Wendy's Co (WEN) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Wendy's Company second-quarter 2015 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.

I will now turn the call over to David Poplar, Vice President of Investor Relations.

Please go ahead, Sir.

Thank you, and good morning, everyone.

Our conference call today will start with comments from our President and Chief Executive Officer, Emil Brolick, who will provide an update on the progress we are making on our brand transformation.

After Emil, our Chief Financial Officer, Todd Penegor, will review our second-quarter financial results and outlook.

After that, we will open up the line for questions.

Today's conference call and webcast include the PowerPoint presentation, which is available on the Investor section of our website, www.aboutwendys.com.

Before we begin, please take note of the Safe Harbor statement that appears at the end of our earnings release.

This disclosure reminds investors that certain information we may discuss today is forward-looking.

Various factors could affect our results and cause those results to differ materially from the projections set forth in our forward-looking statements.

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

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

And with that, I will now turn the call over to our President and Chief Executive Officer, Emil Brolick.

Thank you, David, and good morning, everyone.

I will share a few thoughts on our second-quarter performance, and then speak to the strategic underpinnings of our business that distinguish the Wendy's brand.

In the second quarter, North American system same restaurant sales increased 2.2% and company same restaurant sales were 2.4% or 6.3% on a two-year basis.

Our image activation initiative continues to produce solid results, as reimaged restaurants contributed 170 basis points to company-operated same restaurant sales.

We also realized a 40 basis point year-over-year improvement in restaurant operating margin to 18.2%.

Adjusted EBITDA from continuing operations was up 5.2% despite the ownership of 141 fewer company-operated restaurants, and our adjusted EBITDA margin increased 170 basis points to 21.3%.

These results demonstrate the higher quality of earnings that we are generating as a result of our system optimization initiative.

And, as part of our previously announced share repurchase authorization, we intend to enter into an accelerated share repurchase transaction for approximately $165 million in the very near future.

This is in addition to the $850 million share repurchase program that we recently completed.

Our second-quarter results reflect a more balanced approach to our marketing calendar as we indicated you would see.

We continue to see excellent results from our limited time offers, as the Spicy Jalapeno Fresco Chicken Sandwich and Ghost Pepper Fries worked well in combination.

The sandwich sold at a $0.60 premium to our core chicken sandwiches, and Ghost Pepper Fries sold at $1.99 in Company restaurants, offering consumers the compelling price point as a snack or add-on.

Our increased focus on core products has also helped emphasize our inherent brand equities -- freshness, and sandwiches made when ordered, and customer-prepared to each individual's taste, which are some of the qualities that differentiate Wendy's, and have been core equities since our founding in 1969.

In our balanced approach to marketing messages -- core, LTO, and price value -- we feel very good about our core and LTO messages, while price value still requires refinement.

Finding a consistent price value message that drives sales, customer counts and profits is our opportunity.

We know that our right price/right size menu alone is not a sufficient value proposition to consistently attract the contemporary value-seeking consumer, so we have been testing various value bundles, and we are gaining important insights moving us closer to a solution.

We expect to see this pay off later in the fourth quarter of this year.

The success of the recent promotions give us confidence that we are on track to find the right balance of core LTO and price value messages.

For example, we have seen strong results from this year's top fries promotion, while a value at $1.99, the total Ghost Pepper Fries average check was close to $10, and consumers often bundle the Fries with other value items or added them as an upgrade to a combo.

We saw similar results from a core product pillar in July, the Baconator and Baconator Fries promotion.

Overall, top fries have proven to be highly incremental to the Fry category and our total restaurant sales.

Also, our new premium beverages -- Honest Tropical Green Tea and FruiTea Chillers, continued the success we've seen with lemonade and strawberry lemonade by growing sales and units of our beverage category.

Signature beverage checks have been significantly more profitable than our total restaurant average check.

And we are seeing solid improvement in beverage incidents this year.

I spoke earlier about our brand equities, the qualities that make Wendy's unique and enable us to differentiate the Wendy's brand, and bring to life our cut-above brand position.

Chief among these is our heritage of food quality that began with our founder, Dave Thomas.

Since day one, Wendy's has stood for fresh, great-tasting food.

When Dave founded Wendy's, he wanted to serve hamburgers made fresh, never frozen -- with never-frozen beef, and wanted all sandwiches made fresh when customers order them.

Today, we partner with growers who share this commitment to fresh, quality ingredients, and take pride in their products.

This infrastructure and our system's commitment to fresh, great-tasting food are what makes seasonal promotions, such as our Strawberry Fields Salad, possible.

As part of our commitment to serving high-quality, freshly-prepared food, we have re-crafted the recipe for our grilled chicken sandwich to elevate its flavor profile.

The new grilled chicken sandwich, which is currently in test, features marinated grilled chicken with spring mix, tangy herb sauce, and toasted multigrain bun.

As part of this test, we are offering grilled chicken raised without antibiotics to determine our supply chain capability as well as customer appeal.

The strength of our core equities, our food innovation pipeline, and the evolution of our price value messaging, gives us confidence we can grow North American same restaurant sales consistent with delivering our goal of $2 million AUVs by 2020.

Growth will also come from continued investment in image activation and new restaurant development.

Both are testaments to the strong brand stewardship and commitment that our franchisees continue to demonstrate.

Along with new restaurant growth, consumer-facing technology is an important way that we are increasing Wendy's brand access.

We are investing in platforms such as mobile payments, mobile ordering, and customer self-order kiosks, which provide consumer convenience, the potential for a higher check, faster speed of service, and a seamless brand experience, along with the opportunity for increased customer counts.

North America will, for some time, be the core of our business.

However, international growth is a longer-term opportunity for us, and we expect to share our vision for global growth in early 2016 when we provide guidance for the next year.

Our system optimization initiative has played a strategically significant role in evolving Wendy's company economic model, and moving us to an expected 5% company restaurant ownership during 2016.

While strengthening the Wendy's system, another key benefit of our system optimization initiative is enhancing quality of earnings, producing a more stable earnings stream, and a more predictable free cash flow, all of which should be beneficial to creating shareholder value.

In 2017, the first full year after we expect to complete the third phase of system optimization, we anticipate that 80% of our earnings stream will come from royalty and rental income.

Going forward, we recognize that consistent, strong same restaurant sales, and new restaurant growth in North America and across the globe, will maximize the potential of this economic model.

In summary, we believe our strategic growth priorities have positioned us to continue to deliver value to our shareholders and franchisees.

Key to this is our brand heritage of quality and cut-above brand positioning, our strong company and restaurant economic models, system commitment to executing our recipe to win, and a highly dedicated franchise system of brand ambassadors.

As we look to the second half of the year, our upward revision of 2015 adjusted EBITDA and restaurant operating margin guidance, as well as the reaffirmation of our long-term outlook, underscores our confidence in the Wendy's business.

And now, here's Todd.

Thank you, Emil.

I'll start with financial highlights from the second quarter.

North American system same restaurant sales increased 2.2%.

We generated an increase in same restaurant sales of 2.4% or 6.3% on a two-year basis at company-operated restaurants.

North American company-operated restaurant margin was 18.2% in the second quarter of 2015 compared to 17.8%.

The 40 basis point increase was the result of higher same restaurant sales, favorable product mix and the positive impact from our image activation reimaging program.

General and administrative expense was $60.8 million in the second quarter of 2015 compared to $66.4 million.

The 8.4% decrease resulted primarily from cost savings related to our system optimization initiative, and resource realignment that we announced in late 2014.

Adjusted EBITDA from continuing operations was $104.3 million in the second quarter of 2015, a 5.2% increase compared to $99.1 million, despite the ownership of 141 fewer company-operated restaurants.

Adjusted EBITDA margin was 21.3% in the second quarter of 2015 compared to 19.6%.

The 170 basis point improvement reflects the positive impact of the second phase of our system optimization initiative.

And finally, adjusted earnings-per-share from continuing operations were $0.08 in the second quarter of 2015 compared to $0.09.

The 2015 results include $4.1 million in tax expense related to our recent debt refinancing.

Let's take a look at our adjusted EBITDA bridge for the quarter.

Remember that our comparable 2014 second-quarter results of $99.1 million exclude $1 million in pretax gains, primarily from the sale of restaurants, and about $4 million in bakery EBITDA, which we are now reporting as discontinued operations.

Off this base, we realized about $6 million in G&A savings, about $3 million in technical assistant fee increases, $2.5 million in benefits from image activation, and $1.5 million in core restaurant EBITDA growth.

Partly offsetting these benefits was nearly $7 million in lost EBITDA from the restaurants we sold during the Canadian system optimization initiative.

This year, we expect the Wendy's system to open 80 new restaurants, which will be the highest number in the past eight years.

The Wendy's system remains on target to hit our goal of 450 re-images this year.

This week, we achieved a major milestone when the Wendy's system opened its 1,000th image activation restaurant.

We remain on track with our goal to reimage at least 60% of our North American systemwide restaurants by the end of 2020.

We now have more insight into the comparable sales contribution from company-operated image activation restaurants for the third and fourth quarters due to a number of factors.

These factors include the timing and composition of the reimaged restaurants and the comparable sales base, and the impact of restaurants we expect to sell during system optimization.

As a result, we expect the image activation contribution to decrease from 170 basis points in the second quarter to approximately 50 basis points in the third and fourth quarters of 2015.

Image activation continues to meet our expectation.

Systems -- system reimaged restaurants continue to see average sales lifts of 10% to 15%, with company flow-throughs in the 40%-plus range.

During the second quarter, we completed the sale of our reimaging -- our remaining Canadian restaurants to franchisees.

We plan to reinvest the proceeds from these sales into our build-to-suit program in Canada.

These transactions also generated additional restaurant reimaging commitments, as well as commitments for the development of more than 60 new restaurants.

As we announced in February, the third phase of system optimization is the 540 domestic restaurants that we plan to sell during 2015 and 2016.

Interest in these restaurants is extremely strong at our full asking prices.

And we expect the sale of these 540 restaurants will result in pretax cash proceeds of approximately $400 million to $475 million, and reduce future capital expenditure requirements.

Going forward, as part of our ongoing system optimization strategy, we intend to buy and sell restaurants opportunistically to act as a catalyst for growth by further strengthening our franchisee base, driving new restaurant development and accelerating image activation adoption.

As we have stated, we are committed to maintaining an ownership level of about 5% of the total system going forward.

One key element of our long-term guidance is our rental revenue evolution.

And this chart demonstrates the impact that we expect to realize as a result of our system optimization initiative.

In 2017, the first full year after we expect to have completed the third phase of our system optimization initiative, we anticipate that we will realize $170 million in total rental revenue from the real estate that we own and lease.

This is an increase of about $100 million compared to the 2014 total.

Keep in mind that the offset to the income from sub-leased properties is in the other operating expense line.

We expect this amount to be approximately $90 million in 2017.

By 2017, we expect to have monetized more than 70% of our owned real estate, further enhancing the quality of our earnings.

As noted in our release, today, we announced our intent to repurchase approximately $165 million of our stock in an accelerated share repurchase transaction in the very near future.

This will use the remaining $14.5 million on our previous $100 million authorization, in addition to $150 million of our existing $1.4 billion authorization.

After the completion of the anticipated ASR transaction, we expect to have approximately $400 million remaining under our share repurchase authorization.

We plan to use the remaining authorization before the end of 2016, as funds become available from the sale of company-operated restaurants.

Based on our operating results through early August, we are increasing our 2015 outlook for adjusted EBITDA from continuing operations to $385 million to $390 million from our prior guidance of $375 million to $385 million.

This represents an increase of 8% to 9% compared to our 2014 adjusted EBITDA results, which exclude the EBITDA contribution attributable to our bakery operations.

We are also increasing our 2015 outlook for the restaurant operating margins by 50 basis points to 17% to 17.5%, an improvement of approximately 120 to 170 basis points compared to 15.8%.

This estimate includes an improved outlook for commodity costs.

We now expect our commodity costs to be approximately flat compared to 2014.

We continue to expect 2015 adjusted earnings-per-share from continuing operations of $0.31 to $0.33.

This includes the absorption of $0.02 to $0.03 per share of incremental negative impact, primarily from interest related to our debt refinancing and a higher tax rate, partly offset by the benefit of our share repurchase efforts.

We expect our 2015 interest expense to be approximately $80 million to $85 million compared to $52 million in 2014.

The full-year run rate is $110 million, which includes $90 million in expense related to new debt, $10 million in deferred financing amortization, $7 million related to the 7% debentures, and $3 million related to amortization for the unwinding of swaps.

We now expect a 2015 reported tax rate of approximately 38% to 40%.

We expect our 2015 adjusted tax rate to approximate our reported tax rate.

While we expect our cash taxes to be less than half of our GAAP taxes in 2015, due to the utilization of tax attributes, we do not expect a material difference in future years.

And, as noted in the release, we are adjusting our 2015 same restaurant sales outlook at company-operated restaurants to 2% to 2.5%.

And finally, we continue to expect to achieve the following system goals by the end of 2020 -- average unit sales volumes of $2 million; restaurant margins of 20%; a sales to investment ratio of 1.3 times for new restaurants; restaurant development growth of 1,000 new North American restaurants, excluding closures; and the reimaging of 60% of our North American total system restaurants.

And with that, I will now turn the call back over to Dave.

Thank you, Todd.

Please note that we will be returning scheduled calls at the sell side for the remainder of the day, but if you need to reach us, please email me at david.poplar@wendys.com, or leave a message at 614-764-3311, and we will get back to you as soon as we can.

Before we open up the phone line for questions, I'd like to review some upcoming events on our Investor Relations calendar.

In September, Greg Lemenchick and I plan to attend the CL King conference in New York.

In October, our senior management team will host an image activation market visit here in Dublin, sponsored by Karen Holthouse and Goldman Sachs.

Looking further ahead, we plan to issue our third-quarter earnings on November 4, and Greg and I plan to attend the Morgan Stanley conference in New York on November 18, as well as the Wedbush conference in Santa Monica on December 9. We are currently working on a couple other events in the back half of the year and look to confirm those in the coming weeks.

And now we are ready to take your questions.

Michael Gallo, CL King.

I just want to dig in a little bit.

It seems like whenever you've gone in the core products and the premium products, it's done well, but you haven't been able to really get that balance in terms of value.

So I was wondering -- I know you've made changes to that menu over time, but how do you better make that part of the menu relevant in terms of driving better (technology difficulty) [back] on the menu?

Sure, yes.

Mike, this is Emil.

You know the -- I think it goes beyond just the evolution of the right price/right size menu.

I think we are clearly seeing a shift for the consumer today is looking for more relevant total offering in terms of bundled meals.

And where we see particularly relevance is in that $4.00 to $6.00 check range.

And we believe that the responses that we are in market testing now will definitely address that more aggressively than does the right price/right size menu.

And I think we'll see -- beginning to see the benefit of that early in the fourth quarter as well as into 2016.

Okay, thanks very much.

Karen Holthouse, Goldman Sachs.

One quick just modeling question and then an actual question.

The modeling question is -- I missed this, I think, a little bit in prepared comments.

Can you just walk through 2015 and 2016 again, the cash taxes versus GAAP taxes piece of it?

And then sort of a longer-term question.

The comment earlier that we should expect an international update sometime in 2016, should we think of that as something that has the potential to be incremental, either on the cost or the sales side or the revenue side, to what's been laid out for long-term guidance?

Or, if anything, they are sort of beyond the timeline for how we are already thinking about numbers?

Yes, Karen, this is Todd.

So on cash versus GAAP taxes, so for 2015, we see cash taxes at about half the rate of what you would see GAAP taxes.

So we spell that out in the earnings release.

But as you move into 2016 and beyond, cash and GAAP taxes will move almost the same.

So they would be approximately the same amount, plus or minus $5 million to $10 million, based on timing of these -- some of the tax attributes.

As far as international, we do have international growth built into our long-range guidance that we have already previously provided.

But what we haven't given is anything specific around the number of restaurants that we would expect against that LRP over time.

And what we want to do is provide you more detail, probably at Analyst Day in February, around our long-term growth aspirations in international.

We'll have some updates on the progress in the core four markets that we've been really focused on when you think about Japan, India, Brazil, and the Middle East, and where we want to go from there.

So, more to come on that.

But that is embedded in our guidance at the moment, but we want to provide some more specificity going forward.

Great, thank you.

David Carlson, KeyBanc.

Several questions, guys.

You guys really appear on pace to come in well under the $250 million in G&A you are guiding for 2015, especially when you consider the number of units that will likely be re-franchised in the second half of the year.

Can you remind us if there are any incoming costs in the second half that would cause G&A expense to increase from first half levels?

And then I have a follow-up, yes.

Yes, David.

So, on G&A, yes, if you look at the run rate, I would say we are tracking more to $240 million.

So, you've got to remember just a couple of things when you think about the back half of the year.

One, we have a 53rd week.

So you have another week of G&A expense that we do pick up in the back half of the year.

And, as we previously articulated, with some of the savings that we had from last year's G&A initiative, we are reinvesting back into technology.

We are reinvesting back into development for future growth.

So those investments largely come in the back half.

Some have come to life with the opening of our 90 Degree Labs that we've announced about two months ago.

We are now working to staff up that lab.

And we continue to ensure that we've got the resources on the development front to drive those 1,000 gross new North American restaurants that we committed to have open by 2020.

Okay, that's good.

And then on labor, you guys mentioned some leverage on -- from the positive same restaurant sales on the margin line.

And I'm assuming there were some benefit to the labor line from the image activation process.

But could you touch on what you are seeing with respect to wage inflation at the company-owned stores?

Yes.

So, we continue to see pressure on wages two fronts -- one is, minimum wages at the state level continue to increase.

And as there is a war on talent to make sure that we are competitive in certain markets, so we've made some adjustments to that starting wage in certain markets.

The impact hasn't been material at the moment.

But we continue to look at initiatives and how we work to offset any impacts of future wage inflation through technology initiatives, whether that's customer self-order kiosks, whether that's automating more in the back of the house in the restaurant.

And you'll see a lot more coming on that front later this year from us.

Thank you.

Jeffrey Bernstein, Barclays.

Two questions.

One just thinking about just the broader category, it seems like quick services is performing quite well.

I'm wondering how you think about maybe your own performance, whether you think you might be taking share from fast casual, which I know is kind of who you target to go after, versus maybe benefiting from weakness at your largest peer?

And maybe on that note, any change in category promotional activity, whether it's your largest peer or otherwise?

And then I had a follow-up question on image activation.

Yes, sure, Jeff.

As we look at the category, I still think that there is -- when I look at traffic counts in the industry, they're still fairly soft; while QSR, though, continues to be the stronger element versus casual dining or mid-tier restaurants.

So, obviously, it's a great place to be.

And as we look at share shifts in the business, it is hard to identify exactly where those come from.

So our focus is really, as we've said in the past, very much on feeding ourselves.

And we feel very good about our promotional products, our LTL items, very good about the core items that we have put out there.

They've performed at or above our expectations.

And the opportunity is to continue to refine that price value message.

And importantly, I think we've identified some insights there that are going to help us to do that.

So, we are very encouraged for the remainder of the year as -- really, as we look into 2016.

And so we like where we are.

We continue to execute against the cut-above brand positioning, and believe that that will distinguish us both versus traditional QSR competitors, where we are going to give people a new QSR experience but at a QSR price.

And we also think it's going to hold us up well against the new QSR's, because our average check is [some] 40% to 45% below what their check is.

Got it.

And then the image activation.

I know you mentioned in the press release and I think you said on the call that you are still seeing those sales lift 10% to 15%.

I mean, that number seems, I guess, critical to achieve your ultimate AUV target.

And I think people are always wondering if and when that 10% to 15% might get tweaked downward.

I mean, I was just wondering your thoughts.

It would just seem like as more of your system is complete, and as more across broader quick service pursue a similar strategy, and they get sales lifts maybe not as large, but just hard to imagine the whole category can sustain that momentum.

So I'm wondering if there's any change or tweaking in your outlook?

Or do you see anything new when you do more remodels in existing market, where maybe the next store doesn't get as much of a lift?

Or do you still feel like 10% to 15% is very reasonable over the next two years?

We still feel, for the ultramodern standard design and that design with upgrades, that the 10% to 15% lift is reasonable.

From a company perspective, where we see the results of those incremental sales, we do see those strong flow-throughs of 40%-plus continuing to happen.

And it's really been helping the health of the overall brand.

Right?

As we can create a more consistent experience across all Wendy's across the country, you do get a -- an all-boats-rise-with-the-tide element of IA.

But we continue to see sustainable results.

And as you know, we've been at this now for many years, both from the Company restaurants and now as well as the franchisees that have been adopting, where we see sustainable results in that 10% to 15% range, not just during the first year, but moving into the future, right?

So it's always those lifts in year-one.

And then in year-two, we start to see those restaurants grow in line with the system averages.

And it's really a function of bringing in those lapsed consumers and new consumers into the restaurant, creating a great experience from the place, the people, and the product side, to continue to drive that growth and make sure they become return customers over time.

Great, thank you.

Sara Senatore, Bernstein.

I have one point of clarification, I guess, and then more of a philosophical question.

So, the first question is -- just on the image activation impact, I think the stores are out of the comp base for the first -- during construction, and then immediately after as you get these very big initial lifts.

But I'm just trying to understand kind of the timing in the sense that you are expecting a pretty marked slow or deterioration, I guess, in terms of the contribution in the back half.

Is that -- is it safe to assume that the biggest lift has been in the first half of 2015?

And from here, we'll see kind of diminishing lifts?

And I guess related to that, are you comfortable in your kind of product and marketing calendar that you can offset that and still meet your comp targets with a more diminished contribution from image activation?

Yes, first part on IA and then I'll turn it over to Emil to talk about the back half calendar and the confidence in the guidance that we provided.

But you are exactly right.

So if you think about all of our IA activity from 2014, we did a lot of IA's in the third quarter and the fourth quarter of last year.

And as we go through the construction period, which is usually five weeks of closure, and then the following 13 weeks, which is the grand opening impact, that -- those restaurants, as they are being constructed, are out of comps.

They've got basically an 18-week period.

We've got the benefit of all of those IA openings in the first half of this year.

So they came back into comps; we saw great tailwinds.

Those restaurants are performing very well.

But then remember as you lap those 18 weeks, they come back out of comps.

So a lot of restaurants that are performing well in the first half of the year come out of comps in the back half of this year.

So that's a big driver on the contribution from IA, just because they come out of comps in Q3 and Q4.

System optimization does have a little bit of an impact too, as you get into the back half of the year.

So we've IA'ed a lot of restaurants from a Company perspective.

Some of those restaurants will be transferring from company to franchisee as part of the sale late this year.

So that is an impact on the Company tailwind from IA.

And we're also trying to drive the system with -- really model some behavior for our lower AUV restaurants.

We've talked about this refresh option for restaurants with AUV's $1.4 million or below, so a $250,000 investment cost.

So we're also doing some of those restaurants in the back half of the year to see the response.

We've only got a handful to date, so we've got more coming in the back half.

Those do not come out of comps.

So we have about five days of closure in the dining room when we do a refresh.

We just absorb that in the comps in the back half of the year.

So those are the elements that are driving the IA contribution.

I'll turn it over to Emil on the confidence in the calendar in the back half.

Yes, Sara, the -- so as we looked at our forecast internally for the year, the description that Todd just gave you is included in that.

And so we have great confidence that the calendar and the marketing efforts we have, the price value work, is definitely going to deliver on the outlook that we've provided.

Okay, great.

If I may, just one quick question on the real estate.

It sort of, I think, flies in the face to own more real estate of what some investors are agitating for now with other company restaurants, is to sell real estate.

So can you just maybe talk philosophically about this idea of retaining the real estate versus monetizing it the way that -- like I said, we've heard -- we've seen some investors agitate for?

Yes.

No, we feel good that we've been monetizing our existing real estate through system optimization.

So, we've been able to create rental income streams into the future, which has enhanced the quality of our earnings moving forward.

It's enhanced the quality of our cash flow.

And we've done that in a way that still allows us to have that underlying asset for something that we could potentially do some time into the future.

And it's nice to have monetized the rental income stream while still having that underlying asset on the control of the Wendy's company books.

Thank you.

Will Slabaugh, Stephens Inc.

I had a question about value, if I could circle back there.

Should we assume that, given the positive commentary around your premium LTOs, and then the new value strategy you mentioned coming that should help you out in 4Q, that the share loss at the value end of your menu has become somewhat more material at this point?

Or maybe has that gotten worse or just become more clear in recent quarters that something additional needs to be done?

Yes, I would say that we don't believe it's more material, but I think our understanding and insights into it is clear.

And in how we're going to be able to address that.

But you are correct in saying we feel very good about the performance of our LTO products and our core products.

I guess we are just appreciating even more that the opportunity we have is definitely in the price value area.

And as I mentioned, specifically in that $4.00 to $6.00 check range, which is also where you see a lot of competitive activity taking place in that area.

Got it.

Just one quick follow-up, if I could, on food cost.

Wondering what your outlook was for the back half, if you could talk just a little bit more around that.

And especially around beef, which looks to have been coming down nice in the past month or two.

And a number of your competitors have mentioned around some better outlooks for the back half of the year.

Yes.

Well, so we continue to see beef prices not be as an inflationary as we thought.

In the fourth quarter, we'd, in fact, probably see it a bit deflationary from where we would have been a year ago.

But we have guided now to a flat commodity inflation.

So if you recall at the end of the first quarter, we were thinking the commodity bucket was about 1.5% inflationary.

We are now flat.

That change is really driven on two fronts.

Primarily by beef, which is about two-thirds of that improvement, and by pork, which is the other one-third.

So, year-on-year, we are really looking at a flat commodity bucket outlook.

Thank you.

Matt DiFrisco, Guggenheim Securities.

I was just wondering if you could comment or at least follow-up on some of those questions about the reimaging, if you could talk about the average cost of the stores that you've most recently done?

What it is running at?

And then, also secondarily, I was just curious as far as, is it too early to tell?

Or could you give us an estimate of potentially how many stores could sort of get the activation light, sort of the $250,000 investment, as you refer to the 60% of your base getting image activation, I wonder how high could that number go if you were to include sort of those $1.4 million in lower AUV stores getting a more modest refresh?

Thank you.

Yes, Matt.

So on the costs, we continue to see the costs come in at $450,000 to $650,000 range.

And the wide range is really a function of what upgrades you'd put against the base ultramodern standard design.

So those costs have stayed in that range.

As we do more and more, the opportunity to take some costs out with some sourcing and partnership with QSEC has started to materialize, as folks get better at constructing these restaurants.

We've seen it from a Company perspective; we'll also start to see it from a franchise perspective.

They start to be able to pull some of the construction costs out over time, but still within that overall range.

The refresh option, we only have about 10 of those restaurants open today.

All of those are coming in under $250,000 for the most part.

We are favorably encouraged by the lifts that we are seeing in those restaurants, but it's really too early to declare victory, because we are still through the grand opening phase in a lot of those restaurants.

But we are encouraged that that is another tool in the toolbox to make sure that we can not only reimage our lower AUV restaurants economically, but it gives us a chance to make sure that maybe we have an opportunity to mitigate closures over time, as some of those lower AUV restaurants couldn't afford a full ultramodern standard design upgrade in the future.

So, that's what we are seeing on the results.

As far as what would we see the mix into the future?

Still too early to tell.

But as we look at the AUVs across the system, we could see refreshes being maybe as much as 20% of the system into the future.

And we think that's a real positive thing that it could help us continue to accelerate the pace of the reimaging, make sure that we have economically viable solutions.

And we have a place that continues to draw in those laps to new consumers, and then we'll continue to wow them with the great hospitality in the restaurant and the great food.

Okay, excellent.

Thank you.

John Glass, Morgan Stanley.

Just first on the lower contribution from image activation, is that the new normal for this?

In other words, ones on the company side, now that you've gone through the bulk of them there and you are refranchising more?

Or is this really just more about the timing in the back half?

No, I think it ends up becoming more of the new normal.

It's probably a little more muted this year with the timing in the back half, lapping all that activity from the front half.

But we are coming over that reimage hump as a company.

And as we move down to the 5% ownership, by the end of 2016, we'll have the bulk of the company restaurants reimaged.

So, you will start to see from a company side much less of a tailwind from IA, because we're coming across the other side of the hump.

But importantly, as we move to 2016 and beyond, we are going to start to really focus on systemwide guidance.

And this -- the system still has a big opportunity to continue to image-activate restaurants.

Because if you look at where we were at the end of Q2, we're about 45% of the company restaurants are image-activated.

Only 11% of the franchise restaurants are image-activated.

So the total system is at 16%.

We've now moved to 17% of the system image-activated across North America as we opened that 1,000th restaurant this week.

So we've got some nice momentum.

But we have a lot of company reimages in the back half of this year and into 2016.

And then, the franchise community will continue to pace over the next six years, as we work to get the system at 60% image-activated by 2020.

And remember, they have a requirement to reimage 10% of their restaurants every year as we work towards that 60% commitment.

Great.

Thanks for that.

And just as a related question, how much of the lowered sales guidance for the year is due to just the math around image activation?

And maybe now you've got better insights into the lower contribution, how much of it is related to fundamentals?

I was surprised that you thought your sales were below expectations, given you had a very strong quarter a year ago.

So I would have thought that you would have been pleased with this tier stack.

And it sounds like you were somewhat disappointed maybe the -- maybe some -- you are intimating that the run rate into August isn't as strong as you maybe had thought.

But I don't want to read into it if that's not correct.

A couple piece and I'll let Emil chime in a bit.

So we largely contemplated a lot of the pacing and the sequencing of IAs, but since we started to give you the tailwind of IA performance in Q1 and Q2, we thought it was important to make sure you understood how it paced and sequenced through the year, as you guys think about your model.

So that's why we provided just more detail on it.

The real driver of the sales guidance calldown to 2% to 2.5% is the underperformance that we've seen in the first half of the year.

And it really is entirely focused to where Emil's comments were earlier, on price value.

So if you look at year-to-date, we are at about 2.5% growth, but about 160 basis points on average of that is really driven by the IA contribution.

So that leaves what's remaining on the core.

We feel good about the premium side of the menu, LTO.

We feel good about core.

And we're making some adjustments to the price value in the back half.

So we've just let that underdelivery of our expectations in the front half flow through for the full year, for the most part.

As Emil said in his comments, we do feel good about the start in Q3.

Baconator promotion, Baconator Fries, continue to perform well.

And we've got a lot of tests going on in price value, but we won't really see the benefit of those tests until the fourth quarter of this year.

No, I think that's a great summary.

And the disappointment, John, is definitely focused on the performance in the price value area, that $4.00 to $6.00 check.

And predominantly a lot of that comes at the lunch daypart.

So, the team has really done a nice job of getting very, very targeted about this, which obviously always leads to an opportunity to address it quickly, which is what the goal is.

Okay, thank you.

Joseph Buckley, Bank of America.

A couple of follow-up questions and then maybe one that hasn't been asked yet.

But does the food cost guidance for the year now of flat imply down year-over-year food cost in the back half of the year?

Slightly down, Joe.

So we would have been inflationary in Q1.

Food costs into Q2 would have been slightly favorable year-on-year.

So you do pick up a little more favorability in the back half of the year; really pronounced in the fourth quarter.

So if you remember last year, beef really started to accelerate and become very inflationary in the fourth quarter of last year.

We've seen a moderating of that inflation, and beef will become deflationary in Q4 for us year-on-year.

Okay.

And then question on the image activation and what the experience has been.

So when you lap that 18 weeks where they come out of the comp base, what happens afterwards?

Is there another incremental lift on a year-over-year same-store sales basis, starting that 19th week on?

Or do the stores then kind of perform in line with the system?

For the most part, on average, Joe, they start to perform in line with the system once you get past that whole grand opening impact.

So what we see is you have that new elevated base.

So if a restaurant was $1.5 million AUV, 12 months in, it's now $1.650 million.

And then it starts to grow in line with the system comps from that $1.650 million and beyond.

Okay.

And then I'm curious if you could talk about the refranchising of Canada, what those proceeds were?

And if the margins on those stores were low, and therefore coming out has an impact on your second half margin expectations?

Yes, so the margins in Canada were lower than the total North American overall average.

So in the back half of the year, selling those restaurants -- which we finished most of those deals late in Q2 -- will help continue to provide part of the benefit in the back half of the year.

So we ended up doing eight deals for the 129 restaurants across Canada, primarily with existing franchisees, but we did bring in one new franchisee into Canada as part of the transaction.

And if you look at the total consideration -- so this would be purchase price, partial reimbursement for completed IAs, the technical assistance fees that we get upfront, as well as some restaurant growth and development fees -- for the sale of those restaurants, we picked up about CAD87 million.

Okay.

Okay, that's helpful.

Thank you.

David Palmer, RBC Capital Markets.

This is Eric Gonzalez in for Dave Palmer.

I'm just wondering how the decision to pursue a value strategy was influenced by the beef or commodity cycle?

And then how do you decide what sort of value is compelling but not damaging to the brand?

And then, secondarily, maybe you could touch on some of the technology investments you've made?

I know you've mentioned mobile order and pay.

Hoping you might be willing to discuss some early learnings.

Thanks.

Yes.

This is Emil.

I'll start out and comment.

The value strategy really is not influenced by the beef cycle.

This is really driven by our consumer base.

And we all are very familiar with the patterns we see and median disposable household income in the United States.

And essentially, that number has been flat, if you go back as much as 18 years.

And so there's a lot of consumers out there who are simply heavy users of quick serve restaurants who don't have a lot of disposable income.

And because they are using restaurants frequently, a value -- price value is something that is important to them.

And we see that as something will be important for a long time to come, and we just have to evolve our offering to be more relevant to the specific needs that they have.

And again, I want to emphasize we believe that we have the insights to address that.

But as far as how these things affect brand perception, what we are seeing very clearly is, with these consumers, that there is no adverse effect on brand perception.

Because they are using your brand.

And we believe that actually with Wendy's, one of the distinct things that we have is we're giving people extremely high-quality food experience, custom-built sandwiches, and we can do that at the price point that they need to hit in that $4.00 to $6.00 range.

We think that that's an attractive business opportunity for us and an attractive benefit for them.

So we see all those things working very nicely together.

And we are not at all concerned about in any way degrading our brand image.

And obviously, the ideas we have would be done in a very thoughtful manner, driving sales, driving customer counts, and driving profits.

And all three of those have to work together.

And Eric, on the technology side, we are really focused on mobile order/mobile payments.

So we've been testing both of those elements in 10 Columbus restaurants for a while now.

We do have a market test going on in Phoenix.

We've got about half the restaurants involved in that market test.

And we have the Austin market on a full market test.

And in both Phoenix and Austin, we've now turned on support to drive more transactions.

So, still too early to get a read on operational efficiency, average check, and how they are performing.

Anecdotally, with the Beacon technology and the seamless experience, we are getting a lot of great feedback from a user perspective.

So it will probably be another quarter or so before we have some good tangible evidence on the results from those initiatives.

We're also working hard with our 90 Degree Lab investment to really move from our 1.0 app to our 2.0 app in the back half of this year, probably in the November timeframe.

And at that stage, we'd be able to put integrated offers based on consumer behavior into the mobile order/mobile payment complete experience; be able to do national coupon drops.

So that is a big element of how we'd upgrade the full experience.

And once we get to that app 2.0, that really gives us the platform to continue to drive hard on customer self-order kiosks into our restaurants, as we talked about earlier, as an investment to mitigate some of the pressures that we are seeing on the labor front.

Thanks.

Keith Siegner, UBS.

Just a question, Emil, on the quality of your recipe aspect of the brand.

We've seen a lot of news across the industry with focus on removing hormones, antibiotics, artificial flavors and ingredients.

And I thought that was very interesting how you talked about some of the tests with the chicken.

Now that we have Kurt Kane in place here to help lead these efforts, can you give us an update on, let's say, ingredient or product reformulation and the marketing efforts, how you plan to, say, support or even leverage that quality as a recipe positioning going forward?

Thanks.

Sure, Keith.

And first of all, I think that the great success we had with our Jalapeno Fresco Chicken Sandwich, the very strong success we had with Baconator and Baconator Fries -- and remember, Baconator is a product that has an average price point of over $6.00 because it's a half-pound product.

And when I look at the levels with which we are able to sell these items, I believe it strongly speaks to the core equities and qualities that we have as a traditional QSR.

And I think that that's one of the things that undoubtedly distinguishes the Wendy's brand.

But clearly, quality, like everything else, you have to evolve, you have to change, you have to continue to get better at this.

And we realized, as we looked at our grilled chicken sandwich, that we just felt that it was something that needed to evolve and change, and wasn't as competitive as it was at one time.

And so, the product we have in the marketplace is something that we believe that not only addresses the importance of the taste profile, but also the issue with antibiotics that have become increasingly important in the minds of consumers.

And we know that sourcing issues, particularly for the millennials, is something that's very, very important to them.

And we believe a product like this can satisfy very loyal baby boomer customers, along with the millennials.

And you'll continue to see us do work on our core products as well as LTOs, because maintaining that quality margin advantage over traditional competitors is something that is extremely important to us.

And we are committed to maintaining that advantage.

Thank you.

Jason West, Credit Suisse.

Just, I guess, going back to the discussion around value, can you guys give us an update on kind of the percentage of the menu that -- or I guess the sales that are considered kind of value-oriented, and maybe how that's changed over time?

And as you've looked to push harder on that part of the menu, how do you protect these margins that have gone up quite a bit on the restaurant side in the last few years?

Thanks.

Yes.

So, if you look at the overall marketplace and you look at information from like an MPD Crest, they would probably tell you that somewhere between 26% to 28% of consumers say the most recent purchase they had was a value purchase.

But I think that that could possibly understate the importance of that.

Because I think a lot of consumers that are out there buying bundled meals now don't necessarily look at that as a value purchase, but look at that as something that's available to them on an ongoing basis.

But I think an important part of the art of the way we create our marketing plans and our menus is the balance between core LTOs and price value.

And as you know, our stated goal is to have margins rise to 20%.

And the progress you see this year is just part of the planned continuation.

And so we do not see the efforts that we have underway in our tests in any way degrading our ability to get to those margin goals.

Because remember, one of the most important aspects to drive you margins is volume.

Okay?

And topline volume.

And we see in our restaurants that are at that $2 million average unit volume today, that they are delivering the 20% margins and even more than that.

So, we really see the ability to drive customer count sales and profits, with the value test we have going, as actually an enhancer of our capacity to deliver these margins.

Thank you.

Your final question comes from the line of John Ivankoe of JPMorgan.

Two separate ones, if I can.

You've guided to CapEx -- consistently guided to CapEx of $150 million combined between 2017 and 2018.

And I know from the comments that you are basically going to be done with image activation at company stores.

So, can you help explain how you can spend that much money on the system in 2017 and 2018?

And maybe at least just explain how much of that pretty big bucket is new unit development versus non-discretionary CapEx.

And obviously, I ask that in the context of -- it is a high level of CapEx spend relative to other companies that have a targeted leverage goal of 5 to 6 times.

So, John, as you think about the approximately $75 million in each of those years, so the $150 million that you are talking about, one, we will continue to build new restaurants in the markets that we have retained.

So, as you think about us having 5% ownership, we are talking about 1,000 new restaurants.

So we will be building approximately 50 new restaurants company -- from a company perspective over that time.

So that is a big component of that CapEx in that timeframe.

And then even bigger -- about the same is the technology investment.

So we do continue to believe that investing in technology to manage labor, to create a better customer experience in the restaurant, to enhance the experience for our employees in the restaurants is an important element of continuing to drive margins and the total experience in the restaurant.

That's a big part of the investment.

And then we've got ongoing maintenance against the existing 5% of the restaurants that we continue to retain.

And we do know that we want to continue to invest in our restaurants.

Over time, some of our earliest remodels will need a little spruce-up to make sure that we continue to put the money back into the restaurants, so we don't get to the spot where we were a few years ago when we hadn't invested for many, many years in our restaurants.

So, those are the big three pieces -- development, IT, and maintenance.

And I'm sure you appreciate -- just me looking from the outside in, I mean it looks like $5,000 per existing restaurant over 2017 and 2018 combined.

So obviously that's not right.

So there's a lot going on behind the scenes versus, as you've mentioned, just technology for those restaurants, and sprucing-up in terms of redoing image activation, what have you.

Yes.

I mean, and you think about the technology investments.

Those are investments for the system, right?

So we are spreading that over the system, the experience -- right now that's all included in the royalties.

Is there something different over time?

Who knows.

But what we want to do is continue to invest in things that improve the economic model for the entire system.

Okay, understood.

And then, secondly, I mean, there's obviously a lot of discussion of wage prices, wage costs, and that there will be increased pricing at the franchise level to offset those increased wages, especially in markets like New York, for example, that are going to see some very severe increases in wage costs.

So can you juxtapose the franchisee's desire and/or need to take pricing at the store level with what sounds like an increased focus overall for the brand on value?

Can those two things be achieved simultaneously?

Yes, John, this is Emil.

And our franchisees -- I find them to be very astute business people.

And they have a great sense of their trade areas where their restaurants are, and a great, I think, understanding of what the competitive environment is, in terms of their capacity to price.

I think the reality is that what you will see in -- like some of these markets, the New York's, where there's these very significant increases -- is that they will be -- our franchisees will likely look at the opportunity to reduce overall staff, look at the opportunity to certainly reduce hours and any other cost reduction opportunities, not just price.

You know there are some people out there who naively say that these wages can simply be passed along in terms of price increases.

I don't think that the average franchisee believes that.

And there will have to be other consequence -- which is why we have pointed out that, unfortunately, we believe that some of these increases will clearly end up hurting the people that they are intended to help.

And we continue to believe that one of the great opportunities you have in a business like ours is that a entry-level person, in a very short period of time, can rise to become a manager in a restaurant, and have an income above the median household income in the United States of America.

And it's a tremendous opportunity, I think, that is too often missed in this whole discussion.

But our franchisees are astute businessmen.

They know that price value is extremely important.

We do, I think, a very good job of communicating with facts, not just with emotion.

They understand where we are gaining business.

They understand where the opportunities are.

And they very much support the tests and efforts that we have going on price value.

Thank you.

At this time, I'm showing no further questions.

Thank you, this does conclude today's Wendy's Company's second-quarter 2015 earnings results conference call.

You may now disconnect.