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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by. Welcome to the The Wendy's Company Earnings Results Conference Call. I'll now turn the conference over to Greg Lemenchick, Director, Investor Relations. Please go ahead, sir.
Thank you, and good morning, everyone. Today's conference call and webcast includes a PowerPoint presentation, which is available on the Investors section of our website, www.wendys.com.
Before we begin, please take note of the Safe Harbor statement that appears at the end of our earnings release. This disclosure reminds investors that certain information we may discuss today is forward-looking. Various factors could affect our results and cause those results to differ materially from the projections set forth in our forward-looking statements. Also, some of today's comments will reference non-GAAP financial measures, such as adjusted revenue, adjusted EBITDA, adjusted EBITDA margin, adjusted earnings per share, adjusted tax rate, free cash flow, and systemwide sales. Investors should refer to our reconciliations of non-GAAP financial measures to the most directly comparable GAAP measure.
On our conference call today, our President and Chief Executive Officer, Todd Penegor, will provide an update on key initiatives and our long-term strategy, and our Chief Financial Officer, Gunther Plosch, will review our second quarter results and full year outlook. After that, we will open up the line for questions.
With that, I'll hand things over to Todd.
Thanks, Greg, and good morning, everyone. Let's dive into our second quarter results, which highlights the continued momentum in our business. We continued to deliver positive same-restaurant sales by posting our 22nd consecutive quarter of growth, a streak that continues to be unmatched in the QSR hamburger category. We have accelerated our same-restaurant sales versus the first quarter on a one and two-year basis, by achieving 1.9% growth in the quarter, or 5.1% on a two-year basis. We opened 36 new restaurants across the globe and have opened 69 year-to-date. At the same time, we continue to reimage our restaurants and now have 46% of the global system on the new image.
We have delivered another quarter of strong global systemwide sales growth of 3.1% on the heels of new restaurant development and same-restaurant sales growth. We're also excited to note that we currently have 40% of our North American restaurants on a delivery platform, up from 25% at the end of the first quarter. Delivery has outpaced our original rollout expectations and we are very pleased with our rapid expansion, as delivery is another great way to provide access to the brand.
Our sales and profit growth, coupled with our core working capital initiative, led to strong free cash flow growth of 34% in the second quarter. The company continues to remain on target to achieve our current year financial outlook, which GP will talk through shortly. With that, I want to provide some context around our second quarter same-restaurant sales.
Behind our strong and balanced promotional calendar in the second quarter, we were able to accelerate our same-restaurant sales versus the first quarter on a one and two-year basis. As we continue to stick to our playbook of utilizing a balanced marketing approach, we kicked off the quarter with a focus on our core menu items by launching 2 for $6 promotion. This allowed us to offer consumers some of our most popular menu items at a compelling price point. This resonated with our biggest fans and proved to be a nice check builder.
Our new Southwest Avocado Chicken Sandwich and Salad LTO balanced out the calendar and highlighted our commitment to freshness and quality. This promotion outperformed versus our expectations and as a result, we have added the Southwest salad to our menu to give customers what they crave.
Shortly after, we brought back one of our most loved promotions to kick off the summer, the $0.50 Frosty. This offering continues to give us strong results, by driving more customers more often into our restaurants. In conjunction with the $0.50 Frosty, we highlighted our fresh never frozen beef by promoting one of our fan favorites, the Baconator. It delivered against our expectations and our overall hamburger business remained strong throughout the quarter. From there, we finished off the second quarter with the Berry Burst Chicken Salad, which was a great addition to our menu for the summer.
We also continue to demonstrate our best-in-class digital and social media marketing efforts, as evidenced by some recent awards we won at the Cannes Lions Festival for Creativity (sic) [Festival of Creativity]. This is something myself and the team are very proud of, as the consumer is clearly more engaged with our brand than ever before. All of this ladders up to achieving our 22nd consecutive quarter of positive same-restaurant sales and our 11th straight quarter of holding or gaining traffic share in the QSR hamburger category, according to The NPD Group.
During the second quarter, we made great progress on our global growth outlook by opening 36 new restaurants around the world, with 25 in North America and 11 internationally. Net of closures, we grew our footprint by 23 restaurants, with 13 in North America and 10 internationally, turning net positive of 22 openings globally year-to-date.
In North America, we are on plan to achieve our third consecutive year of net unit growth, as we remain on track to achieve approximately 1% growth in 2018. In addition, we completed 64 Franchise Flips in the second quarter, as we build a stronger Wendy's system. We continue to expect to complete approximately 200 Franchise Flips in 2018.
On the International front, we have a slight delay in our 2018 unit growth expectations. We now expect approximately 10% net unit growth for 2018 versus our original outlook of 16%. As a result of the updated International outlook, we now expect global new restaurant growth of approximately 1.5% for 2018.
Our delivery initiative remains an encouraging opportunity for the business and we are pleased to be expanding ahead of schedule. We grew our delivery footprint by 15% since the end of the first quarter, bringing our coverage to approximately 40% of our North American restaurants. We continue to expand with our current partners, DoorDash in the U.S. and SkipTheDishes in Canada. We have an increased focus on bringing more awareness to delivery throughout the remainder of 2018. We have seen an increase in the number of transactions made through delivery when we put advertising weight behind the platform, such as taking national TV ads or offering free delivery with a minimum purchase.
The consumer has an appetite for convenience and we have seen this through our delivery economics. Average check sizes have been 1.5 to 2 times higher on delivery orders and we continue to see incrementality and customer repeat. In addition, our strongest customer satisfaction scores are coming from delivery, which is very encouraging. We look forward to leveraging our partnerships to rollout delivery to even more markets, as franchisee demand remains extremely high for this offering.
Now I want to bring us back to The Wendy's Way, as everything at Wendy's centers around our brand promise of delighting every customer, period. In order to bring this to life, we must remain focused on investing in the quality of our food, providing great value, delivering exceptional service, and elevating our restaurants. This continues to be our roadmap for growth into the future.
And with that, I will hand things over to GP to take you through our second quarter financial highlights and outlook for the year.
Thanks, Todd. As a reminder, we will be discussing all results versus the prior year on a recast basis, which is inclusive of the impact of revenue recognition and other P&L reclassifications. Please refer to the tables in the back of our earnings release for a reconciliation of these recast financial statements.
Adjusted revenue has increased by 4.6%, primarily driven by systemwide sales growth, including positive North American same-restaurant sales, and global new unit development, as well as increased rental revenue driven by Franchise Flips completed in 2017.
Year-over-year company restaurant margin decreased 140 basis points to 17.4% driven primarily by labor rate inflation, commodity inflation, and high insurance cost. This was partially offset by year-over-year pricing actions. As a reminder, we had a challenged restaurant margin in the first quarter, but this significantly improved by 350 basis points in quarter two driven by increased leverage due to same-restaurant sales accelerating by 120 basis points to 2% and less pressure from commodity inflation.
G&A expense was $49 million compared to $50 million in 2017. This 1.8% decrease was primarily the result of lower professional fees and lower salaries and benefits as a result of the company's G&A savings initiatives.
We were very pleased to grow adjusted EBITDA by 1.5% to $110 million and successfully lapped our strongest quarter of performance in the prior year. Adjusted earnings per share increased almost 8% to $0.14 in quarter two versus the prior year of $0.13. Free cash flow increased 34% to $118 million driven by favorable timing in capital expenditures and increasing cash flows from operations as the result of our working capital initiatives. We are on track towards achieving our goal of $220 million to $240 million in 2018.
For a deeper look into our adjusted EBITDA performance, the 1.5% increase was primarily driven by increases in royalties and net rental income, partially offset by net franchise fees due to some incremental investments we made in technology and franchise support expenses to drive future growth.
Moving on to adjusted EPS results, the year-over-year increase of $0.01 was primarily driven by the tax rate as a result of the favorable changes in the U.S. tax law, partially offset by increased depreciation and interest as the result of the capitalized leases from Franchise Flips completed in 2017.
I also wanted to take the opportunity today to give you an update on our franchisee financial health, as we recently finished collecting and reviewing our franchise financials for 2017. The North America franchise system continued to show a track record of solid financial performance. We have delivered strong three-year annual growth rate of 3% for restaurant sales and 7% for restaurant EBITDA. A healthy economic model remains job number-one for the system. This, along with the strong partnership between us and our franchisees, will set the Wendy's brand up for continued long-term success.
Returning cash to shareholders remains a top priority for us through quarterly dividends and our share repurchase strategy. We repurchased 2.7 million shares for $45.7 million in the second quarter of 2018. We now have approximately $113 million remaining against our current share repurchase authorization. We ended the second quarter with $195 million of cash in our balance sheet, which, along with continued free cash flow growth, provides us the ability to effectively and consistently invest in the business and return cash to shareholders.
Now taking a look at our 2018 outlook, as we remain on track to deliver all of our financial commitments, we have accelerated our same-restaurant sales growth since the first quarter on a one- and two-year basis and have confidence in our remaining calendar to support our outlook of approximately 2% to 2.5%. Our strong second quarter restaurant margin performance has shown that we are on track to achieve our guidance range. With continued leverage from same-restaurant sales and commodities becoming deflationary in the second half of the year, we reiterate our restaurant margin guidance of 17% to 18%.
With same-restaurant sales growth and restaurant margin acceleration in the back half of the year along with lower G&A, we continue to expect adjusted EBITDA of approximately $420 million to $430 million. With all our guidance unchanged, we continue to expect free cash flows of approximately $220 million to $240 million, which is an increase of 29% to 41% compared to 2017.
I will now hand things back over to Todd, where he will provide an update on our long-term strategy.
Thanks, GP. I wanted to provide an update on some changes we have made recently in leadership responsibilities to support growth. David Trimm, our Chief Information Officer, will be retiring early next year. I am thankful for all of his hard work and dedication to the Wendy's brand over the last several years.
With that news, we have taken a fresh look at all of our technology platforms and will refocus our leadership structure moving forward to ensure we continue to leverage technology across all we do. All of our digital initiatives will be led by Kurt Kane, Chief Concept and Marketing Officer, under a newly-created Digital Experience organization.
We have also engaged a global consulting firm to accelerate our work to bring consumer-facing technology such as mobile ordering, rewards, and kiosks to life. GP will be expanding his role by taking on all enterprise technology to ensure that we have a strong foundation in place across all of our IT systems.
Bob Wright, our Chief Operations Officer and Head of International, will be transitioning his International responsibilities to Abigail Pringle, as he will assume in-restaurant technology and continue to focus on driving operational excellence in our restaurants across North America. Abigail, our Chief Development Officer, will take responsibility for the International business, bringing the success she has driven with North American development to the entire globe in a newly-created role of Chief Global Development Officer and Head of International.
I am excited to announce these new opportunities for the leadership team as they will continue to move us towards our vision of becoming the world's most thriving and beloved restaurant brand.
As a brand, our long-term vision remains clear, and that is to become a meaningful global brand that is recognized and loved by all of our customers. We plan to achieve our vision by being an efficient growth company, with our number one goal being to invest in growth, while returning significant amounts of cash to shareholders. We have consistently demonstrated the ability to do this since we began our brand transformation.
We are well on our way to achieving our 2020 goals and we have a proven track record of delivering. This focus has led to 22 consecutive quarters of same-restaurant sales growth. Our highly franchised business model is extremely resilient, making Wendy's a solid, predictable investment. We have returned $2.3 billion of cash to shareholders over the past five years, which includes a 250% increase in our quarterly dividend. QSR is the place to be, as it represents more than 80% of the industry. We can deliver on the consumer needs of speed, convenience, and affordability, while differentiating ourselves on quality.
With that, I'll hand the presentation back over to Greg before we open up for Q&A.
Thanks, Todd. I'd like to quickly review some upcoming events on our Investor Relations calendar. On Wednesday, August 15th, GP, Lauren Cutright, and I will be in Boston for a one day road show hosted by Will Slabaugh of Stephens. On Wednesday, August 29, our senior management team will host a market visit here in Dublin, where we will tour one of our new Smart design restaurants, sponsored by Andrew Strelzik of BMO.
The following week, on September 5, Todd, GP, and I will be in New York for an NDR hosted by David Palmer of RBC. And on September 13, GP, Lauren, and I will be back in New York attending the C.L. King Best Ideas Conference. And finally, GP, Lauren, and I will be going on a West Coast road show hosted by Jeff Bernstein of Barclays. We will be in Los Angeles on September 18 and San Francisco the following day on the 19th.
If you are interested in meeting with us at any of these events, please contact the respected sell-side analyst or equity sales contact at the host firm. On Tuesday, November 6, we plan to release our third quarter earnings after market close and host a conference call the following morning, on November 7.
With that, we are now ready to take your questions.
Your first question comes from the line of Matthew DiFrisco from Guggenheim Securities.
Thank you. My question's with respect to margins and I think, GP, you mentioned that the franchise support number was a little higher or technology investment that you were making. How should we think about that in the second half of the year on a year-over-year basis? I guess, we a lot of times look at that as relative to sales.
Good morning, Matt. Yes, we have the net effect between franchise fee revenue and expense is in the quarter about $2 million of profit that we have. You can expect for the second half that we make a little bit more profit than in the first half.
Could you describe, I guess, or quantify how much that technology incremental support sort of came into this quarter versus sort of the ongoing expenses?
As we said in the previous conference call, we used some of the tax-related savings to make some investments. We didn't disclose previously and we don't want to go into that detail at that point in time.
But, Matt, it was a little frontload...
Understood.
It was a little frontloaded...
Frontloaded.
...on the technology side.
Yeah.
Okay. Thank you so much.
And your next question is from Brian Bittner with Oppenheimer.
Thank you. Good morning. Also a question on your full-year guidance. When I look at your EBITDA growth in the first half of 2018, it looks like it was in the 3% range. So the math just simply says to achieve your full-year guidance, it needs to accelerate into the double-digit growth in the second half, so two questions. One, was that first half EBITDA performance in line with your expectations before you gave the guidance? And two, can you just reiterate maybe the top two drivers for the second half EBITDA acceleration expected? Thanks.
Good morning, Brian. Yes, your math is right that year-to-date EBITDA growth was 3.2%. We have to be double-digit in the second half. First half is totally in line with expectations. So what drives the acceleration in the second half? Couple of things. Clearly, continued SOS and royalty growth. But we have an implied SOS growth between 2.2% and 3.2% for the second half.
Secondly, clearly we are further stepping up restaurant margin in the second half. We need to be slightly north of 18% margin to achieve the guidance range of 17% to 18%, which obviously is a meaningful acceleration, since obviously our restaurant margin in the base was about 16%, 16.2%. So, restaurant margin expansion and growth. And last, but not least, the third lever is further progress on G&A. Since you've probably seen we are little bit frontloaded in the G&A spending in the first half, that will even itself out and will drive further growth.
Appreciate that. And just last question on the commodity front. Can you tell us what the inflation was in the quarter, and then what you're expecting then in the third and fourth quarter on the commodity inflation?
Yeah. The commodity inflation in the second quarter was 1% to 2%. Remember, we had 5% inflation in the first quarter. We're guiding for the year 1% to 2% inflation. So you basically are deflationary in the second half.
Thank you.
Your next question is from John Glass from Morgan Stanley.
Thanks very much. Just first on development, maybe just two separate questions. One is, what led to the shortfall of International? Was it just simply timing or was there some lack of – some resistance from a partner, or some specific country you might want to call it just in terms of what drove that? And then on the U.S. system, it seems like, though, it's limited data that the closures have sort of declined at least relative to first quarter and maybe through most quarters last year. So are we through the worse of the closures now and you think that, therefore, that's what's giving you the confidence in the 1% growth in the U.S. system?
John, I guess, first start with International. There's always going to be a little unevenness in the International growth, and we had just a couple of markets that had slipped from their development in 2018 into 2019. So we feel very confident that we're still on track with the right partners and the right markets, really focused on scaling up our core markets in International to continue to deliver our 2020 commitments on International units.
In North America, it's usually always a back half loaded plan. You start to see from a development calendar things accelerate in the summer months and into the fall months. At this point of the year, we clearly know what new construction is starting, what's planned over the next couple months. So we've got high confidence we can deliver that 1% growth on North America during the course of this year.
On the closure front, there will always be a steady amount of closures over time. But about 20%, 25% of those closures, you got to remember, are relocations. So, we're moving from old, tired trade areas into newer trade areas. So it will be steady in that range, I would imagine, over the next couple of years. That said, we continue to do things like Refresh Lite for our lower AUV restaurants to help mitigate some of those closures over time.
That's helpful. If I could just ask a follow-up on delivery. Can you talk a little bit more about how you measure incrementality of delivery, how you understand that business to be incremental? Can you talk about maybe service times? Are you pleased with the service times consumers are getting and that's what's driving that satisfaction? And can you also talk about just data sharing with DoorDash? Are they willing to share customer data with you? What kind of arrangement you have on that front?
Yeah, John, we're partnering with DoorDash to have the access to the data and to share information. Right now we're still ordering through DoorDash. We're working to integrate DoorDash into our app some time into the future in partnership with them. We've always talked about having the customer – from the time they order to the time that it's delivered, optimal is under 30 minutes. We're just slightly over that. But some of our highest overall satisfaction scores from the consumer is coming from a delivered order.
So we feel good about how the customer is experiencing it, getting the food in a timely manner with high integrity. And we're seeing nice average checks, 1.5 to 2 times of what we see in the restaurant, excluding all the delivery fees. And we see it universally across the day and feel good about the incrementality being a little bit higher in the evening and dinner daypart, but I'll have GP talk a little bit about how we're measuring the incrementality.
Yeah, John, with all the data we get from DoorDash, we are able to actually identify control stores. We're running our testing software against it, try to filter out the noise, and then get to the true incremental number that we are focused on. So it's the same software and same technology we use for any test that we do, we're applying that also on the delivery data.
Got it. Thank you very much.
Your next question is from Sara Senatore with Bernstein.
Hi. Thank you. Two questions, if I may. One is a follow-up. So the first is, you took some price and I think you mentioned that some of the bundled value helped with ticket. So I'm assuming that perhaps traffic maybe was modestly negative. And I know you talked about strength in hamburgers and salads. Can you talk maybe about which dayparts or sales layers are working well for you versus those where maybe you're looking for improvement?
Yeah, Sara, if you look at the overall composition of our same-restaurant sales growth in the quarter, traffic was slightly up. So we felt good that we continue to gain or hold traffic share over the last 11 quarters. You look at some of our share numbers within the hamburger category share is some of the highest that we've seen in the last six years. So we feel good that we continue to stay focused on what we're good at, our hamburger business.
If you think about price, we've had a tailwind on price. I can have GP comment on that in a moment. But we did have a little bit of a headwind on mix in the quarter. And a lot of that's driven by the continued success of 4 for $4. We keep it fresh and ownable. We went to eight items. It's a great compelling offer to continue to bring more folks into our restaurants more often. And we ran our $0.50 Frosty promotion a little bit earlier this year, which was a positive, again, bringing more customers into our restaurants more often.
If you think about daypart, clearly the dayparts that are growing in QSR are dinner and late night. As we continue to reimage assets, create a better experience for families to come in and sit down to support to some extent, which would be small from delivery, that helps continue to grow our business in those dayparts. The biggest daypart's still lunch. So we continue to really work hard to unleash a better experience really from the standpoint of throughput, whether that's leveraging kiosks to drive more orders into the kitchen and the dining room or continue to do things in the drive-thru through mobile ordering or the like, which will come more over time to get more orders back to the kitchen. Those are opportunities to deliver on our promise, speed, convenience, and affordability. On pricing, I'll have GP comment a little bit on pricing.
Yeah. On pricing, just two comments from me. First of all, the system has priced about in line with food away from home inflation. The other example that I can give you, company has priced a little bit more than that. Because we hadn't priced for two years, we have earned now the right to actually create and demand that value from our consumers. So we've accelerated a little bit.
Thank you. That's very helpful. And then just my follow-up question was on delivery, which is it sounded like you said you offered free delivery with minimum purchase to help drive some increased demand. I guess, does that suggest that maybe you'd think about lowering the fees you charge in the sense of – I think now you're charging the delivery fee and a service fee? And perhaps who supports those kinds of promotional activities? Is it you? Is it DoorDash? Do you expect franchisees to contribute? So, I guess, trying to understand the economic tradeoff of maybe offering lower fees to customers versus your own and your franchisee profitability.
Yeah, Sara, no, on the delivery side, we really partner with our partner in the U.S. DoorDash., and we work with them to get placement within the app from an ordering perspective. We work with them on pulsing some offers to drive awareness on free delivery. A lot of times they're supporting all of that along the way, so it doesn't impact our economic model at the restaurant level.
Our opportunity is really how do we continue to partner with them to drive more awareness in total, and you can start to see during the course of some of our ad campaigns in the second quarter and on-air today is we're supporting Dave's Double, we're also taking free delivery. So our opportunity is to continue to educate folks that DoorDash is our partner; that you go to DoorDash and you can get free delivery during some of these promotional windows to get them really comfortable with the overall service experience that we know we can provide.
Thank you.
Your next question is from Jake Bartlett with SunTrust.
Thanks for taking the question. I had a follow-up on the development. And first is I want to confirm your target for 2020 is unchanged, but I want to confirm whether you still expect 6,400 stores in North America and 850 International within that.
Yeah, Matt (sic) [Jake], on our plans, we're still on track and committed to the 7,250 units and the split that you laid out, 6,400 in North America and 850 in International, is still on plan and on track. And as we've said in the past, we've got some nice development commitments across North America; about 50% are locked into development commitments from here to 2020. A little bit lower on International, with about 40% committed on development agreements. But we've got some great partners that will continue to focus on our narrow and deep markets to scale up and to continue to drive some nice acceleration in our International growth goals.
Okay. And for your same-store sales guidance, the implied acceleration in the back half, can you rank order the reasons you're confident in that? Is it the exit rate coming out of the second quarter? Is it maybe some pricing actions you've taken, maybe some of the initiatives on digital, or is it simply the easier compares in the back half?
Well, it does start with easier compares in the back half. And if you look at where we were on a stacked two year in the fourth quarter, what we did in the first quarter, and now where we've accelerated into the second quarter, we feel very confident that we've got some nice momentum on our sales through Q2. We had a tough comp, as you know, in Q2 to over-deliver, and we did that nicely in the face of a lot of competitive pressure.
As you look at the calendar year to go – and I won't rank order these things because they all contribute a bit – we really will continue to play our consistent high-low game. We're going to have support on our core. You're seeing that out there today with Dave's Double. We've got some new to the world LTOs that'll come during the course of the year.
We'll continue to pulse in some good value propositions, like we've done consistently in the past. 4 for $4 continues its momentum, as I said earlier, with eight items now included, so there are more choices. And then the technology initiatives will continue to help support our growth in the back half. We've got offers in our mobile app. We'll continue to put offers out. It's a great way to drive acquisition as well as convert it into traffic. And we'll continue to partner with DoorDash to expand delivery in the back half of the year.
Great. Thank you very much.
Your next question is from Gregory Francfort with Bank of America.
Hey, guys. I've got two questions. The first maybe is for Todd. Just can you help us frame up what the mix of delivery or the lift you're getting from delivery either in the stores that you have it or sort of for the entire base? And then, GP, as your CapEx is falling off, your D&A now is going to be running pretty high above where your rate of ongoing CapEx will be. Any help on just the timing and magnitude of when that gap closes? And maybe not 2019 specific guidance, but maybe directionally just anything that would be helpful.
Yeah, Greg, on delivery, it's still scaling up, so it's still a relatively small percentage of our business, and we haven't quantified what the same-restaurant store tailwind is. We did start talking a little bit about the average check being 1.5 to 2 times higher, so we feel good about that. And we feel good about the consumer experience, with our overall satisfaction scores being the highest in 4.5 out of 5 stars in the DoorDash app.
So, a continued opportunity to provide more access to our brand. That's why we're so excited and we feel like we've got two good partners. We've got DoorDash in the U.S., and we've got SkipTheDishes, which has been expanding nicely in Canada. So we feel like it'll be a nice contributor over time. But it's still going to be a slow build as that continues to scale up. GP?
Hey, Greg, on the capital side, you noted correctly. We are backend loaded from a capital point of view. I'm confident with the capital guidance range of $75 million to $80 million for the year. In terms of depreciation levels over the next several years, you know the guidance for this year is about $130 million. We expect it to stay on this level over the next couple of years.
Great. Thank you very much.
Your next question is from Will Slabaugh with Stephens, Inc.
Yeah, thanks, guys. Two quick ones, if I could. First I wanted to ask on the messaging around fresh never frozen beef. You've been more aggressive with this message to both, it seems to fend off competitors and push your brand agenda as well. And I'm curious if there's anything you could say in terms of mix of your core items today that you've been seeing versus what it has been. And if you're seeing either new customers come in and retry your core items or if you're seeing maybe your current frequent guests trade up to those core items.
Yeah, Will, so a couple of comments. The awareness around fresh never frozen North American beef from Wendy's continues to increase. We talked in the past that it was less than 50%. We're now more than 50%. And if you look at overall awareness in association of our fresh never frozen beef, it continues to be really strong not only for our brand, but we have 4 times more the association of fresh never frozen versus our top two competitors. So, people associate fresh with Wendy's. We continue to support that not only in our traditional media campaigns on TV, but as we focus on the food within our social media following. And when you look at how our businesses performed in the second quarter, we're pleased. We had nice growth on our premium hamburger business. So I'll leave it at that.
Thanks for that. And one quick follow-up, if I could, on company store margins to make sure I understood kind of how to think about this for the back half. Those were slightly below where we expected for 2Q, which you spoke to. Looks like labor and some other costs were offsetting the cost of goods benefit. Can you talk a little bit more about how we should think about that in the back half of the year? You mentioned beef should be more of a benefit and deflationary, and how that could factor against the accelerating labor inflation that we're seeing out there and affecting your P&L overall?
Yeah, Greg – Will, a couple of things on my side. First of all, sales leverage is a big driver for us in the back half. As you remember, company restaurants was declining 0.5% in the third quarter, 1% in the fourth quarter. So with the momentum we have on company, that's a big driver of margin and sale and leverage. Second one is, again, as I mentioned, our quarter three margin last year was 15.9%, and then 16.6% in quarter four. And we are clearly expecting to be kind of in the 18% plus range, to then confidently land in the guidance range of 17% to 18%. And clearly the deflationary trend on commodities is a big contributor to that.
That's helpful. Thank you.
Your next question is from David Palmer with RBC Capital Markets.
Thanks. Hey, guys, two questions for me as well. There were reports out there, I think it was on CNBC, that Wendy's was in talks to buy Papa John's or at least do some sort of a deal with them before the controversy with that brand. And I guess that story begs the question just about M&A strategy long term. Do you foresee Wendy's someday perhaps being a multiple brand holding company, and maybe would you think about buying something for the capabilities? We've had a lot of discussion today about delivery and, obviously, there's certain technologies and know-how that you can buy when you buy something else. So any strategy about M&A would be helpful.
Yeah, David, so as we've consistently said, our number one priority is still the same, and it's getting our operating structure in order and focusing on core growth in order to achieve our 2020 goals and returning cash to shareholders. Our capital allocation strategy remains to, first and foremost, invest in the business for growth. We think there's a tremendous amount of opportunity to continue to invest and drive the growth in the Wendy's business. And then to return cash to shareholders through dividends and share purchases.
Ultimately would we consider M&A opportunities that might arise if they make sense for the Wendy's brand? Yeah, we'd have to look at would it complement the capabilities that we have? Could it accelerate the capabilities that we have? Would it work for our franchise community? But that said, investing in growth is our number one priority, and that's we'll stay focused.
And then on Image Activation, maybe you could give us an update as to some of those statistics. You said I think at one point that that would be about a 60 basis point lift to comps this year. You're doing about 10% of the system, I believe, a year. And, I guess, the question behind the question is, I wonder if there's going be a cumulative positive impact from this at some point. Right now at 10% a year, is that really a 6% lift? And even if it is only 6%, perhaps there's a benefit as you get to scale in certain markets or perhaps year two comps on these IAs are better than average, such that we'll see bigger benefits from Image Activation in the future. Thanks.
Good morning, David. On Image Activation, couple of stats for you. So in the second quarter, the tailwind for the system was 60 basis points. The tailwind for company was about 20 basis points. And we remain confident that we are expanding by about 10% in the year. So we're going to end up north of 50%. And you're right, there's a theory there that once we kind of surpass a certain threshold that it might create even more momentum. But clearly with 45%, 46%, are probably at the cusp of it, we'll have to see. Your theory might be right.
And for us, David, it's really how do you elevate that total experience in the restaurant, right? The asset is one thing that can draw them in. The service is another thing that can continue to bring them back time and again. And when you're in a new higher lighted with more food-forward visibility into the restaurants, clearly it can accentuate all the positives on the quality and the freshness of your food. So they all complement one another, and I do think the more we reimage the restaurants, the more you run into them on a regular basis across any trade area that you're in, the more positive impact it has on our business.
Thank you.
Your next question is from Matt McGinley with Evercore ISI.
Good morning. My first question is on the labor cost. On a per store basis, you had much higher rate of increase in the second quarter versus the first. Was there something unique with the seasonality that made that higher in the second quarter? And it sounded like in the back half that most of the expectation for – rather the biggest driver for margin expansion will be the commodity benefits. But is there something else within labor that would make that a bigger benefit, like kiosks or other labor saving initiatives that will help that line item?
Hey, Matt. This is Gunther. Good morning. You're right, we had 30 basis points of headwind on labor inflation in the quarter. That's really behind a 3% to 4% raw labor inflation. So that actually translates – that would translate in 100 basis points of headwind. But with the leverage that we had in the restaurants, plus the ongoing efforts on deploying technology, we basically put inflation down on the face of the P&L.
I would expect that labor inflation is here to stay for 3% to 4%. And I think there's going to be a slightly better benefit in the second half, since we will have more sales leverage in the second half in our company restaurants, since we have such easy comps. Remember, our comps in the back half were actually negative last year.
Thank you. And on the unit growth internationally, it sounded from the comment you made before that that wasn't just a single country where the pipeline had slowed, but it was multiple countries. Is there a consistent theme about why those projects would have been pushed to 2019? Is it economic or is it just – I don't know – something to do with the development that pushed it later than we thought?
Yeah, Matt, to give you the straight answer, it's about three markets where we had a little bit of impact in really shifting some of the business on new development from 2018 into 2019. Each market's a little different story, and some of it is markets in transition from one owner to another. Another one is how do you continue to build out some of the sub-franchising commitments in a timeframe that we're working against. And one of it's in a market that's got actually very small AUVs, so it doesn't really impact our financials a whole heck of a lot, but a market that's been growing exponentially very fast.
And I think it's also worth pointing out that whilst it slowed down a little bit, we are still expecting system sales growth in the double-digit range for the year, so very, very healthy growth for International. And, as Todd pointed out, clearly no impact on our EBITDA performance for the year.
And we feel good about the health. To GP's point, if you still look at our same-restaurant sales growth, which we don't give specifics, but it's been a contributor to our overall sales. So the total same-restaurant sales growth is growing faster than North American sales growth for the company.
Okay. Thank you.
And your next question is from Michael Gallo with C.L. King.
Hi. Good morning. My question is on the new unit prototype. I was wondering if you can speak to kind of the costs you've been able to remove from that. When that will become kind of a standard? And what kind of range of returns you expect to be able to see on the unit openings? Thanks.
Yeah, Mike, as you know, we continue to evolve the design of our restaurant and introduced last year a Smart 1.0 design that we had talked about, which took our average unit costs down to somewhere in the range of $1.7 million, depending on the trade locale. What we've done is tried to make sure that that design can fit in all trade areas, so we can get onto 0.5 acre or less. And we had a lot of customizable solutions, anywhere from a 28-seater dining room to a 40 to a 55 all the way up to the traditional, if that's where we wanted to have it with 65 seats or more. We've opened a restaurant here in town that we call our Smart 2.0. We're able to pull another $150,000 of costs out of that restaurant. We're able to optimize the footprint in that restaurant.
And really take all the elements that we learned in the DisCoM (00:44:46) restaurant, which we've talked in the past, on the other side of town and really optimize for the consumer flow, optimize for technology. And we'll start to see both of those pick up over time. Smart 1.0 is big part of our pipeline today. You'll start to see, as you get into next year, Smart 2.0 is starting to be a bigger portion of our pipeline.
Just as a follow-up to that. Do you see similar levels of sales with a Smart 2.0 despite having fewer seats or how should we think about that from a return perspective?
Yeah, returns are better as cost goes down and sales stay the same. So we're still seeing those nice sales openings of 1.8% up to 1.9% with the grand opening impacts in there. So those kitchens, those seating arrangements really can support the trade areas that we're putting them in and can continue to drive nice AUVs, so we get a nice return.
Okay. Thank you.
Your next question is from Dennis Geiger with UBS.
Great. Thanks for the question. Wondering if you could talk a little bit about what you're seeing from a competitive perspective, how you respond to that perhaps in the quarter. And any thoughts you can share on going forward, any tweaks that you've made or could make. I guess, clearly, you've got to focus on a balanced high/low approach and that's working. But just curious, any adjustments to product or messaging that's taken place or could take place as you've thought about how value competition has played out this year, how the premium competition, looking at fresh beef, has played out, et cetera. Just any kind of commentary there. Thanks.
Yeah, I mean, we're in a very competitive business. And the category from real terms on traffic has been relatively flat for the last several quarters, last couple of years, in fact. So it is a share of stomach. But it is really driving all of the elements of The Wendy's Way that we talk about. How do we continue to drive reimaging of our restaurants? How do we continue to create an even better service experience? How do we continue to renovate into our food to create a higher quality experience?
All of those things need to work together because we can do a lot of things to drive folks to the restaurant, we just need to keep them coming back time and again. And that's why we're really focused on playing this long-term game, right? Not getting overly aggressive on pricing to drive just short-term same-restaurant sales growth, but trying to balance price along with mix with traffic so we've got a healthy contributor to our growth over time.
The competitive landscape will be what it will be. What we're really proud of is no matter what the industry condition, no matter what the competitive condition has been, we continue to check and adjust our calendar plans to deliver consistent, predictable, sustainable growth, as evidenced by 22 straight quarters of growth today.
Thanks.
Your next question is from Jeremy Scott with Mizuho.
Hey, thanks. Good morning. Maybe just a follow-up on that. You noted that the 2 for $6 did well during the quarter and your success seems to have incentivized a competitor of yours to offer up something similar. So it seems like another leg up in the promotional activity in an already promotional environment. And so do you expect to get more aggressive here in anticipation in the back half, and as a result, do we need to bake in some risk to your restaurant margin guidance as you may need to reinvest some of those COGS savings?
No, I think we've planned out our calendar for the year. You've got to remember, it takes time to plan out your calendar with supply chain, with all the merchandising, get system aligned to be great at executing behind those promotions. And we feel good that we've got a good calendar, as I said earlier, across core, some new to the world LTOs, and some continued pulsing of value offerings. We've got a strong tool box of value offerings that have been tested and proven, so we're confident when we bring them out.
Those are all baked into our guidance for the year on how we're going to deliver our same-restaurant sales growth and how we're going to deliver our margin expectation. So I don't think we're going to have to adjust the calendar at all. And if you look at our toughest comp quarter, the second quarter, right, we had a nice balanced approach on high and low telling the Wendy's story around freshness and delivered a nice 5.1% two-year comp.
Got it. And maybe just to follow-up on delivery and the economics that your partner is currently absorbing on some of those pulse deals and free delivery that you mentioned. Is there a cross-promotional relationship, so maybe a half a second or a second in your national advertising that functions as their compensation and maybe the economics might look different on a go-forward basis if you were to pare that down?
We'll have to continue to work with our partner and how their economics and our economics work. But to the extent that they have large partners like us, we can help drive awareness to the DoorDash brand, just as much as DoorDash can provide awareness to our brand by offering free delivery and getting us better placement in the app. We've tagged a bit in the past and seen some nice lifts and we tag free delivery. We're actually tagging free delivery right now with the Dave's Double advertising that's on air. So that's one of those economic trades that works well for both parties.
I guess maybe the follow-up question there, are the economics starting to show up more in your advertising contribution as opposed to in your restaurant margin?
No, the restaurant margin, it's really no impact to our restaurant margin because we've managed the service fee where the consumer pays and the way we've worked with DoorDash, we've worked our menu pricing as appropriate to pass on that restaurant level commission to the consumer. And the consumer's been responding quite nicely. They feel great about the quality of the food, the quality of the experience that DoorDash provides. So no impact there.
When you think about our mix of 15s and 30s and how we support ongoing advertising, we've consistently always tagged different things over time. It just happens to be we think there's a good tag at the moment around free delivery that can drive awareness and drive sales over time.
Got it. Thank you.
Your next question is from John Ivankoe with JPMorgan.
Hi. Thank you. You mentioned in your prepared remarks what sounds to be some pretty substantial changes in your Digital Experience organization, I think it's now called. Could you update us on the priorities and timing around mobile ordering, kiosk, and loyalty? Those are the three that were mentioned. And whether any of those or all of those can contribute to breaking through on the labor model, which is a subject that we discussed in the last call?
Yeah, John, let me start with we're really focused on three big accelerated growth initiatives, and they're all focused on the restaurant economic model, right? That's the common thread between the company and the system. It starts with all things digital. How do we unlock the potential that technology can bring to our customer experiences? How do we continue to drive new restaurant development to provide even more access to our brand across the globe? And how do we continue to drive operational excellence? So, ensuring no matter what restaurant or customer visit – or what restaurant a customer visits, they get an experience that continues to bring them back time and again. And that's why we've made the changes in the organization. I've got Kurt, Bob and Abigail focused against each of those three initiatives, and we continue to support the first one in all things digital.
And as we think about the customer Digital Experience organization, that's something that we're going to continue to build out. It will complement all the great work that we've done to-date, but it can continue to help us accelerate our initiatives. And if you think about the initiatives, we continue to talk about kiosk ordering. We continue to provide leadership as a company by putting kiosks into our restaurants to really prove out the business case. And we've got about 60% of the company restaurants now with kiosks. We're seeing a little higher average checks, we're seeing increased throughput, and a good customer experience. So that's going to help drive adoption over time.
For the system, we continue to drive offers in the app. So we want to get more people onto our app and we continue to pulse offers time and again. So that's another great tool that continues to get folks to be more connected to Wendy's through our app. Delivery, we continue to partner to drive awareness, as we just talked about with DoorDash, and they continue to expand to provide more access to the brand. We continue to make sure that from a mobile ordering perspective, when we decide to turn it on for the system, that we're ready. We've got separation of order, pay for pickup. We've got the technology in place in our restaurants. We've got the order flow and the customer flow to work nicely. So that's all accelerating on track with what we've talked about in the past.
And loyalty is an ongoing task and we're trying to really make sure we understand the loyalty offer and how that interacts with the digital offer. So when we bring this full ecosystem together, when it's all supported, we have all of those elements working well together. And under Kurt's leadership, with support right now from an outside consulting firm and a focused organization working cross-functionally to bring this to life, we feel like we really put ourselves in a good position to differentiate on technology over time.
And, Todd, Is there a timeline around this that we should be focused on, maybe end of 2019? Is there anything that you're committing to externally at this point?
No, our focus on all this, John, is to go as fast as we can, but do it in a manner that works for our restaurants and works for our consumers. And we want to make sure that those two things really come together at the right time. So when we're providing support, we create an unbelievably great experience for our customer, because this is a about connecting to the customer and bringing them back more often. So we don't have a specific date, but these things are in front of us, and we'll go as quickly as possible to get them out there in the near term.
Okay. Understood. Thank you.
Your next question is from Karen Holthouse with Goldman Sachs.
Hey. Thanks for taking the question. You've mentioned a couple of times about trying to get people onto the app. If you look at the reviews in the app store, it would certainly suggest that there is still not a lot of consumer acceptance for it and still some challenges. What are you most focused on in terms of improving your reviews that can ultimately help improve downloads? Do you think it's more on the technical side that there's bugs or issues, or just that it needs to have more functionality to drive relevancy?
Yeah, no, first and foremost, it's providing offers. That's number one why folks want to go into the app. And if you've got an appropriate level of offers and you've got awareness that the offers are out there, and you could see us taking offers over time too. It's part of the acquisition cost to get folks into the app, get comfortable that they're in there. Once you have them in that app, then you could start to really leverage all the other things that it will do over time, mobile ordering out of that app, mobile payment out of that app, have an integrated delivery coming out of that app. So we've got work to do to continue to drive folks to that app, but we also know that – and this is some of the work we're doing with the refocused organizational efforts, how do we make that more seamless and more frictionless for the consumer when they get into the app to make it a lot easier to use.
And then one quick clarification from earlier. On the labor commentary in the back half, were you trying to say, with a little bit more price and stronger expected comp that you actually expect to leverage labor in the back half, or just less deleverage versus the first half?
Hi, Karen. That's exactly what I wanted to communicate. We have higher leverage, and that should help us in the second half on our labor rates.
Great. Thank you.
And your final question is from Andrew Strelzik with BMO Capital markets.
Hey, good morning. Two quick ones for me. The first one on the delays in the international openings, do you recoup all of those in 2019 so we could just stack those on top of what you would have already expected or are those spread over the next two years? And then with respect to kind of the long-term EBITDA margin trajectory and targets, there've been some things in the first half of the year that kind of ticked up a little more than you would have thought. They tail off in the back half. And then commodities will be a big help as well, obviously. But in kind of a more normal commodity environment, how confident are you in the trajectory of those EBITDA margins over time, given what we're seeing in some of the other line items?
Andrew, on the International growth it's just really a shift from 2018 to 2019, so it's timing of this calendar year versus next. So we feel very confident that that's how it will play out and keeps our trajectory going into our systemwide sales growth goals, as well as our unit goals on International. On the EBITDA margin, I'll have GP comment on that.
Yeah. We did again this quarter reiteration of our 2020 goals. We remain confident that's the right goal set for us. We are an efficient growth company, $12 billion system sales, and continue to be committed to 37% to 39% EBITDA margin by 2020.
Great. Thank you very much.
And we have no further questions. This does conclude today's Wendy's Company quarterly earnings results conference call. You may now disconnect.