The Wendy's (NYSE:WEN)
Integrated Corporate Relation XCHANGE Conference Call
January 13, 2014 8:30 am ET
Margaret Roach Nollen - Senior Vice President of Investor Relations and Strategy
Emil J. Brolick - Chief Executive Officer, President, Director, Member of Executive Committee and Member of Capital & Investment Committee
Todd Allan Penegor - Chief Financial Officer and Senior Vice President
So thanks, everyone, for coming to the -- our 16th annual event. Particular thanks to the sponsors. Without them, there is no event. But we're going to try and stick to the schedule today, and I know Wendy's has a terrific presentation to share with you today. They're going to need all of their time. So without wasting any more time, I want to introduce to you Meg Nollen and the team. Meg?
Margaret Roach Nollen
Good morning, everyone. I'm Meg Nollen, Senior Vice President, Strategy and Investor Relations for The Wendy's Company. Before we begin today, I'd like to refer you to the Safe Harbor statement included in today's press release and presentation.
Certain information we will discuss today is forward-looking. Various factors could cause results to differ materially from those expressed in our forward-looking statements. Please note 2013 fourth quarter and full year results are unaudited preliminary results and represent the most current information available to management. The company has not yet completed its tax-closing procedure for 2013. As a result, the fourth quarter and resulting annual tax provision and earnings per share have been provided as ranges.
Our presentation references non-GAAP financial measures, such as adjusted EBITDA and adjusted EPS. Please refer to the non-GAAP reconciliations included in today's release and posted on our website at wendys.com.
With the formalities out of the way, let me now turn it over to Emil Brolick, Wendy's President and CEO. Emil?
Emil J. Brolick
Well, good morning, and thank you, Meg. We have a very powerful story for you today as our Cut Above brand positioning continues to resonate with consumers and position us strongly versus the competition.
I'm very proud of the year that the Wendy's team produced. Adjusted EBITDA was up some 10% to $367 million. EPS grew 71% to 76% to $0.29 to $0.30. And Image Activation, we achieved our targets of growing 100 image activated company, 100 franchise -- or 99, actually. And by the way, we're going to more than double that pace as we look at 2014. And importantly, as you'll hear, our efforts in terms of selling the 415 restaurants under system optimization are actually running ahead of schedule. We have 384 restaurants either sold or under contract.
And by the way, we're also going to accomplish our goal of saving $30 million in G&A as we look to the second quarter of the year. And importantly, we returned 89% total shareholder return this year, and we returned $141 million to shareholders in terms of dividends, as well as share repurchase.
And consumers are clearly telling us that we're regaining our position as an innovator in the marketplace with products like Pretzel Pub Chicken, Pretzel Bacon Cheeseburger, Bacon Portabella Melt on Brioche. And as I look at the 2014 calendar and pipeline, I'm very encouraged by the kind of products that you will see in the future. And importantly, we're revitalizing our brand position through our Recipe to Win strategies.
So as we step back, we truly believe that Wendy's is A Cut Above investment opportunity. Our brand positioning is unique. It's working in the marketplace, and we believe it has significant legs in front of us.
We are, through Image Activation, repositioning the Wendy's brand experience to that new QSR standard, which is, by the way, the standard that consumers today are expecting. Our product price segmentation strategy is differentiating the Wendy's brand and growing same-restaurant sales and elevating average unit volumes.
And importantly, we've been able to execute system optimization in EBITDA-neutral ways. So next year, we're going to be growing with 415 fewer restaurants. We're lifting margins, and importantly, as Todd is going to talk to you about, we're increasing the quality of our earnings. Our new leadership team is an exceptional team, and they're building 5-star talent throughout the entire organization. And as I mentioned, we're returning significant cash to shareholders, not just this year, but you're going to see in future years as well. And as a result of this, we represent, we believe, excellent total shareholder return to our investors, not just in this year, where we return to 89%, but through growth in income in future years.
And growth is the imperative. We get it. Businesses only move in 1 of 2 directions. And unfortunately, in 1 case, they decline or they grow, and we are very focused on growth. We are fortunate to be part of a massive business, a $435 billion restaurant business, with $61 billion total locations out there. And what we have seen historically is any business that's relevant to consumers has tremendous growth opportunities, even in tough growth periods of time. You have to, though, be in the sweet spot of the business, which is quick-serve restaurants.
So why are they the quick -- the sweet spot? Because quick-serve restaurants have done the best job of delivering against the 2 most fundamental needs consumers have: convenience and value. And that is why they have built share against mid-tier restaurants, as well as casual-dining restaurants over this 5-year period of time. And while mid-tier restaurants and casual dining are fighting back, as you very well know, I believe this trend is going to continue. Now remember, every share point is worth $4.4 billion or 610 million visits. So we believe there's continued tremendous growth opportunity.
But now for our brand, to grow our brand, 2 important things here. You have to have brand relevance, and brand relevance is the key because that drives economic model relevance. And as Todd is going to talk to you about, our core economic model is improving. That is the key to further growth moving forward.
And when you look at our Cut Above brand positioning, this is what's really the difference in terms of brand relevance. If you look at us in the context of traditional QSRs, we are giving a new QSR quality experience, but we're charging that at the same price as our traditional competitors. Versus the new QSRs, we are giving people a comparable experience, but at a 40% to 45% lower average check, a powerful opportunity for our brand.
And the fact is that we have a clear line of sight on how to make this Recipe to Win -- or how to make the Cut Above brand positioning to happen. It is through our Recipe to Win. And this is a recipe, which means it takes all the ingredients coming together, it takes them coming together in the right proportion. But our company and franchise operators are very aligned behind this because they get it. This is what's going to drive profitability, and this is what is going to drive growth into the future.
And the fact is that we are seeing improvements in our economic model. As we look at average unit volumes, up $100,000 over this period of time. And I will tell you that in October, at our franchise convention, we went public with our franchisees and committed to achieving system average volumes of $2 million, and we showed them a clear path on how we can get there, $2 million system average volumes. And when you expand your volumes, you take costs out of the business, you get nice margin improvements, 140 basis points this year. And as Todd is going to share with you, we expect that to continue in '14 and going beyond that.
And as I mentioned, we achieved our targets in terms of Image Activation growth, of hitting 100 company, 99 franchise, and we are going to, basically, double that pace as we look to 2014. When you add on top of this, the new restaurants that are image activated, you can see how many consumers today, their experience at Wendy's is an image-activated experience, which is a very powerful experience.
And our marketing, obviously, continues to be very important. As a marketing organization, we are strategically driven and tactically brilliant. And we know that, from a consumer point of view, the most important thing is message. And we are in a very fortunate position to leverage the quality heritage we have as a brand so we can avoid that trap that others fall into, where we're simply trying to play the same game better. We can play a different game.
And we know that the media world today is very complex. You have to represent a holistic approach to consumers. It's broadcast, it's digital, it's social, it's public relations, all put together. And when you look at what we accomplished over the past 9 months, you can see how this came together in a very powerful way. And we are very fortunate that our creative campaign with Morgan Smith, who we call Red, is the most successful advertising campaign for Wendy's outside of the Dave Thomas campaign, which ceased in 2002 with Dave's passing.
And if we look at 2014, we are clearly going to continue our high-low strategy, which we began in 2013 with a lot of success. And we are very fortunate to be in a position as a brand where we don't have to fall into the trap of simply lowering price to create value. Because of the tremendous quality we have, we create value in both our lower and Right Price Right Size Menu, as well as through our premium products. Not every brand can do that because not every brand has those quality characteristics that we do.
And what's important is our communications are resonating with consumers. We see that total brand communication awareness is at levels that we have not seen since 2005. We expect to be able to continue that. And we are very focused on growth, as I communicated. Our growth pyramid is alive and well, and the foundation of that growth pyramid is same-restaurant sales for North America. We are very focused on continuing to grow that 2.5% to 3% next year, 3%-plus beyond that.
Image Activation experience. We have solutions for 85% to 90% of our restaurants, which Todd is going to talk about. And new restaurant growth, because of the improvement in the economic model, we believe, in the next couple of years, we are going to be able to get to net new restaurant positive growth, which we have not been at that for quite a period of time.
We are always looking for opportunities to heighten restaurant utilization, and we believe through technology today, through mobile ordering and through mobile payment, we can increase brand access and have tremendous upside through doing that.
We've also very recently engaged a prominent national consulting firm that has extensive international experience to help us refine our growth strategy outside of North America. So we are very focused on core organic growth, our growth strategies, but at the same time, Todd and his team are working very, very hard on building shareholder value through financial management strategies, increased dividends, increased repurchases of shares, refinancing the debt, the taking over of $50 million of interest costs out, giving us a nice elevation from Moody's in terms of our ratings.
And while we're at the long end of this phase of our system optimization in the 415 restaurants, you see that restaurant ownership optimization is something that is a permanent part of our growth pyramid. We are going to continue to look at this strategically, continue to look at this tactically, and as appropriate, look at the sale of restaurants, look at the purchase of restaurants to further optimize the Wendy's system as we move forward.
Fortunately, we feel that we are very, very focused on the things that we can control and focused on the things that are going to create brand relevance for our consumers. Brand relevance is going to create that $2 million AUVs. You get that expansion in AUVs, you're going to drive margins, you're going to drive free cash flow.
So as we step back, we believe that there are significant reasons to believe that the Wendy's brand is a tremendous -- track record in front of us, tremendous growth in terms of shareholders. We have a strong brand heritage. We have a unique brand position. Our Image Activation is contemporizing the brand experience. We have a strong leadership team, who's building strong leaders throughout the entire organization. Our economic model at the restaurant level, as well as at the Wendy's level, are both improving, and we have an exceptional base of franchisees, who are very committed to these strategies, both our Cut Above brand positioning, as well as our Recipe to Win.
So with that, I'll turn it over to Todd Penegor.
Todd Allan Penegor
Thanks, Emil, and good morning, everyone. It's a great time to be part of the Wendy's family.
And if I could get the slide to change, we'd be -- so a couple of quick topics for the team today. So I wanted to walk you through several things that I think are very exciting: 2013 results, Image Activation update, system optimization status, our 2014 guidance and our long-term outlook and plans to build shareowner value going forward.
If you look at the Q4 financial highlights, you can see that North American same-restaurant sales growth came in at a very strong 3.1%, which really helped us expand our margins, and you can see company restaurant margins are up 40 basis points at 16.3%, on top of a very strong comp from a year ago. As expected, adjusted EBITDA was down 7.2%. This was really behind a higher incentive comp and also behind our franchise incentives that we had to drive Image Activation, as well as some reinvestment initiatives that really pop in professional fees within the quarter. But importantly, adjusted EPS was up. So we had the opportunity to pick up some tax good news, and we had some of the interest good news that came through with all the debt financing that we had, which led us to be up 11% to 22% on adjusted EPS.
Full year financial highlights. You could see that we came in at 1.9% same-restaurant sales growth, which got us at a 2-year restaurant growth level of 3.5%. North American restaurant margin was very strong, up 140 basis points, really behind the leverage that we've gotten from the top line, price mix and then the exit of advertising against our breakfast program last year, partially offset by higher commodities. But adjusted EBITDA did come in at $367.1 million, up a very healthy 10.1%, and adjusted EPS came in, in the range of $0.29 to $0.30, as Emil mentioned, up 71% to 76%.
And 2013 Image Activation targets were met, and we are very excited that this is building momentum as we go into 2014. So we have planned 300 to 400 -- 350 to 400 reimages in 2014. On top of that, we're looking to do 60 new builds across the system, for a total of 410 to 460 image-activated restaurants during 2014, which would be on top of the 300 that are already image activated in the system. So when we end 2014, we will have 700 to 750 image-activated restaurants in the system.
And as we look at Image Activation, we continue to evolve to try and define the sweet spot between the economics to make sure we get the right investment and return levels, how do we make sure that we meet consumer expectations with the design that we put in place, but also how do we make the restaurants more effective and efficient for our operators to ensure that we can continue to deliver great customer service day in and day out. And we believe, with our new design, the ultramodern design with customizable upgrades that we can actually upgrade to the market conditions where that restaurant competes, is what we need to do going forward.
And if you look at what that design looks like, you can see a picture of it here. This is where we want to evolve. This is the standard ultramodern design. We'll provide upgrades for this restaurant to make sure that it fits the market dynamics in which that restaurant competes. And we are very proud of this restaurant and look to really push this forward as we move into 2014.
But we do know that one size does not fit all. We have about 40% of our system that are restaurants that are 25 to 40 years old. A lot of these restaurants are actually in very good trade areas with high AUVs, and some of these restaurants, rather than just being reimaged, are probably better to be scraped and rebuilt. And those are the restaurants that we'll talk about in a moment, that we think that, that's a better opportunity to drive future growth.
About 60% of the system are more modern restaurants, which are in the less than 25-year-old range. Those restaurants are probably more primed up to be reimaged restaurants. But importantly, as we put together this plan with the standard design and customizable upgrades, we will have solutions for 85% to 90% of the system. And it has been a journey. We started with prototypes of $1.2 million. Our latest design, this ultramodern standard design with customizable upgrades, and that's why there is a range, is in the $450,000 to $650,000 range.
And if you look at the investment posture of what we're going to do with the reimage, the $450,000 to $650,000, a couple of the key elements of that program. To do a reimage is about 5 weeks of closure time. We are seeing sustainable lifts of 10% to 20% when we do reimages. And we are looking for a 40% profit flow-through on those reimages. And of our total reimage -- of our total Image Activation universe, 80% of all of the activity will be reimage.
The other 20% will be the scrape and rebuilds. So I mentioned a lot of the restaurants are in great trade areas with high AUVs. Much better from an economic perspective to actually scrape and rebuild for the long run. The investment is higher, $1.5 million to $1.9 million, about 13 weeks of closure time that we'd have to absorb as we did that activity, but the sustainable sales lifts are higher, 25% to 35% with that same profit flow-through.
Switching gears, system optimization. Just as a reminder, this was the strategic growth initiative to sell 415 company restaurants, company-owned restaurants, which concentrated our ownership at about 15% and really allowed us to generate higher restaurant operating margins as we focused on our business, primarily east of the Mississippi. It improved our quality of earnings and our predictability of earnings, and I'll talk about that in a moment. And as Emil said, we are executing this initiative in an EBITDA-neutral fashion.
And the great news is we had tremendous excitement coming into the system, and we're getting a lot of 5-star franchisees, who are really supportive of the growth initiatives of The Wendy's Company. And importantly, within the sales agreements, they will include commitments to Image Activate 180 restaurants and new build -- new development builds of 100 restaurants over the next 5 years. So just an update on where we are with all of this excitement. We've got a nice mix of existing franchisees taking bigger positions in the system and new franchisees entering the system.
And with that excitement, we've actually sold 243 restaurants through 2013, with total cash proceeds of about $138 million. We have another 141 restaurants already under contract, which we'll sell during the course of quarter -- the first quarter. And we have buyers identified for the remaining 31 restaurants, and we'd hoped to get those sold late Q1 or early Q2, for total restaurants sold of 415 and total cash proceeds of $235 million.
Turning to our guidance for 2014. You can see same-restaurant sales growth guidance of 2.5% to 3.5%, up 60 to 160 basis points from the prior year. Really, with the Image Activation tailwinds kicking in, a strong innovation pipeline and now having the exit of breakfast behind us gives us the confidence on that growth for next year -- or for this year. Restaurant margins continue the expansion, with the system optimization initiative, with the continued growth on the top line to create leverage across the P&L, price mix, we do see our restaurant margins in the 16.8% to 17.0% range for 2014, up 140 to 160 basis points from 2013, and that's on top of the solid 140 basis points of growth that we had to date.
Looking at adjusted EBITDA. We have a range of $390 million to $400 million, plus 6% to 9%. And that includes taking into account the closure time on the scrape and rebuilds and the reimages that we've built into our plan for next year. And adjusted EBITDA -- or adjusted EPS at the $0.34 to $0.36 range, which would be up mid-teens-plus, coming off of the estimated range of $0.29 to $0.30 in 2013.
If we look at 2014, it is a year of improved quality of earnings. We are expecting 6% to 9% adjusted EBITDA growth with 415 fewer restaurants. If you look at the growth components, core restaurant growth is $30 million to $40 million, very strong at north of 10%. So our core restaurants are growing very healthy at that $30 million to $40 million profit -- EBITDA contribution in 2014. And from the franchise revenue and the G&A savings, that contributes about $70 million to $80 million of our growth, which helps us offset $75 million to $80 million of the sold restaurant EBITDA through the system optimization initiative.
If you look at the IA impact though, although it's a tailwind on same-restaurant sales growth, it is a net-neutral to slight profit drag in 2014. So as we ramp up the activity, going from 100 restaurants to 200, have a mix of scrape and rebuilds and reimages, that closure time will impact EBITDA during the course of the year, and we'll see those returns out into the future years. But those are the components that actually drive our growth to $390 million to $400 million guidance for 2014.
So if you look at our long-term outlook, Emil alluded to our $2 million average AUV goal. To get there, we need to drive same-restaurant sales north of 3%, and we are confident, behind IA and product news, that we continue to drive the business to deliver that outlook. On an adjusted EBITDA basis, the growth rate would be in high-single to low-double digit range. And on EPS -- adjusted EPS, the growth rate would be in the mid-teen range.
And Image Activation, system adoption is quickly accelerating. So embedded in our guidance, in our long-term guidance, is a very aggressive IA plan. You can see that the company activation -- Image Activation activity really peaks in 2014 and 2015. And I have -- we have a goal to actually have the system -- or the company restaurants image activated at a clip of 85% by the end of 2017. But what's happening with IA, the improvement -- the economics improving, we're actually seeing the franchisees quickly follow. And we have a chance, in 2014, where franchisees may Image Activate more restaurants than the company does, and you can see the accelerating pace as they continue to follow, with a goal to have 35% of the system image activated by the end of 2017.
What it's going to take to make this happen is capital. Investment is expected to peak in 2014 and 2015 to drive Image Activation. You can see our guidance for 2014 in the $280 million to $290 million range, clips up a little bit in 2015. The numbers are a bit higher than we anticipated in the past, as we're going to do more scrape and rebuilds in those numbers, and we think that's the right economic decision. We're very diligent with our capital, looking for really good returns. And that's the plot that we have. And then you can see, by the time we get to 2018, once we get through the hump, we have a $100 million to $125 million of ongoing capital needs for the business.
So if you look at adjusted EBITDA growth from a long-term perspective, 2014 through 2016, we'll be at the high-single-digit range. And then Image Activation investment does drive accelerated adjusted EBITDA growth to that low-double-digit range once we get past the investment hump and the closure time of Image Activation.
So what are our cash priorities as we continue to work to build shareowner value? Well, first and foremost, we want to invest in our business. We talked a lot about that today, Image Activation reimages, including increasing scrape and rebuilds. We want to continue to drive dividends. So generally, dividend growth will be in line with EPS growth going forward, subject to board approval. And from a share repurchase perspective, we want to continue to leverage share repurchases to offset ongoing options dilution. But importantly, for us, we ended the year in a great spot, with $580 million of cash, and what we want to do is continue to work to return some of that cash to shareowners.
So if you look at how we're going to return some of that cash to shareowners, in the back half of 2013, we did a lot of work, $69 million of share repurchases in the back half of 2013. And the board has authorized a $275 million share repurchase program for 2014. We're going to execute this through a Dutch tender, which will commence tomorrow, January 14, with a price range of $8.50 to $9.25. And this really leverages our excess cash, the proceeds from system optimization of $235 million and the Arby's distribution of $40 million.
So in closing, we do feel like we are building a stronger Wendy's. The results exceeded adjusted EBITDA, EPS guidance. The restaurant economic model is improving. 2013 Image Activation targets have been met and accelerate for 2014. System optimization is enhancing our quality of earnings. We finished 2013 with strong cash, and we're putting that to work. And 2014 is positioned for another strong solid year, and our long-term guidance is on track.
Now I'm very excited. I've been with the company all of 8 months, but what a great time to be part of the Wendy's family. We have a great team really focused in working together to build a stronger Wendy's. And I am very excited about our growth prospects for the future.
Thank you very much.
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