The Wendy's Company (WEN) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Brandy, and I will be conference operator today. At this time, I would like to welcome everyone to The Wendy's Company Third Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to John Barker, Chief Communications Officer. Please go ahead.

Thanks, Brandy. Good morning, everybody. This morning, we issued our third quarter 2012 earnings release and we filed our Form 10-Q. The agenda for today will start with the opening comments from our President and CEO, Emil Brolick, and will be followed by a review of our third quarter financial results from our CFO, Steve Hare. Then Emil will provide an update on Wendy's Recipe to Win and the progress we're making on the brand and our key growth initiatives. Finally, we will open up the line for questions. Today's conference call and our webcast is accompanied by a PowerPoint presentation, which you can find on our Investor Relations page of our corporate website, aboutwendys.com. For those of you who are listening by the phone today, make sure you select the appropriate webcast player option from our website and that will make sure you can sync up the slides with the audio. Before we begin, I'd like to refer you for just a minute to 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 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 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 adjusted 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. And with that, I'll turn it over to Emil.

Thank you, John, and good morning, everyone, and thanks for being on the call. As we look at our progress this quarter and over the last 9 months, we are more clearly seeing the results of our core organic growth strategies pay off in North American same-store sales growth and Image Activation progress. We also have good news around the top layer of our growth pyramid with our shareholder value creation initiatives that will return capital to our shareholders in the near term and we anticipate in the long term as well. Steve Hare will add more color on these value-creating initiatives in a moment. Due in part to the benefit from Image Activation we expect in the fourth quarter, along with positive reaction to our new ad campaign and strong performance of new product initiatives such as Bacon Portabella Melt, we are reaffirming our 2012 adjusted EBITDA outlook, of $320 million to $335 million, which includes the impact from Hurricane Sandy. In 2013, as we continued to ramp up company and franchise Image Activation, we expect solid growth with the 2013 adjusted EBITDA in the range of $350 million to $360 million. This growth is within the long-term guidance previously provided and is a sign that our brand rejuvenation strategies are working. Image Activation remains on track and we are transforming our brand through these restaurants. While closures related to Image Activation had a dampening impact of approximately $4 million on our third quarter adjusted EBITDA, we expect our fourth quarter results to benefit from the 47 Image Activation restaurants that reopened late in the third quarter and early in the fourth quarter. In a few moments, I'll share a more comprehensive update on Image Activation. Our top line sales momentum continued this quarter as we generated our sixth consecutive quarter of same-store sales growth, including a 2-year same-store sales increase of 4.5%. And I can say that the Bacon Portabella Melt promotion, which began October 1, continued this momentum. The continued improvement in sales reflects progress with all of our PEs and our Recipe to Win. While Image Activation is fundamental to our brand rejuvenation, all the PEs working together is what we expect will produce consistent same-store sales, profit and brand growth, as well as building shareholder returns. So as we look beyond 2013, we are committed to an adjusted EBITDA and adjusted earnings per share growth in the high single-digit to low double-digit range. We believe that our core organic growth strategy and financial management initiatives, including share repurchases and optimized restaurant ownership, will put us in a position to consistently deliver adjusted EBITDA and adjusted earnings per share growth. At the same time, we are gaining traction with our core organic growth strategies, we are accelerating Image Activation in 2013, 2014 and 2015. Because we are confident about our free cash flow and the flexibility of our balance sheet, we are also increasing our return of capital to shareholders by increasing our dividend and instituting a share repurchase program. Our board approved a 100% increase in our quarterly dividend payable in the fourth quarter and also authorized a $100 million share repurchase program. As we look beyond 2013, we expect to have the financial capacity to grow shareholder value through dividends, share repurchases and core business growth. I'll now turn the call over to Steve, who will review the quarter's results, and I'll be back later to provide more detail and color on our key growth initiatives. Steve?

Thank you, Emil, and good morning. Let me begin my comments with a review of the third quarter. North America company-operated same-store sales increased 2.7% in the third quarter. The third quarter sales increase was the result of an increase in average check, partially offset by a decline in transactions. Our franchisees' same-store sales increased 2.9% during the quarter. During the quarter, we successfully promoted our new Son of Baconator Cheeseburger and the Asiago Ranch Chicken Club, a premium chicken sandwich. Wendy's company-operated restaurant margin was 13.9% for the quarter, reflecting a 20-basis-point increase from the third quarter of 2011. During the quarter, we improved our food and paper costs and offset slightly higher labor costs related to customer service initiatives and Image Activation. This improvement is a step in the right direction, but we have specific cost reduction and margin-enhancing initiatives underway that we expect to further improve restaurant margin in 2013. Now let's take a look at a financial summary of the third quarter. Total revenues increased $24.9 million in the third quarter of 2012 or 4.1% versus the prior year. This revenue increase included a net sales increase of $19.8 million from new or acquired restaurants over closures and restaurants sold. Adjusted EBITDA for the quarter was $84.5 million, a 2.9% decrease over the third quarter of 2011. Third quarter adjusted EBITDA included the negative impact of approximately $4 million from the temporary closure of restaurants and other costs, such as training and customer service initiatives, related to Image Activation. On average, our restaurants closed for 8 weeks during construction. With most of our construction work completed by October, we expect our fourth quarter results to benefit from the Image Activation restaurants that had reopened late in the third quarter and early in the fourth quarter. And as we look ahead to the fourth quarter, same-store sales will compare against the successful launch of Dave's Hot 'N Juicy Cheeseburger in 2011. Now let's take a look at income from continuing operations and special items. Adjusted income from continuing operations was $11.3 million or $0.03 per share for the third quarter of 2012. Due in part to the negative impact of a $30.9 million or $0.08 per share after-tax charge for the early extinguishment of debt, loss from continuing operations was $26.7 million or $0.07 per share in the third quarter of 2012. During the third quarter, we also incurred a $7 million or $0.02 per share after-tax charge for facility and relocation costs related to the consolidation of our restaurant support centers. Transaction-related costs were incurred as a result of the sale of Arby's in 2011. One driver of our growth pyramid that I'd like to touch on now is financial management, which is one of our key stockholder value-enhancing initiatives. This chart highlights the cash flow generation capability of Wendy's since we began our Image Activation program in 2011, and provides a forward-looking view for 2012 and 2013 based upon our earnings guidance. Cash interest expense is reduced beginning in 2012 and 2013 as a result of our refinancing. As you can see, we expect to consistently generate operating cash flow that exceeds our base capital expenditure requirements. Base capital spending includes both nondiscretionary expenditures required to maintain our company restaurants and strategic capital allocated to upgrade restaurant equipment to support operating, marketing and new product development initiatives and to provide for technology investments necessary to grow and support our business. Over this 3-year period, we expect to generate approximately $360 million of free cash flow. Now as a result of our strong cash flow and the $454 million of cash on the balance sheet, we have the financial flexibility to invest up to $500 million for Image Activation by the end of 2015 to reach our goal of reimaging 50% of our company restaurants. We expect attractive long-term returns on investment from this incremental capital spending. Our strong cash flow also provides us with the ability to increase near-term returns of capital to our stockholders. We believe we can comfortably return capital to stockholders while accelerating the pace of investment in Image Activation. Our Board of Directors and management team have authorized a 100% increase in our quarterly dividend and a $100 million share repurchase program. The dividend will increase from $0.02 per share to $0.04 per share with the fourth quarter 2012 dividend payable on December 17. We expect the share repurchase program will begin in the fourth quarter subject to market conditions. Now let's look at a few selected balance sheet items. We have a substantial cash balance, which is far in excess of our liquidity requirements to run the business. In addition, we own in fee 767 properties for restaurants that we operate or which are leased to our franchisees. We believe the market value of these properties is in excess of the carrying value and these assets provide an additional source of financial flexibility. During the third quarter, we completed the refinancing of our bank debt and high-yield notes with a new senior credit facility. As a result, we expect interest expense savings of approximately $25 million on an annualized basis. At the end of the third quarter, total debt was $1.45 billion and net debt was $1 billion. Based upon trailing 12-month adjusted EBITDA, our current net debt multiple is 3.2x. Now let's review our earnings outlook. We continue to expect 2012 adjusted EBITDA in a range of $320 million to $335 million. This outlook excludes items such as debt extinguishment costs, as well as the cost from the consolidation of our restaurant support centers to Dublin, Ohio. For 2013, we expect adjusted EBITDA from continuing operations to be in the range of $350 million to $360 million. We'll provide much more detailed information about our outlook in January, but wanted you to have this preliminary outlook in conjunction with our announced changes in returns to stockholders. Beyond 2013, we are targeting long-term average annual adjusted EBITDA and adjusted EPS growth rates in the high single-digit to low double-digit ranges. And now let me turn the call back to Emil.

Thank you, Steve. As previously shared, Wendy's Cut Above brand positioning is the natural position for the Wendy's brand, and the layers of the growth pyramid guide the way we think about growing our business long term with near-term emphasis on growing North American same-store sales, Image Activation, new restaurant development, financial management and system ownership optimization. Image Activation is a key part of our future success, as it gives our brand credibility to deliver A Cut Above brand positioning, creates a great work environment for our restaurant teams and distinguishes Wendy's from other traditional QSR restaurants. And most importantly, our customers tell us they love these restaurants, and Image Activation sales reflect this. Image Activation provides guests with a new QSR experience at a QSR price. And because of this, we continue to see very positive sales trends in Image Activation restaurants. The prototype restaurants we opened in 2011 have sustained average annualized sales lifts of more than 25% above pre-Image Activation levels. Now this is pretty impressive when you consider how hard the system works to even gain 3% incremental sales. The 25% increase is even more impressive as 8 of the 10 Image Activation prototypes have now been open for a full 12 months. As Steve mentioned earlier, we reopened 47 company Image Activation Tier 1 reimages in the third quarter and fourth quarter to date. And we are very encouraged by the early results from these restaurants. Here you see a beautiful, ultra-modern restaurant in Salt Lake City, and here's one in Raleigh, North Carolina, featuring our urban design. As we have shared before, Image Activation is more than a remodel. This is a long-term initiative. To be relevant and ensure we are top of line with consumers, we are reinventing our restaurant environment, starting with the brand image and the memorable impression that our new restaurants make everywhere in the restaurant, inside and out. An important part of this effort is people activation, as we believe that great service provided by our restaurant teams contributes enormously to delivering A Cut Above customer experience. And of course, we continue to focus on providing our guests with five-star quality food at a three-star price. Our brand transformation will extend to Wendy's new logo in March when it will be introduced in our advertising, packaging, merchandising, uniforms and other customer touch points. This is the first change made to the Wendy's brand logo since 1983. The new logo will be used in all of our Image Activation restaurants beginning in early 2013 as we begin to implement our tiered strategy to optimize restaurants. As we've shared with our franchise system, we note that a tiered investment strategy is critical to the success of a system-wide Image Activation program. Our team has made significant progress on optimizing the Tier 1 design to a lower -- to lower the targeted investment and achieve lower costs for Tier 2 and Tier 3 designs that will open in early 2013. Our goal with the tiered design strategy is to optimize returns for both company and franchisees, dependent upon economic and trade area profile of each restaurant. Based on our current plans and experience, the Tier 1 investment is around $750,000, with a targeted sales lift of at least 25%. Tier 2 and Tier 3 investments should be around $550,000 and $375,000, respectively, and we expect them to generate sales lift that's scale with the investment. And we continually work to lower the investment cost of all 3 of these tiers. In 2013, we plan to double the number of company reimages from 2012 by reimaging 100 company restaurants. We also will build 25 new company-operated restaurants in the Image Activation design. Based on our current visibility into franchisee plans and commitments, we expect up to 100 franchise reimages in 2013 and 50 new restaurants. This would result in nearly 350 complete Image Activations by the end of 2013. We will continue to refine our plans for all 3 tiers in 2013 and expect more than 50 of the 2013 reimages to be Tier 2 or Tier 3 designs. We have shifted more emphasis to Tier 2 and 3 designs as our confidence in these designs has grown. We expect that this shift in emphasis to Tier 2 and 3 will help accelerate system-wide adoption of Image Activation and free up capital for use in other shareholder value-enhancing initiatives. As noted in our earnings release today, in July, we acquired 24 franchise Wendy's Restaurants in Albuquerque, New Mexico. This transaction is part of our initiative to optimize our system. System optimization strengthens our system through the acceleration of Image Activation by optimizing field G&A for company and franchisees, by increasing company and franchisee market concentration to improve customer service and to facilitate new restaurant development. By raising overall system competitiveness by a larger, well-capitalized existing and new franchisees, who are strong operators excited about the Wendy's brand and eager to grow. Lastly, we believe system optimization will enable us to provide more consistent EBITDA and earnings per share growth. Okay, let me go back. I'm sorry, I see that I missed a page here. And this relates to Page 36, relating to our franchise incentive. Our franchisees do realize the power and importance of Image Activation and are taking this journey with us. In late August, we announced an incentive to our franchisees and have seen really a solid response. We are offering $100,000 to the first 100 franchisees to complete a Tier 1 reimage in 2013. We've had many franchisees apply, and so far have awarded nearly half of this incentive offer. Now based upon our 2012 progress and future plans, we expect 50% of our company restaurants or about 750 restaurants to be image activated through a reimage or new build by the end of the 2015. The constraint to further accelerate Image Activation for company-operated restaurants is actually not capital but zoning, construction, people-sourcing and training constraints. So just to reiterate then, as we noted in the earnings release, we did acquire these 24 franchise restaurants in Albuquerque, New Mexico, as part of this system optimization effort. Now in pursuit of system optimization, you can expect to see Wendy's purchase and sell restaurants with the long-term impact of lowering the number of company-operated restaurants by several hundred. Of course, the biggest near-term contributor to EBITDA is North American same-store sales growth, the foundation of our growth pyramid. And we are seeing encouraging signs on marketing and advertising front. We are seeing positive feedback on our marketing campaign, including our new TV ads that feature both Red, who's an advocate for consumers, and Wendy Thomas, who speaks about the Wendy's brand promise. Ad awareness since the launch of this campaign is up 12% and intent-to-visit scores are up 9% since the April launch of the new campaign. Most importantly, we maintain same-store sales momentum by successfully promoting 2 premium products in the quarter, the Son of Baconator and Asiago Ranch Chicken Club. And customer response to the Bacon Portabella Melt has been very promising, as I indicated previously. And our product strategy is working in building share of large hamburger sandwiches, large chicken sandwiches and salads. In fact, in the latest quarter, Wendy's earned the largest share of premium salads. Finally, we continue to make progress on delivering our brand promise more effectively as evidenced by our improving internal metrics, as well as by external recognition that we have recently received from organizations that track our industry, including the ZAGAT, the American Customer Satisfaction Index and QSR magazine. In summary, we are pleased with the progress we are making with Image Activation, people development, product development and initiatives that return value to our shareholders. And now I'll turn it back to John Barker.

Thanks, Emil. Just before we go to Q&A, I think that I'll take a moment to go over 2 of our key upcoming events. We do plan to present at the ICR Conference on January 16 in Miami, Florida. During this presentation, we will provide details around our longer-term growth initiatives, the 2013 guidance that Steve spoke about in our long-term outlook, and we'll issue a news release that day with these numbers. And then on Thursday, February 28, that's the day that we do plan to release our earnings for the 2012 fourth quarter and the full year. So now, Brandy, if you would help us and go ahead and queue up for questions from the listeners on the line.

[Operator Instructions] Your first question comes from the line of John Glass with Morgan Stanley.

The fourth quarter leaves a large range, given you've retained your EBITDA guidance, but you're now 3 quarters into it. I mean are you -- where does your confidence, I guess, fall? I understand you're talking about difficult comparisons but you also have this benefit of these remodels coming back online. Is there any insights at all in terms of, there's a range of about $15 million are left within the fourth quarter, where that ends up falling?

No, John, we recognize it's a large range. But with the fourth quarter and obviously with some of the weather that we're seeing, that adds another degree of some risk to the range, so we decided to leave it where it was. We're obviously hopeful, with the sales momentum that Emil has talked about, that we can try to get to the higher end of that range.

Okay. You talked about the margin pressure this quarter, some of which I guess came from the closed stores. Maybe you could just talk about -- you talked about some initiatives to mitigate some of the margin pressures that you -- that's something that's been familiar to Wendy's over the last several years. So what is new or different about this? Or where is the opportunity now versus where you've been successful in the past at helping store margins?

Yes, I think, John, 2 areas of opportunity, I think for us is -- and you're right, we have an ongoing sort of cost savings program. But I think in the area of food cost, as we look ahead to next year, we're anticipating another fairly significant increase in our commodity basket. So we've got a good head start there with some very specific looks at product specifications unique to Wendy's that we think can help us in terms of lowering the theoretical food cost of our products and put a dent against that increase that we think we're likely to see. I think, in addition, I think with our purchasing co-op and building, with their capability, more effective ways to purchase some of the products, we're seeing an increased amount of potential opportunity for next year. So I think we're getting better at that aspect of it. And so we're more encouraged we'll be able to generate more cost savings in the next year period. The other area of opportunity for us is around G&A. We've gone through this year where we've had to consolidate the restaurant support center from Atlanta with Dublin. That will all be behind us here as we end the year. And I think that gives us some opportunities to look at efficiencies now that we're all under one roof. So I think you'll be able to see G&A, if not lower, at least flattened out fairly significantly here.

Okay. And then just my last question is you cited some impact from store closures of about 8 weeks and you get that back in the fourth quarter. Have you factored that into your initial thoughts for '13 as well? Or would you call that out as a separate item? And wouldn't it occur again if you're going to step-up the rate of company remodels double that?

Yes, that's factored into our guidance for the year. I think where we'll get a little bit bumpy is on a quarterly basis, so depending when the construction is versus the reopenings. And that's something I think, given what we saw this quarter in January, we'll try to give you some schedule of our openings for the year and when you might see headwinds versus tailwinds.

Your next question comes from the line of Jeffrey Bernstein with Barclays.

Just a couple questions as well. First on the -- from a comp perspective. Obviously, you talked about the more difficult compare, but it sounds like there's some momentum entering the quarter. Just wondering whether you can tell us, at least from the third quarter and what you've seen thus far, I think you mentioned the average check was up but traffic was down, so I'm just wondering if you could talk perhaps a little bit about the mix shift? Whether you're seeing kind of increased competition or a shift in consumer preference more towards value? Kind of how you think about the components of that comp, based on what we've seen thus far and kind of what the industry is showing you thus far in the fourth quarter?

So, Jeffrey, are you speaking of the third quarter or are you speaking of how we entered the fourth quarter?

Would love the fourth quarter but figured you'd probably a little bit more selective on that front. But kind of broadly, as you think about your trends and the industry as it relates to mix, value and couponing and whatnot?

Sure. Well, Jeff, what we're pleased about in the quarter that we feel that we have gotten into a nice rhythm with our premium promotional, as well as core products. And then we have begun to use, on a very selective basis, national couponing, which actually has turned out to be very nice. Again, we're going to be a very judicious about that. But we do believe that the number of price/value-sensitive customers out there is not insignificant. And so, as we move into next year, we also have a thought process how to address that because, if you remember I think on the last call, we talked about the fact that the coupon customer we do see is a different customer than the price/value customer. But I think regarding our brand, one of the wonderful things is that the people really do see us as the quality provider out there and we see that our promotional products really do resonate with consumers and they look forward to our promotional products. And so we continue to do well. And even the momentum that we saw in the third quarter did carry over to the start of the fourth quarter. And you remember we had some very challenging comps in terms of the launch of Dave's Hot 'N Juicy, as well as Asiago Ranch Chicken Club. So we've been pleased but -- and we'll continue to work on it.

Got it. And then just a little bit of a detail -- we appreciate the detail as it relates to the reimagings. Just a couple of questions on that front. The different sales lifts you're seeing, I know still the 25%-plus lift for the, sounds like, the 10 stores that you did last year. I'm just wondering, one, how you think about whether that's kind of a realistic assumption going forward? Obviously when you open up some initial new ones, you get a pretty big lift. And I know a lot of those perhaps you spent a little more than the $750,000. So I'm just wondering, as your franchisees come to you and think about the different options to pursue, just whether you see that as realistic or perhaps that's not necessarily sustainable? And just as an add-on to that, just wondering if those initial guys that signed up for the plan for next year, I think you mentioned they're all Tier 1, but I'm just wondering if the demand was there, would you increase it beyond the first 100?

Well, the good news is, as I mentioned in my comments, on those first 10 prototypes that opened in 2011, 8 of those are now open for more than 12 months and continue to perform very strongly. Also, when I look at the 47 Image Activation Tier 1 restaurants that we now have opened in 2012, the initial sales patterns that we are seeing in those restaurants are very similar to the responses we saw with those original 10 prototype restaurants, Jeff. And we do expect this Tier 2 and Tier 3 designs, the increases will not be quite as significant, but also they're a substantially lower investment. And we do believe, though, that the sales lifts that we'll get are proportional to the investment. And as we've been able to tighten up the designs on the Tier 2 and 3, we're very excited about them because we think a lot of the dimensions in the Tier 1 that people have given us very positive feedback on, we've been able to preserve a fair amount of that in those less costly restaurants. Obviously, the first one, the first Tier 2 and Tier 3 restaurants will open up in late in the first quarter of next year, so we'll have an opportunity to see what that performance is. Regarding the incentive, right now, we're happy with where we are on the incentive and we would not anticipate upping that in the next year.

Got it. And then just lastly, if I can just ask the 2013 guidance, you mentioned giving more color going forward. But it does seem like it's high single-digit EBITDA growth. Just wondering, the confidence, seems like visibility is fairly low for the broader industry, whether you can give any kind of directional color as to the comp assumed or if those comps were to flow? I know we started this year with kind of a higher target and that was kind of tempered down. So I'm just wondering, I think you mentioned there were some cost reduction opportunities that could help you, but what specific leverage you could use if this kind of volatility persists?

Yes, I think that in January, we'll be able to shed more color on how we're thinking about next year. But we do feel confident in the guidance that we're providing you on next year.

Your next question comes from the line of Michael Kelter with Goldman Sachs.

Maybe I could follow up on that question about 2013. The midpoint of the guidance is for 8% to 10% EBITDA growth. And I guess my question is, if same-store sales stay at the current levels and net unit growth remains flat, as it's been for the last few years, it implies you're expecting a lot of margin expansion to hit the target. And that's despite the D&A step-up related to the ongoing remodels. So I wanted to hear a little bit about the primary drivers of margin expansion next year.

Michael, I think the -- if you look at the growth pyramid and where we'll get some lift, obviously we do expect a nice contribution from Image Activation. As Emil has talked about, we're pleased by the sustaining sales lift that we're seeing. And I think we'll continue to see margin improvement from Image Activation as we come up the learning curve on how to run these restaurants because, as we've talked about, there really is a different customer model that we're delivering service at a much higher level. We've got a significant increase of customers now coming in to the restaurant as part of our mix, and obviously that leads to higher checks. So I think the Image Activation is one pillar that we've got here in terms of getting to a higher growth level. The other, I think, is the fundamentals around where our restaurant margins are today and where they can get to. As I mentioned to John's question, I think when you look at our margins, even though they increased a little bit this quarter, we've got an opportunity here to increase those margins, especially if we can sustain the sales momentum that we're seeing today. Now I do think we have to get at it in terms of food cost. Our premium quality position causes us to look at quality ingredients at every step of the way. But I think we've got to be a little smarter about what quality ingredients we're getting paid for out there. And I think as a result, we've got a head start in looking at next year as part of our planning process and we think there are a number of opportunities to lower our food cost without causing a loss of quality that's consistent with our brand positioning. And so I think that's an opportunity that we have, and we've built some of that into our guidance thinking.

Michael, another point is that, as we mentioned in our call last quarter, that we've been reworking where we are on breakfast and focusing any breakfast effort against restaurants that are profitable in breakfast, and as a result of that, that we are going to pick up some EBITDA from a focus on the restaurants that are profitable in breakfast as well.

Can you maybe elaborate on one point you made in the response to that question about lowering food costs next year without lowering quality? I mean what types of changes are you thinking about making that we should be aware of?

Well, Michael, you've heard us share that, historically, our brand has been extremely focused on quality and it will always be focused on quality. But I think that at times, we've almost inordinately focused on ingredient quality and at times, we probably have not been as sensitive as we need to be, is perceived quality. And the fact is that consumers pay for perceived quality. And there are any number of examples, I think, that as we look across the competitive landscape, that we can see that. And so we're just going to be a lot smarter about making sure that we preserve our ingredient quality, but we put the cost into our products where the consumer is willing to pay for them and where they recognize quality. And we simply believe that we can be more astute about that than perhaps we have been at times in the past. But we're also not willing to mention specific things.

And then lastly, on a different point. Can you reconcile the use of free cash flow towards dividends and buybacks when it could be used to accelerate company remodels or provide broader, deeper assistance to franchisees who won't otherwise remodel most of the restaurants until sometime between 2015 and 2020. I guess the question is, if remodeling restaurants is your #1 strategic multiyear imperative and it's capital intensive, why do anything else with your cash until the goal is fully achieved?

Well, I'll start, Michael, and then I'll turn it over to Steve. As I mentioned in my comments, the constraint that we have on company Image Activation is in fact not capital or cash, that we are going very fast with our learning. And as we look out into years beyond 2013, we're going to get going at a rate of doing even as many as 5 restaurants a week. And when you start to think about that, that's a pretty hefty effort out there. So the constraints are really how fast we can get things through zoning, construction issues, hiring and then training the 5-star athletes. Those are more of the constraints than are the capital constraints. And when it comes to the franchise community, the franchise community is very interested in upgrading their restaurants. Now, have they indicated that they believe that the Tier 1s are a lot of the money? Yes, they have. But that is why we're so excited about Tier 2 and Tier 3 restaurants and have, in fact, increased the mix of Tier 2 and 3 restaurants that we anticipate opening. So I believe that that's the single most important step in getting them to the table on that. And as Steve can talk about too, he and his team have worked very closely with a variety of financial institutions out there that are excited about lending our franchisees money. And so the fact is that we've come to the realization that we have the capacity in our balance sheet between cash on the balance sheet and cash flow to do both, to Image Activate at a very aggressive rate, as well as in this case, return capital to shareholders in the form of a dividend increase, as well as share buyback. But, Steve, want to...

Michael, I would say that our approach to this been, what is the maximum amount of spending that we can do on Image Activation to drive that program across as many company restaurants as quickly as we can. And we've built that in. That's the $500 million that we've talked about over the next 3 years, which is from an operational standpoint, we believe as fast as we can go. By the end of that 2015, we are opening 5 restaurants on a reimage basis a week. So that is, from our standpoint, that would be a great operational achievement if we can ramp up to that level. So we've sort of blocked out all that cash and said, "All right, this is reserved for Image Activation." When you look at the free cash flow -- and this is one of the reasons we added a chart in here, to give you a little more view of how we think about free cash flow. The free cash flow that we generate is more than sufficient to cover the increased dividend. So we think that makes sense. And then over time, the Image Activation can reduce the $450 million of cash we've got on the balance sheet, which is far above what we need to run the business. And of course, that we're seeing very attractive returns. What we said at Investor Day, if you remember is, we think we can go through this $500 million capital spending program and probably be about cash positive through those periods of time. So again, I think in terms of use of cash, I think the balance that we can do maximum spending on Image Activation along with increasing our returns of capital for the near term, is something that we have the financial flexibility to do and we thought it was the right thing to do today.

Your next question comes from the line of John Ivankoe with JPMorgan. John W. Ivankoe - JP Morgan Chase & Co, Research Division: Remodel's the topic of the day. When you're developing some of these new tier remodels and you look out into the out years, maybe even beyond 2013, are you seeing any opportunities from a productivity perspective that you can do with costs inside of the restaurants, perhaps, being faster in terms of throughput, that you can begin to add to some of these projects?

Yes. Definitely, John. Here's what we anticipate. Right now, as we've shared, a restaurant, Tier 1 restaurant, is closed something at 7 to 8 weeks. And more of them now, we're making progress in getting it more in the 7-week area. We think because the Tier 2 and Tier 3 designs are simpler, that we'll be able to reduce that time. We don't know exactly what that reduction will be, but we're confident we'll be able to reduce that. The other thing is that we're fully engaging our purchasing cooperative. And as we get this geared up, we think that we'll be able to go out there and get some economies of scale on this that we haven't presently been able to take advantage of. And as I mentioned, we look at this as a continuous process in terms of taking costs out of these Image Activation restaurants. And so we're continually working, even now, on the Tier 1 design to get cost out of that. So it won't be a situation where we, as we open these restaurants in early 2013, that we stop. We'll continue to work on that. And by the way, we are also always doing research to find out what are the elements in the restaurant experience that resonate most with consumers are -- and are most important to consumers. John W. Ivankoe - JP Morgan Chase & Co, Research Division: And, Emil, I mean perhaps I didn't ask the question the right way. It was more about, once it has been remodeled to -- not the cost of CapEx, not the time that the remodel will be closed. But once the restaurant is reopened, do you see any redesign opportunities of the operation itself that allows you to be more efficient or more effective from a cost of sales perspective?

Well, I would say that the customer service initiatives and the things that we're hoping to accomplish, John, are designed into the restaurants themselves in terms of the workflow and service changes that we have made. And what we've hoped to accomplish here are higher levels of customer service and satisfaction. I will tell you that, to put this in perspective, for the 2012 Image Activation restaurants that are open this year, we've seen that, on average, that dining room sales in those restaurants are up close to 110%, the carryout sales are up something in the area of 55% and pickup window sales are up something in the area of 14% or 15%. My point is you're seeing very substantial increases across all of the channels, but most of that percent increase is coming inside the dining room. But remember, the pickup window is 65% of our business, so when it goes up 14% or 15%, you're talking about a heck of a jump there. So I'm saying we've designed efficiencies into the design themselves, if that hopefully helps answer your question. John W. Ivankoe - JP Morgan Chase & Co, Research Division: It does, and I appreciate the color. And then secondly, as we think about margins for next year, are there any substantive changes, substantial changes to the Everyday Value Menu that's contemplated in that margin guidance? Or just the thought that COGS can be better than what commodities would suggest?

Yes, we have had in test a menu that we characterize as the Right Price, Right Size menu. I think we've mentioned that before. And we were very encouraged by the positive impact that had on the cost side of the business. And we think what it does is, John, provides a nice balance, is still providing consumers with 6 items priced at $0.99, as well as having a series of items priced above $0.99. And we think that this menu provides us an opportunity to get tremendous continuity across our system, which is something we haven't had as much of as we would like to have and still, at the same time, do this in a way that is sensitive to margins.

Your next question comes from the line of Michael Gallo with CL King. Michael W. Gallo - CL King & Associates, Inc., Research Division: A question for Steve. The depreciation in the quarter, was there any accelerated depreciation from the Image Activation remodels? Or should we use that number as the going-forward depreciation with obviously step-ups as you do more of these?

Yes, Michael. The depreciation is running higher and will continue to run higher. Image Activation will increase that in 2 different ways. One, just the total amount of CapEx that we're spending obviously is higher and so that'll lead to a higher depreciation charge going forward. But specifically, during the quarter, there was about a little bit more than $2 million, for example, of accelerated depreciation from the assets that are replaced as we do our reimaging. And that's going to be a part of the program going forward. So we -- you should expect that depreciation will run higher on an ongoing basis while we're in the middle of this Image Activation program. And I think what we'll try to do is in the January review, we'll try to give you some ways to measure that for next year, and maybe try to give you some guidance as to what D&A would be for the year in total. Michael W. Gallo - CL King & Associates, Inc., Research Division: But sequentially, basically, the $2 million of accelerated, you really -- that will obviously come out of the fourth quarter, right?

That's right. That $2 million is -- really, think of it is a onetime sort of adjustment to D&A.

Your next question comes from line of Chris O'Cull with KeyBanc.

Just as a follow-up to that, Steve. As long as you're continuing to reimage restaurants, you're still going to have accelerated depreciation, right?

Well, you're going to have the depreciation on the assets that you're adding. So as we do the rebuild, we'll have a new investment in that restaurant that will lead to higher D&A going forward. What Michael was talking about was the fact that, today, when we have a restaurant that we decide to do a Tier 1 on, has a certain book value today. And those -- to the extent that those assets are removed or replaced by the new construction, we have to write those to 0. And that's the onetime nature of the adjustment to D&A I'm talking about.

Okay, okay. I guess my first question just relates to the traffic trends and the higher check. Emil, what gives you confidence that the higher check isn't a problem for -- isn't causing the weak traffic?

We're able to, just with some of the tools that we have to look at the industry and look at our business, and we're able to segment out where there are losses in traffic from, let's call it, value-based customers versus premium customers. And as we look at the information, one of the reasons that we're excited about this Right Price, Right Size menu, is that we have lost some share in the Value Menu area. And we believe that a lot of that is that, for quite a period of time now, that we've not had the continuity in offering that some of our large competitors have had. And when you look at the core 5 items that one of our very large competitors has, they have almost $0.99 compliance on their -- 99% compliance on their system. And we believe that, that has served them very well. So as we work toward that, we think that, that will address some of that traffic loss that we've seen on that end. But let me be clear. This requires a very balanced approach, and we believe that the high-end is an area that you're still going to see an awful lot of pressure against as we look at our 2013 marketing calendar. But this Right Price, Right Size menu, we think will be a nice addition, along with the continued approach on this very sensitive way that we've approached national couponing as well.

Okay. The recent price increase seems to be focused on the combo meals. So you haven't seen any decline in the order incidences of combo meals?

No, we -- as we've shared in the past, we're very fortunate to now possess a very sophisticated tool for looking at pricing decisions that takes into consideration a variety of pricing structures across our system. I think there's a total of 7 different pricing structures. And that's based upon the individual restaurants, competitive and demographics, as well as just the menu composition in their particular restaurant. So we're able to do this with a lot more precision than we've been able to do that in the past. And we've also learned that there are elasticity differences in products and that we felt there was a little more elasticity in the combos than we had seen in the past.

Okay. It looks like the company has been purchasing stores from franchisees around $500,000, $600,000 a store. It would seem risky, to me, for a franchisee to invest $500,000 to $700,000 to remodel a restaurant that seems to be valued at that level, or 4 or 4.5x EBITDA. Have you received -- how many franchisees have already signed up for this program for next year?

About half of the 100, Chris, are spoken for.

Okay. And the feedback you've received from franchisees regarding the Image Activation program. I mean, what are some of the concerns, what are some of the things you think you need to address still to really accelerate the program among the franchisees?

Well, let me just reiterate what I included in my comments, which is overwhelmingly, the franchise system recognizes the need to update our restaurants and there's not a lot of debate about that. The question is just the cost. And in particular, as we started out with a Tier 1 restaurant that is $750,000, we recognize that that's a significant investment. And remember, a system like ours, like any large restaurant system, that you have higher volume restaurants, you have lower volume restaurants, you have restaurants that are owned, you have restaurants that are leased, you have restaurants that have long lease terms left, short lease terms. And so this is where a tiered investment strategy is extremely important. So the capital outlay is absolutely the #1 issue. And of course, the parallel to that is they want to make sure that they're not only getting the sales results but the flow-through is also there as they make these investments. So what we do is we share not only the sales results, but we're in the process of also sharing much more detailed results in terms of the cost compositions, the operating costs as well as the profit flow-through.

Chris, so you know, we recently held our update meeting for our franchisees in Philadelphia and spent a fair amount of time taking them through all this, as well as a tour to one of the restaurants that had opened in that area. [Audio Gap] part of it is the ongoing education of the initial results and the results that we're getting in 2012 as well as the tier, progress we're making on Tier 2 and 3. And so they're getting more information as it comes along, and our job is to continue to provide that and get them comfortable so they come with us.

Chris, one other thought is, I think it's a fair question for franchisees to say, "Okay, I see the data that you're producing on Tier 1 and that looks very positive and that looks like good investment. It's a lot of dollars to the investment, however. So let us see what the Tier 2 and 3 also look like with real data." And so I think it's a natural progression and that's part of our tiered strategy is, we started with Tier 1, now beginning in early in next year, we'll start to have Tier 2s and 3s that the franchisees can visit and see what they look like and what the trade-offs are in terms of customer experience. And also what kind of -- we think the sales lift will scale, but we don't know at what levels yet. So I think unless -- until that data is out there where they can see it and they can really see what these restaurants look like, I think it is -- it is sort of fair to sort of sit back wait a little bit to say, "Okay. I like Tier 1, I like what I see. But what -- how close can I get to that with a Tier 2 or Tier 3?"

Again, we have confidence that we're going to have at least 100 franchise restaurants reimaged next year, along with them building 50 new restaurants. So they are putting a lot of capital against this.

What is the ADA compliance cost typically for one of these remodeled restaurants?

Can we get back to you on that? That is not one that I have readily available.

Chris, we'll track that down and get that for you. I don't remember.

Your next question comes from the line of Nick Setyan with Wedbush Securities.

So I just wanted to drill down a little bit on maybe the differences between the different tiers. I think the information on that, it seems like the look and feel is going to be relatively the same. But the cost is going to be a little bit different, and you expect the different sort of sales lifts. Maybe you can talk about in a little more detail what some of the differences are? What renders a possible remodel of a Tier 2 or Tier 3 candidate as opposed to a Tier 1 candidate? Just a little bit color on that.

Sure. Well, one of the keys to the design approach that we took as we were looking at Tier 2 and Tier 3 designs was that, first of all, almost, if you would, the same approach that automobile manufacturers take with their brands. You can, from quite a distance, recognize the front of a Mercedes-Benz or recognize the front of a BMW because of the grill and certain characteristics of their designs. Well, we have learned from our Tier 1 and a lot of the research that we have done with consumers that, that front, okay, or I'll call it the grill of the restaurant, is very striking and very intriguing to consumers and they like that a lot of. So we're virtually preserving that across all the restaurants. Exterior signage is something that's being preserved. Self-serve beverages, TVs, WiFis, fireplace, lounge seating area, all of that is being preserved. Some of the things that change inside the restaurant would be the use of digital merchandising versus backlit merchandising; the simplified interiors in some cases; a little simplified finish on the exterior of the pickup window; some slight changes in roofline design or what we call that large exterior blade on the restaurant, the red blade is slightly different; some changes in the vestibule. And then the biggest change in the Tier 3 restaurant that saves quite a bit of money, where in the Tier 2 and Tier 1 designs we separate the ordering of the food and the delivery of food, in the Tier 3 design there is not that separation that takes place. But again, if you look at this from the perspective of a consumer who has been going to a restaurant that maybe is 20 or 25 years old, and even when they go into this Tier 3 design it's going to be still an, "Oh my, gosh!" factor when the see this restaurant. Does that help?

Yes, that helps a lot. But I guess the one other thing I wanted to understand a little bit more is, what is the difference in the sales lift? I mean if I'm a consumer, I come in, I still have that, "Oh my, gosh!" feeling, what is the -- is it just because these are sort of already higher AUV restaurants that are going to get the Tier 3 remodels?

Yes, first of all, since we haven't opened any of the Tier 2 or 3, obviously any comments on the sales lift are speculative or our best guess at this point in time. But we would not be surprised to see a Tier 2 to still provide something close to a 20% sales lift, we would not be surprised to see a Tier 3 still provide something in the area of 7.5% or 8% in terms of a sales lift, just -- and this is based upon our instincts of how we have seen the designs and -- of these, and are very excited about these designs. That's why we want to get these opened as quickly as we can in early next year. And the early ones are going to be in warmer weather markets so we can get to work on these and get the franchisees engaged in them as quickly as possible and, again, get consumer reactions.

That is very helpful. And then just on the labor line, my final question. Do we -- can we expect some leverage on the labor line as well? I know we have some more remodels coming onboard next year and it sounds like there are some higher costs associated with these restaurants and the training and so on. So are there some opportunities where we can see a little bit lower labor expense next year?

Yes, Nick, I think that's a fair expectation. I think there's a learning curve that we're going to see on these Image Activation restaurants in terms of the amount of training. Every time we go to do a new one, especially in a market -- we were out in Salt Lake City the other day, where we're -- once -- now we're doing our fourth and our fifth and our sixth Image Activation unit, well, the operational team out there has really figured out what it takes now to run these restaurants and the differences. And as a result, I think you'll see lower incremental staffing and lower training being required going forward. So I would expect that will give us some leverage in terms of our labor. Plus just the leverage on the sales momentum that we're seeing, I think you'll see that flow through a little bit more going forward.

Your next question comes from the line of Keith Siegner from Credit Suisse. Keith Siegner - Crédit Suisse AG, Research Division: To start with, I appreciate the efforts to take costs out of the remodels for the given tiers. At the same time, the Tier 3 remodel looks the cost came up a decent amount, from $300,000 to $375,000. So clearly something strategic was done to adjust that one. I was just wondering if you could tell us maybe what adjustments you made and why you made them to take that from $300,000 to $375,000?

Yes, Keith, these numbers are bouncing around a little bit as we go through design. So the $300,000, I think, was our preliminary sort target for the features that we thought we would retain in a Tier 3. As we've gone through it, the process is, a couple of things that we really like in Tier 1 and Tier 2, the list that Emil just went through, we just said, look, that's going to be a little bit more money, let's put that into Tier 3 so that we can still hopefully see a very positive sales lift. So it's just been a tradeoff as we've gone through from sort of concept to the actual designs that we now have in place. So that's where we're heading right now. Again, we're still hoping from a value engineering standpoint, as we start to build these, that we'll figure out ways to reduce the construction costs a little bit and maybe we can get it back down to something in that low $300,000 range. Keith Siegner - Crédit Suisse AG, Research Division: Okay. And then I have one more question about the 2013 guidance. So you talked about expanding margins to some extent, lowering food costs without hurting food quality. Just to help us put the pieces together, could you give us what your latest thoughts are on gross commodity inflation? So pre the savings you can accomplish, what gross inflation looks like? And maybe any preliminary thoughts on pricing built into that guidance.

In terms of commodities for next year, we'll lay that out in our January more-detailed presentation. But we had talked about a commodity basket for this year of 4% to 5%. I think with the drought conditions that we've gone through this year, the fundamentals around beef in terms of supply and demand, which I think are going to lead to higher beef costs for next year, I don't anticipate a big change in that outlook, certainly not a big favorable change. But we'll lay that out as part of our January detailed presentation for you on the cost side.

Yes, and on the pricing side, Keith, we won't deal with any specifics right now. But we try to be conservative with looking at -- in the preparation of that guidance because we have seen that there's been certainly some slowing down over the last quarter or so here in terms of the industry. And so we felt we don't want to be aggressive about that and we feel that, that could potentially give us some flexibility if that's needed.

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

The $4 million that you -- expenses you incurred this quarter, what percentage of that do you think you'll recoup in the fourth quarter?

Well, we haven't -- Howard, we haven't really quantified it. I mean, I view the $4 million as sort of the cost of the actual closure, the construction where we have to actually shut down these restaurants. The scale of what we had to do is such that we really can't keep even the drive-thru open during that period of time. So you do lose all the sales during that period of time. Now obviously when they start back up and we reopen them, what we've been saying is we would expect to see, hopefully, this 25% sales lift kick in, in the fourth quarter and, therefore, be a net contributor. But we haven't really quantified that on a quarterly basis. But since -- the main thing is all the construction will be behind us by the end of October, so you won't have any of the drag. You'll just be able to see the lift and the flow-through.

But you'll have the same $4 million, assuming you do the same timing on expenses and the same number of stores next quarter as well, though, correct?

Well, except that there's no -- I'm saying in fourth quarter, all the construction that's being done is done by October. There's no additional units that will be closed after October. And then for next year, then we will have that impact going forward. That's why I said, in January, we'll try to give you a good view on a quarterly basis of when the construction will be and we can help sort of shape the quarterly numbers when you -- when we'll have the downtime from construction for next year. But fourth quarter will clearly be the benefit of Image Activation without as much downtime.

So what we're saying, Howard, and we go through this, you'll see that the number of Image Activation openings in the first quarter next year will be fairly light just because we're starting out with taking restaurants down to Image Activate very early in the first quarter next year. A bunch of those will open like in the second quarter of the year. We have openings, but it'll be more taking restaurants down. So that's the kind of help we'll give you as -- when we get together in January.

I guess what I was trying to get at is maybe just thinking about it on an annual basis, the costs associated with taking these down is going to be less than the cash you'll generate?

Yes. Net, net it's not going to be a contributor on an annual basis. It's just going to be some quarters that get impacted from a timing standpoint.

Okay. Because I was just curious about your -- your definition of free cash flow is somewhat unconventional and I don't -- I think most conventional definitions would not have you generating any free cash flow. So I was just curious as to the impact of that on cash, one. And, two, if you think about the definition of your free cash flow on a more conventional basis, you're actually not generating cash? So if you think about it that way, I was just curious if you can go back again and think about the justification for the share repurchase program and/or an increase of dividends. And then my last question would be, can you estimate or you can give any thoughts on the impact of Obamacare?

On the cash flow situation, I think a couple observations to make. I think one is, as you look at our CapEx, we've talked about ramping up total CapEx to support Image Activation and, frankly, to go as fast as we can in terms of getting to 50% of the company restaurants reimaged by the end of 2015, so our total CapEx will go up. But that CapEx we view as growth capital with a solid return on it. And so what we wanted to do on Page 20 was just give you a flavor of, there's a base capital level that we think we need to spend to maintain the restaurants, and also to do the upgrading and improvements to the restaurants, help support the product initiatives that we have out there.

I'm not -- no, I completely agree and I've been in a number of the stores and I think they look great. But it's just that, and not that anybody cares of what I think, but if you have operating cash flow of $250 million, CapEx of $230 million and a dividend of $35 million, and before this press release, you were burning $15 million of cash this year. So I guess I just -- again, I'm confused, one, by your definition and how you can justify buying back stock. I mean, it really just doesn't seem to make any sense to me.

Right. Well, Howard, if you'll let me finish, what I'll say is that the cash flow, for example, if you look at our year-to-date cash flow statement, there is a significant reduction in cash flow from operations this year due to the balance sheet items, and a lot of those balance sheet items were related to Arby's and the sale. So I think it's noise in the numbers. What Page 20 was just trying to do was do simple view of cash flow historically as well as prospectively. And it is a simplified definition, absolutely. It does not include the balance sheet swings, which generally, other than this year, are not going to be significant. Our point is, look, we've got $450 million of cash on the balance sheet. That asset today earns very little to us. We want to spend and use that cash to help with the CapEx that we need to get the Image Activation moving as quickly as possible. I think with the residual cash flow that we generate, I think a boost of the dividend and being able to fund a stock purchase program is all within the financial flexibility we have and we think that's the balance that made sense for us. And again, the point I would like to emphasize to everyone is that the stock buyback program and the dividend do not take away, in any way, from Image Activation.

Howard, this is John. Obamacare, just to get your question, we have been anticipating either way depending on how the election would go, what these impacts might be. And we've studied, obviously, very carefully the law that's been passed. It's extremely complicated. We think it would be somewhere less than $25,000 per restaurant impact. But we're not going to obviously settle with that. We're going to work diligently. We have a cross functional term internally, external experts and we'll get at this. The good news is we have till 2014 to get fully prepared. But we are spending a lot of time on it internally and with our franchisees. Brandy, this is -- we can take one last question because we're past the ending time for this. So one last question, please.

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

Steve, this question is directed to you. You've ticked up the investment costs for the Tier 3 remodels. And just revisiting this a bit. You also ticked up the sales lift expectation from the January conference, Analyst Day, from about 5% to now about 7.5%. And I'm just wondering what gives you the confidence to sort of walk up that sales lift expectation, can you speak to that at all?

Yes. And, Phillip, it is -- it's a bit of a moving target. Until we get these up and running, what we're using these, internally, is a way just to help calibrate the differences of the Tiers for our franchisees so they know what's coming and what we're trying to accomplish. I think the move from 5% to 7.5% in part was also that we added some more features, as I said, going from what we had started with as a concept of about $300,000 remodel by adding back in some of the features that we think really resonate with customers. I think we were comfortable that we might expect a little bit better sales lift there. But these are just our estimates. I think next year, we'll prove that out, and we'll have hard data to share with our system.

Thanks, everybody. Thank you for being on the call. The rest of today, Steve Hare, Ed Poplar and myself will be obviously talking to many of you with regard to those follow-up calls and if you have any questions, please call us or write to us. Thanks and have a great day.

Thank you.

This concludes The Wendy's Company Third Quarter Earnings Conference Call. You may now disconnect.