Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Wendy’s/Arby’s Group (NASDAQ:WEN)

Q1 2011 Earnings Call

May 10, 2011 10:00 am ET

Executives

Stephen Hare - Chief Financial Officer and Senior Vice President

Roland Smith - Chief Executive Officer, President, Director, Member of Executive Committee, Member of Capital & Investment Committee, Interim Chief Executive Officer of Arby's Restaurant Group Inc and Interim President of Arby's Restaurant Group Inc

John Barker - Chief Communications Officer and Senior Vice President

Analysts

Michael Kelter - Goldman Sachs Group Inc.

Christopher O'Cull - SunTrust Robinson Humphrey, Inc.

John Glass - Morgan Stanley

Phillip Juhan - BMO Capital Markets U.S.

Jason West - Deutsche Bank AG

Jocelyn Mackay

Sara Senatore - Sanford C. Bernstein & Co., Inc.

Joseph Buckley - BofA Merrill Lynch

Amod Gautam - JP Morgan Chase & Co

Howard Penney - Prudential Equity Group

Michael Gallo - CL King & Associates, Inc

Reza Vahabzadeh - Lehman Brothers

Operator

Good morning, everyone, and welcome to Wendy's/Arby's Group's First Quarter 2011 Conference Call. Our hosts today are John Barker, Chief Communications Officer; Roland Smith, President and Chief Executive Officer; and Steve Hare, Chief Financial Officer. [Operator Instructions] I would now like to turn the call over to John Barker. You may begin, sir.

John Barker

Thanks. Good morning, everyone. Thanks for joining us. This morning, we issued our first quarter 2011 earnings release and we filed our Form 10-Q.

The agenda for today's call and our webcast will begin with an introduction from our President and CEO, Roland Smith, who is going to provide an update on Arby's strategic alternatives and a general overview of our recent performance. Our Chief Financial Officer, Steve Hare, will then review our first quarter 2011 results and our 2011 outlook. Following Steve's remarks, Roland will discuss Wendy's initiatives and he will provide an update on our international expansion. Afterwards, we'll open up the line for questions.

Today's conference call and our webcast is accompanied by a PowerPoint presentation which can be found on the Investors Relations page at our corporate website, which is wendysarbys.com. For those of you who are listening by phone today, make sure that you select the appropriate webcast player option from our website, and that will ensure that you can sync up with the slides and the audio.

Now before we begin, I'd like to refer you for just a minute to the Safe Harbor statement that is attached to today's release. Certain information that we may discuss today regarding future performance, such as financial goals, plans and development, is forward-looking. Various factors could affect the company's results and cause those results to differ materially from those expressed in our forward-looking statements. Some of those factors are referenced in the Safe Harbor statement that is attached to the news release.

Also, some of the comments today will reference non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization. Investors should refer to our reconciliations of non-GAAP financial measures and the most directly comparable GAAP financial measure.

Now let me turn the call over to Roland.

Roland Smith

Thanks, John. Good morning, everyone, and thank you for joining us today. Before I review the first quarter results, let me give you a brief update on our strategic alternatives process for Arby's.

As you know, we announced in January that we are exploring strategic alternatives for Arby's, including a sale of the brand. We continue to make substantial progress on a potential sale of Arby's. We've narrowed the large initial interest to several quality bidders that have completed significant due diligence and remain active in the process. We believe it is in the best interest of the company to bring this progress -- or process to closure as soon as possible.

As we have previously stated, a potential sale of Arby's would provide 2 key benefits: it will allow us to focus all of our financial and human capital resources on growing the Wendy's brand and to deleverage the balance sheet. In addition, proceeds from the sale would also be available for reinvestment in our Wendy's business and return of capital to shareholders. As a result of this strategic alternatives process, 2011 will be a transition year.

Now, I'd like to provide you an overview of our first quarter results. In the first quarter, we generated revenue growth of 1.2% to $848 million. Adjusted EBITDA for the first quarter was $83.5 million, which met our expectations. Compared to last year, these results were negatively impacted by commodity increases and also reflect our investments and incremental advertising to introduce Wendy's new breakfast to additional markets.

From the sales perspective, we remain optimistic about the remainder of the year at Wendy's as we continue to focus on our Real brand positioning by improving our core menu offerings and introducing exciting new products. I'll provide a more detailed update about our initiatives to drive stronger sales at Wendy's later on this call.

Now I want to comment on each brand's first quarter results. Wendy's North America, system-wide, same-store sales were flat and were negatively impacted by adverse winter weather and soft Canadian same-store sales. Canadian, company-owned restaurant, same-store sales decreased 4.7% and were negatively impacted by the higher -- by the effect of higher sales taxes, which raised our menu prices in 2 provinces.

North America same-store sales for company-owned restaurants declined 0.9%, and our franchise restaurants were up 0.3%. We believe this gap between company-owned and franchise same-store sales was primarily due to higher pricing on certain menu items by franchisees. Since implementing price increases at company restaurants at the end of March, this gap has significantly narrowed.

As you can see on the slide, in January, we promoted our My 99 Everyday Value Menu. In February, we introduced our new Asiago Ranch Chicken Club sandwich, which replaced our existing chicken club. And then in March, we promoted our Fish & Chips combo, which paired our natural-cut sea salt fries with a premium North Pacific Cod sandwich.

Wendy's company restaurant margin was 13.4% in the first quarter, reflecting a 200-basis-point decrease from a year ago. This year-over-year difference was primarily due to 110 basis points of incremental advertising to introduce Wendy's new breakfast in additional markets and 80 basis points of higher commodity costs.

At Arby's, first quarter, system-wide, same-store sales increased to 5.5%. Same-store sales at company-owned restaurants were up 6.8% and franchise restaurants increased 4.8%. In January, we added a new item to our Dollar Menu, the Jr. Turkey Ranch sandwich and successfully promoted our improved fish sandwich in February as part of a $4 combo meal. In March, we introduced our new Angus roast beef sandwich, the Angus Three Cheese & Bacon. It features sliced, lean, Angus, top-round roast with 3 kinds of cheese and bacon and is served on a toasted Italian-style roll. Customer reaction to this new sandwich has been extremely positive, reflected by a very strong product mix of more than 11% during the promoted period.

We also introduced Arby's new brand positioning, Good Mood Food, and customer feedback has been positive. Arby's first quarter restaurant margin was basically flat to the prior year. Significantly higher commodity costs were largely offset by sales leverage resulting from our strong same-store sales increases. We are very pleased with Arby's performance in the quarter. We believe our turnaround plan is working and that the combination of our new brand positioning, value menu and successful new product introductions will continue to drive positive results for Arby's.

Now I'll turn the call over to Steve Hare. Steve?

Stephen Hare

Thanks, Roland. Let's begin with a summary of our key results and the special items that were included in the first quarter.

Total revenues increased $10.4 million or 1.2% versus the prior year. Revenue increases were primarily a result of Arby's same-store sales increases, as well as a benefit from foreign currency translation at Wendy's.

Adjusted EBITDA decreased 9.3% as compared to the 2010 first quarter. This year-over-year decrease was primarily a result of a higher commodity costs as well as incremental advertising to introduce Wendy's new breakfast in additional markets.

Our reported net loss for the first quarter was $1.4 million or $0.00 per share compared to the prior year net loss of $3.4 million or $0.01 per share. The first quarter of 2011 included total net special charges after tax of $0.01 per share, and the prior year first quarter included total net special charges after tax of $0.03 per share.

Special items in the first quarter of 2011 included a reversal of the remaining accrual for our SSG purchasing co-op funding commitment. As a result of the Arby's strategic alternatives process, the SSG board of directors voted in March to dissolve SSG and transfer its activities to the Wendy's purchasing cooperative, QSCC, and the Arby's purchasing cooperative, ARCOP.

Additional special items included in 2011 were impairment charges, primarily related to certain underperforming Wendy's restaurants, as well as expenses related to the Arby's strategic alternatives process.

Now I'd like to review our pro forma results. As we have mentioned before, 2011 will be a transition year as we focus on completing strategic alternatives for Arby's and positioning Wendy's for accelerated growth.

As a result, in January, we provided 2011 adjusted EBITDA guidance on a pro forma basis, which excludes Arby's and related G&A as if a sale of Arby's occurred at the beginning of the 2011 fiscal year. In order to illustrate how we are tracking with that guidance, we are providing first quarter pro forma financial results in addition to our reported numbers.

Pro forma adjusted EBITDA was $75 million for the 2011 first quarter. Pro forma adjusted EBITDA excludes Arby's adjusted EBITDA, which includes brand G&A and Arby's portion of the allocated corporate G&A. In Q1, corporate G&A allocated to Arby's of $8.8 million was equivalent to the expected pro forma quarterly amount of corporate G&A savings.

Now let's discuss cash flow. One of the strengths of this company continues to be our ability to generate positive free cash flow, which we define as cash flow from operations less capital expenditures. We generated $25 million of positive free cash flow in the first quarter, including our investments in breakfast and remodeling.

Cash flow from operations was $53.5 million. Capital expenditures were $28.6 million and were related primarily to our restaurant remodels and maintenance CapEx. In addition, we repaid $30.2 million of our long-term debt, and we returned $8.4 million of capital to our stockholders in cash dividends during the quarter.

Our net cash used in the first quarter was $12 million. And at quarter end, we had a cash balance of $500 million. We continue to have a very strong cash position, which provides us with significant financial flexibility going forward to fund our strategic growth initiatives, dividends and share repurchases.

Now let's look at our debt capitalization. At the end of the quarter, we had total debt of approximately $1.5 billion and net debt of approximately $1 billion. Based on our trailing 12-month adjusted EBITDA, including breakfast advertising expense in both 2010 and '11, our total debt multiple is 4.1x and net debt multiple is 2.7x.

On a pro forma basis, we expect to reduce our net debt by at least $200 million from the elimination of Arby's capitalized lease obligations and cash proceeds from the sale.

Next, I will discuss our dividends and stock repurchases. Our next quarterly cash dividend of $0.02 per share will be paid on June 15 to stockholders of record as of June 1. We continue to have $250 million authorized and available for stock repurchases. We did not buy back any stock during the first quarter because of the ongoing strategic alternatives process for Arby's. We plan to resume our stock repurchase program after the conclusion of the strategic alternatives process, subject to market conditions.

Next, I would like to discuss our outlook for 2011, starting with commodities. Like many of our competitors, we are now forecasting commodity costs for 2011 that are higher than previously expected. We communicated to you back in March that we expected beef costs to rise approximately 10% to 15% and that we expected our total commodity costs to rise 2% to 3% in 2011. We are now forecasting that our beef costs will rise 20% and, along with increases in bacon, fry oil, dairy and distribution costs, our total commodity basket will increase 5% to 6% in 2011.

While we believe that we will be able to use selected pricing and product mix to partially offset these rising costs, we are revising our previously issued pro forma adjusted EBITDA guidance to reflect these higher commodity costs. We now expect our 2011 pro forma adjusted EBITDA to be in the $330 million to $340 million range compared to our previous range of $345 million to $355 million.

Our EBITDA outlook includes the following assumptions. For 2011, we continue to expect Wendy's same-store sales to grow between 1% and 3%. Our expectation of same-store sales is driven by the strong product introductions planned for the remainder of the year as well as strategic price increases. Roland will review these initiatives in a moment.

Based on rising commodity costs, we are revising our margin assumption and now believe that Wendy's company-operated restaurant margin will be flat to slightly down from 14.8% in 2010. We had previously communicated that we expected an improvement of 30 to 60 basis points in Wendy's company-operated restaurant margin. Our restaurant margin includes the effect of incremental advertising expense for Wendy's new breakfast program in both years.

We are reiterating that we will spend approximately $145 million on capital expenditures for the Wendy's brand in 2011, which would include approximately 100 restaurant remodels as we focus on updating the Wendy's system with new designs.

Now I will turn the call back over to Roland.

Roland Smith

Thank you, Steve. Our strategy at Wendy's is to grow sales and margins by ensuring we deliver our Real brand positioning. Our goal is to provide superior quality, freshness and taste in every product that we offer to differentiate Wendy's from our competitors. We have already made significant improvements to 3 of our core menu categories: value, with the introduction of our My 99 Value Menu; salads, with the introduction of 4 premium entrée salads; and fries, with the introduction of natural-cut fries with sea salt. We are also currently working to significantly improve our hamburgers and chicken. By year end, we will have revamped most of our core products and believe these improvements will drive growth in 2011 and beyond.

Now I'd like to share our second quarter marketing calendar and some of our major product improvements.

This slide shows Wendy's marketing calendar for the second quarter. In April, we promoted our new sea salt fries. As you may have noticed in the media last month, consumers in a national taste test said that our new fries taste better than McDonald's. 56% of consumers taking the test chose Wendy's fries over McDonald's. McDonald's fries have be considered the gold standard in QSR, so this is a huge win that we believe will pay dividends over the next several years.

North America, company-owned, same-store sales turned positive in April, up 0.5%, and the U.S. was stronger at up 1.1%.

Last week, we began promoting our Bacon Mushroom Melt hamburger or Flavor Dipped Chicken sandwiches depending on the market.

In June, we will be introducing of our new Berry Almond Chicken Salad and Wild Berry Tea. This seasonal salad will feature fresh blueberries and strawberries, a premium chicken fillet, real Asiago cheese and a 100% natural, fat-free acai berry dressing. As consumers continue to trend towards eating healthier foods, Wendy's premium salad line provides an excellent option.

And in July, we will offer a new Fresh Berry Frosty with fresh blueberries and strawberries.

According to independent, third-party research, Wendy's market share of QSR entrée salads exceeded both Panera and McDonald's for the second consecutive quarter, so we are particularly excited about the June launch of our Berry Almond Chicken Salad. It's a great seasonal addition to our core salad lineup that should help us further increase our share of salad sales.

Now I'd like to update you on the launch of our new hamburger line. We remain on track to rollout our new line of Dave's Hot 'n Juicy Cheeseburgers in the second half of the year. This new cheeseburger line includes beef that is juicier and 40% thicker; quality toppings like crinkle-cut pickles and red onions; melted cheese; and, importantly, a butter-toasted bun. These new burgers are currently in 7 test markets where we continue to see significant increases in hamburger unit sales. Accordingly, our system is very optimistic about this launch.

Now I'd like to discuss another major improvement to our core menu: chicken. In the fall of 2010, we introduced a new premium chicken fillet, which included a larger, more-tender fillet and a change in our marinade and breading system. Then earlier this year, we introduced the Asiago Ranch Chicken Club to replace our existing chicken club.

In the fourth quarter, we will introduce an entirely new line of chicken sandwiches which we refer to as our Gold Chicken line. Our new chicken sandwiches will include exciting new flavors and toppings such as bruschetta with diced tomatoes, chopped basil and balsamic glaze. These sandwiches will also feature a new, butter-toasted bun. We are currently market-testing these new chicken sandwiches, and I look forward to sharing more details with you in the future.

Now I'd like to take a moment to discuss our pricing initiatives. As you may recall, in 2010 we developed a strategic pricing model that gave us the ability to measure the impact of price at the store level. The model uses demographics, the competitive environment and other drivers of product demand to project the impact of pricing on sales, transactions and profitability. We used this model to successfully increase prices in late 2010 and early 2011 and plan to take additional price increases this year.

We believe selective price increases can partially offset the significant commodity inflation we are experiencing this year, but we are also very sensitive to the effect pricing may have on transactions and market share. And therefore, our plan is to selectively take price in a way that balances our need to offset commodity increases while protecting transactions and market share.

Now I'd like to discuss restaurant remodels. Restaurant design is an important part of our Real brand positioning. We've developed several new restaurant designs this year and our first remodeled store using these designs will open in the third quarter. This slide shows one of 4 new restaurant designs we plan to test.

In addition to the contemporary and appealing exterior, all of the new designs feature changes to the interior flow that will highlight our Real positioning and the preparation of our made-to-order sandwiches and fresh ingredients. We are currently building these new designs in several markets and expect to have at least one of each open by late September. We'll analyze customer feedback and sales and expect an aggressive rollout program beginning in 2012.

Now I'd like to update you on our breakfast program. As you know, breakfast is a very important day part for the QSR industry. About 23% of traffic in the hamburger segment occurs during breakfast, representing more than $13 billion in sales per year. For the last 4 quarters, breakfast has generated the most traffic growth and most of our hamburger competitors are benefiting from this growing day part. Wendy's is the only major hamburger QSR chain without a national breakfast offering.

We are making excellent progress on Wendy's new breakfast program, and we are very encouraged with both sales and customer reaction to our new breakfast products. Sales trends are growing in our 6 current breakfast markets, even as we significantly reduce our couponing. And customer awareness, trials and repeat purchase rates are all improving. We also continue to make adjustments to menu offerings and to pricing in order to maximize profitability.

In our test markets, annualized average weekly breakfast sales are meeting our target of an incremental $150,000, which represents a sales list of more than 10% on top of our $1.4 million AUVs. Longer term, we believe breakfast represents an opportunity for almost $1 billion in incremental system-wide sales.

Now I'd like to share some encouraging customer feedback on our core breakfast sandwiches. The core breakfast sandwiches shown on this slide were rated by customers on 8 attributes: satisfaction, appearance, taste, serving size, freshness, quality, price and value for the money. As you can see, the average attribute scores for each product were very high, averaging about 9.1 on a 10-point scale. Additionally, the top-2 box scores on these products, which is an indicator of a customer's future intent to repurchase the product, were extremely high at 95%, some of the highest product scores we've ever received. The combination of our sales results and these excellent scores gives us confidence in the future earning potential of our breakfast program.

This slide shows our breakfast expansion time line. In the second half of 2010, we launched our new breakfast menu in 4 test markets: Kansas City, Phoenix, Pittsburgh, and Shreveport. In the first half of 2011, we further expanded our new breakfast into 2 additional markets: Louisville and San Antonio. Over the remainder of this year, we will continue to add more breakfast markets. And by the end of 2011, we plan to have our new breakfast menu in about 1,000 stores, which will include approximately 600 franchise restaurants.

Now I'd like to provide a brief update on our international plans. We are very proud of what we have accomplished, since the merger, in the area of international development as we continue to expand our global footprint. We have signed 6 long-term development agreements covering 23 countries including Singapore, the Middle East and North Africa, Turkey, the Eastern Caribbean, Russia and Argentina. We also recently signed a joint venture agreement with Higa Industries to develop restaurants in Japan and plan to open our first Wendy's in Tokyo later this year.

We currently have 350 franchise restaurants outside of North America and a total of 700 commitments for future restaurants, totaling over 1,000 restaurants. We are also actively pursuing joint venture opportunities in China and Brazil and look forward to sharing details of additional agreements with you later this year.

As I mentioned, we are expanding to Russia and our franchisee will open their first 2 stores in Moscow later this year. These openings are part of the development agreement announced last August with franchisee Wenrus Restaurant Group to develop 180 restaurants in Russia over the next 10 years.

In closing, 2011 is a transition year as we position the company for double-digit EBITDA growth in 2012 and beyond. We are working diligently on the strategic alternatives process for Arby's, including a potential sale of the brand. A sale would allow us to focus all of our financial and human resource capital on growing the Wendy's brand, which we believe will produce the greatest value for all of our stakeholders.

Finally, I'd like to summarize our Wendy's growth initiatives. We will deliver on Wendy's Real brand positioning by continuing to improve our core menu and ensuring that all of our products provide superior quality, freshness and taste and by introducing exciting new products. We will continue to expand breakfast, which will significantly increase sales and profitability. We will continue to modernize our facilities with contemporary new designs. And we will continue to increase our global footprint with expansion in North America and international markets. We believe these initiatives will help us deliver our long-term goal of average annual EBITDA growth of 10% to 15% in 2012 and beyond.

Now I'll turn the call back over to John for Q&A.

John Barker

Thanks, Roland. Let's open up the lines for Q&A. [Operator Instructions] We also have some calls lined up later today with several of the analysts.

Operator, would you please open up the phone lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joe Buckley with Bank of America Merrill Lynch.

Joseph Buckley - BofA Merrill Lynch

A question, Roland, just on your comments about the sale of Arby's -- the potential sale of Arby's. You mentioned de-leveraging the balance sheet. You also mentioned returning capital to shareholders. Given your balance sheet is not that highly leveraged, could you elaborate a little bit on how you'll think about it post-Arby's?

Stephen Hare

Joe, this is Steve, I'll take a crack at that one. I think the comment around de-leveraging the balance sheet really refers to 2 items. One is, as I think you and I have talked about in the past, looking at Arby's today, it has almost $200 million of capitalized lease obligations on its balance sheet. So to the extent we effect a separation here, that $200 million of balance sheet debt would go away. And then, obviously, to the extent we have some cash proceeds on top of that as part of the sale, that would be available. And from a net-debt standpoint, if it's just initially going on the balance sheet, would cause us to further de-leverage the balance sheet. Again, I think it just gives us increased financial flexibility overall going forward. So again, as Roland has talked about, we can focus all the financial resources to the Wendy's strategic growth initiatives where our priorities, as we talked about, probably shift to a fairly extensive and aggressive remodel program based on the test of the new designs that we're doing this year, as well as supporting the big marketing initiatives around breakfast and the gold hamburger launch, both of which require some capital investment in both the company stores and perhaps supporting some of our franchisees, for example, on the breakfast side, in terms of some of the marketing spend that we need to do there. So again, it puts us in, I think, a very good position of financial flexibility to make the investments necessary to accelerate our growth on the Wendy's brand.

Operator

Your next question comes from the line of Reza Vahabzadeh with Barclays Capital.

Reza Vahabzadeh - Lehman Brothers

Just as far as the input costs that you refer to, do you have good visibility on those pressures for the balance of the year? Or are you still subject to market conditions for the balance of the year, especially on beef?

Stephen Hare

Reza, our forecasts today are really based on the input that we get from our purchasing cooperatives, so on the Wendy's side, the QSCC group, and then on the Arby's side, ARCOP. And I'd say what has changed since our last quarter, if you may remember our last call, we have said, especially on the Wendy's side, that we knew that Q2 and Q3 we would experience very high beef costs. What we were unclear at that point was Q4 and the direction there. At that time, our forecast contemplated some easing of beef costs in Q4 based on those forecasts. Today, what we're seeing is some indication that we may see the prices staying at those high levels or perhaps even having the chance of increasing in Q4. And that's really the big swing, I think, in our overall commodity basket change from our previous guidance to our current guidance.

Operator

The next question comes from the line of Jason West with Deutsche Bank.

Jason West - Deutsche Bank AG

Just a quick clarification and then a question. I just want to clarify that, Roland, you said that you guys have multiple quality bids for Arby's, and then the question that I had was on the commodity inflation. Again, how does the 5% to 6% compare to what you had in the first quarter?

Roland Smith

Jason, what I did say is that we have multiple bidders that have done a significant amount of due diligence and continue to express a lot of interest and are active in the process. From a commodity standpoint, what we had previously relayed was we expected commodities to increase 2% to 3%. As of today, what we relayed was that we expect that to rise to 5% to 6%.

Jason West - Deutsche Bank AG

I was just trying to get the number for the first quarter.

Roland Smith

I mean, from the first quarter standpoint, what we have said is that our margins year-over-year were negatively impacted by 80 basis points of increased commodity so I think that's the question you're asking.

Operator

Your next question comes from the line of Michael Gallo with CLK [CL King & Associates].

Michael Gallo - CL King & Associates, Inc

My question is on breakfast, as you've had a little more time to have that in the stores. I was wondering if you continue to see that as a "$140,000 to $150,000 per year per store" opportunity. And if you could give us just some further color on what you see, profitability-wise, in that segment, whether you're sort of -- as you're getting the sales at the segment, do you think you can get profitable fairly quickly? And what kind of levels of sales, based on where commodity costs sit today, you think you need to get to breakeven in that segment as it rolls out?

Roland Smith

Michael, I can easily confirm for you that -- as I mentioned in my prepared comments, that we are experiencing in our breakfast test markets average annualized sales at $150,000. So we are very encouraged by what we are seeing from a sales standpoint. We are also seeing those sales grow as we significantly reduce our coupon rate. As you can imagine, when we open up a new breakfast restaurant -- I'm sorry, when we open up a breakfast market, we incrementally expand against advertising and couponing to ensure that we get a significant amount of awareness and trial because that sets us up for success in the future. We have always intended to kind of bring both of those concepts of advertising and couponing down over a period of time. We've begun to do that in our more-established breakfast markets, yet we still continue to see our breakfast sales increase and so that's encouraging from the standpoint of overall profitability. At $150,000 of annualized sales, which is our kind of initial goal, our stores are profitable and making money. So that's the good news there. The better news is that I think that our sales will continue to grow from this $150,000 goal, and that will certainly allow us to increase the profitability and expand margins in the longer term.

Michael Gallo - CL King & Associates, Inc

Okay, great. And then just a follow-up for Steve. It sounds like you've made a significant amount of progress on the Arby's alternatives process. Would you expect that, that will -- that Arby's will end up in discontinued ops in the second quarter? Or you think you'll continue to report it as you did in the first?

Stephen Hare

I can't really speculate on timing of a transaction, but to the extent that the process ends up in a sale transaction, I would anticipate that we would qualify them for disc-op treatment.

Operator

Our next question comes from the line of Sara Senatore with Sanford Bernstein.

Sara Senatore - Sanford C. Bernstein & Co., Inc.

I just want to go back to the question of sort of new product introductions and the success you're seeing. I'm trying to reconcile -- I know what we know has been very good growth like you're talking about entrée salads, with comps sets have essentially been flattish sequentially, I mean, and year-over-year. Can you maybe just talk about and even just in broad terms, the proportionality of some of these initiatives you're talking about, whether it's the hamburgers or the chicken? Like what I said, I'm just trying to figure out how to translate what seem to be very good reads or initial reads on product growth with comps that I would -- that are more sort of in line with the industry or more essentially flat?

Roland Smith

Well, Sara, let me start off with talking a little bit about the industry. I believe that Wendy's, compared to the industry, when we start to look at the day part of lunch where we do the majority of our sales, is performing quite well. Clearly, McDonald's is outpacing the industry in most of the categories. But when you take a look at Wendy's, we don't participate, as I mentioned earlier, in any sizable way in the breakfast day part, which is -- you take a look at some of the data that's being recorded -- is the only day part that is really growing in transactions for quite some time. As a matter of fact, the lunch day part has been negative for a number of quarters and has just recently become at least flat year-over-year. So if you're going to grow your lunch day part, both from a transactions and a sales standpoint, you have to grow it by taking share, which obviously is much more difficult and is slower than just expanding along with an expanding market. So when you look at Wendy's over the last couple of quarters, what we have done is something that we are very excited about, that I don't think that we have gotten to this point all of the dividends that our actions will ultimately kind of deliver. We, as you know, some time ago went back and talk to consumers and done a significant amount of research to really understand what could differentiate Wendy's from the remainder of our competitors for the long term, not for just a month or a quarter, but for the long term based on what consumers really want and need. And fortunately, what we learned was something that was really part of Wendy's equity, which is that quite honestly our food is seen as higher-quality. It's seen as fresher. And we relay that the consumers from the standpoint of Real, You Know When It's Real. And I talked about that quite a bit today and will continue to talk about that. And certainly, we will need to -- as we go forward, certainly, if we're going to match other competitors from the quality of facilities, from the friendless and speed of our service -- and we certainly work on those categories also, but a differentiator is something that allows a brand to grow longer-term and our differentiator is great quality fresh food that consumers consider real. And quite honestly, I think it fits very well within the trends, as I mentioned, of where consumers are going, which is healthier, fresher, higher-quality food. So we established that, and then we began to look at our entire core menu to ensure that our menu delivered against it. And quite honestly, as I've relayed to you before, it didn't, which was a huge undertaking to go and look at each of our core menu items that we thought we really needed to revamp so that it actually was kind of -- it matched what our Real positioning was really all about. We started with value, with our of My 99, which has worked incredibly well. And quite honestly, that's allowed us to kind of weed through the current issues as the consumers have been a little bit more careful with what they spend based on what's going on in the economy and gas prices. Fortunately, we've seen over the last couple of days that the newest forecast is for gas prices to come down later this year, which obviously think we will -- that will have a good impact on transactions. Then we kind of looked after salads, which was a category that clearly Wendy's had owned years ago but it lost share in. And as I've talked to you over the last couple of months, we launched 4 new entrée salads last year, very high-quality, very fresh ingredients. And as I mentioned today, the benefit of that has been that we now are leading in salad share for both -- compared to McDonald's and the Panera. Then we went after our French fries, which was quite honestly kind of a major undertaking and something that few QSRs are willing to do, even over their lifetime. But we did our research, and we launched a brand new Russet potato, natural cut, skin-on sea salt fry, which performed very well and we've begun to take fry share also as we've gone forward. And then what we are working on now is the completion of our core menu improvement, which really about 2 very important categories. Burgers, which obviously is the predominance of what we sell in sandwiches. And I think burgers, John, run about 20% or so of our sales, so it's a huge portion of our revenue. And later on this year, as you know, we are revamping the entire hamburger line. Not just one new product with a different type of cheese or some new flavor, a brand-new line that will replace our current line, which we are very excited about based on the significant improvement in hamburger sales that we've seen in some of our test markets. Juicier, thicker patty; better condiments; melted cheese; and probably the most significant improvement along with the hamburger is a butter-toasted bun, which really puts it not only on par, but directionally better than both Five Guys and In-N-Out. And then we kind of finish off our core menu improvements with a significant improvement to our chicken line, which we've already mentioned. We've already begun to get some of those improvements with a better fillet, a change to our breading and our marinade, and we'll pay that off later this year with the introduction of some exciting new flavors and, probably as importantly, include a new bun that is also butter-toasted, which really significantly improves the quality and the flavor of that line. And so what I think you will see as we complete this year is a total revamping of our entire core menu, which will establish, I think, the positioning that we really are the highest quality and the freshest food in the category. It differentiates us as we go forward. It matches with the trends of where consumers are going, and we will begin to see our sales grow month over month over month based on these improvements. None of these improvements quite honestly are kind of intended to be very quick fixes that are just in the market for a month or so. And again, we began to see, kind of, based on external and internal information, share gains in both our value offering, our fries, our salads, and certainly in the markets that are testing hamburgers -- our hamburgers. And I think those share gains will begin to take share from our competitors and allow us to grow our sales this year. We continue to be very optimistic about our ability to grow same-store sales this year, 1% to 3%. And we think that as we complete these new-product core improvements and begin to introduce some additional exciting new products, we will continue to be able to grow our sales over the long term.

Operator

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

John Glass - Morgan Stanley

Two questions. One is just follow-up to that which is, "Is there a barrier?" It seems like there is still that disconnect; you're not generating incremental visits to your business with all these good products. And so is there -- have you ask people who haven't come or lapsed users what is their barrier to not coming back or preferring some other brands? If you could maybe answer it that way. And then secondarily, can you talk about the pacing of pricing this year? What was the pricing in the first quarter? Is the "remainder of the year" pricing a function more of product rollouts where you can take more pricing, like with the burgers? Or do you plan it more discreetly and sort of layering in pricing on kind of that 4-corners model where you just price as you go through each market and find opportunities?

Roland Smith

Let me talk about your concept of barrier first. We don't believe there are barriers based on our brand or our offering that would keep consumers from coming into our store. The major barrier that we're all experiencing right now is what's going on in the economy and what's going on with gas prices and what's going on with jobs. And all brands certainly are feeling kind of some of that effect. As I mentioned earlier, the breakfast day part has been growing and, therefore, I think the majority of our competitors that are showing some growth are experiencing that growth. From the standpoint of our transactions, if you go back 3 or 4 years, we were certainly suffering with transaction losses based on the fact that what had happened with our -- everything from our advertising to our core product line. And we have seen in 2010 significant improvement in those transaction trends, many of those months' transactions being positive. In the first quarter of this year, as you know, based on my previous comments, based on winter weather and some issues obviously in Canada, we saw our company-operated sales down about 9/10. And we saw transactions down about the same level, and I think that was kind of driven by the same factors. As we go forward, as we look at 1% to 3% same-store sales growth this year, we fully expect that, that growth will be a combination of transaction improvement and also selective price increases. Speaking of price increases, let me address your question in both of the categories. First of all, yes, we are introducing higher-quality, fresher, Real products and in that regard, we have the ability to price them at a level that is again slightly above what we're pricing some of those products now. Clearly, that will allow us to kind of maintain as much as possible our margins, and our testing with these products has allowed us to have fair elasticity in these products because of their great quality and the demand. But from the standpoint of what we've done and what we plan to do, clearly, we are using our strategic pricing model to carefully look at all of our product line based on geography as to where we will be able to take price increases as we go forward. And we'll do that selectively based on what the data tells us. We've explained a lengthy example of how we used it in 2010, specifically around the Jr. Bacon Cheeseburger, taking it up in some stores but not in other stores based on demographics and competition and other factors. And so we will continue to be selective as we take price increases. We know that we have some room to do it, and we certainly have plans to do it as we go forward. As I mentioned, same-store sales will be a combination of growing traffic and price increases. But we'll do it in such a way, as I mentioned also in my prepared comments, that we don't kind of suffer from traffic losses or share losses just for a short-term gain in sales, because we think that the long-term benefit of our core product improvements and how we will price this as we go forward to the consumer will allow us to continue to grow sales for the future.

John Glass - Morgan Stanley

I'm sorry, what was the pricing in the first quarter? Nothing?

Roland Smith

No, no, we took some price in the first quarter late in March. We don't talk about the exact pricing obviously from a competitive standpoint.

Operator

Your next question comes from the line of Howard Penney from Hedgeye Risk Management.

Howard Penney - Prudential Equity Group

Hi. Roland, I guess I generally, basically agree with the direction that you're going. But if you allow me to just push back a little bit, it just sort of strikes me as though everything -- you talked about breakfast and the new products that you're rolling out in the back half of the year -- is that it's basically a defensive move. So you're having to react to the fact that the industry has breakfast and now you're adding it and a lot of your competitors have already improved their menus and upgraded, that now you're having to upgrade your menu. Is there something in what you're doing that we don't know or are not seeing that is an offensive move? And I say that in light of sort of what McDonald's has been highlighting in the last couple of days and the balance of this week, some of the new stores and how they're focusing on their dine-in business and another sort of offensive move. Thank you.

Roland Smith

Thanks, Howard. I quite honestly see it somewhat differently than you do. I see the actions that we're taking as very offensive from the standpoint of what we're doing to grow our sales. Let's start with our core menu, which you have written about kind of extensively. I can't find another competitor that has taken the actions that we have taken over the last year and will finish this year to improve almost every core product on our menu. That's a huge undertaking. And I think that is something that will pay dividends over the long term and pay some significant benefits over the long term. From a breakfast standpoint, certainly, we have not participated in the breakfast day part up until now, except for a failed launch attempt 4 or 5 years ago. And I quite honestly think that, that didn't succeed for a couple of reasons: one, the products were not consistent with our brand positioning; and two, it wasn't rolled out in a careful kind of thought-through methodology that would allow us to drive trial and awareness up front so that consumers could come back in. But from the standpoint of our products, quite honestly, I don't see our breakfast as defensive. I see it as taking advantage of a $13 billion category that we currently don't participate in. And quite honestly, I don't believe that any of our competitors have top-2 box or attribute scores anywhere close to the quality of the products that we have and that I've shared with you today. As I mentioned, I believe the trial and repeat numbers are based on the high quality of these products. And certainly, I think some of our competitors have gone out and eaten these products and have said in their own defensive way, "Wow, we better do something to our products or we're going to get share taken away in a hurry." And quite honestly, I don't think they're capable of doing it quick enough and have an entire line that's as high quality of the products as we currently have. And so that's why I think we're experiencing significant sales in our test markets of $150,000. That's why I think they're going to grow. And then also from an offensive standpoint, if you take a look at our share gains, specifically in salads, I mean that's pretty impressive. We are selling more salads in kind of our little -- over 6,000 stores than McDonald's is selling in their stores that are almost double those. I think that's a pretty significant indicator that the consumer has voted for better quality, fresher, kind of higher quality products.

Operator

Your next question comes from the line of Chris O'Cull with SunTrust bank.

Christopher O'Cull - SunTrust Robinson Humphrey, Inc.

Roland, I was wondering what the company's learned so far from the premium cheeseburger tests, maybe in terms of repeat usage, pricing, mix shift and whether you need to make any additional changes before it's rolled out system-wide.

Roland Smith

I think, Chris, our learning so far has been very exciting. And that's, as we shared with you on our last call when we were tracking kind of only several markets, our large hamburger sales were up, someone will have to correct me, about 38% or so, which is pretty exciting from the standpoint of consumers coming in and choosing this new sandwich. In our test markets that we're rolling out, we continue to see significant improvements in large hamburger sales. We don't see any negative feedback from the standpoint that the product is juicier and thicker and has melted cheese, the butter-toasted bun; they're all positives. In fact, what we are hearing from consumers, kind of, some anecdotally and certainly some in the tests that we have done from a research standpoint, is that this hamburger line kind of is better than both In-N-Out and Five Guys, which is pretty exciting, which is why we are very excited about this launch this year, and quite honestly, would love to do it much earlier. But to do it right, you need to do it in a thoughtful and disciplined way. We wanted to make sure that we understood, from a operation standpoint, how this is going to work. We have to adjust all of our grills because the beef is thicker. We have the install bun toasters to toast the buns. We have to train our customer service workers to be able to deliver this product in the same fast speed of service that Wendy's own as we have. And so we're doing it in a systematic and thoughtful way, and we'll have it in all our stores later on this year.

Christopher O'Cull - SunTrust Robinson Humphrey, Inc.

Could help us understand the potential of the new line? And by that, I mean, "What is Wendy's current share of the burger market?" What was it in the past -- what was it at the peak? And maybe, what does a percentage point change in market share equate to in sales?

Roland Smith

Well, all great questions, Chris. I can't tell you that off the top of my head. I can tell you from our internal standpoint, even based on our current product, we believe that in the first quarter, we now exceed Burger King in share of hamburgers even with less stores. So we think we're making great progress across our system. Certainly, we can follow up on some of those details later on today.

Stephen Hare

Chris, we have all that detail. We just don't have it here right with us.

Christopher O'Cull - SunTrust Robinson Humphrey, Inc.

Okay, great.

Roland Smith

But certainly, it is a large opportunity for us. We are first and foremost a hamburger chain, as I mentioned earlier.

Operator

Your next question comes from the line of Phillip Juhan with BMO Capital Markets.

Phillip Juhan - BMO Capital Markets U.S.

You mentioned in the past or you noted that a 30% to 40% traffic lift for breakfast in test markets. And I'm just curious to know, as you back away from discounting promotions in some of those test stores, how was that traffic trending? How much of it are you keeping? And maybe what's the offset to average check during this period?

Roland Smith

Well, Phillip, I don't remember exactly providing those numbers. What I can tell you is this: As I mentioned earlier, our sales are improving. We are running, from the standpoint of average annualized sales, about $150,000. That continues to grow in each of our markets kind of month-to-month. I will say that we have significantly reduced couponing, as I mentioned earlier, and we have not seen our sales decline based on that. And we have also begun to kind of, as I mentioned, manage our pricing. And in some cases, we've taken our pricing down slightly because we've added a value menu or we've learned some information about what the consumer is willing to pay at the breakfast day part. But certainly, those sales are driven by significant increased traffic in the morning day part. I mean, to give you a percentage -- it's a little silly because it's gone from zero to a pretty big number. We could take that traffic and divide it into our overall restaurants. But I think, probably, what is important is, "Are our sales are growing? Can we maintain them? And can we kind of become -- can we kind of generate profitable kind of EBITDA based on $150,000?" And the answer to all 3 of those is yes. I think maybe, Phillip, what you are referencing is in our original test markets, if you take a look at where breakfast was a year or so ago and you take a look at where it is today with the brand-new menu that we have in place, the growth over what we were doing previously in breakfast sales versus where we're trending today is a little over 40%. So I think that's the 40% number, which is also pretty encouraging because those restaurants already had breakfast. It was in place. I think it's an indicator that this new breakfast menu is a significant driver of our ability to go forward with this because, I mean, if there weren't a significant improvement in sales based on the new menu, you'd start to wonder if in fact this has the staying power and the growing power that we suggest. But a 40% increase over the old menu is a pretty significant improvement.

Operator

Your next question comes from the line of Jocelyn Mackay with Morningstar.

Jocelyn Mackay

I had just a quick question, if you couldn't quantify the effect on Wendy's of that increment weather. I know in your Q that you filed, you were able to quantify the Canadian tax issue at just under $2 million. I was wondering, more detail there?

Roland Smith

When we talked last March, we said that certainly the significant impact of weather was in the early part of the quarter. And we said that it was roughly about 1.5 points of same-store sales for that particular time frame. We haven't quantified what that means in bottom line EBITDA.

Jocelyn Mackay

Okay. And then just a quick follow-up. Do you have any details on traffic and pricing and how that affected same restaurant sales at Wendy's?

Roland Smith

For what period, Jocelyn?

Jocelyn Mackay

For the first quarter.

Roland Smith

Yes. Sales, as you know, for company-owned stores in North America was down 0.9%, impacted obviously by the weather and also impacted by what I mentioned in my comments earlier, which was a very soft business in Canada based on an increased sales tax, which raised our menu prices in a couple of provinces. When you take out Canada, we were close to flat in the U.S. I think what'd more important is in April, we've now started trending positive. In the U.S., we're a little over one point. I also mentioned that transactions pretty much mirrored same-store sales in the first quarter for North America, down about 0.8%.

Operator

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

Amod Gautam - JP Morgan Chase & Co

This is Amod Gautam on for John. It seems like a good amount of the margin compression for the quarter was driven by investment-in-breakfast expense rather than solely commodity pressure. I wanted to know if you can give us a sense for whether the 110 basis points is a fair assumption for each quarter for the rest of the year. I'm just trying to get a sense for kind of the pacing of the breakfast headwind and for how long you guys will experience it.

Roland Smith

Yes. I mean, clearly, as I mentioned earlier, in order to ensure that we see the breakfast market with awareness and trial, we investment spend in both advertising and couponing. You saw with what that cost us in the first quarter. I think the biggest impact will be in the first and the second quarter because, starting in the third quarter, we were rolling over what we had done last year and so the incremental-ity is significantly less. And certainly as we get into a more mature situation in our breakfast markets, that begins to come down. So I think you're going to see for the next quarter some continued investment as a comparison to year-over-year margins, and then that will start to kind of significantly be reduced in the third and fourth quarter.

Operator

Your final question comes from the line of Michael Kelter with Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc.

I wanted to ask you a little more about Canada and what went on there. I guess I'm curious how much the sales tax raised your prices effectively in the market that would cause a negative 4.7% same-store sales decline, and maybe what that tells you about your elasticity to price and how that might impact the United States later in the year.

Roland Smith

Mike, I can't tell you exactly how much it raised the price but I can tell you that it was a significant value-added tax called, kind of, HST that happened in a couple of provinces that is already baked in your menu price when the consumer comes in and looks up on your menu board. We clearly understand that there is a real relationship between the pricing of your products and transactions as you go forward. If you take a look at some of our competitors in Canada, they've also talked about the negative impact of this particular tax increase in Canada. The good news is that we will roll over this relatively soon, and so that impact, I think, will be a lot less measurable as we get into the later kind of quarters of the year. One of the reasons we have carefully talked about what we would do in pricing in the U.S. as we go forward this year is because we understand that if you're not careful, if you're not strategic, it will have or could have a negative impact on transactions, which ultimately might have a negative impact on market share. So we're being cautious about that. The Canadian market, as I think you are well aware of, is a market that is already much higher-priced than the U.S. based on what the commodities are there. And I think maybe this increase had a little bit more kind of sensitivity to those Canadian consumers. As an example, our My 99 Value Menu in the U.S. is translated to a $1.89 value menu in Canada. So there's a fair amount of nuances that go on there. But clearly, with Canada down almost 5% in the first quarter, it had a measurable impact on our North American results.

Michael Kelter - Goldman Sachs Group Inc.

So I guess with that amount of elasticity, I guess I'm just trying to get my head around how the back half of the year might play out, because the first 4 months now you're below the 1% to 3% guidance range. And I'm curious what gives you the confidence that the back half will turn around. I know there are a lot of new products coming, but we just had a bunch of new products, too, right, with the new salads and new fries. So I just want to understand your level of confidence and what you think the biggest drivers will be.

Roland Smith

We are very confident, first of all, that we will be able to meet our guidance of 1% to 3%. We've begun to see the trends change in April, as I've mentioned. And as we've looked at early May, that trend is continuing to improve. We had very strong product introductions. Currently, we're going into the salads. We're going into additional value. I don't really want to get into too much in the third and fourth quarter, other than what I've told you, for competitive reasons. But clearly, the last 2 core product improvements of our new hamburger line and our chicken line are going to have a significant impact on our ability to grow sales. And we think that those sales will be a combination of transaction improvement and also price increases that we will take selectively. And while we were confident about this kind of a week ago, a little more confident about it as of the last couple of days as we have seen the forecast of gas prices starting to come down, which will also have a positive impact on our sales going forward. So I guess I'd leave you with the comment that we are very confident that we're going to be able to significantly improve our sales trends so that we can continue to meet our guidance of 1% to 3% for the year.

And thank you all for participating today. I'd just like to close by leaving you with a few thoughts.

First, as we've mentioned a couple of times, 2011 is a transition year for us. We will be working hard to complete the strategic alternatives process for Arby's and do that as quickly as possible. As I've also mentioned, a sale of Arby's would clearly allow us to focus all of our resources on growing the Wendy's brand, which we think will be in the best interest of our shareholders.

Second, while we have lowered 2010 guidance to reflect commodity increases, we are -- continue to be very excited and optimistic about our Wendy's growth initiatives that I shared with you today. We will continue to focus on our Real brand positioning, which we think really differentiates us from our competitors. We will ensure all our products provide superior quality, freshness and taste. We're improving our core menu, as I've talked about extensively today. We've already kind of revamped value, salads and fries. We're growing share in each of these, and we've got some exciting new products starting with some core product improvements later this year with our new cheeseburger line and our Gold Chicken line. We are expanding breakfast. We're growing sales. We're meeting our expectations of $150,000 AUV target, and we are on track to open or have 1,000 stores serving breakfast by the end of this year.

We did talk about modernizing for our facilities. We have 4 new designs, which we're very excited about. Not only are they contemporary and inviting from the outside, but the changes we're making to the inside are very significant from the standpoint of relaying to the consumer why Wendy's is different, why our food is fresh and higher quality, which is certainly in line with our Real brand positioning.

And as you know, we continue to work very aggressively on expanding our global footprint. We have 350 restaurants internationally today. We have another 700 commitments. When those are built, that will be a total of 1,000 stores. And we have continued to work on a joint venture opportunity in both China and Brazil.

Finally, as I mentioned, we're excited about the future of the brand for all the reasons I've relayed and continue to think that we can deliver 10% to 15% average annual EBITDA growth beginning in 2012. Thank you so much for your time and attention today. We'll be looking to talking to you today and tomorrow, over the next couple days to answer the remainder of your questions.

Operator

Thank you for joining today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Wendy's/Arby's Group's CEO Discusses Q1 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts