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Tim Hortons (NYSE:THI)

Q2 2013 Earnings Call

August 08, 2013 2:30 pm ET

Executives

Scott Bonikowsky - Vice President of Corporate, Public & Government Affairs

Paul D. House - Non-Executive Chairman and Member of Executive Committee

Marc Caira - Chief Executive Officer, President and Director

Cynthia Jane Devine - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Analysts

Perry Caicco - CIBC World Markets Inc., Research Division

Irene Nattel - RBC Capital Markets, LLC, Research Division

Michael Van Aelst - TD Securities Equity Research

John S. Glass - Morgan Stanley, Research Division

Michael Kelter - Goldman Sachs Group Inc., Research Division

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

David Hartley - Crédit Suisse AG, Research Division

James Durran - Barclays Capital, Research Division

Derek Dley - Canaccord Genuity, Research Division

Kenric S. Tyghe - Raymond James Ltd., Research Division

Peter Sklar - BMO Capital Markets Canada

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Operator

Ladies and gentlemen. Thank you for standing by, and welcome to the Q2 2013 Tim Hortons Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded Thursday, August 8, 2013.

I would now like to turn call over to Mr. Scott Bonikowsky, Vice President of Corporate Affairs and Investor Relations of Tim Hortons. Please go ahead, sir.

Scott Bonikowsky

Great. Thanks, Tommy, and welcome, everyone, to Tim Hortons Second Quarter 2013 Analyst Call. We released our results earlier this morning before the market opened. And to access our earnings material and also a presentation supporting today's discussion, please visit the Investor Relations section of our website and click on the Events & Presentations tab. We'll have this material available to you for a period of about 1 year.

This is our first conference call since the appointment of our new CEO, Marc Caira. Paul House, our Chairman, will join at the start of the call to briefly discuss the transition and few other items. And then, we're going to turn the call over as well to Marc and Cynthia Devine, our Chief Financial Officer. We will be pleased to take questions after our prepared remarks. [Operator Instructions]

Please do note today that we may make some forward-looking statements and information this afternoon within the meaning of the Private Securities Litigation Reform Act of 1995 and Canadian securities laws. This may include discussions about planned initiatives, future performance, results and outlook based on our current expectations, assumptions and information. These initiatives and results include, for example, information about our recapitalization plans, same-store sales expectations, earnings performance and operational initiatives.

Forward-looking statements are based on a number of assumptions. They contain risks and uncertainties, and our actual results and activities could differ materially from those statements. Please refer to the company's 2012 annual report on Form 10-K filed on February 21, 2013, and our quarterly report on Form 10-Q that we will -- plan to file later today. These include detailed information regarding risks and uncertainties that could impact our ability to perform or launch certain activities as expected, as well as material assumptions underlying the expectations described in our forward-looking statements. Please read our full Safe Harbor statement on our investor website and in our presentation supporting today's call.

I'll remind you that all Tim Hortons results are presented in accordance with U.S. GAAP and we report in Canadian dollars unless otherwise noted. Today's discussion and supporting presentation include 2 non-GAAP financial measures, and they are adjusted operating income and we'll leave it at that. Reconciliation of that non-GAAP measure and their most directly comparable GAAP financial measure and other information relating to our use of non-GAAP measures is included in the appendix of our presentation.

So with that, Paul, I'm going to turn it over to you.

Paul D. House

Well, thanks, Scott, and good afternoon, everyone. As you may know, my tenure as President and CEO of Tim Hortons ended on July 2, when Marc Caira's appointment to that position took effect. I now serve as non-Executive Chairman of the company.

It has been an incredible honor to serve as a leader of this great company. And as we get ready to celebrate the 50th anniversary of the first Tim Hortons restaurant next year, Marc is just the fourth CEO in the company's great history. He takes on the leadership role at a time of great strength and opportunity for the company, but also at a time of challenges. He does so with the full authority that comes with the role of President and CEO. The Board of Directors is very pleased to have an executive of Marc's caliber leading the organization as it begins planning for the next stage of growth.

Marc has a proven track record as a global food service executive. At Nestlé Professional, he led a 10,000-person business with operations in 100 countries and has considerable experience in beverage and food service innovation. I am confident he is the right person to take Tim Hortons to the next level. Marc has already made a strong impression internally. In his first month on the job, he met with the senior leadership corporate team members, as well as our restaurant owners across North America through a series of 21 regional meetings. There is no better way to get to know the company.

And today's call serves as his introduction to the investment community. Marc and Cynthia will review our second quarter results and other strategic developments. The one item that I would like to cover as Chairman of the company is the appointment of 2 new directors to our board. We had 2 vacancies on our board that we had indicated we would be filling. As announced in this morning's news release, the board has appointed Sherri Brillon and Thomas Milroy to fill those roles. Both of these individuals are seasoned executives who will bring considerable financial expertise and strategic insights to our board.

Sherri is the Executive Vice President and Chief Financial Officer of Encana Corporation, a major Canadian public company and leading North America energy producer. In her 28 years with that organization and its predecessor company, she held senior roles in corporate and operation planning, strategic planning and supply management.

Tom is the CEO of BMO Capital Markets, with global responsibility for corporate, institutional and government clients. He has an extensive background in investment banking, as well as corporate banking and security law. The Board of Directors looks forward to working with our 2 new colleagues and of course, with our new CEO, Marc, who I'll now turn the call over to. Marc?

Marc Caira

Thank you, Paul, and good afternoon, everyone. Let me start by saying that it's wonderful to be back in Canada after having been away for more than 7 years. I look forward to meeting you in the weeks and months ahead. To be back in Canada, and at the same time, serve as CEO of Tim Hortons, is both an honor and a privilege. This company and brand is woven into the fabric of Canada, and I believe Tim Hortons has many opportunities ahead of it in Canada, the U.S. and internationally.

Over the past 5 weeks, I've had the opportunity to immerse myself into the business. I have traveled extensively across Canada and the U.S., meeting with our franchisees and employees. I have heard directly from our people as to what they see as opportunities and also challenges. And while at the same time, these challenges and opportunities may vary from market to market, the one thing in common I heard and, more importantly, felt was the passion, the pride and the commitment that our people have for this business. In the coming weeks and months ahead, I look forward to meeting with our shareholders. Their input and engagement is important to me as we start to lay the foundation for the next phase of growth in the months ahead.

I want to now turn to the business and make some observations about our second quarter results. Clearly, we are operating in a very challenging, competitive and volatile environment. In fact, I would refer to this environment as a new reality for our industry and Tim Hortons, a new reality where we need to work harder than ever before to earn and keep the trust of our consumers. And while I'm encouraged with the progress we did make during this quarter, there is clearly more work to be done with urgency in rebuilding top line momentum.

Same-store sales growth of 1.5% in Canada and 1.4% in the U.S. was a step in the right direction after a rare decline in same-store sales the previous quarter. But nevertheless, it was below our own long-term expectations. The company has been facing challenging conditions, driven by a lackluster economy, fragile consumer confidence and a competitive environment that remains intense. However, as I've mentioned, I believe this is the new reality facing our industry. We need to accept this new reality and effectively compete in it.

Our team is working to address this new reality through a number of operational, promotional and menu initiatives. We are also actively working to increase capacity and enhance the image of our restaurants through drive-thru and restaurant renovations. These initiatives also remind us that we need to work harder at providing the ultimate guest experience every time they come in contact with the Tim Hortons brand. Here, I would say that perhaps we are victims of our own success.

The fact is that today's consumer is not prepared to wait in long lineups. While our drive-thrus are relatively quick compared to the industry, we need to get faster. At the same time, we need to make it easier for our guests to get in and out of our restaurants The good thing is we know what we need to do. Now we just need to do it.

On a positive note, our earnings saw double-digit growth in the second quarter. And while a portion of this increase was due to timing and other factors that weren't present in the prior year, the results were still reflective of solid underlying performance in the business. I also want to comment on 2 other important aspects of our second quarter results: first, we generated continued strong cash flow in the quarter; secondly and closely related, our balance sheet remains very healthy.

Something that I found compelling when I joined Tim Hortons is the company's proven ability to generate exceptionally strong cash flows year after year. That's the result of a strong brand and a unique market positioning. But also, more fundamentally, I believe it reflects our powerful business model characterized by multiple, reoccurring income streams.

Our team did a considerable amount of work on reviewing capital structure alternatives long before I arrived, and it was one of the first matters I turned my attention to in my new role. I reviewed several options and recommended a recapitalization to the board, leading to the announcement we made earlier today. Our board has approved a $900 million increase in our debt leverage, and we plan to use the proceeds to repurchase common shares within the next 12 months.

Combined with approximately $100 million of capacity remaining under our existing share repurchase program, we expect to buy back approximately $1 billion of shares over the next year, subject to market conditions, regulatory approvals and the negotiation and execution of relevant agreements. We made the decision to recapitalize at this time within the context of strategic and operational planning activities, which are now underway.

There is still much work to be done, and our strategic planning exercise will continue in the coming months. But on certain issues, including capital structure, we saw no need to delay the implementation of the decisions we have made. By proceeding now, we can take advantage of the favorable low interest rate environment. We will also be placing our debt ratios more in line with both our Canadian retail peer group and many of our U.S. restaurant peers with similar capital intensity. Most importantly, by adding the new debt while maintaining investment-grade matrix [ph], we believe we can generate additional value for our shareholders while preserving our strong balance sheet, cash flows and access to capital, which gives us flexibility as we move to the next stages of our development. Cynthia will provide further commentary on our capital structure.

Another area of our business where we are actively evolving our approach is our business in the U.S. I consider the U.S. to be an important part of our growth strategy. I very much see the U.S. as being a must-win market for us. Based on the dynamics of the market and the footprint we already have created, I believe the U.S. represents an opportunity for significant long-term earnings growth for us. Our sales progression in many U.S. markets mirrors that of many Canadian markets in their early development stages. However, overall sales volumes in these markets do not yet match our larger, more developed markets in the U.S.

We are committed to succeeding in the U.S. market. That being said, we are not satisfied with the returns we have generated to date. We will find new and different models and different ways of doing things. In this context, we have begun to accelerate our efforts in the U.S. by attracting well-capitalized partners to complement our development approach.

We believe that this will support our initiatives to improve returns, including working on box economics, increasing densities in core growth markets, innovation that is differentiating and continued brand building. We expect this change in our approach to resolve and reduce capital being deployed in the U.S. beginning in 2014 and to drive higher returns as we continue to develop the brand in these markets.

I believe Tim Hortons is a great company with significant potential to build on its considerable strengths. The initiatives we've announced today represent an important step forward. Our strategic planning process will help focus our efforts and establish new objectives for these and other areas of the business. I look forward to building on the strong foundation of this organization, and I am excited to have the opportunity to lead this iconic company.

I will now turn the call over to Cynthia.

Cynthia Jane Devine

Thanks, Marc, and good afternoon, everyone. Before I review our second quarter performance, I'd like to pick up on Marc's discussion of strategic developments, particularly as it relates to leverage. We have done a significant amount of work on the balance sheet optimization over the last year, including a more comprehensive review earlier in 2013.

Our board's approval of an additional $900 million in debt, which we plan to use to buy back shares, is based on a number of factors. Adding the targeted leverage to buy back shares is consistent with our focus on building shareholder value. Since our IPO in 2006, we have repurchased about $1.7 billion in common shares while increasing our dividend by an average of 20.6% per year during that time. Over the same time frame, our market capitalization has increased from approximately $6 billion to over $9 billion.

We believe that adding leverage and buying back shares will be accretive to EPS and create additional shareholder value. Importantly, it will also permit us to remain within the bounds of a disciplined capital structure. We have confidence in the strength of our balance sheet and our strong cash flows. Because of that confidence, we can take advantage of historic low interest rates to add leverage while we still protect our investment-grade credit rating. This approach provides strategic flexibility and future access to capital to invest in and drive growth.

In Canada, our investments in our business model have led to exceptionally strong returns, and generally, in our view, profit per restaurant well in excess of those restaurant chains that do not make similar investments. We believe it is important to maintain a capital structure that is aligned with the capital intensity of our business. Unlike some highly levered restaurant companies who carry more debt, our business model requires us to invest in our system to maintain and grow our business. In our view, our new debt ratios will be more in line with both our Canadian consumer company peer group and many of our U.S. restaurant peers with similar capital intensity.

One of the other key factors we took into account in the determination of the appropriate level of debt was the constraints of our existing cross-border corporate structure. At the approved debt level, we believe that the accretive benefits of the planned share repurchases should more than offset the nondeductible portion of interest that results from increasing the amount of debt to fund the repurchases.

Under the current structure, increasing our debt levels substantially beyond the additional $900 million to repurchase shares could significantly accelerate our obligation to pay Canadian withholding taxes due to our cross-border structure, and/or it could also result in us incurring additional nondeductible interest expenses. In the coming weeks, we intend to finalize arrangements regarding the additional debt. Details regarding our plans will be disclosed when they are finalized. At this stage, we believe that the new debt may take the form of either a bank debt or a bond issuance.

So in order to commence the program immediately, we will begin purchasing shares starting in August under a recently approved amended normal-course issuer bid. We will, however, keep of our options flexible regarding the most effective and efficient vehicle to complete the targeted $1 billion of repurchases, including, for example, implementing a new NCIB or a substantial issuer bid.

Okay. So now let me turn to some of the highlights of the second quarter results. Our systemwide sales grew by 5% in the quarter on a constant-currency basis. That breaks down to 4.4% in Canada and 8.6% in the U.S., driven by the addition of new restaurants and same-store sales growth.

In Canada, same-store sales growth of 1.5% resulted from pricing in our system and to a lesser extent, favorable product mix. Same-store transactions were down while systemwide transactions increased.

We saw positive contributions, once again, from Panini sandwiches and single-serve coffee. In the U.S., we were pleased to see the 1.4% same-store sales increase, driven primarily by transaction gains. Breakfast, hot beverages and Panini sandwiches all had positive impacts on our sales. We expanded our breakfast selection with the introduction of the Jalapeno Cheese Flatbread Breakfast Panini.

While same-store sales improved from the first quarter and brought our year-to-date figures back to positive, these second quarter results were below our expectations. We believe the challenging economic climate and the continued intensified competitive environment were key factors impacting our sales. We anticipate further positive growth in the second half of the year. But based on our year-to-date performance, we now expect that our full year same-store sales growth to be below our previously established target of 2% to 4% in Canada and 3% to 5% in the U.S. Despite our moderate sales outlook, we are maintaining our EPS guidance of $2.87 to $2.97 for the year given our year-to-date results, including our systemwide sales growth, lower G&A and the benefits of an expected lower effective tax rate.

Our total revenues increased modestly in the second quarter, as you can see on Slide 14. The revenue growth rate was below that of our systemwide sales due to a decline in distribution sales caused by lower prices for coffee and other commodities, which were also reflected in lower cost of sales, as shown on Slide 15. The decrease in distribution sales was partially offset by growth in our systemwide sales.

G&A expenses decreased by 5.5% due to lower salaries and benefits resulting from vacancies and lower stock-based compensation expense. Operating expenses increased by 6.5%, largely due to increased depreciation and rent expenses associated with new properties added to the system, as well as the depreciation impact of the digital menu board program.

So now turning to Slide 16. The growth in systemwide sales, combined with the reduced expenses, led to an 11.2% increase in operating income in the quarter. Adjusted operating income, which excludes the impact of corporate reorganization expenses, had a similar growth rate of 10.7% as adjustments were minor in both this past quarter and on a year-ago basis. We reconcile adjusted operating income, which is a non-GAAP measure, on slides 21 and 22.

Net income attributable to Tim Hortons increased by 14.5%, and that's a higher growth rate than our operating income because we had the benefit of a lower effective tax rate due to certain net favorable discrete items that occurred during the quarter and not in the prior year. Earnings per share of $0.81 was up by $0.12 or 17%. This was a higher growth rate than net income due to a 2.2% reduction in our share count as a result of the cumulative impact of our share repurchase programs.

So at this point, I'll discuss the performance of our operating segments, which are summarized on Slide 17. In the Canadian segment, operating income increased by 5.7% to $174.8 million. The segment benefited from systemwide sales growth, resulting in higher rents and royalties and supply chain income, as well as reduced G&A expenses.

In the U.S. segment, operating income decreased by $1.5 million to $2.6 million. Nearly half of the decrease or $700,000 is related to the lapping of a favorable reversal of previously accrued closure costs that were recorded in Q2 2012. In addition, the positive effect of systemwide sales growth on rents and royalties were offset by relief provided to some of our newer restaurants and higher operating expenses.

Lastly, in the corporate services segment, an operating loss of $1.4 million represented a $9.7 million improvement over Q2 last year. This was driven by operational improvements in our distribution centers, as well as favorable product margin variability, which will partially reverse in the second half of the year. G&A savings was also a key contributor to the year-over-year improvement, but we expect some of this favorability will reverse in the second half.

So to wrap up, we had sales progression in the quarter and solid earnings growth, but operating conditions remained challenging. Our cash position remains solid, and you can see from the highlights on Slide 18. Based on this and our belief that our overall financial outlook remains excellent, our Board of Directors has approved a $0.26 per share quarterly dividend.

So with that, I will turn the call back over to Scott.

Scott Bonikowsky

Okay, great. Thanks, Cynthia. Operator, we're ready to begin our Q&A portion of the call. [Operator Instructions] So Tommy, with that, if you can please proceed with the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll proceed with our first question from the line of Perry Caicco with CIBC World Markets.

Perry Caicco - CIBC World Markets Inc., Research Division

Marc, you've mentioned that you've accelerated your initiatives to partner with well-capitalized franchisees in the U.S. Are you looking more at this model for existing assets or for new territories? And what are the tradeoffs you're willing to make to pull this off?

Marc Caira

Yes, I think it's both. I mean, we're committed to our existing business in the U.S. And we must remember, we already have a significant business in the U.S. We have many markets where we're doing very, very well. We have some markets where we would like to do better. But as a whole, we need to do better. So I think as we look at this model, we can look at the existing markets where we can augment what we already have. And I also think that we can look at new markets that we're looking to enter. So I think it's wide open. Here, it's about getting into a partnership with the right partner. We've identified the U.S. as a market that we're going to be committed to. We're going to stay, and it's a must-win battle for us. So not only do we need partners that are well capitalized, but we also need partners that have resources that perhaps are better tailored for local markets, whether it be real estate, media, that type of thing, which allows them to move faster than we would. So the tradeoff is that you're going to move, I think, a lot faster than perhaps we can, doing it one restaurant at a time, but the margins will be slightly lower than we would enjoy with a full franchise type of model.

Operator

And we'll proceed to our next question from the line of Irene Nattel with RBC.

Irene Nattel - RBC Capital Markets, LLC, Research Division

Both Marc, you and you, Cynthia, made reference several times to the challenging operating environment and that results are unsatisfactory and that you need to accelerate results. And really wondering if you had to drill down, is it -- if you could sort of tease through for us the effective consumer spending versus heightened competitive activity and what can you realistically do against that backdrop to accelerate the trend.

Marc Caira

Well, let me start, and then I'll let Cynthia chime in. Look, I talked about this new reality that I see. And this new reality is this low-growth environment, this very high competitive intensity. Those things are there, and I think they're going to be there for a while. Our challenge is to really look at ways that we can win in this new reality that you've just described. So I'm less concerned about the environment, I'm more concerned about what we can do. What can we do with our business to effectively compete and win? And I'm back only a very short period of time, but I'm also a very heavy user of the Tim Hortons brand. I've been a very heavy user of the Tim Hortons brand. And I think, not all of them, but I think a lot of the issues that you see here today are what I would consider to be self-inflicted. I'm not prepared to wait in lineups for a long period of time to order a cup of coffee. So we need to address the capacity issue, and we're doing that. We got the double drive-thrus. We got the fifth car [ph]. We got the beverage express. We have the renovations. So these actions are already in place. And we don't have detailed results, but we're getting some favorable results. You also -- we look at our restaurants, and I've just come home from a 21-city tour with Paul. And we listened to our franchisees, and there's a lot of complexity in our restaurants. So how do we simplify our operations? How do we reduce the number of products, the number of sizes, the number of price points? How do we simplify the menu boards? Innovation has always driven our business. How do we make our innovations more differentiated? Consumers are looking for healthier choices, so what can we do to participate in that area? Coffee has always been a driver for us. It continues to be a driver. It's what we're all about. How do we put more creativity around coffee and attract new users to the coffee category? Alternative channels. Tim Hortons has trust. It's earned the trust of consumers in Canada. We have permission to go into other channels, if we choose to. Where can we bring the Tim Hortons brand? And the last one is technology. Technology plays an important role in our business, and we have some work to do in this area in terms of leveraging technology to enhance the consumer experience. So I know you started with a competitive set in the environment, and that's true. It's there. But I can't really control that. And we have to find ways of winning and competing in that environment. I think there's many things that we can do ourselves to be successful.

Operator

And we'll proceed with our next question from the line of Mr. Michael Van Aelst with TD Securities.

Michael Van Aelst - TD Securities Equity Research

I guess on the $1 billion buyback, typically NCIBs are done at market or slightly below, if you negotiate agreements. And the SIBs are done at a decent premium. So can you talk a bit about your view of the need to execute quickly if you go ahead and do a bond issue versus taking your time and trying to get it done at better rates?

Cynthia Jane Devine

Thanks, Mike, for your question. That's some of the analysis that we're working on right now. And as I said in my prepared remarks, our intention right now is to start purchasing through an NCIB. But we're leaving some flexibility in terms of looking at whether we amend or have a new NCIB program or whether we consider a substantial issuer bid. But a lot of that is going to depend on the analysis. And as we get out there, looking at financing, alternatives and things like that, so there's still some work to be done. And as I said, as soon as we have more definitive answers on that, we will certainly communicate those.

Michael Van Aelst - TD Securities Equity Research

Okay. You mentioned the nondeductibility of the debt interest, though. Can give us some indication as to what it's going to do to your tax rate over the next couple of years?

Cynthia Jane Devine

So we think with this level of debt that we're talking about, the $900 million, we think that there will be a slight uptick in our tax rates, all things being equal, because of the nondeductibility portion. But it's not significant, Mike, and we feel that the accretive benefits of the share repurchase will offset it. But I think, as we look going anywhere beyond that, it would have definitely a bigger impact on the tax rate. But it's manageable within a fairly tight range from where we've been with regards to our tax rate. So that was taken into account in terms of arriving at the appropriate amount of debt so that it wouldn't have a significant negative impact on the rate.

Michael Van Aelst - TD Securities Equity Research

Can you give us something specific on the tax rate? Like, you guided, I think, below 28% last time. Is it going to be closer to 30%?

Cynthia Jane Devine

No, it would not be that significant. But what -- you have to -- one of the things -- one of the variables in it really depends on the interest rates, and so some of those variables still need to be worked out. So I can't give you a specific answer. But no, we're talking about a much more modest impact on the rate than that, Mike. Hopefully, that helps a little.

Operator

And we'll proceed to our next question from the line of Mr. John Glass with Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

Marc and Cynthia, in addition to your own analysis, there were at least a few shareholders who are proposing similar initiatives to the ones you undertook. I guess 2 questions related to that. One is, in your mind, is this closed, that discussion? In other words, do you think you've done what you need to do and there's no further movement and change of your capital allocation strategy or not? And specific to that, can you talk about or are you willing to think about how you deal with your Canadian franchisees, how you fund their development, how you fund their remodels? Or do you think that's not worth touching, given the success in the -- historic success in the Canadian business?

Marc Caira

Yes. I mean, look, I can start. First of all, we like to listen and engage with all of our shareholders, and we're meeting with them starting next week. But to me, the important thing here is that I came into this job July 2, and the buyback was already ongoing. So this is not something that I came in and I initiated. The buyback was ongoing. I reviewed the situation. I looked at the different scenarios. I looked at the balance sheet, and I felt very comfortable, very comfortable with the decision that was announced today. And what you have is a balance sheet that remains very strong. We take advantage of the current favorable interest rates. We remain investment-grade, which gives us flexibility for the future. We're able to do that within the context of our current tax scheme, and it provides shareholders with long-term value. So we made that decision because we thought it was the right decision today. We're going to move forward in the preparation of a strategic plan, which has already started. And we'll continue for the weeks ahead, and we will look at future decisions based on how this plan evolves.

John S. Glass - Morgan Stanley, Research Division

And just to finish that thought, does it involve potentially looking at more capital allocation decisions around funding franchise development and Canada remodels?

Cynthia Jane Devine

I think it's probably too early to comment on that as we're working through the strategic plan. But I think we're very comfortable with the recommendation and the approval that we have here today. About the $900 million, we think it's the right move forward for the company, and it puts us in a strong position. Our balance sheet remains strong. We have a lot of flexibility. But as Marc said, any time that you're in the strategic planning process, you look at a number of things in the business, including, obviously, how you're going to grow your operating income, what your capital needs look like for the next number of years, what the dividends and share repurchase and all those types of variables look like. So that -- all of those things will be part of our strategic planning exercise, as you would expect that any company does as they undertake that. So that is absolutely the work that's ongoing.

Operator

And we'll proceed to our next question from the line of Michael Kelter with Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc., Research Division

I wanted to ask if you guys acknowledge that you need to make changes to adapt to this new reality, new environment, which includes increased promotional intensity. But none of the bigger-picture investments you mentioned earlier, like throughput or technology upgrade, seem like they're going to help any time in the near term. Is there also a plan to reinvigorate sales now or we have to wait some time to get traction with the different initiatives you have?

Marc Caira

Well, I mean, there's -- from what I can see, having come to the organization just a short time ago, there's already ongoing initiatives to try and invigorate sales. We continue to do very, very well in the breakfast daypart. We have made significant inroads with our lunch daypart. Our Panini is doing extremely well. Our cold beverage, the weather hasn't helped, but a lot of innovation there. So that's always been, I think, something -- when you look at Tim Hortons over the years, I think that they've been very, very good at innovation, at being able to differentiate themselves. And I think we continue to do that.

Cynthia Jane Devine

Yes. And just further on that, Michael, it really is. I mean, we have a very robust calendar for the back part in addition to some of the things Marc mentioned. We have the launch of the single-serve in the Keurig-compatible format, which we think will be -- both in Canada and the U.S., we think will be a very positive addition to that category. But as well, both from an operation standpoint and a marketing perspective, we have a continual pipeline. You're going to see new things from us in the back half of the year. So those are -- so we have some short-term things that we absolutely think will help continue to get -- as we said, we're expecting positive same-store sales growth in the back half of the year. But then some of those other things, you're quite right, Michael, are going to be longer-term positive impacts for same-store sales. But I think you always need a combination of the 2 things or the things that are closer in and the longer term to get at addressing how we're going to grow the business for the long run.

Michael Kelter - Goldman Sachs Group Inc., Research Division

And maybe as a -- go ahead, sorry.

Marc Caira

No, no. Go ahead, finish off.

Michael Kelter - Goldman Sachs Group Inc., Research Division

I was just saying, given -- I guess as a related question then, given this increased promotional intensity, is it possible, you think, to reinvigorate sales without asking your franchisees to invest some margin at the same time you're asking them to invest capital to improve throughput and invest in technology and upgrade the aesthetics of the restaurant? Just it feels like you're going to have to ask your franchisees for a lot.

Marc Caira

Well, I think it's always been a partnership between Tim Hortons and the franchisees. I can tell you, having traveled across the country with Paul, visiting 21 cities, that there's a very, very good relationship with the franchisees. And if investments are required to gain competitive advantages, we'll do what we've done in the past. We're going to look at it, and we'll make the right decision.

Cynthia Jane Devine

The other thing that I think is really important to look at, Michael, is that -- one of the comments we made with regards to why our distribution sales are a little bit softer is the commodity benefit that we have passed on to the restaurants this year. I think in the first half of the year, coffee prices in -- were down close to 20% year-over-year, and so that's a real positive for our system. And those monies get passed back to our restaurant owners, as we've said. So that helps their P&L, and it helps them invest back in the business and do other things. So I think in terms of health from an overall commodity standpoint, in some of the key aspects of the business, 2013 has been a big improvement from where we've been in the past couple of years.

Michael Kelter - Goldman Sachs Group Inc., Research Division

And sorry for the multiple questions. But just on that topic you brought up, for clarity, does your cost of sales reflect the trough of coffee costs in the $1.20 range? Or there's still more deflation to come?

Cynthia Jane Devine

There -- we buy over time, so you're never going to be able to compare our coffee costs to the spot market. So what you'll see in -- that we're going to continue to have some favorability in the back half. But again, because we buy over long periods of time and then what we do is we lock down our pricing with our restaurant owners for a period of time despite the fact that we may have some ups and downs in terms of how we purchased. But yes, the short answer to the question is, in the back half, you would expect to see continued kind of favorability, if you will, from a commodity standpoint, so -- which impacts us in the form of lower revenues from the distribution business but lower cost of sales as well. So again, passing on that favorability to our restaurant owners.

Operator

And we'll proceed to our next question from the line of Matthew DiFrisco with Lazard.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

With respect to, I think, an earlier comment you made during the prepared remarks, the U.S., you're looking to sort of revisit how you're coming in, store format. Also, you were talking about better, well-capitalized franchisees. I'm curious, is there anything on the Tim Hortons side as far as the infrastructure, people on the ground, anything that you're looking at that might require a near-term or onetime investment in order to set yourself up. Or is that process still going on to determine how you might have to set up your corporate structure in the U.S.?

Marc Caira

Look, it's too early to get into that detail. It's all work in progress. As I said, we're going to look at this business, and we'll develop a very thorough thinking and strategic plan, and that will be incorporated in that. So I think it's a little bit too early.

Operator

And we'll proceed to our next question from the line of Mr. David Hartley with Crédit Suisse.

David Hartley - Crédit Suisse AG, Research Division

Marc, I appreciate the candor on discussing the new reality that you discussed. What I'm curious about is, as we look at the pipeline or as you look at the pipeline of investments in sales, new product, innovation, et cetera, it doesn't seem as robust now today as it has in the recent future. How do you think about that going forward? And also, how would you think about the capital required -- I know there's a lot of questions here on capital, but the capital required to take the company, Canada in particular, to the next, I guess, leg of growth as we move forward?

Marc Caira

Yes, I'm-- I mean, for those of you that follow me in my past life, innovation is key to being able to grow your business. So there's -- I think that Tim Hortons has always been very, very good at innovation. There's a renewed focus on innovation. There's going to be a renewed focus on the pipeline. But it's not just innovation here, it's what I call "differentiating innovation" and for me, innovation that differentiates you from your competition. So we've always been good at that, I think. Tim Hortons has always done a good job. There's no question that, in this environment, we're going to have to step it up a bit, and we're going to have to be even better. We're going to have to have better intelligence, better consumer insights to drive this thing. And so that's what we're planning to do. On the capital, look, there's a lot of discussions around capital and how much money or how much capital we spend or don't spend. Very clearly, for me, we're going to have to make choices moving forward. We cannot do everything. We're going to decide what we can do and also, as importantly, what we will not do. So this is a -- in this new reality, to me, that is the key point, our necessity, our need to make choices. And again, I keep going back to the document that we're going to have to prepare to align the organization, to align and direct the organization. That's going to be part of it. We're going to spend capital. We'll determine what level of capital we can afford to spend, and then we're going to make choices to see that we put this capital into the areas that we get the greatest and the best returns.

David Hartley - Crédit Suisse AG, Research Division

And just as a follow-up, on the cap -- you added $900 million in debt, but using $750 million of that, if I read that correctly, toward share repurchases, but then also talking a bit about reducing your capital outlays in the U.S. starting in 2014. How should we think about that in terms of reinvestment in the business? Will capital levels go down? Will they go up? How should we think about that?

Marc Caira

Well, I don't think you should come to any conclusions at this point in time. Clearly, we need to change the financial model, the financial performance of the U.S., and we're going to do that. We're going to continue to spend capital. But within that context, we're going to have to, again, make choices on where we put this capital. And we're going to put the capital into those areas that will give us the best returns. So we're -- it's not that we're going to walk away from the business, it's just that we're not going to have available to us what perhaps we had available in the past. We just have to make better decisions in terms of where we put the money.

Cynthia Jane Devine

Can I just clarify something you'd said? I think we announced that we're going to borrow $900 million, and we're going to use the $900 million to repurchase shares. I thought I heard you something about $750 million, so I don't know where that came from.

Operator

We'll proceed to our next question from the line of Jim Durran with Barclays.

James Durran - Barclays Capital, Research Division

Just can you go back to the complexity of the stores? Part of that, from my understanding, talking to franchisees, is just the breadth and depth of your product offering and the amount of equipment that's been brought into the system over the last 5-plus years. How do you see simplifying that without negatively affecting your sales line?

Marc Caira

Well, I mean, some of the things that we're looking in terms of speed of service, whether it's the double drive-thrus, the fifth car [ph], menu boards where we can bundle meals and promotions, that's one way. In some cases, we may be carrying too many products. There may be too many SKUs or too many ingredients. So we're going to have to have some -- we're going to have to have a tough look at the operations. And I mean, I come from this environment also from the consumer side, where it's always better and easier to introduce new products. So we're very good at introducing new products, but very rarely do we ever discontinue products. And again, there's no sacred cows here. We're going to have to look at all of the menu, all of the price point, the SKUs and decide what we absolutely need and what we don't need. And to me, it's more about, "Do you have the right platforms to be able to grow? Do you have the right platforms to be able to innovate, to differentiate yourself?" And I think that we do have the right platforms in our stores. But I think the issue is that maybe there's too many products on each platform. So we're going to have to look at that and streamline it. And I think that the benefits, we will see that. And it's also very interesting because when I was out across the country talking to the franchisees, this is an area that they want to also get engaged with us. So it's an area that they're going to support in terms of simplification, simplifying, taking complexity out of the operation. So we're working this together with the franchisee community, and we'll see where it takes us. But for me, it's a good starting point to try and -- at the end of the day, it's all about what I call the ultimate guest service. How do you provide your consumer the ultimate in guest service? Because in today's world, I really believe that the battle is going to be won at the store level, and that's where we have to put our focus. Again, removing these lineups, getting the orders right the first time. And I mean, I'm mentioning some of the negatives, but there's also a lot of positive things that we're doing. We didn't get to be Tim Hortons with the type of performance and organization that you see today by not doing things well. We do many, many things well. In fact, one of the research I saw talks about the trust to the Tim Hortons brand in the mind of consumers. That's a huge advantage for me that we have the trust of these consumers. We just have to look at our own house and try and get this thing in order a bit to try and make it easier for consumers to come in and enjoy a good cup of coffee or a really good sandwich.

Operator

[Operator Instructions] And we'll proceed to our next question from the line of Derek Dley with Canaccord Genuity.

Derek Dley - Canaccord Genuity, Research Division

Just in terms of the CapEx, looking forward in the U.S. business, what can we expect for CapEx in 2014, given that you're expecting to have a reduction? And given this reduction in CapEx, a new comfort debt level of 1.7x, assuming you're not going to use any free cash flow to pay down debt given the new level, what will be the pecking order for uses of that free cash flow next year?

Cynthia Jane Devine

I think, Derek, it's early, again, because of the strategic planning work. But I think one of the things that we know, given the focus on the U.S. business model, and that is that there will be a reduction in spending. To give you an exact amount out of context of what the entire plan looks like for '14 is probably a bit premature. But all of that work in terms of what is free cash flow, what do the earnings look like and what does the next leg of our strategic plan look like, all of that information will be part of the output coming out of it. So I think it's hard to answer some of it out of context for the rest of it.

Marc Caira

I want to clarify something because we talked about spending less CapEx in the U.S. and we said that we would do that. But as we look at new models -- the new business model, as we align ourselves with new partners that are well capitalized, those partners will be spending money in the U.S., CapEx money in the U.S. So in totality, the CapEx that we will spend in the U.S. will be -- I don't think it will be reduced. In fact, it might even be higher. It's just coming from different sources.

Operator

And we'll proceed to our next question from the line of Kenric Tyghe with Raymond James.

Kenric S. Tyghe - Raymond James Ltd., Research Division

In terms of the U.S. discussion and just moving ahead on that discussion, as you look to repositioning the U.S., is this part of the discussion going to include perhaps a resizing of what is a standard store versus we'll grow into it? Is that perhaps where there is opportunity outside of by geography or market, as we've been discussing to date?

Marc Caira

Yes. I think that's one of the areas that we'll be looking at. One size doesn't fit all anymore. So we have to be flexible in terms of the type of stores that we build, that we get involved in. And size will matter in this case in terms of the approach that we take.

Operator

And we'll proceed to our next question from the line our Peter Sklar with BMO Capital Markets.

Peter Sklar - BMO Capital Markets Canada

Just a question about the quarterly operating results. I noticed your corporate services segment improved with a much smaller loss. It seemed there was something going on with the DCs. You made some improvement with your distribution. Can you talk a little bit about what went on there?

Cynthia Jane Devine

Yes. There were some operational improvements within our core distribution business. We also talked about there was some favorable timing of margin, some of which we expect to reverse in the back part, and we have had that before. So as I spoke about earlier on the call, as we purchased commodities over a longer period of time and we have a fixed price with our restaurant owners, sometimes you have margin fluctuations that may straddle a quarter. And so that is some of the favorability that exists, and you'll see some of that reverse in the back half. But I think the other important item that has significantly improved the corporate services segment is G&A. So we've seen -- our G&A was down year-over-year, and so that provided a chunk of the favorability as well, Peter.

Operator

And we'll proceed with our next question and our final question from the line of John Ivankoe with JP Morgan.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

The question is on the existing stores in the U.S. And what I imagine, there might be stores that exist that Tim Hortons doesn't necessarily make money on each store, on a store-by-store basis, which would be unusual in a traditional franchise system but certainly possible with the rental model that you have. So I mean, could you help us think about if you do kind of have portfolio management options in terms of perhaps making a more profitable business out of a smaller business and how, mechanically, that might work?

Marc Caira

Well, look, I'll start, and Cynthia, you can jump in here. When we enter a relationship with a franchisee, the relationship is based on a theory that that business is going to be profitable and that you were going to succeed. So if there are restaurants -- and there are some that we would like to do better in. I said that at the beginning of my commentary. There are restaurants where, in the U.S., we do extremely well, and then there's other restaurants where we would like to do better. Well, we're not going to give up on those restaurants where we'd like to do better. We're going to work with the franchisees to try and get them to the level that we would like them to be at and that they themselves would like to be at. So again, it's this commitment and this mutual trust to each other that we have in order to try and get us to the level that we need to be.

Operator

And Mr. Bonikowsky, I'll now turn the call back to you.

Scott Bonikowsky

Okay. Thanks, operator. And again, we had more calls than the time, so I appreciate those that were trying to get back in. We appreciate everybody joining our second quarter 2013 analyst conference call. And as always, if you have additional questions or topics that you want to address, feel free to contact me at (905) 339-6186 or alternatively by email. Thanks, everyone.

Operator

Ladies and gentlemen, this concludes the call for today. We thank you for your participation and ask that you disconnect your lines. Have a good day, everyone.

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