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Executives

John Barker - IR

Kerrii Anderson - CEO and President

Jay Fitzsimmons - CFO

Ian Rowden - CMO

David Near - COO

Analysts

John Glass - CIBC

Louis Parks - EP Management

Steven Kron - Goldman Sachs

Larry Miller - RBC Capital Markets

David Palmer - UBS

Paul Westra - Cowen & Company

Glen Petraglia - Citigroup

Tom O'Neill - Barclays Capital

Rachael Rothman - Merrill Lynch

Joe Buckley - Bear Stearns

Jason Boucher - Wachovia

Jeff Bernstein - Lehman Brothers

Wendy's International, Inc. (WEN) Q3 2007 Earnings Call October 26, 2007 8:00 PM ET

Operator

Good morning. My name is Crystal and I will be your conference operator today. At this time, I would like to welcome everyone to the Wendy's Analyst Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Barker, you may begin your conference.

John Barker

Thanks, I appreciate it. Good morning everyone. The purpose of our call and our webcast today is to talk about the third quarter and to provide an update on some of our key business initiatives. We did announce our third quarter numbers yesterday after the market close. We also had a brief news release out this morning about some of the initiatives we are undertaking from a strategic planning standpoint.

The agenda for today’s call, we will begin with remarks from Wendy’s CEO and President, Kerrii Anderson, and then after that Jay Fitzsimmons, our Chief Financial Officer will discuss the quarter and then we will take your questions. Also on the call today, with us, our Chief Marketing Officer, Ian Rowden; our Chief Operations Officer, Dave Near; and other members of our senior management team.

I would like to refer you for a moment to the Safe Harbor statement that is attached to the news release. Certain information that we may discuss today regarding future performance, such as our financial goals, plans, 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 set forth in the Safe Harbor statement attached to the earnings release. Finally, some of our comments today will reference non-GAAP financial measures, such as EBITDA, and you can find reconciliations in our press releases and on our website.

Now, let me turn it over to Kerrii.

Kerrii Anderson

Thanks, John, and good morning, everyone. The financial results we released yesterday are a clear indication that we continue the Wendy turnaround. We are focused on exactly, what we could control, which is improvement and our core business. And improvement in our core business quite honestly is the best way that we can create value for our shareholders, our franchisees, and our employees.

We continue to execute our strategic plan and we have delivered significantly improved results this quarter at both the corporate as well at the restaurant level despite a very tough competitive environment and commodity pressures.

For the third quarter, we reported improving EBITDA, and income, and EPS result, and we have now produced five consecutive quarters of positive same-store sales. Our total adjusted EBITDA from continuing operations increased 57% to $95 million for the third quarter, and that’s up from $60.3 million a year ago. Now this does include the expenses that are related to the Board’s Special Committee process, which were about $13.4 million, restructuring charges for the quarter of $1.4 million, and from pension settlement charges of about $1.

Our US Company operated restaurant EBITDA margins improved 330 basis points to 12.6% for the third quarter of ’07 and that’s compared to a 9.3% in the third quarter of last year reflects positive same-store sales for the quarter including price increases, menu management, and labor efficiency.

Our third quarter US, operating margins and EBITDA margins will have improved an additional 140 basis points to 14%, if it worked for the commodity cost pressures and headwinds, we faced in the quarter. These financial highlights are a clear signal that we are revitalizing Wendy’s.

We are doing a better job of taking care of our customers with improved operations. We are delivering new products such as the Baconator, the Frosty Float, and others that we have tested. And our market-based pricing strategy is working and it’s improving our margins. And our advertising is breaking through and gaining new attention of our consumers.

Overall, our progress on the key elements of our business since June has been very encouraging. Now, we expect to produce 2007 full year EBITDA and EPS near the high end of our guidance range that we gave you in June, and that’s really reflects our improving margins, and our cost controls. We are very confident about our business outlook for the remainder of 2007. Now Jay is going to discuss our third quarter financial results in greater detail in just a few minutes.

From a strategic perspective, we introduced Wendy’s recipe for success about a year ago in October of ’06. The plan focused on initiatives to grow sales and profits in every restaurant in our system. And we have made significant progress in the last 12 months as a result of the initiatives implemented under this plan.

And foundation of our business is stronger today thanks to the performance of our restaurant crews, of our great operators, our franchisees, and our field and corporate employees. We have produced five consecutive quarters of positive same-store sales. Store operations profit margins are up about 200 basis points year-to-date. And our consolidated earnings are improving. This is a significant progress.

Now, while we are encouraged about the improved results during the quarter and year-to-date, we know, we must do more. We must intensify our focus on driving growth and transactions, profitable transactions, improve our store economics, and accelerate our progress, and that’s exactly what we are doing in the second phase of our strategic plan, which we highlighted this morning with the news release.

Our leadership team has identified ten imperatives aimed at achieving improved results of every restaurant in our system. These are part of our 2008 business plan focused on doing what’s right for our customers and our key drivers are operation, marketing, facilities and our people and made the imperatives build on top of Wendy's "Recipe for Success" plan, which is focused on Revitalizing the Brand, Streamlining and Improving our Operations, Reclaiming our Innovation Leadership, Strengthening our Franchisee Commitment, Capturing New Opportunities and Embracing a Performance Driven Culture.

Now seven of the strategic imperatives drive growth, and the final three create efficiencies and improve our returns on invested capital. As we think about the -- just talk about the first seven number one, Core Hamburger. We talked a lot about of how important the hamburger business is to us, that the business we are in and we need to improve our large hamburger market share by increasing the appeal and building transactions with our consumers.

Second initiative is the value menu proposition, we plan to introduce our data more effective value strategy to capture growing share of that 18 to 34-year-old customer. From a beverage perspective, we have initiative to increase our drink incidences and our margins. For example, we have expanded the Frosty brand very successfully over the last year. From a late night and snacking day-part, we are focused on reenergizing our late night business and capturing afternoon and evening snack opportunities, which is clearly what we see the consumers are demanding in the market.

Now from a breakfast standpoint, we have our new breakfast menu in more than 850 restaurants and at year end; it will grow to about 1000 restaurants including 351 franchise restaurants. We are moving to the next stage of our program to offer high quality premium breakfast to customers and to optimize our restaurants. This just remains the fastest growing segment of the QSR restaurant segment, and our major competitors attribute breakfast of a large component of their growth.

Now from our perspective, in addition to breakfast, what’s most important is the focus on customer service, and we are implementing in our company restaurants a total customer feedback system to improve customer service both from a proactive perspective as well as the reactive perspective.

Our seventh initiative is reinvestment. We must reinvest in our restaurants and it’s critical to meeting the consumer needs becoming more competitive and quite honestly driving long-term sales improvement. From a people quality standpoint, our initiative there is to elevate the customer experience by improving the hiring and the retention of our employees, while reducing our turnover, improving our training and generating savings at the store level.

Now from a refranchising perspective, we are focused on improving the overall health of our system, while refranchising a number of stores in 2008. And lastly and probably most importantly store margins. We will leave no stone on turn to achieve our objectives to continue to expand our store margins.

In summary, our strategic plan has a bold vision for Wendy’s consumer focused, successful, more profitable in every restaurant and growing and I’m committed to driving phase two of our strategic plan is the right thing to do for our customers, our employees, our franchisees and our shareholders.

Now finally, as we has our outlook for the remainder of the year, we are on target to produce 2007 full year EBITDA and EPS near the high end of the guidance range I have said earlier provided to you in June. And we are confident that our business turnaround will continue. We remain focused on driving growth in transactions to improving marketing and operations.

And we are working on a number of initiatives to offset rising cost, as we continue to focus on improving our margins at every Wendy’s restaurant and system. We are committed to fiercely protecting this great brand and improving the value of this great brand in this company, as we positioned it for future growth and profitability.

Well, that at this point, I would like to turn it over to Jay to review the numbers, Jay.

Jay Fitzsimmons

Thanks, Kerrii. I would like to summarize the quarter as follows. We had a solid financial performance in the third quarter in a difficult and competitive environment. I think the headlines are that if you exclude expenses related to the board’s special committee, restructuring and pension settlement charges, adjusted income from continuing operations increased 55% to $38.6 million that’s up $24.9 million from a year ago.

Adjusted diluted EPS from continuing operations increased 100.10% to $0.44 up from $0.21 in the third quarter of 2006. Adjusted EBITDA from continuing operations increased 57% to $95 million up from the $60.3 million a year ago. We take a look at US company operated restaurants, EBITDA margins, as Kerrii said they improved 330 basis points.

Total company stores, EBITDA margins and this includes our Canadian and International operations improved 270 basis points to 12.5% in the third quarter of 2007 and that compares to 9.7% one year ago. It was our fifth consecutive quarter with positive same-store sales growth with same-store sales up 0.2% at the company-operated restaurants and up 1.3% at franchise restaurants. Another way of looking at this is the company's two years sales trends and they continue to improve and have averaged got more than 4% in the past 4 months.

We are encouraged by the results, but we recognize that further opportunities exist to gross sales and improve operating margins. As Kerri said, we have a strategic plan in place to generate even better results in future periods.

Now let's look at some of the line items on the P&L. Cost of sales of $334.9 million or 60.4% in the third quarter of 2007, compared to $345.8 million or 62.1% in the third quarter of 2006. The 170 basis point improvement as a percentage of sales is due primarily to our higher menu pricing tied to our market-based pricing strategy and improved menu management.

Now as Kerri said, without the impact of higher commodity costs third quarter US company-operated restaurant costs of sales margins would have improved an additional 140 basis points.

Now let's look at the commodity outlook for the remainder of the year. Beef prices in the fourth quarter will be down about 68% from the third quarter of this year, but will be up from the fourth quarter of last year. Chicken prices have held fairly constant in the second half of this year, but we are expecting the prices of French fries to be the biggest drivers of upward pressure in the fourth quarter by going up 11% to 13% as our contract take effect.

We continue to see upward pressure on dairy cost of about 5% to 7% for the quarter and we also expect higher grain prices to impact the quarter due to the continuing biofuel demand. Paper costs are expected to be flat. To offset these cost increases in the fourth quarter, we continue to focus on credit optimization, labor initiatives, menu management thing such as the higher priced Baconators and the Frosty Float, which has a great food costs, Kerri, and aggressive food costs management.

Now let’s talk about company restaurant operating cost, a $148.6 million or 26.8% of sales in the third quarter of 2007 that compares to $155.3 million or 27.9% of sales in the third quarter of 2006. The year-over-year improvement, as a percentage of sales is due primarily to lower utility, bonus and insurance costs. These improvements were partially offset by the change in accounting that we talked about in the prior quarters for the real estate joint venture with Tim Hortons.

As the result of this change in accounting, third quarter 2007 company restaurant operating costs included rental expense paid to the joint venture by Wendy’s, which in the prior year was eliminated in consolidation. Without this change in accounting, reported third quarter 2007 company operated restaurant EBIDTA margins would have been 30 basis points higher or 12.7.

On the operating cost line, $6.3 million in the third quarter of 2007 compared to $8.3 million in the third quarter of 2006. This year-over-year decrease is due primarily to a decline in franchisee rent expense; again as a result of the change in accounting for Wendy’s real estate joint venture with Tim Hortons, which is no longer consolidated.

Now, let’s move onto G&A. G&A in the quarter was 7.8% of revenue compared to 9.9% of revenue in the third quarter of 2006. This 210 basis point improvement as a percent of revenue primarily reflects the impact of the cost savings initiative related to the reduction of salaries and benefit as a result of the elimination of positions in 2006 in last year’s next chapter program. It also includes $6.4 million in lower insurance costs. The decrease in insurance costs come from lower D&O expenses this year and favorable claim experience.

And the other income expense line the $2.9 million of income in the third quarter reflects $3.1 million in income from the 50/50 joint venture with Tim Hortons, and insurance gains partially offset by store closure charges and other asset write-offs. Remember the income from the joint venture with Tim Hortons is partially offset again by the higher rent expense I talked about in company restaurant operating costs. This compares to $1.6 million in other income in the third quarter of 2006.

Interest expense was $1.5 million higher in 2007, as a result of the sale of 40% of Wendy's U.S. royalty stream for 14 months that we entered into in the fourth quarter of 2006. This obligation is recorded as debt on the balance sheet. In 2006 we have received $94 million in cash in return for the 2007 future royalties. In 2007, the repayment of this royalty related debt is being accounted for as a loan, comprising both the repayment of the debt principle balance and recording of the interest expense. As a result, interest expense is up in 2007.

Interest income, the $11.7 million decrease in the third quarter 2007 interest income reflects lower cash balances, as a result from the modified Dutch auction tender and the accelerated share repurchase completed in the fourth quarter of 2006 and the first quarter of 2007 respectively.

Taxes - the company’s effective tax rate was 34% in the third quarter of 2004, but that compares to 26.5% in the third quarter of last year. Now both quarters benefited from the settlement of prior year tax audits. The normalized rate is 38% but as you know certain discrete adjustments will cause that rate to fluctuate from quarter-to-quarter.

Shares outstanding lower this quarter due to the share repurchases. Previously discussed $22.4 million from the modified Dutch auction tend to offer in the fourth quarter of 2006 and a $9 million on the accelerated share repurchase in the first quarter of 2007. This resulted in a lower share count of $88.4 million average shares in the third quarter of 2007 compared to $118.3 million average shares a year ago.

Now, as usual, we had some unusual items in both this ands last years third quarter. Special Committee expenses of $13.4 million in the third quarter of 2007 recorded in the line of restructuring and special committee related charges. These costs did not occur in the third quarter of 2006. There were restructuring charges of $2.4 million also recorded in that account restructuring and special committee related charges in the third quarter of 2007. This compared to $2 million in restructuring charges in the third quarter of 2006.

In the third quarter of 2007, this includes $1 million in pension settlement cost. Now, year-to-date, this is what, we have recorded, $18.1 million in special committee expenses, $9.4 million in restructuring, which includes $6.4 million in pension settlement charges.

At the end of 2006, we indicated the total pension charges could be up to $60 million in total. Based on the current interest rates updated assumptions and pension charges recording to-date, we know expect remaining pension charges of up to $35 million of which about $10 million of that will represent a cash out flow.

The timing of these pension costs is dependent upon obtaining the necessary regulatory approvals to terminate the plan. In the fourth quarter, we do expect additional expenses related to the Board’s Special Committee process and possible restructuring and pension settlement charges.

Now, going back to the outlook for the full year 2007. As Kerrii mentioned, we expect to report 2007 full year EBITDA near the higher end of the outlook we provide to investors in June. That outlook was a range of $295 million to $315 million.

We also expect to report full year EPS near the high-end of the range that we provided, which was 109 to 123. Now remember these ranges exclude expenses related to the Board’s Special Committee activities any potential restructuring and pension settlement charges. As a reminder, we suspended our previous earnings guidance for 2008 and 2009 due to the special committees strategic review process now underway.

Finally as you known, we can not comment on the special committee’s strategic review process. That are complicated process, I know you would like to hear more that the Board’s Special Committee is following a very disciplined approach. Now, we acknowledge that the process is taking longer than we originally anticipated and this is due impart to the well publicized uncertainty in the debt capital markets. But I assure the special committee process is continuing and we believe there will be more clarity relatively soon.

Now, let me turn it back to John.

John Barker

Thanks, Jay. Couple of notes before we open up the phone lines for questions. First of all our Board of Directors approved our 119th consecutive quarterly dividend that will be paid on November 19th and then it will be to shareholders of record as of November the 5th. The quarterly payment is $12.5 per share. This is the fourth dividend payment since the board voted to increase our annual dividend by 47% up to $0.50 per share.

As Jay said as we get into the Q&A, we really did not intend to provide further updates today regarding the special committees action. We will, as we have said in the past, we report on developments in the future, if circumstances want. We do intend on this call to talk about the results, we just reported year-to-date in quarter as well as outlook, and our updates on operations and marketing, and we would ask that you focus your questions on those subjects.

Now operator, we would like to open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from John Glass with CIBC.

John Glass - CIBC

Hi, thanks. In the implied fourth quarter EBITDA guidance it looks like margins probably also declined sequentially, and I know there is a little bit of decline seasonally in revenue. But is there any other reason why margins would be less -- would decline in the fourth quarter, is it a commodity issue is there something that was one-time in this quarter that doesn’t occur?

Kerrii Anderson

Jay?

Jay Fitzsimmons

I did the seasonality issue in that as you know and also as we did point out we have continuing commodity pressures and those will be the major items.

John Glass - CIBC

Okay and specifically have you call better much commodities impact the fourth quarter related to the third?

Jay Fitzsimmons

I think, there is a seasonality issues in that, as you know, and also as we did point out, we’ve continuing commodity pressures and those have been the major items.

John Glass - CIBC

Okay. And specifically, if you call that how much commodities impact the fourth quarter relative to the third?

Jay Fitzsimmons

I think in the call, we gave you some clues, as to what it is. My guess is, we talked about $140 million

Kerrii Anderson

140 basis points.

Jay Fitzsimmons

140 basis points in the third quarter that its going to be, the same maybe even a little bit higher in the fourth quarter.

John Glass - CIBC

Okay

Jay Fitzsimmons

Going up with the exception sequentially people becoming down, but remember it, we still be up from last year’s fourth quarter.

Kerrii Anderson

Right.

John Glass - CIBC

And breakfast is in above 40% or maybe a little more of your company stores, I calculated that correctly. How much do you think that’s adding to comps right now?

Kerrii Anderson

Yeah, John from your question perspective, we had to really disclose the element of the comps related to breakfast. We really just 12 months to the stores in the third quarter, the one thing we have indicated is that we do expect breakfast actually create a small loss at the restaurant operating level, as we in-depth in the day-part and try to make very positive business take forward.

John Glass - CIBC

Gotcha, okay. Thank you.

Kerrii Anderson

Thanks, John

Operator

Your next question comes from [Louis Parks with EP Management]

Louis Parks - EP Management

I just wanted just to clarify, when you said that the process of the special committee that we will hear from them relatively soon. The announcements this morning on the strategic goals for 2008, is that in anyway tied into the work of the special committee and in other words is that, something that will, is that a follow-on to their work, in other words they process is that end of the process?

Kerrii Anderson

I appreciate the question Louis. From our perspective, we build our strategic plan a year ago and really went to New York and introduced to the analyst. What we have the second phase as we call it Phase II, is really it’s an evolution of our current plan and how do we take our performance to the next level much improvement as we have seen.

We know we have to do better and there is tremendous opportunity, which in our core business and certainly in our company's store performance and this Phase II is just now amount of being able to make sure that the Board does, what the opportunity are, as they evaluate their options.

Louis Parks - EP Management

Thank you, Kerrii.

John Barker

John, you got to understand the 80% of our system is franchised.

Kerrii Anderson

Right.

John Barker

So regardless of what the special committee is doing. We have to in the strategic plan for both '08 and the next three to five years.

Louis Parks - EP Management

Okay. Thank you.

Kerrii Anderson

Thank you.

Operator

Your next question comes from Steven Kron with Goldman Sachs.

Steven Kron - Goldman Sachs

Hi, good morning guys. A couple of questions on same store sales, can you talk about the market-based pricing strategy maybe if won’t give details just to how much prices currently in the menu. Can you talk about, whether there is still opportunity to raise prices going forward and maybe Kerrii you can just comment on the traffic fall of the proceeding as a result of the price increases?

Kerrii Anderson

Yes, there is no doubt Steven that from our perspective, pricing has been very key element to us being able to gain our margins along with menu management, as well as new products rollout. I would tell you that, we believe there is still pricing opportunity in certain elements of our menu compare to the competition and add, as David to be may be give a little more color on that.

And your question about transaction certainly, given the overall focus we have had on prices as well as menu management, it’s certainly it had an impact on our transaction in the short-term that we know the right thing to do, but David you wanted to add a little color here.

Dave Near

Yeah, I’d agree with what Kerrii said. And just for context, I don’t see just doing anything materially different from a pricing perspective than a lot of the competitors that are out today. Just for some context there.

Steven Kron - Goldman Sachs

Okay. I guess just a follow-up staying with the same-store sales. If I think about it, you’ve obviously been pretty outspoken about the pricing opportunity that’s currently working through the menu you’ve been offering some more premium products. You’ve kicked in the advertising more aggressively in the last few months and you’ve also rolled out breakfast to quite a few stores.

So, I guess, with that as context, can you just talk a little bit about how the 0.2% same-store sales that you had in the period, how that’s compares or tracks versus, what you guys have been anticipating?

Kerrii Anderson

I guess the one thing; I’d be very clear about what you know Steve is that last year in the month of July, August and September, we delivered 32, 45, and 42, 93 same-store sales comp. So, it was the absolute strongest quarterly sales comp that we had to rollover from last year.

So, in that case, while, we indicate, where sales actually came out at 0.2, as you indicate, we were, I’m sorry, actually, I gave you bad numbers that was the US stores franchise. Our company was 36, 47, 43, 41, so we are well in over very, very strong comps and there is some, in this business the challenge that you face. Having said that, we are very focused on continuing to drive things, our self confident is the key driver to this business.

Steven Kron - Goldman Sachs

Okay. And as far as the product that you guys highlight in your phase 2 plan, the beverage platform is not gaining products, are there already new kind of products in test or it’s just kind of the beginning phases?

Ian Rowden

Steven, this is Ian. There are new products in test. There is being some test on locally on things like Frosty Shakes, which we’ve announced. We’ve done some coffee work. We continue to expand our beverage platform. We’re deep into our value menu and redefining that from a transaction driving point of view. So, we’ve got a lot of news that we will bring to the market in the future. But we’re not ready to disclose today obviously.

Steven Kron - Goldman Sachs

Okay. Thanks.

Operator

Your next question comes form Larry Miller with RBC Capital Markets.

Larry Miller - RBC Capital Markets

Yes. Actually that was my question, but I did have a couple of others. At the meeting last spring, Kerrii you talked about, you gave some parameters on the success of breakfast business. I was wondering, if you can kind of revisit those, as you’re seeing it and specifically, can you talk about how records is mixing, as a percent of average unit volumes?

Kerrii Anderson

Okay. With respect to breakfast what we laid out is that we would see our fair share of breakfast based on provider market potential as about $3000 to $3300 per store, if we could achieve our market share ownership of breakfast. From a breakeven standpoint, what we’ve indicated is and the company stores it’s more in the $1900 to $2000 range and in the franchise stores because they pay royalty it’s more in the $2200 to $2300 range in order to really need breakeven.

So, you’ve got to that level drive your performance and exceed it, so that you build the business case to have acceptance from a franchise perspective because they are in the business to make money as we all are. So that’s been our area of focus Larry trying to drive towards best it fits.

We learned something from owning comps for 10 years and that is, this is a difficult had it to break, it is important to really market it locally within the market, but we’ve also one of our next phases is to really roll breakfast out to 4 or 5 DMAs, focus on it from a DMA perspective in order to really prove that’s the business case that breakfast can work for us.

But, it is not as you probably got a sense from the overall strategic initiatives its [characteristic] on the list and I mean that in that we have so much opportunity in our core with hamburgers and with value and with beverages and with those elements. That’s really where our primary focus is and, quite honestly its every sources on. That I know if anybody helps to like improvement.

Jay Fitzsimmons

No, I’d just say we are in about 800 to 850 stores right now. Average about 35% to send a franchisee based stores and the plan is to be just over 1000 by the end of the year. As Kerri said, of which about 350 stores will be franchisee.

So, we are seeing success in getting franchisees to come on board with the program. Our next price, as Kerri said will be to fully market the great work we've done in building the menu and the program in some D&A wide activities, so we just on track as we continue to learn and move forward.

Larry Miller - RBC Capital Markets

Great, thanks. Just a follow-up on that, are you guys giving support to the franchisees of 35% that accepting for you?

Kerrii Anderson

Yes, we are supporting it from a local marketing perspective, Larry.

Larry Miller - RBC Capital Markets

Okay. And then just on EBITDA guidance you read out Jay, is that assume products comps for sales in the fourth quarter. How should we think about that, what's the kind of sales or is it more cost based statement?

Jay Fitzsimmons

We are assuming in the fourth quarter both relative to the cost as well as the sales as pretty much the same. So, we are not looking for an acceleration of sales in the fourth quarter. And the forecast we gave you, of course we would like to see acceleration in sales, but we forecast based on the current run rate and the commodity cost pressures, which we were able to identify, we talked about in the call.

Larry Miller - RBC Capital Markets

Okay. Thank you guys

Kerrii Anderson

Thanks, Larry.

Operator

Your next question comes from David Palmer with UBS.

Kerrii Anderson

Good morning, David.

David Palmer - UBS

Good morning, Kerrii. The first question I’ve is on refranchising, could you perhaps give us an update on your thinking there obviously this is a major initiative that was talked about in the past. What’s holding you back from doing that more aggressively now?

Kerrii Anderson

Yes, David, I would say two key things. The first and foremost, we believe, we had significant opportunity to grow improved margins. This quarter, we delivered on our ability to do that 330 basis points at US company stores. For us, who have been in an accelerated mood to sell those restaurants really quite honestly with the reduced the value, that we could have captured for our shareholders because generally these refranchising opportunities are priced on a cash flow basis.

So, as we’ve improved to kind of margins, we improved the opportunity to gain value for our shareholders. So that’s the number one, and most importantly. And then secondly, the question was okay, if we’d have gotten very aggressive, I think, the price on balance sheet today we’ve got $220 or $230 million of cash on our balance sheet.

Then the other question is what exactly we will do with the cash at this point of time given the strategic review and everything else. So, that's the other, we’ve not been in a situation where we cold utilize the cash perhaps and return the greatest value to the shareholders given everything that’s circling around us. So, those are the two key reasons, we’ve really not been more aggressive at this point.

David Palmer - UBS

So, I suppose that those things could change with the discussion of management pretty much at any point. I mean, obviously your goals on margins are much, much higher than where you are now, but it’s hard to believe that you would wait the amount of quarters and years to get to that point before you start refranchising, and obviously the strategic review is something that's going now. Is there any other sense you can give us about refranchising and when we might kind of hitting the inflation point?

Jay Fitzsimmons

I think David you identified the key point is that strategic review is underway and that’s obviously going to be a factor in this. But could potentially lead to higher leverage give you even more incentive to do the refranchising. We’ve also fairly public about the fact that we believe there is another 450 stores at a minimum that we could refranchise. So it would be a reasonable expectation that you would see the refranchise program accelerate in 2008.

David Palmer - UBS

And the second question is just revisiting breakfast. I guess folks might have a hard time believing that breakfast is going all that well, obviously we have to be patient with that day-part, but your company is rolling it out more aggressively, obviously your new franchisees, your company comps are trailing franchisees by 0.5 or so.

You said it’s costing you money at this point, but when you want to quantify the lift of sales, but is there anything you can tell us that could make us believe that is going well or anything you can talk around this?

Kerrii Anderson

I think from our perspective, Larry a couple things, in breakfast is absolutely the fastest growing day-part with industry. We are seeing the impact it’s having on our competitor’s results it is going to be faster growing day-part than the dinner day-part within the next few years.

So you look at that, as to what the current consumer trends are, what the consumers demanding. That said, we make it’s important to invest in this from a long-term, it’s not a short-term impact for us.

And quite honestly, the consumer as we have done our research says, gosh, everybody else is open a breakfast. I don’t understand why you are at Wendy and we’re getting a lot of feedbacks from consumer standpoint that what consumers looking for. They want the restaurant available, when they want it.

So it’s more the consumer demand and we understand it’s an investment we’re not probably got a 1000 stores, we’ve always led by example it's what the company does with every initiative we’ve we generally do that. And so, as a result, we think it’s the right thing to do for the brand and system long-term, but it's not a short-term, great short-term benefit.

Dave Near

David, this is Dave. I think from an operational perspective, we feel like breakfast is going very well. We feel like, we’re executing at a high level in that day part. So, certainly from an operational perspective, we feel good about it. And we've got markets and stores in different pockets of the country; they are doing very well with it.

I think, they were continuing to learn more and more, as the weeks and months pass as to what exactly makes breakfast a success in the Wendy’s system. So, I think with the evolution and the addition of new products, of new menu boards, of new POP that we’re continuing to and getting traction with the coffee piece is really ailing us and make sure that we know what success means in respect to stay part.

David Palmer - UBS

Okay. Thanks, guys.

Kerrii Anderson

Thanks, David.

Operator

Your next question comes from Paul Westra with Cowen & Company.

Paul Westra - Cowen & Company

Hi, good morning everyone.

Jay Fitzsimmons

Good morning.

Paul Westra - Cowen & Company

Hi, good morning, how are you. Just a few questions, just if I can start with the updates that you can give us on the remodel program give us an idea of the numbers that have been remodeled given data of the company’s franchise side. May be what you feel, so it’s the backlog of the franchisee spending up for the program and any changes you’ve made during the year to it?

Dave Near

Paul, this is Dave. I think we’re looking for the exact numbers, as we speak. But generally what we’re doing on the reinvestment piece it is continues to trip along on the company side and the franchise side. We’re also in the midst of exploring some other designs right now from a reinvestment perspective from an exterior perspective.

I guess much more aggressively then we’ve in the past. We’ve done quite a few different remodel schemes in different stores throughout the country. And we continue to focus on the interior as well, if they are different things that we need to do from interior perspective, that we rolled out about seven years ago as well. So, it continues to go fairly well, I think Jay may have an update on the numbers.

Kerrii Anderson

Yes, the only thing I would say from our franchise’s perspective is, as you might guess Paul, without the uncertainty around what’s happening from a strategic standpoint, there is some hesitancy on behalf of the franchisees as well quite honestly, we are focused on improving margins and cash flows certainly have been, the focus of quite honestly most of the franchisees less improved cash flows, wait and see what happen strategically, but with that and Jay you’ve got some specific numbers, as what’s the remodels have been.

Jay Fitzsimmons

Yeah, Kerrii, you’re right. We haven’t had to take up on the incentive that we provided that we originally expected our budget is impart because of the insecurity around the system. But we’ve had so far this year 186 franchise stores remodeled, another 50 company stores of 236 stores have been remodeled year-to-date.

Paul Westra - Cowen & Company

I know you had a five year goal. It’s obviously giving uncertainty, that’s a little less clear at the moment, now the entire system?

Kerrii Anderson

Yeah, that is exactly correct Paul. I will tell you we are still very committed. We know reinvestment as you heard me say and the strategic initiative is key to us. One of the things that the customer ends up, rating you owned in their overall experiences, what were the facilities and the facilities each for working 65% of our gas or whatever they see from the standpoint of their car, through the parking lot and drive-through. And so, as a result it is important for us to continue to update our facility to the new menu board, as well as to maintain the presence of our outside and inside facilities.

Paul Westra - Cowen & Company

Yeah. And there is a follow-up to that I know some of the remodeling was tide to the beverage station moving out and perhaps [clients] of your whole beverage strategy. So, but they still link pretty heavily or is that going to put a governor on what you can do on the beverage, as the definition objective?

Jay Fitzsimmons

What you will see Paul, with all new stores that are being build that we’ll certainly have the beverage station out in the dining room. And then, as we remodel stores you will also see the beverage station moved out there in the dining rooms as well because that’s really from a cost perspective that’s when it makes more sense to do to make that transition is when we’re remodeling the restaurant, the dining room, we are tearing up the floor, we can put in the floor and all that kind of good stuff. So, that’s still on track, and that is still where we would like to be.

Paul Westra - Cowen & Company

Okay. Last two questions, one is that your supply contract and now potatoes losing out the wheat and corn and soybeans. Can you give us an update what it sound like you signed, you find a new one for up some of the numbers off the top of my head, which is only about 10% or so? How long is the contract and it’s just about to kick in? Then last question on the value combos you’ve some new strategy, I assume you’re not talking about price points, talking about strategies like value combos and stuff?

Kerrii Anderson

Paul, Jay is going to take your question with respect to potatoes contracts. And Ian is going to talk about the value combo strategy.

Jay Fitzsimmons

Yeah. We don’t have all of our fried contracts expiring at the exact same time. But we’ve just our new contracts that will take us through 2008. So, that’s what we’re pretty well walked in through then.

Paul Westra - Cowen & Company

They just begun this quarter or next quarter that new higher rate?

Jay Fitzsimmons

Yes, this quarter.

Paul Westra - Cowen & Company

Last quarter?

Jay Fitzsimmons

Fourth quarter.

Ian Rowden

And Paul just on the value composition, you’re right. We understand and we’re looking at without getting the specifics of mixture of maybe dialogue [price shows] you combined the combo and at various products at various price points.

Paul Westra - Cowen & Company

Okay.

Operator

Your next question comes from Mr. Glen Petraglia with Citigroup.

Glen Petraglia - Citigroup

It's Petraglia. Good morning.

Kerrii Anderson

Good morning, Glen.

Jay Fitzsimmons

Good morning, Glen.

Glen Petraglia - Citigroup

It’s nothing new there. In terms of reimaging several maybe it was several quarters ago, but I think you provided an updated in terms of what sales that you are getting from reimaged restaurants. And it was fairly significant and I would think that if the franchisee could capture those sorts of economics they would be happy.

Do you think that the incentives that you offered it was 25,000 per restaurant, is it sufficient. And how do you think about that going forward with nearly $250 million of cash on our balance sheet that clearly you are struggling to find useful.

Jay Fitzsimmons

Glen, just kind a tag on Kerrii's comments earlier. I don’t think the $25,000 is initiate at all. I think its good incentive. The big thing that is holding up more reinvestment at this point is simply the process that we are going through right now.

And I think that is maybe here from a franchise’s perspective that I want to make sure that we have clarity coming out of this process before they commit to the dollars that are necessary to grow the business. So that’s the biggest reason and that’s obviously being gone on now for full well over year.

Glen Petraglia - Citigroup

And then just lastly in terms of value Ian, if you could maybe helps us think about are you moving away from $0.99. Is it different items at $0.99 that maybe have lower margin and if you put them together in a combo similar what you did, I think earlier this year with the Double Junior Cheeseburger, I don’t remember exactly what you called this, but, as you could think about that?

Jay Fitzsimmons

Just a couple of things Glen and again, I don’t want to get ahead about sell through, as we’re completing testing. But McDonald’s and Burger King are very aggressive at the dollar price points with products that we noted from a definition of price tag you’re very important. So, we are going to be very competitive in that regard with them.

So, when come a loser that emphasis. But yes, you’re right we’ve learned very, very positively earlier this year and work with you without, you like to serve your meal offerings and some other menu development work that we’ve been doing for products that fulfill both price points and usage occasion.

So, there is an opportunity for us to expand the value proposition in that regard. So, you can expect a number of initiatives that we’ll all work together to offer, I mean, more blended strengthening of the profitability and drive transactions that's the point. And again, I don’t want to get into specifics but, we’re very close to agreement to our business.

Glen Petraglia - Citigroup

Okay. And just one more question, Jay the $6.4 million in lower insurance cost, as part of G&A. Is that something you are thinking, is sustainable I know, you mentioned better claims experiences is there, anything in particular that you’ve done to drive that or was it luck?

Jay Fitzsimmons

Glen, there is a number of factors in that. First of all last years, we’ve mentioned that they were higher to D&O cost, and that’s the onetime item that actually related to Tim Hortons. So, that was in the amount of about $2 million, little over $2 million, so. Obviously that won’t recur. Obviously, when you’re trying to predict employee related claims and workers comp related claims, we’ve a number of moving factors.

One of the factors that we had was the next chapter and the impact that had which maybe a little bit harder to forecast what should be in that account. I would not expect those numbers to reoccur, that we have control over the claims, but we probably have a good idea, what your accrual should be.

And what we are seeing now, as we are seeing flat healthcare cost based upon one of our benefit plans for next year. And so we should be able to hold the line, where we are, but in terms of having future benefits in the quarters always hard to predict, but I won’t account on it.

Glen Petraglia - Citigroup

Okay. Thank you.

Operator

Your next question comes from Jennifer Preller with Barclays Capital.

Tom O'Neill - Barclays Capital

Yeah, it’s actually Tom O'Neill from Barclays Capital. The capital markets as you alluded to in your statement earlier suddenly have changed since your last call, yeah I know you can talk about the strategic review. But can you update us really on your overall philosophy on your capital structure, maybe in terms of your willingness to operate with higher debt loads, what things are you doing given some companies don’t have a access of CP etcetera?

Jay Fitzsimmons

Well, obviously, we do not have that this to CP because of our credit rating. What we talked about relative to the special committee, which we did make public, is that it was our intention to offer staple financing package, which would give them the option to put the leverage on. But it also we would give the company to put the leverage on, and as you know in today's environment investors are demanding higher leverage on the balance sheet and likely outcome of the special committee process is that we will have more leverage next year than we have this year, Tom.

Tom O'Neill - Barclays Capital

Okay. This is a follow-up question again I know you can talk about the strategic review, but we talked in the last call about hypothetical situation if you remember, if you were to securitize your stream of franchise fees. You’re taking to look at your bond indenture based on your understanding of the language in your bond indenture. Would you’ve to takeout your bonds, if you were to engage in such a franchise fees securitization transaction?

Jay Fitzsimmons

I think we would do obviously what we’re required to do. And it is likely that if you entered into stake hold financing that we would address those existing bonds.

Kerrii Anderson

I think, we are very aware of our obligations to our public note orders and but certainly be our commitment to buy, and the requirements.

Tom O'Neill - Barclays Capital

Sure. So, that means that for securitization in all likelihood, would you have to take out the bonds?

Jay Fitzsimmons

It may be an outcome of securitization.

Tom O'Neill - Barclays Capital

Okay. But obviously everything it's still open in terms of what you may actually do?

Jay Fitzsimmons

That’s correct, Tom.

Tom O'Neill - Barclays Capital

Okay. Thank you.

Operator

Your next question comes from Rachael Rothman with Merrill Lynch.

Rachael Rothman - Merrill Lynch

Guys, a question for Dave since maybe he is the only one that’s been around long enough to remember. But can you think back to a time when QSRs in general as taken as much prices, they seem to be taking these days. And can you talk about may be what the near term and longer-term and the implications of that were from obviously traffic and from a shift perspective.

Dave Near

Rachel, I think pricing is slippery slope. There is no doubt about it. We all need to be very careful about raising our prices. Because I think, we’ve certainly been viewed historically and I think we’re still viewed today as a great value generally our industry is.

In terms of historically, I’ve not seen the industry take as much prices, I think that the industry has taken over the past three years, I’ll say. I think it is certainly a response to what's happening from a commodity perspective and normally we are seeing that in QSR; we are seeing it in fast-casual and mid-scale and all the way up and down the chain.

So, from a historical perspective it is at high level for sure and again something that we’ve implemented a much more disciplined process than we’ve ever had at Wendy’s in terms of how we look at price. In terms of how we look at products, in term of how we look at markets and that we’re doing is right thing, but again it is high in our priority list to make sure that, we don’t go too far with pricing item.

Rachael Rothman - Merrill Lynch

Great and then a follow-up on the remodel for Jay, could you say that the uptick on the incentive has been lower. Can you quantify for us actually how much you’ve given in incentives and what the average cost for the remodel has been year-to-date?

Jay Fitzsimmons

Rachael, it’s very difficult to say what the average cost of the remodel is, because you go anywhere from just an interior to, an interior or exterior to what we call a scrape and rebuild to relocation. So, that's the question that is individualized based upon what the opportunities are.

We never gave you what the actual budget was this year. So, I’m not going to give you what the actual expenditures we are against that, but I will tell you that it’s less than we expected. We’ve also opened up that, so that the new menu board, which is used in conjunction with the breakfast comes from that and everybody is putting in the breakfast is taking advantage of that.

And what we’ll do, after this process, we’re probably reassess the program and decide what we need to do.

Rachael Rothman - Merrill Lynch

Into the point someone questioned earlier, is it the right incentive 25,000 of north. We believe that why it is substantial, there maybe opportunities to further expand that to encourage people, who invest in different ways within their restaurant. And as we get through this process I think that’s going to open up the opportunity to do exactly what Jay said, which is consider other modifications for franchisees to utilize that incentive.

And how would you think about beginning that you’re in and in terms of the remodel, as the other chains have been remodeling now for three and four years and have already committed that capital to both franchising company operated assistance. To what extent does that putting you at a competitive disadvantage and are you just in the beginning of your remodel program or you further along then it may appear from the outside. Do you feel like this is disadvantaging you or your franchisees at all?

Dave Near

Rachael, this is Dave. I think in certain respects, I don’t know, this is a disadvantage. But it’s certainly an opportunity for us to reinvest at more aggressive rates. And I think the big thing that we all know, I mean, we see exactly what the dollars is doing out there in the marketplace right now they are doing a lot of reinvestment, a lot of scraped rebuilds.

And I certainly think, when you look at their sales comps that is one of the big reasons for that because I think on a from a facilities perspective they have certainly improved a lot of the stores in their system and that’s something, but again we need to be focused on as we move forward. And I wouldn’t say that we’re at the beginning, but we are probably, we’re certainly closer to the beginning then the end.

Kerrii Anderson

And I’d just also remind you that McDonald's really quick building stores back in the last ‘90s as they focused on our 2000, as they are focused on improving the results from their core. We were still building stores as many company and franchise at 250 or 300 almost 300 stores a year for the five years of 2000 to 2005 at least.

And so, from that perspective some of our system is newer but maybe that 20% of the system versus the 80% that’s been around. I know that half of our buildings were build prior to 1990, company and franchise. So, from that perspective it is an opportunity for us to improve the facilities which is key and critical to our customer.

Rachael Rothman - Merrill Lynch

Great, thank you so much.

Kerrii Anderson

Thanks, Rachel.

Operator

Your next question comes from Joe Buckley with Bear Stearns.

Joe Buckley - Bear Stearns

Thank you. I just have couple of questions on margins and cost again. Can you quantify the impact of breakfast is add on the margins obviously negative from your comments? But have you calculated that?

Jay Fitzsimmons

It's negligible, Joe.

Joe Buckley - Bear Stearns

Okay and then.

Dave Near

The food is actually, if you think food cost is actually slightly lower, but given the penetration breakfast it’s not really having a significant impact on the margin.

Joe Buckley - Bear Stearns

Okay. And I know its fourth quarter the beef costs been down sequentially, how much of that up year-over-year?

Dave Near

For the full year they will be basically about flat.

Jay Fitzsimmons

But in the fourth quarter they will be higher than they were in the fourth quarter of last year.

Dave Near

That’s correct.

Joe Buckley - Bear Stearns

Do you know how much?

Dave Near

Somewhere around [north] I don’t use that.

Joe Buckley - Bear Stearns

A north down.

Dave Near

Yeah.

Joe Buckley - Bear Stearns

Okay. And then just question on Frosty costs, yeah particularly what's going on in California. Historically, wind has been very sensitive to Frosty markets any feel for whether the outfield where you see a spike there in the fourth quarter?

Dave Near

Yeah, we are seeing a little bit, but I wouldn’t call the fight. We’ve got some contracts in place that are helping protectives on some of that as well. So, we are certainly feeling a bit of it, but not the full [advantage] that you may expect.

Joe Buckley - Bear Stearns

Okay. Alright, thank you.

Kerrii Anderson

Thanks, Joe.

Operator

Your next comes from [Jason Boucher] with Wachovia

Jason Boucher - Wachovia

Hi, it's Jason for Jeff Omohundro. Just wondering if you all could provide little more commentary on your commodity outlook for ’08 maybe for some of the key categories in addition to the French Fries. And then also, whether you’re seeing any regional sales trends across the system particularly the stores related to located in Southern California?

Jay Fitzsimmons

Broadly speaking for ‘08, I think that the big pressure that we’re forecasting is really going to be on the protein side. Obviously it’s hard to tell right now. But I think the protein side in the beef and the chicken, it’s where, we’re expecting most of the pressure to be. Those markets have been tough. After that it just rolling over that the French Fries would be the other piece because of the new contracts.

Kerrii Anderson

And Dave maybe from a regional sales perspective.

Dave Near

Yeah, I mean, regarding the fires in Southern California because we are not as penetrated in that part of the country as a lot of our competitors are. We are really not seeing a big impact from the fires. I mean, just a couple of stores, a handful of stores are being impacted right now. But just as an aisle to, we’re doing a lot in terms of providing free meals for the firefighters and those that have been kind of driven from their homes and things like that. So, we’re doing a lot from a community standpoint with our stores in that area.

Jason Boucher - Wachovia

Great. Thanks very much.

Operator

Your next question comes from David Palmer with UBS

David Palmer - UBS

Hi, question on McDonalds innovation pipeline. How scary is that for Wendy’s in each of the next two years it looks like they are going to be aggressively pushing a big premium sandwich that’s southern style chicken and then perhaps the third pound or [hangus]. Both would seem to be really something that would hit Wendy’s core. How are you thinking about this, is that something that you can convince us wouldn’t be a hit to your business? Thanks.

Kerrii Anderson

David, first and foremost there is no question that the competition has stepped up generally over the last couple of years. And as a result of that, well we really have to take our initiative to next levels. We continue to focus on our fresh never frozen beef and in fact that we are made order, which is something while McDonald's has rolled out like the third the youngest burger you got to it, keep saying to yourselves go to freezer and buy a burger or do you go to the fresh section and buy your burger.

So from that perspective, our competitive difference and the quality positioning of Wendy’s is critical to us communicating from a customer standpoint to be able to really improve the results of Wendy’s going forward. So, it does mean we have to step up our game here Wendy, they are the 100 pound grow out there.

With that, I have Ian to make some comments about some of the R&D in our thought process.

Ian Rowden

John, just to build on Kerrii’s point there, that obviously the work that the major competitors in the marketplace is doing is going to have effect on everyone. But, we’ve got enormous upside and our core business as it currently stands and our ability to compete at a premium level, we’ve got great upside from a value point of view from a beverage point of view.

So we’ve got a lot of things in our armory not to mention. Frosty is a desert and of course the work we will do as part of the breakfast program. That gives us confident that we can deliver strategy Kerrii said. So, we are going to continue to be aware, be responsive which we have to be, but to be aggressive on our own platform of what make us the brand we are and the business we are.

David Palmer - UBS

Okay. Thanks very much.

Kerrii Anderson

Thanks, David.

John Barker

Operator, one more question please?

Operator

Thank you. Your next question comes from Jeff Bernstein with Lehman Brothers.

Jeff Bernstein - Lehman Brothers

That’s worse than Glen Petraglia probably, it’s Jeff Bernstein.

Kerrii Anderson

Your voice is changing Jennifer.

Jeff Bernstein - Lehmani Brothers

Getting old deeper. Couple of questions. First I know where we are now pushing the end of October here you put out an initial strategic plan for '08, I know, you’ve withdrawn your '09 guidance, but was there anything official. I’m just wondering, if you could put out some initial thoughts in terms of sales trends perhaps, some preliminary comp type guidance that’s just based on you’re seeing right now.

And then from a cost perspective, I know, you’ve made some comments on commodities. But just wondering from a commodity and labor standpoint, where do you see significant further offset the margins or whether a lot of the cost saving benefits have already been achieved in '07?

Jay Fitzsimmons

That’s the tough question. Your crystal ball is probably as good as our crystal ball. If we look to 2008 the process could give us different leverage ratio that’s clearly would effect the P&L. We know food costs are going up and you can probably make as good as an estimate, but you are probably talking about something in the 4%.

To the question as to whether there is further opportunity, we believe there is further opportunity. And I think, we've indicated that we've made a lot of progress this year. There are still a lot of things that we can do. Some of the optimization we did this year, some of the labor initiatives that we had this year will continue into next year.

We’ll then get a full year of credit root for those. So, I’m not going to give you the number. But I’m telling that we’re obviously expecting next year on the same basis with the same relative amount of leverage to be up from this year.

Kerrii Anderson

And I think Jay makes a very good point. I mean some of the initiatives, we talk about our labor initiatives that's fully got implemented from 3.6 managers to 3.3 in the company stores that took place really finally in May to June. We’re going to see a rollover of that in the first half of next year that we didn’t experienced this year.

So, and I think there are some opportunities for us and that’s what shareholders demand that you improve results, how do you improve result and that's what makes the high performance team and we know, we’re expected to deliver.

John Barker

Operator and everybody thank you for joining our call today. If you have any follow-ups, please give me a call later today or Marsha Gordon or Kim Messner. Thanks a lot.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Wendy's International Q3 2007 Earnings Call Transcript
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