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Executives

Scott Bonikowsky – VP, IR

Don Schroeder – President & CEO

Cynthia Devine – CFO

Analysts

Irene Nattel – RBC Capital Markets

Perry Caicco – CIBC World Markets

Michael Van Aelst – TD Newcrest

Turan Quettawala – Scotia Capital

David Hartley – BMO Capital Markets

Robert Mickey [ph] – National Bank Financial

Steve Kron – Goldman Sachs

Candice Williams – Genuity Capital Markets

Winston Lee – Credit Suisse

Keith Howlett – Desjardins Securities

Tim Hortons Inc. (THI) Q4 2008 Earnings Call Transcript February 20, 2009 10:30 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Tim Hortons 2008 Fourth Quarter and Year End Earnings Conference Call. During the presentation, all participants will be in a listen only mode. Afterwards, we will conduct a question and answer session. (Operator instructions). As a reminder, this conference is being recorded Friday, February 20, 2009.

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

Scott Bonikowsky

Thanks, operator, and good morning, everybody.

We apologize for the delay. We’ve had a very large number of participants this morning and we wanted to accommodate as many people as we can. So, we appreciate your patience.

Welcome to our 2008 fourth quarter and year-end conference call. If you have not yet accessed the earnings material that we released earlier today, it is available on our Investor Relations website as always at timhortons-invest.com. A presentation supporting today’s discussion is also available on the website. You can access this and the other material associated with the call by clicking on the Events and Presentations tab and it is available for a period of a year.

Joining me on the call are Don Schroeder, our President and CEO; and Cynthia Devine, our Chief Financial Officer. After their remarks, we’d be pleased to take questions. Don is going to speak about the operating environment and our overall performance for the quarter and full year, and Cynthia will provide color on our financial performance and position, as well as speak to our targets that we’ve established for 2009.

Before we begin, please note that we are providing 2009 targets and potentially other forward-looking statements this morning within the meaning of the Private Securities Litigation Reform Act of 1995. And this includes discussions about future performance based on our current expectations and information. Various risks and uncertainties could cause the 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 in the Safe Harbor statement located in the earnings release that we issued this morning. You will also find additional risk factors described in our public securities filings, including our 2007 Annual Report and 10-K filed on our website under Regulatory Filings, and also in our 2008 Annual Report which I’d note for you that we plan to file on February 26.

All Tim Hortons results, I would remind you, are presented in accordance with US GAAP and reported in Canadian dollars, unless we otherwise note. Our discussion and the following presentation does include non-GAAP financial measures today. We will remind you that a reconciliation of the non-GAAP measure and it’s most directly comparable GAAP financial measure and other information required by Regulation G is also included in our presentation on our website.

And it’s now my pleasure to turn the call over to Don Schroeder, President and CEO of Tim Hortons. Don?

Don Schroeder

Thanks, Scott, and good morning, everyone.

In 2008, Tim Hortons grew our operating income close to 10% after taking into account the impact of an important decision we took to close a number of underperforming corporate restaurants in Southern New England and the related asset impairment charge, as well as management restructuring charge we announced in the second quarter. We also grew our same store sales for the full-year in both Canada and in the US in one of the toughest operating environments in memory. We believe this underlying performance is a testament of the strength of our brand, loyalty of our customers, and the soundness of our business model.

In the fourth quarter, system wide sales grew 8.2% on a constant currency basis and 9.5% on a currency unadjusted basis. In our core Canadian market where the company derives more than 90% of its revenue, the macro economic situation deteriorated significantly in the fourth quarter. In this environment, the company grew fourth quarter same store sales by 4.4%, the same rate of growth achieved for the full-year. Previous pricing in the system played a role in this growth, contributing approximately 3%. In addition, our 40% plus share of QSR traffic, the strength of our marketing and promotional programs, unparalleled customer loyalty and our outstanding storeowners helped us achieve these sales despite the challenging sales environment.

In the US, the economic situation showed continued signs of stress. Our brand is much less developed in most of our US markets and the company or the economy was under greater pressure. Our slight same store sales decline of 0.1% in the fourth quarter reflects that operating environment. We lost some store level transactions as pricing contributed about 3% to our same store sales in the US as it did in Canada. In the US, as I mentioned, our brand is not as developed and we don't enjoy the scale and competitive advantages at this stage in our development in many of our US markets. Given that it is a developing market for us, I was pleased with the team’s continuing focus on building momentum. It is not business as usual in our US operations and the team is adapting and innovating with the objective of profitably growing our brand. I would spend more time on our segments in a few minutes.

As I said at the outset, consolidated earnings this quarter were impacted by the store closures and the related asset impairment charge. We announced the closures previously and I indicated my view then that this was a very important step in working toward achieve profitability in our US business. I would like to spend a moment on these closures which represents a very small portion of our US business, but which had a disproportionate drag on profitability in the US segment. We ended up closing a total of 11 restaurants and this decision also triggered an asset impairment review within the affected markets as we indicated would take place in our prior disclosure. At a high level, the closure costs and asset impairment charge had an eight-cent impact on our EPS and a 21.3 million impact on our operating income in the fourth quarter.

Absent these changes we are pleased with the performance of our underlying business. In fact, consolidated adjusted operating income was up 11.1% in the fourth quarter after adjusting for the closure and impairment costs. These costs were also recorded in our US segment operating income and accounted for all of the loss in our US segment this quarter. Adjusted operating income is a non-GAAP financial measure, so please refer to the slide presentation for a reconciliation to the closest GAAP measure and other required disclosures. And Cynthia will discuss the impact in more detail in a few moments.

Continued healthy system wide sales growth was the largest driver of our operating income, which contributed to higher warehouse sales, rents and royalties. In addition to contributions from unit growth, system wide sales benefited from a robust marketing and promotional program, new product combinations, bundles at attractive price points and a successful holiday merchandise offering. We also saw an a acceleration of Tim Card usage in the fourth quarter. You will note on our balance sheet that restricted cash and cash equivalents essentially the Tim Card float increased from about 38 million at year-end 2007 to about 62 million by year-end this year.

Now I'm going to turn now to restaurant development on slide eight of the presentation. We set ambitious targets with 210 to 250 projects for the full-year. We ended up delivering 266 projects, 161 of which were opened in the fourth quarter. Our development team opened 55 restaurants in Canada during the fourth quarter and a total of 130 for the full-year, meeting our target of 120 to 140 restaurants. Our team opened 106 sites in the US in the fourth quarter and 136 for the full-year, exceeding our target of 90 to 110 locations. And our full-year openings reflect the Tops agreement, and of the total number of openings, 87 were nonstandard units, including 73 self serve locations.

Internationally, we ended up the year with 293 licensed locations in the convenience channel in Ireland and the United Kingdom. And Cynthia will outline our 2009 targets, but I want to comment on our overall restaurant development strategy this year. In Canada, we continue to see real estate growth opportunities, particularly in our focused growth markets of Quebec, Western Canada, and downtown urban locations. Our scale and financial strength allows us to fully pursue real estate development opportunities in our growth markets. In the US, we are taking a prudent approach to our development activities in light of the unprecedented challenges specific to that market. We are focused on profitable growth. In fact, our target is to achieve breakeven operating income in our US segment on a full year basis in 2009, assuming of course some gradual recovery in the US economy later in the year.

Our financial capacity and strength allows us to be opportunistic however, and we plan to focus our full serve restaurant openings in our core US markets such as Western New York, Michigan, and Ohio, opening 30 to 40 full serve restaurants. We're driving efficiencies and the sign of our restaurant design, taking capital and operating cost out by reducing our average restaurant footprint, while extending our brand presence further. Our full serve restaurant development approach in 2009 in the US will be complemented by the growth strategy we first developed in Canada in the 1990s. That is seeding our brand presence and the distribution points in a less capital intensive manner through nonstandard restaurants and strategic alliances.

More recently we announced a co branding test with Cold Stone Creamery, which will help seed the brand even further. Based on positive customer reaction in our two original test restaurants, the Cold Stone initiative provides us an interesting opportunity, which we are working to determine if we can replicate on a broader scale. Put simply, we are offering customers two great brands, which stand for quality and freshness in complementary day parts. We drive much of our business in the morning, lunch and snack day parts, whereas Cold Stone does most of their business between 4 and 10 p.m. And we are creating additional points of distribution, trial and awareness by working with a premier brand in the US. To be clear, this is a test, a test that fits into our overall approach of complementing our core full serve restaurant development program, which remains the engine of our long-term growth in the US, so we will monitor results with interest. Internationally, we continue to add locations to our existing license sites in Ireland and the United Kingdom as we work on continuing to develop our international growth strategy outside those markets.

Now there are a few other topics I would like to speak to before turning it over to Cynthia. Let me start with commodities. We indicated last quarter that we were bought out through at least the first half of the year in various commodities. It is hard to predict where commodity pricing will go, but there has been some relief to commodity costs pressure of late. Commodity prices are better than they have been in the past several months, particularly before the fall of 2008, but not relevant to historical trading ranges. We also had the fall of the Canadian dollar to manage since it has been steeper than the fall of commodity prices, more than offsetting any potential gains. For example, with coffee, we are now bought out through most of August, while underlying green coffee cost has come off their recent highs, we continue to face the weakened Canadian dollar causing some cost pressure. And while we are primarily a franchise system and the P&L impact on our business due to commodity fluctuation is typically not as significant, they can and do have a very real impact on our storeowners. So we actively work with them to manage the impact of commodity input costs.

The second topic I want to address before I wrap up is our views on the current operating environment and outlook for the year. Now we aren’t economic forecasters and can't say with any certainty when economic recovery will begin to take hold. We like you certainly hear some emerging consensus that gradual recovery might begin to emerge late this year or early 2010. And massive government stimulus programs should help toward that end. However, visibility to the full-year is certainly more challenged than in typical operating environments. While our business model has served us exceptionally well in good times and bad, it is not business as usual. We have adapted with consumer programs aimed at being responsive to our customers who have fewer discretionary dollars. We have looked to take capital cost out of our store development, and we continue to look for efficiencies and to help our storeowners do the same.

We are focused on delivering products that people value at reasonable prices, executing each day for our customers by delivering an always fresh experience, introducing continued menu news that creates excitement, and focusing on operational excellence. We have seen many challenging cycles over our long history and has historically tended to perform relatively well in good times and bad. Our average check of 2.75 to 3.50 Canadian, strong menu offering, and great customer loyalty positions us well. While our rate of growth may not be as highly as in boom times, we have tended to grow in recessionary times. These are unprecedented times, but we continue to be positive and optimistic about our inability to grow our business just as we have in the past when times were challenging.

I would also like to address our announcement that we have commenced assessment of various initiatives in the fourth quarter related to our corporate structure, including potentially re-organizing as a Canadian public company. Tim Hortons has its roots and heritage in Canada, and this is an exciting development that we believe can significantly benefit shareholders through long-term growth. Let me emphasize, there is no certainty that any transaction will be reached. There is also significant complicity associated with this transaction, which Cynthia will address in her comments.

And finally, I would like touch on our Board’s approval of an 11.1% increase to our quarterly dividend rate and the commencement of our new discretionary 200 million dollar share repurchase program which we announced late last fall. The new quarterly dividend rate is ten cents per share and is effective with our dividend payable on March 17. Our policy is to pay 20% to 25% of prior year, normalized annual net earnings and returns value to shareholders based on growth of our company. The dividend increase and commencement of the share repurchase program clearly demonstrates the strong cash generation and financial strength of our company.

And with that, I will turn it over to you, Cynthia.

Cynthia Devine

Thanks, Don, and thanks everyone for joining us this morning.

There are a fair number of significant developments this quarter, so let me get right at it. Last quarter we told you we were closing up to 15 restaurants and that charges would be taken in the fourth quarter. As Don said, we closed 11 restaurants, and took a total of 21.3 million in store closure and related asset impairment charges. Our underlying business absent those charges performed very well during the quarter proving the resilience of our brand and business model.

If you look at slide 12, we outline revenue details for the quarter. Fourth-quarter revenues grew 9.4% to 564 million. Sales were up 11%, the largest component of which were warehouse sales. System sales were healthy, up 8.2%, on a constant currency basis. For the first time in a while, currency played a larger role this quarter on a number of lines. Systemwide sales was no exception as they were up 9.5% without adjusting for the impact of currency. New products managed to our supply chain also contributed to our rate of sales growth. We had fewer company operated restaurants in the fourth quarter, which partially offset those other factors. We saw 10% increase in rents and royalties, fairly consistent with system wide sales growth. Testes were down in the quarter decreasing 8.5% compared to the fourth quarter of 2007, mostly due to the timing of revenue recognition with our franchise incentive program, and fewer standard restaurants opened in the quarter compared to last year.

Let us turn to the cost picture for the quarter and slide 13. Cost of sales were up close to 10%, driven mostly by system growth. Operating expenses were a little higher coming in at closure to 12% growth. A couple of items caused this higher rate of growth. These included an increase in the number of units in the system, percentage ran increases on variable rank ranked contracts, and the impact of foreign exchange on US currency translations. Franchise fee cost were down by about 11%, fairly consistent with the drop in franchise fee revenues. ‘’

G&A expenses were up fairly significantly in the fourth quarter, with an increase of just over 16%. The climb in G&A cost this quarter is in part reflective of the feasibility review relating to a corporate structure. This initiative resulted in higher than normal professional fees in the quarter. We will continue to invest in this work in the first half of 2009, particularly if we proceed with the transaction. Another factor causing higher G&A cost this quarter was the timing of the storeowners meeting cost and related travel.

As you will recall, our 2007 storeowners convention was in the third quarter of 2007, and was a factor be called out last quarter as a timing benefit. This year we hosted our regular, yearly regional store making across Canada and the US in the fourth quarter and that caused our meetings and travel costs to increase compared to last year in the fourth quarter. And finally currency translations from our US business affected G&A growth as well. In asset dispositions, in one of joint ventures in the fourth quarter, help increase equity income which grew by 9.4% to 10.5 million. Equity income also benefited from increased contributions from our two largest joint ventures as sales growth helped drive increased income.

Please turn to slide 14 in the presentation. I will walk through earnings. Operating income was down 7.2% in the fourth quarter to about 108 million. This includes the 21.3 million impact of the restaurant closure and related impairment charge. To break this out in a bit more detail, the 21.3 million is comprised of 7.6 million in restaurant closure costs, and 13.7 million in an asset impairment charge that was triggered by these closures. On an after-tax basis, these costs were 15.4 million. Adjusted operating income, excluding these charges , was up 11.1% in the fourth quarter to about 129 million, more than respectable performance in light of the current condition. In our view. As a reminder, please refer to the non-GAAP reconciliation in our presentation as adjusted operating income is a non-GAAP measure. Net interest expense was up about 1 million over last year, basically the result of lower interest income and higher interest expense on capital leases. This is partially offset by lower interest cost on our external debt.

Net income was down by 8.6% in the fourth quarter compared to last year, obviously impacted by the 15.4 million in after-tax charges mentioned previously. The effective tax rate was eventually flat compared to the fourth quarter of last year, coming in at 32.8% compared to 32.6% last year. Finally, EPS was 38 cents per share compared to forty cents in the fourth quarter of 2007, which included the eight cent per share impact for the closure and related impairment charge. Our EPS performance also reflects a 2.9% reduction in average shares outstanding compared to the fourth quarter of last year as a result of our share repurchase program.

I'm going to move to segment information and you can find that on slide 15. The Canadian segment had an increase of close to 9% in operating income of 137 million. The business had slightly higher margins due to sales growth, benefit benefited rents and royalties, and from some improvements in distribution business. The US segment had an operating loss of 21.3 million in the quarter. It is very important to note that the restaurant close and impairment charge of 21.3 million drove all of this loss. Currency translation raised US segment revenues and cost by approximately 15%, respectively during the quarter. As you know, we have communicated that we believe we have achieved a critical mass of restaurants in the US, to position us to achieve profitability, having celebrated our 500 location in the US in December of 2008. In 2009, we're targeting breakeven operating income on the full-year basis in a US segment, which assumes a gradual economic recovery.

If you turn to slide 16 and then 17, I'm going to cover our balance sheet and cash flow highlights. We continue to enjoy considerable financial flexibility through the strength of our balance sheet and cash generation. We continue to self fund our business growth through operations and our debt ratios are among the best in the industry. With only 392 million in term debt and capital leases, our leverage continues to provide us with exceptional financial flexibility. We ended the fourth quarter with about 100 million of cash and cash equivalents on hand. Capital expenditures in the quarter totaled 62.2 million and 174.2 million for the full-year. We didn't spend as much as originally planned due to the mix of leased versus owned properties and the heavier weighting of nonstandard restaurants particularly self serve which were much less capital intense.

Our CapEx program was focused primarily on our store development and renovation. Depreciation and amortization for the quarter were 24.5 million and 91.3 million for the full-year. Liquidity continues to be a topic of interest among investors in the restaurant industry. In addition to the excellent financial picture I just walked through, we also have access to Canadian and US revolving credit facilities, which are primarily undrawn, which provide access to CAD$200 million and US$100 million if needed. Our senior bank facility which consists of a 300 million dollar 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 access to the revolving credit facilities is substantially unchanged. Credit tightness continues to be a factor in the restaurant industry although as it relates to the Tim Hortons and our franchisees, we have franchise financing programs established with Canadian and US lenders to help our franchisees fund their businesses. We also support our US franchisees using our franchise incentive program.

Consistent with what we have indicated last quarter, despite the current economic and credit conditions, our franchisees continue to have access to financing programs with third-party lenders, although processing may take longer, and cost may be higher, consistent with the prevailing market conditions. We continue to have full confidence that we will generate strong operating cash flows to fund both our ongoing capital expenditures, our expected debt service requirements and programs to return value to shareholders.

Before I turn my attention to 2009 targets, I would like to address ongoing work on our corporate structure. As it relates to our corporate structure, I should remind those of you who are not aware that certain time constraints were placed on us under US tax rules and tax agreements at the time of our spin-off in 2006 from Wendy's. These constraints limit our ability to pursue certain acquisitions, reorganizations and other transactions that could affect the tax free nature of the spin-off. These time constraints have about expired. There are various and significant complexities in our structure that stem from our unique situation being a US domiciled company that has significant operations in Canada. At the same time, changes to the tax treaty between Canada and the US ratified in December 2008 creates additional complexity which could if not addressed increase our tax rates in future years. Based on our evaluation today, we believe various alternatives exist, including potentially converting our parent companies from a US to a Canadian Corporation. Such a transaction would be expected to bring our effective tax rates closer to Canadian statutory rates in 2010 in future years. Although this type of re-organization would also cause us to incur certain charges in 2009 for discrete tax items, the majority of which would be noncash and for transactional costs.

We feel it is important due to the complexity, additional costs in the first half of 2009 and potential importance of such a transaction to communicate about this work. It is also important to note that there can be no assurance that we will be able to complete a reorganization of our company or any other transaction for that matter or the expected benefits will ultimately be realized.

So to wrap up, let me turn to our 2009 targets. We continue to have confidence in our business platforms and strategies to grow the business. Our approach is to be realistic and pragmatic, but also to look for opportunities given our scale, our financial strength and our competitive advantages. With this in mind, our 2009 targets include operating income growth of 11% to 13%. On a comparable basis, the real growth rate is 6% to 8%, once the impact of closure costs and related impairment charges are excluded from our 2008 results. This includes approximately 1% positive impact of a 53rd week in 2009. We're targeting breakeven operating income performance in our segment on a full-year basis. For 2009, our same-store sales growth targets are between 3% to 5% in Canada and 0% to 2% in the US. For restaurant openings, we're targeting 150 to 180 new openings, 120 to 140 restaurants in the Canadian segment, and 30 to 40 full serve restaurants in the US segment, complemented by additional nonstandard locations and sites from strategic alliances. We expect that our capital expenditures will be between 180 million to 200 million and that our effective tax rate will be between 32% and 34%.

Let me spend a minute on the tax rate. This has the potential to move in 2009 depending on what happens with our re-organization review. If the new structure is approved and implemented in 2009, it could have a significant negative impact on the effective tax rate in 2009 due to discrete items, most of which are noncash, and transaction costs could also affect our operating income growth rates. The benefits as we covered before include effective tax rates that begin to move in 2010 and beyond towards Canadian statutory rates. Overall, we believe our outlook and our targets are prudent and responsible in the context of the conditions in which we are operating. And while there is the certainty than normal regarding the macro outlook, we believe these targets are reasonable and achievable given our current views on our marketing, menu expansion and operational programs.

With that, I will turn it back to Scott.

Scott Bonikowsky

Great. Thanks Cynthia. We'll now begin our Q&A session, and we do as always request to the extent you are willing to do that to limit your questions to just one at a time so that everybody can get into the queue and get the opportunity. We have a lot of participants today, so to the extent we all can, we will try to keep our answers crisp and you return on the questions would be appreciated very much as well. After your questions, you are welcome to get back into the queue of course for any follow-ons you may have.

With that operator, I'm going to turn it over to you to start the Q&A.

Question-and-Answer-Session

Operator

(Operator instructions). Our first question comes from the line of Irene Nattel with RBC Capital Markets. Please go ahead ma’am.

Irene Nattel – RBC Capital Markets

Good morning. Sorry to be so predictable. I will ask my one question, Scott. The outlook that you provided for same-store sales in Canada of up 3 to 5%, certainly seems fairly robust, and could you just work us through what your thinking is behind that, how much price you’ve already taken, whether you're likely to take further price traffic, menu all that nifty sort of stuff?

Cynthia Devine

Sure. Thanks for the question Irene. With respect to growth outlook for next year, it is a game going to be a combination has it has been in the past of new products, of speeder service initiatives that our operation team has in place. There is a little bit of pricing that has carried over from last year but at this point in time we can talk about any future pricing as those meetings continue to take place with us storeowners in the coming months. But it really is from our standpoint, it is going to be again a combination of new products, promotional activities, speed of service and operations initiatives, that help us deliver the same store sales growth.

Irene Nattel – RBC Capital Markets

And is there anything that you can tell us about new products?

Don Schroeder

No. We have new products that are planned for this year to address the particular circumstance of this current environment where our customers are faced with fewer discretionary dollars. So we will be looking at products that specifically address that concern.

Irene Nattel – RBC Capital Markets

Could you give us an idea of what your thinking – are you thinking about more combinations or actually new products?

Don Schroeder

Well, again, with the – 40% of our customers traditionally come to us more than four times a week, wherein difficult times, you see those customers unable to come four times, maybe they only come three times. So giving – trying to drive traffic, particularly in the sacking day parts, that is one of the focuses that we have this year to get traffic back, and also at a price point that will address again the limited number of discretionary dollars that our customers have available to them.

Irene Nattel – RBC Capital Markets

Thank you very much.

Operator

Our next question comes from the line of Perry Caicco with CIBC World Markets. Please go ahead Sir.

Perry Caicco – CIBC World Markets

Thanks very much. On your outlook, the breakeven operating outlook in the US, essentially I guess you're looking at not much progress from this year on that one. I know it is tough down there, and I know you have recently made some alliances, but what is it going to take to get the US business to turn the corner from an operating profit point of view?

Don Schroeder

Well, again, we had set the target when we had the IPO a couple of years ago. We wanted to have 500 stores in the US by the end of 2008. We have got to that number last year, now the focus is on profitability. And David Clanachan and his team have been focusing with us storeowners there how do we take costs out of the business, the bundling, the combination or the combos that are available now and so on, are all working to increase profitability within the stores, and they are working very hard to get to that point with the breakeven at the end of 2009.

Perry Caicco – CIBC World Markets

And at this point, is there a large difference in consumer behavior in your stores between Canada and the US? I mean I would assume there is some behavior differences because of the brand penetration, but there might also be some due to the economy, can you differentiate between them?

Don Schroeder

Well, there is no question the buying patterns in the US have always been different from Canada, that’s why the introduction of combos and so on. That is a more important element in the US, the combos David and the team introduced last year. Also they have a great variety to the customers, including alternative like you can have fruits, you can have chips, or whatever, so just to address the different needs and eating habits in the US.

Cynthia Devine

Also I think what we're seeing, Perry, is that the discounting activity from competition in the US is probably a little bit different, although there’s a fair amount going on in Canada now. But that existed in the US markets for most of 2008. We are seeing it more in Canada in 2009, but that is probably one of the key differences that everybody was focused on kind of discounting and value pricing, if you will.

Perry Caicco – CIBC World Markets

Okay, thanks.

Operator

Our next question comes from the line of Michael Van Aelst with TD Newcrest. Please go ahead sir.

Michael Van Aelst – TD Newcrest

Hi, good morning. Just wanted to talk a bit about your operating outlook, operating income guidance of I guess 5 to 7% on an apples to apples basis for 2009. You has some pretty good growth in Q4 2008 and even though it is quite a difficult operating environment, can you kind of in big baskets I guess explain where you that drop coming from? Is it coming from helping your franchisees absorb some of the cost increases? Where is it coming from the difference?

Cynthia Devine

With respect to – I just want to clarify, you said five to seven, I am assuming that you excluded the 53rd week?

Michael Van Aelst – TD Newcrest

That's correct.

Cynthia Devine

Okay. Because as the target it, we talked about six to eight, okay. Just want to make sure that we were clear on it. With respect to – there are some areas of the business that we talked about before, particularly as it relates to our equity income line. That line of business for us does not necessarily grow at the same rate as the chain does. It has two main joint ventures and one of them is our bakery joint venture and the other one is our Tim Win or combo real estate partnership that we have. We're not expecting the same sort of growth from that equity income line. Really for the most part driven from our Maidstone bakery joint-venture, we had some great commodity buying in 2007 and the first part of 2008. Now as we’ve purchased some of the commodities out for 2009, we are expecting that those costs will go up in the bakery, and we're working on not passing that pricing on to our storeowners, because we think during these challenging times, it makes a lot of sense for us to keep that category very important for our storeowners and not to pass on some price increases. So that is one of the areas where we are seeing little less growth on our P&L. I don't know if you have further – Mike, are you still there?

Michael Van Aelst – TD Newcrest

Yes. No, that is fine, thanks very much.

Operator

Our next question comes from the line of Turan Quettawala with Scotia Capital. Please go ahead sir.

Turan Quettawala – Scotia Capital

Yes, good morning. I guess just on the US store growth, I'm just looking at that number and thinking if you have already reached sort of critical mass like you’ve said, why would you sort of slow the growth I guess in this year? Also wouldn’t you also be – would the real estate pricing be lower as well in the US here right now, just because of the environment, so from a longer term basis I am not trying to sort of figure that out?

Don Schroeder

Okay. Again, the target for this year is certainly lower than last year, and a I said, we're looking at prudent restaurant development in the US for 2009. I also indicated that we're opportunistic. If we see the opportunity attractive real estate prices in the US, then we would certainly be able to look at that. Our balance sheet gives us the freedom to do that totally. So it is a conservative statement based on the current economic climate, but if we see good opportunity from a price standpoint or even opportunities to acquire a number of pieces of real estate, we would certainly do that.

Turan Quettawala – Scotia Capital

Okay. And I guess maybe as a quick follow-up, the Cold Stone locations, is it possible to give us some you as to how much the average sales are from that one, just because that’s a majority of the slow growth in 2009, I guess?

Don Schroeder

I wouldn't say that that is the majority of the store growth in 2009. We have two stores in test, and a third one actually opening it this morning, or the official opening. So we wouldn't give any indication at this point in terms of what the sales levels are. But we’d certainly hope that we're very positive about the results to date as are people from Cold Stone. And going forward in the test, our hope is we will be able to get that same trend of consumer respond as we broaden the test.

Turan Quettawala – Scotia Capital

Okay. Just a...

Cynthia Devine

Turan, the 30 to 40 that we have outlined is not looking at the Cold Stone piece of it.

Turan Quettawala – Scotia Capital

I know. But I'm just – I am thinking, but it is 50 Cold Stone right, incremental locations?

Don Schroeder

And again, the 30 to 40 as Cynthia say, excludes any of the test stores with Cold Stone.

Turan Quettawala – Scotia Capital

No. I understand that, thank you.

Operator

Our next question comes from the line of David Hartley with BMO Capital Markets. Please go ahead sir.

David Hartley – BMO Capital Markets

Good morning and thank you. Just some questions on I guess first the revenue line, 3 to 5% is really good number, and I would assume that with the level of price increases taken probably in you budget are not as high as what we saw last year. So what you see here, is this maturing stores kicking in more, or is it going to be much more related to kind of the value program you're putting in place? And my second question just would be on the cost side, it looks like you're going to get some good leverage here based on your forecast or your guidance, I just wanted to know where the coffee roasting plant that you are building comes into play here?

Don Schroeder

Yes. First off in terms of the revenue, we're looking at, as Cynthia indicated, in one of the other questions, menu items. We will be there to drive sales, the promotional calendar, innovative products, and then working with our storeowners on speed of service to be able to move more business through the restaurants. So those are always the key factors for us in getting that 3 to 5% of sales increase. In terms of the new coffee roasting plant, that is scheduled to open in the fourth quarter of this year.

Cynthia Devine

Really, it won't have a big impact on our year because it is going to be opened so late.

David Hartley – BMO Capital Markets

Okay. And just as a follow-up on the revenue side, what are your expectations there on the average ticket? Are you expecting that to go up considerably this year, or is it really more a volume thing and keeping those customers in line as opposed to seeing them walk away?

Don Schroeder

Well, again in terms of the average ticket, when we talk about the type of products and promotions that we're going to have this year, they are really aimed at addressing the limited number of discretionary dollars that our customers have. So it is probably not going to impact the average ticket in an increased way. It is all about traffic. Everybody in the industry is trying to protect or grow the traffic levels in their stores.

David Hartley – BMO Capital Markets

It just seems – I should pass this over, but it just seems strange that you are expecting such a solid increase on that front. But anyways I'll pass it over. Thank you.

Operator

Our next question comes from the line of Robert Mickey [ph] with National Bank Financial. Please go ahead.

Robert Mickey – National Bank Financial

Hi there. I'm just wondering if you could provide a little more color on how menu promotion and value meals impacted volumes in Canada in the quarter (inaudible) volumes?

Cynthia Devine

Most of the combo offerings that we really have started in 2009, so there is not a lot that we can comment on that with respect to our 2009 traffic.

Don Schroeder

We can tell you that that the Chilean Garlic Toast promotion that we ran in the fall was just a tremendous example of what happens when we are promoting within the restaurant. Chile has been around for a long time, we hadn't promoted it in a long while, and just our reminding customers of that great quality product that was there, we had tremendous response across the chain.

Robert Mickey – National Bank Financial

So you would say than that the increased volume was through sort of more effective advertising and promotion?

Don Schroeder

Yes. Again the end marketing programs are always a key part of what we do, and again that is going to play a significant role in 2009. We have a number of great initiatives in the marketing program and the calendar that we have in place, we're confident will help us significant in achieving our sales goals.

Robert Mickey – National Bank Financial

Okay. And given the sort of poor weather we had in Canada in Q4, was there any impact on volume, store volumes due to the snow?

Don Schroeder

We certainly felt there was a lot of snow and whenever that happens, you never get those sales day back. So unfortunately we did have that and certainly in the US with the limited market in Canada because of the size of the country, we can have bad weather in one region and not totally impact the sales for the chain. In the US, given the restricted area of the market, when you have bad weather there, that does impact sales.

Robert Mickey – National Bank Financial

Okay, great thanks.

Operator

Our next question come from the line of Steve Kron with Goldman Sachs. Please go ahead sir.

Steve Kron – Goldman Sachs

Thanks. Hi, guys. A couple of quick profitability follow-ups and then I have a bigger question, if I think – sorry for being repetitive if this was sort of asked, but if I look at the operating profit guidance, excluding the 53rd week of 5% to 7%, and I look at the revenue line items that are kind of targeted here, same store sales, up three of more, unit growth probably net 4% to 5% range, it would seem to me that the revenue growth would be outpacing the operating profit expect Asian by a couple of hundred basis points. So my question is absent the equity income line, is there other areas where you might see some margin pressure, where are you focusing that?

Cynthia Devine

It is not necessarily margin pressure. We are not seeing expansion, but one of the other line items, I mean equity income is an important part of it, but another line is, and we have talked about this before as well, that the franchise fee line item, in that we're not expecting real significant growth in those line items. We are opening in Canada the same number of stores that we did in the previous year, a little bit lower on the US side of things, so we're not going to get as much growth out of those line items. So I think the combination of things and of course during this challenging time, we're looking for expansion in margin in any component of our business.

Steve Kron – Goldman Sachs

Okay. And then the other follow-up on profits, back to the US profitability question, on a like-for-like basis, if you take out the charges you guys took, I mean the business is basically flat year over year, but now you have less of this company on stores that are kind of losing money for you. So you are play 95% and 6% franchised, I think now you are targeting zero to two per cent same store sales growth. You have some new unit growth coming online, yet you're not going to be growing profits, versus what you did this year and was versus what you did in the prior year, or the run rate that showed in the fourth quarter. So I guess the question is, are you offering greater incentives to franchisees today, are you having to fund that program a little bit more so than you have in the past, what is combating net profit growth?

Cynthia Devine

Sorry Steve. Just to clarify something, on a full year basis in our US segment, we lost 5.2 million. So we actually do see there is significant improvement and a significant milestone for the company and our US team. So we're very pleased with that. Obviously, the store closures is going to represent a significant component of that. When we have new stores, we will continue to help our store owners or challenge stores; we will continue to help them, and especially during challenging times. That has always been our business model, both in the US and in Canada on our development. So we're looking for some baseline improvements in our business as we probably opened or are looking to open less stores. We hope that we will not have as much relief associated with our store openings in 2009, and so that is representing some of the improvements as well. But we feel we are making significant progress in that business from where we have been in the past.

Steve Kron – Goldman Sachs

Since there is this big shift in the US towards nonstandard stores, less so from the standard source, can you share with us a little bit of kind of the collective economics whether it is, what it costs to kind of get the business up and running as supposed to kind of the real estate aspect? Do you guys participate in that in any way on some of the other stores, what’s the financing agreements or arrangements, how much do you collect (inaudible)? I mean some parameters with which we can effectively kind of look at how that business should transpire?

Don Schroeder

Yes. First of all, just in terms of when you indicate that there is a shift to nonstandard stores, that is not the case. As I indicated in my opening remarks, the standard store operation will continue to be the core of our business operations in the US. The introduction of nonstandard stores, doing things like with Cold Stone, is similar to what I indicated we did in the 1990s. If you go to the 1990s in Canada, we developed a relationship with Esso, went into their gas stations, and initially they were primarily self-serve operations. As the business grew, developed and we could identify which one of those units should be converted to full serve, we did that, and that's a big part of our business today. So we will do the same type of thing in the US, but we will not abandon the idea of our standard stores as the core business model. What we're doing is, we're looking at the size of the footprint of those restaurants, reducing that, in order to take cost out, not only in the development of the stores, but also in the operations of the stores for our store owners and help them get to profitability faster.

Steve Kron – Goldman Sachs

Okay, thank you.

Operator

Our next question comes from the line of Candice Williams with Genuity Capital Markets. Please go ahead.

Candice Williams – Genuity Capital Markets

Thanks. Just a quick question on your specialty coffee, the BC rollouts, for the stores that you have added, what did it do to comps, was it material, and where and when could you roll it out further?

Cynthia Devine

It is really rolled out fairly late in the fourth quarter of 2009, so probably had very little impact on – 2008, sorry about that. I have already moved on in years. But it was rolled out fairly late in the quarter in 2008, and we didn't have any advertising associated with it in the fourth quarter. So we're just getting geared up for that in 2009.

Don Schroeder

Yes, the active promotional campaign for that product is just underway at this point.

Candice Williams – Genuity Capital Markets

Okay, thanks.

Operator

Our next question comes from the line of Irene Nattel with RBC Capital Markets. Please go ahead, ma’am.

Irene Nattel – RBC Capital Markets

Thanks. If I might just move on to the possible re-organization, could you just give us a little bit more color, Cynthia or Don, on when we might actually hear about this, on an ongoing basis will you isolate the cost associated with this initiative, and what might some of the benefits be on a go forward basis besides the tax rate?

Cynthia Devine

Irene, we hope over the coming months that we can get back and communicate more on it, and get more visibility around both the cost side of it and the potential savings in the future. Some of the other benefits besides tax benefits associated with bringing our rates closure to the Canadian statutory rate, administratively sometimes there are structure today, it is more difficult to move cash through the structure, because we generate significant portion of our cash in Canada and then move it up to the US. So some of that will be simplified, some of the corporate administrative activities that take place through the company, because so much of the activity for the subsidiary company takes place in Canada, sometimes it is a bit cumbersome from an administrative standpoint. So we expect to see some benefits there as well.

Irene Nattel – RBC Capital Markets

That is great. Thank you.

Cynthia Devine

Thanks, Irene.

Operator

Our next question come from the line of Winston Lee with Credit Suisse. Please go ahead.

Winston Lee – Credit Suisse

Hello, can you hear me?

Cynthia Devine

Hi, Winston.

Winston Lee – Credit Suisse

Hi, thanks. Your operating income growth target, does that include professional fees? I know that it is – part of the corporate reorganization, it is contingent on it actually occurring, but it seems like you're going to get or you are going to incur fees in the first-half anyway whether or not it does happen, it doesn't happen?

Cynthia Devine

That is correct. Targets, at the time when the targets were set, we did not anticipate the potential costs associated with the fosters or our inversion project, but those costs we will detail when we have more information. Obviously they will be a lot lower if we are not doing a transaction. If we do a transaction, the costs will be higher. But as I said to Irene, over the coming months, we will detail those costs and associated benefits in more much more detail for you.

Winston Lee – Credit Suisse

And relating to the re-org, is that – were there prior opportunities that you were unable to execute on, i.e. acquisition opportunities that you were looking at? Is that something now that you consider, or is it just not the environment to look at it?

Cynthia Devine

I am sorry. Winston, can you repeat your question? It was a bit – we couldn't catch it all.

Winston Lee – Credit Suisse

Sorry. I think you said that with the tax sharing agreement, you are restricted on engaging in certain activities like acquisitions, and what I wonder is, did you look at any – are you looking – does it give you the – do you need to consider acquisitions right now if you were able to do the re-org?

Don Schroeder

Well, again as I indicated before, the financial strength of the company certainly gives us the flexibility to look at anything. And now that the time or strains have gone by, it is completely open. We can look at whatever opportunity might present itself to us.

Winston Lee – Credit Suisse

Could you give us an idea in terms of what would be an area you’d like to grow in? Like what – I mean when we think about acquisition, is it more sort of geographic expansion, or is it into a different product area? I know it is kind of hard to comment, I understand, but just maybe some sense of it?

Don Schroeder

The one area that we hope – from an historic standpoint, real estate opportunity certainly present themselves during recessionary times. And I think that was one of the top of the list, we would be open to look at that if they present themselves. So we have the flexibility to do that if a good opportunity presents itself.

Winston Lee – Credit Suisse

Okay, great. And on the US, what would the US comp look like? I think for the year it was 0.9%. If you had had those closures say done in the beginning of this year or beginning of 2008, what do you think the comp would have looked like?

Cynthia Devine

Again because it represents such a small portion of our US business, it is not a significant impact on our comp store sales.

Winston Lee – Credit Suisse

Okay. And was most of that – I assume that most of the store closures is cash, but most of the impairment is non-cash?

Cynthia Devine

That is correct. The store closure cost for the most part would be cash coming in 2009 and the impairment charges noncash.

Winston Lee – Credit Suisse

Okay. And so now are we done because I think you remember – I think you remember potentially spanning into Q1 but are we done with all the US impairments or store closures at this point?

Don Schroeder

As we talked about before, that was it. We did it all in the fourth quarter.

Winston Lee – Credit Suisse

Terrific. Thanks very much.

Operator

Our next question comes from the line of Keith Howlett with Desjardins Securities. Please go ahead.

Keith Howlett – Desjardins Securities

Yes. I was wondering if you could share any historical data that you have on the 1982 or 1992 recessions in Canada and how same store sales growth and customer frequency were affected?

Don Schroeder

Yes. If you go back to 91 in Canada, there were a couple of things. We had a recession, plus we also had the introduction of the GST, and that certainly affected our sales at that time. But the big thing that we have seen at any time that we have been involved in any kind of recessionary times, couple of things have happened. One which we have already talked about in terms of real estate opportunities, all of a sudden, real estate that maybe the year before we couldn't afford to look at becomes available to us at attractive prices. And the other thing that happens is, there are a lot of people that are displaced from their jobs, all of a sudden want to take a greater control of their lives, decide to apply and become Tim Hortons franchisees. And if you go back to the early 90s, we had a tremendous influx of new store owners who were very strong operators, people that wanted to again take control of their lives and own their own business. And we expect that same type of thing will probably happen again during these difficult times.

Keith Howlett – Desjardins Securities

And just a question on, you have a large drive through business, is there a strong correlation between your unit sales and the price of gas or not really or is that dwarfed by employment or other factors, can you sort of see traffic go up and down and as the gas price came down?

Don Schroeder

Well, I think if you go back to last summer and early in the fall when gas prices went unreal levels, we saw an impact in terms of traffic at the stores. I mean the average individual when the price of gas went up that much, the number of discretionary dollars that they had left in their pockets shrank dramatically. What happened subsequent to that time when the price of gas fell off gain, it increased the number of discretionary dollars, but I think in many cases, people were still reluctant to part with those dollars because of the uncertainty and what was happening in the economic environment.

Scott Bonikowsky

Keith, it is Scott. We have said at the time, you may recall that it has much to do with the impact on discretionary dollars as it was a drive through correlation per share.

Keith Howlett – Desjardins Securities

And just one last question on the warehouse, you mentioned some new products going through the warehouse and also some efficiencies in the warehouse operations had helped the margins for that operation, can you just add any color to that – those comments?

Don Schroeder

Well, the big thing was, we opened our new distribution center in Guelph, Ontario a couple of years ago, and as we work through with the new systems, the new employees and whatever, we introduced the concept of lean with a view to improving efficiencies within the operation, and that has worked out very well for us, and has allowed us not to have to pass on increased cost to our storeowners through product increases. So we have been able to absorb a lot of the increased operating cost as a result of efficiencies that lean processes provided to us.

Keith Howlett – Desjardins Securities

Great, thanks very much.

Operator

Mr. Bonikowsky, I now turn the call back over to you.

Scott Bonikowsky

Okay, thanks operator. We didn't get to everybody in the queue. We have a lot of interest this quarter, so unfortunately if we did not get to you, please do feel free to give me a call at 905-339-6186 or alternatively by e-mail at investor_relations@timhortons.com and I would be pleased to spend time talking with you. So again thanks for joining our conference call this morning and if you have any additional questions, give me a call and have a great day, everyone.

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 line.

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Source: Tim Hortons Inc. Q4 2008 Earnings Call Transcript
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