Wendy's Co (WEN) 2013 Q2 法說會逐字稿

Good morning.

My name is Brandi and I will be your conference operator today.

At this time, I would like to welcome everyone to The Wendy's Company second-quarter 2013 earnings results 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. John Barker, you may begin your conference.

Thanks, Brandi.

Good morning, everyone.

Earlier today we issued our preliminary second-quarter 2013 earnings release and we announced an initiative to sell approximately 425 company-operated restaurants as part of our brand transformation to further enhance our earnings quality, help optimize our restaurant portfolio, and to increase shareholder returns.

On our conference call today we will start with comments from our President and CEO, Emil Brolick, who will highlight these initiatives and provide an update on the progress we are making with the brand transformation.

Following that CFO Steve Hare will review our second-quarter financial results and our outlook.

And, finally, we will open up the line for questions.

Today's conference call and the webcast includes a PowerPoint presentation, and that is available on our Investor Relations page of our corporate website www.aboutWendys.com.

For those of you listening by phone today, please make sure to select the appropriate webcast player option from our website to ensure that you can view the slides.

Before we begin I would like to refer you for just a minute to the safe harbor statement that is attached to today's release.

Certain information that we may discuss today 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 referenced in the Safe Harbor statement that is attached to the news release.

Also, some of the comments today will reference non-GAAP financial measures such as adjusted EBITDA and adjusted earnings per share.

Investors should refer to our reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measure.

And with that I would like to turn the call over to Emil.

Thank you, John, and good morning, everyone.

We're making considerable progress with our brand transformation as a result of a number of initiatives which we want to discuss with you today.

These initiatives have put the Wendy's brand in an outstanding position for the future.

For example, as we saw in the first quarter, the investments and key actions that we took in 2012 continue to pave the way for a successful 2013.

These actions include significant progress with Image Activation, the decision to remove breakfast from certain restaurants, ongoing improvement in restaurant operating efficiency, and reductions in G&A expenses.

As a result, we delivered strong second-quarter earnings.

We also continue to make excellent progress in virtually all dimensions of our brand transformation, which has led to today's announcement of a new phase of our transformation -- the decision to sell about 425 company restaurants.

We believe this initiative will yield multiple benefits, including higher free cash flow and further enhancements of our earnings quality, by increasing the percent of rent and royalty revenue and providing more predictable earnings stream.

Also, despite the reduction in sales from the disposition of company restaurants, we believe that we can maintain the absolute level of adjusted EBITDA and our outlook for high single-digit to low double-digit adjusted EBITDA growth.

Additionally, we will drive accelerated adjusted EPS growth.

Finally, due to the continued benefits from our 2012 initiatives, strong first-half earnings, and our brand transformation, I want to share that we are trending toward the high end of the range of our outlook for 2013 adjusted EBITDA and adjusted EPS.

Let's take a closer look at each one of these points.

We delivered adjusted EBITDA of $102.1 million in the second quarter, a 15% increase.

Adjusted EPS increased 60% to $0.08.

Company-operated restaurant margin improved 260 basis points to 16.7% due to a number of initiatives that we started in 2012 and have been executing over the past several quarters.

While second-quarter same-restaurant sales were only slightly positive, we produced two-year systemwide same-restaurant sales growth of 3.6%.

We did see solid consumer response to the April introduction of our new Flatbread Grilled Chicken sandwiches, although the price value component of our business largely offset this positive response.

As we mentioned last quarter, we are adding additional media support for the price value component of our menu to address the loss of share in price value.

We have already begun to see the benefit of this shift and we expect to see continued benefit through the remainder of the year.

Steve will review more details throughout the quarter in a few moments.

We have begun the third quarter with a very positive catalyst to kick off the second half of the year, the Pretzel Bacon Cheeseburger, which is one of our most highly anticipated product launches in recent history.

This product clearly delivers on our Cut Above brand positioning, offering new QSR quality at a QSR price.

Pretzel Bacon Cheeseburger advertising began on July 7 and early results are meeting the high expectations we have for this product.

With the expected performance of Pretzel Bacon Cheeseburger, along with a strong marketing calendar for the remainder of 2013, we believe that we can achieve our 2013 same-restaurant sales guidance of 2% to 3%.

To support Pretzel Bacon Cheeseburger launch we engaged in an innovative public relations and social media campaign targeting Millennials, which has already resulted in more than 1 billion consumer impressions and we are still counting.

This slide highlights some of the media coverage we have received.

I also encourage you to visit the Wendy's website to gain a full appreciation for the important role digital media is now playing in our marketing mix.

As John mentioned earlier today, we announced an initiative to sell approximately 425 company restaurants as an important next step in our brand transformation.

We expect system optimization to further enhance earnings quality, expand participation in Image Activation, improve margin, reduce capital requirements, and increase shareholder returns.

This initiative is an important new dimension of our brand transformation, which to date has included reimaging and developing new restaurants, a contemporized Wendy's logo, updated menu boards, innovative products such as the Pretzel Bacon Cheeseburger and Grilled Chicken Flatbread, and bold new packaging.

These initiatives have been instrumental in positioning Wendy's for accelerated sales growth and introducing strong first-half results.

Consistently growing North American same-restaurant sales continues to be the foundation of our growth strategy.

Additionally, we will demonstrate how system optimization will be fundamental to further enhancing shareholder value.

We believe that we can deliver growth and income to our shareholders.

Importantly, system optimization will also help create a growth opportunity for the Wendy's brand and for strong franchise operators by expanding participation in our Image Activation program.

We also expect system optimization to drive new restaurant development while improving ROIC.

Here is a high-level look at our plans to optimize restaurant portfolio, financial performance, and shareholder returns.

We plan to concentrate our company restaurant ownership geographically and reduce total system ownership from 22% to approximately 15% with the sale of about 425 company restaurants.

We believe that this will help improve our restaurant margin by 50 basis points or more.

The sale of restaurants has already begun and will continue in the coming quarters.

We expect to complete the sale of restaurants by the end of the second quarter of 2014.

We intend to prioritize the sale of restaurants to successful, well-capitalized franchisees with a demonstrated history of operational excellence and a stated commitment to Image Activation and new restaurant development, amongst other criteria.

As part of our system optimization initiative, we recently completed the sale of 24 Wendy's restaurants in Kansas City market to NPC, the largest franchisee in the Pizza Hut system with more than 1,200 restaurants.

NPC recently signed an agreement to acquire an additional 13 Wendy's restaurants in Kansas City from an existing franchisee.

We also sold five restaurants in Kansas City market to a long time Wendy's franchisee who now owns 26 restaurants.

As stated, we expect to improve our financial performance as a result of the system optimization initiative.

More specifically, we believe the following benefits will offset the decrease in sales resulting from the disposition of the 425 company restaurants.

Reduced annualized general and administrative expenses of approximately $30 million by the end of the second quarter of 2014 when compared to 2012 G&A.

Improve company restaurant operating margin by 50 basis points or more due to a focused concentration on more profitable restaurants.

Higher cash flow due to the expected increase in rent and royalty revenue, lower ongoing capital expenditures, and proceeds from the sale of restaurants.

Lower annualized depreciation expense of approximately $30 million, due primarily to the expected reduction in company-operated restaurants by the end of the second quarter in 2014.

And improved return on invested capital.

Due to the expected benefits from our system optimization initiative, we now believe that we will generate a long-term adjusted earnings per share growth rate in the mid-teens beginning in 2014 compared to our previous guidance of high single-digit to low double-digit growth.

Despite the expected reduction in sales and EBITDA from the disposition of the 425 company restaurants, we believe that we can maintain the absolute level of adjusted EBITDA and our outlook of high single-digit to low double-digit growth due to the higher royalty and brand, as well as field and Restaurant Support Center efficiencies that we expect will reduce G&A expenses by approximately $30 million.

The end result, we believe, will be an enhanced quality of earnings with lower risk from a more predictable revenue stream with higher royalty and rent income.

In addition, system optimization further enhances our ability to drive organic growth by broadening franchise participation in Image Activation and new restaurant development while driving sales growth.

We also believe system optimization creates the opportunity for regular dividend growth and share repurchases.

Our goal is to annually review our dividend rate with our Board and consider potential increases as long as we continue to achieve our long-term earnings growth plan.

Lastly, before I turn it over to Steve Hare, I want to acknowledge that this will be Steve's last call as Wendy's Chief Financial Officer.

Steve is one of the true gentlemen in the business, a person of tremendous character, and an invaluable partner to me, the Board, and the Wendy's system.

Steve, all the best and it is all yours.

Thank you, Emil, and I will start with a review of our financial results.

North America company-operated same-restaurant sales were 0.4% in the second quarter, including the benefit of Image Activation.

Same-restaurant sales were negatively impacted by more than 1% from the removal of breakfast at certain restaurants in 2012.

We also reported a strong 260 basis point improvement in restaurant margin due to a favorable sales mix, improved management of restaurant labor, reductions in breakfast advertising, as well as lower paper and beverage costs.

Partly offsetting these benefits was an increase in commodity costs of 80 basis points.

Now let's take a look at a financial summary for the second quarter.

Total revenue increased $4.7 million, or 0.7%, versus the prior year.

The same-restaurant sales increase and incremental sales from a higher year-over-year net number of company-operated restaurants were the primary drivers of the revenue increase.

As Emil mentioned, we are seeing the benefit of decisions we made in 2012 in our 2013 results.

Adjusted EBITDA of $102.1 million increased approximately 15% compared to the second quarter of 2012 and adjusted EPS increased 60% to $0.08 per share.

Overall, this was another strong quarter and we are very pleased with the momentum we have seen with the profitability of the business for the year-to-date.

Now let's take a look at adjusted income and special items.

Adjusted income was $31.8 million, or $0.08 per share, for the second quarter of 2013 compared to $19.2 million, or $0.05 per share, in 2012.

Adjusted income for the second quarter excludes after-tax charges of $13.1 million from the early extinguishment of debt and $4 million primarily from the system optimization initiative.

Adjusted income also excludes $2.7 million from depreciation of assets that will be replaced as part of the Image Activation initiative.

As you may recall, last quarter we explained that we expect this Image Activation depreciation charge to sequentially decline throughout 2013.

Wendy's reported net income for the second quarter 2013 was $12.2 million, or $0.03 per share, compared to a $5.5 million loss, or $0.01 per share loss, in 2012.

Now let's look at a few selected balance sheet items.

Cash balances increased to $489 million compared to $454 million at the end of fiscal 2012.

At the end of the second quarter total debt was approximately $1.5 billion and net debt was about $1 billion.

Based upon our trailing 12-month adjusted EBITDA, our current net debt multiple is 2.7 times.

As of June 30 we will reclassify our 6.2% 2014 notes from long-term to short-term debt to reflect the June 2014 maturity date.

We are currently evaluating market opportunities to refinance those notes.

Now let's look at our 2013 outlook.

As Emil mentioned, we are reaffirming our 2013 outlook for adjusted EBITDA and adjusted earnings per share and now believe we will be at the high end of both ranges.

We are confident in our outlook because we produced strong first-half adjusted EBITDA of $179.4 million, an increase of 17% versus 2012, and adjusted EPS of $0.11 versus $0.06 last year.

We expect to generate ongoing margin improvement from many of the initiatives implemented last year.

These include the expansion of our Image Activation reimaging program, the implementation of our Right Price, Right Size value menu, the reduction in the number of restaurants serving breakfast, and multiple cost reduction initiatives.

Included in this outlook is same-restaurant sales growth of 2% to 3%.

This includes year-to-date same-restaurant sales of 0.7%, along with the expectation of stronger same-restaurant sales in the third and fourth quarters.

As Emil mentioned, we are happy with the early results we are seeing from the Pretzel Bacon Cheeseburger and we will begin to lap the discontinuation of breakfast in certain markets later in the year.

Our year-to-date restaurant margin is 14.7% and we are trending toward the high end of our guidance for the year due to ongoing operating efficiencies and potential favorability in our commodity forecast.

Franchisees have applied to reimage nearly 150 restaurants under the Image Activation program.

Approximately 100 of those restaurants are currently in various stages of active process.

We believe most of the 100 restaurants now in process will be open or under construction by the end of 2013.

As we have previously stated, we expect to incur about $10 million in incremental year-over-year G&A expense in the fourth quarter associated with the incentive program.

As a result, we believe year-over-year fourth-quarter adjusted EBITDA could decline by more than 10%.

We are committed to deploying capital to drive the organic growth of our restaurant business in addition to returning cash to shareholders.

In connection with the announcement of the system optimization initiative, our Board of Directors authorized a 25% increase in the quarterly cash dividend rate from $0.04 to $0.05 per share.

This increase will be effective with the next quarterly cash dividend, which is payable September 17 to shareholders of record as of September 3. And to reiterate Emil's earlier statement, our goal is to annually review our dividend rate with our Board and consider potential increases as long as we continue to achieve our long-term earnings growth plan.

During the fourth quarter of 2012 the Board authorized a share repurchase program for up to $100 million of our common stock through December 29, 2013.

We did not repurchase any shares during the fourth quarter of 2012 or the first half of 2013, but we intend to begin repurchasing shares in the third quarter.

Due to the expected benefits from our system optimization initiative, we now believe we will generate a long-term adjusted earnings per share growth rate in the mid-teens beginning in 2014 compared to our previous guidance of high single-digit to low double-digit growth.

We also reaffirmed our long-term adjusted EBITDA outlook of high single-digit to low double-digit growth.

Now I will turn the call back to John Barker.

Thanks, Steve.

Before we open up the phone line for questions, I would like to just take a minute to go over some upcoming events on our calendar, investor relations calendar.

As we noted in the release, we do plan to file a Form 10-Q on August 7, so mark that down and watch for that Q which will have all of our financial filings.

On August 15 we will host a reception in New York for sell-side analysts who are currently covering Wendy's.

This will be a chance to meet our new CFO, Todd Penegor, who is also with us here today.

We will be sending out invitations to this event in the next few days, so mark your calendars and certainly hope to see you there.

This summer we have introduced a new layer of our investor relations outreach with Image Activation restaurant tours in select markets.

We have been doing those earlier this year and our next visits will be in Philadelphia, New York, and Dublin.

And those will be in September, October, and November.

You see those dates on the slide.

Please work with the appropriate sell-side analyst if you are interested in attending one of those.

And, lastly, for our next reporting period that is scheduled for November 7. We will release earnings for the third quarter 2013 at that time.

Also before we open up the line for questions, just as a reminder, later today Steve and David Poplar and myself and Todd will be available as we talk to the sell-side analysts follow-up after this.

Brandi, we are now ready to open up the line for questions if you can give instructions for that.

(Operator Instructions) Joseph Buckley, Bank of America Merrill Lynch.

Thank you.

Can I just ask a couple of questions on the re-franchising announcement?

It is unusual that you would re-franchise units and adjusted EBITDA would be maintained, so can you fill that out for us?

What are the margins at the restaurants to be sold?

Are they unusually low?

And are you expecting to collect both rent and royalties?

I have a couple of others, but I maybe I will through one in, too.

Are you getting remodel commitments as you sell those restaurants?

Is that part of the deal?

Joe, this is Steve.

Let me walk through that a little bit with you.

The selection process -- when we went through to identify re-franchising candidates, we did an analysis of our entire company-operated system and we did identify, as Emil mentioned, stores that ended up being primarily in the West region.

As we look at the financial characteristics of those restaurants, they tend to be our lower operating margin restaurants.

In addition, as we look to sell these markets we are, as a target, going to retain the real estate as part of these transactions.

So there would be -- when you think about the pro forma EBITDA of these going forward, there would be, for us, a rental stream of income on these fee-owned properties, the new royalty as they convert from company to franchise operations.

And then as Emil has mentioned, we are also looking at right-sizing the organization so there is a G&A decrease.

Really those three components, as we have looked at it, we think will largely offset the immediate reduction of EBITDA generated by the company-operated units.

Okay, and (multiple speakers)

I will mention, Joe, that we -- just to reinforce that.

There is about $20 million of that G&A that is in the field and then about $10 million here at the corporate RIC.

We have a very clear line of sight on how to accomplish the $30 million.

Okay.

And then will you get remodel commitments, reimage commitments on the deals?

Yes, we will.

Then one last one.

Why is the growth rate -- how does the growth rate accelerate from this?

Can you just outline how do you get to a mid-teens growth rate driven by this deal?

Driven by this strategic move, I should say.

Joe, I think it is a combination of profitability of the remaining restaurants that we think we have got the potential, especially with a more focused market in terms of our company operations that we think we will be able to manage even more efficiently going forward.

You also have the impact as we generate cash proceeds from the sale of the restaurants, as we look ahead to the ability to buy back shares.

We think that is an element.

And so when we combine the flexibility created by the optimization program, we do think that we will be able to sustain a higher growth rate at the earnings per share level.

Also understand we lose a fair amount of depreciation as we sell these restaurants to help our overall reported profitability.

Okay, thank you.

Jeff Farmer, Wells Fargo.

Great.

Good morning.

You did touch on this, but could you shed some additional light on our confidence in delivering material same-store sales growth in the back half of the year per your guidance?

And what, if anything, can you tell us about quarter-to-date trends, especially in light of all the publicity the bacon cheeseburger is getting?

Sure, Jeff, this is Emil.

As you know, Jeff, we don't give specific guidance on performance on an individual period basis.

But as we look at the performance of Pretzel Bacon Cheeseburger and as we know what our marketing calendar is going to be for the remainder of the year that gives us confidence that we can get within that 2% to 3% same-restaurant sales guidance.

Okay.

And then just one other quick one.

You have acknowledge that -- it sounded like you lost some share in the price value arena on last couple of quarters.

What did that look like in the second quarter for you?

We did acknowledge that we lost some share.

What we have seen with some of the changes we have made in terms of putting some incremental media dollars against price value messages is we have begun to bend the trend in reducing that share loss and getting centered in a more positive direction.

And I would anticipate that we are going to continue to make progress in that area.

Philosophically, the other thing I mentioned, Jeff, in the first-quarter call is we had been looking at price value as kind of a pillar message.

We have moved away from that and now price value is part of a layer message.

In other words, we are always going to have a higher-end message, think about it is a top layer, and then underneath that on an ongoing basis we are going to have price value messages in the marketplace.

What we increasingly realize is just in an environment where many of the large competitors out there have price value messages on an ongoing basis that you simply can't afford to step out of the marketplace, because some of the price value customers are just very sensitive to the economics that they face in their life.

You have to give them a price value offering if you are going to get them to come to your restaurants significantly.

So we think this layered approach is really smart and it is going to pay dividends over time.

Thank you.

Will Slabaugh, Stephens Inc.

I wonder if you could give us an update on how company reimage stores have been trending recently.

Then also any update on any sort of conversations you have had with franchisees about signing up for the reimage process.

Sure.

We continue to see very strong performance in the sales of our reimage restaurants, so we have only seen things that give us more and more encouragement all the time on the strength of those.

I think, as we mentioned, we have -- in our release -- we have I think 150 franchisees in various stages of commitment on Image Activation.

By the end of this year we will have 100 franchise restaurants image activated or under construction to get to that 100 number.

When you think about the fact that we only did, I think, two franchise restaurants last year, we basically came from a dead stop to running 100 miles an hour in a very short period of time.

So there is a lot of support for it.

As we have shared, we continue to work to constantly taken investment costs out of the Image Activation at restaurants and so we are never going to stop that effort.

So I would say they are quite enthusiastic about it.

Great.

One just quick follow-up, if I may.

Could you give us any sort of guidance on the cadence of selling those 425 stores over the next four quarters?

Yes, you know, it is hard to exactly predict that, first of all.

We do expect there to be a lot of interest in this and we have engaged what I will call a boutique investment banking firm to assist us in this process, a third party to make this go as efficiently as possible.

This is somebody that has extensive interest -- experience in the quick-serve restaurant industry, so they are going to add a lot of value to this process.

I would actually hope that we have most of this done by the end of the first quarter of next year, but I am eternally optimistic about that.

Great, thank you.

Michael Kelter, Goldman Sachs.

Thanks.

I guess first off, in the selling of the 425 restaurants is this a discrete one-off transaction that you are going to put to bed next year and move on, or is this possibly on the path towards 95% or more franchise model in the future?

Michael, for right now, as Steve mentioned, we went through a very exhaustive detailed review of our system and how to grow this -- grow our brand, gross sales, and grow profits.

Right now this is a step we are going to take and we think strategically it makes a lot of sense.

It also leaves us with an ownership position that provides us the opportunity to be tremendous leaders in Image Activation and all the strategic initiatives that we have going.

So we think that, as I mentioned in my comments, we are going to be able to show great growth in our system as well as provide income to our shareholders at the same time.

So we think it is the right path for the Wendy's brand at this time.

Well, I'm not sure understood though.

Does that mean that this is a one-off and these are the ones you went through and these are the ones you're going to sell?

Or you are still thinking about what makes sense after this and you might re-franchise more in the future?

I certainly wouldn't characterize this is a one-off, Michael, because again we went through a very extensive thought process on this.

So we are very diligent about it.

It wasn't any kind of a sporadic reaction to anything.

Do you look at other things in the future?

Sure, that is, of course, a possibility.

But I'm saying for right now we are talking about about 425 restaurants.

Then just wanted to follow-up on the question earlier about taking up the out-year EPS growth target, because I guess, similar to the question earlier, I wasn't sure how you were getting there.

And so I thought maybe perhaps it would be helpful to get some sort of a directional bridge about what things will look like in the future, the contribution to the mid-teens earnings growth from same-store sales versus unit growth versus margin expansion versus cash deployment.

Which are the biggest buckets, which are going to be the key drivers, and what has changed versus maybe your prior assumption?

Yes, Michael, I think that as we look at it going forward, I mean the key is sort of that beginning balance that we had talked about.

So we think that what we are focusing on going forward is a more efficient set of 1,000 company restaurants in fewer markets that we think we will be able to manage more effectively, both cost effectively but also from a marketing standpoint.

We think we will be more effective in markets where we have larger share of the market.

And we think that can lead to slightly better growth and certainly better profit margins for us going forward.

I think the other elements of this I think would be that with the commitments that we are asking for around new unit development, more accelerated Image Activation that will help to drive franchisee revenues and our participation on the royalty side.

So as a result, when we put our modeling together for the future we are able to, as we said, not see a reduction in the absolute level, but actually see a slight acceleration going forward.

And the last element of that, when you start looking at it on a per-share basis, is the ability we have to continue to look at and evaluate stock buybacks as a way to also produce accelerated growth.

Then lastly, in light of the re-franchising, does it change your view of what the optimal capital structure is for Wendy's?

Might you take up leverage given that, as you said, you do have more stable free cash flow streams in the future?

We have not -- at this point we have not looked at increasing the debt levels overall.

I think when we look at our capital structure right now we have significant financial flexibility.

Obviously, generating some proceeds from the optimization program will give us additional liquidity.

And that is really the significant part of the decision making we have gone through and our comfort level, along with the Board, to increase our dividend payout on an immediate basis and to begin to execute under our stock buyback program going forward.

So I think that is all independent of looking at the capital structure.

The only element of the capital structure we have of immediate interest I think is our 2014 notes, as I mentioned, that we are currently looking at refinancing opportunities given the strength of the capital markets.

Thank you very much.

Jeffrey Bernstein, Barclays.

Good morning.

Thank you very much.

Couple of questions, just first on the optimization.

Obviously it sounds like you haven't signed on the dotted line for these 425 units, but any ballpark estimate as to your thought process on the selling price?

Whether it be multiples of recent sales you have done or how you think about whether it would seem prudent to even discount a little bit if, again, these franchisees promised not only to remodel the ones they are buying but to remodel their own if they're existing franchisees?

So any color you can give on the price or whether GE might help finance, and/or if you would be willing to give a discount to kind of accelerate the Image Activation.

Then I had a follow-up.

Jeff, I think we sort of conceptually look at Image Activation in a different light.

I think we see that as a significant opportunity to actually generate attractive return on investment on that incremental capital that a franchisee could put into play.

That is why we are working so hard on the Image Activation company restaurants to be able to prove and have a track record that shows there is a very attractive return on that incremental investment.

So rather than argue for a discount, I would say it is an attractive part of why growth-oriented franchisees will want to buy these company markets.

So I view that as a positive, not a discount factor.

From an overall valuation, as I said, a rule of thumb in a lot of QSR concepts, but especially in Wendy's, is something in that 5 to 6 times EBITDA has generally been a transfer valuation multiple point on EBITDA.

But remember now, as we talked about in the beginning, is that the EBITDA that the franchisee will be buying will have the royalty, will have a rent factor for the fee-owned properties that we will retain.

Then they will have to, depending on the buyer, see how much they can leverage their G&A in the process.

The idea being that as existing franchisee would you require that they remodel their existing along with the 425 they are taking from you?

I think that is certainly momentum that we have independent of this process.

But again I think my view is that the more that our franchisees begin to participate in Image Activation it will spread across not only the restaurants that they are buying, but I think it will help to accelerate the process for their existing portfolio.

I will remind people that we have indicated that at some date, which we have not set that date yet, that we will stipulate that Image Activation is a requirement for renewals and rebuilds and new restaurants as well as transfers.

And so there is that other dimension that is going to come into play here, too.

Then just on that Image Activation front, I know initially it was all about Tier 1 and it got a lot of publicity around the $750,000 cost.

Can you just update us?

It seems like the message more recently is Tier 2 and Tier 3 have become the new Tier 1. So in terms of the cost, you are confident you can get it down to that $550,000?

I know that is what you are working towards.

And then on the sales --?

Jeff, I think what is going to happen, in all honesty, is the nomenclature of tiers is really going to disappear and within the system that has already begun to happen.

And only because we are getting strong sales results in the Tier 2s and Tier 3s that we have opened.

So we are going to continue to work the number down and I think we can get into that $550,000.

Quite honestly, our goal was to continue working to get it below that if we can.

The message we continue to send to the franchise system is our goal is to seek the optimum of minimum capital input, maximum sales, and maximum EBITDA.

I don't think we have [quite hit] that sweet spot, but we are certainly moving strongly toward that direction.

Got it.

Then just lastly on the new product pipeline and I guess the pretzel fits within there, but it sounds like the new product pipeline is more robust than it has been.

I'm just wondering whether you still see the pace of rollout at the same level we have done in the past, or now having done the flatbread last quarter, the pretzel this quarter, should we expect some sort of an uptick if the pipeline is better?

We are pleased with the pipeline, but as I shared in the first quarter I think we still have opportunity to take that to the next level.

Having said that I feel quite good about where we are on the calendar for the remainder of the year.

And as you would expect, looking down the road we have also begun to lay out a hypothetical calendar for next year and particularly the first quarter.

And I think that there is some very exciting ideas that are in that calendar as well.

Great.

Thank you very much.

Michael Gallo, C.L. King.

Good morning and congratulations on the improved results.

I guess a couple of questions.

When you look at the 425 units you are planning to re-franchise, do you already have kind of a pipeline building to buy those units or it is still kind of you decided you wanted sell these units and the expectation is you will build that pipeline?

Where do you stand in terms of stages of interest there?

Michael, we have started some work.

As Emil had mentioned, the NPC transaction in the Kansas City market is an early stage.

And we do have a couple of markets that we have been working, but really this announcement is really the starting point for the bulk of the 425.

So as we go forward you should think about that most of these markets will be sort of -- day one we will start to provide information to interested parties.

And that is really be basis for our projection that we should be able to get this done sometime early in 2014.

Okay, great.

Then on just the expected CapEx reduction, Steve.

I mean is it fair to assume on a maintenance basis the D&A reduction would be kind of the ongoing CapEx reduction but then also obviously the cost?

I assume these were units for the most part you would have plan to image activate at some point.

So how much do you expect the capital needs to -- the CapEx to decline?

Michael, that is the way to look at it I think is immediately we will get the benefit of the capital reduction in terms of our ongoing normal maintenance CapEx just because of the number of units being lower.

But then long term I think the capital intensity of the business does come down since there are fewer restaurants on the Company side that we would fund the Image Activation.

Now we still want those units to be image activated and that is why we will be working with the potential buyers of these markets to make a commitment so that they get done.

And we think actually having more people involved in Image Activation will broaden the participation and, hopefully, keep us on a nice accelerated path there.

John Glass, Morgan Stanley.

Good morning.

First, just a couple of follow-up questions.

Are the 450 that you are going to sell, do they all have owned property?

Are those all going to be rental models or just a portion of those?

It is just a portion of those, John.

We own about 650 of the 1,400, so it will be market by market in terms of where the fee properties are.

Okay, thank you.

Then, Emil, just on the reimaging you talked last quarter about specific lifts you are getting in Tier 1 and you talked about some early experiences in Tier 2. Can you just frame out how the Tier 1s have done from a sales lift perspective as they age, and then also what your experience specifically is on the Tier 2 and Tier 3s that you have open so far?

John, on the Tier 1s we still feel that we are looking at that 20% as sustainable, but I think -- obviously we are very early on in the Tiers 2 and 3s, but I think thinking about the high teens is something that is probably a good target.

Jason West, Deutsche Bank.

Thanks.

In terms of the Image Activation commitments for 2014, I think in the past you guys had said, I believe -- actually I don't remember exactly what the guidance -- just give us an update on where the guidance is now, where you think franchise with activations and company Image Activations will be for next year?

Yes, I think the numbers that we have had in the past are [200] and [200].

Because of this transition that we are going through on the 425 restaurants, it is reasonable to think that we might continue to work on Image Activation in these markets.

And so I think that it is probably smartest to just focus on the combined number of the [400] and aspirationally we are still shooting for that kind of number.

Can it be divided slightly differently?

That is certainly possible.

But we are in the process of retesting this and looking at this, but believe me throughout this whole process, and even for the company, our number one use of capital is still going to be Image Activation.

So we remain very, very focused on this.

Okay, that is helpful.

Can you remind us what the royalty rate and the rental rate would look like for a transaction like this after the franchisee buys the unit, sort of what those percentages would be?

Our royalty rate, Jason, is 4%.

And then the rent, I would say as a rule of thumb think of a rent factor in the 7% range would be average.

There will be some -- we need to fit that rent to the specific restaurant itself, but 7% would be what we would view as a market interest rate -- market rent factor.

Chris O'Cull, KeyBanc.

Steve, the stores sold to NPC appear to have system average volumes and I think you guys sold them for roughly $450,000 each.

It seems like they were sold well below the 5 to 6 times EBITDA.

Did these stores have a significant rent factor?

Yes, Chris, that is the analysis you need to go through.

It is a little hard using that per restaurant metric.

You really need to get down to what the EBITDA after we factor in royalties and rents, and then from a franchisee standpoint sort of looking at what kind of incremental G&A factor there might be there.

So when we get to it, again, we are still getting the multiple of EBITDA that we are looking for.

But you are right; if the market has a higher proportion of rent then the per restaurant sale price, since these all exclude real estate, will be lower than you might see in other situations.

So the 5 to 6 times EBITDA is the franchisee's EBITDA?

Yes.

That is what they are -- generally when we look at how restaurants move across our system it is a 5 to 6 of what the franchisee actually generates in terms of EBITDA.

That is a good rule of thumb.

And the rent that we are talking about for the stores that are re-franchised, are you renting to them the land and the building?

And if you lease the land, will you sublease the land to the franchisee?

Yes.

Okay, great.

Keith Siegner, Credit Suisse.

Thanks, Steve.

Just a question on the margins.

Obviously, I understand that 2012 initiatives are kicking in to some extent, but on a relatively flattish comp to get this type of margin expansion all of a sudden is pretty impressive.

Is there anything one time that happen to the margins, or is there anything really to call out in subcomponents that we won't get till the 10-Q?

Then, as an offshoot, when you talk about the 50 basis points lift to company restaurant margins with this 425 units sold, off of what base is that?

Is that off run rate for where you think things are now or is that off 2012?

Thanks.

Yes, when you look at the margin I think where -- the one element that I would say is a little bit of both when you think of it as one-time would be the benefit we are getting from pulling back on breakfast advertising.

Because of the smaller number of restaurants serving breakfast after our decision in 2012, we have been able to reduce the breakfast advertising.

Because, if you remember, we were actually providing that support across the system.

So we have been able to pull back that and so you are seeing the benefit of that in the margin itself.

But beyond that I think you are seeing positive influence of the Image Activation on the program and a margin benefit, notwithstanding the fact that value sales are being challenged in this marketplace, though the margin side of the equation has helped us in terms of year-over-year comparisons.

Beyond that then we are looking at some focus on cost reduction initiatives.

We have done some good things on the packaging side of our business that have been helpful.

So I would say it is a combination of operational efficiencies that we are bringing to the table.

You are obviously seeing commodities come in slightly below our expectations from a range of commodity costs in the second quarter.

Phillip Juhan, BMO Capital Markets.

Thanks, guys.

As we look back through recent history and we look at portfolios sales from concepts with similar UVs, similar margins, and we see cash proceeds on a per store basis of about $500,000 depending on the concept, implying maybe over $200 million of aggregate gross proceeds if we sort of apply that to your re-franchising opportunity, can you give us a sense as to what your expectations may be in terms of aggregate gross proceeds for this portfolio?

The way we look at it, again, as I said, average proceeds per restaurant is a little problematic in terms of extending that across the 425.

What I am probably more comfortable with is that I do believe sort of that 4 to 5 to 6 times multiple of the EBITDA that the franchisee is likely to be able to sustain going forward that would be the basis of our estimates for proceeds going forward.

We have not put that number out there, but I would say that the number that you are suggesting on a per restaurant basis, that $200 million, that does sound a little aggressive overall.

Keeping in mind in the context of we are asking our buyers to make a commitment around Image Activation that could be a fairly substantial amount of capital going forward.

A new unit development agreement, if appropriate, in the marketplace as well.

And also absorbing, for example, to the extent that we have Image Activation already underway, sort of picking up the cost of those units that are in progress.

So it is a little difficult to use averages and we will have to look at it really market by market, but something less than that target I think would be more realistic for us.

Thanks, Steve.

Just one more housekeeping question, and if I have missed this I apologize.

But are you able to provide us with a detailed cost of sales by line item -- food and paper, actual dollars, restaurant labor, and occupancy/other?

You get the breakout in our 10-Q.

Which will be filed in a couple of weeks?

Yes, so you will get that in a couple weeks.

Nick Setyan, Wedbush Securities.

Thanks.

The pretzel burger really does feel like a Cut Above and I really wanted to ask sort of a bigger strategic question around your pipeline.

What have you done that is different than the way you used to approach that previously that should give us a little bit more confidence that going forward that pipeline is going to produce these types of compelling sort of LTOs that could potentially drive comps in a more sustainable fashion going forward?

Sure.

First of all, I think there is one very important factor here and it is called brand Wendy's.

This is a brand that, as I have shared in the past, I believe has a lot of latent brand equities.

Part of that equity is a heritage of product innovation.

I do believe that people give us credit for having higher ingredient quality and fresh, never frozen North American beef.

Characteristics like that that are unique to our brand.

Then when you look at our operating system, I will tell you it is not easy handling things like Pretzel Bacon Cheeseburgers in the back of the house.

When you think about the build of that sandwich you have got natural cheddar cheese, a very, very high quality natural cheddar cheese.

You got cheddar cheese sauce.

You actually have a smokey honey mustard that is specifically brought in for this.

You have a bacon that is extremely hard to find out there.

It's a center cut bacon.

And you put all of these things together, you put this on a spring mix and not just leaf lettuce.

You put all of these things together; we are used to custom building sandwiches and building sandwiches to order.

I would say you would be hard pressed to find this other than going to a quick casual restaurant.

And that is why I go back to this fundamental position that we have taken that, first of all, we are not going to just get caught up in trying to play the same game better.

We are going to play a different game, and that game is providing new QSR quality at a QSR price.

And I think that that is extremely compelling proposition.

There are a lot of people that can afford to go to quick casual restaurants, but there is many, many, many more that cannot afford or certainly not afford to go on a consistent basis.

So when you can give them Pretzel Bacon Cheeseburger quality products at a QSR price we think that is a heck of a proposition and you are going to see more of it.

John Ivankoe, JPMorgan.

Great.

Just a couple of follow-ups, if I may.

In terms of at leases, I think I saw franchisee closures more than franchisee openings for this year.

When do you expect that to stop and to see net growth in the franchise community?

John, I think we are seeing some of the higher closures, as we have talked about in the past, is somewhat related to Image Activation.

As people, I think, are looking at their portfolio of restaurants and trying to identify those candidates those candidates that qualify for Image Activation that will produce an attractive return on that incremental investment.

Maybe looking at some of their lower AUV stores and then having conversations with us about if we close the lower AUVs then we can accelerate our Image Activation of the stronger restaurants or ones in very good trade areas.

And we are willing to support them in that kind of decision making.

So I think that kind of higher pace of closures will continue into next year and maybe at that point I think you would start to see it abate.

Okay.

I think you have articulated before that there would be over 500 company Image Activations by the end of fiscal 2015.

Does the major re-franchising change that thinking?

And certainly in the context of kind of reducing the CapEx, I would assume that reducing the CapEx would also reduce the number of company Image Activations you do, but maybe you can correct that.

We are still going to be very aggressive about pushing on the company Image Activation because again we still feel that we need to take a leadership role in that.

Remember this by itself is a motivation, because with our restaurants even being more concentrated as we image activate in markets what we clearly see is that it is a motivation for everybody in that market to take their game up and image activate as well.

The magnitude of the consumer response that we are getting to these restaurants I think by itself is an economic motivation.

So we are going to continue to be very aggressive about Image Activation.

Brandi, this is John Barker.

It is almost the top of the hour.

We will take one more question and close out the call.

Mitch Speiser, Buckingham Research.

Great, thanks very much.

Of the 425 stores you plan to re-franchise, how many deals do you think it will take to get done?

Are you looking for big chunks to be sold?

Just any framework around that would be helpful.

Mitch, we will be flexible in terms of our approach there, but in general we think it would make most sense from an efficiency standpoint if we could do those transactions market by market.

So if you look at it we have got I think it is about 13 markets identified.

And so ideally you would have maybe one very strong franchisee step up and take on the entire market.

Because I think from an efficiency standpoint, much like we are concentrating in terms of our markets for company restaurants, I think that might be the most efficient platform for our franchisee buyers.

Great.

Now, of course, you will sell these stores to franchisees.

You will ask them to image activate.

Do you plan any franchisee assistance or franchisee guarantees just given the level of capital commitment?

Not really contemplating that, Mitch, as we have thought about it.

I think the one element of support from a structural standpoint, as I mentioned before, was the idea that we would retain the real estate ownership.

So from a cost of a financing of the entire transaction that is an outlay that the buyer would not have to make.

I will now turn the floor back over to Mr. John Barker for any closing comments.

Thank you, everybody, for joining the call today.

As we mentioned, we will be available this afternoon.

We have a number of conference calls set up with analysts and look forward to talking to you then.

Of course, David and I are reachable any time the rest of the week.

Thank you very much.

Thank you.

That concludes today's conference.

You may now disconnect.