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Tim Hortons Inc. (NYSE:THI)

Q3 2008 Earnings Call

November 7, 2008 10:30 am ET

Executives

Scott Bonikowsky - Vice President of Investor Relations

Donald B. Schroeder - President and Chief Executive Officer

Cynthia Devine - Chief Financial Officer and Executive Vice President

Analysts

Irene Nattel - RBC

Steven Kron - Goldman Sachs

Jim Durran - National Bank Financial

Turan Quettawala - Scotia Capital

Rachael Rothman - Merrill Lynch

Winston Lee - Credit Suisse

David Hartley - BMO Capital Markets

Keith Howlett - Desjardins Securities

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Tim Hortons Third Quarter 2008 Conference Call. [Operator Instructions]. As a reminder this conference is being recorded Friday, November 07, 2008.

I would now like to turn the conference over to Mr. Scott Bonikowsky, Vice President of Investor Relations for Tim Hortons. Please go ahead sir.

Scott Bonikowsky - Vice President Investor Relations

Thanks Frank and good afternoon, everyone. Welcome to our third quarter conference call. We have prepared a presentation to support today’s presentation. You can access this and other material associated with the call on our website and if you click on the events and presentation’s tab in the Investor Relations section at timhorton.com. It will be available for a period of one year.

Joining me as usual on the call this morning are Don Schroeder, our President and CEO; and Cynthia Devine, our Chief Financial Officer. After their remarks, we’d be pleased to take questions.

Before we begin, please note that we may make forward-looking statements this morning within the meaning of the Private Securities Litigation Reform Act of 1995. And this statement includes discussions about future performance based on current expectations and information. Various risks and uncertainties could cause our company’s results to differ materially from those expressed in our forward-looking statements, which speak only as of the date and time made. More detailed information about these risks and uncertainties is contained within the Safe Harbor statement included in the earnings release issued that we issued this morning. Additional risk factors are also described in our public securities filings including our 2007 Annual Report on Form 10-K, also available on our website under the regulatory filings tab.

All Tim Hortons results, I would remind you I presented in accordance with US GAAP and reported in Canadian dollars, unless otherwise noted.

So, with that it’s now my pleasure to turn it over to Don Schroeder, President and CEO of Tim Hortons. Don.

Donald B. Schroeder - President and Chief Executive Officer

Thanks, Scott and good morning everyone. Tim Hortons has delivered another strong quarter, the entrenchment of our brand in Canada where we drive more than 90% of our revenues in the dominant position we have in the Canadian QSR sector is reflected in our positive same-store sales and earnings growth in the face of economic conditions that we’re showing clarify the weakness. In the US, our brand is less developed and consumer pressures and economic weakness are more deeply embedded than in Canada. As a result, we experienced the slight decline of 0.6% in same-store sales this quarter and a $2.1 million operating loss. Now I’ll talk about our segmented performance in a few minutes.

Our consolidated earnings performance this quarter benefited from a number of factors, most important of which was healthy system-wide sales growth in Canada, which contributed to higher rents and higher royalties. We anticipated the strength of our earnings this quarter, the combination of certain cost items that positively affected year-over-year comparisons. And the lower affective tax rate due to the reduced Canadian statutory rates, were both known factors as we entered into the quarter.

We continue to grow our consolidated business in the face of challenging economic conditions. Our Canadian business tends to be fairly resilient to economic pressures. We stand for good food and premium coffee at reasonable prices, which positions us well with customers looking for value when the number of discretionary dollars available to them is reduced.

On slide six; you can see that we delivered system-wide sales growth of 7.8% during the quarter, which includes sales from company operated and franchise restaurants. System-wide sales growth in the quarter included same-store sales of 3.8% in Canada, with the rest of the world coming from new units opened year-over-year.

This quarter as I mentioned a moment ago, we had a small same-store sales decline of 0.6% in the US. The Canadian segment lapped very robust things for a sales growth of 7.75 from the third quarter of 2007, while the US business also lapped more than respectable things towards sales growth of 4.5% from 2007. In this type of challenging environment, we intend to keep our loyal customers, because of the value we represent. But they may not come to us frequently as their ration reduced to discretionary. So, transactions can be impacted.

Historically, 40% of our customers in Canada; visit us four or more times each week. And for maintaining transactions with this high level of loyalty in this environment can indeed be a challenge. Our frequency of visits moderated in Canada, our loyal customers are still coming to us.

While pricing contributed the lion’s share of our growth in the quarter, the fact that we did experience some organic growth continues to lend credence to our price value position, given the sales climate in which we operated and the strength of sales in the comparable period last year.

One other factor we believe maybe significant, as the price of gasoline, which was quite high for much of the third quarter. Only recently declining to the levels we enjoy today. A slight decline this quarter in same-store sales in the US market shows us that our brand is still developing and not is in trench as in Canada, where we are in many respects, the de facto, number one choice for the quick service experience in good time and in bad times. Based on our year-to-date same-store sales growth of 1.2% in the US, it is unlikely that we will hit our forecasted same-store sales target of 2 to 4% growth.

The challenges that confront US consumers and the economy are significant and not likely to change quickly. We are tackling these challenges head on and it is certainly not business as usual. First, as we announced this morning, we plan to rationalize some underperforming restaurants in the Southern New England market, while these stores represent a very small portion of our US business. They do have a disproportionate drag on profitability in the US segment. Second, we are taking concrete steps to meaningfully exceed our brand in developing market through ways that don’t require significant capital. Third, we have taken tangible steps to reinforce the value we provide our US customers through new combo programs and product bundles at various price points.

I will talk about each of these items. We have made significant progress in our effort to transition company operated restaurants to the owner operator model. And have seen encouraging early signs that this transition will ultimately improve profitability. There are some stores in the southern New England market, however, that we believe will take longer to reach profitability than we are willing to accept. By rationalizing some of these restaurants, we intend to eliminate a significant drag on earnings in the US segment.

This will also benefit owner operator and company operated stores nearby as sales migrate, migrate from closer sites to remaining restaurants. Our team is focused on profitable growth and we believe this plan is an important step forward to improve profitability in our US business.

One of the other elements, I talked about in terms of our response to existing market conditions is creative ways to feed our brand without consuming significant capital. We have put a strong push behind seizing our brand through self serve and full serve, non-standard units creating greater market penetration with less capital intensive.

Ultimately, allowing us to broaden awareness of convenience in a cost efficient manner. Previously, you will have seen this approach begin to take live through a deal reached last year with a Shell operator that resulted in 15 self serve locations. More recently, we announced an agreement with Tops Friendly Markets, a leading regional grocery brand which will seat Tim Hortons self serve and some full serve location pair up with 80 tops locations in Central and Western New York, with the few locations in northern Pennsylvania all by the end of this year.

Our brand requires convenience of locations and awareness in order to build trial and repetition and we believe seating our brand in a less capital intensive manner is a key tool to help us achieve that goal. And, I’m very pleased with all out effort of our US operations team to get these sites opened. Because self serve locations typically have lower volumes than standalone restaurants, they do not contribute as significantly to royalties and warehouse sales.

However, as I mentioned, they do play an important role strategically in seating our brand and creating customer loyalty and reputation. The last refinement in our US business approach I want to discuss is our evolving response to the current economic situation, and the intensive competitive discounting activity it has spawned. We have sharpened our message and our focus on reinforcing the value we represent with US consumers. We are building our reputation for price value in the US, and enhancing that message with US consumers in tangible ways they can experience.

For example we’ve introduced the new combo program called Fresh Choice sides, which includes combos of apples, hashbrowns, muffins, and donuts, all as part of a hot breakfast sandwich offering. We’ve also introducing new product bundles with various value price points. Our intent is to strengthen and build our price value position, and we are working with franchisees to communicate and interact with customers in ways that respond to their current situation in the economic environment around them.

I believe these important adjustments in our approach will help us respond directly to our customers challenging circumstances, position our US business for improved profitability, and accelerate our brand development in the market. I’m going to turn now to store development. Slide 9 in the presentation. As you can see we’ve ramped up our expansion activities from the second quarter with a total of 49 restaurants opened.

In Canada, we opened 30 restaurants bringing the total of 75 restaurants opened on a year to date basis. In the US, we opened 19 restaurants for a total of 30 unit’s year to date. We’ve started to open our planned units in Syracuse, New York, with more on the way, and we are aggressively entering the market with 6 new restaurants this year.

We are also on track to bring most of the Tops Friendly Markets locations on line in time for the US, Thanksgiving. As we’ve mentioned on several occasions, our real estate development activities, like most other restaurant companies, are typically back-end loaded and this will be the cases in 2008 as well. We have kept you apprised of our international platform outside of Canada and the US and you know, in that front we now have 261 license sites in Ireland and the United Kingdom.

The last topic I would like to touch on are few growth catalysts that we are working on which have been rolling out in the fourth quarter. The first update is on specialty coffee. We mentioned last quarter, we were rolling out specialty coffee in a Canadian province and I can now tell you that we have rolled out the specialty coffee program in the province of British Columbia adding to existing locations in all of Manitoba and other areas where we have been testing.

British Columbia has a high penetration of specialty coffee players and we believe it’s predisposed to this type offering even when the economy is somewhat slower. So, we can see this as a defensive program as well as opportunistic. We expect to have most installations completed by the end of November.

The second initiative I would like to talk about is the launch of an e-commerce platform in the Canadian business, which is rolling out as we speak. Canadians have a strong emotional bond with Tim Hortons in getting access to merchandise on-line is a real win for customers. Customers will now have online access to a range of items such as gift baskets, coffee brewers and travel mugs as well as our full can beverage line up of coffee, teas, cappuccinos and hot chocolate. We view the e-commerce initiative as another platform to reinforce our convenience with our customers and strengthen their connection to our brand.

To sum up, the quarter all-in-all it was fairly good quarter with clear challenges in front of us which we continue to focus on and address. Our very strong positioning with consumers in Canada which represents most of our revenues and all of our profitability continues to be unmatched with especially strong relevant when times are challenging.

So, with that I’ll turn it over to Cynthia.

Cynthia Devine - Chief Financial Officer and Executive Vice President

Thanks, Don and good morning, everyone. As Don indicated, we delivered strong earnings results in a challenging economic environment this quarter. I’ll provide color on some of the key drivers of our third quarter financial performance and given the state of the macro environment, I will touch on a few other areas that will likely be interest to you including commodities, liquidity and our financial position.

On Slide 14, details about revenues for the quarter are outlined. Our total asset revenues were up about 3.8% to 509 million, sales which are comprised primarily of warehouse sales and revenues from company operated restaurants were up 2%. Several items affected the year-over-year comparability of revenues this quarter which I’ll walk through in a moment. Remember the total revenues can be highly variable in our business quarter-to-quarter, due to a number of factors primarily related to the sales line.

We made significant progress in converting company operated restaurants to the owner-operator model which reduced company’s store revenues by almost 4 million or 30.4%. We had 43 company operated stores at quarter end compared to 70 at this time last year. This is one of the key items that affected our year-over-year revenue growth. We see this trend as a real positive even with higher relief support as these stores tend to perform better under owner-operator model, where an operator has a vested stake in the outcome of the store.

Having a fewer corporate stores is offset in part by higher number of stores consolidated under FIN 46R mostly due to the owner-operator unit. We believe that generally in the long-term, the owner-operator model and the continued progression to franchising provides better overall profitability to this company.

Growth and underlying product demand through our warehouse operations from system-wide sales growth was partially offset by specific sale items in 2007 that did not recur such as our uniform program rollout further affecting our sales growth.

Our rent and loyalties in the second quarter grew about 8%, to about 155 million have directly inline with our system-wide sales growth. Franchises were flat in the quarter at 20 million a higher number of openings and increased franchise renewals were mostly offset by lower retails and replacements along with lower equipment revenues recognized from our franchise incentive program. Now on the cost side of the P&L, cost containment contributed to earnings growth this quarter as well, although there were a number of moving parts that I’ll walk you through.

Turning now to Slide 15, I will start with franchise fee costs. These costs decreased about 3% driven mostly to few resales and replacements, with lower cost per unit, and due to lower equipment cost recognized in 2008 from our US franchise incentive program. These factors were partially offset by higher costs from increase number of restaurant openings. Cost of sales were also up modestly about 2% compared to last year, warehouse cost of sales were up just over 2% accounting for the majority of the higher costs due to system-wide sales growth excluding the impact of pricing. Lower cost of sales from having fewer -- company operated restaurants were partially offset by higher costs from additional restaurants consolidated under FIN 46R.

Our distribution business represents about 65% of our total net costs and expenses in the quarter up less than 1% of total cost from the third quarter of 2007. Remember that our distribution business will continue to be impacted positively and negatively due to changes in underlying commodities which flow through the business, which can impact warehouse margins.

Operating expenses in the third quarter were up close to 4% compare to the same period last year. The increase was due mostly to increase number of openings in the quarter and higher variable rent on existing properties based on sales growth. Our rate of operating expense growth was lower this quarter, due to the timing of certain expenses in 2007 that didn’t reoccur this quarter.

G&A expenses were down the quarter by about 2.5%, G&A decline reflect the number of variable factors. The most significant factor in favor of the lower cost was the spending on our franchisees convention in 2007 that didn’t take place this quarter. Higher salary class to support the business in higher stock-based compensation were the largest offsetting factors. We experienced the modest increase in contributions from both of our largest joint ventures this quarter, but the rate of growth in equity income declined this quarter by more than 4% as these increases were not enough to offset a gain from an asset disposition in 2007 that didn’t reoccur in 2008.

Moving to earnings, please turn to Page 16 of the presentation. We are pleased with our operating income growth this quarter close to 13% once again a several factors contributed to our higher operating income this quarter, the most important of which with system-wide sales growth that drove both our royalties and our rental income. Several other factors benefited operating income this quarter as well. For example, there are number of cost items that were positively affected our year-over-year earnings growth rate as did a lower effective tax rate, which I’ll provide a perspective on it few moments.

We also benefited from higher income from our distribution business as well as some other income and lower G&A costs as I previously mentioned. Overall, highest system-wide sales were supported by certain costs from 2007 that didn’t reoccur this quarter.

As we send our release this morning, our operating income performance to the end of the third quarter was generally consistent with our 2008 expectations of 10% annualized growth excluding the impact of the $3.1 million restructuring charge we’ve recorded in the second quarter.

Well rationalized restaurants will contribute to future profitability the 2008 operating income target did not contemplate a charge for closed restaurant that will likely occur in the fourth quarter. Until our assessment is complete, we cannot quantify the impact of this. As context though, I would note that the closures would affect less than half of our 30 company operated restaurants in the United States.

During the third quarter, our net interest expense was up 24% to 5.3 million this significant change was primarily due to lower interest income as a result of reduction in rates and lower cash on hand.

Net income in the quarter grew by about 17% benefiting from a lower effective tax rate of 32.5% compared to 35.2% in the same period last year. The lower tax rate is primarily the result of lower Canadian statutory rate and certain expense items in 2007 that did not affect the tax rate this quarter.

Finally, EPS is up 20% to $0.43 per share compared to $0.36 per share in the third quarter of 2007. In addition to strong our operating income, our EPS performance is reflective of a lower tax rate and the impact of our share repurchase activities which decreased our average shares outstanding by 2.8%.

Don described our top line segment results in some detail, so I’ll give an update on the segment operating income and then focus on the broader macro environment and related questions that may be on your mind.

Earnings performance in the Canadian segment was close to 133 million increasing about 12% year-over-year. Earnings performance of the Canadian segment benefited from higher system-wide sales which drove rents and royalties higher franchise fee income as well. The segment also benefited from increase distribution income primarily the result of changes in product mix and the timing of certain revenues. The US segment had an operating loss of 2.1 million in the quarter with more restaurants in the system in developing market and more company operated restaurants converting to the owner-operator model, we had more restaurants remaining on relief on the system in the quarter on a year-over-year basis.

Don addressed the proactive and targeted activities that the team is taking in the US so I won’t expand upon that here.

I’ll turn now to the broader environment by starting with commodities. We’re heavily franchised and as a result the biggest commodity impact we experienced corporately is on margin percentages, since most commodity fees typically float through our distribution system to the restaurant level, and we generally operate on a fixed penny profit basis for most products that flow through your distribution business. We do however see some impact from commodities flowing through our joint venture stake rate.

However, commodities swings can really clearly have a significant impact on our franchisees, and we work actively with them to mitigate the impact of these swings. One of the most important factors we manage with commodities is a significant portion of our commodity purchases are dominated in US dollars. The strength of Canadian dollar relative to the US dollar can be an important factor relative to commodities, and there’s been significant volatility in the third quarter and beyond in both currency and commodities.

Earlier this year, we benefited from a high Canadian dollar, which helped to offset the impact of some higher commodity prices we saw in the back half of 2008. However, the Canadian dollar has recently contracted sharply, and subsequently began to rise again, just as certain commodities came off of recent highs.

Getting longer term visibility around commodities, which has been exceptionally volatile, most recently coming off historic high takes a bit of a crystal ball these days. This is what we know for certain, we’re bought out in coffee and most of our key commodities for the first half of 2009. With the combination of currency fluctuation and commodity swings, we locked in first half pricing for coffee that was somewhat higher than the comparable first half of 2008, but better than the back half of this year. We believe there may be opportunities in the current volatile commodity and currency environment, that we’ll be actively engaged in the market to take advantage of these opportunities as they present themselves for the back half of 2009.

Let me turn to an even more topical issue that is liquidity, which has been in the news everyday as of late. I believe one of the defining traits of Tim Hortons within the QSR Sector is the underlying financial strength of the company and our balance sheet. Our proven ability to generate strong cash flows and fund our business growth through operations and maintain very healthy debt ratios positions us extremely well within our peer set.

Turning now to Slide 17, you can see that our balance sheet remains very strong with only 389 million in term debt and capital leases, our debt ratios by almost any measure provided for the exceptional financial flexibility. We ended the quarter with about 68 million of cash and cash equivalence on hand heading into the fourth quarter which is typically our largest quarter from a positive cash flow perspective. Our ability to generate strong positive cash flows help to fund our share repurchase program and we spend close to 50 million in the third quarter to purchase 1.6 million shares.

Given the ongoing strength of our business model, our strong balance sheet and our proven ability to generate significant positive cash flow the Board has approved and new $200 million share repurchase program subject to regulatory approval that is planned to commence in the first quarter of 2009 subject to management’s discussion the market and cost consideration.

Going forward commencement of the share repurchase program in the beginning of the year will allow us to align timing with our annual capital allocation and budget process including dividends and capital expenditure decision making.

Capital expenditures in the quarter totaled about 46 million, and 112 million year-to-date as we continued to execute our store development and renovation program. As an aside, depreciation and amortization for the quarter was 22.7 million. We are unlikely to get the targeted 200 million to 250 million CapEx range for 2008 given two important factors. First, the mix of leased versus owned properties, and second, the heavier weighting of non-standard restaurants, which are much less capital intense.

I talked a minute ago about our strong cash flow history, which has funded our operations our growth in new restaurants our capital expenditures, and our dividends and share repurchase programs, as well as acquisitions and investments in future growth.

When it comes to liquidity, we also have Canadian US revolving credit facilities, which are primarily un-drawn, which provide access to $200 Canadian and $100 US if needed. Our senior bank facility, which consists of a $300 million term-loan, in addition to the two revolvers, does not mature until February of 2011. These facilities are supported by 13 financial institutions, of which Canadian institutions hold close to 60% of the commitment. We carefully monitor our bank group, and believe our liquidity is substantially unchanged and our access to capital is strong, despite the current despite the current market condition.

As it relates to franchise funding, the restaurant sector does appear to have been somewhat impacted by credit tightening, particularly with the US banks. However, we have franchise learning programs to established and in place to help our franchisees fund their businesses both in Canada and the US. We also support our US franchisees using our franchise incentive program.

Despite the current economic and credit conditions, our franchisees continue to have access to learning programs, with third party lender, although processing may take a little longer an the cost may be a little higher consistent with prevailing market conditions. Overall, we have full confident that we will continue to generate more than adequate operating cash flows to fund both ongoing capital expenditure, our expected debt serving requirements and programs to return value to shareholders.

Additional fund are needed for strategic initiatives and other corporate purposes and also believe that the strength of our balance sheet provides significant financial flexibility and that we are borrow additional funds if needed. To wrap up, we continue to have confidence in our business platform in the strategies for the business, and we feel that we are well positioned from a financial strength perspective.

So with that I’ll turn it over to Scott.

Scott Bonikowsky - Vice President of Investor Relations

Thanks Cynthia. We’ll now begin our Q&A session Frank, so we would request, though before that everyone stay to a limit of one question, with one follow-up so that anybody on the call who wishes to ask a question gets that opportunity. I know that’s always a challenge each quarter. It seems that we would ask you to stick to one question to begin if you would. After you’re questioning your welcome absolutely to get back into the queue for any other questions on your mind. And with that, Frank, I’ll turn it over to you to start the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Irene Nattel from RBC. Please proceed.

Irene Nattel

Thanks and good morning, everyone. I was wondering if we can get a little more color around same store sales performance. Don, you eluded to the fact that what we’re seeing is a bit of a drop in frequency, so we’re seeing slightly lower traffic. I took from naturally to that average ticket is okay, but if you could talk about what’s happening to average ticket whether you’re seeing the weakness in particular categories or particular day parts?

Donald B. Schroeder

Yeah, we’re seeing the average ticket increase, but again, the traffic is down slightly. I think there is considerable pressure on the customer as we indicated, with respect to the high price of gasoline and so on shrinking their available dollars. But the net at the end of the day, with the pricing impacts, our average ticket has gone up, but it has impact, we have been impacted by the level of traffic during the quarter.

Irene Nattel

Was that traffic more at lunch than in the morning? Like, was it was it particular to any day part or just across the Board?

Donald B. Schroeder

No, we continue to see the breakfast day part grow. Where we see the impact, and that gets back to the number of discretionary dollars available to our customers, we we’re seeing it being impacted in the morning at snack part, the afternoon snack time, and the evening snack time. So again, as I said, historically we’ve seen our customers come, on average, four plus times a week. But with the limited number of dollars in their pockets, they are still coming at breakfast and getting their regular morning fix, but not visiting as often throughout the day.

Irene Nattel

And on, as a follow-up to that, as we look ahead to 2009, with commodity prices coming down, in the past Tim’s has not used price, as a tool to drive sales and more to recover commodity pricing, so what does that imply for same store sales as we look into 2009?

Donald B. Schroeder

Well what our plan is, we’re just going to continue to try and reinforce with our customers the price value proposition for which we stand. So, we will have limited time offerings just again reminding customers of the type of value that we represent every day. Discounting will not be part of the way we do business in Canada at all, but just constantly reminding the customer of the price value that we’ve represent every day.

Irene Nattel

Thanks very much.

Operator

Our next question comes from the line of Steven Kron from Goldman Sachs. Please proceed.

Steven Kron

Great, thanks very much. I guess just a follow-up to Irene’s to begin on. You talked on, just about the price of gas being a factor on the traffic front. As you’ve seen that come down in the month of October, have you seen the traffic stabilize a little bit or come back a little bit? And then I have another question?

Donald B. Schroeder

It’s still early to tell. But you know, historically, again, if the price of gasoline comes down, hopefully that will relief some of the pressure on our consumers and they’ll have more discretionary dollars to spend.

Steven Kron

Okay. And my question is, on the development in the US and it seems to be shifting quite rapidly toward more of these non-standard self serve stores versus the traditional stores. Can you just review for us, maybe Cynthia, what is the sales per store in these self serve units that you will get on an annual basis versus a traditional store, and do you collect the same kind of royalty rate as you would, are the economics, from a revenue and expense standpoint, a return standpoint, can you just kind of review that for us?

Cynthia J. Devine

Sure. Steven, the shift, we have moved to a number of things with respect store size and the capital intensity of the stores. Self service is one of the elements, a self serve kiosk, but in addition to that, we’re looking for full serve, non-standard stores, as well as bringing down the overall box size of our traditional sites. So, it’s a combination of all the things. You recently saw the Tops announcement, which definitely had a self service component to it that was a shift, I guess, from full serve non-standard units to the self serve. But, with respect to your sale questions, without getting into specifics around it, the self serve model definitely has much lower revenues anticipated from it, but a much, much lower capital investment. With respect to the how it works, we generally get a royalty contribution from it, and that’s how the model works. In terms other financials on it, probably not going to into a lot more detail on that.

Steven Kron

But, I guess, is the royalty rate the same as it will be to for traditional store, is the first part. And then, for modeling purposes, because you have development going through and we apply some sort of unit volume associated with those new units that are getting put in on-line. Historically, that was the right way to do it is look at your system, look at what same store, or when the unit volumes typically are, maybe account for some sort of ramp up process but the shift seems to be a little bit greater here. So, just trying to get a little bit of visibility as to the order of magnitude, as to how much lower this unit volume will be? So, if you could just comment on that, that would be helpful under and the development that we should expect beyond this year, like into 2009 as well?

Cynthia J. Devine

Well Kron, I can’t comment on 2009 at this time. What we’ll do is that a more full-some discussion of 2009 when we’re ready to kickoff our goals and objectives for the year probably in and around the February timeframe. But, yes, with respect to the self serve model, it is definitely lower revenue, and so I understand what you’re asking from a modeling perspective. I think it would be definitely lower than a full serve non-traditional site, but probably in term of specifics, it really varies. I mean, if you have a self serve kiosk that’s in the University of Buffalo, that does a lot better one that’s in a Shell Station in Rhode Island so there’s a lot of variability in it, but it’s definitely a much lower revenue contribution than our previous non-standard units.

Steven Kron

Okay. I’ll reach you. Thank you.

Operator

Our next question comes from line of Jim Durran from National Bank Financial. Please proceed.

Jim Durran

Thanks good morning I just wanted to ask you about cost containment initiatives with the G&A down 2.5%. I know there was the franchise cost. I don’t know if you are prepared to give us an indication into how much that Franchisee Convention represent in dollars, but are there other items that would cause G&A growth on a normalized basis to not be up as much as it has been over the last several quarters?

Cynthia J. Devine

We are working on a big focus on cost containment through some of the initiatives that we have in the organization, whether it’s through lien initiative or other things we have going on, but no we are the reason it is down versus prior year is absolutely in a big way related to the convention expenses that we incurred in 2007. Now, and I think Jim we stay to our commitment in terms of making sure that sure that our G&A, that we’re monitoring it very closely and over the long term, we don’t expect to you latter see our system growth and we’ve been fairly consistent with in message and that’s what we’ll continue to do but in challenging time we think every one is looking all ways to do things more efficiently and effective and our organization is definitely on that track.

Jim Durran

So, along the same vein then just looking at the gross margin improvement in the quarter, is that solely because the Guelph D.C. ramp-up is down now or is there other elements that have managed to enhance the margin performance?

Cynthia J. Devine

No, I think if you look at the combination of thing. The Guelph is not a big contributor in the quarter, what I would say if you look at our operating expenses they were up 3.8%, so that was, and you look at rents and royalties and they were up 8.2%. So, there was some leverage there and a big part of that that we outlined is related to some expenses that were incurred -- timing of expenses that were incurred in the prior year that were lapping, so that’s part of it as well. And then the G&A, the leverage that we got out of G&A, being down 2.5% in the quarter, definitely helped improve our margins.

Jim Durran

Thanks Cynthia.

Cynthia J. Devine

Welcome.

Operator

Our next question comes from the line of Turan Quettawala from Scotia Capital. Please proceed.

Turan Quettawala

Yes, good morning. Just really quickly on the US store rationalization, just wondering, are you exiting any markets or you just closing some stores in various markets?

Donald B. Schroeder

No, we are clearly not exiting any markets; we’re just reviewing all of the corporate store profitability there, and we will close some stores, but we are clearly not exiting any markets.

Cynthia J. Devine

As we said we expect that it will impact less than half of our US corporate store base, which at this time is about 30 stores.

Turan Quettawala

Okay, yeah. And I guess just another question with the new deal with Tops, should we consider this to be sort of a more of a maintain strategy in terms of new store development in the US? I guess really the other day it’s just like, of is there probability that there’s going to be more deal like this coming down the pipe here?

Donald B. Schroeder

Yeah. David Clanachan, when he assumed his new role as Chief Operations Officer in the US, I challenged him to look at every aspect of the business in the US and how we’re doing things from operations, store openings, and so on. Tops is a new example of what we are looking at doing. I would expect there will be similar opportunities hopefully that will come along like that. We are testing some other things with co-branding and so on, and so we are looking at a variety of things to move the business ahead.

Turan Quettawala

Great. Thank you very much.

Operator

Our next question comes from the line of Rachael Rothman from Merrill Lynch. Please proceed.

Rachael Rothman

I just wanted to ask, I’m presuming I guess from your disclosure about southern New England preponderance of the stores are basically the old Bess Eaton stores. Do I recall correctly that? They were on owned real estate, or are these basically, is this a re-franchising, or is it closure, are they on owned sites or on leased site?

Donald B. Schroeder

First of all, we haven’t determined what stores will be closed, but the Bess Eaton stores the good portion of those stores when we made that acquisition, the land was owned by Bess Eaton.

Rachael Rothman

Okay. So in the instance where you owned the real estate, essentially you would be talking about a re-franchising of the stores should we thick of it shifting into the franchise?

Donald B. Schroeder

If we close the store, and we own the real estate, in all likelihood, we will either sell the real estate or lease it out to someone else depending on the environment and the piece of the property that’s identified.

Cynthia J. Devine

Yeah Rachael, we have two initiatives going on. One is we continue to have the corporate store base that exists, so we have 30, corporate stores in the US, and there area number of those that we area moving out into owner-operator model, which has been a very effective initiative that’s been underway for this year. But, in addition to that we have some corporate stores and less than half those ones that we’ve identified, that we’ve said that the under-performance of those stores that we need to evaluate it, and we will likely be closing those corporate stores. Its two different initiatives underway.

Rachael Rothman

Okay. Do you have an ultimate target base for ownership in the US, post the closures and post the re-franchising?

Donald B. Schroeder

Well long-term we would love to have the same level of franchise operations in the US as we do in Canada. We know that’s the model that works best for us, and that’s our goal long-term.

Cynthia J. Devine

In fact, we’re extremely close to that today. There’s really only 30 corporate stores in our US portfolio.

Rachael Rothman

Okay. Great. I’ll get back in the queue. Thank you.

Operator

Our next question comes from the line of Winston Lee from Credit Suisse. Please proceed.

Winston Lee

Thanks. I think that I heard you say that the corporate stores had a disproportionate amount of loss or US loss and but I also read in your release that there is higher franchise relieved that account from mostly year-over-year, change in the operating loss. Is it more the corporate stores as an issue or the franchise incentives?

Cynthia J. Devine

Sir, I don’t think we commented on our corporate store losses being higher. I am not sure but we did say that we convert corporate stores to owner operator models in order to help that operator be successful, we need to provide them with relief. So what we have said is that our corporate store losses actually went down in the quarter but on the other hand, relief associated with our rent and royalty and other cost components actually went up and so to some extent those two things offset each other.

Winston Lee

No, I think you had said that there were a disproportionate none of loss, relates to the stores that you are both rationalized and so what I am trying to figure out is, the U.S. loss that we are seeing in this quarter, is it more due to these kind of underperforming stores that you are looking at now or is it more due to higher franchise relief?

Cynthia J. Devine

Okay, now I understand. Sorry about that. With respect to – it is a portion of both but absolutely there is corporate store losses that still exist. We declined our corporate store loss, quarter-over-quarter but the corporate stores that exist in the base, the underperforming ones, absolutely contributed to loss this quarter.

Winston Lee

So how do you deal with the higher franchise relief this year then?

Donald B. Schroeder

Well as of, when you are moving the store from corporate store to the operator agreement, there is no question the relief to the operator goes up but the benefits that we derive from the reduced corporate store losses is outweighed by that, that you are further ahead because again the operator model works better, the losses in that store is going to be lower with the operator than they would if they remained as a corporate store.

Winston Lee

Okay thanks.

Donald B. Schroeder

It is confusing but…

Winston Lee

Yes, I am, just want to still just want to get my head wrapped around it but thanks a lot.

Operator

Our next question comes from Irene Nattel from RBC. Please proceed.

Irene Nattel

Okay, let’s keep feeding this horse. I think that what we are all really trying to get at is, if we were to adjust or what is the aggregate current annualized loss trade at the stores that you are planning on closing?

Cynthia J. Devine

That is what -- until we complete that evidence, thank you for clarifying but no that the announces that we are going through. We need to identify the stores that are being closed specifically and then we need to go through above, but what we can tell you Irene is that with the closure of these stores, once we get through any onetime cost associated with those closures, we absolutely expect improved profitability in the business as a result.

Irene Nattel

Thank you, Cynthia. And then just a different follow up question please. The specialty coffee that you are currently rolling out, what is the price point?

Cynthia J. Devine

Price?

Irene Nattel

The price point, yes.

Donald B. Schroeder

I think for a large, it is $2.29 for a cappuccino or a la day.

Irene Nattel

That’s great, thank you.

Operator

Our next question comes from the line of David Hartley from BMO Capital Markets. Please proceed.

David Hartley

Yes, good morning everyone and thanks for taking the call. Just want to ask you a bit about an opportunity here, given the impending economic conditions potentially getting worse. Is there an opportunity for you in the lunch and dinner day parts now to come with a value offering? I don’t want to make it sound like a Mc Donald’s $1 value offering but something there, I site successful examples of trade down in the U.S. in particular with Mc Donald’s premium coffee program and others. Is there an opportunity here and are you ready to move on this, if so?

Donald B. Schroeder

Now there currently is an opportunity and we are indeed ready. We have been working our marketing department and our R&D group to get some good price value deals for our customers that will again respond to the limited number of dollars that they have in their pockets, so it is all about price value and quality.

David Hartley

And is this – and as I am actually kind of focused here on the Canadian market. Do you have that opportunity here in Canada or? Or sorry. Are you ready to move with that opportunity here in Canada now and if so how quickly will we see this?

Donald B. Schroeder

Going into the New Year, we will have a number of new products that address that issues coming forward.

Scott Bonikowsky

Probably won’t surprise you David to know that we won’t tell you what that looks like.

David Hartley

Maybe you can just give me, part C of one my question, would be the roast beef sandwich and other initiatives you’ve had at lunch, can you talk about the success, failure or in and out strategy around these products a little bit? Can you tell us how that’s going?

Donald B. Schroeder

Well, again as we indicated before, the roast beef sandwich, we got a tremendous amount of learning at a lunchtime from an operational standpoint, it was certainly a product that was appealing to the customer. There were operational issues around it that we’ve addressed and so on, but bringing products like that in and out, we’ll continue to do that, but as I said going forward, certainly into next year given the economic climate, the type of products that we will present to our customer will really be there to truly reinforce the price value proposition for which we stand.

David Hartley

Okay. And part D, and finally the last one, the lawsuit that you’re facing, I know you can’t have much comment on it, is it possible that one of the stores that I guess the plaintiff’s represent has been closed?

Donald B. Schroeder

Again, because of the nature of the lawsuit and so on, I think it would be an inappropriate for us to discuss that at all at this time.

David Hartley

All right. Thank you.

Cynthia J. Devine

Thanks.

Operator

Our next question comes from the line of Keith Howlett from Desjardins Securities. Please proceed.

Keith Howlett

I have one question, in 22 parts.

Cynthia J. Devine

Thank you.

Keith Howlett

Just on the franchisee availability in the United States, are you seeing sort of more available qualified franchisees that are interested in Tim Hortons? I know you’re brand isn’t as well recognized in many markets, but is there a positive element there?

Donald B. Schroeder

There is a positive element. We’ve seen that and if you look historically, times like this have really presented us with great opportunities to meet some excellent new operators and bring them within the system. Clearly there are a lot of people in the US that are being displaced at the present time, and will clearly want to look for an opportunity and maybe have the opportunity to take more control of their own life. So, I would not be surprised. In fact, I would be surprised if we don’t see an influx of that type of application going forward.

Keith Howlett

Thank you.

Cynthia J. Devine

Thanks.

Donald B. Schroeder

Thank you.

Operator

Our next question comes from Steven Kron from Goldman Sachs. Please proceed.

Steven Kron

Hi, thanks. A couple of follow-ups just on the franchisee finance side. I guess Cynthia, just going back to franchise relief, it makes sense that as you sell some of these corporate stores to franchisees the relief bucket will go up, but I guess on a like for like basis, are you offering more relief today, excluding those stores to franchisees, versus the same basket of franchisees that you were offering relief to last year?

Cynthia J. Devine

Well, we are offering more relief in total because we had a number of stores that doesn’t exist in the system last year at this time, so not only the conversion of the corporate stores to owner-operator models, but in addition to that, as you’ll recall in the fourth quarter of last year, we brought a lot of new sites on stream, so many of those stores are on relief as well.

Steven Kron

I guess, if I think on it on a per store basis, is it going up? You guys talked about franchisees having a little bit more difficulty maybe, like the credit environment in the US is seemingly a little bit more challenged, are you guys offering more up front to franchisees is the question?

Cynthia J. Devine

The relief just so we’re clear, I don’t think you’re asking us, but I want to make sure we’re clear, the relief and the financing are two totally different things, other than if you’re talking about the FIP program, the Franchise Incentive Program. The relief we provide our store owners doesn’t impact their ability to get financing or not. So but, is that clear.

Steven Kron

Yeah no that’s clear I guess I’m just thinking about it around the same terms of, on the one hand your offering relief for certain things, on the other hand franchisees also, new franchisees need access to capital to build stores and stuff. So, if you guys are providing that kind of backstop, is the relief part of the equation going up as well?

Cynthia J. Devine

Okay. Yeah, two different things but one of them, with respect to the ability of our franchisees to get financing, you know, when we offer the franchise incentive program, that’s been in place for a number of years and that will continue in place, where we help the franchisee in the first two years that they are not buying the store at that time. You know fully from a cash perspective. Then beyond that, as we said, we have financing, lending program in place for a franchisees that as we require financing, whether it’s through, renovations or things like or they’re moving off the Franchise Incentive Program into purchasing the full store, that we have a finance lending arrangement in place in the US. Now, with respect to the relief, yes, as we’re in a challenging economic environment here, it’s always been our history whether it’s in Canada or the US to help the store owners so that they can get through these challenging times.

Steven Kron

Okay. And then, just one last one if I might, the stores that you’ve re-franchised that you’ve sold off, I believe a few years ago, you kind of wrote down the New England market basically to zero. Are you booking gains on these sales at this point? And if you are, where is that flowing through in the P&L?

Cynthia J. Devine

Steven, a lot of the move to owner-operator models which is, I think you’re familiar with it, we refer to as 18/20 model, and yeah I know at the time of the IPO, we spent a lot of talking about 18/20. 18/20 operator models, most of those corporate stores, that’s the evolution, you like to move a corporate store to an owner-operator model, which is the 18/20 model for the most part, and then we move them to a franchise. So, during the past year, we’ve been mainly moving them to owner-operator models in the US market.

Steven Kron

God it, that’s helpful, thank you.

Operator

Our next question comes from Jim Durran from National Bank Financial. Please proceed.

Jim Durran

I might have missed this earlier, but did you tell us what the price increase contribution was in Canada and the US, with respect to the comp store sales number?

Cynthia J. Devine

It is 3.4% in Canada and 3.2% in US.

Jim Durran

And do you still expect it to be 3% as we go into Q4?

Cynthia J. Devine

Exactly, we said that’s it ground mad man that exit in the market price.

Jim Durran

Okay, thank you.

Operator

Our next question come from Winston Lee from Credit Suisse. Please proceed.

Winston Lee

Hi, thanks. Just want to ask on the restricted cash balance on the [ten card], what was it at the end of the quarter?

Cynthia J. Devine

19 million, 10 - - So it was up a little bit. 18 to 20 million somewhere around there.

Winston Lee

18 to 20 million, okay thank you.

Cynthia J. Devine

Yeah. Just one important point we broke it out because of some of the cash has gone into just a slightly longer term maturity, so it’s broken out on two line items on the balance sheet, so that may be causing a little bit of the confusion, sorry about that.

Operator

There are no further questions at this time.

Scott Bonikowsky

Okay. Well, thank you operator and thanks to everybody for joining us for the 2008 third quarter Tim Hortons’ earnings conference call. If you have any additional questions or topics that you wish to address, absolutely please feel free to give me a call. You can reach me at 905-339-6186, or alternatively by e-mail at investor_relations@timhortons.com. Have a great day.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everybody.

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