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

Wendy's International, Inc. (NASDAQ:WEN)

Q4 2007 Earnings Call

February 4, 2008 9:00 am ET

Executives

John Barker - IR

Kerrii Anderson - CEO and President

Jay Fitzsimmons - CFO

Dave Near - COO

Edward K. Choe - EVP Restaurant Services

Bob Holtcamp - SVP Brand Management

Paul Kershisnik - SVP Marketing Strategy and Innovation

Analysts

Glen Petraglia - Citigroup

John Ivankoe - J. P. Morgan

Mitch Viser - (Unidentified Company)

Roger Saks - Societe Generale

David Palmer - UBS

Joe Buckley - Bear Stearns

Steven Kron - Goldman Sachs

Larry Miller - RBC Capital Markets

Operator

Good morning. My name is [Christy], and I will be your conference operator today. At this time I would like to welcome everyone to the Wendy's International fourth quarter and year end results conference call. (Operator Instructions)

I would like to turn the call over to Mr. Barker, Senior Vice President, Corporate Affairs and Investor Relations. You may begin.

John Barker - IR

Thanks, Christy, and good morning, everybody.

The purpose of our investor call and our webcast today is to discuss our 2007 results and to provide an update on our key business initiatives. We released our full-year 2007 earnings as well as our fourth quarter results before the market opened this morning. The news release as well as the financial statements and other investor information is all available, if you don't have it yet, on www.WendysInvest.com.

The agenda for today's conference call will begin with remarks from our CEO and President, Kerrii Anderson. Kerrii will review our financial highlights and discuss our strategic initiatives. After that, Jay Fitzsimmons, our Chief Financial Officer, will discuss the financial details, and then we'll be prepared to take your questions.

Also with us on the conference call today are Chief Operations Officer Dave Near, our Controller Brendan Foley, our Senior Vice President of Marketing Strategy and Innovation, Paul Kershisnik, our Senior VP of Brand Management Bob Holtcamp, and other members of our management team.

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

Also some of the comments today will reference non-GAAP financial measures such as earnings before interest, taxes, depreciation and amortization, or as we call it, EBITDA. You can find those reconciliations of non-GAAP terms to the most directly comparable GAAP financial measure. They're either in our earnings release or on our web site, either place.

Last Monday the company issued a news release from the Special Committee of our Board. The committee was formed in April of 2007. Jim Pickett, Chairman of the Board and the Special Committee said, "The review process being undertaken by the Special Committee has taken longer than anticipated, primarily due to the continuing turmoil in the financial markets." "However," Mr. Pickett said, "the Special Committee is working diligently to conclude its review of the strategic options, and believes that the process is in its final stages." Mr. Pickett added that, "There is no assurance that the process will result in any changes to the company's current plans or when a specific announcement may be made."

As we have state before, the company will report further developments regarding the Special Committee's actions only as circumstances warrant and as directed by the Special Committee. We will not discuss this matter further on the conference call today. When we get to the Q&A session, please limit your questions to our financial results, our overall business plans, marketing, and operations initiatives.

Now let me turn over to Kerrii.

Kerrii Anderson - CEO and President

Thanks, John, and good morning, everyone.

The results that we released earlier today I believe show improvement in every significant financial category, whether it's sales or profits, store margins and cash flow, and that really occurred as a result of the fact that in 2007 we executed our strategic plan.

In addition, we launched Phase 2 of our plan, focused on growing sales. We achieved significant profit growth at both the corporate level and in our company restaurants, and most importantly, we strengthened the financial foundation of this company.

We drove this performance despite challenges of a rapidly rising commodity cost, a weakening economy and fierce competitive environment. We also delivered this performance in the face of all the distractions of the Special Committee process that John just discussed.

You know, I am so very proud of our franchisees and our company employees for this effort. Together, we produced tremendous improvement in our business, and we're focused on more growth in 2008.

Now what I'd like to do is just share a few of our financial highlights in Q4 2007, and Jay is going to give us a lot more detail.

Our 2007 total adjusted EBITDA from continuing ops increased 38% to $305 million, up from $221 million a year ago. This was above the Wall Street consensus expectations for Wendy's EBITDA of $301 million.

Our EBITDA results exclude the full year expenses related to the Board's Special Committee process, which was $24.7 million, as well as some restructuring charges of $9.8 million.

Our U.S. company operated restaurant EBITDA margin improved 210 business plans to 11% in 2007, reflecting slightly positive same-store sales, labor efficiencies, and improved menu management.

In addition to the financial results, we are very proud of some other achievements in 2007. We added outstanding talent to our executive team with Jay Fitzsimmons as CFO, Tad Wampfler as SVP of Supply Chain, and Paul Kershisnik as the SVP of Marketing Strategy and Innovation.

We also earned three prestigious brand accolades during the year, including "Best Hamburger in the Business" from Zagat, we reclaimed the number one position in QSR Magazine's "Speed of Service" survey, and kept this organization focused on the future and we did this by building on the turnaround that we started in 2006.

Now, as we move forward into 2008, we've continued to execute our strategic plan. We recently launched Phase 2 of our plan, called "Doing What's Right for Our Customers," and 2008 our organization is focused on Wendy's hallmarks of quality and innovation in the four key cornerstones of our business, which is operations, marketing, people and our facilities.

You know, if you really look at it, the hallmarks of quality and innovation have historically set Wendy's apart from our competition, and in the future we are determined to deliver breakthrough products that distinguish Wendy's from our competition. That's our heritage, and that's what will bring more customers into our restaurants.

Phase 2 of our plan focused on growth drivers in the areas of core hamburgers, chicken, salads, as well as our long-term value strategy of beverages, snacks, late-night and yes, breakfast.

In the first half of '08 we plan to feature new quality products like our new Premium Codfish Sandwich that is in our stores this month, and in fact, we're advertising it on national TV beginning today. We also have extensions of our very popular Baconator, Frosty brand extensions, as well as new snack items.

As for breakfast, we have added our new breakfast menu in approximately 1,000 restaurants in over 86 markets, and about 35% of the stores are franchise owned. We continue to focus our resources on a small group of fully implemented breakfast markets, and we are determined to follow a disciplined approach with breakfast to ensure a profitable path for this major opportunity.

All these products and opportunities have something in common  Wendy's superior quality to drive sales. In late January - in fact, just a week ago  we held our franchise convention to share details about our new system in 2008 and beyond that focus on improvements in all areas of our business. We had more than 2,600 franchisees, employees, suppliers in attendance in Orlando, and I am very pleased with the franchise turnout and their participation.

It was an extremely important event for our organization in an effort to build system unity, focus everyone in the organization on driving our business, and update our operators about the most important programs scheduled for 2008. And yes, to also celebrate Wendy's very special culture.

While at the convention we announced that we are evolving our advertising, and we unveiled our new TV ads. The ads will invite customers into our restaurants. They will spotlight our superior quality food, and make you hungry. They will leverage Wendy in a way that is genuine and true to our brand, and when I speak to Wendy, I mean, the Wendy icon. The TV ads open and close with an animated version of our familiar logo, the image of Wendy. She's a little girl who represents the daughter of our founder, Dave Thomas. Most importantly, the ads also feature close-ups of our Wendy's delicious high quality food.

We do believe that the food, for Wendy's, is a clear point of difference between us and our competition, and we will spotlight our fresh, never frozen, beef, center-cut chicken breasts, our fresh toppings, our freshly made salads, and our premium codfish sandwiches and chilli that's made every day in our restaurants.

The advertising begins today on national TV and will be supported with a fully integrated plan for radio, billboards, Internet and our in-store merchandising. Furthermore, this campaign will be central to our strategy of highlighting Wendy's superior quality in everything we do.

Finally, we are committed to fiercely protecting this great brand and positioning it for future growth and profit. We had both achievements and challenges over the last year, and I know many of you - our shareholders - are frustrated with the length of the Special Committee process and the fact that there has been little public communication from the committee. As John's already said, the Special Committee is working diligently to conclude its review of strategic options and the committee will comment as circumstances warrant.

In the meantime, our management continues to focus on what we can control  the business and our plans to improve it. We are optimistic about the future, although the first part of 2008 looks challenging due to economic headwinds and rising commodity costs. Despite the macro issues, we are focused on building momentum, driving transactions, and growing store profit margins.

We have a very powerful brand, and as we align all of our resources and initiatives, I believe Wendy's is poised to grow sales, transactions and profits in every restaurant.

So with that, I'd like to turn it over to Jay to review some of our key financial results.

Jay Fitzsimmons - CFO

Thanks, Kerrii. First I'll comment on some of our key financial results.

Excluding expenses related to the Board's Special Committee and restructuring charges, we reported 2007 adjusted income from continuing operations of $108 million. That's up 50% from the $72 million a year ago.

Adjusted EPS on a diluted basis was $1.20 for the full year, and that's up 94% to $0.62 a year ago.

And adjusted EBITDA for the year increased 38% to $305 million.

As previously reported, same-store sales at U.S. franchise-operated restaurants increased 1.4% for the year compared to a 0.6% number a year ago. Our franchisees have produced seven consecutive quarters of positive same-store sales growth.

As we previously reported, U.S. company operated same-store sales increased 0.9% for the year. That compared to a 0.8% increase last year.

If we'd look at it on a two-year basis, the company's same-store sales growth averaged 1.7%.

Sales were impacted positively by breakfast sales, improved menu management  which includes things like our three-tier combos, the Baconator, value meal, combo upgrades and menu price increases. It's also partially offset by negative transactions compared to a year ago.

We are encouraged by our 2007 results, but we recognize that further opportunities exist to grow top line sales and improve operating margins in 2008. As Kerrii said, we have a strategic plan and new initiatives in place to generate even better results in 2008.

The 2007 income statement in our detailed appendix to the earnings release demonstrates the excellent cost controls achieved in a difficult environment.

Now I'll highlight some of the key items on the 2007 P&L.

Cost of sales were $1.32 billion, or 61.2% of sales. That's down from the $1.35 billion or 62.8% of sales year before. The improvement as a percent of sales was driven by improved menu management and labor efficiency. These improvements were partially offset by higher commodity costs, which impact U.S. margins by 90 basis points for the year.

G&A - in 2007, G&A decreased 100 basis points as a percent of revenue from the 2006 results. This is primarily the result of the company's next chapter reorganization completed in 2006. We also benefited from lower insurance costs and bonus expense.

Interest expense was higher in 2007 as a result of the sale of 2007 royalties that was entered into in 2006. In 2006, the company received $94 million in return for 2007 future royalties. The $94 million was accounted for as debt in 2006. In 2007, the repayment of the royalty related debt was 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.

Now I will describe the significant items that affect the comparability of 2007 results to 2006, and there are a lot of them. This information is provided in detail in the appendix to the earnings release for the year and the fourth quarter.

All of the following comments refer to your full year 2007 and 2006 results:

We incurred Special Committee charges of $24.7 million in 2007. These charges did not occur in 2006.

We had restructuring costs of $9.8 million in 2007 which includes $7.4 million in pension settlement charges. This compares to $38.9 million in restructuring costs in 2006.

The company made a special advertising contribution of $25 million in incremental pre-tax advertising expense in 2006 which impacted the operating cost line on the income statement. This did not recur in 2007.

And in 2007, we did not have the [Tim-Wen] joint venture income of $7.2 million, which impacted several lines on the income statement in 2006.

Excluding these items, adjusted EBITDA was $305.4 million in 2007, and that compares to $220.7 million a year ago. This represents a 38% increase over 2006.

We also had other significant items affecting comparability for the year:

Insurance gains related to Hurricane Katrina of $9 million in 2007, which impacted the other income line. These gains did not occur in 2006.

We had store closure charges of $7.3 million in 2007, which compares to $16.7 million in 2006. And this impacted the other income line in both years.

We paid franchise incentives of $6.4 million in 2007, which impacted the operating cost line. This compares to $1.1 million in 2006. These expenses were established to encourage franchisees to remodel and upgrade their restaurants.

A gain from the Tim Horton's tax agreement of $5.7 million impacted the other income line in 2007. This gain did not occur in 2006.

Finally, we recorded a Pasta Pomodoro impairment charge of $5 million in 2007 which also impacted the other income line. This charge did not occur in 2006.

Now a couple of quick comments on the fourth quarter:

Excluding expenses related to the Board's Special Committee and restructuring charges, we reported fourth quarter adjusted EBITDA from continuing operations of $57 million, up 48% from the $38 million a year ago.

And adjusted EPS on a diluted basis was $0.21 for the fourth quarter, up 50% compared to the $0.14 a year ago.

We have provided a detailed review of the fourth quarter in the appendix.

Finally, I'll take a minute to talk about 2008.

As previously announced, we do not plan to provide detailed guidance until the completion of the Special Committee process. That said, we expect a challenging first quarter of the year due to consumers' nervousness about the economy and the current slowdown in restaurant spending.

In addition, we continue to see commodity price increases in 2008 which we plan to offset with menu price increases and further cost reductions.

Higher grain prices and petroleum are expected to keep food cost increasing in 2008. For instance, compared to last year, 2008 corn futures are up approximately 42%, wheat futures are up 17%, and soybeans are up 45%.

For the year, food and paper costs are expected to increase in the range of 140 to 180 basis points compared to 2007, or about 3.5% to 5% as a percent of food cost. For example, beef should be up around 3% to 4% and chicken as much as 5% to 8%.

We expect store closure costs in the fourth quarter of - in the first quarter, excuse me - of 2008 in the range of $5 to $10 million. In 2007, we had store closure charges of $7.3 million for the full year, which impacted the other income line on the income statement. So again, in the first quarter of 2008, our estimate for store closure costs is $5 to $10 million.

In addition, the expenses for the January franchise convention will be recorded in the first quarter of 2008. The first quarter of 2007 did not include any similar expenses.

It's important to note historically we would expect 20% of full year EBITDA in each of the first and fourth quarters of the year, and about 30% of our EBITDA in each of the second and third quarters, due primarily to the seasonality of our business. We believe that the first quarter of 2008 will experience more pressure due to the facts previously mentioned.

As you think about Wendy's 2008 EBITDA, I would encourage you to consider all of the nonrecurring items I just discussed.

Finally, although we are not going to provide you with detailed earnings guidance for 2008, we are comfortable in saying that we expect our 2008 EBITDA to be near the lower end of current analyst estimates on first call, and that's excluding Special Committee charges, restructuring charges, and pension settlement charges. The analyst estimates for 2008 as of Friday range from a low of $324 million to a high of $358 million. Again, we believe it is prudent to expect our performance near the lower end of that range.

If the Board of Directors decides that Wendy's should continue to operate as a public company, we would plan for a conference call or meeting to provide more detailed information about our outlook for 2008 in the longer term.

Thank you. Now let me turn it back to John.

John Barker - IR

Thanks, Jay. A couple of notes before we open up the phone lines for questions.

First, the Board of Directors has approved our 120th consecutive quarterly dividend, and that will be paid on February 29 to shareholders of record as of February 14. The quarterly payment will be $0.125 per share, and this is our fifth dividend payment since the Board voted to increase our annual dividend rate by 47% from $0.34 previously to $0.50 per share.

And as I mentioned at the beginning of the call, the company will report further developments regarding the Special Committee's action only as circumstances warrant. We do not intend to discuss this matter further on the conference call today. Please focus your questions on the financial results that we just reviewed as well as the business initiatives, marketing and operations.

Now, Christy, I'd like to open up the Q&A session for those on the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Glen Petraglia.

Glen Petraglia - Citigroup

Good morning. It's actually Glen Petraglia from Citi.

Kerrii Anderson - CEO and President

Good morning, Glen. We knew it was you.

Glen Petraglia - Citigroup

Thank you. In terms of maybe Dave Near can answer this question, but in terms of remodel prototype presuming that the company does remain standalone, the system that you folks have been working on for quite some time, I'm curious to know where we stand in that process. Thanks, and then I have a follow up.

Dave Near - COO

Glen, in terms of a new prototype, we have several different prototypes currently. We have a small building design, we have a square building design, and then we have our current E-2000 design that we continue to build.

We've also explored drive-through onlys, as you know, which continue, I think, to be an opportunity for us as we move forward, but we have not done a tremendous amount of work in terms of really driving an initiative towards an entirely new prototype building. That may be something that we look at towards the latter half of the year, but currently we've got several different options that are available.

Glen Petraglia - Citigroup

And in terms of, you know, I think one of the things you folks have talked about a lot over the course of the last, let's call it one to two years, is at some point needing to remodel the system. Do you think that you're at a point that if you decide to remain a standalone company that you're in a position to get franchisees to make those necessary investments?

Dave Near - Chief Operating Officer

You know, Glen, I do. I think that it's certainly something as a franchisee that everyone that signs a franchise agreement that has very specific detail in there as to when remodels need to take place. And, you know, we feel very strongly that we need to enforce that to the degree that it's necessary to make sure that our brand stays current.

So I do. And I think there's also general understanding and feeling in the franchise community that, you know, reinvestment is really a big driver of the business and something that needs to happen.

So I do feel like going forward our franchise system will embrace the [inaudible].

Kerrii Anderson - CEO and President

And Glen, I might add, we had been testing a number of different designs for remodels, and Dave, I know Ed Choe is here at the table, we had tested a number in Cincinnati and Columbus and we have settled on two that add or are within about $100,000 on the outside remodel, right?

Edward K. Choe - EVP Restaurant Services

Yes, we have worked our design schemes or designs, exterior designs, down to two that we - we, as management, are pleased with, but more importantly our consumers are pleased with. We will be under construction with them in the next 30 days, and we will read the results of those two new designs.

Kerrii Anderson - CEO and President

And we shared those with our franchisees at convention.

Glen Petraglia - Citigroup

Okay. And then what gives you the confidence that this ad campaign is the right one? I think maybe it was eight months ago that you launched the red wig campaign and, you know, I think that that was - there was a lot of hope in Dublin about that campaign, and I guess, you know, why is this one the right one? I've seen the ads that were sent out by John last week and they don't, to me at least, they don't scream 18 to 34-year-old core hamburger user. So if you could maybe address that.

Kerrii Anderson - CEO and President

Sure, and I'll have Bob Holtcamp and Paul jump in here with me.

First I would say the red wig campaign did a lot of good things for Wendy's. It broke through the clutter, it raised our awareness, and we have now the research tools and information to really measure what our attributes are from an advertising perspective, and we know it did that.

However, it did polarize, as we actually shared with our franchisees, we now know from research that has been done the red wig campaign was polarizing.

Having said that, this new campaign - and Bob and Paul can comment - we have already done significant consumer research from a qualitative perspective and it's undergoing quantitative at the moment that says to us that it has - very in line with who we stand for at Wendy's, and that we can't be something that we're not.

So we started to get some very preliminary results that indicate that it is received very positively.

And most importantly, also, you know, while - we haven't changed our target, and Paul and Bob can speak to that. Our target's certainly the sweet spot; it's always 18 to 34. They're frequent users.

That said, we know from research performed that what attracts them to our industry is high quality delicious food, and that's what we're focused on delivering.

So I'd have Paul and Bob maybe make any comments you think would be helpful in answering Glen's question.

Bob Holtcamp - SVP Brand Management

Yeah, this is Bob Holtcamp. You know, Kerrii spoke to it, but this is a much more authentic approach to the Wendy's brand, and, you know, the red wig campaign did do some good things for us.

More specifically, it heightened the awareness around Wendy herself, Wendy the icon. And, you know, for us, we just simply didn't want to continue to look like a brand that wasn't really real and authentic to what the brand is all about.

This advertising is designed to go squarely against elevating our premium quality look and feel, and the brand has stood for that for many years. And what we weren't seeing the current advertising was the increases in consumer ratings around quality. And so this approach is designed to not only leverage the Wendy icon in a more authentic and honest manner, but it's also designed to go squarely against delivering on higher quality and higher premium quality versus our competition.

Kerrii mentioned this. We did take the creative into focus groups. We're in quantitative now on finish creative, and in the focus groups done in five cities, we put the two different campaigns head-to-head against each other, and what consumers fed back to us was that this new approach was more true to the fundamental principles of the brand, that it did speak directly to quality, that it was a more honest approach to our food and what our food delivered for consumers. And so in that regard, we see this as a very strong evolution from the red wig campaign, one that's a bit more true to the brand.

Glen Petraglia - Citigroup

Thank you.

Operator

Your next question comes from the line of John Ivankoe.

John Ivankoe - J. P. Morgan

Hi, thank you. A few questions, if I may.

First and, you know, thank you for the commodity guidance for 2008. If you could review for us various operational cost savings initiatives that will be incremental in '08 versus '07, and then I'll have some follow ups.

Jay Fitzsimmons - CFO

John - hello?

John Ivankoe - J. P. Morgan

Yeah.

Jay Fitzsimmons - CFO

Yeah, there we go. We've got - from a cost saving perspective in '08, we are continuing to look at labor efficiencies in the store. We will be rolling over certain pieces of that in the first two quarters of this year where we implemented some of those initiatives in the back half of '07, so we'll continue to see some efficiency there.

We'll also continue to look at some of the different management layers that we have in the store in terms of our general manager, co-manager and assistant ranks, and I think there's some opportunity for us to become more efficient there as well.

We also have developed a new daily operations plan that helps us load our crew and management more efficiently as we move forward, and I think that will yield some cost savings as well. So I think that's kind of the bulk of it from a labor perspective.

John Ivankoe - J. P. Morgan

Okay. Is there anything else on the food side that's possible relative to what you've already done?

Kerrii Anderson - CEO and President

I think, John, the biggest opportunity from a food standpoint is what we call menu management. You know, a menu mix, in the sense that, you know, if you can increase the percentage of beverages sold or combos or, you know, French fries or things of that nature, what you end up doing is you end up shifting, you know, you lower your food costs and you increase your gross margin because you are shifting the product mix.

And that is a very key component to us driving what we call the Snack Attack part, along with the Frosty extension. And so that is probably the biggest opportunity from a food cost is in mix because certainly from a commodity standpoint, there's not much positive news on the horizon.

John Ivankoe - J. P. Morgan

I know you moved to market-based pricing throughout 2007. Can you talk about the success of that from a consumer perspective and whether there's more opportunities in '08?

Kerrii Anderson - CEO and President

Paul?

Paul Kershisnik - SVP Marketing Strategy and Innovation

Yeah, I think there will be more opportunities. This is Paul Kershisnik. I think there will be more opportunities for that going forward, and the important part about it is that it allows us just to be more competitive on a market-by-market basis and so the - and intermarkets are freer to do what they need to do to be competitive. And so I do think we'll continue to do that, and we'll continue to see positive results because of it.

John Ivankoe - J. P. Morgan

When is the biggest lapse that we should be sensitive to in fiscal '07 for that? I mean, was there like a point in time to where it was, you know, a significant change, just to refresh my memory?

Kerrii Anderson - CEO and President

Well, actually, John, we came out of the beginning of the year, you know, we had talked our market-based pricing take place really January 1 of '07.

John Ivankoe - J. P. Morgan

Okay.

Kerrii Anderson - CEO and President

I wouldn't say there's a big lapse.

John Ivankoe - J. P. Morgan

Okay. That's very good. And my final question, in getting back to some of Glen's points on remodels, you know, at least in my model I have franchisee remodel assistance actually fairly significant in '08 and '09 relative to your previous guidance that I think you gave a year ago. Is that still something that we should plan for? Is it still something - will there be a significant step function up relative to '07 with that program, or might it be delayed?

Kerrii Anderson - CEO and President

Well, I would say certainly the impact of a Special Committee decision, whatever that decision might be, has probably, I would say, the greatest impact on the timing.

The franchise incentive exists and it is available to them until 2010. We've actually talked about, you know, could we even think of other areas to expand the incentive.

So at this point in time, the most important thing and the most positive thing would for us to be to pay those incentives because franchisees are reinvesting back in their business.

Jay, I don't if you've got comments about - you know, we did talk about how we spent this year in '07 versus '06, and we would expect '08 to be greater.

Jay Fitzsimmons - CFO

Yeah. Clearly, the Special Committee has impacted the amount of special incentives that have actually been taken by the franchises, and the amount that we took this year was less than we had originally planned in our forecast.

We forecasted more next year, but again, it could be dependent upon first, whether we decide to revamp that program and offer it for different purposes to the franchisees or whether the Special Committee makes a decision which would impact the desirability of using that money.

John Ivankoe - J. P. Morgan

Okay, thank you very much.

Operator

Your next question comes from the line of [Mitch Viser].

Kerrii Anderson - CEO and President

Good morning, Mitt.

Mitch Viser - (Unidentified Company)

Good morning. Thank you, and a couple questions.

First on the commodity cost guidance of 140 to 180 bps in '08, does that include price increases or is that before any [M&N] price increases?

Jay Fitzsimmons - CFO

It's before price increases. That's just on what would happen to the cost line if you looked at the cost of the individual products.

Mitch Viser - (Unidentified Company)

Do you plan on offsetting that with increased prices?

Jay Fitzsimmons - CFO

Yes. As we said in the call, we plan on offsetting it with higher prices.

Bob Holtcamp - SVP Brand Management

And John, I can tell you that Tad is also working with suppliers, specifically on removing costs throughout the manufacturing process as well as with freight.

Mitch Viser - (Unidentified Company)

Great, thanks. And secondly, I guess on the Snack Attack, is that a permanent menu item or is that a potential LTO-type item.

Kerrii Anderson - CEO and President

Yeah, Mitch, we ran the Snack Attack in January as a national promotion at $0.99 and we have continued to require it - that's what we call a required item in our restaurants. In other words, it's not an option. It is offered in every Wendy's restaurant. Now, the price at which it is offered, although we highly have recommended that we stay with $0.99 given the current competitive environment, certainly what we see with Burger King and McDonald's, it is up to the individual franchisee as to what they do charge.

We see the Snack Attack as part of an evolving part of the overall value strategy for Wendy's, which, you know, we've been in value since 1989 at $0.99. We think that's part of the evolution of value, and we are encouraging our franchisees to stay with that price.

But it is a longer-term strategy.

Mitch Viser - (Unidentified Company)

Got it. Thanks. And just lastly on the [Prescota] which I believe is not discontinued, maybe just a big picture view as to why it was pulled off the menu. Was it just because of lower sales or were there operational issues or anything along those lines? Thanks.

Jay Fitzsimmons - CFO

It was purely because of sales declines on that. But one thing we're excited about is that Prescota did appeal to a certain target that's important for us - women - and we've got some good new products coming out this year that will appeal to that segment as well, so we hope to rebound on that front. Having taken it off the menu recently, we hope that the new additions will get that particular segment excited again with Wendy's.

Kerrii Anderson - CEO and President

And I would also add, Mitch, you know, what drove our decision was certainly the product mix piece, which is what Paul has alluded to. At the same time, we did acknowledge that, you know, it did create some more complexity in operations, and so with the lower sales, it was important to go on and pull it out so that we could continue to focus on improving operations by reducing the complexity. So it was good.

Mitch Viser - (Unidentified Company)

Great. And my last - lastly - is just on food cost, again. Does your margin forecast, does that reflect commodities being down in the third or fourth quarter, or if you could just give us a sense of what your second half '08 outlook is on commodities.

Jay Fitzsimmons - CFO

We haven't specifically looked into the quarters from a commodity cost. Our crystal ball is not that clairvoyant.

However, what I would say is I think the best news you can come up with on the commodities side is that hopefully commodities will not rise as quickly as they did last year, but I think the trend unfortunately is for higher cost.

Kerrii Anderson - CEO and President

And I would maybe add to that, you know, I think the majority of your commodity cost impact you're already feeling today, you know. I mean, we usually have annual contracts. We work very diligent. We do have beef that fluctuates on a quarter-by-quarter basis, which you guys all know, so you might see a little more pressure on beef in the back half than we'd see the first half, but it's still higher than last year at this time.

Mitch Viser - (Unidentified Company)

Great. Thank you very much.

Operator

Your next question comes from the line of Roger Saks.

Roger Saks - Societe Generale

Hello?

Jay Fitzsimmons - CFO

Hey, Roger.

Roger Saks - Societe Generale

Hi. How are you guys?

Jay Fitzsimmons - CFO

Good.

Roger Saks - Societe Generale

I wanted to circle back on a couple of the earlier questions. First, just a point of clarification on the franchise agreements and what that means in terms of reinvestment or remodelling in stores. Is there some kind of provision that basically stipulates that franchisees have to do a certain amount of reinvestment over time or how does that work?

Dave Near - Chief Operating Officer

Roger, this is Dave. We've got in franchise agreements, we have every 20 years there is a renewal on the franchise agreement which requires the franchise to bring that individual store up to whatever the then-current standard is.

And then within the franchise agreement - within that 20-year term - we have something called a review, which is something that every five to seven years we can require our franchisees to bring stores up to current standard as well.

So there are - we do have stipulations in those agreements where we can require our system to do certain things, and over the course of time, I think our system's been very good about the investment piece, but we do contractually have that in all of our franchise agreements.

Roger Saks - Societe Generale

How does that get enforced? I mean, do you basically just say now you have to do it because we're telling you to?

Dave Near - Chief Operating Officer

It's kind of enforced on a store-by-store or franchisee by franchisee basis, just depending on what the exact needs are of the individual store.

So we have a third party that goes out and does assessments on stores. We also have internal folks, franchise area directors, that go out and evaluate stores. And so we just deal with it kind of on a store-by-store and individual-by-individual basis.

And of the current franchisees, how many are rolling off of a five- to seven-year cycle that this would have to enforced.

Dave Near - Chief Operating Officer

You know, I tell you, we provided that about a year ago when we did our analyst meeting, Roger. I can pull that out. We had a couple charts which kind of showed where things were going to be rolling over for the next few years. I don't know if you still have any of that, but if you don't, I can send that to you.

Roger Saks - Societe Generale

Oh, I'll take a look through my files. If not, I'll get in touch.

Dave Near - Chief Operating Officer

Okay.

Roger Saks - Societe Generale

And just a second question on the new marketing campaign. Through all of Wendy's research and such, is there anything that you've located that ties in to your target audience - 18- to 34-year-olds - and, again, the look and feel of how stores should be?

Paul Kershisnik - SVP Marketing Strategy and Innovation

Yeah. I mean, the bottom line is what we've found thus far is that the younger you are, the more likely it is that you don't have a connection with the brand. And the new advertising that we're working on, that we've developed, really kind of levels the stage and clearly articulates what the brand is about.

It's more of a reinforcement for anybody who is a bit older, but it's also a good grounding for those consumers who are a bit younger who are just not as familiar with the brand.

Our intention is that every bit of research that we've used thus far to bring us to this point on the advertising, obviously that's being used as well in David's ad work related to the restaurants, and ensuring that the restaurants themselves are also a strong communication point for the value of the brand, both in the way we may merchandise our products in POP as well as the basic structure and design and décor of the restaurants.

Roger Saks - Societe Generale

And what sorts of things in your stores - are you having more drive-throughs, is it in the signage - what correlates to 18- to 34-year olds that you would have to do in your stores?

Paul Kershisnik - SVP Marketing Strategy and Innovation

Well, there's a couple things. First of all, it's the products that we market and what mix we're trying to drive on the different products. And we know that with the younger target it's stuff like the Frosty Evolution and moving that particular franchise from more of a $0.99 small item to leveraging some premium quality products off of that brand base that will retail in the neighborhood of, you know, $2.00 to $3.00, if you will. So that's one part of it.

The other part of it is ensuring that that consumer understands what our hamburger business is built off of, which are some of those things that make it a better tasting product and customized exactly to their taste. So we want to continue to leverage that as an aspect of our business.

But the basic design of our POP elements as well is designed now to really highlight the quality of the product. We're eliminating unnecessary type. We're being much more straightforward and direct with those elements that drive premium quality in the type in the copy. We're also including elements along the Wendy icon, utilizing her in a much stronger way than we have in the past in that POP. And then as far as the actual pictures that we have in our restaurants, the décor package, those will highlight specifically food versus other aspects of the brand.

So we want consumers when they walk in the door as well as when they drive through the pick-up window to see a brand that's really built off of quality in the QSR space.

Roger Saks - Societe Generale

Terrific. Okay. Thank you very much. Appreciate it.

Operator

Your next question comes from the line of David Palmer.

Kerrii Anderson - CEO and President

Morning, David.

David Palmer - UBS

Hi, Kerrii. I have two questions. My first question is on breakfast. I'm just embracing the numbers that you said, you know, out of the 1,000, 35% of those are franchised and just backing into that, it appears about 45% of company restaurants had breakfast at year end, meanwhile about 7% of franchise units had it. You know, the comps at your company stores have been about 1 percentage point worse than what you see in the franchise stores, so I'm wondering, just seeing this general math, how do you explain this in light of breakfast, and what are the implications for the future of breakfast.

Kerrii Anderson - CEO and President

I'll start by saying this, you know, with respect to company comps, you know, the company, as we talked about, went to market-based pricing in 2007, which certainly had quite, I would say, an impact on overall company markets and from a same-store sales perspective, so we, you know, our franchisees, in many cases had already changed price relative to where the company was.

So from that perspective, that's kind of just a general comment relative to our comps versus our franchisees.

Now Jay, from a -

Jay Fitzsimmons - CFO

David, we went back and did some research on this to see why there was a discrepancy. As you remember, typically the company's franchise - the company's same-store sales have exceeded the franchise same-store sales, so it's been just a trend which started this year where we've lagged them.

And when we looked at the individual markets in which we're in and compared them to the franchisees in our markets the disparity is not nearly as great, so some of it is the distribution of company stores versus the franchise stores.

To the effect of breakfast, yes, it is a positive affect to the comp, however, there is some cannibalization on breakfast. Because of the fact that we don't have a concentration of stores, it's hard to measure what that cannibalization is, but it does cannibalize your lunch and dinner sales at the same time it's building up the sales line from the breakfast standpoint.

David Palmer - UBS

Very helpful.

Bob Holtcamp - SVP Brand Management

David, one other thing. Historically if you go back on an annual basis - and I've not shared this with you - you will see years where the company is ahead of the franchisees fairly significantly, and years where the franchisees were significantly head of company.

And some of it is just catching up to programs, you know, did we put new products before they do and test? Do we renovate certain things? There's a number of factors, but for example, 2002, franchisees were 71 for the year, and Wendy's company stores were up 47.

David Palmer - UBS

Right. Well, that's helpful. The second question I was in your value message to the consumer. Basically I guess it comes back to the Snack Attack introduction. How did that work to drive traffic in the first quarter and perhaps can you give any color about how - what sort of impact that had to margins? And broadly speaking, if the Snack Attack is not going to be kind of the big value weapon to drive traffic and EBITDA, I'm wondering what you might be thinking about to reinforce your value message to the consumer.

Paul Kershisnik - SVP Marketing Strategy and Innovation

Well, a couple things. You know, the Snack Attack I think was successful for us in the sense that we were bringing in more the typically lower guest check customers that we've lost over some period of time because of pricing action, et cetera, and so I think we were appealing to the right kind of customer with the Snack Attack. That's why we're leaving it on the menu. It will be at $0.99 in all company stores, so we're keeping that pressure on.

But beyond that, you know, we want to take value to a place where it goes beyond just a single menu item because you can well imagine if you're duking it out at $0.99 on the specific item, there's just never going to be enough margin there to make that work over the long term, particularly with all the commodity pressures that are growing.

So our real focus is on trying to broaden the value picture so it's not just about the sandwich but it's rather about the sandwich, a drink and a side, and do that in a way that provides value to the consumer at a price point that's relevant and that keeps the traditional Wendy's focus on quality.

One thing we're not going to budge on on our value menu is the quality of our product, and so we've only got price and portioning to deal with. And so I think you'll see in the coming months a shift away from a single-product focus on our value strategy to a broader-based meal sort of approach that will improve our margins while still allowing us to keep some fairly significant price pressure out there, because we understand that, you know, we can't price combo meals or value meals at inordinately high prices because they'll just lose the appeal.

But that's going to be the approach. It will help us stay relevant for the value consumer on the price end, and it will increase our opportunity to become stronger on the food cost and margin side as we push multiple menu items versus just a single one.

Operator

Your next question comes from the line of Joe Buckley - Bear Stearns.

Joe Buckley - Bear Stearns

I couldn’t hear Jay’s answer on the pricing question. I was curious on a weighted average basis in the company stores how much price you took last year and then what your pricing plans for ‘08 might be?

Joseph Fitzsimmons

We didn’t actually give the amount of pricing that we took last year. I think the answer that we gave was that the pricing was taken earlier in the year, so the majority of it had an impact on 2007. There is not an anniversary impact on.

I think we did say that this year like most other people we’re planning on taking 3% to 4% in price and our intention was to take most of that beginning in the year.

Joe Buckley - Bear Stearns

You made comments about the consumer and restaurant sales. Looking at your fourth quarter sales pattern, it actually seems fairly consistent, December was actually a little bit better than November on both one year and a two-year basis. Are you seeing further pressures at the start of ‘08?

Kerrii Anderson

Joe, I would start with what our same-store sales were in ‘07 that we are comping against. January we were 4.8.

Joseph Fitzsimmons

Yeah, 4.8 in January, 3.3 in February and 3.6 in March.

Kerrii Anderson

So the first quarter for us last year was very, very strong same-store sales comps and we have to acknowledge that those are the strongest quarter that will go up against in ‘08 against ‘07. So from that standpoint certainly, I think we feel that we saw a lot of value in January, which we felt was important to run Stack Attack. Consumer, I think coming out of year end with gas prices and credit cared bills, I will tell you we are continuing to watch consumer carefully and think about how do we create opportunities to leverage their concerns and focus on value.

Joe Buckley - Bear Stearns

The franchise cost, can you quantify that? You mentioned it’s something we should be aware for the first quarter, just curious if you could quantify?

Joseph Fitzsimmons

It would be a couple million probably.

Operator

Your next question comes from the line of Steven Kron - Goldman Sachs.

Steven Kron - Goldman Sachs

Kerrii, you have a lot of initiatives in place, a lot of new products trying to drive better mix in the menu, taking more price, you have more marketing coming through. In this environment, are you guys able to really get a good read on how successful these different initiatives are given that the consumer certainly seems to be a bit more frugal with their spending particularly in the more recent time period?

Joseph Fitzsimmons

As we sit down and evaluate the effectiveness of the stuff that we put out into the marketplace there are a couple of levels that are important for us. One is are we driving traffic and sales, and the other is what kind of feedback are we getting from consumers both qualitatively and quantitatively with regard to specific reactions to the specific food items that we put out there?

Wendy’s has historically been known as an innovator, a company that comes out with lots of new products that are meaningful and we’re really trying to make sure that heritage is bright and promising as we go forward into 2008 as it’s ever been.

We have had some sale softness that you guys have seen and so that’s been a disappointment, there have been I think a lot of competitive reasons for it and demographic shifts et cetera, but I think the product line-ups that’s that we’ve got in 2008 will more effectively address those.

I think what we will see is, consumers reacting positively to the kind and quality of products that we put out there and that will also begin to reflect itself more positively in terms of garnering more of their traffic and dollars. So I think we’ll see much, much better sales in 2008 because of those product initiatives.

There have also been, if I can take an opportunity to say something too about some of the advertising questions that have come. We have to be all around the food. People don’t go to Wendy’s because Wendy’s is a cool place, and they’ll never go to Wendy’s because Wendy’s is a cool place. I think that all the things that Bob talked about with regard to how the advertising focus is on the food, you will see a continued R&D focus on making sure that he has got great stuff to talk about, great stuff to photograph and great stuff to put on there and I think that will really appeal to the consumers in the near and long term.

Kerrii Anderson

The other thing I might add just as a side benefit to the new advertising and the campaign slogan which is it’s way better than fast food, it’s Wendy’s. What’s been interesting for me and a very much of a positive is that we’ve always been the operations leader in this QSR industry. When I say that that means great in service as well as accuracy and quality and cleanliness in all the other areas. We are still number one in a number of them but we do not have the margin gap between us and our competitors that we would like to see.

One of the most exciting things from a franchisee perspective is when you stand up and say somebody we are way better than fast food, it’s Wendy it is a call to the action quite honestly and a rallying cry where we need to be better in all areas. We need to be better in the people we hire in training and motivate. We need to be better in the food that we bring out, as Paul just indicated, and the way we advertise. We need to show quality advertising. We also need to be better in our operations and how we execute the brand at the store level everyday and better in our facilities.

So it truly is more than just an advertising slogan. It’s a call to action for us and our system to really step up and be what Wendy’s always has been which is the best in QSR and we are excited about that.

Steven Kron - Goldman Sachs

As it relates to the EBITDA comment that you made, talking about the lower end of current consensus expectations around $325 million. Just to be clear this is off of the $305 million adjusted EBITDA from continuing ops that you reported for ‘07. Is that correct?

Joseph Fitzsimmons

Correct.

Steven Kron - Goldman Sachs

So that represents around 6% growth and I recognize we have another year of material commodity inflation and you’ve talked about that but I just want to make sure that I am not missing a bigger point here, because given all the opportunities that you have, given that you expect through the year as a lot of this stuff starts to take hold you expect better sales trends, I’m just curious as to why only 6% growth given you there’s still significant opportunity here? Does it reflect greater top line concerns and perhaps deleverage or are we just cycling just more limited cost opportunities?

Joseph Fitzsimmons

First of all, I would characterize it’s about 10% increase. Clearly we’re not quite satisfied with that, but we do have to acknowledge that we’re starting the year with very low momentum in sales and in this business as you know it’s sales that really drives the numbers. What we’ve done is we’ve been conservative in how we put this together and that’s why we are encouraging you to look towards the lower end of the current estimates.

Operator

Your final question comes from Larry Miller - RBC Capital Markets.

Larry Miller - RBC Capital Markets

Can you update us on the share repurchase or authorization and also whether or not you can actually be in the market given the strategic action?

My second question was on refranchising, you guys talked about doing 300 or 400 beginning ‘08. Is that still a legitimate target? And are the franchisees able to get financing and do they have the appetite to take on some of these stores? What finally what proceeds should we kind of think about if any as a result of those sales? Thanks.

Joseph Fitzsimmons

We still have 4 million shares that we can buyback and that limitation is through October 1 of 2008, we have 4 million shares. The answer to whether or not we can do anything during through the Special Committee process it’s doesn’t make any sense for us at this point in time to do anything through the Special Committee process. So we have not done any share repurchases.

Kerrii Anderson

From a refranchising standpoint Larry, you are right. We continue to believe that refranchising a number of our restaurants and reducing the company stores is the right think to do. We have to recognize in light of the Special Committee process we need a decision from them before we can move forward with that. While we had talked about may be refranchising up to 400 stores in ‘08 originally certainly we already into January waiting for a decision from them; you probably wouldn’t get more than half of those done 200 to 250, if you started tomorrow and we know which ones we want to refranchise. We know what markets make sense and where we can reduce expenses.

To answer your question with franchisees, we have a number of franchisees who very much would like to increase; it helps them diversify. Can they get financing? Financing is available and actually with some of the rate decreases is actually sort of a positive to the current environment for them to be able to borrow funds.

So there is a lot of interest from refranchising. That said they also want to see certainty in decision.

Larry Miller - RBC Capital Markets

Any thought on if you were to get them done with proceeds per store maybe to you guys? I know it will vary, but just generally speaking?

Joseph Fitzsimmons

It obviously varies by store. Traditionally, the industry has been about 6x EBITDA.

John D. Barker

Thank you all for dialing in today.

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

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

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

Source: Wendy's International, Inc. Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts