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The Wendy's Company (NASDAQ:WEN)

March 13, 2013 8:00 am ET

Executives

Stephen E. Hare - Chief Financial Officer and Senior Vice President

Analysts

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

I'm Joe Buckley, Bank of America Merrill Lynch's restaurant analyst. We're very pleased to be kicking off day 2 of our consumer conference. We're chock-full of restaurant companies today, and we're very pleased to launch the restaurant portion of the conference today with Wendy's. Representing the company will be Steve Hare, the Chief Financial Officer; and Dave Poplar, who heads up Investor Relations. Steve and Dave, thank you for joining us. Steve, I'm going to turn it over to you.

Stephen E. Hare

Thank you, Joe, and it's good to be with you. Thanks for including us, and good morning, everyone, to the hard-core here at the early session, I'd say. What I wanted to do today was just briefly give you a quick framework for thinking about Wendy's, especially if you're new to looking at the story. A lot going on at Wendy's, to say the least.

What I'd like to do before we start is just point out that some of the comments I'll be making today will be forward-looking, so I would ask you to refer to our Safe Harbor language.

In terms of the presentation, just in terms of financial information, obviously, this is getting to be a little stale, but the latest numbers we have released were our fourth quarter numbers. You can see that we finished, in terms of our adjusted EBITDA, at $333 million, a slight increase over the previous year. Probably more importantly was the fourth quarter results. You can see the adjusted EBITDA was up about 19%. So a strong finish to the year, especially when you think that in the prior year was when we had launched the redo of our hamburger line, the Dave's Hot 'N Juicy, which was a strong quarter. From a same-store sales standpoint, you can see we came in at 1.6% for the year, and on a 2-year basis, about 3.6%, which we think is good performance overall. But clearly, as we look forward, we like to ramp that up a bit.

From a quarter standpoint, even though we dipped down to a negative number in the fourth quarter, again, I'd point out that we rolled over our strongest quarter of the year with the Dave's Hot & Juicy launch of 5%. So again, on a 2-year basis, almost a 5% lift.

So a good finish to the year, as we go into 2013. I'll point out that our growth levers, when we look at the strategy for the business, the 3 I really want to concentrate on today would be the core growth of the North America business and then the impact on our business from what we call Image Activation, which is our look at the quality of our facilities and really trying to take brand positioning, which is A Cut Above in the QSR space, and apply that as well to our facilities. We're a 40 -year-old brand, so the average age of our facilities is 20 years. So we think it's time for a significant upgrade of the quality of the facilities, and I'll walk you through some of the information there but it's probably our most important strategic objective overall in terms of growth. And when we talk about Image Activation, it applies not only to reimaging of existing restaurants, but also to our design of new units as well.

In terms of our marketing approach, when you think about Wendy's, again, consistent with brand equity over the years. The nice thing about Wendy's is our customers come in with the expectation of -- established over many years of higher-quality food in the QSR space. And so with that, what we're trying to do is continue to be viewed as an innovator in the space. And in QSR today, it really means really looking at a segment of both high and low, high being our premium quality products where, if you look at our core menu, we do think we offer a higher-quality product offering than our competition. We try to bring new news to the category with limited time offerings and we'll talk a little bit about that for 2013. But at the same time, recognize there's a significant part of our customer base that is very cost conscious, especially in this economic environment. So being able to compete at the discount end of the price spectrum is very important to us. About 15% of our customer traffic, we would like to sustain in the discount level.

Now for us, in terms of discounting, I would say that if you looked at 2012, we did see a loss of customer traffic overall, and all the loss of customer traffic was on the value side of the business. So we didn't feel we were being effective in communicating our value offerings to our customer base. And again, we see a significant amount of competitive activity as we head into 2013, focused on the value customer, and I think part of that is because of all the economic headwinds that our industry faces out there.

So for us, we launched, in January of 2013, what we call the Right Price, Right Size value menu. We hit the air with, I think, a pretty effective advertising campaign to raise awareness of it. And what it really is an extension of value from a price point, from a $0.99 price point for us up to just under $2. And what we're trying to do is build a consistency across the system that, frankly, was lacking in 2012 and really try to make it a compelling value offering to our customers, but at the same time something that makes sense for our franchisees because they're in this business to make money. And with the high cost of our food, and we'll talk little bit about inflationary pressures there, we really face a situation where it's not profitable for franchisees to sell some of these products at $0.99. So our marketing campaign to say these are quality products, especially some of the signature items that you can only get at Wendy's, we're very pleased with this program. We're off to a good start in the year, and I think it's something that we'll be able to build on for the rest of 2013.

Image Activation, I touched on briefly. Again, I think that's a program that we started in 2011. We started with 10 concept stores just to try to look at what kind of building would complement A Cut Above brand positioning and really try to move customer perception of Wendy's and also customer traffic. In 2012, we completed 48 of what we call Tier 1 designs, which are our higher costs on the spectrum of cost designs, and we're very happy with the progress we're making. To date, what we've shared is that the -- all the reimages, both classes of the concept stores, as well as the 48, are averaging post-reimaging sales that are 25% or more higher than they were before we had reimaged these the stores. So a compelling, I think, financial response but also a compelling consumer response to these newly designed restaurants, and you can see some of the pictures here.

When we look at 2013, the evolution of Image Activation for us is now to explore what kind of customer response do we get at what we call Tier 2 and Tier 3. Roughly, Tier 1 would be, today, about a $750,000 investment. Tier 2 is going to be in the $550,000 range, and the Tier 3 would drop down to about $375,000, excluding any deferred maintenance you might encounter. You can see that the designs we have here will open our first ones at the end of this quarter so we're excited about that, and we see a significant amount of interest coming from the franchisees, especially at these lower cost points.

Our rollout plan, as you look ahead for the next 3 years, is a pretty aggressive plan. We've said that we want to have 50% of our company restaurants reimaged by the end of 2015, and we have put in a franchisee incentive program to help get some early adopters on the franchise side to build momentum there. And we would hope we'd see a similar path of growth on the franchisees as we start to open, especially the Tier 2s and 3s.

Our outlook for the year for 2013 is to deliver same-store sales of 2% to 3%. We recognize that that's going to be in the face of some economic headwinds, but we think with the marketing calendar we have for the year and the momentum in the business, we think we can deliver on that. We do see another year of significant commodity cost increases. We estimate the basis point impact to us will be about 90 to 120 basis points. Again, our commodity exposure is primarily to beef, about 20% of our basket, and chicken is another 20%.

Offsetting that, though, as we look at margins, we came in at 14% at the restaurant level in 2012. We see the ability to increase that margin, about 20 to 50 basis points next year, despite the commodity increases. Now how do we do that? A couple of key initiatives there. One is, you do have the Image Activation program. When you're generating 25% sales increases, you're going to see some favorable leverage on labor and your operating cost so they will -- that will help with the overall margins, some new units kicking in as well. And the one thing we did towards the end of 2012 is we made a strategic decision to discontinue breakfast in those restaurants where it was unprofitable, both in the company and in the franchise restaurants. The impact for 2013 financially is that, that will help us on the margin side so we reduce operating losses for that breakfast day part, as well as eliminate the advertising that we were providing for the system to support breakfast. So that will have a favorable impact on our restaurant margin in 2013.

When you net all that together, we projected a range for adjusted EBITDA of $350 million to $360 million, about a 5% to 8% increase over 2012. And on an earnings per-share basis, again, adjusted $0.18 to $0.20 per share over the $0.17 we reported in '12. I would point out that when you look at our quarterly progression, we're likely to have the strongest quarter in terms of growth over last year would be this quarter, primarily because last year's quarter was our softest of the year and we would see a higher growth rate. Also, I'd point out that probably we'll see a trend downward each quarter and in the fourth quarter is where that franchisee incentive program I talked about, about $10 million, is likely to be incurred all in the fourth quarter so that will reduce our profitability in the fourth quarter. So you'll see a downward progression in growth quarter-by-quarter.

Image Activation in terms of the rollout. You can see the schedule we've got, heavily weighted in the second and third quarter from a construction standpoint, and then you can see the mix that we'll have for the year. About half of the 100 that the company will do will be in the Tier 2 and Tier 3 category.

From a new restaurant standpoint, about 25 on the company side, 40 in North America from franchisees. And we do expect 60 new openings on the international side of the business. That's the highest number that Wendy's has opened on the international side. There will be higher closures. I would like to point that out. We'll have another year of higher than historical levels of closures. Some of that relates to the Image Activation program as we're working with franchisees to prune their portfolio of restaurants. And for restaurants at the lower end of sales and profitability, we're allowing them to close those in return for a commitment to Image Activate their other stores.

From a CapEx the standpoint, we've committed $245 million. You can see $100 million of that is what we call base capital that we need to run the business but $145 million of that is totally dedicated to Image Activation. So we're totally committed to the capital needed for this important objective and that's an increase over about $200 million of CapEx from last year.

From a cash flow standpoint, we continue to generate strong cash flow. Obviously, we're going to have a period here of high CapEx. But we do think with the high CapEx from Image Activation, that we have the ability, both with the cash flow generation of the business, as well as the high cash balance we have. We have over $400 million of excess cash from the balance sheet. That gives us the ability to both reinvest heavily into the business but also, as you saw on last year's fourth quarter, we increased our dividend, doubled it, so that we feel that we're comfortable in both reinvesting in the business, as well as returning a higher amount of cash to shareholders in the form of cash dividends. We also authorized a stock buyback program of $100 million in the fourth quarter.

From a long-term outlook standpoint, in addition to the outlook we talked about for 2013, we've said that we believe, especially with the contributions from Image Activation kicking in, that we should be able to grow EBITDA in the high-single digits to low-double digits, as well as adjusted earnings per share going forward.

So with that, Joe, I'll turn it over. I would like to spend the rest of the time, obviously, answering some of your questions.

Question-and-Answer Session

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Very good, Steve. We -- I will launch the Q&A session here. We have a microphone available in the audience, encourage audience participation. It's a great opportunity to ask questions, and please wait for the microphone to get to you before asking a question. Steve, let me start off with questions on the Image Activation plan. If you meet your goals at the end of 2015, 20% of the systemwide Wendy's will be updated. Is that a large enough percentage for the brand to reap the benefits of this very significant upgrade?

Stephen E. Hare

Yes, so the question around the pace of Image Activation, I mean, we are clearly committed to go as fast as possible. And I think you see, from a company standpoint, obviously, we can drive the schedule on the company side. So we're very comfortable with the projection of getting 50% of the company restaurants done. And we're building a pipeline to do that even today, reaching out to 2015. The harder part is trying to sort of spec out the timing that we'll see on the franchisee side. Right now, I think we're talking about giving incentives to get people to early adopt. We've had a couple of franchisees that we've allowed to sort of test the designs already, great results. And we think that once we get people to do 1 or 2 of these, we think we'll see a significant acceleration of the pace. But I think over time, I think before we really see an acceleration, I think we've got to prove out the results, not only of Tier 1 but of the 2s and 3s, because I think, practically, the franchisees would like to see that sales lift but they'd like do it at a lower cost point. So I think proving out, which I think we'll be able to do by the end of this year, the economics and the returns on 2s and 3s, I think then -- I think we'll start to see an acceleration of interest. And then maybe that 20% is our best guess from where we sit today, Joe. That number could be, I think, significantly higher if we see great results from our Tier 2s and 3s.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. And the goal, I think, is to try to reestablish the premium position that Wendy's used to enjoy, and Wendy's still does enjoy, to some extent, but maybe by a narrower margin versus the other national competitors. And I guess, my question is, is what percent of the system do you think has to have that look before you really reap the full benefits of it? Is 20% enough for -- or is 30% enough to get the full benefit?

Stephen E. Hare

Well, I'll look around and, obviously, a lot of our competitors are doing similar reimage programs. And I don't think you'll ever -- I mean, it's not -- the goal is not to get to 100%. I mean, we do not have 100% of our restaurants that would be candidates for that kind of investment. What I'd like to get to beyond, say, on the company side, beyond 50%, absolutely. I don't say 2015 as an endpoint that we would stop there. And I do like the idea that in a market, as we start to have a majority of our restaurants have that common look, and you can see from the pictures we put up, even at Tier 2s and 3s, we're trying to sort of have that very contemporary look where people come in and say, "This doesn't feel like an old Wendy's anymore. I'm really in a different environment." And hopefully, you're getting a high customer experience as well. So we'd like to have a majority of the system look that way. But Joe, I think even at 20% you're going to see a significant improvement overall as people just perceive Wendy's a little differently, and we think, hopefully, consistent with the Cut Above.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

For the Tier 2 and Tier 3 remodels, what are the key features that you'll focused on? Is it more interior or exterior? I mean, the slide, it looked like some of it was exterior but I guess I'm just curious what features will be the dominating parts of the Tier 2 and Tier 3.

Stephen E. Hare

So from a cost standpoint, if you think about the concept stores we went out with was really just sort of a process to really test what really resonates with customers. We went very quickly and ended up with very high cost in doing that. We had $1 million or more dollars invested in each of those 10 concept stores. We brought that down from a value engineering standpoint for Tier 1s to $750,000, and we think we can bring that down even further as we get smarter about how to build these restaurants. At the same time, we recognize that number's too high for most of our franchisees to really rally around and go quickly. So that's why we have these lower cost targets. What we really try to bring down are those elements that we can, from a construction standpoint, do more cost effectively, maybe with lower cost materials, to try to keep some of the DNA of the design, but maybe you're not doing the accentuated blade at the roof level. So you'll start to see that in the designs. Now we look at it from when you stack up Tiers 1, 2 and 3 side-by-side, we say, "Well, I see the differences." But if you're comparing it to the old restaurant that was there before to, say, a Tier 3, I think you're going to see a dramatic positive difference. The focus, to your point, I think is mostly at the interior level. We've got great consumer data now in what resonates with our customers. So we're trying to incorporate as much of the interior that we see worked in Tier 1, and hopefully, that will lead to a significant sales increase even at a lower cost point.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

And the 25% lift you've gotten in the initial Tier 1 stores, how is that spread among day parts? I mean, is there anything that would suggest the customers using Wendy's differently after the reimages? Or is it just more frequently?

Stephen E. Hare

What's interesting is it does come across from a channel standpoint. It does positively impact all channels. So the dine-in as well as takeout, as well as pick-up window, because we are affecting the exterior and the interior. But the most significant change we've seen in customer behavior is a significant increase in dine-in. And by design, I think, obviously, we're really working on having the Wi-Fi and the fireplace and a much more comfortable setting, which we hope would entice people to come inside. So that's where the biggest significant growth we're seeing, is the proportion of people dining in, and the nice thing for us from a business model standpoint is the check is higher for dine-in customers than the other channels.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

You're getting a -- we have a question here in the audience.

Unknown Analyst

A couple of questions on the reimaging. Tier 2 and Tier 3, what kind of sales lift are you expecting? And then on the franchisee subsidization, how much are you contributing to the remodel?

Stephen E. Hare

So in terms of the sales lift, what we really said and we've modeled out some targets but they're clearly, at this point, just targets since the first ones we'll open will be this quarter. So in March of this year, we'll start to have our first live data on Tier 2s and 3s. Our sort of going in assumption has been it has to scale down from Tier 1s because you're spending less money. We're going to have to test that though. I mean, obviously, there's an inflection point out there. At some point, if you bring the cost down too much, that you won't get a significant sales lift. We're hoping that we've still captured a lot of the features that drove the success of Tier 1s so that we'll see good sales lift. But rather than speculate what that is, I think we'll be able to share that data with you as we open these 2s and 3s. And I think based on the designs you see from the pictures here, I think we're optimistic that we're going to see a nice sales increase, even at a Tier 3 level.

Unknown Analyst

Yes, but the...

Stephen E. Hare

The Incentive program, we started out with just a Tier 1. We started out last year where we just had the Tier 1 designs out there. So we put out a Tier 1 program. It's a $10 million program, and we were targeting 100 franchisees to come in at a single unit. So $100,000 per unit. Now what we've done since that time is now that we're ready to go with Tier 2s and 3s, and we can share those designs with our franchisees. We've extended that program, and we've reduced the amount of the incentives somewhat. But it's still -- we've capped the whole program at $10 million but it'll spread across Tier 1s, 2s and 3s in about a proportionate manner.

Unknown Analyst

Do you expect [indiscernible]

Stephen E. Hare

That's really designed to be a kick-starter for early adopters in '13 because it's higher risk in '13 to jump in the pool with us because we don't have a lot of data yet it, we're just opening. We recognize that, and we recognize also the costs are going to continue to come down as we come down the learning curve. So what we've said, let us help offset some of that risk with $100,000 incentive program. I think going forward in 2014, our focus for support, financially, will shift from incentive program to more of financing support. So we do have customers out there that say, "Hey, I like this program but I need to be able to finance this," And remodel finance is the hardest kind of financing for franchisees to do because of their existing capital structure. You got to work around that. So our intention, I think, for 2014 would be to make sure we've got a financing program available that's geared towards Image Activation.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. Switching gears for a moment to the Right Price, Right Size launch this year, what have been the key benefits of that? Having followed Wendy's for a long, long time, the premium end of the spectrum has always been your primary playing field and the value in the spectrum has always been a challenge. So how is this working differently for you?

Stephen E. Hare

Well, if you go back -- way back in time, Wendy's was actually an innovator in coming out with discount menu items, but that was a long time ago. And we've bobbed and weaved, unfortunately, over the years around stressing our value and then moving away from it. And I think with our approach of A Cut Above, you do get pulled towards the premium side of menu innovation. I think that's absolutely true. And our franchisees, I think, clearly like bringing out premium products that are better. But in this environment, especially in this economy, we've got to find a way to be more consistent. If you look at 2012, and if you compare our approach to value, say, versus McDonald's, who obviously is very successful at that end of the spectrum, they have a consistency in approach to which menu items are on the menu at what prices, whereas for us we have a lot of variation. And I think that comes back to the food cost issue that I mentioned. So we want to provide compelling value to customers, but we have to recognize that it's got to make business sense for all of our franchisees out there that want to make money at that lower price point as well. So we want to drive traffic. I think to drive traffic in QSR, you've got to have a compelling value message to our discount customers because we have many customers out there that will only pay $0.99 for a product. And no matter what we do, no matter what we do in terms of quality, that's all -- and we've taught them that you can get a pretty good deal at $0.99, so we're to blame for that intransigence, I think we see, on our customers to move them off. Clearly, we're trying to do that a little bit by going up to $2 on our Right Price, Right Size. But if you look at the quality of those products, I still think you're getting a compelling value up to $2. But this is a program, Joe, I think we can have a consistent application across our system. And I think that'll help us, along with what I think has been a pretty good advertising campaign behind it.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Has the franchisee adoption of the program been higher than usual?

Stephen E. Hare

It has been. And I think we're in conversations right now, I think, to extend that program out. So I think you'll be able to see more promotion of that over the year, again, going back and forth between high and low over the year.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. We have one in the audience.

Unknown Analyst

So when looking at some third-party data, it showed that, I guess, you guys seem to spend a lot of -- more advertising dollars in Q1 this year versus last year. Is it a similar level we should expect throughout the rest of the year? Or should we see lower quarterly ad spend as the year progresses?

Stephen E. Hare

Well, I think in terms of our actual ad spend for the year, it should be relatively consistent year-over-year. I'm not aware of anything that -- we obviously have been advertising the Right Price, Right Size. We've had a national campaign supporting our Premium Fish in February, and we actually go to local media in March. So I don't think there's anything extraordinary around the level of spending in Q1. So I'd have to look at that data to see what's there. But I'd say year-over-year, our spend, although we are able -- one thing we have talked about is in terms of allocation of funds, we are able to push a little bit more money into actual ad spend versus some production cost that we had in the past. So you'll see a little bit more. But overall, the contribution advertising will remain the same. So year-over-year, we should be pretty consistent.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

But just to follow up on that for a moment. Has the contribution to the national ad fund changed at all for the company or franchise restaurant?

Stephen E. Hare

Not this year.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. So it's just greater efficiency in terms of how you're allocating those dollars?

Stephen E. Hare

It's greater efficiency that's going to allow to -- absolutely, that's the point.

Unknown Analyst

Can you talk about breakfast? How many restaurants it was in before and how many it's going to be in now? What costs you're going to save from not doing it, both in like labor and other operating expenses, as well as what you're cutting out from advertising? And maybe the corresponding sales decrease that you'll see.

Stephen E. Hare

All right. So in terms of the decision around breakfast, as you know, if you've been following us, for the last couple of years, we've been trying to come up with a differentiated menu to allow us to effectively compete in the breakfast day part. We're the only hamburger player that really doesn't compete in the breakfast day part. We think we came up with a differentiated menu, but we did not see traction around sales in many of the markets. A little frustrating in that some markets it worked well with the same menu, but I think it had to do with local execution, local marketing efforts. And we made a decision that because we were not seeing traction that to have, say, our franchisees continue to lose money at the breakfast day part did not make sense. And so we made a tough decision because it's frustrating, frankly. 25% of the traffic in QSRs in the morning day part, we want to be a player in that day part but the reality was without seeing traction, without really being able to go to national advertising, we don't have that scale, we made the decision to pull back. We'll come back -- I think we'll have still have breakfast in about 400 restaurants across the country systemwide when the dust settles this year. The impact is twofold, as you mentioned. One, is on the company side. We were supporting most of the advertising around breakfast as an inducement for our franchisees to participate in that day part. So that advertising cost goes away for us. Also, because we took the breakfast day part out of unprofitable company restaurants, the operating losses we were incurring at that day part, those will also be eliminated. So when I talk about positive impact on our margin for 2013, it's those 2 issues, the advertising elimination and the operating loss elimination, that caused that favorable impact on our margin going forward. And we'll see. There's no immediate plans to jump back into breakfast. But with 400 restaurants serving breakfast, we'll continue to maintain, support those restaurants going forward. And we'll have to see. We'll continue to work on our coffee program. We have a Redhead Roasters private brand that taste -- from a taste test standpoint, proves out pretty well. We'll continue to build that during the day and try to build up brand awareness of that product and maybe down the road, come back to using that coffee as a platform to begin to extend hours, much like we do at late night.

Unknown Analyst

How many restaurants were you -- have reported? And is the advertising decrease -- is that gone? Or are you replacing that for advertising a different day part?

Unknown Executive

No, that will be savings. So that's why I say it'll be a margin enhancement so that dollars that we had allocated to breakfast will be eliminated and that'll be savings to us overall. The restaurants, I think we have probably gotten to maybe 700 or so, to give you a rough number, where the breakfast restaurants were, so pull back to a 400. It's about -- it's in that range.

Unknown Analyst

And how does that split out between company and franchisee?

Stephen E. Hare

I don't have that number with me, but I assume it's about that 80-20 mix.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Just to follow up on that, Steve. Have you quantified what you were spending on breakfast advertising?

Stephen E. Hare

Yes. We just made a decision. We're not going to quantify that publicly as what that number is. But that's -- it's built in. When we talk about a 20 to 50 basis point restaurant margin improvement, as you go through with the commodity increases, that's a piece of how you get to that improvement. And I think without that then, obviously, that improvement would have been smaller.

Unknown Analyst

Okay. Can you talk a little bit about the sales lift with the reimages and how that looks in year 2 and the out-years? And also, on the 25% increase, how you think about the flow-through on the margins?

Stephen E. Hare

Sure. So sustainability is a big question around the sales lift. Obviously, when you open up a reimage or you open up a new unit for that matter, you're going to have sort of a grand opening effect where the sales lift is even higher than the 25%. But that scales down over time. The nice thing is with the concept stores that opened in 2011, they've now rolled over a year. So you've got a pretty sustainable period of time to look back. And the 25% is not 25% over the 2011 when they open. So I'm just going back to say before you did the reimaging, you're sustaining that 25% sales lift. We would expect then sort of a normal 2% to 3% sales lift in those restaurants going forward. But you're not losing -- the important thing was you're not seeing that 25% erode at this point. From a flow-through standpoint, the question there is, what kind of margin flow-through do you get when you increase your sales by 25%? I think rule of thumb in a Wendy's restaurant would be you could expect as much as 40% of that to flow through to your restaurant margin. But I think, given the complexity of these reimages and the newness of them and there's a lot of aspects that, from an operational standpoint, with the higher volumes of customers coming in, initially, we are making an investment on the labor side. So the flow-through we would expect would be lower than, say, the 40% target. But we would still expect be able to generate about 30% of flow-through at that level.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Steve, can you talk a little bit about the food cost guidance? Generally, broadly, across the industry, food cost has been not as bad as I thought it would be, given all the headlines last summer. And could you just review -- remind us the way you buy beef and chicken? And are you somewhat uniquely exposed to these pressures versus your competitors?

Stephen E. Hare

I think we are a little atypical because when I look at how some of the other customers talk about their commodity basket, I think we are different primarily because we're buying fresh beef. And so in our markets here, what that really means is that we're exposed to market price changes. Very difficult to try to hedge against that in any way so that when you look at market prices today for the beef that we buy, that will be our cost of sales, say, 3 months out is the way to be thinking about it. So when you start to see prices move today, that'll flow through our cost of sales, so about 1 quarter lag. And I think that -- so our -- the quality of the beef that we're buying is slightly different than some of the other competitors. And I think, as a result, we probably do have a little bit of higher basket of cost as a result of that. On the chicken side, we do contract that out. So we're a little more, I think, similar to other companies around how we buy chicken. Everything we do goes through our cooperative that we set up about 3 years ago, QSEC. I think we're getting better in the science of purchasing products. We've got a pretty big initiative around cost savings. If we look at the 90 to 100 basis points and we say, "Look, rather than take pricing, if we can do some things around how we spec our products or how we buy our products to help offset some of that, that takes some of the pricing pressure off, which helps us from a traffic standpoint." So we've got a number of initiatives now. And I think a pretty good approach of looking at -- are we, in any way, spec-ing additional costs that there's no visible customer benefit of? And so that's one way we're helping to try to offset some of that commodity increase we see.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Is the beef mechanism still where the price is sort of fixed each quarter based on, I think, based on prior quarter average prices? That's the buying mechanism?

Stephen E. Hare

Yes, yes, that's the buying mechanism. That's the way to think of it.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. Shifting gears again a little bit. Curious if you had any -- have any updated thoughts in the whole health care insurance issue. I think your prior comments were there might be about $25,000 of incremental cost per restaurant. It sounds relatively high to what some others have said, given your store -- your average unit volume. So if you could just update us on your thoughts there.

Stephen E. Hare

Yes -- no, we're all enjoying going through that analysis. I'm trying to figure out the impact of that. I did see a picture last night of the number of pages that actually towered over the person doing the analysis. So I feel sorry for a lot of our franchisees for having to go through that analysis. But to answer your question, I think the $25,000 does appear high. That was our original going in estimate, really, as we start, even before we had a lot of regulation detail to look at. So I think, theoretically, that was what the cost could be. I think we're feeling better, Joe. I think as we look at what the likely cost is going to be, there's still a lot of work to be done there. We still need some clarity around the details of implementation. But we start to look at the average cost per person that it would take. And then you really start -- the big variable of bringing the $25,000 down, I think, is how many people are likely to accept that insurance that we may be required to offer. And I think the acceptance level is likely to be lower. And so as a result, I think the cost is going to be lower. So hard to quantify but I think it's definitely going to be below $25,000. It might -- as I look at it, and again it's subject to the acceptance rate, I think, on a cost basis, it might be actually closer to $5,000 a restaurant. So -- but Joe, that's the rough estimate, and we'll continue to share that as we refine our analysis. But I think just to be helpful, I think -- I do think the more work we've done, the more we feel better about the impact on us because that, again, is not only just the company restaurants. I also worry about the franchisee restaurants who are running some narrow margins and what kind of cost impact that's going have because a lot of our franchisees fall in that minimum size basket. So they're affected by it as well.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Sure. Can you just, on the health care again, what kind of plan, if any, do you have in place now for the hourly workers? And what is the optimum rate on that plan that you provide?

Stephen E. Hare

Yes, the focus of most of our insurance programs today are for the full-time workers that we have. Today, we have elective programs that provide insurance for hourly workers, but the participation rates there generally are pretty low.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. Just a question on the competitive environment. McDonald's has very publicly pronounced and executed more focus on their Dollar Menu. Do you see the level of competition more intense than it was, say, 3 months ago or 6 months ago?

Stephen E. Hare

I hate that question, Joe. I was -- this business is so competitive every year. But if possible, I think this year's even more. And can it be more competitive? I think it actually is because not only do you have the traditional battle for market share. Let's look at the industry overall. Traffic is slightly increasing. At least QSR is probably the place to be from a restaurant standpoint, but the market's relatively flat so we're fighting for share. So I think the competition is going to be more intense to take share. And then, of course, you go outside the traditional QSR and we've got new QSR, especially when you're A Cut Above and we're at the higher quality spectrum in QSR. We've got competition above us, and you've got this emerging convenience store group that are pulling away at the lower-end customers. So I would say, overall, the total competitive activity is as intense as we've ever seen them.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Steve, thank you very much. Dave, thank you.

Stephen E. Hare

Thank you.

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