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Wendy's International (NASDAQ:WEN)

Q1 2007 Earnings Call

April 26, 2007 1:00 pm ET

Executives

Kerrii Anderson - President, CEO

Jay Fitzsimmons - CFO

Brendan Foley - SVP, Controller

Ian Rowden - CMO

Dave Near - COO

Jonathan Catherwood - Treasurer

Tad Wampfler – SVP, Supply Chain Management

Everett Gallagher - SVP, Enterprise Tax & Risk Management

John Barker – IR

Analysts

Jeffrey Bernstein - Lehman Brothers

John Glass - CIBC World Markets

Glen Petraglia - Citigroup

Andy Barish - Banc of America Securities

David Palmer - UBS

Roger Saks - Societe Generale

John Ivankoe - JPMorgan Chase & Co.

Rachael Rothman - Merrill Lynch

Joe Buckley - Bear, Stearns & Co.

Steven Kron - Goldman Sachs

Howard Penney - Prudential Equity Group, LLC

Scott Frost - HSBC

TRANSCRIPT SPONSOR
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Operator

I would like to welcome everyone to the Wendy's International first quarter results conference call. (Operator Instructions) I would now like to turn today's call over to John Barker. Please go ahead, sir.

John Barker

Good afternoon, everybody. The purpose of our investor call and webcast today is to discuss our first quarter results and to provide an update regarding some key initiatives. We released the first quarter numbers after the market closed yesterday and we just held our annual meeting this morning here in Dublin at our corporate headquarters. The news release and the financial statements and other information from the release are available on our website, www.wendys-invest.com.

Our agenda for today, we will begin with remarks from Wendy's Chief Executive Officer and President, Kerrii Anderson. Kerrii's going to review our first quarter highlights and then share an overview of some strategic initiatives. After that, you'll have an opportunity to hear briefly from Jay Fitzsimmons, who is our new Chief Financial Officer; and then Brendan Foley, our Senior VP and Controller will walk us through the financials for the quarter and after that we'll be taking your questions.

Also on the call today from management is Chief Marketing Officer, Ian Rowden; our Chief Operations Officer, Dave Near; as well as Dave Poplar, our Head of Investor Relations.

Looking ahead, please note that we plan to release our second quarter sales on Friday, July 6 and our second quarter earnings date is set for Thursday, July 26. In the near term, we have some events coming up. The first one is we have an analyst day on Monday, April 30 here in Dublin and what that is, we typically bring in ten to 12 analysts and basically just take them through a day. It's not a full-blown analyst meeting, so that is something we've been working on for quite some time. That is set up. Nothing special, just standard procedure, talking about the business, nothing special.

We'll then be attending two conferences coming up. The first is the Lehman Brothers 10th Annual Retail Conference and that is in New York on May 2nd we'll be there. Later in the month, we'll be at the FDR Growth Conference on May 30th and 31. All these disclosure dates, as we confirm them, will be listed on our website and you can take a look at them there or contact Dave or I to confirm.

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

Finally, some of our comments today could reference non-GAAP financial measures such as earnings before interest, taxes, depreciation and amortization, or EBITDA, and you can find reconciliations to any of those non-GAAP terms to the most directly comparable GAAP financial measure either in the earnings release or on our website.

Now let me turn it over to Kerrii.

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Kerrii Anderson

Thanks, John and good afternoon, everyone. The first quarter financial results we released yesterday, I believe, really do show that we are executing our strategic plan and as a result, our performance is continuing to improve. Our sales strengthened during the quarter; menu management and our initial-cost cutting efforts are generating earnings improvements.

Same-store sales at our U.S. company-operated stores increased about 3.8% for the quarter, compared to a 4.8% decrease for the first quarter of last year, so that's really a change of 8.6%. Our same-store sales at our U.S. franchise restaurants increased 3.7% compared to a 5.2% decrease in the first quarter of last year and again, that's about an 8.9% improvement.

Our EBITDA margins from continuing operations improved 440 basis points while our EBITDA from continuing ops increased $57 million from $31 million. I am truly proud of this management team, our employees throughout the organizations at our stores, as well as our franchisees for their contributions to this performance. Our company-operated EBITDA margins were up about 260 basis points, which is up from 6% last year in the first quarter to 8.6% this year.

Now, Brendan is going to discuss in detail the financial results, but overall it was a very good quarter.

I would like to give you a few other points about the quarter. From a development perspective, we did open about 11 new restaurants system-wide, but at the same time we closed about 26 restaurants system-wide and I think we talked about the fact that we anticipate in the end of the year, opening about as many as we have closed. The openings consisted of three company-operated restaurants and eight franchises.

We continue to see many other good signs in the quarter, which give us confidence that our turnaround is gaining momentum. It was the fourth consecutive quarter of positive same-store sales, and we are excited about the new products and the marketing initiatives that we've got in place for the rest of 2007.

As you can see on the income statement, we did an excellent job of cost containment in the quarter, which is primarily a result of our successful effort to achieve the G&A in the overhead cost savings, and in the first quarter, G&A decreased about 100 basis points as a percentage of revenue relative to last year’s first quarter.

Finally, the positive impact from new product introduction, such as our Deluxe Value Meals and our Three-Tier Combos as a part of our menu management strategy -- that's what we mean when we talk about menu management – the new products, what we're changing as far as the mix on our menu, really did help improve our results compared to last year.

From a corporate perspective, the past few months have been very busy. In the past month, we've bolstered the talent and the experience of the management team with the appointment of what I would consider to be three key consecutives.

In early March, we announced the hiring of Paul Kershisnik, our new Senior Vice President of Marketing Strategy and Innovation. He is responsible for our newly expanded innovation and strategy group in marketing, which consists of R&D, strategic insights and operations innovation. He is a seasoned professional who has a very impressive resume with 21 years of experience, some of the world's best known consumer brands including Pizza Hut, Pepsi, General Mills, and Sprint.

Along with Paul, we announced in early March that Tad Wampfler had joined us as our new Senior Vice President of Supply Chain Management. Tad's got an excellent background for his position with strong technical skills in the supply chain area, as well as tremendous leadership in operations positions in other companies such as: Dunkin' Donuts, Dunkin' brands, Church's, Popeye's, and Cinnabon. He is absolutely a key member of our management team, working in concert with marketing, research and development, QA and IT.

Finally, last week we announced the hiring of a new Executive Vice President and Chief Financial Officer, Mr. Jay Fitzsimmons, who comes to us from after more than 12 years of being a member of the executive management team as Treasurer of Wal-Mart. As you saw in the press release we issued, he's been a key player for one of the largest retail companies in the world and has a good restaurant background. He even served as a sell side analyst for the restaurant industry, so now we know all the questions you guys are going to ask. We're excited about the experience he brings to our team and to our strategic planning committee. He's here with us today. So I would just like Jay to say hi for a couple minutes.

Jay Fitzsimmons

Thanks, Kerrii. I must say that my first three days at Wendy's have been very exciting. Seriously, I'm delighted to be associated with a great brand and excellent management team with a solid strategic plan. I look forward to helping Kerrii and the management team here create value for all of our constituencies: our shareholders, our franchisees, our employees, and our customers. Given my short tenure, I can't add much at this time, so I'll turn it back over to Kerrii for further details.

Kerrii Anderson

We look forward to introducing you to Jay, if you don't already know him, during our upcoming Investor Relations events that John mentioned earlier.

In March, we also announced the successful completion of our accelerated share repurchase transaction, which we bought back more than 9 million shares at an initial purchase price of $31.33 per share. As a result of the lower number of diluted weighted average shares outstanding, of course we now expect that our new full year 2007 EPS guidance to be in the range of $1.26 to $1.32, which is up about $0.09 from our prior guidance.

Our full-year EBITDA guidance remains unchanged at $330 million to $340 million so as we look ahead, our 2006 sales results were much stronger in the balance of the year relative to the first quarter, so we are focused on improving sales through better operations and marketing to meet or exceed our first quarter same-store sales performance in the second quarter.

Also, rising commodity costs driven by the demand for ethanol -- and I know you're hearing this in every conference call you're participating on -- will result in higher than expected food costs for the balance of the year. We believe that chicken for us will be up on a year-to-year basis for the rest of the year somewhere in the 3% to 5% range; and it really varies, certainly, compared to others in the industry, depending on their contracts. Beef for us, and I just remind you all that we're on a quarter lag with beef, so when it's going down, we don't get it as quickly and when it's going up, we don't feel it as quickly. So beef for us, our expectations for the rest of the year are actually supposed to be flat to slightly down 1% or 2%.

We're also concerned though about the forecast for inflation increases and its affect on consumer spending. However, we intend to balance our Premium Value strategies to make sure that we meet the changing consumer's needs. We do have a number of initiatives that we are driving in order to help offset some of the pressure from food cost. I mean, we've got price which we've talked about, we've got changes in specs, we've got menu mix management, we've got beverages which certainly add to really improving margins and lowering food costs. So we're working on many of those initiatives as a part of our system.

We are confident about our initiatives to drive sales, reduce our store level management labor, and improve our service will result in profit growth in the second quarter and second half of the year. Looking ahead, I am really excited about the upcoming promotions in marketing. We're currently promoting the new double-melt cheeseburgers, you guys saw a variety of that at one of our meetings in New York. This is a steakhouse double melt, which is great as well as a new chunky chicken salad that is a Freschetta deli sandwich. We've got great news coming throughout the year and our pipeline of innovation and new products is very strong.

We also continue to focus on strengthening in the overall brand perception and value perception of the Wendy's brand as we evolve our brand positioning with our new advertising agencies, Saatchi & Saatchi and kirshenbaum bond + partners. And while our cost cutting efforts to date have been successful, we will focus on creating additional efficiencies in every area of our business as we continue to explore opportunities to reduce G&A.

In closing, I am very optimistic about the remainder of 2007. We have got good momentum in our business, we have a solid strategic plan, and we have the leadership in team in place to execute it. That will allow us to continue to drive sales and profits. We're very happy that we've got this team together and I look forward to working with the group to continue to identify and implement opportunities to drive improved performance.

So at this point I would like to turn it over to Brendan for some comments on the financials.

Brendan Foley

Thanks, Kerrii. I'll start with an overview of our key performance metrics and then walk through the income statement line by line to discuss some of the more significant items that affected the quarter. Total revenues were up 2% from about $579 million to about $590 million. Increase in revenues was driven by improved same-store sales. As Kerrii mentioned, our Wendy's U.S. company stores same-store sales in the first quarter of '07 was 3.8% compared to a negative 4.8% in 2006, an improvement of 8.6%.

Our Wendy's U.S. franchise stores same-store sales were 3.7% compared to 5.2% last year, an improvement of 8.9%. Reported store operations EBITDA margins improved 260 basis points from 6% to 8.6%; and without the impact related to an accounting change for the company's Canadian 50-50 joint venture with Tim Horton’s from full consolidation to the equity method of accounting, the store EBITDA margins for the first quarter of 2007 would have been 8.9% versus the 8.6% being reported today. That 8.9% versus the 6% last year represents a 290-basis point improvement.

As a result, pretax income from continuing operations improved from a loss of $7.6 million last year to $21.8 million this year. Net income from continuing operations improved from a loss of $6 million last year to net income of $14.5 million from continuing operations this year. Diluted EPS from continuing operations of negative $0.05 last year improved to $0.15 this year. EBITDA from continuing operations improved from about $31 million to $57 million, and EBITDA margins from continuing operations improved 440 basis points, 5.3% to 9.7%.

Looking at the individual lines on the income statement, as I mentioned, sales and franchise revenue growth are primarily impacted by positive same-store sales. Looking at cost of sales, this is where most of the store operations EBITDA improvement came from in the first quarter of 2007. Cost of sales declined from 64.2% in 2006 to 62.0% in 2007. This 220-basis point improvement is due to positive same-store sales, lower beef cost partially offset by higher costs in other commodities, an improved mix of products sold, and better food cost management resulting in lower food waste.

Company restaurant operating costs as a percent of sales declined from 29.2% in 2006 to 29.1% in 2007. The improvement reflects both the impact of the 2006 cost savings initiatives and better leverage from higher sales. The reported results on this line item would have improved an additional 20 basis points except for the impact related to the accounting change for the company's 50-50 Canadian joint venture with Tim Horton’ from full consolidation to the equity accounting method. As a result of this change, the 2007 company restaurant operating cost line includes rent paid to the joint venture that was previously eliminated in consolidation. This increased expense on this line.

On the operating cost line, the $15.9 million decline is primarily due to $15 million in special advertising expenditures made in the first quarter of 2006 that did not recur in 2007. For G&A, the lower expense and 100 basis point improvement as a percent of revenue primarily reflects the impact of the 2006 cost savings initiatives. These benefits were partially offset by higher bonus accruals of approximately $3 million based on improved financial performance, higher stock compensation expense of approximately $2 million and general inflationary cost increases.

On the other income expense line, the $8.9 million increase in net expense is due primarily to approximately $4 million in asset gains recorded in 2006 that did not recur in 2007 and also include approximately $3 million in incremental store closing charges recorded in 2007 compared to 2006.

Interest expense was higher in 2007 as a result of the sale of 2007 royalties that was entered into in 2006. To remind you in 2006 the company received $94 million in return for future 2007 royalties. The $94 million was accounted for as debt in 2006. In 2007, the repayment of this royalty-related debt is being accounted for as a typical loan, comprising both the repayment of debt and the recording of interest expense. As a result, interest expense is up in 2007.

For interest income, the approximate $3 million increase in 2007 is due to higher average 2007 cash balances, and a higher rate of interest earnings on those balances. For taxes, the effective tax rate of 22% in 2006 and 34% in 2007 both reflect certain discrete items that reduce the effective rate for both periods. You may be aware with the implementation of FIN 48 there may be more volatility in the effective tax rate going forward than there has been historically.

Before turning it back to John, let me summarize the significant amount that affects the comparability of the first quarter 2007 results to 2006. First, the $15 million of incremental pretax advertising expense that impacted the 2006 operating cost line but did not recur in 2007. This quarter the company recorded approximately $3 million in incremental pretax expense for performance-based incentive compensation, commensurate with stronger 2007 operating results compared to 2006. This impacted the G&A line on the income statement. While this was certainly not a one-time item, I do want to call it to your attention because it affects comparability to 2006.

2007 included a higher stock compensation expense of approximately $2 million. The other expense line this quarter shows an incremental $3 million in pretax restaurant closing and lease termination expenses. These store actions were announced in 2006 and were completed and recorded during the first quarter of 2007. The company did not have significant expenses for restaurant closings in the first quarter a year ago.

The other expense line item in the first quarter of 2006 includes approximately $4 million in gains on asset sales that did not recur in 2007. The impact of no longer fully consolidating the company's real estate Canadian joint venture with Tim Horton’ impacts a number of line items, but overall the net decline of first quarter 2007 operating income from this joint venture was approximately $2 million. In sum, those items that I just walked through on comparability year to year net to a $1 million differential.

We recorded tax expense at an effective rate of approximately 34% in the first quarter of 2007 compared to a tax benefit of $1.7 million one year ago. Finally, the last comparable item I wanted to mention was our first quarter diluted weighted average share count of about 96 million this quarter compared to approximately 115 million a year ago.

Now, let me turn it back to John.

John Barker

Thanks, Brendan. I hope everybody was able to follow along with that from a P&L standpoint, because that would answer a lot of questions we were getting even last night. Let's kind of move forward to a couple of last things. First, the board of directors approved yesterday our 117th consecutive quarterly dividend, and that's going to be paid on May 21st to shareholders of record of May 7th. Quarterly payment is $0.125. This is our first payment since the board voted in February to increase our annual dividend by 47%. So the annual rate would go from approximately $0.34 to $0.50.

Finally, before we open up the Q&A, I would like to address the announcement in our release yesterday that regards the special committee that the board of directors has formed to investigate strategic options for the company. As we noted in the release these options may include, among other things, revisions to the company's strategic plan, changes to our capital structure, or a possible sale, merger, or other business combination. Our Chairman, Jim Pickett -- and Jim's been on the board, I think many of you know, for 25 years -- is going to be the head of the committee and that committee is focused on driving the future value for our shareholders and stakeholders.

We do not intend to provide updates regarding the committee's actions, but we will and intend to report specific developments as circumstances warrant. The committee does not have a specific timeframe to complete its review and we are not disclosing the specific members -- these are independent board members, by the way -- who will comprise the committee. We will not discuss this matter further on the conference call today. What we would rather do and what we're going to do is take your questions about the first quarter results, our '07 outlook, and operations and marketing.

We have Dave Near, as I mentioned, we have Ian Rowden here. We'd like to talk about the quarter, so please focus your questions on those subjects. Cynthia, if you could now start queuing up for questions, we'd appreciate it.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeffrey Bernstein - Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

If I have to stick with the first quarter, just a question on comps and your outlook for the rest of the year. I know you're targeting 3% to 4% in '07. I believe that's prior to any breakfast benefit. It's obviously a significant ramp up, especially looking at the year-ago period. I know you've highlighted that your comps did come in in that range in the first quarter, but that was lapping close to a down 5%.

Just wondering what gives you comfort that as you move through the year and you lap actual positive comps that you will be able to deliver what will presumably have to be much stronger comps to come into that 3% to 4% range? Thanks.

Kerrii Anderson

First of all, I think we feel very good about the 3% to 4% for the rest of the year, and I think what drives that performance for us as we look out first and foremost, is a really strong marketing calendar. Ian, you can pop in here at any point in time, but we have got some great new product introductions that are coming up in a lot of categories, whether it be new sandwiches from a hamburger which is our primary focus, as well as value for our customers and a great beverage strategy that's going to introduce, for us, I think some real new news to our customers.

Last year at this time, we were just rolling out Vanilla Frosty and it didn't roll out until the end of July. So we are entering in a period in which we've got floats, Vanilla Frosties, a number of new products. That's number one.

Number two I would say, is we also have new agencies, new creative. You won't see any of that creative until the end of May. I think we feel very good about our message that we're talking to consumers about and our focus to really drive transactions and check, especially in the second quarter as well as beyond the rest of the year. Now, that's it from more of the marketing standpoint.

Operationally, a couple things there and Dave, you can pitch in at any point. But we have really focused from an operations perspective on improving the key attributes, whether it's accuracy or customer courtesy, our cleanliness in our restaurants. We're spending a lot of time talking with our operators about the importance of that, as well as speed of service. Speed of service certainly drives same-store sales.

Those are, and you are correct, Jeffrey, it's without breakfast. But those are the things that give us confidence.

The back half of the year is much stronger. This current quarter, just to remind everybody, the comps we're going up against are basically flat in April, flat in May, and 2.4% in the month of June. So that's what our current quarter looks like and it's the height of the season. The back half will certainly be stronger from the standpoint of being able to carry over some of the strong numbers that we had last year.

Ian Rowden

I just think the confidence we have is based on the balance of the calendar. Kerrii's already said this, but ten new products this year. We've got the flow through effect of our Three-Tier Combo pricing program and we've got learning from a value point of view, plus our market-based pricing initiatives that we've put in place and I think we've got a great balance that understands when we can pull certain levers, at what time, in our business.

Dave Near

From an operations perspective, we made some good progress in the first quarter versus some of our own internal measurements and metrics, so our plan is for those to certainly continue in the second quarter and beyond.

Jeffrey Bernstein - Lehman Brothers

I don't know if you're willing to talk about this, but obviously we're towards the end of April. Just wondering if you'll give any color in terms of what the trends are looking like as we move through this month.

Dave Near

To summarize our answer, no.

Kerrii Anderson

I think everyone knows, we went to a strategy of releasing quarterly comps last year.

Dave Near

I think I gave you the date when we'll put out our second quarter sales in July.

Ian Rowden

Just from a brand strategy point of view, the other thing we're getting greater confidence in is the way in which the strategy we have in place is starting to get traction from a quality perception and from our communication of the things that truly differentiate us. We feel good we're finally starting to find our feet with all the things we've talked to you about in the last year.

Operator

Your next question comes from John Glass – CIBC World Markets.

John Glass - CIBC World Markets

Could you help summarize just what are the one-time events or one-time items in the first quarter results that will not recur later in the year? Asked another way, comps are going to be 3% to 4%, if that's the plan, why will margins get better from here if costs are incrementally more challenging? Could you cite those things which are going to change in the next couple of quarters on the cost side, because it looks like leverage is what it is now, unless you think it gets better for some reason other than sales?

Dave Near

From an operations perspective, we are continuing to work on labor initiatives, many of which we put the foundation in place in first quarter. We should start to see the benefit of that in the second quarter or beyond, both on the management and the crew side of things. From a food perspective, as was mentioned earlier, we continue the look at the menu management side of things. That helps us from a product mix perspective. Also in terms of controlling the things on the store level from a waste perspective, from a theoretical to actual variance perspective, we continue to make good progress on. So I think those are probably two of the main drivers as we look forward.

John Glass - CIBC World Markets

In the first quarter, could you call out anything specifically other than the store closures that were one-time in nature?

Brendan Foley

No, not really. I think as you look at the rest of the lines on the P&L, there were no significant one-time items.

John Glass - CIBC World Markets

Breakfast R&D, or extra advertising?

Brendan Foley

I mean, there's always timings of amounts between quarters but nothing unusual.

Operator

Your next question comes from Glen Petraglia - Citigroup.

Glen Petraglia - Citigroup

A quick question on the share count. I thought that the share count going into the first quarter was about 96 million shares and you did the 9 million ASR, so I was a bit surprised to see the share count not really move down a great deal in the first quarter. If you could maybe comment on that? The upward move in the stock obviously today. What sort of impact from an accounting perspective does that have on how the ASR is recognized or completed by whomever was conducting that for you?

Jay Fitzsimmons

Yes. I'll take those. The diluted share, you may recall we completed that ASR transaction the last half of March, so as you know, the shares are calculated on an average basis over for us a 13-week period. So you don't get the full impact of those 9 million shares; you will see that full impact in the second quarter of 2007, though. On the potential relative to the increase in share prices, our share price, any potential increase will go to the equity count for Wendy's and into treasury stock.

Jonathan Catherwood

You may remember that we have a collar around this. I don't think the pricing on the collar has been disclosed, but we do have a collar around it and it won't make any difference to the end date for the ASR.

Glen Petraglia - Citigroup

Does it have an impact in terms of maybe not the number of shares, but the cost to you?

Jonathan Catherwood

It does, but that cost is bracketed, it's limited.

Glen Petraglia - Citigroup

If we can get an update on refranchising, I believe you're targeting 50 units this year. Then if you had any breakdown of your sales between chicken and beef, that'd be helpful. Thanks.

Dave Near

In first quarter, we refranchised eight restaurants and the forecast for the guidance of 50 restaurants, I believe is still very much on track as our number for 2007.

Kerrii Anderson

Glen, as a part of product mix, historically we do not disclose the specifics of what our product mix are, and we've generally said chicken is about one-third and I would say not much different from that and beef's about one-third.

Operator

Your next question comes from Andy Barish - Banc of America Securities.

Andy Barish - Banc of America Securities

I know there are some IRS limitations on the share repurchase related to all the stuff that went on to maintain the tax-free status. Do those limitations apply to any of other big changes in the asset base or control of those assets?

Jay Fitzsimmons

When you say the asset base, can you elaborate a little bit on what you mean?

Kerrii Anderson

Are you asking like the real estate, doing a sale in the leaseback of real estate?

Andy Barish - Banc of America Securities

Your stock. Anything else associated with a large portion of your stock.

Jay Fitzsimmons

Well, I think the limitations are relative to Wendy's stock and the company of Wendy's itself. So, I'm not sure if that answers the question or not.

Kerrii Anderson

Just to make sure I'm clarifying the point here, it's relative to how much stock the company can repurchase, and that's solely the limitation.

Andy Barish - Banc of America Securities

There is no control or change of control associated with that?

Kerrii Anderson

With the IRS limitation?

Andy Barish - Banc of America Securities

Yes.

Dave Near

Not that we're really aware of right now. I mean it would be all fact and circumstances specific, but there's nothing that jumps out right now in our minds.

Jay Fitzsimmons

Again, it's really more just on the company's ability to purchase Wendy's shares, that is the real limitation that we've been talking about.

Operator

Your next question comes from David Palmer - UBS.

David Palmer - UBS

It seems that some of the things that you've been targeting as benefits to company restaurant margins have been more specific to the company stores and not something that would generally benefit the franchisees as much. I was wondering if you could comment on franchisee cash flow this year? Is it improving or is it set to improve or are they not really participating in the cash flow growth that the company stores are having?

Dave Near

David, I think there are a couple things. The franchisees, I believe, are experiencing improvements as we are. They may not be experiencing them quite at the rate that we are, but I think that they are certainly taking advantage of our new pricing strategy. I believe that we were a little bit behind our franchisees from a pricing perspective, so there may be a little bit more on the company end there, but they will also be able to take advantage of the labor initiatives that I talked about that we laid the foundation for in first quarter. As we roll that out in second quarter that will certainly be available for our franchisees to take advantage of as we move forward, along with the entire menu management process helps the entire system there.

From a cash flow perspective our analysis, our results indicate that in 2006 which is really the most recent financials we have from our franchisees, that cash flow did improve in fact over 2005, and we would certainly hope and expect that that would be the case in 2007.

David Palmer - UBS

In terms of the brand and the same-store sales momentum, I think what people have been trying to get at here is that they're just overall concerned about the sustainability of Wendy's same-store sales. It's that we don't have necessarily all the signs of a big brand recovery. It's not like you had a negative brand attribute that you've stamped out, like maybe McDonald's did once upon a time, or it seems like there's been some sort of major new platform, or day part, or even technology driving throughput. Anything that would give us confidence that there's a real step change in terms of the rate such that you can lap tougher comparisons?

So is there anything that you can really go with that introduction that could give us more confidence that you could lap tougher comparisons as the year goes on?

Ian Rowden

A couple things, David. I understand the question very clearly. As we built the turnaround in the brand position in 2006, we very clearly recognized that there were things that we had not been doing to help differentiate our brand as clearly as we needed to and with the currency that we needed to. We also knew there were certain platforms that we needed to put into the business to help the brand get back into a dialogue with consumers.

I want to reiterate again what we did in 2006. What give us confidence this year is we're starting from a point that while we have seen deteriorating same-store sales, we're starting from a point where the consumer preference for the brand and purchase intent for the brand had not waned as much as some of the numerics in the business.

Some of the refinements we've made combined with, as Dave and I have talked about, the kind of menu management, the innovation in product development, the expansion of the beverage category and our beverage offering along with a reconstituted understanding of what drives true value for the Wendy's brand. I don't mean value as expressed by just the $0.99 price point. I mean the ability to engage and drive true consumer preference at a premium price point, at a competitive product versus product comparative price point, and at a value price point. This gives us the combined belief that while we acknowledge we've got tough numbers, numbers that we established by our own actions in '06, that we can lap them with some of the new innovation that we're bringing that obviously you haven't heard about yet and we can't talk about today and we won't talk about today, but with deeper understanding of what can help drive differentiation for our brand in this business.

Kerrii Anderson

I'll add too Ian, and you can speak more directly towards this, I think an acknowledge that we really were not connecting with that customer that drives our business, 18 to 34 hamburger, and the acknowledgement we have to connect with them with a different message. Our competition had been doing that for quite a few years.

Ian Rowden

That's true. That's absolutely true. The products we're bringing, the focus we have on the balance of the year in terms of driving indulgent product offerings along with very clearly focused transaction value offerings is a key part to the strategy.

Operator

Your next question comes from Roger Saks - Societe Generale.

Roger Saks - Societe Generale

Can you just go back to I think it was Glenn's question on the share count. For second quarter, would we expect to see something closer to the high 80s as a starting point? Did you end first quarter with a high 80s share count and will we expect to see something higher, mid 80s for the full quarter?

Dave Near

Yes, I think that's fair.

Roger Saks - Societe Generale

When you were talking about the labor initiatives at the restaurant levels, is this strictly scheduling, is it laying off some people, what does that actually mean?

Dave Near

Part of it, Roger, is we talked about at the end of last year how we were going to reduce our salaried management staffing from 3.6 salaried managers to 3.3. Our timeline for that was May 1st and we are on track to achieve that. As of May 1st, we will be down to 3.3 salaried managers per store, which is a reduction of about 430 some salaried managers from the beginning of the year. Then on the other side from a crew hour perspective, through some studies we've done over the past two quarters, we are going to be able to pull some hours out of our labor guide, which will make us more efficient, certainly from a labor percentage perspective and also the way we're doing that, we believe it will actually enhance how we operate the stores.

Roger Saks - Societe Generale

From your experience to date, the store, the managers, the employees have been receptive?

Dave Near

They have been. Going from 3.6 to 3.3 has gone very, very well and in studies that we've done on the crew side, it has been accepted very, very well by the managers.

Roger Saks - Societe Generale

Then going back to the comp store situation, just want to be sure I heard you right. So it is your belief that in 2006 you were able to reestablish the Wendy's brand with your core customer and with the right mix of promotions, with menu management, having the core customer thinking of Wendy's again, you should be able to get the 3% to 4% comp store sales?

Ian Rowden

Yes. The fundamental basis there, Roger, is reconnecting with a younger consumer set that didn't have the same acknowledgement or preference for our product and our brand as we had seen a broader consumer set have. We recognized that was a weakness from both a transaction point of view, from a preference point of view and from a repeat purchase point of view. We've worked very hard on rectifying that and we continue to do so and we're going to accelerate that effort here in the next few weeks with enhanced advertising and a stepped-up refocus.

Roger Saks - Societe Generale

Your intelligence to date shows you are reconnecting with that core customer?

Ian Rowden

That's true.

Roger Saks - Societe Generale

Lastly, I'll take a shot at this question although I don't know if you're going to answer it or not. But as a shareholder, seeing how the quarter was certainly an improvement over recent quarters, showing that your cost initiatives are working and things are coming together, the announcement of the strategic alternative seems a little strange, being things seem to be working. Can you comment on that at all?

Kerrii Anderson

I guess the only comment I would really have, Roger, is the board has a responsibility to consistently seek to improve the value of this company for the shareholders and for all its constituencies on a consistent basis. We have taken a lot of actions over the last 18 months to do just that. As a result of that, we've delivered a lot of value.

As the press release indicates, we've had a number of shareholders, analysts, other people who have continued to come up with ideas that they think or questions that they raise and I think the board takes seriously their liability and responsibility to make sure that they are consistently exploring all the alternatives that can be out there to create value for us.

Roger Saks - Societe Generale

While that review is going on, your formulated plan of cost cutting is still going to go on as planned? Your plans haven't changed how to operate the company?

Kerrii Anderson

Yes. The marching orders for this team are to continue to execute the strategy that you are executing and do it well.

Operator

Your next question comes from John Ivankoe – JP Morgan.

John Ivankoe - JP Morgan

The question is on the pricing for company stores. Have you put in location-based pricing already across your company system? And if so, how much is that aiding your average ticket year over year?

Dave Near

We haven't put in specifically location-based pricing, but we have gone to DMA or market-based pricing. That is actually something that's on our radar screen to look at as we move forward.

John Ivankoe - JP Morgan

But you have gone to the DMA-based pricing as of now?

Dave Near

Yes, we have.

John Ivankoe - JP Morgan

When was that put into place?

Kerrii Anderson

John when we did the analyst meeting in February, we said effective beginning January, we had taken that position and put that in place.

John Ivankoe - JP Morgan

Now that you put that pricing and you have had a full quarter to study it, how much is that helping your average check? Just the price piece alone?

Dave Near

As you may know, the fourth quarter of last year the company stopped disclosing the details of transactions and prices and checks, and going forward that's the position the company is taking right now.

Kerrii Anderson

And really for competitive reasons, we watched what else is happening out there with others.

Operator

Your next question comes from Rachael Rothman - Merrill Lynch.

Rachael Rothman - Merrill Lynch

Can you talk a little bit about the remodel program and where you are this quarter with the company-operated stores? I know you guys have been planning on incentivizing some franchisees to begin with the remodels, maybe how many they've done and what reactions they're seeing.

Dave Near

I don't know the exact number off the top of my head that have been done on the franchise side, but we continue to remodel company stores. We're also looking at new designs as well, which is something that we should do on an ongoing basis, and so we're really continuing to score not only new, exciting interior designs, but also exterior designs as well. But so far, the franchisees have taken advantage of the incentive program have been very pleased with it.

Kerrii Anderson

From a company perspective, I think we shared this with you in our guidance. We had hoped to plan to remodel about 200 company store this year and we're on track.

Rachael Rothman - Merrill Lynch

And in terms of the incentive fees that you guys planned to spend, I think it was $12 million this year, is that roughly on track as well, and maybe how much of that was baked into the first quarter?

Dave Near

We continue to think that number's pretty good as far as incentives go. In the first quarter, I think we were a little slower, I think we were more closer to the $1 million number.

Rachael Rothman - Merrill Lynch

Okay. As you guys think about breakfast, it seemed like I think in the annual meeting slides, you guys said you're at 160 units, which I think is the same amount that you disclosed at the February analyst day. Can you maybe talk about the pace of the rollouts since you're still targeting the 20% to 30% rollout in 2007 and any changes that you'll be making to the platform near term?

Ian Rowden

I'll let Dave just weigh in on the back end of this. He and I and Kerrii have just finished a series of meetings with our franchise community and we told you at our last update that we were very happy with the progress we were making on breakfast and we continue to feel that way. We've done a lot of work optimizing the menu, getting merchandising in place, confirming the marketing at a store-by-store level and you're right, we're in 160 stores. We have a plan to expand that program to somewhere in the vicinity of 20% to 30% of our stores system-wide by the end of the year and we're marching down that track as we speak.

Dave Near

I think that's sums it up very well.

Operator

Your next question comes from Joe Buckley - Bear Stearns.

Joe Buckley - Bear Stearns

Could you talk a little bit about the food costs? I think you were originally targeting 160 to 180 basis points of margin improvement. The language in the release sounds a little bit onerous on that front. Beef being flat to down and chicken being up 3% to 5% doesn't sound all that bad. Is produce running up a lot on you and what are your thoughts on the 160 to 180 bips of target improvement?

Dave Near

I think for the first quarter, we were pretty much on track for that. Looking forward, obviously there's going to be pressure on that number, the food cost number, but we're looking at other initiatives to hopefully try to offset that to the degree we can. Just planning for that.

Kerrii Anderson

Tad, why don't you share with us your thoughts on produce.

Tad Wampfler

Produce right now is certainly more expensive than it was last year, and that's our forecast for the balance of the year is that we're going to be up. But I think that the big parts are all the other initiatives that we have in place relative to keeping control of our food costs, including working with a lot of our suppliers to take costs out of the business as opposed to just squeezing them down. So we've got some of those initiatives that will start hitting the middle to the back part of year that we're very excited about.

Joe Buckley - Bear Stearns

Can you give us a sense of how much produce costs are running up year over year?

Tad Wampfler

Yes. It would be probably 4% to 5% right now.

Joe Buckley - Bear Stearns

A question again on the IRS implications of anything you do. Is there any restriction on paying out a special dividend related to the Tim Horton’s spin-off?

Everett Gallagher

There aren't any restrictions that I'm aware of. We should be able to pay a special dividend without causing a problem under our ruling.

Dave Near

Everett's our head of tax, so he knows what he's saying.

Joe Buckley - Bear Stearns

Just a follow-up question on a question that was asked earlier. I got the impression at the February meeting that you were going to spend a year improving the business, implementing the turnaround, and then perhaps examine the strategic alternatives. It seems to have been accelerated. What may have driven that?

Kerrii Anderson

I have to be honest with you, Joe. This is something the board discussed and we're going to continue to evolve the strategic plan. That's our responsibility and in fact one of the things we have to provide the board on an annual basis is an updated evolution of the strategic plan. That doesn't mean it changes significantly, it just means it evolves with the knowledge and learning that we have. It's really a board-driven decision.

Operator

Your next question comes from Steven Kron - Goldman Sachs.

Steven Kron - Goldman Sachs

As far as the balance sheet goes, we've certainly seen quite a bit of change more recently, cash coming down as you bought back a lot of stock. I guess, Kerrii, maybe you can just comment on whether you think you're at the point now where you're at the appropriate capital structure to run the business and maximizing cost of capital and certainly taking on debt is a theme here in the industry. Just wondering what your thoughts are there.

Kerrii Anderson

I think from our perspective, I think everyone knows we have a very low leverage balance sheet, we're aware of that relatives to others in the industry and I believe that part of this strategic review, if you read the information by the special committee, will be to consider a recapitalization of the company, which could result in some sort of levering up. From that perspective, I can answer that question a lot more as we proceed.

Steven Kron - Goldman Sachs

I listened to your shareholder meeting this morning and when you talk about breakfast and you have used this language a few times in the past, quite a bit of learning is going on. I know it's still somewhat early in the test, but can you discuss specific as far as those learnings? Is it around the menu optimization as you mentioned before? Is it a real estate selection process? Maybe you can benchmark how you're thinking about breakfast today relative to when you first talked to us about it nine months ago or so?

Ian Rowden

I will just go back if you like, start a bit with the menu. One of the things we've built in the last eight months is a very, very strong value component to our breakfast menu. I think we have worked on continually optimizing each of the product offerings on the breakfast menu, including things like breakfast burritos and optimizing the carrier for our breakfast sandwiches, understanding how to market those particular items.

We've also spent a lot of time in the marketplace developing the economic model from a store-by-store basis and understanding how to activate marketing around each of the individual stores, so that's been key learning. That's learning that we said we would get and as we got it and as we learned through the process, we sort of tinkered with our direction, if that's a correct use of the language, and made sure that we understand exactly what the competitive response will be to our actions. We are at a point now where we feel very strongly that we've got the type of learning that we need to have from a real estate point of view.

I'll let Dave talk to this more from an operating point of view.

Dave Near

Yes, from an operations perspective, we continue to feel really good about our ability to execute the breakfast day part. So we continue to learn and enhance it, but I feel very good about our ability to do that.

Operator

Your next question comes from Howard Penney - Prudential.

Howard Penney - Prudential

Again, just sort of on the timing of the announcement last night of this strategic committee, the system is singularly focused on the turnaround of Wendy's and growing same-store sales and growing profitability and cutting costs and all of that. If there's one thing you could have done as we have seen in the past from other companies to be more disruptive to that process is to sell the company or announce the sale of the company, because it is I would assume, very distractive to franchisees, crew members, store managers, as they are looking over their shoulder as to what their future is.

Kerrii, you said earlier that this was a board decision which obviously it was, but somebody had to propose this to the board and I assume it was you. How is this or what have you done to communicate to the system that we are status quo and going forward and nothing's really changed?

I know you don't want us to talk about this today, but I think given the context of how you need to keep people focused on operations and getting things going that that's an important topic to talk about.

Kerrii Anderson

I guess I'll make a couple of comments. One, Howard, I wouldn't assume your assumptions are correct and from my perspective, you're exactly right. What this management team has to focus on what I am focused on is what I can control. What we can control as a team together is operations and marketing and making every customer count, quite honestly. That's the focus we have right now as a team, and it's no different than the focus we had two days ago, quite honestly. So from our perspective, that's where we are and that's what we have to do to drive the business forward.

John Barker

Howard, we will be taking a lot of time. Yesterday, Kerrii and Dave and Ian spoke extensively to the leadership group in the franchise system, to our officers, we have several employee events to walk through and make sure they understand what's happening and what everybody in this system needs to stay focused on.

Operator

Our final question comes from Scott Frost - HSBC.

Scott Frost - HSBC

Just to address your debt ratings. I don't want to talk about what your plans are going to be here, but is there a specific ratings context that you need to maintain in implementing some of these strategic initiatives, or is there a cost of capital you need to keep under in order to maintain the momentum that you've got in terms of your debt capital? Can you give us any color on that at all?

Ian Rowden

The answer to your question is no. Options are open for us to be able to examine.

Kerrii Anderson

And really none of our debt is based on any sort of rating, the rate of our debt.

Ian Rowden

Exactly. And our line of credit is just on a ratings grid and it's undrawn.

Scott Frost - HSBC

Are there any other metrics that you plan to maintain, or as you said, everything's on the table?

Ian Rowden

Everything's on the table to be looked at in the context of what the scenario is.

John Barker

That concludes the conference call for Wendy's today. If you have additional questions, please reach myself or Dave Poplar later today and on Friday. Appreciate you joining. Thanks.

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Source: Wendy's Q1 2007 Earnings Call Transcript

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