.

Now, we acknowledge that the process is taking longer than we originally anticipated and this is due in part to the well publicized uncertainty in the debt capital markets, but I assure you the Special Committee process is continuing and we believe that there will be more clarity relatively soon.

Now let me turn it back to John.

Thanks, Jay.

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

First of all our Board of Directors approved our 119th consecutive quarterly dividend.

It will be paid on November 19, and that will be to shareholders of record as of November the 5th.

The quarterly payment is $0.125 per share.

This is the fourth dividend payment since the Board voted to increase our annual dividend by 47% up to $0.50 per share.

And as Jay said, as we get into the Q&A, we really do not intend to provide further updates today regarding the Special Committee's actions.

We will, as we've said in the past report on developments in the future as circumstances warrant.

We do intend on this call to talk about the results we just reported, year-to-date, and quarter as well as outlook and our updates on operations and marketing and we would ask that you focus your questions on those subjects.

Now, Operator, we would like to open up the call for Q&A.

(OPERATOR INSTRUCTIONS) Your first question comes from John Glass with CIBC.

Hi, thanks.

In the implied fourth quarter EBITDA guidance it looks like margins probably also declined sequentially and I know there's a little bit of a decline seasonally in revenue but is there any other reason why margins would be less, would decline in the fourth quarter?

Is it a commodity issue?

Is there something that was one-time in this quarter that doesn't occur?

I think there's a seasonality issue in that, as you know, and also as we did point out, we have continuing commodity pressures and those would be the major items.

Okay, and specifically have you called out how much commodities impact the fourth quarter relative to the third?

I think in the call we gave you some clues as to what it is.

My guess is we talked about 140 million--.

140 basis points.

140 basis points in the third quarter that it's going to be the same, maybe even a little bit higher in the fourth quarter.

And that would be going up with the exception of sequentially beef will be coming down but remember it will still be up from last year's fourth quarter.

Right.

And I think breakfast is in about 40% or maybe a little more of your Company stores if I calculated that correctly.

How much do you think that's adding to the comps right now?

Yes, John, from your question perspective we haven't really disclosed the element of the comps related to breakfast.

We just really rolled most of the stores in the third quarter.

The one thing we have indicated is that we do expect breakfast to actually create a small loss at the restaurant operating level, as we invest in this day part, and try to make a very positive business case for it.

Got you, okay, thank you.

Thanks, John.

Your next question comes from [Lewis Clark] with BP Management.

I just wanted just to clarify when you said that the process of the Special Committee that we will hear from them relatively soon, the announcement this morning on the strategic goals for 2008, is that in any way tied into the work of the Special Committee?

In other words is that something that we'll -- is that a follow-on to their work?

In other words, will they -- is that the end of the process?

I appreciate the question, Lewis.

From our perspective, we rolled our strategic plan a year ago and really went to New York and introduced it to the Analysts.

What we have, the second phase as we call it Phase II is really just an evolution of our current plan and how do we take our performance to the next level and as much improvement as we have seen we know we have to do better and there's tremendous opportunity which in our core business and certainly in our Company store performance, and this Phase II is just an element of being able to make sure that the Board knows what the opportunities are as they evaluate their options.

You know--.

Thank you, Kerrii.

Lewis, this is John.

You got to understand that 80% of our system is franchise, so regardless of what the Special Committee is doing we have to have a strategic plan for both '08 and the next three to five years.

Thank you.

Your next question comes from Steven Kron with Goldman Sachs.

Hi, good morning.

A couple of questions.

On same-store sales, can you talk about the multi-based pricing strategy, maybe if you won't give details as to how much price is currently in the menu, can you talk about whether there's still opportunity to raise prices going forward, and maybe Kerrii you can just comment on the traffic fall off that you're seeing a result of the price increases.

Yes, I think there's no doubt, Steven, that from our perspective pricing has been a very key element to us being able to gain prices as long as menu management as well as new products rollout.

I would tell you that I think we believe there's still pricing opportunity in certain elements of our menu compared to the competition and I'd ask Dave to maybe give a little more color on that.

And to your question about transactions, certainly, given the overall focus we have had on price as well as menu management, it certainly has had an impact on our transactions in the short-term but we knew it's the right thing to do, but Dave why don't you add a little color here.

Yes, I would agree with what Kerrii said and just for context, I think -- I don't see us doing anything materially different from a pricing perspective than a lot of the competitors that are out there today just for some context there.

Okay, and I guess just a follow-up, staying with same-store sales.

If I think about it, you've obviously been pretty outspoken about the pricing opportunity, that's currently working through the menu.

You've been offering some more premium products.

You've kick you've kicked in the advertising more aggressively in the last few months, and you've also rolled out breakfast to quite a few stores, so I guess with that as context, can you just talk a little bit about how the 0.2% same-store sales that you had in the period, how that compares or tracks versus what you guys had been anticipating?

I guess the one thing I would be very clear about which I know you know, Steve, is that last year, in the months of July, August, and September, we delivered 3.2, 4.5, and 4.2 for a 3.9 same-store sales comp so it was the absolute strongest quarterly sales comp that we had to rollover from last year.

So in that case, while we indicate where sales actually came out the 0.2 as you indicate, we were, sorry, actually I gave you bad numbers, that was the U.S.

stores franchise.

Our Company was 3.6, 4.7, 4.3, for a 4.1.

So we're rolling over very very strong comps and there's some in this business, that is the challenge that you face, having said that we are very focused on continuing to drive same-store sales comps and it's the key driver to this business.

Okay, and as far as the product pillars that you guys highlight in your Phase II plan, the beverage platform, the snacking products, are there already new kind of products in test or is this kind of the beginning phases?

Steven, this is Ian.

There are new products in test.

There's been some tests done locally on things like Frosty Shakes which we've announced, we've done some coffee work, we've continue to expand our beverage platform, we're deep into our value menu and redefining that from a transaction driving point of view.

So we've got a lot of news that we will bring to the market in the future but we're not ready to disclose today obviously.

Okay, thanks.

Your next question comes from Larry Miller with RBC Capital Markets.

Yes, actually that was my question but I did have a couple others.

At the meeting last Spring, Kerrii, you talked about -- you gave us some parameters on the success of breakfast and I was wondering if you could kind of revisit those as you're seeing it and specifically can you talk about how breakfast is mixing as a percent of average unit volume?

Okay, with respect to breakfast what we laid out is that we would see our fair share of breakfast based off of our market potential as about 3,000 to $3,300 per store if we could achieve our market share ownership of breakfast.

From a breakeven standpoint, what we have indicated is in the Company stores it's more in the 1,900 to $2,000 range and in the franchise stores because they pay royalties, it's more in the 2,200 to $2,300 range in order to really meet breakeven.

So you've got to get to that level, drive your performance and exceed it so that you build the business case to have acceptance from a franchise perspective because they're in business to make money as we all are.

So that's been our area of focus, Larry, trying to drive towards that success.

We know, we learned something from owning Tims for 10 years and that is that this is a difficult habit to break.

It is important to really market it locally within the market but we've also, one of our next phases is to really roll breakfast out to four or five DMA's, focus on it from a DMA perspective in order to prove out the business case that breakfast can work for us, but it is not as you probably got a sense from the overall strategic initiatives, it's fifth or sixth on the list and I mean that in that we have so much opportunity in our core with hamburgers and with value and with beverages and with those elements that's really where our primary focus is and quite honestly it's where our resources are.

So I don't know if anybody else would like to comment?

No.

I would just say we're in about 800 to 850 stores right now of which about 35% are franchisee based stores and the plan is to be just over 1,000 by the end of the year as Kerrii said, of which about 350 stores will be franchisees.

So we're seeing success in getting franchisees to come on board with the program.

Our next phase as Kerrii said will be to fully market the great work we've done in building the menu and the program in some DMA-wide activities, so we're just on track as we continue to learn and move forward.

Great.

Thanks, and just a follow-up on that.

Are you guys giving support to the franchisees, that 35% that are testing it for you?

Yes, we are supporting them from a local marketing perspective, Larry.

Okay, and then just on the EBITDA guidance you laid out, Jay, does that assume we'll have comp store sales in the fourth quarter?

How should we think about that?

What kind of sales or is it more cost based?

I think what we're assuming in the fourth quarter, both relative to the cost, as well as the sales is pretty much the same, so we're not looking for an acceleration of sales in the fourth quarter in the forecast we gave you, of course.

We would like to see an acceleration in sales.

Sure.

But we forecast based upon the current run rate, and the commodity cost pressures which we were able to identify and we talked about on the call.

Okay, thank you, guys.

Thanks, Larry.

Your next question comes from David Palmer with UBS.

Hi.

Good morning, David.

Good morning, Kerrii.

The first question I have is on refranchising.

Could you perhaps give us an update as to your thinking there?

Obviously this is a major initiative that was talked about in the past.

What's holding you back from doing that more aggressively now?

David, I would say two key things.

First and foremost, we believed we had significant opportunity to grow improved margins.

This quarter, we delivered on our ability to do that, 330 basis points at U.S.

Company stores.

For us to have been in a accelerated mode to sell those restaurants really quite honestly would have reduced the value that we could have captured for our shareholders because as you know generally these refranchising opportunities are priced on a cash flow basis.

So as we improve the kind of margins we improve the opportunity to gain value for our shareholders so that's number one.

And most importantly and then secondly, the question was okay, if we would have gotten very aggressive I think you probably saw balance sheet today, we've got 220 million or $230 million of cash on our balance sheet.

The other question is what exactly will we do with the cash at this point in time given the strategic review and everything else.

So that's the other, we have not been in a situation where we could utilize the cash perhaps and return the greatest value to the shareholders given everything that's circling around us.

So those are the two key reasons we have really not been more aggressive at this point.

I suppose that those things could change with the discretion of management pretty much at any point.

I mean, obviously, your goals on margins are much much higher than where you are now but it's hard to believe that you would wait the amount of quarters and years to get to that point before you start refranchising, and obviously the strategic review is something that's going on now.

Is there any other sense you can give us about refranchising and when we might hit an inflection point?

I think David you identified the key point is that strategic review is under way and I think that's obviously going to be a factor in this, but could potentially lead to higher leverage, gives you even more incentive to do the refranchising.

We've also been fairly public about the fact that we believe there's another 450 stores at a minimum that we could re franchise.

So I think it would be a reasonable expectation that you would see the refranchised program accelerate in 2008.

Yes.

And then the second question is just revisiting breakfast.

I mean, I guess folks might have a hard time believing that breakfast is going all that well, obviously we have to be patient with that day part, but your Companies are rolling it out more aggressively than your franchisees, your Company comps are trailing franchisees by 1.5 points or so.

You said it's costing you money at this point, but -- and you won't quantify the lift to sales but is there anything you could tell us that can make us believe that it's going well or anything that you can talk around this?

Yes, I think from our perspective, Larry, a couple things.

Breakfast, I think, is absolutely the fastest growing day part in the industry.

We're seeing the impact it's having on our competitors results, you know?

It is going to be faster growing day part than the dinner day part within the next few years.

So I think you look at that as to what the current consumer trends are and what the consumer is demanding.

That said we think it's important to invest in this for the long term.

It's not a short-term impact for us, and quite honestly, I think the consumer as we have done our research says, gosh, everybody else is open at breakfast.

I don't understand why you aren't, Wendy's, and we're getting a lot of feedback from a consumer standpoint that that's what the consumer is looking for.

They want the restaurant available when they want it.

So I think it's more the consumer demand and we understand it's an investment and we're not, while we've got a thousand stores, we have always led by example.

It's what the Company does.

Every initiative we have we generally do that and so as a result, we think it's the right thing to do for the brand and the system long term but it's not a short-term, great short-term benefit.

And David this is Dave.

I think from an operational perspective, we feel like breakfast is going very well.

We feel like we are executing at a high level in that day part, so, certainly from an operational perspective we feel good about it and we've got markets in stores in different pockets of the country that are doing very well with it and I think that we're continuing to learn more and more as the weeks and months pass as to what exactly makes breakfast a success in the Wendy's system.

So I think with the evolution and the addition of new products of new menu boards, of new POP, that we're continuing to -- and getting traction with the coffee piece, is really aiding us in making sure that we know what success means in this breakfast day part.

Okay, thanks, guys.

Thanks, Larry.

David.

Your next question comes from Paul Westra with Cowen & Co.

Hi, good morning, everyone.

Good morning.

Hi, how are you?

Just a few questions if I can start with the update if you can give us on the remodel program, give us an idea of the numbers that have been remodeled year-to-date on the Company franchise side, maybe what you feel is in the backlog of the franchisees signing up for the program and any changes you've made during the year to it?

Paul, this is Dave, and I think we're looking for the exact numbers as we speak, but generally, what we're doing on the reinvestment piece, it continues to clip along on the Company side and the franchise side.

We are also in the midst of exploring some other designs right now from a reinvestment perspective, from an exterior perspective I guess much more aggressively than we have in the past.

We've done quite a few different remodel schemes in different stores throughout the country and we continue to focus on the interior as well as if there are different things that we need to do from an interior perspective than we rolled out about seven years ago as well so it continues to go fairly well and I think Jay may have an update on the numbers.

Yes, the only thing I would say from a franchisee perspective is as you might guess, Paul, with all of the uncertainty around what's happening from a strategic standpoint, there is some hesitancy on behalf of the franchisees as well as quite honestly we're focused on improving margins and cash flows certainly have been the focus of quite honestly most of the franchisees let's improve cash flows, wait and see what happens strategically but with that, I know, Jay, you've got some specific numbers as to what the remodels have been.

Kerrii you're right.

We haven't had the take up on the incentives that we provided that we originally expected or budgeted in part because of the insecurity around the system, but we have had so far this year 186 franchise stores remodeled and another 50 Company stores so 236 stores have been remodeled year-to-date.

I know you had a five year goal, obviously given the uncertainty that's a little less clear at this moment?

For all of the entire system?

Yes, that is exactly correct, Paul.

I will tell you we're still very committed.

We know reinvestment as you heard me say, and the strategic initiatives is key to us.

One of the things that the customer ends up rating you on in their overall experience is what were the facilities and the facilities for 65% of our guests are whatever they see from the standpoint of their car, through the parking lot and the drive through.

So as a result it is important for us to continue to update our facilities with new menu boards as well as to maintain the presence of our outside and inside facilities.

And follow-up to that, I know some of the remodeling was tied to the beverage station moving out and perhaps tying into your whole beverage strategy at the store.

Are they still linked pretty heavily or is that going to put a governor on what you can do on the beverage destination objectives?

What you'll see, Paul, with all new stores that are being built that we will certainly have the beverage station out in the dining room and then as we remodel stores you will also see the beverage station moved out there in the dining rooms as well because that's really from a cost perspective, that's when it makes the most sense to do to make that transition is when we're remodeling the restaurant and the dining room, we're tearing up the floor, we can put in the floor drains and all that good stuff.

So no, that's still on track and that is still where we would like to be.

Okay, last two questions, one is your fry contract, I know potatoes is losing out to wheat and corn and soy beans, can you give us an update what you -- it sounds like you signed, plan a new one for, I forget what the number was off the top of my head, something about 10% or so, how long is this the contract and did it just start to kick in and last question on the value combos, you had a new strategy.

I assume you're not talking about price points, you're talking about strategies like value combos and stuff?

Okay, Paul, Tad is going to take your question with respect to the potato contracts and Ian is going to talk about the value combo strategy.

We don't have all of our fry contracts expiring at the exact same time, but we just signed new contracts that will take us through 2008, so that's, we're pretty well locked in through then.

They just begin this quarter or next quarter at a new higher rate?

Yes, this quarter.

Meaning the fourth quarter?

Fourth quarter.

And, Paul, just on the value conversation, you're right.

We understand and we're looking without getting into specifics a mixture of kind of an everyday low price strategy combined with either the combo and to add various products at various price points.

Okay, thanks.

Your next question comes from Glen Petraglia with Citigroup.

It's Petraglia.

Good morning.

Good morning, Glen.

Nothing new there.

In terms of the reimaging, I think several, maybe it was several quarters ago but I think you provided an update in terms of what sort of sales lift you were getting from reimage restaurants and it was fairly significant and I would think that if a franchisee could capture those sorts of economics, they would be happy.

Do you think that the incentive that you've offered I think it was 25,000 per restaurant is it sufficient and how do you think about that going forward with nearly $250 million of cash on your balance sheet that clearly, you're struggling to find a use for?

Glen, just to kind of tag on Kerrii's comments earlier, I don't think the $25,000 is an issue at all.

I think it's a good incentive.

I think the big thing that is holding up more reinvestment at this point is simply the process that we're going through right now and I think that that is mainly from a franchise perspective they want to make sure that we have clarity coming out of this process before they commit to the dollars that are necessary to grow the business.

So I think that's the biggest reason and that's obviously been going on now for well over a year.

And then just lastly, in terms of value, Ian, if you could maybe help us think about are you moving away from $0.99?

Is it different items at $0.99 that maybe have lower margin and if you put them together in a combo similar to what you did I think earlier this year with the Double Jr.

Cheeseburger I don't remember exactly what you called it but if you could help me think about that?

Yes, just a couple of things, Glen, and again I don't want to get ahead of ourselves here as we're completing testing, but McDonald's and Burger King are very aggressive at $1 price point with products that we know from a definition of price value are very important.

So we're going to be very competitive in that regard with them, so we're not going to lose that emphasis, but yes, you're right.

We learned very very positively earlier this year in work we did with our deluxe value meal offerings and some other menu development work that we've been doing for products that fulfill both price points and usage occasions that there's an opportunity for us to expand the value proposition in that regard.

So you can expect a number of initiatives that will all work together to offer a more blended strengthening of profitability and drive transactions, that's the plan, and again I don't want to get into specifics, but we're very close to bringing that to our business.

Okay, and just one more question.

Jay, the $6.4 million in lower insurance costs is part of G&A, is that something you think is sustainable?

I know you mentioned better claims experience.

Is there anything in particular that you've done to drive that or was it luck?

Glen, there's a number of factors in that.

First of all last year as we mentioned there were higher D&O costs an that's a one-time item that actually related to Tim Hortons, that was in the amount of $2 million, a little over $2 million.

So obviously, that won't recur.

Obviously, when you're trying to predict employee related claims and worker's comp related claims you have a number of moving factors.

One of the factors that we had was the next chapter and the impact that that had which made it a little bit harder to forecast what should be in that account.

I would not expect those numbers to recur.

I think that we have control over the claims but I think we probably have a good idea what the accrual should be.

I think what we're seeing now is we're seeing flat healthcare cost, based upon what our benefit plans are for next year, and so we should be able to hold the line where we are, but in terms of having future benefits in the quarters, always hard to predict but I wouldn't count on it.

Okay, thank you.

Your next question comes from Jennifer Preller with Barclays Capital.

Yes, it's actually Tom O'Neill from Barclays Capital.

The capital markets as you alluded to in your statements earlier certainly have changed since your last call.

I know you can't talk about the strategic review but can you update us really on your overall philosophy on your capital structure in terms of your willingness to operate with higher debt loads?

What things are you doing given some companies don't have access to CP, et cetera?

Well, obviously, we do not have access to CP, because of our credit rating.

I think what we talked about relative to the Special Committee which we did make public is that it was our intention to offer up a staple financing package, which would give them the option to put the leverage on but it also would give the Company to put the leverage on, and as you know in today's environment, investors are demanding higher leverage on the balance sheet, and a likely outcome of the special committee process is that we'll have more leverage next year than we have this year, Tom.

Okay, just as a follow-up question, and again I know you can't talk about the strategic review, but we talked on the last call about the hypothetical situation if you were to securitize your stream of franchise fees, you were taking a look at your bond indenture.

Based on your understanding of the language in your bond indenture, would you have to take out your bond if you were to engage in such a franchise fee securitization transaction?

I think we would do obviously what we're required to do and it is likely that if you entered staple financing that we would address those existing bonds.

I think we are very aware of our obligations to our public noteholders and certainly would be our committment to abide by the requirements.

Sure, so that means that for securitization in all likelihood, you'd have to take out the bonds?

It may be an outcome of securitization.

Okay, but obviously it's -- everything is still open in terms of what you may actually do?

That's correct, Tom.

Okay, thank you.

Your next question comes from Rachael Rothman with Merrill Lynch.

Hi, guys.

A question for Dave, maybe he's the only one that's been around long enough to remember, but can you think back to a time when QSR's in general have taken as much price as they seem to be taking these days and can you talk about maybe what the near term and longer term implications of that were from obviously a traffic and consumer shift perspective?

Yes, Rachael, I think pricing is a slippery slope.

There's no doubt about it and we need, we all need to be very careful about raising our prices, because I think we've certainly been viewed historically, I think we're still viewed today as a great value generally, our industry is.

In terms of, historically I have not seen the industry take as much price as I think that the industry has taken over the past three years we'll say.

I think it is certainly a response to what's happening from a commodity perspective and not only I think are we seeing that in QSR, but I think we're seeing it in fast casual, in mid scale, and all the way up and down the chain, so I think from a historical perspective, it is at a high level for sure, and again, it's something that we have just, we've implemented a much more disciplined process than we've ever had here at Wendy's in terms of how we look at price, in terms of how we look at products, in terms of how we look at markets and I think that what we're doing is the right thing but again, it is high on our priority list to make sure that we don't go too far with pricing either.

Great and then a follow-up on the remodel for Jay.

Did you say that the uptake on the incentive has been lower?

Can you quantify for us actually how much you've given in incentives and what the average cost of the remodel has been year-to-date?

Rachael, it's very difficult to say what the average cost of the remodel is because you go anywhere from just an interior to an interior exterior to what we call a scrape and rebuild to a relocation, so that's a question that is individualized based upon what the opportunities are.

We never gave you what the actual budget was this year, so I'm not going to give you what the actual expenditures were against that but I will tell you that it's less than we expected.

We have also opened it up so that the new menu board which is used in conjunction with the breakfast comes from that and everybody who's putting in the breakfast is taking advantage of that.

And I think what we'll do is after this process, we'll probably reassess the program and decide what we need to do.

And to the point, I think someone questioned earlier is it the right incentive?

Is 25,000 enough?

I think we believe that while it is substantial, there may be opportunities to further expand that to encourage people to invest in different ways within their restaurant and as we get through this process I think that's going to open up the opportunity to do exactly what Jay said which is consider other modifications for franchisees to utilize that incentive.

And how would you think about the inning that you're in in terms of the remodel as the other chains have been remodeling now for three and four years and have already committed that capital to both their franchise and company operated systems?

To what extent is that putting you at a competitive disadvantage, and are you just in the beginning of your remodel program or are you further along than it may appear from the outside?

Do you feel like this is disadvantaging you or your franchisees at all?

Rachael, this is Dave.

I think in certain respects, I don't know if this is a disadvantage but certainly an opportunity for us to reinvest it at more aggressive rates and I think the big thing that we all know, we see exactly what McDonald's is doing out there in the marketplace right now, they're doing a lot of investment, a lot of scrape and rebuilds and I certainly think when you look at their sales comps, that that is one of the big reasons for that because I think on a, from a facilities perspective, they've certainly improved a lot of the stores in their system and that's something again we need to be focused on as we move forward and I wouldn't say that we're at the beginning but we're certainly closer to the beginning than the end.

And I would just also remind you that McDonald's really quit building stores back in the late '90s, as they focused or 2000 as they focused on improving the results from their core.

We were still building stores and as many Company and franchise as 250 or 300, almost 300 stores a year for the five years of 2000 to 2005 at least.

And so from that perspective, some of our system is newer but maybe that's 20% of the system versus the 80% that's been around.

I know that half of our buildings were built prior to 1990, Company and franchised, so from that perspective, it is an opportunity for us to improve the facilities which is key and critical to our customer.

Great.

Thank you so much.

Thanks, Rachael.

Your next question comes from Joe Buckley with Bear Stearns.

Thank you.

I just had a couple questions on margins and costs again.

Can you quantify the impact that breakfast has had on the margins?

Obviously negative from your comments, but have you calculated that?

It's negligible, Joe.

Okay.

And then--?

The food cost is actually, if you think about it the food cost is actually slightly lower, but given the penetration of breakfast, it's not really having a significant impact on the margin.

Okay, and you mentioned fourth quarter beef costs being down sequentially.

How much are they up year-over-year?

For the full year, they will basically be about flat, but in the fourth quarter, they will be higher than they were in the fourth quarter of last year.

That's correct.

Do you know how much?

Somewhere around $0.05, why don't you use that?

A $0.05 a pound?

Yes.

Okay, and then just a question on produce costs, particularly with what's going on in California.

Historically Wendy's has been very sensitive to produce markets.

Any feel for whether we'll see a spike there in the fourth quarter?

Yes.

We're seeing a little bit but I wouldn't call it a spike.

We've got some contracts in place that are helping protect us on some of that as well so we're certainly feeling a bit of it but not the full brunt that you might expect.

Okay, all right, thank you.

Thanks, Joe.

Your next question comes from [Jason Belcher] from Wachovia.

This is Jason for Jeff Omohundro.

I was just wondering if you all could provide a little more commentary on your commodity outlook for '08 maybe for some of the key categories in addition to the french fries, and then also whether you're seeing any regional sales trends across the system, particularly the stores related to -- located in Southern California?

Broadly speaking for '08, I think the big pressure that we're forecasting is really going to be on the protein side, obviously it's hard to tell right now, but I think the protein side, beef and the chicken is where we're expecting most of the pressure to be.

Those markets have been tough.

After that, it's just rolling over the french fries would be the other piece because of the new contracts.

Yes, and Dave, maybe from a regional sales perspective?

Yes, regarding the fires in Southern California, because we are not as penetrated in that part of the country as a lot of our competitors, we're really not seeing a big impact from the fires.

Just a couple of stores, a handful of stores, a handful of stores are being impacted right now, but just as an aside too, we are doing a lot in terms of providing free meals for the firefighters and those that have been kind of driven from their homes and things like that so we're doing a lot from a community standpoint with our stores in that area.

Great.

Thanks very much.

Your next question comes from David Palmer with UBS.

Hi.

A question on McDonald's innovation pipeline.

How scary is that for Wendy's, and in each of the next two years it looks like they're going to be aggressively pushing a big premium sandwich, the Southern Style Chicken and then perhaps one-third pounder Angus.

Both would seem to be really something that would hit Wendy's core.

How are you thinking about this and is this something that you can convince us wouldn't be a hit to your business?

Thanks.

Well, I think, David, first and foremost there's no question that the competition has stepped up generally over the last couple of years, and as a result that's why we really have to take our initiatives to the next level.

We continue to focus on our fresh, never frozen beef, and the fact that we are made-to-order, which is something while McDonald's has rolled out like a third, the Angus burger, you got to keep saying to yourself, do you go to the freezer and buy your burger or do you go to the fresh section and buy your burger.

So from that perspective, I think, our competitive difference and the quality positioning of Wendy's is critical to us communicating from a customer standpoint to be able to really improve the results of Wendy's going forward.

So I think it does mean we have to step up our game at Wendy's.

They are the 100 pound gorilla out there.

With that I'd have Ian make comments about some of the R&D and our thought process.

Yes, and I think just to build on Kerrii's point there, obviously the work that the major competitor in the marketplace is doing is going to have an effect on everyone, but we've got enormous upside in our core business as it currently stands and our ability to compete at a premium level.

We've got great upside from a value point of view from a beverage point of view, so we've got a lot of things in our armory, not to mention Frosty as a desert and of course the work that we'll do as part of the breakfast program.

That gives us confidence that we can can deliver on the strategy Kerrii said.

So we're going to continue to be aware, be responsive if we have to be, but to be aggressive on our own platform of what makes us the brand we are and the business we are.

Okay, thanks very much.

Thanks, David.

Operator, one more question, please?

Thank you.

Your next question comes from Jennifer (sic) Bernstein with Lehman Brothers.

That's worse than Glen Petraglia's problem.

It's Jeff Bernstein.

And your voice is changing, Jennifer.

Getting a little deeper.

A couple of questions.

First, I know we're now pushing the end of October here, you put out an initial strategic plan for '08.

I know you have withdrawn your '08 and '09 guidance, but without anything official I'm just wondering if you could put out some initial thoughts in terms of sales trends, perhaps some preliminary comp tech guidance just based on what you're seeing right now and then from a cost perspective I know you've made some comments on commodities but just wondering from a commodity and labor standpoint whether you see significant further upside to margins or whether a lot of the cost savings benefits have already been achieved in '07?

That's a tough question.

Your crystal ball is probably as good as our crystal ball.

If we look to 2008, the process could give us different leverage ratios and that clearly would affect the P&L.

We know food costs are going up.

You can probably make as good of an estimate but you're probably talking about something in the 4%.

So the question as to whether there's further opportunity, we believe there is further opportunity, and I think we've indicated that.

We've made a lot of progress this year.

There's still a lot of things that we can do.

Some of the optimization we did this year, some of the labor initiatives that we had this year will continue into next year.

We didn't get a full year of credit for those, so I'm not going to give you the number but I'm telling you that we're obviously expecting next year, on a same basis with the same relative amount of leverage to be up from this year.

And I think Jay makes a very good point.

I mean, some of the initiatives we talked about our labor initiatives that fully got implemented from 3.6 managers to 3.3 in the Company stores and that took place really finally in May to June.

We're going to see a rollover of that in the first half of next year that we didn't experience this year.

So I think there are some opportunities for us and that's what shareholders demand that you improve results.

How do you improve results and that's what makes a high performance team and we know what we're expected to deliver.

Operator, and everybody, thank you for joining our call today.

If you have any follow-ups please give me a call later today.

Or Marsha Gordon, or Kim Messner.

Thanks a lot.

This concludes today's conference call.

You may now disconnect.