The Wendy's Company (WEN) Q3 2011 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Third Quarter 2011 Conference Call for The Wendy's Company. Our hosts today are John Barker, Chief Communications Officer; Emil Brolick, President and Chief Executive Officer; and Steve Hare, Chief Financial Officer. [Operator Instructions] I would now like to turn the call over to John Barker. You may begin, sir.

Thanks. Good morning, everybody. This morning, we issued our third quarter 2011 earnings release, and we also filed our Form 10-Q. The agenda for today's call and the webcast will include comments from our President and CEO, Emil Brolick. Our Chief Financial Officer, Steve Hare, will then review our third quarter financial results, as well as our 2011 outlook. And then afterwards, we'll open up the line for questions. As a reminder, due to the sale of Arby's, the restaurant group, on July 4, 2011, Arby's results of operations are reflected at discontinued operations. Today's conference call and our webcast is accompanied by a PowerPoint presentation that can be found on our Investor Relations page on our corporate website, which is www.aboutwendys.com. For those of you who are listening by phone today, make sure you select the appropriate webcast player option from our website and that will make sure that you can sync up with the slides and the audio. Before we begin, I'd like to just take a minute to read you the Safe Harbor statement that is attached to today's release. Certain information that we may discuss today regarding future performance such as financial goals, plans, development is forward-looking. Various factors could affect the company's results and cause those results to differ materially from those expressed in our forward-looking statements. Some of those factors are referenced in the Safe Harbor statement that is attached to the news release. Also some of the comments today will reference non-GAAP financial measures such as earnings before interest, taxes, depreciation and amortization. Investors should refer to our reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measure. As you know by now, Emil Brolick took over as our CEO of The Wendy's Company on September 12. And because this is his first quarterly earnings call with us, I'd like to provide just a little bit of background about Emil. He joined Wendy's from Yum! Brands where he had held several leadership positions including President and Chief Concept Officer of Taco Bell, President of U.S. Brand Building, Chief Operating Officer and President of A&W All-American Foods and Long John Silver's. Prior to his time at Yum!, he worked at Wendy's for 12 years, lastly, serving as our Senior Vice President of New Product Marketing, Research and Strategic Planning. During his time at Wendy's, Emil worked closely with Wendy's founder, Dave Thomas. And we are very excited to have him back. Let me turn the call over to Emil.

Thank you, John. Good morning, and thank you for joining The Wendy's third quarter earnings call. It's quite an honor to have the opportunity to lead The Wendy's brand to -- and to build upon the good work of Roland Smith, David Karam and Steve Hare. Moving forward, the goal is simple: return The Wendy's brand to the luster and performance of the 90s and 2000s, the period of time when the brand enjoyed 16 years of consecutive same-store sales growth. The turnaround of The Wendy's brand has already begun, but to sustain brand sales and profit growth will take a cohesive effort of company and franchise operators united in reigniting the brand vision of our founder, Dave Thomas, and by being true to the very high people and operating standards of brand legends, Jim Near and Gordon Teter, all of whom I had the privilege of knowing and working with. My first 2 months in position could not have been better. Franchisees and employees had been very welcoming as has been Nelson Peltz, Peter May and the entire Wendy's Board of Directors. In mid-October, we held our National Franchise Convention in Las Vegas with an all-time record attendance in both domestic and international franchisees, as well as record supplier participation. The mood was very upbeat. The Wendy's family is excited and committed to the operating effort and capital that it will take to continue the momentum that is building in The Wendy's brand. This excitement is, in large part, due to the significant success achieved by the launch of the Dave's Hot 'n Juicy hamburger line, featuring our signature fresh, never-frozen North American beef, 2 slices of cheese, crisp leaf lettuce, red ripe tomatoes, red onions and crinkle-cut pickles, all on a warm butter-toasted bun. Sounds great. And customers' response has been excellent. And importantly, sales have exceeded our expectations. For example, we would have to go back to early April/May of 2004 to find a 5-week period of sales growth higher than the most recent 5 weeks in sales. We are pleased with this performance, but we know that the key for investors is consistent sales and profit growth over a sustained period of time. Since the beginning of the Asiago Ranch Chicken Club national marketing message on October 31, our sales momentum has held nicely, giving us a great start to the fourth quarter. We are confident that with the strong results of Dave's Hot 'n Juicy and the continued sales strength with Asiago Ranch Chicken Club, we will be able to move to third quarter year-to-date same-store sales growth of 1.1% to the middle of our annual target of 1% to 3% same-store sales growth by year end. Following Asiago Ranch, our December marketing message will feature the launch of an exciting new taste profile to the Wendy's hamburger line up with a product that we simply call the W. The W is a mid-tier priced product that will feature 2, 2.25 ounces of fresh beef, never-frozen North American beef and a surprise taste profile. The W is positioned between our line of Dave's Hot 'n Juicy Cheeseburgers and our entry-level hamburger offering. We believe that the W will be a compelling way to finish the year and put Wendy's in a position to enter 2012 with significant momentum. So let's spend a little time talking about what will make -- what we will make sure that this is the beginning of a sustained period of success for the Wendy's brand. Many people have asked, what has changed since 2000, which is when I left Wendy's? Those obvious change to all of us is the evolution that we've seen in the competitive and consumer environment. Quick-serve restaurants, I call them the new QSRs, have surged to success in the past 10 years. Why? I believe that they have demonstrated to consumers that they offer a superior overall experience to that of many old-line traditional QSRs. Specifically, they offer high-quality food, as well as food transparency or food with integrity, as some would call it. They offer a better restaurant environment and they have restaurant teams that represent the brands extremely well. The bottom line is that they offer a better total experience and many would say, a better overall value. The success of the new QSRs is unmistakable as they have accounted for 80% of QSR growth since 2005 and 100% of growth if you eliminate breakfast. So, yes, the competitive set has changed significantly. We understand this, and we are confident that we can successfully build our brand, build sales and build profits in this new environment. The other thing that has changed since 2000 is that Wendy's went through a difficult period and lost clarity of vision for the brand. One might say that The Wendy's brand went through an identity crisis. In the past 18 months, important progress had been made to help stabilize the situation. Clarity of vision is obviously essential, and we have now identified a position in the marketplace that is unique to Wendy's, is defensible and is profitable. That position is called A Cut Above. Not coincidentally, this is the same position that Wendy's held in the marketplace in 1969 when Dave Thomas conceived The Wendy's brand. A Cut Above says, "We are going to be ourselves, not somebody else. We control our future, our competitors do not". Our focus will be on beating ourselves, being the very best Wendy's that we can be and building our brand, sales and profits to levels not previously seen. Our philosophy is simple: focus on the things that we control. And if you want to predict the future, you must invent the future. So, yes, you will see us return to the roots of meaningful product and service innovation. So how do we bring the vision, A Cut Above, to life in a vibrant and exciting way? Our brand vision will be brought to life with well-conceived strategies for all the Ps: price, product, promotion, place, performance and people. While these are the same tools that our competitors have, we will use these tools in a proprietary way in what we internally call, "a Wendy's kind of way". When the competition zigged, Dave Thomas zagged. When they zagged, he zigged. Dave beat to a different drummer. We will beat to a different drummer, too. Let me briefly touch on the key Ps. First, price. Consumers in the U.S. are under a significant financial pressure. Household incomes have been flat in real terms since 1996, and a recent U.S. government projection indicated that household incomes were not expected to exceed current levels until the year 2021. In essence, that is a 24-year period of flat real household incomes. So, yes, price value is important to consumers. Our belief is that there are only 2 ways to deliver value to consumers. The first way is it to provide consumers a similar product to the competition and charge them less money for it, not an approach that we would choose to take. The second way to provide true value to customers is to provide them a clearly superior product and charge a competitive price. At Wendy's, we call this "5-star quality at a 3-star price". This is The Wendy's way. It is a consumer win and a consistent win with our overall economic model. Next, the product P. We intend to leverage the unique capability of the kitchens in our restaurants to create enhancements to our core hamburgers, core chicken sandwiches and core salads and drive innovation beyond the core. The Wendy's operating system is unique, and we intend to leverage this uniqueness to provide made-to-order products for our customers consistent with the quality of products offered by the new QSRs but at a price below them, re-enforcing our brand position of A Cut Above. The quality of our new Dave's Hot 'n Juicy Cheeseburger line is an example of this strategy as will be the launch of the W in December. The very successful launch of the Berry Almond Chicken Salad and the Asiago Ranch Chicken Club are also examples of successful core innovation. We, however, know that this is not enough. This is a dynamic, consumer and competitive environment, and we are testing or will be testing products that will re-establish The Wendy's brand as a leader in meaningful product innovation, re-establish Wendy's as A Cut Above. Also in the product arena, we remain excited about the opportunity for the morning meal, breakfast. Over the past 5 years, breakfast has accounted for 92% of all traffic growth in the QSR segment and represents 21% of all traffic, not that much smaller than the 27% that dinner represents. We believe there is an opportunity for a fresher, higher-quality QSR breakfast that utilizes more natural ingredient and fresh preparation in our restaurants. Pictured here are our artisan egg sandwich, our grilled paninis and an indulgent warm oatmeal bar that scored exceptionally well with consumers. All of these products are great examples of "5-star quality products at a 3-star price". Consumers have given The Wendy's breakfast at minimum, a rating of 9 on a scale of 10 for variety, taste, freshness, quality, convenience, price and yes, value as well. We know that coffee is also a very important component to a breakfast offering. And we are evaluating a proprietary branding approach that we call, Redheaded Roasters. While work remains to commercialize breakfast, we are very optimistic. We are committed to taking our franchise partners with us, and we intend to demonstrate financial, consumer and operating viability as the foundation of a national launch. As you know, we are operating hundreds of restaurants with breakfast. But please note that going forward, we have made a conscious decision not to provide any specific store count updates regarding our breakfast test for competitive reasons. We will be aggressive, but responsible, in the evaluation of breakfast, and we see it as a complement to our strong offering of core hamburger, chicken, sandwiches and salad products at the other dayparts. The promotion P, has been working very hard for us of late as we have leveraged customers' memories of the 1984 blockbuster advertising sensation, Where's the Beef? We are always striving to communicate our brand messages in the most compelling way possible and capture a unique look, tone and feel in our advertising. In a related manner, I have initiated the search for an exceptional CMO to fill the existing vacancy and hope to complete that search in the first quarter of 2012. During the second quarter call, we discussed the exciting work that is being done to reinvent our restaurant environments. We've heard from our customers that our restaurant designs and interiors are not as relevant to them as they once were, but we intend to change that. We have 4 very exciting prototype restaurants under evaluation. Pictured here are our ultra modern restaurant in Columbus, Ohio. And please take a moment to look at the before and after pictures of the restaurants, and I think you will see a very dramatic difference. The second prototype is what we call our traditional design in Virginia Beach. And again, I encourage you to look at the before and after. The third is our urban prototype in Phoenix, Arizona. And then lastly, our contemporary restaurant prototype in Pittsburgh, Pennsylvania. We have now opened up 9 prototype restaurants, and they are experiencing significant sales growth above the pre-renovation levels. We are working to reduce the investment costs of these prototypes, working to determine which prototypes to focus on and, of course, we are anxious to learn how well sales sustain themselves over months period of time. I will be visiting the Pittsburgh and Virginia Beach markets tomorrow to see the new prototypes. I'm confident these restaurants will be as stunning as the Columbus and Phoenix restaurants, which I previously visited. We believe that all of these prototypes are consistent with our brand position of A Cut Above and most importantly, our consumers are telling us this. Let me briefly address the performance and people P together as they are so closely related. We, at Wendy's, believe that our people are the most valuable asset we have. They are our greatest source of differentiation. Through the efforts of our company and franchise operators, we've made significant operating progress and more upside remains. As recently as 2008, 25% of system restaurants were rated F by our internal metrics. We now have fewer than 10 restaurants rated F. And this reminds me of a quote from Dave Thomas, who often chided us that the goal was not to be the biggest, but to be the best. "Win the hearts and minds of consumers, and you will win their pocket books." Dave would say. We are committed to providing a customer experience consistent with that of the new QSRs and even better. The essential component to operating excellence is our commitment to hiring 5-star athletes because we want to produce 5-star results. And we know that these 5-star athletes contribute significantly to the environment created in our restaurants. Now let's turn to the international for a moment. The growth potential for Wendy's outside of North America, where 95% of the world population lives, is equally exciting. Beginning from an embryonic phase of just 336 restaurants, we have development agreements that will grow the global Wendy's system outside the United States to 1,000 restaurants. What has been particularly energizing is the quality of the partners that we have been able to attract. Our Russian franchisee, Alex Kovaler is a great example of this. He has opened 4 very successful restaurants and has very exciting plans for growth in the Russian market. Ernie Higa, our Japan JV partner, brings a wealth of experience as a former Domino's operator. Ernie's first restaurant opens in late December. We are doing it the right way and building a solid foundation for international growth and profits that will be meaningful in the future. So in summary, we have a brand vision that everyone is excited about, A Cut Above. We believe that it is the natural position for The Wendy's brand. We are working through all the P's to bring our brand vision to life in a cohesive way, where everything our customers experience in the Wendy's brand says, A Cut Above. We will be aggressive, but responsible, in pursuing the breakfast opportunity. We will take our franchisees along with us in this process and ensure operating, financial and consumer green lights, which initial testing gives us confidence that we can achieve. We are blessed with domestic and international franchisees with a passion for The Wendy's brand and with the financial and operating strengths to succeed. We are committed to building people capability because we know that when you place people first, customer sales and profits always follow. Lastly, The Wendy's brand turnaround has already begun. And for this, we are pleased, but not satisfied. You will see us continue to feed the momentum in everything that we do. I will turn it over to Steve in a moment, but let me highlight the third quarter, which I believe was very solid. First of all, we achieved positive transaction growth for the quarter of 1.1%. And, in fact, in 2011, we believe that we will report positive transaction growth for the first time since 2003, quite an achievement. North American company-operated same-store sales growth was 1.8%, and we're proud of the fact that we achieved a 30 basis point margin expansion even with significant food cost pressures across the industry. And we achieved 6.5% adjusted EBITDA growth. Earlier, I mentioned the strong sales performance of our Dave's Hot 'n Juicy Cheeseburger launch and the continued sales strength in the first weeks of Asiago Ranch Chicken Club. As of this call, we will not be releasing any monthly comp same-store sales going forward. Our commitment is to consistent and sustainable sales growth, and we believe that quarterly and annual performance metrics are the true measure of our sales and profit trends. I'm looking forward to talking with you more in the future. We are planning an Investor's Day in late January in New York City, where we will touch on keys strategies and important initiatives, we'll provide guidance on 2012 and discuss long-term trends. Now I will turn it over to Steve Hare, our Chief Financial Officer.

Thanks, Emil, and good morning. As Emil highlighted, North America company-owned same-store sales increased by 1.8%. This sales increase was driven by a 1.1% increase in transactions and a 0.7% increase in the average per customer check amount. Our franchisees' same-store sales increased 0.7% during the quarter. As you can see on this slide in July, we promoted our Wild Berry Frosty Parfait and Wild Berry Frosty shake, which featured fresh strawberries and blueberries. In August, we added 2 new items to our My 99¢ Everyday Value Menu, the Monterey Ranch Crispy Chicken Sandwich and the Cheesy Cheddar Burger. In September, we promoted local options such as the Spicy Chicken Sandwich. And in some markets, introduced Dave's Hot 'n Juicy Cheeseburger line. Wendy's company restaurant margin was 13.7% for the third quarter, which reflects a 30 basis point increase from a year ago despite higher commodity costs of 140 basis points. For comparison purposes, 2010 restaurant margin includes incremental advertising expenses as reported and consistent with 2011. We were able to offset higher commodity costs with strategic pricing and mix shifts that produced a net positive change of approximately 120 basis points. In addition, restaurant margin was favorably impacted 80 basis points due to a year-over-year reduction in breakfast advertising expense. Now I'd like to go into more detail on our third quarter results. Total revenues for the third quarter of 2011 increased by $10.7 million or 1.8% versus the prior year. Revenue increases were primarily a result of same-store sales increases. In addition, the increase in revenues reflects a $3.5 million benefit from Canadian currency exchange rates. Adjusted EBITDA for the third quarter of 2011 was $87 million and represents an increase of 6.5% compared to prior year. Adjusted EBITDA in the current year excludes transaction-related cost resulting from the sale of Arby's. To present comparable results, prior year adjusted EBITDA excludes Arby's indirect corporate overhead and integration costs. Now I would like to talk about income from continuing operations and special items affecting this quarter's results. Income from continuing operations totaled $2.5 million or $0.01 per share. These results included Arby's after-tax transaction-related costs of $15 million or $0.04 per share. In the 2011 third quarter, there was no adjustment required for Arby's indirect corporate overhead in G&A. Third quarter 2010 loss from continuing operations was $0.8 million or $0.00 per share including after-tax special items of $17.9 million or $0.04 per share. Now let's discuss corporate G&A and Arby's transition. During the third quarter, we completed the transition of G&A services to Arby's for all departments other than IT. We incurred costs and were reimbursed for these transition services of $5.9 million. Both the cost and the reimbursement are included and net in the reported G&A. We currently anticipate that the Arby's G&A expenses and the related reimbursement will end during the fourth quarter. Consistent with historical patterns, we expect our fourth quarter adjusted G&A to be higher than the third quarter. We now anticipate adjusted G&A for 2011 to be in a range of $275 million to $280 million, reflecting the elimination of a substantial portion of the support center G&A related to Arby's. Now let's discuss cash flow. Cash flow from operations was $182.1 million for the first 9 months of 2011. Capital expenditures were $91.9 million and were related primarily to restaurant remodels, maintenance CapEx and new restaurants. This amount includes approximately $9 million for Arby's during the first half. We still anticipate that our capital expenditures for the full year will be approximately $145 million. One of our strengths continues to be our ability to generate positive free cash flow, which we define as cash flow from operations less capital expenditures. We generated $91.2 million of positive free cash flow in the first 9 months of 2011. Net proceeds from the Arby's sale added $103 million of cash. We spent $152.7 million on stock repurchases, and we returned $24.6 million of capital to our stockholders in cash dividends during the first 9 months. In addition, we repaid $36.6 million of our long-term debt. Our net cash used was $23.7 million and at quarter end, we had a total cash balance of approximately $489 million. Now let's look at our debt capitalization. The third quarter 2011 balance sheet includes the cash received from the sale of Arby's and excludes Arby's debt. By comparison, the year-end balance sheet included Arby's debt. At the end of the third quarter, our total debt was $1.4 billion and net debt was $0.9 billion. Based on our trailing 12-month adjusted EBITDA, which excludes Arby's, our current net debt multiple is 2.7x. Next I would like to give an update on our stock repurchase program and dividends. We continued our stock repurchases during the third quarter. Year-to-date through October 2, we have purchased 30 million shares for $152 million at an average price of $5.09 per share. Of our $250 million authorization for 2011, we had $97 million remaining as of October 2. Since our repurchase program began in 2009, we have repurchased 82 million shares through October 2 for approximately $398 million at an average price of $4.84 per share. Our next quarterly cash dividend of $0.02 per share will be paid on December 15 to stockholders of record as of December 1. Next, I would like to discuss our outlook for 2011. We are reaffirming our 2011 adjusted EBITDA guidance to be in the $330 million to $340 million range. This outlook only includes continuing operations and excludes items such as Arby's indirect corporate overhead, transaction-related cost and the reversal of Strategic Sourcing Group purchasing cooperative expenses following the dissolution of that co-op. Our 2011 outlook includes the following assumptions: same-store sales growth of 1% to 3% at Wendy's North America company-operated restaurants, which we now expect to be in the middle of that range; Wendy's company-operated restaurant margin is now anticipated to be approximately 100 basis points lower than prior year primarily due to higher commodity costs; Wendy's capital expenditures are expected to be approximately $145 million for the year; and we estimate Wendy's 2011 unit development to represent a total of 34 new restaurants as follows. For North America company-owned restaurants, we expect 20 openings and 16 closures for a net of 4 new company restaurants. For North America franchise restaurants, we expect 45 openings and 42 closures for a net of 3 new franchise restaurants. And for international, we expect 35 openings and 8 closures for a net of 27 new international restaurants. And that concludes our third quarter financial review. I'll now turn it back over to John Barker. John?

Thanks, Steve. Before we open up the lines for Q&A, I just want to share a little more information regarding our Investor Day that we are planning to host in late January 2012 as Emil mentioned a minute ago. At that time, when we have that meeting, we will issue a news release, plan to issue one with our preliminary 2011 results, as well as our outlook for 2012. Also at that meeting, we will plan to talk about our strategic plans for the future in terms of growth, as well as updates in our core business, some of the remodeling the units that Emil mentioned, breakfast and international. We will provide more details specifically about the location and date, time in the coming weeks. I'd also like to address the transition that is currently underway in our Investor Relations group. As some of you may already know, our current VP of Investor Relations, Kay Sharpton, has decided to remain in Atlanta to pursue a position closer to her home as we move our headquarters back to Dublin, Ohio. David Popler, who previously served as our Director of Investor Relations from 2004 to 2007 has returned to us after spending the past 4 years leading Investor Relations at Bob Evans. Kay will continue to be your primary contact for follow-up calls related to this earnings release for the remainder of the week. And then beginning next Monday, on November 14, I would ask you to contact David. He'll take over as our daily point of contact. Dave's number is (614) 764-3311. Please join me in thanking Kay for her excellent work over the past 3 years and welcoming Dave back to Wendy's. With that, operator, we are now ready to begin our Q&A. We have a large number of participants in the call today. [Operator Instructions] Operator, please open up the lines for questions.

[Operator Instructions] Your first question comes from the line of Jeffrey Bernstein with Barclays Capital.

I guess a 2-part question related to the products that you talked about earlier, Emil, it sounds like with a lot of excitement. The first was just specific to the burger rollout. I know you referenced back to 2004, the last time you saw this type of momentum. I know you had previously mentioned 2% or 3% was kind of your test number. So I'm wondering what additional color you can give in terms of what you're seeing with the actual results in terms of mix or margin on this product versus your existing, or -- and it seems to imply you're running in on the 5% range for the fourth quarter. So I'm just wondering if you can touch a little bit on the burger and then separately, the breakfast rollout. It sounds like the franchise convention went well. It seems like it's a must-have in your language. I'm just wondering if you're not going to give us the pace of unit openings, what milestones should we look for, sales of breakeven hurdles we should expect, or whether or not you help support the franchisees?

Sure. Well, Jeff, first of all, as I -- I'd characterize that we were extremely happy with the launch of Dave's Hot 'n Juicy. In fact, we purchased some incremental media to run for 3 more weeks, along with the Asiago Ranch Chicken Club. And I will say that the product did perform quite a bit better than the numbers that we saw in the test market. As we mentioned, we're not going to be giving monthly comps going forward, but we are very, very pleased with the results that Dave's Hot 'n Juicy product, as is our franchise community. So hopefully, that helps you understand that. And as we look at breakfast and we did have a very positive communication at the convention regarding breakfast. And when you look to the future, Crest looked out for 10 years, and they actually see the dinner daypart as fairly flat. They see, the lunch daypart increasing a little bit. They see continued strength in the breakfast daypart as well as the snacking daypart. And we feel that we have to find a way to take advantage of that. But as I emphasized with our franchise partners, we're going to be aggressive, but responsible. We believe that we can demonstrate again, good economics to this, solid operating attributes, as well as consumer attributes and have all 3 of those be a win. And my commitment to the franchisees was to show that result before we launched. However, we are -- one of the reasons that we are not giving numbers, as I said, is for competitive reasons. But also, the fact is, Jeff, the number we want is we want a full rollout, and that's ultimately the goal. So I think the intermediate step-stones really don't -- it don't contribute a lot. But we are convicted to doing this the right way. And as I mentioned, we believe there is an opportunity in the marketplace for a higher quality breakfast offering. And if you have the chance to have our products, I think you would agree that they fit that classification.

Is the biggest hurdle the sales level or is it more of the breakeven for breakfast on the franchisees perspective? And if it's the cost side of things, would you be willing to help them or?

Well, we -- Jeff, we know that it's going to take an incremental media effort to put against this, and we have already discussed that with them, and they support that idea. And we believe that some of the people that have had forays into breakfast that have not done as well as they would like to, and part of the reason is that they haven't put consistent pressure against the breakfast. And if you look at the approach that McDonald's takes, it's out there advertising breakfast on an ongoing basis. And we believe to be an important player in that marketplace that, that's what we're going to have to do. But we have built that into the mathematics on this idea.

Your next question comes from the line of Michael Gallo with CL King. Michael W. Gallo - CL King & Associates, Inc.: Emil, my question is, I guess if just look at the service level, the labor in the restaurant, Wendy's has always been very efficient in the drive-through. But I guess particularly with some of the surge in traffic that, at least, we observed in the month of October, it appeared servicing, moving people through the line, particularly within the restaurants, it seemed like a lot was bottleneck. So if you can give us some thoughts on just service levels in the restaurant, steps you take to improve that and how you get it where it needs to be because, obviously, there's a big sales opportunity there if you can improve that.

Well, Michael, we couldn't agree more. And I would tell you that one of my important messages at the convention was an opportunity that few people mentioned that I happen to think is a big opportunity in the business, which is the dining room business. We have been so focused on the drive-through, and I think we're doing an outstanding job there. But to some degree, I think we've taken our eye off the ball on the dining room. And by the way, this is over a long period of time. This is not something just recently. And I would tell you that the franchisees and our operating people embrace this idea very enthusiastically that we feel by paying more attention to the dining room, that we can drive business. And by the way, my sense is that demographics also favor this because as people age, they have more time, and they'd like to spend more time in restaurants. And we have always historically served that clientele very well. With an anticipated launch of breakfast at some point in time, we also know that we have to do a better job inside the dining rooms, particularly on weekends for that. So we're in the same place that you are. We see that actually as a growth opportunity in sales across all dayparts.

Your next question comes from the line of David Palmer with UBS.

I wanted to ask about some of the new products that are coming up. You're renovating, obviously, the burger with the Dave's Hot 'n Juicy burger, and I thought next was going to be the premium chicken sandwich renovation. And then -- but instead, next is this W burger, which I'm guessing from your comments is going to be helpful to your margins, as well as perhaps sales. And then am I guessing this right that you kind -- you maybe reached into the basket of new products and pulled this one forward and maybe ahead of the chicken sandwich renovation, any thoughts on that would be great.

Sure. Well, the -- we had planned this pacing and sequencing, and we are testing chicken line innovations that I think are really quite step change. And I would tell you, they involve products that I don't believe anybody else could produce to the standard that we are going to produce them. And I think they reflect a going-forward perspective on how people are purchasing chicken sandwiches today versus maybe how that they purchased them in the past. When you look at the positioning of the W hamburger, this is going out at a $2.99 price point. And one of the things we want to do is put a product out there that we think is going to encourage people to trade up perhaps those individuals that are purchasing $0.99 item will trade up to this product. It is a very, very high-taste profile, very indulgent sandwich and did very, very well in test markets. So this is on the calendar where we've planned it, Dave, and we still have our plans for chicken sandwiches next year. I don't want to give you anymore details on those, but they are heading to the test markets, and they've done extremely well in a preliminary consumer research.

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

I have actually 2 questions, one on, Emil, sort of a bigger picture. I understand you -- The Cut Above and going back to 1969, but it's not 1969. And it's 2011, 2012 and consumers use concepts differently. So maybe if you can sort of compare and contrast your previous time at Wendy's and how you're approaching it differently? And then, I'm a little confused about the breakfast message that you're sending. It sure sounds like you're pulling back from breakfast, or you're going to take a little bit more time to maybe figure out what the right strategy is and then just maybe I missed that message, but I was a little confused on what you're were saying, what you are doing with breakfast today.

Yes, okay. Well, first of all, on A Cut Above, you're right. This isn't 1969. But I do believe that this is the natural position for the brand, Howard. And I think, unfortunately, in -- we went through a period of time as a brand that we stepped back from this position, and we have to step back into this position. And by the way, I'm not for the moment suggesting that we want to try to pretend to become a Five Guys or Smashburger or something like that because I think that would be a big mistake for us to do that. But I do believe that there's a significant opportunity in the marketplace for higher-quality products that are fresh made-to-order products. And The Wendy's brand is virtually the only brand out there that is a non-new QSR that easily customizes items. And so I think that it's very natural for the brand to get back into this position and be at the very high end of quick-serve restaurants. And I'm confident that, that is a position that we can hold quite uniquely that is defensible and is profitable. Regarding the breakfast, you should not take away from this a difference in timing or a different level of commitment. And as I mentioned, we're not giving the numbers for the reasons that I've already stated. We believe that this does represent a significant opportunity. We also know that we want our franchisees to be very enthusiastic about this idea because their commitment to this is going to make a huge difference in the level of success we accomplish with this. So they're going to move with us on this thing, and we got a very warm reception on this. And so I really believe that we're going to end up in a very good place and even a better place than ever conceived.

The next question comes from the line of Joe Buckley with Bank of America Merrill Lynch.

I have 2 questions, one on breakfast as well. I kind of get the same impression, Emil, that while you're reaffirming your breakfast commitment, you might be pulling back a bit. And I know that you mentioned the product being -- or the breakfast daypart being in hundreds of stores. But you mentioned 1,000, which is sort of the prior target. So what kind of changes or fine tuning to the program do you think it needs before you can roll ahead a little bit more aggressively?

Well, the key thing that we're working on right now, Joe, is the integration of the coffee offering, as well as bakery offerings that we also have in test and how we integrate that with our sandwich line because we want to go out there with an offering that really is very distinctive and the consumers will sense that distinctiveness. And at the same time, this is clearly going to be a QSR breakfast but a high-quality QSR breakfast because we know convenience and portability are very important at that daypart as we also know that the coffee offering is very important. And we're working with a very large supplier partner in the coffee business, and they're helping us sort through this. So again, we feel that by taking the approach that we're taking, we are ultimately going to have a much stronger, much more successful offering in this arena.

Okay. And then kind of a broader question. You talked about The Wendy's operating system as being uniquely capable of delivering differentiated product. Could you remind us sort of what is distinctive about the operating systems, the back of the house kitchen operating systems, just as a way for us to think about the capabilities?

Well, I think some of the key perspectives, Joe, is from the very beginning, Wendy's has always been a custom sandwich restaurant. And so we are used to building sandwiches on a custom basis. And while we'll have a standard build, many of our products are ordered custom by consumers. And so we do that very naturally, which is something that consumers want today. And also, you'll see when we -- when you look at the build on some of the future chicken sandwiches and the bread carriers, we're using in different items, how that we can process things in the back of the house that our competitors have a very difficult time copying those things just because of some of the equipment we have in the back of the house. And I don't want to go into too many details because I'm going to give this away. But go in other competitors and see how easy it is to order customized products versus the way it is for us to do it. Also, Joe, if you look at just our salad offerings and how we build salads to order, and when you look at the ingredient components on our sandwiches, whether it's leaf lettuce, whether it's onions that are cut in the stores or tomatoes that are cut in the store, we believe that freshness adds to the taste of the sandwich as does eating enjoyment adds to the value of it. And we give that to a much higher degree than anybody else out there. And we appreciate that food transparency is very, very important to consumers today. And we believe that we can leverage that to a much higher degree, and that is going to be an important part of the whole positioning of A Cut Above.

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

I wanted first ask about advertising, and then I had a question about capital spending. On advertising, Emil, do you believe it is -- it requires incremental advertising spending to launch breakfast, or just a reallocation of funds? And I think it was mentioned this quarter about less advertising spend on breakfast. Have you completely eliminated breakfast advertising in the near term until you've retooled the message, or you're still advertising just at a lower rate than you did last year? And I wanted to follow up.

John, we do believe that it will require incremental advertising effort and not just the reallocation. But remember, we're also expecting significantly increase in sales from the launch of breakfast, too. So that's an important part in the equation. And no, we have continued and plan on continuing to market the breakfast in the test markets that we have. We do not want to back off that effort. As I mentioned earlier, having sustained pressure in the marketplace is we believe is one of the things that is part of the commitment to the breakfast daypart.

Great and then my follow up has to do with capital spending. Steve, you had mentioned, the important part of the business model is that your ability to generate free cash flow in the business, but you also highlighted a number of remodel initiatives, and you've got a large amount of cash still on the balance sheet. So how do we think about this going forward? Is there a period of time in which your capital spending is likely to exceed the cash generation capabilities of the business? Or do you want to keep that in balance that you're always spending less than you generate and remodel pacing, therefore, will be slower based on that?

Well, John, I think the first step here, as Emil mentioned, and just showing the -- that the pictures of the 9 prototypes we've got out there, I think it's the first question we've got around this remodel opportunity, which again, we're very pleased with the early results there. But we need a little more time there to see what the sustainable lift that we're getting from these investments in providing a better customer experience, along with the better food that we're talking about, I think once we can dimension that opportunity, then I think we can then look at using some of the cash we've got on the balance sheet or this excess cash flow generation that we consistently have and apply that. And, frankly, I would like to see us apply a significant amount of additional capital to both the company stores and perhaps providing some assistance to the system overall because we're based on at least recent early results, and we're very excited about this opportunity to refresh the facilities.

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

My question is regarding the same-store sales sustainability here. What indications do you have so far that the strong comps can be sustained, especially if promotional spending starts to normalize?

Well, Chris, we feel quite good about the results that we are seeing post the launch of Dave's Hot 'n Juicy, and we're now into the second week of Asiago Ranch Chicken Club. And sales have held very, very, very well. And we also are confident with the moving into the W because that is a product that we had in test market experience on, so it's not -- it's a product that we have an idea of what the performance on that is going to be. And the thing that we have done with -- the thing that we feel that we have done with the launch of Dave's Hot 'n Juicy and our refocusing on core items has really gotten us back into the business of selling large hamburger chicken sandwiches and salads as a balance with our My 99¢ Menu. And I think we probably went through a period of time as a brand that, that got a little out of whack, and we're getting that back into position. So we really feel very good about the momentum that we can sustain.

Emil, let me ask, why do you need to introduce a new mid-tier burger line so quickly after launching this new cheeseburger line? I mean, do you expect it to drive enough frequency to really offset what I would assume to be unfavorable menu mix?

Well, we do -- one of the things we're trying to do with this product and is a key part of this strategy is having price point at $2.99 that is closer to where the -- to some of My 99¢ set products are or even some of the $1.29 or $0.39 products. So we actually trade people up into that product. If, for example, that, that did not sustain on a long basis and not prove out, well then, obviously, we would make adjustments in that product. But believe me, we are going to continue on an ongoing basis to put pressure against Dave's Hot 'n Juicy as we look to next year. We've been so pleased with the success of this that we have no interest in not coming back to this product. In fact, as we look back historically, and it's always easy to look back, is that we feel by not putting pressure on some of our core hamburger and chicken sandwiches, that certainly contributed to the erosion in the sale of those products. They are the products that carry the biggest, richest equities of the brand, and we clearly are going to continue to put emphasis upon them.

Your next question is from the line of Jason West with Deutsche Bank.

Actually, Chris just asked the question I had on sustainability, so I'll ask on the cost side of things. This quarter, the cost of goods sold improved a little bit sequentially. Was there a bit of a lull in the beef pricing, you expect that cost of goods sold pressure to build again going forward, or is this more the run rate we should expect at the current level of inflation?

Yes, we saw -- we did see a little help on the beef costs recently, Jason. But again, I think when we look ahead and we look at next year, and we'll obviously share our view at Investor Day. We're still, at this point, looking at some headwinds in terms of commodity costs overall as we go into next year.

Okay. And then just one follow up. Emil, if you could talk a bit about any changes in the incentive structure that you foresee, either at the store level or at the senior management level? And within the store level, back to the question earlier about service and sort of making sure you're fully staffed to take advantage of the better traffic trends?

That's something that I have not had the opportunity to spend a lot of time thinking about as yet. So I would not have a new point of view on that at this time.

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

Yes, I was hoping that maybe you can provide the breakout between menu pricing mix impact on check in the quarter, so what was the average price increase in the third quarter, what was the mix impact on check? And then looking ahead to the fourth quarter, do you continue to see incremental pricing opportunities in the fourth quarter? And do you see sort of a continuation of the current kind of cost pressure in the fourth quarter as well?

We do not break out price separately, so the information we did give you was that we saw transaction growth for the third quarter 1.1% and then the change in average menu check, 0.7%, which should include some price, but we don't break that out separately.

Okay. And in the fourth quarter incremental price increase opportunity that you see, do you see opportunity in the fourth quarter to perhaps take incremental price, or what are you guys thinking about that now?

Well, for the entire year as we've talked about, in the face of these very high commodity costs, we try to be very strategic in our approach on pricing. Because as Emil has emphasized, our focus is really on a year where we're very pleased to see transaction growth. And so we are taking price where we can, but the idea has not been to fully offset commodity costs given the large runoff we've seen there.

That will be the last call because we're already at the top of the hour. Emil, you want to close with a few comments?

Sure. Well, thanks. Thank you, John. And again, thank you for being on the call. And I want to reinforce that we are very, very bullish on the potential for The Wendy's brand in the United States, and we think The Cut Above positioning fits very, very well. And we believe the success that we're going to have in the United States builds a wonderful, wonderful foundation for moving forward outside the United States where Darrell van Lichtenberg is doing a wonderful job of leading that organization, setting us in a position with a strong foundation to really ultimately have a business that contributes significantly to the profit growth in The Wendy's organization. So thank you again, and I look forward to seeing all of you in January in New York City.

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