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Burger King Holdings Inc. (BKC)

F2Q07 Earnings Call

January 30, 2007 10:00 am ET

Executives

Amy Wagner - IR

John Chidsey - CEO

Ben Wells - CFO, Treasurer

Russ Klein – President, Global Marketing Strategy and Innovation

Analysts

Joe Buckley - Bear Stearns

Glen Petraglia - Citigroup

Steven Kron - Goldman Sachs

Jeff Omohundro - Wachovia

Jeffrey Bernstein - Lehman Brothers

Mark Wiltamuth - Morgan Stanley

John Ivankoe - JP Morgan

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Burger King Holdings' second quarter fiscal year 2007 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's conference, Amy Wagner, SVP of Investor Relations. Please proceed, ma'am.

Amy Wagner

Thank you, Colby and good morning. Welcome to Burger King's fiscal year 2007 second quarter earnings call. We have prepared an earnings call PowerPoint presentation to assist in presenting our second quarter results. These slides, as well as the audio broadcast of this call, may be accessed through our Investor Relations page on our website at www.BK.com. Both the audio portion and the slide show will be archived on our website where it will be available for playback and for future reference.

Presenting on the call today are John Chidsey, Chief Executive Officer; and Ben Wells, Chief Financial Officer and Treasurer. Also with us on the call is Russ Klein, President of Global Marketing Strategy Innovation, who will be available to answer any questions you may have regarding our marketing, advertising, and products during the Q&A portion of this call. We will spend about 20 minutes today discussing our second quarter results before opening the call up for questions.

Before we begin today I would like to remind everyone that this conference call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect management's current expectations based on currently available data. However, actual results may be impacted by future events and uncertainties and could differ materially from what is discussed today. More detailed information about these uncertainties is contained within the Safe Harbor statement included in this earnings release this morning.

With that, I will turn the call over to John.

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John Chidsey

Thanks Amy, and good morning everyone. I'm very pleased to be here today to share with you our robust second quarter results for fiscal '07, and to provide you with an overall update of the business and answer any questions you may have on the quarter.

The strong business momentum we witnessed during the first quarter carried over into our second quarter. We stayed focused on our global Go Forward growth plan and delivered strong overall results. Page 3 of the presentation outlines several of this quarter's highlights.

Revenue increased in all segments, driven by solid comp sales, strong growth in average restaurant sales, and an increase in net new restaurants. Revenue for the quarter of $559 million was up 9% over the prior year second quarter of $512 million. We recorded our 12th straight quarter of positive worldwide comps and, again we saw positive comps in every reported business segment, the best level of consecutive comp performance in over a decade.

In the U.S. and Canada, comps for the quarter were 4.4%, and marked the 11th straight quarter of positive comps. We saw comps accelerate as we launched our $0.99 kid’s meal promotion, and gained even more momentum as we rolled out our Xbox 360 video games promotion, which sold more than 3.2 million copies in the U.S. Comps this quarter were also fueled by our successful BK Value Menu, which we launched in February of last year. Consistent with last quarter, comps are again being driven by a healthy balance of guest count and check.

We opened 55 net new restaurants during the first half of our fiscal year and announced interest entrance into two additional markets, Japan and Indonesia, both representing a great opportunity for us to grow the brand on a global basis. To demonstrate the potential earnings power of these new markets, I would like to talk about our success in what was a new market for us just two years ago, Brazil. Burger King did not have a single restaurant open in Brazil only two years ago. Through the tireless efforts of our Latin American team we have signed on eight new franchisees that have opened 27 new restaurants in ten cities in just under two years. Even more impressive is the fact that those restaurants opened for more than 12 months are generating $1.7 million in ARS.

The system-wide average restaurant sales of $297,000 for the quarter is a 6% increase over prior year; and, our trailing twelve-month ARS of $1.16 million is the new record high for the system. We continue to focus on ARS because it drives greater cash-on-cash returns to our franchisees, increases our royalties, and ultimately generates attractive returns for our shareholders.

Continuing on to page 4. Strong top line growth, coupled with improved company restaurant margins, drove this quarter's profitability. EBITDA was $96 million this quarter. Cost pressures, primarily in the UK, offset much of the top line gains. Later in the call I will address in detail our business in the UK, what we are doing to improve performance there, and the positive trends that are beginning to emerge.

Net income increased 9% to $38 million compared to an adjusted net income of $35 million and earnings per share also increased 8% to $0.28 as compared to an adjusted $0.26 per share in the same quarter last year. As we discussed last quarter, an improved year-over-year tax rate will allow for margin expansion between the EBITDA and the net income line. Our highly franchised business model continues to generate strong and consistent cash flow and has enabled us to pay down another $50 million in debt during the second quarter.

Because we believe in the Company's long-term growth potential and financial strength, our Board of Directors declared a quarterly dividend on January 29, 2007. The quarterly payment of $0.0625 cents will be paid on March 15, 2007 to all shareholders of record as of February 15, 2007. As we look toward the future, we believe that we can return capital to our shareholders while maintaining the cash required to aggressively grow our net restaurant count globally, to drive operational excellence, and to continue our marketing and product innovations. We are pleased with this quarter's financial performance and our ability to issue a dividend in less than one year of becoming a public company. This event sends a very positive signal that we're clearly on track, executing our plans, delivering the expected results, and adding shareholder value.

On page 5 of the presentation we have presented key worldwide quarterly financial highlights, and I want to take some time to discuss our results. Revenue was solidly up for the quarter at a 9% increase. Innovative promotions like the Xbox 360 games, favorite limited time offers such as the Angus 'Shroom and Swiss, and the Italian Original Chicken Sandwich, the $0.99 kid’s meal with the purchase of a Value Meal promotion, and the continuing success of the Value Menu and the Stacker Sandwich, has positively impacted guest count and sales, resulting in increased comps, system-wide ARS, and revenue.

Company restaurant margins improved by 70 basis points to 15.9% from 15.2% in the same period last year, driven by lower food cost and higher revenues at company-owned restaurants. Our second quarter EBITDA was largely impacted by strategic investment spending in our UK market. As you recall, we invested $3 million during the first quarter in expenses primarily associated with solidifying our management team. In the second quarter, the company incrementally contributed $7 million to the UK advertising fund to improve brand recognition and to introduce new products, and incurred an additional $2 million in UK franchisee-related financial distress.

Working with our advertising agency, Crispin Porter + Bogusky, we have rolled out the GBP0.99 Whopper promotion in October, the famous Manthem Double Whopper commercial and promotion in November, and the introduction of the Aberdeen Angus Burger in December. Our market repositioning, which includes focus on our fresh and high-quality products, and our Have It Your Way brand promise, is resonating exceptionally well with British consumers. We are seeing positive guest count and sales development from our $7 million advertising contribution, and have posted positive comps in both November and December; and, our January results have been the strongest yet.

We have made significant progress analyzing the UK market, developing corrective actions, and executing those plans that have been identified. Even though we are early in the game, I'm encouraged by our results during the last three months. We have much work ahead of us, but we're clearly on the right track.

Our year-over-year tax rate decline by approximately 15 points to 34.5% from 49.1%, and Ben will provide more details later in the presentation. Our share count was up substantially, primarily due to the issuance of 25 million shares in conjunction with our IPO on May 18.

On page 6 of the presentation we have depicted our year-to-date results, and I want to briefly point out some highlights.

First, our worldwide comps have been improved by 1.7 points, and our ARS has improved by 9%. Our royalty rate continues to accrete as our U.S. franchisees renew their contracts and are migrated to the higher 4.5% royalty rate.

Company restaurant margins have improved by 60 basis points as we continue to enjoy decreases in food costs, which is more than offsetting increases in labor, rent and utility costs. We are realizing the benefits of our new, more efficient organizational structure that is yielding a reduced effective tax rate.

I want to stress that even though we have had to make more than $12 million in strategic investment in the UK in order to get restaurants in that country back to a position where they can begin to contribute positively to the bottom line, we have been able to grow our top line revenues year over year by 8% and our adjusted net income by 11%. Net income growth without these additional UK investment costs would have been approximately 22% during the first half of the fiscal year, and EBITDA growth for the same period would have been 10%.

In the UK, we have revitalized our marketing fund, introduced new products, and have seen positive improvements again during last three months. Over the next 18 to 24 months investment spending in the UK will primarily be on rationalizing our real estate portfolio to take advantage of the UK property market. Because of our multifaceted growth opportunities, we have many levers to pull, and all these levers don't need to be pulled all at once. We expect to deliver on the long-term earnings results we have committed to.

Our net unit growth is expected and projected to significantly increase during the second half of the year. Performance in our U.S. and Canada and Latin America regions are forecasted to remain strong. Our other EMEA/APAC countries are performing on plan. Our UK operations should begin to stabilize and we have many exciting products and marketing innovations rolling out during the second half that should contribute to solid comps and ARS growth.

Because of our broad-based strength demonstrated during the first six months, and our second half forecasted earnings momentum, we are reiterating a year-over-year EBITDA growth of 10% to 12%, and net income growth of 20% plus for fiscal '07.

Page 7 further illustrates our quarterly results on a reported segment basis. As depicted, revenue was up across all segments, and segment operating income was up in the U.S., Canada, and in Latin America. U.S. and Canada revenues grew 6%, and operating income grew by 12%, both positively impacted by comp sales of 4.4% versus the prior year of 2.3%, primarily driven by the promotions and the limited time offers sandwiches I mentioned earlier. Company restaurant margins were up 120 basis points, aided by reductions in food costs and the fixed cost margin leverage inherent in the company restaurant P&L attained from higher comps.

Latin America revenue and profitability increases of 8% and 25% respectively were driven by strong 4.1% comps versus 1.6% in the prior year, and 90 new restaurant openings in the region. Strong results were fueled mostly by favorable results in Central America, driven by indulgent product promotions, including the Stacker and the Texas Double Whopper. In Argentina, results were positively impacted by the Whopper Mania promotion and in the Caribbean comps were up due to cross promotion with Coca-Cola in the advertisement of XL sandwiches.

EMEA/APAC revenue grew by 16%, primarily driven by 85 new restaurant openings in the region. Comps sales, which increased to 1.7% versus 1.3% in the prior year, and the acquisition of 31 company-owned restaurants from financially distressed franchisees in the UK. Even though EMEA/APAC revenue grew by 16%, margins were impacted by the UK expenses I discussed earlier. These increased expenses were partially offset by strong performance in the Netherlands, Germany, and Spain, primarily due to our successful extra-long and XXL sandwich promotions.

Page 8 illustrates our year-to-date financial highlights reported on a segment basis. Solid revenue growth in all segments, strong operating income results in both the U.S. and Canada and Latin America's segments, and reduced tax expense have fueled net income growth. Delivering on all our key financial metrics has yielded solid results year-to-date, and our continued focus on these drivers will enable us to deliver on our fiscal '07 financial plan.

On page 9 is our scorecard, and it provides a very clear progress report on our multifaceted growth opportunities. Comparing second quarter fiscal '07 to second quarter fiscal '06, you can see that we are on track to improve our business and to deliver the expected results. I will now take a few minutes to discuss each one of these metrics.

On page 10 we depict our comp sales for both worldwide and U.S. quarterly results. Our U.S.-Canada segment comps were 4.4%, as we discussed earlier. And the U.S. standalone comp was 4.5%. Both worldwide and U.S. comps reached another record high of consecutive quarters of positive comp sales. I do want to remind everyone that we're facing strong quarter over quarter comps during this next period. Last year's U.S. third quarter comp was 4.9%, driven by our very successful launch of the BK Value Menu. We are, however, enthusiastic about the current quarter, which includes our February 19 nationwide rollout of our Breakfast Value Menu, the first to national market in the QSR industry. Our year-to-date worldwide comps are at 3%, and we expect our full year comps to be in the 2% to 3% range we previously articulated.

Turning to page 11, unit growth continues to be a main focus of the Burger King team. We ended this quarter with 43 more restaurants that we had a year ago today. During the first half of our fiscal year we grew our restaurant count by a net 55 restaurants. We also publicly announced our interest into two new countries, Japan and Indonesia, both of which are highly attractive from an economic growth standpoint. Both are expected to have their first Burger King restaurant opened in their respective markets by the end of this fiscal year.

As we planned, we expect net openings to accelerate and closures to diminish during the second half of this fiscal year. Our development plan indicates that we will open approximately 60% of our new restaurant during the second half of the year. Additionally, we have closed the majority of planned closures in the first half of the fiscal year. Net growth will therefore pick up. Net unit growth is obviously a function of both new store builds and closures. We have a very solid handle of where we are on the new builds and I'm confident that we will open approximately 490 new restaurants by the end of this fiscal year. We will watch our closures closely in the back half of the year. I still feel comfortable that our net unit growth for the full year will be in the range of 250, a significant increase over last year's net restaurant growth of just 25.

At this point I would like to turn the call over to Ben, who will update us on the rest of our metrics.

Ben Wells

Thanks, John and good morning everyone. As John said earlier, we are pleased to announce that we have achieved another record high systemwide ARS. Our second quarter ARS was up 6% to $297,000 and our trailing twelve-month ARS was $1.16 million. Since the U.S. still represents about two-thirds of our business, I would like to spend some time specifically discussing our U.S. company ARS and restaurant margins on page 12 of the presentation.

U.S. company ARS continues to climb, aided by solid comp performance, the closure of underperforming restaurants, and the opening of new, higher revenue producing restaurants. We now 2,146 seasoned U.S. system restaurants, or approximately 31% of the system at or above our $1.3 million ARS interim goal. The last 50 freestanding restaurants that opened in the U.S. that have operated for at least 12 months have an ARS now of $1.51 million, a 30% increase over the current U.S. system ARS.

U.S. company restaurant margins were 15.9% during this quarter, driven by higher comps, lower food costs, primarily in the beef and cheese commodities, partially offset by higher wages and benefit rates. Strong U.S. comps this quarter certainly were key to leveraging our restaurant fixed cost structure resulting in higher than forecasted company restaurant margins. While seasonally lower third quarter revenues will compress margins, we should see improved efficiencies as we roll out our labor scheduling and new batch broiler systems throughout this fiscal year. Both initiatives are now in full roll out mode, and will be in all U.S. company restaurants by the end of this fiscal year. As far as the rest of the system, it will take about two to three years to implement. Once these initiatives are completed, the Company restaurant margins should improve by an incremental 100 to 200 basis points. However, we realize that these initiatives may play more of a defensive role, helping to mitigate potential increases in labor and other operational costs.

Turning to page 13. As we anticipated, we realized quarter-over-quarter increases in our worldwide royalty rate as U.S. franchisees renewed their franchise agreements at the higher 4.5% royalty rate and as new franchisees came into the system at the 4.5% level. As of second quarter fiscal '07, our blended worldwide royalty rate was 3.73%, and approximately 20% of our U.S. franchisees were above a 4% royalty rate.

Our new European and Asian operational structure continues to yield tax efficiencies. The effective tax rate for this quarter was 34.5% as compared to last year's second quarter's effective rate of 49.1%. This quarter's effective tax rate was incrementally affected primarily by the closure of a state tax audit. The lower than anticipated tax rate positively impacted second quarter EPS by $0.01. Going forward, based on what we know today, our 37% to 38% guidance range still appears to be a reasonable effective tax rate for the third and fourth quarters.

Adjusted free cash flow is slightly down from last year due to the increased payments of federal taxes on earned income. In fiscal '05 we had a loss in the U.S., and therefore were not a federal tax payer. In fiscal '06 we were able to utilize the '05 losses to reduce the amount of federal tax payments. But now as we have earned income in the U.S. once again and have no losses left to offset income, our federal tax payments have increased year-over-year, reducing free cash flow.

Turning to page 14, as we reported, we retired $50 million in debt during the second quarter and $100 million in debt during the first half of this fiscal year, using cash generated from operations. We also retired an additional $25 million this morning. Our solid operational performance and reduced debt levels are yielding improved, strong and steady cash flows.

On our last earnings call we said that we were considering additional uses of cash beyond debt repayment, including strategic investments and a return to shareholders in the form of a dividend payment. Because we have generated these strong consistent cash flows and expect them to continue to strengthen, we decided we could and should implement our first-ever quarterly cash dividend as a public company of $0.0625.

Based on our full year projected debt levels and our net debt to EBITDA ratio, we believe that we will trigger our last positive debt covenant, which will reduce our effective interest rate by 25 basis points.

We believe that we are uniquely situated. We can continue to strategically invest the brand, continue to pay down the debt, and return value to our shareholders. Before I turn the call back over to John, I would like to point out that we have again included additional company data and reconciliations in the appendix of this presentation.

John Chidsey

Thanks, Ben. We continue to deliver on our key drivers and metrics, unchanged from those we're articulated when we became a public company last May 18. By executing on our global Go Forward growth plan, and by remaining intensely focused on our key initiatives, we have been able to achieve strong results. We are pleased with the quarter, and expect to accelerate our year-over-year profitability improvements during the second half of the year as we open many more new restaurants, roll out our new Breakfast Value Menu, continue to lead the way in operational excellence, and remain the market leader in innovative advertising and promotions. We are reiterating our annual year-over-year financial growth targets, revenue in excess of 6%, EBITDA of 10% to 12%, and net income of 20% plus for this fiscal year.

I would like to thank everyone on the call for their time and their continued interest. Operator, you may now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joe Buckley - Bear Stearns.

Joe Buckley - Bear Stearns

First on the U.S., do you think the December same-store sales benefited at all from the Taco Bell issues during the month?

John Chidsey

That is very difficult to tell. I don't think so. But again you have so many things going on, whether it is Xbox promotions and lots of other ins and outs; so if anything, I would say minimal at best. I don't know, Russ, if you have any other thoughts, but that would be my answer.

Russ Klein

I think if you look back over the last number of years we really haven't seen any correlation between Taco Bell's growth or decline that is remarkable in relation to us. I would say it would be minimal.

Joe Buckley - Bear Stearns

A question on the food cost, which are obviously favorable this quarter. What is your expectations looking out over the next couple of quarters for beef and cheese and commodities in general?

Ben Wells

Right now we are saying a continued moderation, flat to moderation, in those commodities. We don't see any pressures on the upside at this time.

Joe Buckley - Bear Stearns

A question on the UK. A lot of news on the UK in this release. John, I appreciate the update on sales over the last three months. Could you talk a little bit about the UK? You obviously bought some units during the quarter. You mentioned an opportunity for real estate portfolio management in the UK. Although comps sounded like they were positive, as you said, November December, I guess they were negative for the full quarter. Can you put a little bit more context or numbers around what is going on there?

John Chidsey

Actually one misnomer. They were basically flat for the quarter as a whole. Like I said, November-December were positive, and January was the strongest of the three. In fact, I think January was the best month we have had since June of '03. So I think the strategic investments are definitely paying off. As we have said, I don't think we are any different than a lot of the other QSR players. It is a tough real estate environment just because of the way leases are structured in the UK, a very competitive market. A lot of pressure from the UK government in terms of health concerns. I think it is a whole host of factors that all in the QSR space going up against.

We just decided this year to invest strategically, whether it was picking up some restaurants that we thought we could run better, or whether it was making commitments to the ad fund. We talked about the $7 million in the ad fund. That obviously is money for the full year. It is just the way ad fund accounting works. You book it now even though you're going to spend some of it in the third and fourth quarter once you make a commitment. Collectively we put that $12 million into the UK, which I think is the right thing to get the brand back on solid footing and moving in the right direction.

Joe Buckley - Bear Stearns

Do you anticipate buying more of the franchise units? What will the mix of company versus franchise look like in the UK going down the road?

John Chidsey

No, I don't think we intend to buy any more. I think our comment on the taking advantage of the UK property market is just that the UK property market is very hot right now. To the extent that we have locations that are cash flow negative, purely from a real estate standpoint, if we can unload some of those at flat to minimal cost that would obviously be the intelligent thing to do while UK banks and other people are very interested in some of these High Street locations.

Operator

Your next question comes from Glen Petraglia - Citigroup.

Glen Petraglia - Citigroup

Good morning. I was hoping you could give us an update on the U.S. market, specifically in terms of your ability to entice franchisees to extend the number of hours that they are operating.

John Chidsey

Russ is probably the most fluent on that topic.

Russ Klein

We have continued to make what we would call marginal progress over the last 18 months on hours of operation. It still represents a sizable opportunity for the brand. There is headroom there for profitable hours of operation. We do have a balanced spectrum of initiatives that include some food innovation. Certainly our entry into the Value Menu business, with the success we've had, some of the snack items that we have gotten in the pipeline will enable us to have more appeal as we push into competitive hours of operation. Even on the morning side with our Breakfast Value Menu, there is certainly going to be an improving business case for opening earlier.

Our view is that we have to innovate around the edges of the business. We have to promote around the edges of the business in terms of advertising and media. I think that what we are also seeing is a concurrent franchisee momentum where, just among colleagues, franchisees are continuing to experience the benefits of competitive hours and/or extended hours and are sharing their conviction with their colleagues. We are seeing steady progress. It is not at the pace that we would like. We do have some things in store as we move into Q3, Q4 which we hope to accelerate that trajectory, but that remains a priority.

Glen Petraglia - Citigroup

John, you seemed highly confident in your ability to hit your unit opening target. You seemed a little bit less sure about the closures. If you could maybe share some insights into that, and what sort of opportunities or what changes there are where there are some surprises in terms of closures? If you could tell us how many restaurants you have coming up for renewal in the U.S. over the course of the next, let's call it two years, and what your renewal experience has been more recently?

John Chidsey

Sure. Well, as I said, we feel very confident on the new builds, because as you can imagine I think our plan was 490, and you obviously know by now what you're going to open because basically we better know what '08 is as well. So that is why we feel very confident on the new builds to your point.

In the U.S., as we have said, on average there are 325 to 350 that come up per year. Just because if you have got twenty-year agreements, by definition 5% of them come up every year of our 6,500 franchise restaurants. The renewal rate, as we have said, this year when you consider FFRP trailed a little bit this year, between renewals and extensions it comes in somewhere at 75% to 80% this year. Next year I would expect us to be in the mid-80s to 90%, so not that different than really a lot of our competitors.

But I always like to say to investors that if even if we renewed 80%, and say 20% of 350 didn't renew, that is 70. This year we will build north of 100 in the U.S. so net-net we will be a unit grower in the U.S. next year. As long as we even maintain the closure rate we have this year, forget if there's any improvement for next year, again we will be headed in the right direction.

To me the only wild card is in the back half year, I think we have a great handle on the U.S. For instance, we had a chance to refranchise the Philippines this year, which was one of our less than stellar markets in Asia. But to do that the new franchisee wanted to close I think it was 15 or 17 restaurants, which was the right thing to do, but clearly was not in our forecast. But it will definitely get us positioned better over the next few years in the Philippines.

So outside of some unforeseen event like that, I think we do have a pretty good handle on it. I think that is why we're confident we will open 250 restaurants. Again, even if that slipped 20-25 units, anything over 200 in my mind, when we opened 25 last year, I think shows great progress on getting net unit growth moving in the right direction.

Operator

Your next question comes from Steven Kron - Goldman Sachs.

Steven Kron - Goldman Sachs

First on the Breakfast Value launch, I was wondering if you could just provide a little bit more color around that, particularly how long the promotional window will last and in the test markets, what kind of margin you have seen in the product, and the comps potentially?

Russ Klein

The Breakfast Value Menu test was one of our most successful in the four years that we have been running the business. The blended margin is in the area of high 71, 72. So it is quite commensurate with our overall GP, and in fact again, not unlike our PM Value Menu, borders on being accretive. The test markets that we were in experienced significant traffic gains during that day part and we found the strong appeal with the products that are essentially the flagships. The center of the plate flagship is our Hamlette sandwich, which in and of itself runs in the high 60s on a GP basis. Cheesy Tots, which is a very differentiated products, part of both AM and PM menus, runs anywhere from a 72 to a 78 GP, depending on the size of the product.

We feel great about our opportunities again to push development around this. This is obviously a place where we are underdeveloped. We have, we believe, differentiated products to roll out that should have a significant impact, not only on the breakfast day part, but improving our overall value for the money ratings, which the brand continues to have opportunities with.

Steven Kron - Goldman Sachs

That is helpful. How long will the promotional window last or the advertising around it?

Russ Klein

We're going to launch the Value Menu next month. We're probably going to run the initial launch period for a good 60 days. But not unlike the PM Value Menu, this is something that you have to stay with and continue to create continuity of messaging around. So expect it to remain a key part of our calendar visibility, not only in the back half of this fiscal year, but into FY '08 and beyond.

Steven Kron - Goldman Sachs

I am just trying to reconcile some of the data in Latin America that you guys provided. I guess looking at the company's side of things, units on a year-over-year basis were up 13%. Revenues on the company's side were up only 7%, yet you reported a positive 4.1% blended same-store sales. I know it is largely a franchise market, but just wondering was there that much of a discrepancy in company and franchise same-store sales? It would seem that company same-store sales were very much in the negative, if my math is correct. I am just wondering if you could reconcile that?

Ben Wells

A number of factors played through it, but frankly we had some movement in the Mexican peso, which translated into foreign exchange. Again, we're dealing with the law of small numbers, so the percentages don't necessarily reflect a lot of the activity that is going on down there, but that explains the bulk of it.

Steven Kron - Goldman Sachs

Russ, just going back to the extended hours, you made the comment that is not accelerating at the pace that you would like, but it is moderate and you are optimistic on the momentum. Is it really just educating the franchisees here and word-of-mouth spreading, or is there some margin or profitability push back that you're getting from some of the franchisees?

Russ Klein

We believe the business case is there. But we also understand that the business case is not there for every restaurant in the same way. Restaurants in rural areas and in urban areas and based on the trading area, are all going to differ in terms of what the right place is in terms of extended hours. Many restaurants, and on increasing basis, are going on a strong business case for 24 hours of operation. That doesn't make sense everywhere.

We have not been as brute force with our push behind it. We're really trying to build the business case, leading our field marketing and operations team continue to keep those results in front of franchisees. Some of the push backs, if you will, on profitability, some are perceptual, some are real depending on the circumstances of a trading area.

John Chidsey

I think the last thing I would say on that point too and we have talk a little bit about this, we do have a franchisee base that, in some cases in addition to what Russ is saying, have been in the system a long time. The best sales they have seen; margins are great, making a lot of money and just simply are resistant, not because the business case isn't there, but they are just very happy where they are sitting today. That is sometimes a reason why you like to see a mixture of new franchisees with the old, just because you tend to get a better balance and some more aggressiveness in the system.

Operator

Your next question comes from Jeff Omohundro - Wachovia.

Jeff Omohundro - Wachovia

Just one follow-up on the breakfast. Where are you now in terms of the day part mix there, and what kind of opportunity do you see? In the quarter, I am also wondering if there was much regional trends, pockets of strength, or perhaps pockets of weakness that you could comment on. Thanks.

Russ Klein

On the breakfast front, today we're as a system overall in the U.S. we are 12% to 13%. Obviously, like a lot of our competitors, we're stronger in different regions in the country. In the Southeast or the Southwest breakfast tends to be stronger, but if you look across the whole probably in that 13% range. When you look at McDonald's is sitting there probably closer to 22% to 25% for breakfast that gives you some idea of what is possible. We're certainly not saying we're going to hit there in a year by any stretch of the imagination, but you can see there's a lot of ground to be gained.

As to your second question about did we see a lot of regional variations or pockets, actually there were some regions that were stronger, but we are divided up into eight regions in the U.S., and all did well and all were positive, so we didn't see much variability.

Operator

Your next question comes from Jeffrey Bernstein - Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

First on priorities for use of cash. It seems like you are approaching comfort with debt at current levels. Wondering if you can talk about your next priorities. Obviously dividend is a great piece of news, but thoughts for share repurchase, greater color around maybe other strategic initiatives or investments you noted in the release. I am just wondering when you would expect your private equity owners to perhaps file a secondary, and what impact that might have on the stock and potential for future share repurchase.

John Chidsey

I will address part, and then Ben can chime in. We talked about strategic investments. I think there are franchisees in the U.S., again, where we can help expedite the process of moving some franchisees out, and again getting some new blood in, whether it is larger franchisees that we can break up into smaller groups so we get three or four developers coming in as opposed to one, or whether it is some bad ops that we can get cleaned up. Again not necessarily ones we would own long-term, but we can certainly just help the process and own them for 12 to 24 months to clean them up or just break them up and push them back out.

The dividend was obviously another use of funds. I think Ben will chime in, but I think you're correct that we're very comfortable with our debt level where it is. The last point would be share repurchases. As we have said with our private equity sponsors, until they sell, you really can't step into the market or be buying these shares back, because we continually hear from investors that the more liquidity we would have in our stock the better off we are.

Again, I would remind people that the sponsors made their investment in December '02. So they are now four plus years into this investment. When you think their average time horizon is usually five to seven years, again, I wouldn't be surprised if we don't see some selling in the next couple of quarters here from the sponsors. I don't know if you have anything you want to add, Ben?

Ben Wells

No, that pretty much sums it up.

Jeffrey Bernstein - Lehman Brothers

I just had one follow-up question. In terms of the components of comps, just a little greater color in terms of the breakout of the U.S. comp. I think you said it was a fair mix of traffic and price. I just wanted to clarify in terms of taking additional menu pricing in the current environment.

Lastly just the sequential comp trends throughout the quarter, specifically in the U.S.. I know last quarter you were able to talk about October, I am just wondering if you were seeing any directional guidance on January versus October, November, December?

Russ Klein

As you know, we don't report guest counts, but we certainly can say that not only are we pleased with the mix of guest counts and pricing and pricing power that we have had, we have particularly experienced a richer blend of guest count-driven growth since 40 some weeks ago when we introduced the BK Value Menu. That is about as much insight as I can give you into that.

I would also tell you that as we look over the last number of years at the price side of how we have driven growth, about 80% of the pricing seen in the average check has been driven through true mix enhancement with premium products, as opposed to nominal price increases. That meaning another 20% perhaps coming from nominal price increases. We always survey by trading area the pricing opportunities that are there for our franchisees to make sure that we're leaving no money on the table, if you will. That is our disposition right now.

Jeffrey Bernstein - Lehman Brothers

Just on the sequential trends, perhaps through the quarter and into January?

John Chidsey

I think, as we said in the last quarter, we knew that we had Xbox and things like that coming up, and we felt good. I think all we're trying to say in this quarter is don't forget that we're lapping over that 4.9. That is really all we were trying to draw attention to. That with the launch of, as Russ calls it, the PM Value Menu those are just some high mountains to climb. While we're certainly confident we will eclipse them, it is just a little stronger wind in terms of what we are up against than this quarter we just reported.

Operator

Your next question comes from Mark Wiltamuth - Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

Just to dig in a little more on that EMEA/APAC line. If you were to take the UK out completely, not just the incremental investment, but if you take the UK out completely, was the rest of the segment up for operating earnings? If you could just also talk a little bit about the fact that that is a market where you're adding a lot of units, is there a margin drag from all that market development you're doing there?

John Chidsey

Obviously, as we said Mark, the revenues were up 16%. And I think operating income, if you were to take out the UK, would be up $11 million over a six-month period. I don't know what that is on a percentage basis. I don't have a calculator in front of me. But you know clearly it would be up, and it would be up strongly. It is really just the strategic investments we're making in the UK.

In terms of the drag, you're right, I think we're going to open, I think the plan is 230 plus restaurants in Europe. But there is really not a drag because the vast majority of those are franchise restaurants, 90% of them. Again our infrastructure is in place to open those without us adding any people. So they pretty much are accretive day one from a royalty standpoint.

Operator

Your next question comes from Joe Buckley - Bear Stearns.

Joe Buckley - Bear Stearns

I just had a follow-up on the extended hours. I was curious if you were incenting the franchisees to go to extended hours by royalties during certain hours of operation, or something like that? I was just wondering if you had an update on the gap between hours of operations that you faced versus McDonald's or other competitors?

John Chidsey

I will answer the first part, and then Russ can chime in. As you know, we have done incentives in the past and I think they have been somewhat successful. I think on the last call, or the one before it, we talked about that we had doubled the number of franchisees this summer on our extended hours program that we had the year before. But truthfully that is called happiness is a low base. I think we went from like 10% to 20%. We continue to look at things to do. With the summer coming up in the next two or three months would probably be another time. That is the best time to encourage them obviously to take chances and push their hours back. We will certainly look and see if some other incentive program makes sense. Now would not be the time to do it. Again, it would be when you get closer to Memorial Day through Labor Day. But obviously we will look at that.

Russ Klein

I would just add to John's comments that I think what we're learning is that our franchise system is more responsive to our ability to innovate and to create revenue on top of those essentially fixed labor costs, particularly at the AM but also in the PM, through innovation, through promoting our open late message. We are really focused on that as opposed to the prospect of another incentive, at least at this point.

Part of what we have seen, again through both the AM and the PM Value Menu is our ability to excite our system around really being in the business of being open as early as competitors and as late as competitors. The numbers on McDonald's in a kind of crude math is that our disadvantage versus McDonald's hours of operations is probably worth a minimum of $100,000 ARS per restaurant.

Operator

Your next question comes from John Ivankoe - JP Morgan.

John Ivankoe - JP Morgan

Thanks. If we could please review the economics of the batch broiler; firstly, how many company stores is it in now? I think you said that you will be done with that by the end of this fiscal year, but if you could remind us what the investment cost is. I think you said it is 100 plus basis points of improvement. When do you really think the franchise system is going to have this system-wide to where they can start benefiting as well?

John Chidsey

We have 60 installed as we speak in 60 company restaurants, and we are ramping up as we go. We will be up to about 150 a month here in the next two months. We still stick by our statement that by June 30 we will have all 850 company restaurants in the U.S. and Canada done by June 30. In terms of the savings, now that we've got 60 installed as we sit here today, it is still in that 45% to 50% range for utility savings. We haven't seen any changes in that as we continue to roll them out.

Ben Wells

What we have also seen in operational efficiencies inside the restaurant. The crews love them, the operators that are responsible for them. This is going to be a win-win. It saves about $600 per month.

John Ivankoe - JP Morgan

Did you say that it would take two to three years to be system-wide in the franchise system?

Ben Wells

I did. It is a lot of restaurants to get out there as we roll them out, but we are seeing our suppliers develop efficiency around getting them out. But still it going to take two to three years.

John Ivankoe - JP Morgan

It is a supplier issue at this point or is it a franchisee intent issue?

John Chidsey

We are working with one supplier. Even if they ramp up to 300 a month, and let's say you did 3,000 a year, with 11,000 plus restaurants two, three years from now you will be at 12,000 restaurants. That is where you get the math.

John Ivankoe - JP Morgan

I got you. A second question unrelated. You are opening 100 system stores in the U.S. this year. How many of those are the ROC? And could you give us an update on how the smaller box prototype is doing?

John Chidsey

Yes, of the 100 and whatever, 110, 120 we opened this year in the U.S., probably 50 to 60 of them I would say would be the ROC building, at least half. There is 26 or 27 open now, with another 12 or 13 under construction, again, in the U.S. I'm going to say it is running 50 to 60% of the mix. I think Jim Hyatt would certainly tell you that as people get more and more comfortable with the volumes that are going through there, the people that are starting to develop now are more and more favorably disposed towards the ROC. They just wanted to watch and see.

We have got one is doing $1.7 million. Some of them doing over $2 million. I know of one that is doing $2.5 million. So they clearly are able to do the throughput. I think franchisees are happy with what they are seeing, so I wouldn't be surprised to see that percentage mix climb from 60% up to maybe 80%. I don't think you'll ever have everybody doing them, but I could see three-quarters of the new builds down the road being the ROC.

John Ivankoe - JP Morgan

Finally, in terms of new product development, is the [inaudible] still part of your plan in calendar '07? Were you able to get that worked out operationally and is it testing well with the consumers?

John Chidsey

Yes, everything has worked out fine. We made the decision, which Russ can certainly jump in here, just to back it up a little bit into '08. And the reason is really when Jim and his ops team were working on it to turn it into an all-day product made a lot more sense than just launching it purely as either a lunch product or a breakfast product, just simply from an operational efficiency standpoint and from the crew's muscle memory, if you will. Therefore to make sure we launch it as an all-day product, we just want to take an extra couple of months and make sure we have it right. That will launch very early in fiscal '08 as opposed to the last quarter of '07.

Operator

Your next question comes from Glen Petraglia - Citigroup.

Glen Petraglia - Citigroup

Just a quick follow-up. Ben, I apologize, I missed your comment in your prepared remarks. But you commented on debt and maybe being able to buy down the rate by 25 basis points after you make some sort of payment. If you could maybe just repeat what you said, just so I catch it, I would appreciate it.

Ben Wells

What we made a comment is that the $25 million debt pay down that we're making actually today will probably cause us to fall below that positive covenant level. At the end of this quarter we will pick up the interest savings that will come from it, and that is 25 basis points.

Glen Petraglia - Citigroup

What is the rate on the debt today?

Ben Wells

It is running around 6.93% all-in, 6.90%. Obviously that is just at the mercy of the market.

Operator

There are no further questions in queue at this time, so I will now turn the call over to Mr. John Chidsey, CEO of Burger King.

John Chidsey

Thank you very much for your time. Thank you for your questions and your support. We look forward to speaking to you next quarter.

Operator

Thank you for your participation in today's conference. This concludes the presentation.

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Source: Burger King F2Q07 (Qtr End 12/31/06) Earnings Call Transcript
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